Citi tells investors to take profit on this well-loved large cap stock

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You’d be hard pressed to find a bad word levelled against BlueScope Steel Limited (ASX: BSL) as the stock has rallied on several powerful tailwinds, but Citigroup is warning investors to take profit on the stock as the broker slashes its price target on the steel products maker.

The downgrade comes as the share price of BlueScope surged 50% over the past year and is currently trading up 1% this morning at $16.78. In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index has gained 7% over the last 12 months.

The buoyant US dollar, high US steel prices from Trump’s trade tariffs, strong demand for BlueScope’s products from the construction boom and a healthy balance sheet have made this stock a hot favourite with investors and analysts alike.

This is what makes Citi’s call an interesting standout as the broker lowered its recommendation by two-notches to “sell” from “buy” as it lowered its price target on the stock to $15 from $20.50 a share.

“In our view, the strong tailwinds of rising steel prices/spreads have begun to reverse, signalling that we may now be past the peak,” said Citi.

“With sentiment in US steel markets and China macro data likely to get worse before it gets better, we believe risk-reward at this point of the cycle has turned negative.”

US steel prices surged when the US imposed tariffs on steel imports from several countries. But the broker noted that US benchmark steel prices have eased 5% and are expected to retreat further.

This is because US steel makers, including BlueScope’s joint-venture Northstar, are expanding or restarting production. Citi estimates that around 23% of extra flat rolled capacity could come online in 2018 to 2022.

There’s also pressure for the US to remove the tariffs, and this combined with the extra supply, could send steel prices tumbling by up to $225 a tonne over the next 12 months.

China is another wildcard that could drag global steel prices lower. The government has relaxed winter restrictions on steel production as it stares down a trade war with the US.

A full-blown trade war will cut Chinese economic growth and that could lead to steel makers in that country to flood the global market as domestic demand drops.

Could BlueScope do the unthinkable and announce a profit downgrade?

“We see BSL’s FY18 AGM [annual general meeting] in Nov-18 as the next event signpost. Typically, BSL provides updated 1H EBIT guidance,” said Citi.

“Given weakening steel prices, risk of a negative guidance has risen.”

The risks may be real but I feel there are too many variables right now to turn negative on BlueScope.

But if such a dire outcome comes to pass, it may have implications for our iron ore majors BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, BlueScope Steel Limited, and Rio Tinto Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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