Many blue chip companies are trading on what would be considered 'cheap' earnings multiples following a tough year for S&P/ASX 200 Index (ASX: XJO) shares.
Nealy 15% of companies included in the Aussie benchmark index now have a price-to-earnings (P/E) ratio below 10. However, one broker is concerned that there is possibly a good reason for the steep discount on a staple of the materials industry.
Holding the title of the second-lowest P/E ratio in the benchmark — at 3.1 times earnings — shares in BlueScope Steel Limited (ASX: BSL) might look like a golden opportunity. Though, the team at Ord Minnett begs to differ based on its forecasts.
Image source: Getty Images
Tailwinds fade in a slowing economy
Share market investors and a single-digit P/E ratio can be like moths to a flame. The attraction is in the chance of investing in a company that is potentially mispriced. This strategy falls apart when the underlying fundamentals continue to erode, resulting in what is called a 'value trap'.
According to the analysts at Ord Minnett, BlueScope Steel might have the makings of a value trap right now. This is largely based on their estimates that the steel giant will experience significant reductions in its earnings this year and through to FY25.
Specifically, Ord Minnett analysts expect that rising interest rates will squash steel demand. This paired with the absence of monetary stimulus and an easing of supply disruptions will see BlueScope earnings fall off a cliff.
In FY23, the team forecast BlueScope's earnings before interest and tax (EBIT) to fall from $3.79 billion to $1.6 billion. From there, EBIT is expected to slide further — descending to $1 billion by FY25.
Commenting on the forecasted future direction of BlueScope earnings, the Ord Minnett team wrote:
We do not believe this negative earnings profile is reflected in BlueScope Steel's stock price, trading at a premium of more than 20 per cent to our fair value estimate.
In December, Fitch Ratings revealed its expectations for metals prices across the world to weaken in 2023. Likewise, a mill source informed S&P Global Commodity Insights of their view of further weakness, stating:
China's steel demand is likely to continue falling in 2023 due to slowed demand both home and abroad, so the commissioning of these new steel projects will put a lot of pressure on the market trends, if most steel makers do not put their production under control.
Where could this ASX 200 share end up?
The BlueScope Steel share price has already fallen by 18.4% over the last year, but Ord Minnett anticipates further downside.
In light of forecasts for its earnings to more than halve, the team has set its price target on this ASX 200 share to $13 per share. This would suggest there's still another 26.5% worth of space left for BlueScope to tumble from its current $17.69 position.
The steel giant's 52-week low is $14.74.
