January 30, 2007 POSCO (005490) Steel/Non-ferrous metals Richard Kim, CFA 82-2-3276-6186 richard.kim@truefriend.com Eun Jung Yang, CFA 82-2-3276-6239 ejyang@truefriend.com Long-term BUY (Maintain) W325,000 (January 29, 2007) Price target: 6 months W400,000 (+23.1%) Share data 52-Week High/Low (won) 336,000/207,000 Market cap (USD mn) 30,128.7 Shares outstanding (mn) 87.1 Dividend yield (%, FY07F) 2.5 Foreign ownership (%) 62.0 Price performance (%) Absolute Relative to Kospi 1m 5.18 10.68 3m 22.64 22.01 6m 40.69 33.88 The great company We maintain Long-term BUY and raise the six-month price target to W400,000. We derived the price target by averaging share prices calculated using the global peer average PER of 10.75x and EV/EBITDA of 5.33x and then applying a 4% discount. The price target of W400,000 equals a 2007F implied PER of 10.43x. Ongoing structural change in the steel industry. Currently, the most noteworthy changes to the global steel market are accelerating consolidation and continued rapid growth of demand. The first change, consolidation, is allowing steelmakers to adjust production volumes to better respond to changing demand, to have the upper hand in controlling supply and demand and eventually prices, and ultimately to create new value. The second, fast-rising demand, is opening a new growth era for the industry and this is due mainly to the BRIC economies rapid growth, especially China, since 2000. We estimate the steel industry to grow at a CAGR of 4.9% until 2010. Robust growth potential ahead. POSCO plans to raise the sales portion of eight strategic products from 57% in 2006 to 80% in 2008 to strengthen profitability and ensure earnings stability. Moreover, to overcome limited growth domestically, the company plans to increase overseas investment in India, China, Vietnam and Mexico and raise crude steel production from the current 31mn tonnes to 50mn tonnes. Price Chart 2006.7.26=100 145 140 POSCO 135 130 125 120 KOSPI 115 110 105 100 95 06.7 06.8 06.9 06.10 06.11 06.12 07.1 Source: DATASTREAM 2004 2005 2006F 2007F 2008F Sales (W bn) 19,792 21,695 19,934 21,252 21,730 % chg. (YoY) 37.8 9.6-8.1 6.6 2.2 Operating profit (W bn) 5,054 5,912 3,988 4,101 4,372 Recurring profit (W bn) 5,231 5,354 4,248 4,428 4,592 Net profit (W bn) 3,826 4,013 3,080 3,210 3,329 EBITDA (W bn) 6,740 6,861 5,821 6,211 6,402 EPS (won) 47,301 50,670 36,797 38,357 39,776 % chg. (YoY) 94.6 7.1-27.4 4.2 3.7 BPS (Won) 188,408 231,724 260,647 290,403 321,375 PER (x) 3.5 4.0 8.7 8.3 8.2 PBR (x) 0.9 0.9 1.2 1.1 1.0 EV/EBITDA (x) 1.9 2.2 4.1 3.8 3.6 OP margin (%) 25.5 27.2 20.0 19.3 20.1 EBITDA margin (%) 34.1 31.6 29.2 29.2 29.5 ROE (%) 26.3 22.5 15.1 14.2 13.2 Net debt (W bn) -1,074-1,936-2,027-2,729-3,591 Int. coverage (x) 35.15 66.95 38.72 33.94 42.27 D/E ratio (%) 32.6 24.0 22.4 20.3 16.6 Source: Korea Investment & Securities Korea Investment & Securities Co., Ltd. does not own over 1% shares of POSCO as of January 30, 2007. Korea Investment & Securities Co., Ltd has issued ELW with underlying stock of POSCO, and is the liquidity provider as of January 30, 2007. Korea Investment & Securities Co., Ltd. has provided this report to a third party. Neither the analyst covering this company nor his spouse owns any POSCO shares as of 30 January 2007. The contents of this report accurately reflect the analyst s views. Under no circumstances were there any external pressures or intervention during the analysis process or the preparation of this report. Prepared by: Richard Kim, Eun Jung Yang
Korea Investment & Securities Co., Ltd. stock ratings based on six-month forward share price performance relative to market index Long-term Buy: Expected to outperform the market by 10%p or more, and has strong growth potential or high stability and profitability. BUY: Expected to outperform the market by 10%p or more. Hold: Expected to either outperform or underperform the market by less than 10%p. Underweight: Expected to underperform the market by 10%p or more. * As of December 26, 2006, Korea Investment & Securities Co., Ltd. has adopted a new stock rating system comprised of Long-term Buy, BUY, Hold and Underweight. Korea Investment & Securities Co., Ltd. sector ratings for the next six months Overweight: Recommend increasing the sector s weighting in the portfolio compared to its respective weighting in the Kospi (Kosdaq) based on market capitalization. Neutral: Recommend maintaining the sector s weighting in the portfolio in line with its respective weighting in the Kospi (Kosdaq) based on market capitalization. Underweight: Recommend reducing the sector s weighting in the portfolio compared to its respective weighting in the Kospi (Kosdaq) based on market capitalization. Analyst Certification I/We, as the research analyst/analysts who prepared the report, do hereby certify that the views expressed in the research report accurately reflect my/our personal views about the subject securities and issuers discussed in the report. I/We do hereby also certify that no part of my/our compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report. This report was written by Korea Investment & Securities Co., Ltd. to help its clients invest in securities over which Korea Investment & Securities Co., Ltd. holds the copyright. This report cannot be copied, redistributed, forwarded or altered in any way without the consent of Korea Investment & Securities Co., Ltd. This report has been prepared by Korea Investment & Securities Co., Ltd. and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. We make no representation as to its accuracy or completeness and it should not be relied upon as such. The company accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. The final investment decision is based on the client s judgment, and this report cannot be used as evidence in any legal dispute related to investment decisions.
