The cyclical nature of the industry forces us to downgrade our recommendation on Korea-based POSCO (PKX) from Outperform to Neutral.
 
The global economic downturn has adversely affected demand for products in Korea and overseas, such as those in the automobile, shipbuilding and construction industries, which have led companies to reduce their production.
 
POSCO has decided to adjust its future crude steel production or sales prices on an on-going basis subject to market demand for the products, the production outlook of the global steel industry and global economic conditions in general. The current market conditions are unpredictable.
 
We expect the general decline in demand for steel products to continue to prevail at least in the near future, which may adversely affect the business of POSCO.
 
However, POSCO is rapidly increasing the proportion of value-added products in its product mix (such as cold-rolled steel, automotive steel plates and electric steel sheets). Since these products attract better realizations and margins over commodity hot-rolled coils, we expect POSCO to outperform its peer group in terms of revenue growth and earnings.
 
Moreover, the company is focused on cutting down operating costs, having reduced it by KRW 322.3 billion in the first quarter of fiscal 2010. Cost saving would definitely enhance top line results to a greater extent.
 
Nevertheless, there has been a recent trend of industry consolidation. For example, the merger of Mittal and Arcelor in 2006 created a company with approximately 10% of global steel production capacity. Competition from global steel manufacturers with expanded production capacity, such as ArcelorMittal (MT), and new market entrants, especially from China and India , could result in significant price competition, declining margins and reduction in revenue.
 
With respect to price, POSCO operates in a highly-competitive environment. Due to high start-up costs, the economics of operating a steelworks facility on a continuous basis may encourage mill operators to maintain high levels of output, even in times of low demand, which increases the pressure on industry profit margins. In addition, competitive pressure on steel prices may hugely affect the company’s profitability.
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