Iron Age must go on
Reinstate coverage on the steel sector with Overweight
We reinstate our coverage of the steel sector with an Overweight
recommendation as 1) the steel sector cycle should bottom out, 2) raw
material prices should rebound from 2H and lead steel product price
hikes, and 3) the economic rebound should help keep production
volume up from 2Q09. Our sensitivity and valuation analysis points to
Dongkuk Steel Mill (001230, BUY, TP: W45,000) as the most preferred
stock and Hyundai Steel (004020, BUY, TP: W78,000) and POSCO
(005490, BUY, TP: W470,000) as the next promising ones.
KIS steel sector cycle – 2Q09 is the rock-bottom
We divided 1989–2011 into four time zones by using the sales of three
large domestic steelmakers, domestic GDP growth rate, and external
factors. Then, we derived the operating margin disparity by deducting
each zone’s average operating margin from the yearly or quarterly
operating margin to create a KIS steel sector cycle. The KIS sector
cycle reveals 1Q-2Q09 to be the bottom as the graph derailed from the
standard deviation -2σ for the first time since 1989.
Steelmaker profitability to improve from 2H09 on raw material price
hikes
We compared raw material and semi-finished product prices between
2005 and 2009 as the two years are similar in terms of crude steel
production volume. The results of our comparison said that an
additional decline in prices is very unlikely. We expect raw material and
semi-finished product prices to rebound from 2H09 as China has been
maintaining its crude steel production volume and crude steel
production should post a net quarterly increase. Steelmaker profitability
is also likely to improve.
Most attractive stocks, Hyundai Steel and Dongkuk Steel Mill
One of the major steel investment indicators, the KRW/USD is falling
precipitously. We assumed that the quarterly average KRW/USD would
dip W100 more from the KIS KRW/USD estimate and based on the
assumption, we estimated the sensitivity of each steelmaker to the price
and change in shipments. Accordingly, we view Hyundai Steel and
Dongkuk Steel Mill to be the most attractive steel stocks. Given won
appreciation, we also recommend investors to focus on the improving
non-operating balance.
Steelmakers deserve high PERs
Given disparate stock market conditions by country, we deem the
application of a PER valuation relative to the broader market as valid,
rather than a global peer comparison method. Relative PER analysis
should 1) reflect overall conditions of respective stock markets, 2)
exclude high valuations resulted from the broader stock market, rather
than from corporate performance, and 3) take the steel market cycles
into valuation considerations. As PER moves in the opposite direction of
the steel cycle, we believe it is reasonable to apply a high PER to
steelmakers which are at the bottom of the market cycle.