EUR 850.00 For Business Accounts Only

Morningstar | Posco’s Fiscal-Year 2018 Within Expectation; Net Income Misses on One-Off Impairments; FVE Cut

Posco’s full-year 2018 EBIT increased by 20% year over year to KRW 5.54 trillion from KRW 4.62 trillion in 2017, within our expectations. However, net income decreased by 39% year over year to KRW 1.69 trillion from KRW 2.79 trillion in 2017 mainly due to one-off impairment charges of KRW 1.14 trillion, lower gains from selling of available-for-sale securities, and higher income tax charges. Excluding the one-off impairments, net income would have increased by 2% year over year. For fourth-quarter 2018, EBIT increased by 10% year over year to KRW 1.27 trillion from KRW 1.15 trillion from the same period last year. The strong 2018 performance is mainly due to stronger contribution from its Steel, Trading, Engineering and Construction and Chemicals, Materials, and other divisions that was partly mitigated by weaker contribution from its Energy and ICT divisions. The robust performance in its steel division is mainly driven by an increase in shipments and steel prices on the back of a tighter steel market benefiting from the steel capacity rationalization in China and a reduction of net exports of steel from China. On the other hand, the disappointing performance in its Energy division is due to the increase in fuel prices for its power generation facilities as well as the restructuring of its fuel cell business. After fine-tuning our model and updating our foreign exchange forecasts, we lowered our fair value estimate for Posco marginally to KRW 295,000 per share (from KRW 300,000) while our fair value estimate of $66 per ADR is unchanged. Our no-moat and stable moat trend ratings remains intact. We think that the shares are slightly undervalued at the current price with long-term overcapacity issues in the steel industry factored in.

In terms of guidance for full-year 2019, Posco is forecasting revenue to increase slightly to KRW 66.3 trillion from KRW 65 trillion in 2018 on roughly flat steel shipments. Management is also guiding for an increase in capital expenditures to up to KRW 6.1 trillion in 2019 from KRW 2.7 trillion in 2018. We do not expect the management to fully utilize the budgeted capital expenditures in 2019 as we believe they will remain prudent in their capital allocation. In terms of steel demand outlook, management expects demand from the autos and construction sectors will continue to decline while demand from the shipbuilding industry to continue to grow year over year in 2019.

For its mid-term plan, management is targeting to increase gross sales to KRW 123 trillion in 2021 from KRW 103 trillion in 2018, underpinned by growth from non-steel and new growth businesses that are mainly related to its energy material and battery materials businesses. In terms of consolidated revenue (after deducting intersegment sales), management is expecting it to grow to KRW 78 trillion in 2021 from KRW 65 trillion in 2018. We continue to view management’s strategy to increase sales of high-grade steel products and alloys, focus on technological advancement, and invest in new growth opportunities such as gas field and battery materials as the right moves going forward. However, we think that the company should remain prudent on its capital allocations and expand in a more moderate manner. Going forward, due to our bearish long-term view on the steel sector, we expect the positive impact from these initiatives to be partly mitigated by the weak performance of the Steel division. In the long term, we think that the midcycle EBIT margin will drop to 5.6% in 2023 from 8.5% in 2018 mainly due to a decline in the Steel division as competition in the steel industry remains intense in an overcapacity environment.