Maintaining our rating
We have initiated a “HOLD” rating on POSCO Holdings (New York Stock Exchange:PKX) on September 1, due to macroeconomic and labor headwinds. Since then, POSCO Holdings has performed remarkably well, returning 7.32% since our publication, which far outpaced the S&P 500’s decline of -4.78% during that year. same time frame. Despite that, we believe that the aforementioned headwinds are still relevant, but we see more headwinds from the slowdown in the economy and demand for steel. Given the uncertain macroeconomic outlook, we reiterate our “HOLD” rating going forward.
POSCO holdings reported a drop in operating profit of 71% on a year-over-year basis, as management cited price declines and losses from flood in September. However, the company was able to report a marginal year-over-year increase in its top line and the company attributed this increase to price increases in some of its units. However, the company’s profit margin, even excluding the impact of the flood, has been on a downward trend, as evidenced by a 10% or more increase in cost of revenue year over year. The company’s management also provided expectations that demand will be “weak” in the “first half of next year” as a result of economic factors.
Deterioration of the monetary image
As of this writing, the Korean won has depreciated further and is currently trading at KRW 1,360 compared to the US dollar. This metric is substantially below the ~1430KRW range just a month ago, and such deterioration confirms our view that there is currency risk in the stock. The weakening of the won will translate into higher input costs (raw materials) as well as higher labor costs due to inflation. Although a weaker currency would favor exports, as we will see below, we believe the company will also see headwinds in global demand for its finished steel products. As a result, we believe that higher input costs as a result of the weakening currency and domestic inflationary pressures will lead to compressed margins and affect the company’s outlook.
Weak steel demand
Due to interest rate hikes by the Federal Reserve, the world economy is starting to show signs of slowing down. As economic activity slows, we are beginning to see signs of reduced demand for steel. For example, in a recent poll, the majority of those surveyed had a bearish outlook for finished steel prices, with 87.1% predicting a fall in prices in the month of November. Demand for raw minerals has also decreased as a result of China’s economic problems and, according to a report, producers are still hesitant to restrict supply, which will affect steel prices. Other economic indicators, such as housing construction, point to downand therefore, we believe that the poor macroeconomic environment will translate into major headwinds for POSCO’s demand, worsening the company’s financial prospects due to higher input costs in KRW-denominated terms.
Therefore, we still recommend “HOLD” on POSCO Holdings. POSCO has had a mediocre quarter of performance and many economic indicators point to a worsening environment for POSCO’s operations. Additionally, the risks we discussed in our previous coverage remain relevant, and some risks, such as currency risk, have worsened materially since our last writing. We will reassess this stock as new economic data comes to light or some of the risks we identify ease.