Bluescope Steel has been in the headlines for all the wrong reasons since announcing a $1bn net loss in financial year 2011. I’ve not looked at the company in detail for some time, but with the share price now down 93% since July 2008, and trading at a 64% discount to net tangible assets, is the stock now beginning to look like one for the Benjamin Graham acolytes?
Stocks trading at a discount to liquidation value were a favourite of Graham’s. Whilst admitting that ‘earnings [might] decline or losses continue… and the intrinsic value ultimately become less than the price paid’, he saw a ‘much wider range of potential developments which may result in establishing a higher market price’. These developments included:
The creation of earning power commensurate with the company’s assets;
A sale or merger;
Complete or partial liquidation.
So does Bluescope meet his criteria? Graham explains his method of calculating liquidating value in Chapter XLIII of Security Analysis:
The first rule in calculating liquidating value is that the liabilities are real but the assets are of questionable value. This means that all true liabilities shown on the books must be deducted at their face amount. The value to be ascribed to the assets however, will vary according to their character. The following schedule indicates fairly well the relative dependability of various types of assets in liquidation:
The resulting liquidation value range is between negative $1.4bn and positive $1.0bn, while a ‘rough average’ value is negative $0.5bn. Compared to the current market capitalisation of $1.25bn, even the high end of Graham's range provides no comfort.
The issue is that Bluescope has plenty of debt and the value of the fixed assets is particularly uncertain. Our 'rough average' valuation has attributed $525m of value to property, plant and equipment with a book value of $3.4bn. That might seem harsh but, given $2.9bn of this is plant, machinery and equipment specific to an industry with a limited life in Australia, it might be more than fair.
The current market capitalisation of $1.25bn implies a total enterprise value of $4.65bn, a discount to gross tangible assets of only 31%. It's the leverage involved that makes for a seemingly attractive 64% discount to net tangible assets. Bluescope may well provide adequate returns from here, but Benjamin Graham would give it a miss.
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