Re: OST - One Steel
VG news article in March 17 Australian
http://www.theaustralian.news.com.au/story/0,20867,21395644-5001942,00.html
OneSteel could forge world presence
VISION 2010
March 17, 2007
ONESTEEL is at the crossroads. Its future for the next five to 10 years will be decided next week by the ACCC, when it adjudicates on the proposed merger with Smorgon Steel.
If the ACCC rejects the merger (and there is no successful appeal), OneSteel will still enjoy a big rise in profits in the next two years as a result of its iron ore developments in South Australia.
But after that it will need to do something radical to develop a growth path and may find it harder to cope with the low carbon emissions environment likely to dominate long-term strategies in the world steel industry in the coming decade.
There will be great institutional pressure on the company to enjoy its strong cash generation rather than embark on high-growth strategies.
But if the merger is approved (and the odds are it will, particularly as the ACCC has already approved the merger of the companies' pipe and tube operations), OneSteel will acquire a suite of growth options that have been built up by Smorgon chief executive Ray Horsburgh.
Whereas Smorgon, with its big family stake, would be tested if it tried to fully pursue all its growth plans, the combined OneSteel/Smorgon balance sheet has the size to go much further and can raise equity if required.
However, next week's ACCC decision may not totally settle the issue. Apart from the question of appeal, BlueScope, which owns 19.9 per cent of Smorgon, could still play hard ball. BlueScope makes flat steel products whereas OneSteel and Smorgon make long products mainly used in the building industry.
BlueScope refused to approve the original merger proposal because it was unhappy with the arrangements for the OneSteel and Smorgon steel distribution businesses. The current plan is to merge all the assets of the two companies, excluding the Smorgon distribution business, which will remain in the Smorgon listed public company. Smorgon shareholders will receive OneSteel shares for their non-distribution assets.
Under this plan, only a simple shareholder majority is required to approve the deal, so whereas BlueScope had the power to block a full merger, the Smorgon family stake in Smorgon will ensure shareholder approval. OneSteel's latest half-yearly earnings equalled an annual profit rate of around $196 million or 34.5c per share. But within two years the decision to enter the iron ore export trade, which also improves the economics of the Whyalla steel plant, is expected by analysts to increase earnings to around $260 million - 45c per share on capital before any Smorgon merger.
The Smorgon merger will not boost earnings per share in the first year because of implementation costs, but OneSteel chief executive Geoff Plummer expects to achieve net synergies - after market share loss - of around $70 million, which could translate into a further $50 million profit increase in two years.
The main reasons for the expected merger profit rise is a reduction of head office costs, the ability to close one or two plants and the economies in the supply chain which will stop the Hume Highway being flooded with OneSteel and Smorgon trucks carrying steel in opposite directions.
Smorgon and OneSteel say that although they will be the only Australian producer of long steel products, imports have 20 to 30 per cent of the market and there is no meaningful tariff protection.
If the merged company lifted prices substantially above world levels, imports would pour in, although the local company's ability to supply when the customer wants the product is a clear advantage. At this stage, global steel demand and supply are about in balance, but if there was an Asian downturn and China and other Asian countries had substantial excess steel capacities, then the Australian market could be flooded with low-priced steel.
But while that is a potential threat, the success or failure of the merger in the long term will depend on what OneSteel CEO Plummer and his people do with the Smorgon growth options, which go to the heart of future world steel development.
The world steel industry is in the front line in the global warming issue and the Australian government that wins the next election will be under pressure to act, but Plummer says: "There is no point in Australia doing things unilaterally. If all you do is tax the Australian supplier, you won't change the total demand. All you will do is shift the problem offshore."
On the other hand, if there are world global carbon measures, which affect most industries, then all steel producers will suffer, with the danger of a significant world downturn.
But, in Plummer's words, if any global carbon tax "is introduced in an orderly way", then OneSteel, being more energy efficient than most of its Asian rivals, should be better placed while the ability to recycle scrap steel will become more important. Here Smorgon is a potential world leader.
Some 30 per cent of Smorgon's sales are in Asia, mainly reflecting its scrap exports from Australia, but the company recently bought into recycling in Thailand and has begun recycling on the west coast of the US.
In a greenhouse-affected world both US and Asian steel recycling will require substantial capital investment.
The merger is not completed, so Plummer is cautious and says that while he needs to better understand the Smorgon recycling operation, the greenhouse issues mean that world recycling "will be a stronger business, so I think it would be one we would want to invest in".
Plummer says that while Smorgon is small in America at the moment, US recycling "is an area where there is going to be significant amount of change and consolidation. That creates opportunities".
Plummer is a potential buyer in the US consolidation, not a seller.
Smorgon technology has also developed a light steel beam that will increase the penetration of steel in home and other building markets.
Smorgon has established a plant in the US and others are expected in Asia.
This will be another major international growth option.
It is paradoxical that over the last four years Smorgon's greatest weakness has been that its steel was based on recycled scrap rather than iron ore.
Steel makers such as OneSteel, with their own iron ore, had a huge advantage.
But depending on technological developments and what actually happens in response to greenhouse, in the long term recycling may prove to be more economical than the carbon-based conventional steel making.
OneSteel has the opportunity to buy Smorgon because the disparate Smorgon family are no longer a cohesive unit and many family members want to sell. And because it is on the exchange, Smorgon shareholders can participate in their growth options, with the backing of a stronger company. Individual Smorgon family members will be able to sell their OneSteel shares, whereas any Smorgon family selling of Smorgon Steel sent the stock spiralling down.
The global steel industry is undergoing fundamental change with steel makers becoming more regional and more market driven. Nevertheless, China, as the powerhouse in the Asian region, will have a big influence on the future of smaller regional companies like OneSteel.
Plummer says: "I think the Chinese advantage is not one of cheap labour. It's actually cheap capital and, for a centrally controlled economy, it's actually surprisingly bureaucracy free, if you're Chinese and you know how to work the bureaucracy."
While the Chinese have access to cheap capital and little regulation, Plummer points out that Australian capital and regulation are much more complex.
On capital he says: "What I've learnt is that I can't please all of the investment community. There's some people who want high dividends. There's some people who don't want cash back. They want it reinvested in high growth. There's some people who like to have diversified businesses to spread risk. There's some people who want to have businesses that are extremely focused.
"What I think we've got to do as management is make sure we're clear about what is our value proposition to the investment community and we've got to stick to that and then deliver it.
"We can't try and please all of the investment community."
In some ways, Australian regulation is more difficult than China. For example, OneSteel tried to introduce a national safety program but found that it had to be adapted for every state.
"It's to do with bureaucracy and not whether it is a better system," Plummer says.
"We really pride ourselves on our safety performance and how well we go. But we have to change it in each state. Well-intentioned governments try to encourage green building codes in areas where it is actually questionable whether it achieves the intended purpose."
And then, to top it off, the Australian tax office pursues large companies, often without logic. For example, Plummer points out that the tax office is trying to fine OneSteel over the way it treated GST, even though the treatment the company used in good faith did not cost the tax office a cent.
In competing in Australia, OneSteel has the home ground advantage and produces end products like reinforced mesh, which it can supply to builders at a specified time much more easily than importers. But, on the global market, Australian companies really suffer, if their home business is forced to divert time and money to either conflicting regulations between states or mindless games played by bureaucrats in Canberra.
Nevertheless, a combined Smorgon/OneSteel company has an opportunity both in Australia and on the world stage which few other Australian manufacturers could contemplate.