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Zacks Investment Research downgraded POSCO to a Zacks Rank #5 (Strong sell) on Apr 4, 2013.

Why the Downgrade?

Currently, POSCO is the world’s third largest steelmaker on the basis of output with attractive long-term growth prospects. Global steel demand is on the rise with an expected growth rate of 3% in 2013; being largely pushed by restocking activities in China and strong demand from the U.S, India and Southeast Asian countries. Also, to leverage benefits from the growing demand, the company has been expanding its operations and production capabilities.

Despite these positives, the company’s weak financial results in 2012 have marred the near-term outlook for POSCO. The company posted its annual results on Jan 29, 2013 and since then its earnings estimates have seen a downward movement. The Zacks Consensus Estimate for 2013 has gone down by 6.4% to $8.70 while for 2014, the estimate plummeted 17.7% to $8.35.

A small recap of 2012 financial results shows that net income in the year fell by 35.8% year over year, due primarily to a decline in revenue generation and increase in costs and expenses.  The steel sector’s poor performance was the prime reason for a 7.7% fall in consolidated revenue of POSCO.   

Cost of goods sold as a percentage of revenue continued to grow from roughly 82.9% in 2010 to 86.8% in 2011 and 88.3% in 2012. Selling and administrative expenses also increased in the year resulting in an overall fall of 290 basis points in operating margin.

Also, the company’s net earnings per ADR in the fourth quarter fell 15.4% short of the Zacks Consensus Estimate for the quarter. This, combined with the previous quarter’s negative earnings surprise of 5.0%, give us an average negative earnings surprise of 10.2%. Thus, POSCO’s weak financial results, falling earnings estimate and negative earnings surprises have raised our concerns over its results in the coming quarters/years.

Other Stocks to Consider

POSCO is a $21.3 billion Korean steel maker. Other stocks to watch out for in the industry are Shiloh Industries Inc. (SHLO), Gibraltar Industries, Inc. (ROCK - Analyst Report) and Nippon Steel & Sumitomo Metal Corporation (NSSMY), each holding a Zacks Rank #1 (Strong Buy)

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