POSCO Strengthens in Australia – Analyst Blog

Korean steel maker, POSCO (PKX) remains well-positioned to leverage from its expansion into the fast-growing markets. Following a 70% stake acquisition in Australia’s Sutton Forest coal mine, the company has acquired a 24.5% share in API (Australian Premium Iron) Iron Ore Mine. The deal was approved at the company’s board meeting on July 16.

The Iron Ore mine is located in Australia’s northeast region of Pilbara and the stake acquisition will cost approximately 183 million AUD (approximately 194.6 billion KRW) to POSCO. Apart from this, the company will be bearing development costs necessary to carry out the project.

As per the terms of the transaction, POSCO will receive a supply of roughly 9.8 million tons of iron ores from the mine’s annual capacity of 40 million tons when fully operational in 2014. The deal increases the company’s self-sufficiency in iron ore from 18% to 34%. The company intends to use the acquired iron ore for steel manufacturing (both domestic and international) and for supplying to its counterparts in countries like China.

Following POSCO’s investment, roughly 50% of the API mine will be owned by Aquila and 25.5% by American Metal and Coal International (AMCI).

Apart from investments in Australia, the company is working to expand its footprints in China (contract with Jilin Province), India (Orissa project and joint venture with SAIL), Indonesia (Krakatau steel project) and Brazil (20% stake in Brazilian steelworks project together with Dongkuk Steel Mill and Vale). POSCO anticipates that global steel demand will grow 12% in 2010 due to continued economic recovery with domestic demand rising 16%.

Despite being endowed with benefits from regional diversification, POSCO’s operating performance in the quarters ahead is expected to be disappointing. Lackluster operating earnings guidance based on higher raw material costs and anticipated increase in Chinese steel volume exports for the second half of 2010 play the spoil-sport. On the steel price front, POSCO’s steel prices will be challenged by the falling spot prices for steel in China due to declining domestic iron ore costs.

Moreover, financing of huge overseas investment plans will result in an increase in the company’s debt levels. Higher debt together with risks from volatility in foreign exchange and the cyclical nature of the industry will be detrimental to the company’s financial results.

Hence, we maintain an Underperform recommendation on POSCO, as supported by Zacks #5 (Strong Sell) Rank.