Primary Metals Korea: Finding The Bottom As Worries Continue

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Includes: PKX
by: Hyundai Motor Investment & Securities
Summary

The lack of winter steel production cuts in China have resulted in weaker steel prices there.

Chinese steel production and exports are likely to increase next year, which could be challenging for Korean steel names.

If the Chinese steel furnace spread enters negative territory, steel shares are expected to rebound, albeit briefly.

Steel prices and shares remain weak amid macro uncertainties on US-Sino trade tensions

The steel sector index has corrected by 15% over the past two months. Unlike other years, China’s winter production cuts have not materialized and Chinese steel prices have remained weak due to low seasonality. China’s HRC (Rockwell) price currently stands at CNY3,783/tonne, down 13% from CNY4,357/tonne seen in September. Its rebar price also fell 11% in the past month. The steel sector will likely face a challenging situation in 2019. If we think about the motive behind China’s decision to scrap its winter production reduction plan, it is likely that Chinese steel output will continue to increase next year, regardless of demand. China-led steel oversupply will then work to distort Asian and global steel prices again. We find it discouraging that small steel mills in China are again picking up production and that the refund rate on VAT has been expanded for exports.

We recommend a long-term approach, but historically low valuation suggest firm support for shares

Ongoing macro uncertainties call for a long-term approach but we believe steel shares are unlikely to fall further and could stage a rebound in the short term for the following reasons: First, in the case of POSCO (PKX), the stock is trading at 0.47x P/B, close to its historical low of 0.44x seen in 1997. In 1997, demand was sluggish due to the Asian economic crisis but supply increased because of the Russian Moratorium, which worked to distort steel prices. In 2015, the stock fell to as low as 0.32x P/B but it does not offer a good reference since the stock de-rating had mainly to do with a decrease in NAV (for a second consecutive year) caused by reckless sales and the amortization of investment assets. Second, in 2011-2014 when Chinese oversupply was severe, steel prices temporarily rose when the spread turned negative, and the Chinese steel furnace spread is currently approaching zero.

We present the Korean steel sector with Neutral, with Korea Zinc as our top pick since its cost base should improve next year upon favorable T/C (treatment charge) contracts. Our second picks are POSCO and Hyundai Steel for their attractive valuations.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Hyundai Motor is a passive investor in our bank.