If there's a virtue to stocks with low single-digit P/E's, it's this -- Korean steel giant and Motley Fool Income Investor recommendation POSCO (NYSE:PKX) had a pretty bad quarter, but expectations were already so generally dismal (as seen in the P/E) that the stock isn't down all that much today.
It was a rough quarter. Sales were down more than 7%, operating income dropped almost 33%, and net income fell by about 68%. That bottom-line number was especially ugly; POSCO delivered about $391 million in net income vs. the average analyst expectation of $646 million.
The culprits in the quarter aren't too exotic or difficult to find. China has been aggressively ramping up steel production, lowering prices for Asian steel by about a third in 2005. As a result, POSCO recently had to take double-digit price cuts on many product lines.
On the other side of the ledger, production costs are much higher this year. Coking coal (a.k.a., met coal) prices have more than doubled, and iron ore prices were more than 70% higher in 2005. No wonder, then, that many major steel companies are hard at work developing captive supplies of ore and coal.
Things will likely get worse for POSCO before they get better. Companies like BHPBilliton (NYSE:BHP) may cut the price of coking coal slightly in response to declines in production, but it seems likely that iron ore suppliers like CVRD (NYSE:RIO) will manage to secure another 10%-plus price hike. China could become a net exporter of steel next year, but there's also the possibility that the government will look to rationalize the industry and eventually push out marginal and/or unprofitable producers -- actions that could help rein in supply growth.
I wouldn't call POSCO my No. 1 or No. 2 idea in steel today, but it's a very strong company with a near-monopoly in the Korean market -- a big producer of steel-using goods like appliances, cars, and ships. What's more, the company is expanding into higher value-added products and gaining more control over its power and raw material needs. And it provides a nice little dividend, to boot. All in all, I'd say it's still a stock worth holding.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (which means he's neither long nor short the shares).
