With economic weakness stretching from Europe to Asia to North America, there is no shortage of resource and commodity companies that appear to be trading below fair value. That's not quite so true in the steel sector, though, where valuations have seemingly held up a little better. Unlike global steel giant ArcelorMittal (NYSE:MT), which does appear to be meaningfully undervalued, South Korea's POSCO (NYSE:PKX) appears to be enjoying a relatively healthy benefit of the doubt from the Street. While I certainly wouldn't argue that POSCO will go along for the ride when investor sentiment on steel turns more positive, I think the margin of error here is too slight to make this a compelling buy today, even with the stock near a 52-week low.
 
When Good Is Bad
I think the biggest problem with POSCO is that it's such a well-run steel company and that fact is so widely known. POSCO is not only the world's third-largest steel producer, but it's well-known for having/developing superior technology and operating with exceptional efficiency. Accordingly, investors are happy to assign above-average multiples to the stock, not unlike the above-average multiples that American mini-mill operators Nucor (NYSE:NUE) and Steel Dynamics (Nasdaq:STLD) have long enjoyed due to their efficiency and technological sophistication.
 
SEE: Spread Out Risk With Sector-Based ETFs

It sounds twisted, but the reality is that better operators have less to gain (relatively speaking) when conditions improve. As POSCO already operates so efficiently, it's not as though better prices will “rescue” the numbers and inferior producers will see much better improvement in their profits and cash flow during the next up cycle. To that end, a company like AK Steel (NYSE:AKS) could ultimately offer more leverage/upside to a steel rebound.
 
It's All About Pricing Now, And That's Not Helping
Shipment volumes are pretty soft for much of the steel industry, but not soft enough to underpin any sustained price increases. While POSCO has reported good demand for sheet steel used in autos, shipbuilding is pretty weak and demand for appliances has softened as well.
 
POSCO is getting some relief from input costs, but not enough to really drive improved results. Not unlike ArcelorMittal, POSCO has made it a priority to become more self-sufficient. The company has ownership stakes in more than 20 mining operations around the world, and is looking to go from roughly 30% self-sufficiency in coal and iron back in 2011 to almost 50% in 2014. That's not always as easy as it sounds, though, and POSCO is seeing some of the same production cost increases that have impacted coal and iron companies like Peabody (NYSE:BTU) and Vale (Nasdaq: VALE).
 
There is also the question of whether POSCO's rivals will remain rational. POSCO has about half of the South Korean steel market and Hyundai Steel and Hyundai Hysco seem to be acting pretty responsibly with respect to capacity. The bigger concern, not surprisingly, is China. More than a quarter of POSCO's exports go to China and I would argue that even in this downturn there are still many operators behaving in pretty irrational ways.
 
The Bottom Line
I suppose the real question for investors is just how much they are willing to pay for what POSCO offers. Certainly the company deserves a premium valuation for its demonstrated efficiency, technology (including technology that allows them to use inferior grades of iron and coal), and growing self-sufficiency. Likewise, I do believe the company should be rewarded for its efforts to expand into markets like India, Indonesia, and Vietnam.
 
But how much? ArcelorMittal looks notably undervalued at about 6.5x forward EBITDA, but a 7.5x multiple for POSCO only produces a target in the low $60's. If you go as high as 8.5x the resulting target price starts to get interesting (close to $80), but that's a pretty steep multiple for the sector even if you include companies like Nucor as peers. With that, I have a hard time getting excited about POSCO shares today – I think this is a top-notch steel company, but the market already knows that and has priced it accordingly.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Markets

    The 4 Biggest Russian Mining Companies

    Discover information about the metals and mining industry in Russia, along with information on some of the largest Russian mining companies.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!