The past few years have not been favorable to the steel industry, at least not considering the way the rest of the market has been humming. Many businesses and industries have fully rebounded from the post-recession declines. Steel has not been one of them.
One company in particular that looks ready to re-emerge is South Korean steel giant Posco (PKX). After trading for nearly $140 in 2010, the shares fell by more than 50% over the next four years. They hit a low of $65 this year, but, since then, the shares have rebounded to $83. Even at the current share price, Posco is an undervalued business that looks set to benefit from the coming cyclical upturn in the steel industry. Over the past six years, the steel industry has been plagued by overcapacity. Prices weakened and steel margins fell through the floor. Posco was not immune.
Looking ahead, the steel industry and Posco look ready to emerge from the bottom of the cycle. China's capacity expansion is over. Steel prices are starting to settle down. More specific to Posco is that shipbuilding activity in the East is starting to rebound and that requires a lot of steel.
Posco's location makes the company uniquely situated to benefit from this trend. South Koreans have always been known for running lean operations, but Posco recently hired a new CEO back in March who has realigned the company's cost structure into a leaner and more efficient business model.
Posco's new CEO has stated he wants to shift the company's focus to profitable growth. In fact, Posco has a goal of doubling profits from $3 billion in 2013 to $6 billion by 2016. Some analysts see that achievable as Posco plans to dispose of non-core assets, focus on higher margin products and shut down plants abroad with a bloated cost structure. In 2014, Posco's profits are expected to grow about 40%.
With a market cap of $27 billion, Posco trades at less than 5x the 2016 earnings number the company is going for. In other words, the current market cap makes Posco very cheap -- even if profits grow to $4 billion by 2016. However, as the company moves toward generating cash from asset sales and paying down debt, Posco shares could be a standout over the next several years. It's no wonder that Warren Buffett, who has patiently owned Posco for over six years, with a meager 22% total return to show for it, continues to patiently wait.
As Posco returns to its roots of being one of the most profitable steel companies in the world, the share price could likely double in two to three years.