Can BlueScope recover from its $1bn loss?

Why capital intensive companies make poor investments

Mike King

Mike King is a Fool.com.au Investment Analyst and Writer. He caught the investing bug more than a decade ago, at a time when the U.S. had invaded Iraq and fear reigned in the markets. His initial success as the markets took off encouraged his passion and thirst for knowledge. With 13 years behind him at one of Australia's largest domestic banks, Mike's passion for stocks led him to join a boutique funds management firm, where he stayed for four years. A seven-year stint in equity research at one of the largest investment banks in the world followed that, giving Mike a thirst to pursue his passion further. Mike holds a Diploma in Applied Finance and Investment and a Graduate Certificate in Financial Planning. His passion is to help retail investors invest better, and that passion was one of his primary reasons for joining The Motley Fool Australia in late 2011. Mike has written thousands of articles since joining, including for Fairfax Media, Yahoo!7, Ninemsn and has also appeared on ABC's The Business. You can see all of Mikes' holdings here

Published August 20, 2012 11:32 am AEST

BlueScope Steel Limited (ASX: BSL) has today reported a net loss after tax of $1,044m after taking $806m in abnormal expenses, including writing down the value of its goodwill, restructuring and redundancy costs.

The company's Australian operations remain the chief concern, with its New Zealand Steel and Pacific Steel, Coated & Building Products Asia and Hot Rolled Products North America divisions all reporting positive underlying earnings before interest and tax (EBIT). The two Australian operations on the other hand reported a combined EBIT loss of $379m.

BlueScope has provided an optimistic outlook for these operations, expecting them to report positive earnings before interest, tax, depreciation and amortisation (EBITDA) by 2013/2014. Although it appears that depreciation and amortisation are still likely to drag both divisions into the red.

The big news though for the company is the US$1.4 billion joint venture with Nippon Steel Corporation (NSC), where NSC will pay BlueScope a net US$540m (after taxes etc) to invest in the company's building products business in Asia (ex-China and India) and the US. That should allow BlueScope to pay down its debts, although the company has flagged that it could use the funds to reinvest in its businesses.

BlueScope sees the JV with NSC as very positive, allowing the company to enter new product segments such as home appliance and white goods manufacturers in Asia. Given the growth of middle-class Asia, demand for these products should be healthy.

Despite the positive spin from management, BlueScope still faces many headwinds. News out today suggests Chinese steel mills have record stockpiles of steel, with the sector expected to record its first annual drop in production in 31 years. That suggests that BlueScope could face intense competition and margin pressure as steel prices fall. Competitor, Arrium Limited (ASX: ARI) formerly known as OneSteel is also likely to face the same pressures.

In addition, the company faces pressures from the recently implemented carbon tax, despite government handouts. Political pressure to avoid further mass redundancies could also be on the cards, which the company probably needs to do, to remain competitive.

Weak construction markets have contributed to soft demand for BlueScope's products, and there doesn't appear to be much improvement in the near term. As a capital intensive business, BlueScope faces continual reinvestment in its plant and equipment, much like print media companies such as APN News and Media Limited (ASX: APN) and Fairfax Media Limited (ASX: FXJ) with their printing presses.

The Foolish bottom line

Capital intensive companies usually make poor investments – the return on BlueScope shares, having fallen from well over $8 just a few years ago to around 40 cents currently, is a classic example.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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