Raised price target We derived the price target by averaging share prices calculated using the global peer average PER of 10.75x and EV/EBITDA of 5.33x and then applying a 4% discount. The price target of W400,000 equals a 2007F implied PER of 10.43x. At present, POSCO stock trades at 29%, 63% and 41% discounts to the global peer average PER, PBR and EV/EBITDA. As the robust growth potential backed by increasing overseas investment has not yet been factored in to the current valuations, we believe POSCO s growth potential will shore up its share price over time. Price target calculation Fair value based on EV/EBITDA multiple 2007F EBITDA (W bn) 6,211 Market cap (W bn) 36,742 Net debt (W bn) -2,027 Treasury stocks (W bn) -1,612 EV (market cap+net debt+treasury stocks) 33,103 Shares outstanding ('000 shares) 87,187 Global peer average EV/EBITDA (x) 5.33 Fair value (won)-(a) 421,414 Fair value based on PER multiple Global peer average PER 10.75 2007F EPS (x) 38,357 Fair value (won)-(b) 412,334 Price target Average of fair values (won) - [(A)+(B)]/2 416,874 Price target (won) 400,000 Source: Korea Investment & Securities Valuations of global peers 96%of fair value Stock Share P/E P/B EV/EBITDA ROE code price 2006F2007F2006F2007F2006F 2007F2006F2007F (Local currency) (x) (x) (x) (x) (x) (x) (%) (%) POSCO 005490.KR 318,500 8.7 8.3 1.2 1.1 4.1 3.8 15.1 14.2 Mittal Steel MT.US 46 8.4 7.8 1.6 1.4 3.9 2.7 19.5 16.1 Arcelor LOR.FR 45 8.8 8.5 1.7 1.4 5.6 5.2 21.2 17.0 US Steel X.US 78 7.1 9.0 2.2 1.9 4.1 4.4 34.5 20.6 Nucor NUE.US 61 12.0 12.7 3.2 2.8 5.7 5.6 29.7 25.3 Nippon Steel 5401.JP 704 14.6 14.1 2.5 2.2 7.8 7.2 18.0 16.4 JFE 5411.JP 6,690 13.1 12.6 2.6 2.2 7.0 6.5 21.0 18.3 China Steel 2002.TW 33 9.9 8.7 1.9 1.8 7.5 6.3 18.9 21.2 Baosteel 600019.CN 10 14.1 11.9 2.1 2.0 6.5 5.4 15.5 17.2 Corus CS/.GB 6 14.5 13.6 1.4 1.3 7.4 7.2 9.7 8.5 ThyssenKrupp 35 10.1 11.1 1.8 1.6 4.0 4.2 17.8 15.0 Average 11.01 10.75 2.02 1.79 5.79 5.33 20.08 17.25 POSCO discount to average 27% 29% 65% 63% 40% 41% 33% 21% Source: IBES, Korea Investment & Securities Ongoing structural change 1. Global consolidation stable prices and more bargaining power The steel industry can be regarded as the most undervalued sector in the world. The reason behind the excessive discount lies in destroyed corporate values that occurred during the following process: Steelmakers failed to adjust production to deal with changing demand supply exceeded demand prices fell the operating profits of steelmakers plunged and wiped out corporate values. As the market was fragmented, steelmakers were unable to control production. Moreover, as the steel industry is a capital-intensive industry, fixed costs such as depreciation account for a large portion of expenses, so that even a 1% drop in average selling price trims as much as 4-6% from operating profit. This means the steel industry has a high operating leverage stemming from earnings volatility. However, a period of global consolidation appeared. The world s largest producer, Mittal Steel (Netherlands), bought out the second largest, Arcelor (Luxembourg), and is driving the consolidation trend in the sector. We see a bright spot that industrial consolidation is sweeping the market and bringing benefits to steelmakers stronger bargaining power against both upstream and downstream industries and the ability to adjust production volume to cope with changing demand and the resulting stable prices. The recent global crude steel production volume shows that the US and Europe have reduced production to be more responsive to demand. The December crude steel production volume inched up a mere 0.5% worldwide but dipped 2.6% and 6.1% in the European Union (25 countries) and US, respectively. We believe the production cut in Europe and US was due mainly to Mittal Steel-led ongoing consolidation and the resulting concentration within the industry. As global consolidation presents greater value for investors, it will continue and be a valuation re-rating factor for the industry. 