POSCO (PKX) is the fourth largest integrated steel maker in the world. The shares of most of its competitors have done quite well in the past 6 month, while the shares of POSCO have been under pressure. Why? Pricing! Investors have been criticizing POSCO’s hesitance to raise their price. Weak pricing power usually turns me down especially when the cost inflation is high. In the case of POSCO, this is not because of weak pricing power. In fact, major domestic and Asian competitors have aggressively raised price. POSCO choose to sacrifice near term profit to keep a good long term customer relationship. The market took this strategy negatively which is reflected in POSCO’s stock price. I do not have a value for the intangible customer relationship. As POSCO trades in line with its global competitors at 11 times earning, the market apparently gives no value for the improved customer relationship, which I believe will pay off in the long run.

POSCO’s management team is best of the breed in the steel business. POSCO operates its steel business in a tough environment. 1, rapidly growing Chinese steel producing capacity intensifies price competition in east Asian market. 2, POSCO is heavily exposed to stainless steel, which has been very volatile in the recent years. 3, POSCO has less internally supplied raw material. POSCO also prices their products below domestic competition. Yet they generate better gross margin (21% in the most recent quanter vs Mittal’s 12%, and US steel’s 7%). This is achieved after POSCO exprense its massive R&D in COGS. The ROE of POSCO has been in low 20s and high teens in spite of lower than average financial leverage and massive cash and equity investment on its balance sheet (15% of Equity is in Cash and equivalent and 32.2% in equity investment). Its long term debt to equity ration is 23.7% vs Mittal’s 74.5% and US steel’s 121%

POSCO’s strategy is to leverage its technology innovation to achieve lower cost and product differentiation. Due to its scale, POSCO has successfully leveraged its R&D spending. An interesting figure to look at is 2005-2007 average capex per ton of major steel maker, which I pulled from US steel’s presentation. POSCO spends almost twice the average to improve efficiency of their steel mill and invest in better technology.

Result? POSCO has decreased their coal ratio from 850kg/THM to 700kg/THM. (chart is cited from POSCO’s 1Q 2008 presentation). Given the fact that coal price has increase almost five folds during last 4 years, the value of such efficiency improvement worth a lot more now.

POSCO also leads the industry in production efficiency. (adopted from 1Q 2008 presentation.)

POSCO also invest heavily to produce high value added products to defend its margin from Chinese competition. Although this strategy backfired in 2006 when its stainless steel business recorded a negative margin, product innovation will help them to sustain higher-than-average gross margin.

The competitive advantage of POSCO

The biggest hidden value of POSCO is its leadership in FINEX technology. FINEX is designed to produce molten iron directly using iron ore fines and non-coking coal, eliminating the costly preliminary process of sintering and coke making. Thanks to the reduced iron making process, the overall construction cost will be slashed by 8 percent compared to that of conventional furnaces. The $1.1bn furnace is expected to produce steel about 17 percent cheaper than the conventional ones since it can use cheaper and more abundant coal fines instead of the previously used high-quality sticky coal lumps. As the skyrocketing coking coal price, the cost advantage of new steel mills build with FINEX technology will be even wider.



In the $140 barrel of oil world, being close to customer is a significant advantage. The undergoing urbanization in India and China will sustain the growth in steel demand for the near future. POSCO is well positioned to ride this trend. Chinese government has ordered to close low efficient and high polluting steel mills by 2010, which effectively reduce supply. POSCO will build a 12M ton steel mill in Orissa, India using the FINEX technology. FINEX technology + low cost ion ore will ensure the cost leader status of POSCO India giving a boost to their bottom line. The new steel mill will serve as a significant base for POSCO to expand into India and Middle East market.

POSCO have good long term relationship with its customers and often hold equity investment in their customers. Although POSCO has more pressure to raise their price in a strong market, it will benefit from the customer relationship during tough time. This is evidenced by the 100% utilization rate in its two major mills from 2002-2006, when other domestic producers suffered influx of steel imports..





The disadvantage of POSCO

Both Korean and Japanese steel makers do not have as much cheap self-supplied raw material as their global competitors (Mittal, US steel). The Chinese competitors have access to lower cost coal, while the Indian Competitors have access to cheaper ion ore. Steel price in Asia is lower than those in North America or Europe, while high shipping rates make it more expensive to sell products in US.

Disclosure: I currently have long position in PKX.