Has South Korean steel giant and Motley Fool Income Investor recommendation Posco (NYSE:PKX) hit the top of the mountain? Judging by its current P/E of about 4 and the mean analyst expectation for a one-third drop in earnings next year, the answer appears to be "yes."
It's an understandable, and popular, position to take. Pricing for hot-rolled steel has weakened across the board -- dropping so far this year by 15% in Germany, 20% in the U.S., and 36% in China. Rival steel producers such as Mittal (NYSE:MT), Arcelor, and ThyssenKrupp have all announced pricing cutbacks, and China has delayed import shipments of iron ore.
But even faced with all of those challenges, Posco has done all right for now. For the second quarter, it grew sales by 13%, operating profit by 45%, and net profit by 38% -- in spite of a 3% decline in production and a 4% drop in sales volumes.
Posco has helped itself in part by shifting away from products such as hot-rolled steel and plate and toward cold-rolled steel and wire rods. With the higher average sales prices in these products and better overall efficiency, the company has managed to stay ahead of the tougher times in the business.
Still, I'd caution Fools to go back two paragraphs and pay attention to that "for now" part of my assessment. Though Posco is doing well, management doesn't seem confident that industry conditions are going to improve markedly soon. So while analysts may be over-anticipating the drop in steelmakers' earnings, they're likely right about the direction even if they're wrong about the magnitude.
Nevertheless, Posco management is moving ahead with its plans for the business. The company has recently begun a major steel and iron project in India, and it's getting more involved in non-steel businesses, including power generation and liquefied-natural-gas terminals. Posco also continues to make investments in iron ore around the world, a decision that should help guarantee access to this critical input.
I happen to really like Posco, and I'd go so far as to say that it's my favorite steelmaker. But I'm not sure that I want to buy just now. With so many people seeming to agree that the steel boom is over, the sector might be undervalued and ready to rebound. But it's tough to ignore what's happening in the market right now.
Long-term investors will likely come out just fine, but more short-term-oriented Fools might want to steer clear of steel for just a bit longer.
Steel yourself for more Foolish metal mischief:
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned.