2. New growth era until 2010 global steel demand will grow at a CAGR of 4.9% The steel industry boomed during 1950-70 as seen in the annualized 5.9% growth of global crude steel production. The next three decades then witnessed slow growth until 2000 with an annualized rate of 1.2%. However, a new growth era has begun since 2000 with the rapid rise of the BRIC economies, especially China. According to the International Iron & Steel Institute, global steel demand will rapidly rise at a CAGR of 4.9% until 2010. The BRIC countries China (annualized 8.4% growth of steel demand), India (7%) and the CIS (5%) will be the major drivers of such strong growth. Global steel demand growth forecast Annual growth to 2010 EU (15) 2.0% EU (25) 2.5% CIS 5.0% NAFTA 1.9% South America 3.9% Japan 0.4% India 7.0% China 8.4% Korea and Taiwan 3.1% Rest of the world 4.0% World 4.9% World (excl. China) 3.0% Source: IISI, Korea Investment & Securities 3
Global steel production volume trend (mn tonnes) 1,200 1,000 800 600 400 1950~1970 CAGR 5.9% 1970~2000 CAGR 1.2% 2000~2005 CAGR 5.9% 36 in 2008. 2. Larger portion of high value-added products POSCO has selected eight strategic products to: 1) effectively cope with increasing commodity steel exports from China and steel demand polarization into high-end and lowend steel, and 2) ensure price stability with higher selling prices for strategic products amid volatile market conditions. POSCO plans to increase the sales portion of the eight strategic products from 57% in 2006 to 63% in 2007 and 80% in 2008. 200-1950 1960 1970 1980 1990 2000 2005 Source: IISI, Korea Investment & Securities POSCO specifics We believe the following three factors will be upward catalysts for POSCO. 1. Growth driven by overseas investment Korea s per capita finished steel consumption came in at 975 kilograms in 2005, the world s most. This suggests that further growth of the domestic steel market is very limited. As such, POSCO is increasing overseas investment to overcome the limited growth potential domestically. By destination, POSCO s overseas investment plan is summarized below. India In the first phase, POSCO aims to build a 4mn-tonne integrated mill by 2010 two FINEX plants with annual capacities of 2mn tonnes each to produce 2.5mn tonnes of hot-rolled coil and 1.5mn tonnes of slab. In the second phase, after the integrated mill completion in 2010, the company will expand the mill s capacity by 12mn tonnes to nearly equal 80% of the Gwangyang mill s capacity. What is noteworthy for the India project is that it includes development of an iron ore mine located 290 kilometres from the mill. If the development of the mine goes smoothly, it will produce 600mn tonnes of ore for the next 30 years or 20mn tonnes annually. The India project is expected to spur both growth and profitability by enabling POSCO to enjoy the cost-saving FINEX technology and having a source of cheap iron ore. Vietnam In the first phase, POSCO plans to build a 70mntonne cold-roll mill by December 2009. In the second phase, the company will set up a 3mn-tonne hot-roll mill and expand the cold-roll mill s capacity by end-2012. According to POSCO s estimates, the total investment will be more than USD1.1bn. After