The Investment Column: Prices fears temper steel profits

When a company breaks through the billion pound profit barrier for the first time, management could be forgiven for expecting a little more than a ha'penny rise in the share price. But such is life in the steel sector. British Steel has been riding the cycle and the market had been expecting a strong performance. The share price reaction shows that the market is predicting the best may be over and worse yet to come.

Chief executive Sir Brian Moffat accepted yesterday that since the steel industry was at the top of its cycle, profits for the current year would be adversely affected, though he still anticipated a "satisfactory performance".

Quite what that means largely depends on your view of how far steel prices will fall in the next two years. Some analysts are predicting a "soft landing" following the difficulties in the second half last year, which spilled over into the first quarter of 1996. But the bears are predicting significant falls in steel prices. They are also wary of British Steel's ability to manage the decline.

All this is harsh on a company whose shares had a good run earlier this year. Profits were struck at a record pounds 1.1bn compared with the previous year's figure of pounds 578m.

The results were boosted by the contribution of Avesta Sheffield, the Swedish stainless steel group, in which British Steel increased its stake to over 51 per cent. They also include a full-year's contribution from British Steel Engineering Steels, British Steel Forgings and Scunthorpe Rod Mill, all of which became wholly owned in March 1995.

Even with capital expenditure topping pounds 320m, there was a cash inflow of pounds 561m, which took net funds as at 30 March to pounds 690m. There has been talk of a share buy-back but the company said yesterday that it was more likely to spend the cash pile on acquisitions.

British Steel shares have enjoyed a strong run in the last few years, rising from a low of just 47p in 1992 to almost 200p earlier this year. But the price has come off in the last couple of months, reflecting concerns over de-stocking and the steel price. Sir Brian indulged in a fresh outburst against state subsidies, though British Steel has responded in an aggressive manner to produce more to try and improve short-term profitability.

The big question is whether the newly privatised European steel industry will change its past habits and rein its production back. In the past they have, like British Steel, made the dash for volumes to support their overheads as the cycle turns.

With analysts forecasting profits of pounds 578m this year, the shares, at 178p, are on a forward rating of 8. Avoid.