Should You Buy BlueScope Steel If Profits Increase 116%

A lot of the time financial numbers are manipulated to make a company look better than it actually is. Now this doesn’t mean companies remove items that are damaging toward themselves. However they may use flashy numbers to represent performance. And the actual reason for the company’s extraordinary performance is pushed to the side.

One place they might be hidden is in the company’s financial reports. If you’ve ever seen a company’s financial report you’ll know they’re massive. Hundreds of pages all about the company’s performance and everything else related.

To read the whole thing would be a feat in itself. But it’s usually enough to look at the financial statements and the notes to the financial statements. These sections alone can be up to 50 pages long. That becomes a big ask for anyone trying to sift through the thousands of companies on the ASX. However if you take the time to read them, you’ll have a better understand of the particular company you want to invest in.

BlueScope Steel [ASX:BSL] might be a company you want to invest in. They announced an underlying profit increase of 116% to $200.1 million. But was this the true performance of the business?

Underlying profits were 47% higher than 1H FY15 and 125% higher than the previous period. BSL CEO, Paul O’Malley said, ‘The Company has continued its good momentum in earnings growth. It’s a very positive outcome and a credit to our teams around the global. Today’s result is the outcome of a deliberate strategy that has been underway for over a year.

But was it really BSL’s strategy? Or was it something external that added to their outstanding performance? BSL has been able to cut costs across their Australian and New Zealand businesses.

Our relentless focus on cost reductions in Australia must continue and we are now targeting $270 million in FY2017. We also continue to target at least NZ$50 million of cost reductions, in New Zealand in FY2017 and we have commenced a sale process of the Taharoa export iron sands business,’ said O’Malley.

But there were two other factors that influenced BSL’s performance. The first was a weak Australian dollar.

AUD USD Difference

Source: Forex Factory

The graph above shows the price of the AUD for the first half of FY16. The AUD slipped under 70 cents per USD in early September. It might seem weird to hear at first but a lower AUD actually benefited BSL. You see, BSL sell their products all over the world. This means BSL are accumulating profits in various currencies.

All these different currencies then need to be converted back into AUD to calculate profits. So if the AUD is lower, different currencies are able to buy more AUD. This then increases revenues from overseas, thus increasing total revenues.

The second factor is the appreciation of BSL’s US business North Star. BSL acquired 100% of the North Star business back in October last year. Back then North Star was a producing 2 million tons of hot-rolled coil a year. ‘We have moved to full ownership of North Star, recognised as the best steelmaking business in the US. It has a clear pathway of incremental growth ahead of it,’ O’Malley said in a statement.

The overall message I’m trying to convey is an increase of 116% in profit might be misleading. BSL might not be the best investment at this time. Why? Macroeconomic factors can come into play. Demand for steel may be low, or any other external factor affecting BSL’s overall profitability.

Many other investors have the same attitude toward BSL. Share prices this morning only rose 3.7%, after which shares traded down mid-morning to $5.57 per share.

Bluescope steel feb

Source: Yahoo finance

Steel industry lacking strength

Steel workers are losing jobs left right and centre. Bill Shorten has called for the government to protect jobs, but not much is happening. Steel group Arrium [ASX:ARI] said earlier this week that its Whyalla steelworks needs to find $60 million. If the funds cannot be raised then the facility could face closure.  Shorten told reporters:

Right now the steel industry’s under attack. What we see is Chinese and Korean steel companies effectively engaging in the trade version of match-fixing and we need the rules to back up our jobs and our people.

Industry minister Christopher Pyne said:

If there is to be any kind of financial advice for Arrium, it would take some time to discuss that with the South Australian government and with Arrium, and any kind of support like that would need to be a long-term structural reform… We’re not in the business of giving taxpayer money to businesses that are struggling.

Even China’s steel industry is struggling. At the start of the year Chinese mills produced less than last year. This was the first time something like this has happened since 1991. Local Chinese demand has dropped along with global demand.

A core reason for shrinking demand is policy makers steering the economy away from consumption-led growth. More output cuts are predicted for this year. So before you jump into BSL believing that share will rally, that a look at what makes up those numbers. If the wider industry is suffering, what are the chances of continued increasing profits?

Härje Ronngard,
Junior Analyst, Money Morning

PS: Market times have put pressure on the global equities market. Even big blue chips are being beaten down by the markets turmoil. But just because blue chips have reduced in price doesn’t mean they’re no longer great companies. Rather, it makes them much cheaper to buy.

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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