POSCO Sees Everything Growing Except Profits

Like MacGyver without a paper clip, steelmakers find themselves caught between a rock and a hard place ... with no apparent means of escape.

Domestically, the challenges are well known. Nucor (NYSE: NUE  ) anticipates a fourth quarter loss of $0.10 to $0.15 per share amid rising scrap metal prices. U.S. Steel (NYSE: X  ) idled its Hamilton Works blast furnace last October in response to reduced order rates, and particular weakness in demand for fabricated steel products has weighed heavily upon operators like Commercial Metals (NYSE: CMC  ) .

Over in Asia, the hottest regional furnace in the world's growth mill, the steelmakers are churning out plenty of volume to quench healthy industrial demand. Even in this relative hotbed of global demand, however, the producers are struggling to make a buck. South Korean steelmaker POSCO (NYSE: PKX  ) expanded production by 14.2% during 2010, and although full-year profit saw a solid 33% improvement, the added volume could not shield the company from suffering a dramatic 59% year-over-year decline in fourth quarter profit.

Caught between cost-sensitive buyers on the one hand (whom POSCO considers incapable of absorbing substantial hikes in steel prices), and abruptly rising raw material costs on the other, POSCO is wedged in the middle of a classic margin squeeze. About 70% of POSCO's sales go to South Korean buyers, with automobile manufacturers and shipbuilders carrying the heaviest loads. With China already wooing global customers with loans supporting vessel construction at Chinese shipyards, Korean shipyards like Samsung Heavy Industries likely face elevated price sensitivity when securing contracts like the multi-vessel drillship order that Samsung is presently building for DryShips' (Nasdaq: DRYS  ) Ocean Rig subsidiary.

Due largely to China's seemingly insatiable hunger for imported iron ore and metallurgical coal, prices for these steelmaking ingredients have risen sharply in recent months. Disruptions to met coal exports from Australia due to an historic flood event are showing signs of abating sooner than anticipated, Miner Peabody Energy (NYSE: BTU  ) was forced to revise full-year 2010 earnings expectations downward as a result of related production shortfalls. Still, met coal supplies were already extremely tight before the waters rose, and Fools are not likely to see prices recede as quickly as the floodwaters may. While I perceive a less acute supply shortfall in iron ore than in the market for met coal, Asian demand for seaborne iron ore is nonetheless sufficient to nudge Cliffs Natural Resources (NYSE: CLF  ) into a major expansionary move.

Even with worldwide steel production slated to expand by 5% or more during 2011 -- and perhaps as much as 30% over the next several years -- I do not view steel as an attractive industry for investment at the present time. China's steel industry overall saw a profit margin of only 3.5% in 2010, and one of its leading producers is diversifying into sales of food products like olive oil and wine (of all things!) to chase higher-margin operations. I expect rising input costs to continue exerting pressure upon profitability, and therefore I recommend that Fools move up the supply chain into raw materials like met coal and iron ore.

Do you have a different outlook on steel from that expressed above? Please share your view in the comments section below. Exchanging diverse perspectives in open dialogue is what we're all about at the Fool, and I encourage you to speak your mind.

Nucor is a Motley Fool Stock Advisor pick. The Fool owns shares of Nucor. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of DryShips and Peabody Energy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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