Will Tata Steel results go the Posco way?

Investors in Tata Steel may be a worried lot after Posco announced its results. Despite an aggressive cost cutting by the fourth largest steel manufacturer in the world, Posco posted a 66% drop in its profit. Although sales fell by only 3.3%, the company posted a 29% drop in its operating profit. Financial and forex losses resulted in the company posting a sharp drop in its net profit.

Though Posco derives a major chunk of its revenue from Asia, unlike Tata Steel for which Europe is the largest contributor to sales, the underlying dynamics of the sector remains the same. Excess capacity in China and Japan is leading to steel being dumped into the global market, especially at a time when there are not many buyers. A slowdown in steel demand in China has resulted in record exports from the country to various locations.

Despite the fact that Posco has cut costs, it has not been able to improve its operating profit as steel prices were down. Posco, along with other companies in South Korea, is building up a case for an anti-dumping duty on Chinese and Japanese manufacturers. If imposed, this material will end up in other parts of the globe.

Apart from exporting a record 27.26 million tonnes in the first six months, China is sitting on a stockpile of 15 million tonnes of steel. A number of Chinese companies are either already reporting losses or have seen a sharp drop in their profits in the first half of the current year.

For the second time this year, Posco is cutting down its sales expectation for 2012, saying the business environment looks ‘volatile’. In order to cut expenses, Posco plans to sell more than 10 non-core assets to bolster its finances.

For Tata Steel, its Chairman Ratan Tata said in the annual report that its European operation will be under enormous stress for the next year or two, at least till western economies pick up.

Posco’s outlook and the fact that Japanese and Chinese goods might be diverted from South Korea if the country imposes anti-dumping duty are likely to put further stress on the Tata Steel’s financials. It is important as the company’s $382 million FCCB (foreign currency convertible bond) comes up comes up for repayment in September 2012.