Korea Steel:Wait for a better entry point
Investment thesis unchanged despite adjusted down iron ore
With the recent downward revision of iron ore forecasts, our investment thesisremains intact: a) ASP (thus, stocks as well) is likely to peak in H1, along withdeclining steel-making materials and b) upside potential is limited, even underour bullish view on the regional steel market, which is ahead of consensus. Weconclude that risk/reward is balanced with 5.4% ROE and 0.54x PBR (POSCO,beta of 1.2x) and 5.4% ROE and 0.47x PBR (Hyundai Steel, beta of 1.4x). Bothstocks are trading below the historical average PBR, but so does ROE. We stillprefer POSCO over Hyundai Steel, as POSCO is more exposed to potentialregional steel market upside potential, if any.
Steel price trend and outlook: remaining downside potential
We identify that regional steel prices have not fallen at the same pace of thedrop in steel-making materials, which is different from the case in 2010-16. Itis attributable to robust regional steel demand due to low base effect in H1-16,in our view. As demand returned to normal in H2-16, we believe yoymomentum will likely weaken in H2-17. Therefore, we expect steel prices tofollow the further downward pressure in iron ore and coking coal. History saysquarterly stock prices have been moving along with the parent ASP.
Spread vs. quarterly profitability – qoq decline is inevitable
Although the market spread is not identical to profitability, we sense that thetrend has been similar to that of OP/t, based on historical analysis since 2013,in which ROE of POSCO had sunk below 5%. QTD average concurrent HRCspread of global and domestic shrank 15% qoq. As a result, we estimatePOSCO’s OP/t in Q2 could stand at W78k/t (-W13k/t qoq), leading to POSCO’sparent OP at W672bn (-15% qoq). In addition to the relationship betweenaverage selling price and POSCO’s performance, we find that delta of quarterlyOP has played an important role. Given that we forecast a qoq earnings declineuntil Q4, upside potential at the currently neutral valuation is limited. HyundaiSteel’s profitability might improve due to the contribution from rebar and thecaptive client price hike.
YTD Korea demand/supply: tight rebar, not favorable flat products
Domestic retailers’ prices indicate that rebar demand/supply is favorable, whileflat steel is not constructive to mills. YTD rebar price rose 4% without discountto quoted price (vs. the five-year average of a 7% discount). Otherwise, plate,HRC and CRC dropped 3% with a 48% discount (vs. 38% discount), 13.5% and8.6%, respectively. YTD domestic shipment of rebar increased 13.5% yoy, butplate plunged 24% yoy.
POSCO and Hyundai Steel are likely to be in line with consensus in Q2
We maintain Hold on POSCO with a target price of W269,000. We fine-tuneour Q2 operating profit estimates to W1,022bn from W977bn (released on 31March) as average selling prices have been relatively stronger compared to themovement of steel-making materials, despite muted STS. Q3 OP of W817bn is17% lower than consensus, as we factor in a spread drop. We maintain Holdon Hyundai Steel with a target price of W58,000. We raise our Q3 OPestimates to W412bn from W382bn (released on 27 April) to reflect aretroactive autosheet price hike at W60k/t from May and the robust rebarmarket. We use GGM for valuation. The regional steel market situation is a riskto our view (details on page 8-11).