PKX - POSCO Holdings Still Has Legs To Run

2023-08-31 11:55:31 ET

Summary

• POSCO Holdings Inc. shares have performed well in recent times, but its current valuations are still undemanding.
• POSCO Holdings' plans to increase its operating earnings contribution from the company's battery materials business might be the key driver of valuation multiple expansion for the stock.
• I maintain a Buy rating for POSCO Holdings as I think that the company's shares have the potential to rise further.

Elevator Pitch

I still have a Buy rating for POSCO Holdings Inc. ( PKX ) [005490:KS] stock.

Earlier, my June 16, 2023 update for PKX touched on the company's new capital return approach and the investor outreach for its subsidiary POSCO International Corporation [047050:KS]. With this latest article, I evaluate whether POSCO Holdings' share price outperformance is sustainable.

My analysis suggests that PKX's shares are still inexpensive, and the growing profit contribution from its battery materials business is expected to be the catalyst that re-rates the stock. As such, I retain my Buy rating for POSCO Holdings.

POSCO Holdings' Stock Price Performance And Valuations

As per Seeking Alpha price data, PKX's share price rose by +44% since my prior article was published in mid-June this year, while POSCO Holdings' stock was up by +81% after I upgraded my rating for its shares to a Buy on January 19, 2023. In the past one year, PKX's shares have gone up by +140% .

POSCO Holdings' shares have performed well because the company's recent results were excellent. Operating income for PKX expanded by +88% QoQ to KRW1,326 billion in the second quarter of this year as revealed in the company's Q2 2023 earnings presentation . In fact, POSCO Holdings' actual Q2 operating profit beat the sell-side analysts' consensus estimate of KRW1,216 billion (source: S&P Capital IQ ) by +9%. With respect to profitability, the market was previously anticipating that PKX will achieve an operating margin of 5.9% for Q2 2023, but POSCO Holdings' actual operating margin for the second quarter turned out to be higher at 6.6%.

But it is important to note that POSCO Holdings' valuations aren't demanding. According to data taken from S&P Capital IQ , PKX currently trades at 6.2 times consensus forward next twelve months' EV/EBITDA and a 19% discount to its trailing book (or 0.81 times P/B). In my opinion, assuming that PKX's battery materials business continue to grow, POSCO Holdings should still have room for further valuation re-rating.

Expansion Of PKX's Battery Materials Business Could Drive Multiple Expansion

At its key investor event last month referred to as the second Annual Battery Materials Business VALUE DAY , POSCO Holdings disclosed a couple of key metrics which should give investors confidence that its battery materials unit has substantial growth potential.

In particular, investors need to pay attention to the upward revision in the long term revenue and operating profit targets for PKX's battery materials business. POSCO Holdings raised its 2030 top line and EBITDA goals for the battery materials segment by +51% and +36% to KRW62 trillion and KRW15 trillion, respectively, as compared to its initial guidance issued a year ago. To put these numbers in perspective, POSCO Holdings' company-wide revenue and EBITDA were KRW84.8 trillion and KRW4.9 trillion, respectively for FY 2022. In other words, PKX expects its battery materials business to contribute three times as much EBITDA in 2030 than what the company as a whole earned last year.

The bullish growth expectations for POSCO Holdings' battery materials business are reasonable, as the company has become more aggressive with its capacity expansion plans.

For example, PKX had earlier guided for its cathode production capacity to triple from 215,000 tons in 2024 to 610,000 tons by 2030 at its first Battery Materials Day in July 2022. A year later, POSCO sees the company's manufacturing capacity for cathode reach a million tons in 2030, which doubles PKX's 2030 EBITDA estimate for the cathode segment from KRW1.6 trillion initially to KRW3.3 trillion now. Similarly, a +16% upward revision in PKX's 2030 anode production capacity target between July 2022 and July 2023 translates into an updated EBITDA forecast of KRW1.4 trillion for the anode segment in 2030, which is +180% higher than this segment's prior operating earnings projection of KRW0.5 trillion issued one year.

In the earlier part of August, POSCO Holdings issued a press release disclosing that "its new brand slogan 'Green Tomorrow, with POSCO.'" In its media release, PKX highlighted that this move represented "an extension of its business transformation," especially the expansion of its battery materials business which it referred to as "the core of green mobility." The company's new branding is consistent with the change in its investment focus. Specifically, PKX noted in its second Annual Battery Materials Business VALUE DAY presentation in July 2023 that it expects its proportion of capital expenditures allocated to the battery materials business to increase significantly from 20.8% for the FY 2019-2022 period to 46.2% for the 2023-2025 time frame.

As highlighted in the preceding section, PKX is now trading at a meaningful discount to book value and valued by the market at a mid-single digit forward EV/EBITDA multiple. This is because investors still perceive POSCO Holdings as being largely a cyclical steel business which warrants a valuation discount; the steel segment accounted for over three-quarters of the company's operating income in Q2 2023.

In comparison, PKX's battery materials business has tailwinds relating to the rising penetration of electric vehicles and the growing emphasis on the green economy. As the earnings contribution of the company's battery business increases over time, it is reasonable for the market to award higher valuation multiples to POSCO Holdings going forward.

Concluding Thoughts

There is room for POSCO Holdings Inc.'s share price to go up further, as its valuations aren't rich and the company has a significant growth driver in the form of its battery materials business. In that respect, I believe that a Buy rating for PKX is still justified.

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