PKX - POSCO: Spotlight On Corporate Actions And Business Outlook

Summary

• I am positive on POSCO's recent two corporate actions, namely the planned merger of two of its subsidiaries, and the cancellation of treasury shares.
• But my view of PKX's 2H 2022 outlook is negative, considering expectations of slower top line growth and a larger earnings drop for the company in 2H 2022.
• I retain my Hold rating for POSCO, taking into account both the company's recent corporate actions and its outlook for the second half of the year.

Elevator Pitch

I continue to rate POSCO Holdings Inc.'s ( PKX ) [005490:KS] stock as a Hold.

I touched on PKX's diversification efforts in expanding the company's non-steel businesses in my previous June 20, 2022 update for the stock. With this current article, I write about POSCO's corporate actions and business outlook.

On one hand, the planned merger of POSCO Energy and POSCO International will aid PKX's business diversification efforts, while its recent treasury share cancellation sends a strong signal about POSCO Holdings' commitment towards shareholder capital return. On the other hand, PKX's 2H 2022 business outlook is unfavorable, with the expected decline in steel prices being a key headwind. Considering both the positives and negatives associated with the stock, I choose to maintain a Neutral view or Hold rating for POSCO Holdings.

Proposed Merger Of The Company's Two Business Subsidiaries

Korean news publication The Korea Times reported on August 12, 2022, that POSCO Holdings' "trading arm, POSCO International" is merging "with its power generation unit, POSCO Energy."

As it stands now, POSCO Holdings owns 89.0% and 62.9% of the outstanding shares of POSCO Energy and POSCO International, respectively. Assuming that the merger between POSCO International and POSCO Energy is completed as planned in January 2023, POSCO Holdings will then have a 70.7% equity stake in the merged entity, the "new" POSCO International.

This specific corporate action will have a positive impact on POSCO Holdings' plans to diversify beyond its core steel business. In my prior June 20, 2022 article for PKX, I highlighted that POSCO Holdings' goal is to have "the non-steel businesses" contributing "half (versus 20% currently) of the company's operating profit by 2030." The proposed merger between POSCO Energy and POSCO International is expected to boost POSCO Holdings' efforts to grow in the area of LNG or Liquefied Natural Gas.

According to its corporate website , POSCO Energy operates the "first independent LNG terminal" (Gwangyang LNG Terminal) in South Korea, and it boasts a "LNG Combined Cycle Power Generation" capacity of 3,412 MW. On the other hand, POSCO International notes on the company's website that it is "consistently expanding its business across the Gas value chain, including liquefaction plants, LNG trading, bunkering, receiving terminals, pipelines, and Independent Power Producers (IPPs)." In other words, there are good reasons for POSCO International to create an integrated LNG company by bringing its two LNG-related business subsidiaries together via a merger.

Besides business diversification, shareholder capital return is another critical issue that investors are focused on. I highlight a key recent corporate action initiated by POSCO Holdings relating to capital return in the next section of this article.

Treasury Share Cancellation

An August 12, 2022 news article published by Yonhap News Agency mentioned that POSCO Holdings "has decided to cancel 672 billion won (US$517 million) worth of its stocks", or specifically "2.61 million treasury shares" which "represent about 3 percent of its total stock issued."

This specific corporate action is significant for three key reasons.

Firstly, it isn't the usual practice for Korean listed companies to cancel their treasury shares following share repurchases. Based on a May 7, 2017 Yonhap News Agency news commentary , "treasury share cancellations by listed manufacturing companies" in South Korea merely represented "2.3 percent of stock buybacks, resales and retirement" based on a study of "7,428 manufacturing companies" in the 2004-2015 period. This implies that PKX's move to cancel treasury shares and reduce the company's share count as part of shareholder capital return initiatives is a notable exception.

Secondly, treasury share cancellations aren't something that POSCO Holdings does regularly. In fact, the previous time PKX cancelled the company's treasury years was in 2004, or more than 18 years ago.

Thirdly, POSCO Holdings' recent treasury share cancellation action needs to be viewed in the context of the company's overall shareholder capital return plans. In tandem with its treasury share cancellation announcement, PKX also disclosed that it will distribute a dividend per share of KRW4,000 for the second quarter of 2022. This means that POSCO Holdings' dividend payout has increased from KRW7,000 per share in 1H 2021 to KRW8,000 per share for 1H 2022. In summary, POSCO Holdings is clearly intent on returning a greater proportion of excess capital to its shareholders, as evidenced by the company's recent treasury share cancellation and increase in dividends.

Moving away from corporate actions, I discuss about PKX's near-term business outlook in the subsequent section.

Outlook For The Second Half Of 2022

The market's current expectations for POSCO Holdings as implied by consensus financial estimates indicate that the company's 2H 2022 results should be worse than its 2Q 2022 performance.

As per consensus numbers taken from S&P Capital IQ , POSCO Holdings' revenue growth on a YoY basis is forecasted to moderate from +28.0% in the second quarter of 2022 to +11.3% and +8.3% for the third and fourth quarters of the current year, respectively. Also, PKX's YoY normalized earnings per share or EPS decline is projected to widen from -12.1% for Q2 2022 to -56.5% and -29.9% in Q3 2022 and Q4 2022, respectively.

In my view, the sell-side's consensus estimates are realistic. PKX's core steel business is expected to underperform in 2H 2022 due to a drop in steel prices, which will be a drag on the company's overall financial performance in the latter half of the year.

At its earlier Q2 2022 results briefing on July 21, 2022, POSCO Holdings noted that "the biggest variable that impacts the (Korean steel) price is the Chinese (steel) price." Steel prices in China are likely to remain depressed in 2H 2022, and this will hurt POSCO Holdings' steel business segment. An August 11, 2022 research commentary published by S&P Global Commodity Insights highlighted that "China's domestic demand for construction steel is likely to remain low for the rest of 2022" based on conversations with "market participants."

Closing Thoughts

My Hold rating for POSCO Holdings stays unchanged. I have a favorable view of PKX's recent corporate actions, but the company's financial performance is expected to deteriorate in the second half of 2022 which will cap PKX's upside potential in the near term.

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