construction is completed, POSCO plans to use slab made at the Indian mill to make hot-rolled steel. With the Vietnamese economy on a fast growth track, steel demand will likely remain strong for a long time. Mexico POSCO will establish a continuous galvanized steel line (CGI) to make 400,000 tonnes of automotive sheets per year by June 2009. POSCO's eight strategic products 2006 2008 Automotive sheets 5.1 6 High-quality cold-rolled sheets/strips 3.6 4.8 High-quality American Petroleum Institute steel 0.7 1.9 High-quality hot-rolled sheets/strips 1.9 4.5 Thermo-mechanical control process steel for ships 1.3 2.7 Electric plates 0.2 0.6 High-quality wire rods 1.3 1.9 Stainless steel 400-series 0.6 1.4 Total (mn tonnes) 15 24 (% of sales volume) 57 80 Source: Company data, Korea Investment & Securities 3. Cost-saving efforts POSCO targets a W500bn cost reduction in 2007. In detail, the company wants to raise the portion of cheap raw materials to save W364.1bn and the remaining savings will come from other material costs of W40.9bn and W35.3bn of energy costs. Changes in recommendation and price target Company (Code) Date Recommendation Target price POSCO (005490) 10-13-04 BUY W240,000 03-14-05 BUY W270,000 06-13-06 BUY W286,000 11-27-06 BUY W320,600 12-22-06 Long-term BUY W320,100 01-30-07 Long-term BUY W400,000 Price target Wider sales network overseas. POSCO plans to raise its number of overseas steel processing centers from 14 in six countries as of 2006 to 25 in eight countries in 2007 and to 4
Balance sheet Fiscal year ending Dec (W bn) 2004 2005 2006F 2007F 2008F Current assets 7,742 8,399 8,597 9,434 10,012 Cash & cash equivalents 782 834 697 891 911 Accounts receivable 1,985 2,110 1,939 2,067 2,180 Inventory 2,109 2,719 2,237 2,385 2,438 Fixed assets 13,625 15,807 17,499 19,258 20,908 Investments 4,059 4,631 4,724 5,432 7,333 Tangible assets 9,203 10,899 12,573 13,677 13,467 Intangible assets 363 278 203 149 108 Total assets 21,367 24,207 26,096 28,692 30,920 Current liabilities 3,221 3,777 2,627 2,809 2,823 Accounts payable 444 445 409 436 445 Short-term borrowings 14 0 0 0 0 Current portion of LT debt 927 931 455 455 455 Long-term debt 2,036 908 2,153 2,026 1,581 Debentures 1,491 442 1,708 1,564 1,120 Long-term borrowings 58 41 30 20 9 Total liabilities 5,257 4,685 4,781 4,836 4,405 Paid-in capital 482 482 482 482 482 Capital surplus 3,771 3,879 3,879 3,879 3,879 Retained earnings 12,864 16,192 18,638 21,179 23,839 Capital adjustments -1,008-1,032-1,685-1,685-1,685 Shareholders' equity 16,110 19,522 21,315 23,856 26,516 Cash flow Fiscal year ending Dec (W bn) 2004 2005 2006F 2007F 2008F C/F from operations 4,955 5,306 4,345 4,525 4,715 Net profit 3,826 4,013 3,080 3,210 3,329 Depreciation 1,445 1,482 1,605 1,822 1,884 Amortization 0 0 0 0 0 Net incr. in W/C -363-480 -63-170 -220 Others 47 292-277 -338-279 C/F from investing -3,342-3,293-3,984-3,652-3,633 Capex -2,027-3,123-3,318-2,965-1,713 Decr. in fixed assets 47 45 0 0 0 Net incr. in current assets -1,377 302-942 -294-330 Incr. in investment 159-441 154-411 -1,618 Others -145-76 123 18 28 C/F from financing -1,705-1,970-451 -713-1,075 Incr. in equity 0 0 0 0 0 Incr. in debt -912-942 855-58 -411 Dividends -525-681 -638-634 -670 Others -269-348 -668-21 5 Increase in cash -92 43-90 159 7 Income statement Fiscal year ending Dec (W bn) 2004 2005 2006F 2007F 2008F Sales 19,792 21,695 19,934 21,252 21,730 Gross profit 6,085 6,992 5,064 5,223 5,525 SG&A expenses 1,031 1,080 1,076 1,122 1,154 Operating profit 5,054 5,912 3,988 4,101 4,372 Non-operating profit 871 747 887 960 896 Interest income 80 63 135 160 177 FX gains 