With Higher Optimism on Korea, Should You Buy POSCO?

With Korea showing better industrial production data, is it time to buy Posco?

Apr 9, 2014 at 10:25AM

In a time when China is plagued by economic concerns and capital is flooding out of the emerging markets, South Korea seems to be withstanding the pressure. In fact, the country is receiving net capital inflows, which have strengthened its currency.

Lately, South Korea has been showing a healthier external position compared to its Asian peers. Last month, its current account surplus widened to $4.5 billion, showing a 37% increase compared to January's $3.29 billion surplus.

There is also good news coming from the industrial sector, as the country's industrial output showed 4.3% year-over-year growth in February. This has pushed manufacturers' confidence, which advanced to an almost two-year high.

Korean steel
This favorable data could be a sign that it is a good time to get some Korean assets. If you are thinking of industrial output, there's one key company to analyze, POSCO (NYSE:PKX). In fact, it's one of the 10 largest steel companies in the world.

Overall, 2013 was very disappointing for the company, as it produced its lowest full-year result over the past decade. Last year, Posco generated $2.84 billion, down 18% compared to 2012 and down 45% from 2011. So what happened?

The company's performance has been affected by low steel prices and tepid demand. The reality is, shipment volume decreased and carbon steel average selling prices declined 12% in the year.

The China issue
China is the world's largest steel consumer and Posco's largest export market, taking a quarter of its exports. This makes Posco vulnerable to the country's policies and overall demand.

It is important to know, contrary to China, the Korean government does not impose trade tariffs or provide meaningful subsidies to its steel industry. Anyhow, the company's low-cost position has enabled it to compete with Chinese steel mills, despite these structural disadvantages.

Lately, there has been talk about a probable change in China's growth model, as many analysts believe the country could move to consumption-led growth from infrastructure-led growth. This risk is beyond Posco's control, but should be taken into consideration, as it would affect the company's biggest market.

Nonetheless, about half of total shipments are generated domestically, where Posco has the biggest market share, at 43%. This provides it with meaningful pricing power, allowing for better margins.

So, should you still buy Posco?
In terms of steel, Posco is well-positioned on the low end of the industry cost curve, and holds a mid-cycle operating margin of 9%. In fact, its plants are among the most efficient steel mills in the world, enabling relatively low energy costs. Last year, R&D investment was pretty effective, as it generated steel processing technologies for wire steel and rolling that saved $640 million in costs.

Further, through its investments in the Australian Roy Hill and the Australian Premium Iron projects, Posco has committed to raising its self-sufficiency in iron ore to 50% from the current 30%, by the end of this year. This higher integration should lead to lowering its cost structure and allow better overall profitability.

Final thoughts
Although it is true that Korea, Asia's fourth-largest economy, is showing improving data, Posco is still not enjoying the benefits of it. But if this trend continues, the company will eventually show better results.

You should consider that the company relies on China, and the steps that this country will take to combat a slowdown will be critical. Last week, China outlined a $24 billion package of stimulus; including railway spending, tax relief to support the economy, and increased efforts to create jobs.

We still do not know the full extent of these measures and implications, but steel demand is clearly affected. According to a Bloomberg survey in March, China's economy probably grew 7.4% last quarter from a year earlier. So it makes sense to stay tuned and be ready for any potential opportunities.

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Louie Grint has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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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