It took just one spare sentence of 27 words and numbers to throw a $1.6 billion shadow over what otherwise was a spectacular start to Paul O’Malley’s final four months as chief executive of Australia’s steelmaker, BlueScope.
Towards the end of Monday’s profit detail that announced the best financial year of O’Malley’s decade at the top and that he would be replaced by CEO-in-waiting, Mark Vassella, BlueScope offered up some fateful guidance on the year now well under way.
“The company currently expects 1H FY2018 underlying EBIT around 80 per cent of 2H FY2017 underlying EBIT (which was $527.3 million). Expectations are subject to spread, FX and market conditions.”
And with that disappointment, a bloodbath of sorts began.
By trading day’s end $1.64 billion had been stripped from BlueScope’s marketing capitalisation as four months of speculative froth was removed from the company’s share price.
One of O’Malley’s great strengths is an ability to avoid distraction. So, while he was put slightly off-stride by the weight of the market’s intolerance for the potential of a surprise $100 million shortfall in interim earnings, he received the market judgment as a lesson in communication.
“It is our job to demonstrate that the baseload of earnings that we have today is three to four times greater than what they were two years ago,” he said.
“There will always be cyclicality, but we are now working off a level of earnings that is structurally higher than it has been in the past,” O’Malley told The Australian Financial Review on Monday.
“There is always a short-term reaction to news. But there is a sense that investors can be confident in BlueScope and if we keep pursuing the strategy, the market reactions will ultimately take care of themselves.”
O’Malley’s sanguinity in the face of this short-term equity market punishment reflects his steel-strong confidence that he has forged a more secure and predictable BlueScope over seven years of often painful and sometimes controversial reformation.
To be clear, this is a business that was nearly crushed by the twin weights of post-global financial crisis debt and structural recession in regional steel markets, a business that just three years ago struggled to find the financial means to maintain it steelmaking legacy.
The past three years have seen massive change at BlueScope. Across the business, operations are hitting their own stringent return on invested capital targets, leaving board and management publicly confident that BlueScope can fund organic growth opportunities while manufacturing a balance sheet that is net cash.
The thematic now is that BlueScope will continue to return capital to shareholders and sustain a balance sheet that is fully able to finance the sort of counter-cyclical opportunism that inspired the move to 100 per cent ownership of the North Star not-so mini- mill in Ohio.
The other 50 per cent of North Star cost $US750 million in 2015 and it briefly stretched the BlueScope balance sheet. That debt has already been fully retired.
The sum of the O’Malley proposition is that BlueScope is now a less cyclical business that is built to prosper in a market whose long-standing trading paradigms were overturned by the rise of China’s steel industry.
“When I joined, China was just moving from being short steel to balanced steel to long steel, to a scale of production the world had never seen before. The world produced 100 million tonnes a year of steel in 1945. It produced 700mtpa at turn of century. It’s now producing more than 1.4 billion tonnes and a lot of that growth has come out of China,” O’Malley assessed.
Just a decade ago the biggest strategic priority for the steel companies of the world was to manufacture at scale enough to cover substantial fixed costs. The steel industry was a first world business that traditionally shipped its necessary excess to the developing world.
But that flipped for the first time ever with China’s evolution and the developing world over-produced and started exporting back to the developed world.
O’Malley recalled the closure of one of BlueScope’s two blast furnaces in 2011 as being indicative of this shift in the tectonics of global steel. And what it really announced to all of his contemporary legacy producers was that their futures were going to be local not global.
“We needed to produce purely for domestic economies and it was the end of wholesale exports of commodity steel,” he said. And the only way to sustain those domestic markets was to become cost competitive with the steel’s new world, to ensure that anti-dumping protections were maintained and enhanced and to grow margins by developing branded, value-added products.
A decade ago some 70 per cent of BlueScope’s revenues were derived in commodity steel markets in Australian and export markets. The BlueScope O’Malley leaves is a better balanced business with Australia generating 40 per cent of its income, the US another 40 per cent and the balance coming from a growing community of Asian business outposts.
BlueScope is a business essentially constructed around three core hubs with maybe a fourth emerging. Two of them – Port Kembla and North Star in the US midwest industrial centre of Ohio – maintain an increasingly intense focus on domestic markets. A third, in Thailand, is allowed a more regional focus given the growing prosperity of the ASEAN region. And BlueScope’s gathering Indian business. And around these cores lives a community of value-adding businesses that are crafted to extract value from niche markets, large and small.
To some degree the three core triggers of BlueScope’s first-half fragility might well offer early proof to the O’Malley thesis of solidity. The issues, in order of impact, are lower steel spreads in the US, price deflation in Australia caused by the exploitation of “gaps” in the existing anti-dumping regime and a lag in the mitigation of rising energy costs that will begin to really hurt later this year.
There is not a lot that BlueScope can do about the pressure in the US, but O’Malley insists that the problems here have been identified and “we are onto it”.
BlueScope has already been rewarded for work done on closing those gaps in the anti-dumping rules while pricing in regional markets has removed some of the incentive to export product to Australia.
The Australian energy market situation, while it accounts for but 15 per cent of the damaging downgrade, attracted an overweight burden of O’Malley’s vigorous and informed ire. And, as ever, he prosecuted his case for urgent, government managed, market reform with informed ferocity.
“Six months ago, at our half-year results presentation, I warned of an imminent energy supply catastrophe,” he said. “This catastrophe is now happening.”
O’Malley said BlueScope’s Australian electricity costs will likely be 93 per cent higher by the end of FY18 than they were in FY16. His gas prices are forecast to rise by 33 per cent, but the full weight of that is being felt in power markets.
“And these sorts of increases are being faced by manufacturers, businesses and households across the country – dampening investment and employment, and squeezing household budgets,” he said.
“The increase in domestic gas prices since 2015 has cost Australian gas users approximately $3.5 billion per annum. For electricity, the cost to users of rising electricity prices is over $3.7 billion per annum.
“Australia’s baseload generation mix is almost uniquely reliant on coal-fired generation,” he continued. “Because of the fragility of our baseload generation mix, we need to be very careful about any policy that puts it at risk.”
O’Malley warned that it would be a mistake for Australia to bank only on the “fancy stuff” of reform, like the Finkel recommendations and smart technologies that “aren’t here yet”.
“If Australia is to retain its economic competitiveness, it also must focus on the basic stuff – that is, fundamental baseload energy that powers our homes, factories, schools and hospitals. We need more gas, at lower prices. And we need to maintain reliable and affordable baseload generation, until renewables can pick up the load – in about a decade’s time.
“The core challenge is for all sides of politics to find an urgent solution to energy security and affordability – one that benefits all the people, not just the sectoral interests of a few. I believe, the current government and opposition know all this – they just have to find the will to make it happen. For the people.”