POSCO Upgraded to Neutral - Analyst Blog

We recently upgraded our rating for the South Korean steelmaker POSCO (PKX) from Underperform to Neutral considering the benefits expected from the company’s wide regional diversification and higher proportion of value-added products in its product mix. We believe the company stands well positioned to leverage from its recent acquisitions and expansion into international markets.

Second Quarter Highlights

POSCO reported encouraging financial results for the second quarter of 2010, with net income increasing 117.5% year over year to KRW 1,196 billion (US$1.02 billion). However, compared with the first quarter 2010 results, net income plummeted 16.8%, primarily due to higher foreign exchange translation loss of KRW 443 billion (US$0.38 billion). Earnings per share were KRW 13,708 (US$2.93 per ADR) in the second quarter versus KRW 4,940 (US$0.96 per ADR) in the comparable quarter of 2009.

Consolidated net income in the second quarter was KRW 1,173 billion (US$1,004.5 million), up 174.7% year over year and down 19.2% sequentially. Consolidated EPS was KRW 13,444.1 (US$2.88 per ADR).

Revenue was KRW 7,933 billion (US$6.8 billion), up 25.0% year over year and 14.1% sequentially. The sequential growth was attributable to higher sales volume and sales price, which more than offset an 11.2% increase in raw material costs. Consolidated revenue in the second quarter was KRW 11,013 billion (US$9,431.4 million), up 23.4% year over year and 11.5% sequentially.

Production was 8.4 million tons of crude steel, a rise of 17.3% year over year and 1.6% sequentially. Sales volume amounted to 7.8 million tons of finished products, an improvement of 11.7% year over year and 4.8% sequentially, driven by solid domestic demand and exports in emerging markets.

Outlook

POSCO is confident it will complete its facility additions and upgrades for capacity expansion in the second half of 2010. Also, the company is progressing well with its overseas investments in India. Global steel demand is expected to grow 12% in 2010 due to continued economic recovery.

For fiscal year 2010, POSCO expects consolidated revenue of approximately KRW 46.5 trillion (versus its prior expectation of KRW 45.2 trillion) and consolidated steel production to reach 36,100 million tons. Sales volume is expected to be roughly 32.3 million tons and consolidated operating profit would be around KRW 6.2 trillion.

POSCO raised its investment target for 2010 to KRW 10.4 trillion from KRW 9.0 trillion. The company allocated roughly 4.9 trillion for domestic steel, 1.5 trillion for overseas investments and 4.0 trillion for new growth opportunities.

Upgraded to Neutral

POSCO remains well positioned to benefit from wide regional diversification and higher proportion of value-added products in its product mix over the longer term. The company expects global steel demand to grow 12% in 2010 in the wake of continued economic recovery with domestic demand rising 16%.

However, rising competition, especially from its Chinese counterparts, is expected to aggravate price competition and impact margins and revenues. Besides, gains/losses from volatility in foreign currency and the cyclical nature of the industry remain a cause of concern.

But POSCO’s expansion into international markets through investments in Australia, China, India, Indonesia and Brazil is encouraging and expected to boost growth, going forward. The company’s recently announced joint venture with Krakatau Steel, new processing facility in China and stake acquisition in Australia’s iron ore and coal mines are expected to be the prime share-driving catalysts.

Thus, we upgrade our recommendation from Underperform to Neutral, supported by its Zacks #3 Rank (Hold).