BlueScope: Weak Building Approvals a Near-Term Headwind; Decarbonization Is a Longer-Dated Story

We maintain our fair value estimate of AUD 16.50 for no-moat-rated BlueScope BSL, with shares screening as overvalued. We think the steel spreads of the past three years are untenably high, driven by pandemic-induced stimulus and the subsequent demand bump, and supply chain disruptions. We expect steel spreads to return to historical averages longer-term as higher interest rates weigh on activity, prices, and margins.

BlueScope is facing a challenging path over the coming decades as it reaches for its greenhouse gas emission targets. In particular, the plan to decarbonize Port Kembla, which is the main operating asset in Australia and accounts for 35% of the company’s revenue, could disadvantage BlueScope versus its global peers. Since setting emission goals in fiscal 2018, BlueScope is on track to meet its targets thanks to the expansion of North Star which is contributing a larger proportion of production volumes. North Star uses electric arc furnaces which are more energy-efficient than the blast furnaces, or BFs, used at Port Kembla.

BlueScope’s options to meaningfully lower carbon emissions are pricey. For instance, management estimates greener technologies will require electricity prices in New South Wales to go below AUD 30 per megawatt hour to be economically viable, a price point that has not been seen in five years. Decarbonizing will also demand significantly more natural gas, where prices have been trending up in the past decade.

However, decarbonizing is not our near-term concern as the relining of a BF at Port Kembla will buy BlueScope some time up to 15-20 years. Shorter term, building approvals across Australia have fallen since 2021 and will likely stay relatively muted due to higher interest rates, and property developers rebuilding their financial strength postpandemic.