Korean Steel: A Steal?

03/18/2005 12:00 am EST


Gregory Spear

Editor and President, The Spear Report

Gregory Spear and Steve Sjuggerud provide two of the most interesting newsletters around. Both offer in-depth fundamental analysis in a clear-cut and understandable manner. Both also were recently attracted to the same stock--Korean steel maker, Posco.

"We continue to emphasize non-cyclical plays in our profiles, which is a more conservative way to deploy capital after a two-year market advance," says Gregory Spear, editor of The Spear Report. "For the most part, we are now looking for non-cyclical companies that are growing at a much faster pace than the average corporation. Homebuilders and energy stocks have been obvious leaders. Another industry that may be experiencing the same transformation is steel.

"Posco (PKX NYSE), a South Korean steel maker, is a direct play on the continuing growth of China and on the Japanese auto industry. China is expanding its economy at a 9% pace and yet inflation is less than 4% because the Chinese are a nation of savers. Should the Asian economic expansion falter, PKX would feel the heat. However, the company is one of the fastest growing and most profitable steel companies out there. We expect Chinese growth to continue at a robust pace well into 2008, the year the Olympics will be held there. Japan's economy appears to be improving as well. Toyota, which now uses a minimal amount of Posco-made steel sheet for interior parts, plans to start using PKX steel for doors and other major exterior components in 2006.

"For the latest quarter, profits were $1.1 billion, up 155% year-over-year and up 30% sequentially. For the year, sales rose 38% and profits were up 93% to $3.67 billion. That is the kind of earnings leverage one used to see in tech stocks. But the stock trades at a low multiple because the industry is perceived as cyclical. Do steel producers deserve higher multiples in a global economy where demand is now outpacing supply, and supply growth is constrained? Multiple expansions are happening in the energy sector. It is happening in the housing industry. If it happens in the steel industry, then this is just the beginning for PKX. We also recommend that over the next few years investors diversify their core holdings with an increasing emphasis on international names. PKX is an ideal candidate for such a long-term strategy."

"Nothing beats a good old-fashioned emerging markets boom," says Steve Sjuggerud, editor of True Wealth. "They come every decade or so. We're extremely overdue for a good run, as the last emerging markets boom peaked in 1994 and bottomed in 2001. Now it seems we're off to the races again and our plan is to get on board for the ride. When money flows to emerging markets, much of it will flow to Korea. Why? Because the job performance of many emerging markets fund managers will be based on how they do in relation to the MSCI Emerging Markets stock index, and South Korea has the largest weight in that index. In plain English, that means that as money flows into emerging markets funds, much of it will be invested in Korea.

"To benefit from this expected move into Korean stocks, we suggest Korean steel maker Posco. The stock is easy to buy, trades at a super cheap 2005 p/e of 4.8, and pays a nice dividend of 5%. Wow. I first became familiar with Posco when it started trading in the US over a decade ago. Back then, it was a state-run Korean steel maker called Pohang Iron & Steel. The stock was cheap, but for a good reason, as it was a state-run company. But much has changed since then. Posco privatized in late 2000. It is now the world's most efficient operator and world's lowest cost producer.

"Meanwhile, the company is generating so much cash (earning double-digit net margins) that it will have enough to pay off its debt by the end of this year--hard to believe in a capital-intensive industry. Yes, Posco is producing steel in Korea, and Korea is at China's doorstep. But in our view, the primary attraction is how cheap the stock is. We believe that it deserves to trade at a premium to its world peers instead of a discount, and we may be in the midst of another emerging markets boom."

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