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28/5/2018 — Other Minerals and Metals
Brokers ponder Steel & Tube’s path ahead
By Simon Hartley

Steel & Tube Ltd’s (NZX: STU) sweeping downgrades last week have left brokers' concerned with the steel distributors outlook, labelling the bad news clean-out “opaque.”

The company announced more than $50 million in downgrades on Wednesday, and also that it had breached one or more banking covenants; prompting negotiations with its bankers.

Steel & Tube's share price was subsequently savaged by investors, which on Friday had retraced some of the 20% losses to trade up at $1.62, which was about 35% down on a year ago.

Earnings before interest and tax (ebit) had been expected around $31 M, but were downgraded to a $38 M ebit loss.

Forsyth Barr broker Damian Foster said Steel & Tube's latest profit warning was one of its more dramatic, incorporating a guidance downgrade, business closure, impairment, inventory write down, and debt covenant breach.

“The business continues to pay the price for a series of missteps over recent years, and these will continue to represent challenges for the new management. Forsyth Barr was maintaining its neutral rating on the stock, but Foster emphasised it was difficult to hold any firm investment view, and shifted the risk rating to speculative.

“The medium-term earnings outlook, uncertain at the best of times, is now completely opaque,” Foster said.

Steel & Tube announced it expected to write-off at least $12 M from either the sale or closure of its plastic irrigation division, which has no major works lined up, intangible assets down by a further $10 M and full year $23 M write-off of old inventory.

The company described the write-offs as dealing with legacy issues, under previous management, and believed it would be back into profitability by full year 2019.

Craigs Investment partners broker Chris Timms said pressure was now building on Steel & Tube's earnings and balance sheet, and its changes programme “must succeed.”

Because of uncertainty in debt levels and earnings, Timms said there was an implication for a dividend cut, and potential need for equity raising. However, Steel & Tube ruled this out.

Both brokers were concerned about Steel & Tube's debt levels - Timms predicting debt would be more than $100 M by next month, while Foster said those debt levels needed to come down. Both believe the debt level could see dividends cut.

“We suspect STU's discussions with domestic banks will likely be easier than Fletcher Building's recent negotiations with its offshore lenders,” Foster said.

However, irrespective of the outcome STU was over extended and it needed to de-gear debt, with Foster picking this could lead to a cut in dividends.

The magnitude of the profit warning had reemphasised the lack of visibility and the challenge in forecasting future earnings, he said.

Foster said STU had inherently dramatic earnings leverage to volatile prices, margins and operating expenditure. There was also a lack of any detail on the current year's earnings composition, negative momentum in the business or the new management's restructuring initiatives.

“There is a very high margin of error in Steel & Tube's earnings outlook, valuation assessment and investment view,” Foster added.

*Simon Hartley is senior business reporter and assistant chief reporter for the Otago Daily Times.

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