PKX - POSCO: 2 Key Catalysts To Watch

Summary

• The first catalyst for PKX is the potential issuance of favorable financial guidance for Q1 2023 when the company reports Q4 2022 earnings in the following week.
• The second potential catalyst is the narrowing of the conglomerate discount assigned to POSCO Holdings' shares following the merger of its subsidiaries, POSCO Energy and POSCO International.
• I think that PKX deserves a Buy, rather than Hold, rating now after taking into account these two catalysts.

Elevator Pitch

My investment rating for POSCO Holdings Inc.'s (PKX) [005490:KS] shares is a Buy.

With my prior write-up for PKX published on September 1, 2022, I discussed the company's expected financial performance for the second half of 2022 and its recent corporate developments.

My attention turns to POSCO Holdings' potential catalysts such as a business recovery in the first quarter of the current year and a narrowing of the conglomerate valuation discount for its shares in this latest article. I upgrade my rating for PKX from a Hold earlier to a Buy now, in view of the re-rating potential for its shares.

Look Beyond Q4 2022 And Focus On Q1 2023

PKX is expected to report the company's Q4 2022 financial results next week on January 27, 2023 . POSCO Holdings' financial performance in the final quarter of the previous year should be poor, but investors are most probably going to focus on PKX's positive Q1 2023 guidance instead.

As per the market's consensus forecasts taken from S&P Capital IQ , the analysts see POSCO Holdings announcing a substantially lower Q4 2022 top line and bottom line next Friday. Specifically, the sell-side estimates that PKX's revenue and normalized net profit will decrease by -17.2% YoY and -86.7% YoY to KRW9,545 billion and KRW143 billion, respectively in Q4 2022. It is reasonable that sell-side analysts have an unfavorable view of PKX's financial performance for the last quarter of the prior year. In Q4 2022, the company is very likely to have been negatively impacted by steel price weakness and the suspension of production at its steel mill in Pohang resulting from typhoons.

But POSCO Holdings should experience a substantial turnaround in the first quarter of the current year. PKX's Pohang steel mill is expected to be up and running again in 2023 ; while the company is increasing its hot rolled steel price for January as reported by Korean media earlier. The sell-side predicts that POSCO Holdings' top line and bottom line will expand by +42.1% and +149.3% to KRW11,055 billion and KRW693 billion, respectively in YoY terms for Q1 2023.

I am of the view that POSCO Holdings will issue positive Q1 2023 guidance when it discloses its Q4 2022 financial results in late-January. This should be one of the key catalysts to re-rate PKX's stock price and valuations.

Completion Of The POSCO International-POSCO Energy Merger

On January 4, 2023, POSCO Holdings disclosed in a 6-K filing that POSCO Energy will no longer be a subsidiary of the company. This is because POSCO Energy has been successfully merged into another one of PKX's subsidiary, POSCO International. In my opinion, this is the other major re-rating catalyst for POSCO Holdings.

A stock typically suffers from a conglomerate or holding company discount, if it owns and operates multiple, unrelated businesses that have limited synergies with each other. According to valuation data sourced from S&P Capital IQ , POSCO Holdings has never traded above 0.75 times price-to-book or P/B in the past decade. This supports my view that a hefty conglomerate discount is one of the key factors responsible for PKX's depressed valuations.

With the completion of the merger between POSCO Energy and POSCO International, PKX's corporate structure has become leaner with one less subsidiary.

More significantly, POSCO Holdings has shown that it is able to exploit synergies between the two former subsidiaries with this recent merger. PKX had guided at a media conference in early-January 2023 that the merged entity will benefit from improved profitability and reduced financial leverage. Specifically, the combined EBITDA for POSCO International and POSCO Energy is projected to rise by more than +30% to KRW1.7 trillion in 2023, and the aggregate debt-to-equity ratio for the combined company will be lowered from 2.0 times to 1.6 times.

Also, PKX is sending a strong message that it is serious about making the new POSCO International a bigger success than it was prior to the merger with POSCO Energy.

One thing to note is that POSCO Holdings has made a key change to the management team of the new POSCO International. A December 29, 2022 The Korea Times news article noted that Jeong Tak, who has built a reputation with his "sales and marketing" capabilities within the POSCO group of companies, has been tasked with the role of leading the new POSCO International as its Chief Executive Officer.

Another thing to pay attention to is that PKX is ready to ramp up its investments associated with the new POSCO International. POSCO International is expecting to spend about KRW3.8 trillion in the coming three years to become a fully vertically integrated player in the Liquefied Natural Gas or LNG space. POSCO Holdings also recently revealed in the current month that POSCO International is venturing into Indonesia's palm oil refining industry as part of its plans to optimize its portfolio mix with an emphasis on high-growth business areas.

Prior to the recent merger between the two subsidiaries, PKX was perceived as an overly diversified conglomerate that enjoyed little synergies between its various businesses. As it stands now, PKX has a slightly slimmed down corporate structure with the combination of POSCO International and POSCO Energy. Also, the merged entity appears to have a stronger financial position and a superior earnings growth outlook as compared to the two former subsidiaries on a stand-alone basis. As such, it is reasonable to see a narrower holding company valuation discount being assigned to POSCO Holdings' shares in the future.

Bottom Line

POSCO Holdings' shares are rated as a Buy. PKX's current valuations metrics (source: S&P Capital IQ ) such as a trailing P/B of 0.42 times and a consensus forward next twelve months' dividend yield of 3.0% are reasonably attractive. I think there are catalysts in place to drive a positive re-rating of POSCO Holdings' valuations, which explains my Buy rating for the stock.

For further details see: