POSCO's Exposure to Risks Dims Long-Term Growth Potential

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We issued an updated research report on South Korean steel producer POSCOPKX on Jan 2, 2017. The company is one of the largest steel producers in the world in terms of output. We believe that the company has strong long-term growth potential, but its exposure to risks has dimmed its growth opportunities.

In 2016, POSCO's American Depository Receipt (ADR) yielded 48.6% return, underperforming 70.8% return generated by the Zacks categorized Steel Producers industry.

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 is highly leveraged, with non-current liabilities of approximately KRW 14.9 trillion at the end of third-quarter 2016. Its liability to equity ratio was 70.4% at end of the quarter. If unchecked, higher debt levels might increase the company's financial obligations and prove to be detrimental to its profitability.

Moreover, POSCO's geographical expansion of business has given rise to geopolitical and foreign currency fluctuation risks. With respect to price, the company operates in a highly competitive environment.

Over the last 60 days, earnings estimates for the stock declined 2.4% to $5.30 per ADR for 2017.

Notwithstanding the negative impacts of above-mentioned woes, we believe that POSCO stands to benefit from its regional diversifications and superior product portfolio including hot-rolled and cold-rolled products, plates, wire rods, silicon steel sheets and stainless steel products. In addition, business diversification, with operations in growth businesses including energy, materials, infrastructure and trading, works in the company's favor.

In addition, POSCO has undertaken measures to dispose some of its profitable but non-core assets, in order to improve its core competitiveness. By 2017, the company aims to reduce its low-performing domestic affiliates by 50% and overseas businesses by 30%. In the first nine months of 2016, the company has restructured 16 subsidiaries while it sold 14 assets.

Over the long run, POSCO aims to improve its businesses and services. By 2017, the company targets to generate earnings before interest, tax, depreciation and amortization (EBITDA) of KRW 7.5 trillion and achieve debt/EBITDA ratio of 3.1x. Also, the company intends to improve its cash position and profitability by reducing KRW 500 billion in costs annually and decrease consolidated debt by KRW 6.7 trillion to KRW 20.7 trillion.

We believe that the above-mentioned headwinds and tailwinds clearly justify POSCO's Zacks Rank #3 (Hold).

Some better-ranked stocks in the industry include Angang Steel Company Limited ANGGY , Schnitzer Steel Industries, Inc. SCHN and AK Steel Holding Corporation AKS . While both Angang Steel Company and Schnitzer Steel Industries sport a Zacks Rank #1 (Strong Buy), AK Steel Holding carries a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

Angang Steel Company Limited's earnings estimates for 2017 have been revised upward over the last 60 days.

Schnitzer Steel Industries, Inc. reported better-than-expected results in the last four quarters, with an average earnings surprise of 71.32%. Also, its earnings estimates on the stock improved for fiscal 2017 and 2018, over the last 60 days.

AK Steel Holding Corporation's average positive earnings surprise was 170.80% for the last four quarters. Also, its earnings estimates for 2017 have been revised upward over the last 60 days.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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