278 230 194 194 141 Equity gains 206 147 340 391 391 Non-operating expenses 694 1,305 627 633 675 Interest expenses 144 88 103 121 103 FX losses 96 87 108 87 87 Equity losses 41 100 30 30 45 Recurring profit 5,231 5,354 4,248 4,428 4,592 EBT 5,234 5,354 4,248 4,428 4,592 Income taxes 1,408 1,341 1,168 1,218 1,263 Net profit 3,826 4,013 3,080 3,210 3,329 Adjusted EBIT 5,294 5,379 4,216 4,389 4,518 EBITDA 6,740 6,861 5,821 6,211 6,402 Key financial data Fiscal year ending Dec 2004 2005 2006F 2007F 2008F Per-share data (won) EPS 47,301 50,670 36,797 38,357 39,776 BPS 188,408 231,724 260,647 290,403 321,375 DPS 8,000 8,000 8,000 8,000 8,000 SPS 223,375 248,834 238,158 253,911 259,621 Growth (%) Sales growth 37.8 9.6-8.1 6.6 2.2 OP growth 65.2 17.0-32.5 2.8 6.6 NP growth 93.2 4.9-23.3 4.2 3.7 EPS growth 94.6 7.1-27.4 4.2 3.7 EBITDA growth 57.5 1.8-15.2 6.7 3.1 Profitability (%) OP margin 25.5 27.2 20.0 19.3 20.1 NP margin 19.3 18.5 15.5 15.1 15.3 EBITDA margin 34.1 31.6 29.2 29.2 29.5 ROA 25.4 25.9 15.9 15.0 14.7 ROE 26.3 22.5 15.1 14.2 13.2 Dividend yield 4.3 4.0 2.5 2.5 2.5 Stability Net debt (W bn) -1,074-1,936-2,027-2,729-3,591 Int. coverage (x) 35.2 66.9 38.7 33.9 42.3 D/E ratio (%) 32.6 24.0 22.4 20.3 16.6 Valuations (x) PER 3.5 4.0 8.7 8.3 8.0 PBR 0.9 0.9 1.2 1.1 1.0 PSR 0.7 0.8 1.3 1.3 1.2 EV/EBITDA 1.9 2.2 4.1 3.8 3.5 5
HEAD OFFICE WON-JAE RHEE, Managing Director (wonjae@truefriend.com +822 3276 5660) SIMON MUN, Director (simonmun@truefriend.com +822 3276 5662) KENNETH KANG, Sales Trading (kenhkang@bloomberg.net +822 3276 5664) 27-1 Yoido-dong, Youngdeungpo-ku, Seoul 150-745, Korea Toll free: US 1 877 309 5218 Fax: 822 3276 5681~3 Telex: K22966 NEW YORK HK KANG, Managing Director (hkkang@kisamerica.com +1 201 592 0631) DY LEE, Sales (dylee@kisamerica.com +1 201 592 9161) JU KIM, Sales (jukim@kisamerica.com +1 201 592 6473) Korea Investment & Securities America, Inc. Two Executive Drive, Suite 640 Fort Lee, NJ 07024 USA Toll free: 1 866 DONGWON Fax: 1 201 592 1409 HONG KONG KYUNG HEE OH, Managing Director (khoh@kisasia.com +852 2530 8901) JOSEPH KIM, Head of Asia Sales (josephkim@kisasia.com +852 2530 8911) JOHN CHANG, Sales (jchang@ kisasia.com +852 2530 8910) ANDREW CUNNINGHAM, Sales (ac@kisasia.com +852 2530 8913) JEONG HEE LEE, Sales, (jeonghee@kisasia.com +852 2530 8912) Korea Investment & Securities Asia, Ltd. Room Suite 2110 Jardine House 1 Connaught Place, Central, Hong Kong Fax: 852-2530-1516 LONDON JJ MOON, Managing Director (jamesmoon@kiseurope.com +44 207 236 4800) KEVIN JEE (kevinjee@kiseurope.com +44 207 236 4800) BRANDON JUNE (brandonjune@kiseurope.com +44 207 236 4800) Korea Investment & Securities Europe, Ltd. 2nd Floor, Cheyne House, Crown Court 62-63 Cheapside, London EC2V 6JP Fax: 44-207-236-4811 Telex: 8812237 TOKYO SK SHIN, Chief Representative (Dongwon@marinet.co.jp +813 5363 5376) Tokyo Representative Office 10F Yotsuya Orchid Building, 23-3, Daikyo-cho, Shinjuku-ku, Tokyo, 160-0015, Japan Fax: 813-3358-8401 This report has been prepared by Korea Investment & Securities Co., Ltd. and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. While all reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. This report is provided solely for the information of professional investors who are expected to make their own investment decisions without undue reliance on this report and the company accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is not intended for the use of private investors. 2007. All rights reserved. No part of this report may be reproduced or distributed in any manner without permission of Korea Investment & Securities Co.,Ltd.