POSCO (PKX) reported 2Q19 parent operating profit of KRW724.3bn, in line with the consensus and our estimate (KRW726.3bn). We reiterate BUY on POSCO for the following reasons: the stock has bottomed as it trades at the lower end of its historical P/B bands; steel price hikes are unavoidable as raw material costs will rise in 2H19; and the supply/demand balance in China is expected to improve and Chinese dealer steel prices are likely to rebound. We maintain our target price at KRW330,000.
Major issues and earnings outlook
POSCO posted 2Q19 parent sales of KRW7.48tn, operating profit of KRW724.3bn, and pretax profit of KRW745.5bn. Operating profit was down 12% YoY and 13% QoQ. Consolidated, operating profit fell 14% YoY and 11% QoQ to KRW1.07tn.
The earnings decline is mainly attributable to an unfavorable QoQ base stemming from the sales normalization in 1Q19 after inventory depletion. It also has to do with a failure to raise steel prices despite raw material price hikes, because of a quarterly/semiannual price setting structure and the correction of Chinese dealer steel prices.
Iron ore spot price has now soared past USD110/ton from USD70 at the beginning of the year. With some time lag, this will affect POSCO’s raw material costs, which will force the steelmaker to raise steel prices in 2H19. Similarly, Japanese and US steelmakers have begun to raise their steel prices on a large scale in July, and China’s Baosteel has also announced that it plans to raise its domestic prices in August.
Due to sharp raw material price increases, 3Q19 parent operating profit is expected to slide 4% QoQ to KRW691.7bn. However, in 4Q, it should rebound 18% QoQ to KRW821.1bn on the recognition of higher steel prices.
Share price outlook and valuation
The stock has been mostly rangebound between KRW230,000 support and KRW240,000 resistance. We expect the shares to move northwards as steel prices rise and Chinese dealer steel prices rebound in 2H19.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Hyundai Motor Company is a passive shareholder in our bank.