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OneSteel results announced: Shares up 54%, but it’s still no rose

OneSteel Limited (ASX: OST) shares are up by 54% in the four days since it announced that it was expanding its resources-based businesses and away from its unprofitable Australian steel operation.

According to the company, Mining and Mining Consumables businesses comprise roughly 40% of the company’s total revenues, and looks set to make a higher contribution in future.

Out of the frying pan and into the fire?

With iron ore prices falling, I’m not so sure that the company is making a great decision. The company’s own mining segment revenues were down in the first half by 10%, partly due to lower iron ore prices, and the company said “sales revenue for the second quarter was adversely impacted by the dramatic decline in spot prices.”

Only in November 2011, the company’s shares fell 17% because it revised down earnings expectations due to a 30% fall in iron ore prices (in just 3 weeks).

Should iron ore prices fall much further or demand from China slow up dramatically, OneSteel could find itself in deep water.

A rose by any other name

OneSteel also announced plans to change the company’s name, now that it’s a mining, mining consumables and steel business.

While it appears that management are doing everything they can to restructure the company by selling assets, exiting businesses and switching focus to resources (well, just iron ore it seems), I can’t help feel that it may all be in vain.

Headwinds

The company faces many headwinds and has unattractive business economics. It’s hard to know where to start, but here goes:

  • The high Australian dollar and low international steel prices are affecting its steel exports.
  • Cheap imported steel is stealing (pun intended!) [sorry! - Ed] business, and putting pressures on OneSteel’s margins, which are already low. The company’s net profit margin from continuing operations for the first half of 2012 was a very skinny 1.5%.
  • OneSteel has $2.4Bn of debt. Although interest cover is 4.1 times, revenues going forward will be heavily dependent on iron ore prices, and it wouldn’t take a very large fall in prices to have OneSteel’s bankers coming round for a quiet chat.
  • Return on equity and asset ratios are both below 4%. As my colleague Dean Morel has said before “If a company’s return on capital is less than its cost of capital then run away…fast.”. I don’t think there’s much chance its cost of capital is below 4%
  • Earnings per share of 5.8 cents to Dec 2011, is only up slightly on earnings per share 10 years ago in 2001.
  • The company is still capital intensive, with operating cash flows of $187m for the half, but still spent $166.5m on capital expenditure in the same period. In addition to $272.9m spent on controlled entities and $51m on dividends, it’s no wonder the company had to borrow an additional $382.5m from its bankers.

The Foolish bottom line

Now is not the time to be buying OneSteel shares, and there may never be a good time to do so. There are plenty of better opportunities out there.

If you’re looking for a business we think is worth your consideration, check out The Motley Fool’s Top Stock For 2012. Request your copy of this report, whilst it’s still free and available, by clicking here now.

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Motley Fool contributor Mike King does not own shares in OneSteel. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool’s disclosure policy

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