POSCO (PKX) and Krakatau Join Forces

Korean steel maker POSCO (PKX) enters the Indonesian steel industry in a joint venture with Krakatau Steel by initiating the construction of the first integrated steel mill in Indonesia. Krakatau Steel is a state-owned steel producer having 60% market share of steel plate market.

The integrated mill with an annual capacity potential of 6 million tons will be constructed in two phases, with the first phase of 3 million tons expected to start in the second half of 2010. The companies target to complete the initial stage by December 2013.

As per the agreement, POSCO will initially own roughly 70% share of the mill, with the rest 30% with going to Krakatau Steel. Option for a further increase in shares up to 45% is also available to Krakatau Steel, exercisable only after attaining some stability in the business.

The proposed project to be built next to Krakatau Steel factory in Cilegon is categorized as a Brown field investment as existing infrastructure such as harbors, land, water, and electricity of the partners will be used for its construction.

We believe the project will enable both, POSCO and Krakatau Steel to produce low-cost steel due to easy availability of raw materials as Indonesia has roughly 2.4 billion tons of iron ores and 20.9 billion tons of coal reserves. Besides, rising demand from countries like India and other Southeastern countries will be a major growth booster.

POSCO is the world’s third largest steelmaker, supplying primarily to the shipping and construction industries. The company has been growing internationally through its investments in Australia (70% share in Sutton Forest coal mine and 24.5% in API Iron Ore mine), China (contract with Jilin Province and manufacturing of processing centers), India (Orissa project and joint venture with SAIL), and Indonesia (Krakatau steel project). Besides, it has a 20% stake in Brazilian steelworks project together with Tongue Steel Mill and Vale S.A. (VALE).

POSCO anticipates that global steel demand will grow 12% in 2010 due to continued economic recovery with domestic demand rising 16%.

Despite being endowed with benefits from regional diversification, POSCO’s operating performance in the quarters ahead is expected to be influenced by higher raw material costs, increase in Chinese steel exports and falling spot prices for steel in China due to declining domestic iron ore costs. Moreover, higher debt due to enhanced investment activities together with risks from volatility in foreign exchange and the cyclical nature of the industry will be detrimental to the company’s financial results.

We currently maintain an Underperform recommendation on POSCO, as supported by a Zacks #5 Rank (Strong Sell).

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