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Morningstar | Posco's 2Q18 Results Above Expectation; FVE Increased to KRW 365,000 per share ($81 per ADR)

Posco's second-quarter 2018 EBIT increased by 28% year over year to KRW 1.25 trillion, and is above our expectations. This is mainly due to stronger-than-expected contribution from its steel and trading divisions, partly mitigated by weaker-than-expected contribution from its energy and chemicals, materials and others divisions. After factoring in the stronger results and incorporating our latest commodities price deck, we marginally increased our fair value estimate to KRW 365,000 (from KRW 360,000) per share while lowered our fair value estimate for its ADR to $81 per ADR from $83 due to the strengthening U.S. dollar. Our no-moat and stable moat trend ratings remain intact. We also increased our uncertainty rating to high from medium as we expect the steel industry to remain volatile and will continue to suffer from overcapacity issues. In our view, there will be limited upside for Posco's share price in the near term, due to concerns of a trade war between the U.S. and China.

Posco increased its revenue guidance for 2018 to KRW 64.1 trillion (from KRW 63 trillion) on the back of 1.4 million tons (from 1.2 million tons) increase in steel shipments. In terms of steel demand outlook, management have seen an improvement in demand from Korean shipbuilders and they expect this trend to continue. This has enabled the company to raise plate prices in first-half 2018 and Posco expects to raise plate prices in second-half 2018 as well. On the flip-side, demand from the auto and construction industries are expected to remain weak due to weak consumer sentiment, sluggish housing market and weak infrastructure investments.

Posco continues to reiterate its plans to expand in the electric vehicle ecosystem and is aiming to generate KRW 17 trillion of annual revenue from this business (which includes cathode, anode, lithium, and nickel) by 2030. Cathode materials will be the main contributor by contributing more than KRW 11 trillion of revenue. We continue to view management's strategy to increase sales of high-grade steel products and alloys, focus in technological advancement, restructure businesses, and identify new growth opportunities as the right moves going forward. However, the positive impact from these initiatives are expected to be partly mitigated by the weak performance of the steel division. In the long term, we think the firm's midcycle EBIT margin will drop to 6.4% in 2022 from 7.6% in 2017 mainly due to earnings decline in the steel division, as competition in the steel industry remains intense in an overcapacity environment.