POSCO Downgraded to Neutral

We recently downgraded our rating on the South Korean steelmaker POSCO (PKX), from Outperform to Neutral.

POSCO is the world’s third largest steelmaker on the basis of output. The company primarily manufactures steel for the shipping and construction industries and operates through its two steel production facilities, the Pohang Works and the Gwangyang Works.

POSCO is in an advantageous position to benefit from its wide regional diversification, self-sufficiency in raw materials and higher proportion of value-added products in its product mix over the longer term. The company expects global steel demand to grow 5.3% in 2011 due to continued growth in demand from the emerging markets.

In October 2010, POSCO signed agreements with Kazakhstan-based ZAMAN Group to build a ferro-silicon aluminum plant; while in the next month, the company joined hands with Brazil’s Vale S.A.and Dongkuk Steel Mill for the construction of a steel plant in the state of Ceara. POSCO also signed a memorandum of understanding with Russian steel maker Mechel to invest in the development of resources in Siberia and distribution routes in the Far East.

In January 2011, POSCO’s $12 billion Orissa project, involving an integrated steel plant (12 billion tons of annual capacity) and a port in Orissa, got conditional approval with 28 new conditions for the integrated steel plant and 32 fresh conditions for the captive port. Thus, regional diversification will help the company ward off difficult situations in future.

Despite all the positives, rising competition and higher raw material costs are expected to aggravate price competition and impact margins and revenues. The company’s fourth quarter results with its net income down by 50% sequentially were severely impacted by higher raw material costs. Further increase in material prices will be a major concern for the company’s growth.

Moreover, rising competition from global steel manufacturers with an expanded production capacity could result in significant price competition. The company faces stiff competition from Arcelor Mittal (MT) and Nippon Steel Corp.

Anticipating a lack of positive catalysts in the near term, we downgrade our recommendation from Outperform to Neutral.

POSCO-ADR (PKX): Free Stock Analysis Report

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