How this stock's valuation soared to $18bn before heading for a big drop

Posco's headquarters in Seoul, South Korea. Reuters

The frenzy surrounding all things EV has transformed a sleepy South Korean stock into one of the world’s best performing large and mid-cap names. But headwinds are emerging.

The winning streak in steel maker Posco Holdings may grind to a halt after shares jumped 65 per cent in July on bets that the firm’s $92 billion spending plan would give it a foothold in the fast-growing green industry.

Analysts see expensive valuations as a deterrent following a rally that added almost $18 billion to the stock’s market value last month. Posco shares are headed for their biggest weekly drop since mid-May, down 4 per cent.

The gains are not simply a story of how a traditional coal-heavy steel producer is winning over investors amid efforts to expand into green businesses. It is also a cautionary tale of how frantic buying by the nation’s retail traders may send shares on a roller-coaster ride to unsustainable levels.

“Despite us being a believer of its long term transformation story, we believe excessive optimism has run ahead of fundamentals,” Morgan Stanley analysts Young Suk-shin and Michael Koh wrote this week, downgrading the stock to underweight from equal-weight.

“At current valuation, we see Posco as one of the most expensive steel stocks regionally.”

In response to a request for comment, Posco said its lithium salt lake in Argentina is expected to be highly profitable and its lithium plant construction is starting production as planned. It also emphasised the company’s businesses encompass the entire EV battery supply chain, not only steel and lithium.

“It appears that such value and synergies have been ignored,” the company said in a statement to Bloomberg News.

The world’s third-biggest steel firm has seen its shares fall more than 7 per cent in August after a surge in July made it among the top performers and most volatile in a Bloomberg gauge of global large- and mid-cap stocks.

Its affiliates Posco Future M and Posco International jumped 49 per cent and 126 per cent, respectively, last month.

Thanks to purchases by retail investors, Posco Holdings’ increase in market cap in July was the biggest among all South Korean shares, according to exchange data. It was also the most traded stock during the month, with turnover surpassing even that of Samsung Electronics, the country’s largest company.

In addition, bearish bets on Posco have climbed, with the short balance on its shares spiking to more than 1.2 trillion won ($924 million) as of July 31, data from Korea Exchange showed.

After the rally, Posco is now one of the most expensive large-cap steel companies in the world, trading at about 13 times its estimated earnings over the next 12 months, according to Bloomberg-compiled data. That compares to a median of eight times among its regional peers.

Posco’s current valuation implies a “near perfect execution” of its lithium business when the company has yet to produce any of the battery material on a mass scale, Morgan Stanley wrote.

Jang Jae-hyeok, an analyst at Meritz Securities, said investors should watch for any increase in volatility as the shares have risen “too quickly” and added that the short-term surge is likely to take a breather.

Still, some local brokerages remain bullish about Posco, with Meritz Securities and Hana Financial Investment raising their price target on the stock last week. They said the firm’s battery business merits higher valuations and it should be compared to other high-flying EV battery stocks, rather than rival steel shares.

Rising sales volume of battery materials, along with higher orders in the green-infrastructure segment may push Posco’s profit higher in 2024, said Yi Zhu, a senior analyst at Bloomberg Intelligence.

To be sure, while Posco is trying to pivot away from emissions-intensive operations by betting on greener assets, it is still the biggest corporate polluter in South Korea and is a long way from meeting its net-zero commitment by 2050.

Posco, whose metals business still accounts for more than half of its revenue, has rebranded some of its affiliates with new names and logos that underscore its ambitions for a lower-carbon future.

Posco Future M, which used to be called Posco Chemical, is ramping up production of battery components through massive investments, while Posco International plans to spend $2.7 billion to transform into a clean-energy producer by expanding the use of hydrogen and renewable power.