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This ASX 200 stock could excite investors with a capital return this year

The BlueScope Steel Limited (ASX: BSL) share price is taking another beating today as the stock re-tests its four-month low.

The BSL share price slumped 2.2% to $11.10 in after lunch trade when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index gained 0.5%.

But BlueScope is in good company as the Domino’s Pizza Enterprises Ltd. (ASX: DMP) share price and QBE Insurance Group Ltd (ASX: QBE) have also copped a big beating. All three have something in common – they are all at risk of issuing a profit warning during this “confession season”.

This is the period where most companies start closing off their book for the financial year and have a better picture of how their FY19 results would look like. Their continuous disclosure obligation forces the profit disappointers to issue an earnings update to the market.

Profit warning candidate

The chance of BlueScope missing their earnings guidance has increased since US President Donald Trump lifted steel tariffs on BlueScope’s Canadian and Mexican rivals, who will likely ramp up exports into the US.

BlueScope’s subsidiary North Star produces steel products at its factory in Delta, Ohio, and its earnings are under pressure from falling US steel spreads even before the lifting of Trump’s tariffs.

Management said at its half-year results announcement in February that it expected underlying FY19 earnings before interest and tax (EBIT) to be around 10% above the previous year, which implies a figure just under $1.4 billion.

Brokers downgrading forecasts

But BlueScope was expecting US steel spreads to rise in this half when it’s gone the other way. The market is bracing for a profit downgrade although many brokers have already moved to cut their forecasts.

One of these brokers is JP Morgan. Its analysts have cut their EBIT estimates to 6% below the company’s guidance although it’s keeping the “overweight” recommendation on the stock given that it’s fallen significantly below the broker’s price target of $16 per share.

But being cheap won’t save the stock from underperforming. There needs to be a catalyst. The good news is that BlueScope could have one up its sleeve.

How BlueScope can win over investors

JP Morgan thinks BlueScope could redeem itself if it undertook a share buyback instead of expanding its North Star operations.

Putting the $1 billion into a buyback would generate a net present value (NPV) of around $400 million given the differential between BlueScope’s current share price and the broker’s valuation of the stock.

In contrast, pumping the cash into expanding North Star would yield a NPV of around $141 million (based on North Star’s cash flow).

The broker believes that such a buyback would boost BlueScope’s earnings per share by 10% and would be better received by investors than the North Star expansion given the volatility of US steel spreads and fears of an oversupplied market due to imports.

JP Morgan isn’t recommending BlueScope make such a large capital return and is only using this as an example to give management something to chew on.

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Motley Fool contributor Brendon Lau owns shares of BlueScope Steel Limited. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. 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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