Costs Weighing on POSCO

POSCO (PKX - Analyst Report) is well-positioned to achieve long-term growth as the company is rapidly shifting production to higher-margin products and undertaking investments to secure low-cost raw material supply. Moreover, the company's new FINEX technology will provide meaningful cost-savings over the long term.

However, the company's margins may suffer from high energy and raw material costs like iron ore and coking coal. Moreover, concerns of an economic slowdown cast a shadow on the future steel price outlook. We reiterate our Hold recommendation on shares of POSCO.

The company is rapidly increasing the proportion of value-added products in its product mix. POSCO expects value-added products to constitute 80% of revenue in 2008. 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.

POSCO's second quarter net income increased 34.0% year-over-year to $1,476.1 million led by strong sales, higher steel prices, and cost-cutting efforts. Operating income increased 51.2% year-over-year to $1,866.2 million. Revenue increased 28.3% year-over-year to $7,383.4 million. Crude steel production of POSCO during the quarter increased 7.8% to 8.429 million tons from 7.817 million tons a year ago.

In June, POSCO bought 10% stake in Macarthur Coal, an Australian coal mine. The company also participated in the development of a manganese mine in South Africa. In addition, POSCO has long-term contracts with raw material suppliers to cope with the ongoing cost-side pressures. For the full year 2008, the company expects cost savings of KRW860.6 billion (up from the previous target of KRW750.6 billion), of which 47.5% was achieved during the first two quarters. Finally, the company is also expanding its operations in fast growing markets like China, India, Japan and Brazil.

Read the full analyst report on PKX