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Here's Why You Should Hold on to POSCO (PKX) Stock for Now

We issued an updated research report on South Korean steel producer, POSCO PKX on Sep 20, 2017. The company is poised to gain from its diversified business structure, strategic initiatives and healthy global demand for steel. However, we believe that exposure to industry competition, high-debt levels and weak steel demand expected in the domestic market might restrict its growth momentum in the quarters ahead.

It currently carries a Zacks Rank #3 (Hold). Over the last 60 days, the stock’s Zacks Consensus Estimate remained stable at $7.73 per American Depository Receipt (ADR) for 2017 and $8.31 for 2018.

Below we discuss why investors should now hold POSCO’s stock.

Growth Drivers

Strengthening Steel Demand: We believe that improving steel demand will create lucrative business conditions for companies like POSCO in the quarters ahead. On the domestic front, any investment by the government in infrastructure improvements and demand expansion in China, India, Southeast Asia and other emerging nations will be promising. Per the World Steel Association report, the global steel consumption is predicted to grow 1.3% year over year in 2017.

Diversification Benefits: We believe POSCO’s well-diversified business structure — including steel and four other major growth businesses, i.e. energy, materials, infrastructure and trading — will help it grow in the quarters ahead. Notably, the company derives roughly 49% of its total revenues from Steel while the rest comes from other businesses.

The company’s broad product line includes hot-rolled and cold-rolled products, plates, wire rods, silicon steel sheets and stainless steel products. These products are primarily used in the automobile, ship building, home appliance and construction industries. Also, international diversity, with businesses in China, Japan, Europe, the Middle East and North America, has played a major role in enhancing its profitability over time.

Strategic Initiatives and Impressive 2017 Guidance: POSCO is undertaking initiatives to improve its competitiveness in steel production, leveraging new businesses opportunities and improving its financial as well as managerial structure. Investments, primarily toward renovation of existing steel facilities, enhancement of steel production capabilities, improvement in steel manufacturing process and expansion of trade businesses, will be a priority.

For 2017, the company anticipates consolidated revenues to be approximately KRW 59.3 trillion, up from earlier forecast of KRW 54.8 trillion. Consolidated investments are likely to be KRW 3.5 trillion. Finished product sales will be 35.1 million tons, up from the previous projection of 34.6 million tons in 2017. Crude steel production is projected to be nearly 37 million tons.

In the last three months, POSCO’s ADR has yielded 19.8%, outperforming 17.5% gain recorded by the industry it belongs to.

Headwinds Restricting POSCO’s Growth Prospects

Poor Valuation: On a P/E (TTM) basis, POSCO’s ADR looks overvalued compared with the industry with respective tallies of 12.8x and 9.6x in the last three-month period. This makes us cautious on the stock.

Despite solid prospects backed by rise in global steel demand, we believe that near-term weakness in the domestic market might restrict POSCO’s growth momentum. In third-quarter 2017, steel demand in South Korea might suffer from weak demand from auto industry and decelerating ship building activities.

Rising Debt Levels: POSCO faces risks from high-debt levels. Exiting second-quarter 2017, the company was highly leveraged, with non-current liabilities of KRW 13.7 trillion. We believe that a rise in the debt level, if unchecked, will increase the company’s financial obligations and hence hurt profitability.

Others: POSCO faces stiff rivalry from other players in the industry. Global steel manufacturers with an expanded production capacity and new market entrants, especially from China and India can give rise to a significant price competition. Also, the company’s geographical expansion of business has given rise to geopolitical and foreign currency fluctuation risks.

Stocks to Consider

POSCO currently has $22.6 billion market capitalization. We believe that the above-mentioned positives and negatives clearly justify the stock’s current Zacks Rank #3.

In the steel producers space, some stocks worth considering are Kobe Steel Ltd. KBSTY, Universal Stainless & Alloy Products, Inc. USAP and ThyssenKrupp AG TKAMY. All these stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Kobe Steel’s earnings estimates for fiscal 2017 were revised upward in the last 60 days.

Universal Stainless & Alloy Products pulled off a positive earnings surprise of 30.77% in the last quarter. Also, its earnings estimates for 2017 and 2018 improved in the last 60 days.

ThyssenKrupp AG’s earnings estimates for fiscal 2017 and fiscal 2018 were revised upward in the last 60 days.

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POSCO (PKX): Free Stock Analysis Report
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