Attractively Priced Steel Industry Leaders: Mittal (MT), Posco (PKX)

At current market valuation, the largest U.S. stock exchange-listed steel companies by market capitalization and sales, Mittal and Posco, are trading at the lowest forward P/E ratios:

Company (Ticker): 2005 Est. Sales, P/S, Fwd. P/E, Profit Margin, D/E

Mittal (MT): $33.75 bil., 1.14, 6.0, 24%, 0.34
Posco (PKX): $22.5 bil., 1.12, 5.5, 11%, 0.36
Nucor (NUE): $11.4 bil., 0.86, 16.8, 10%, 0.27
Companhia Sider (SID): N/A, 4.3, 6.6, 31%, 3.3
Kubota (KUB): N/A, 0.77, 13.1, 6.5%, 0.72
U.S. Steel (X): $14.4 bil., 0.48, 11.6, 7.8%, 0.35

(Large steel companies listed only on non-U.S. stock exchanges are: Arcelor (Europe), Nippon Steel (Japan), JFE (Japan) and Baosteel (China).)

This is a curious situation, since market leaders usually trade at higher, not lower, P/E ratios. Mittal (global), Posco (Korean) and Companhia Sider (Brazil) are trading at P/E ratios in the 5 to 7 range, while Nucor (U.S.), Kubota (Japan) and U.S. Steel (U.S.) have P/Es from 11 to 17. It appears that this difference in P/Es could be due to an "established market" bias, with the companies having emerging market operations (Poland, Korea, Brazil, etc.) trading significantly cheaper than their U.S. and Japanese counterparts.

Mittal is the company resulting from the acquisition of 15 steel companies over the past decade by an Indian steel magnate, Lakshmi Mittal, and his Wharton-educated son, Aditya. International Steel Group (ISG) is their most recent acquisition and is expected to close during March. With global operations in North America, Europe, Kazakhstan and South Africa, Mittal is a low-cost producer with high profit margins (24%) and a low D/E ratio (0.34). Having mines that supply 40% of the iron ore and coke needed for their steel production, Mittal is less dependent on upstream suppliers than particularly their Japanese and Korean competitors who do not own mines. This year Mittal also is entering the Chinese market through acquisition of 37% ownership of Hunan Valin Steel. Successful integration of all of its acquisitions could keep Mittal positioned at the top of the steel industry if management is able to execute on its plan to become the world's "most admired" steel company.

Posco is a more regional player, with the majority (69% in 2003) of its production staying in the Korean market. Its primary export market is Asia, with China (taking 11% of its production) and Japan (5%) being its largest Asian customers. Among the non-Chinese steel companies, Posco is best positioned to benefit from increasing demand for steel from continuing growth of the Chinese economy. Unlike Mittal--which is about 90% owned by the Mittal family, has a public float of just 4.5%, and became one of the world's top steel producers only during the past year--Posco began as a government-owned steel company, now has 99% public float and has long been an established player in the steel industry.

As consolidation of the steel industry continues, three or four global players will likely emerge over the next few years. I expect that with consolidation will come greater resilience on the part of the largest companies to withstand the cyclical downturns that have triggered so many bankruptcies and restructurings (recall LTV, Bethlehem, Birmingham, National, others) in the industry in the past.

Mittal, with its global reach and low cost structure, and Posco, being a key supplier of steel to the rapidly growing Chinese market, are two companies to keep an eye on. Their very low P/Es and high earnings growth potential make them quite attractive at current prices. I plan to research industry fundamentals and pore over annual and quarterly reports for these companies during the next few weeks before making a buying decision. I will also be looking for a price pullback (technical short-term buying opportunity) following last week's sharp price run-up.