Materials Stock Analysis

Fisher College of Business – Student Investment Management

Materials Stock Analysis

By Joshua Carter & Kyle Shaner


Presentation Overview

Sector Recap

Sell Recommendation

Buy Recommendation

Recommendation Summary

New SIM Portfolio


Sector RecapCurrent SIM Weight = 1.79%Current S&P Weight = 3.04%Continue to Underweight by 1.25%


Sector Recap – Current Holdings

Unit Cost

Total Cost

Market Price

Market Value

Unrealized Gain/(Loss)

Loss

$117.06 $468,225.60 $52.11 $208,440 ($259,785.60) (55.5)%

Posco ADR (PKX)South Korean steel manufacturer

Hot-rolled steel

Cold-rolled steel

Stainless steel


Sector Recap – Current Holdings…

POSCO Notable News Events

Geographic Segments Revenue Segments

Feb 2009 – 6% annual production cut

Feb 2009 – Iron Ore miners increase price 5%

Jan 2009 – CEO steps down after poor performance

Feb 2009 – Cuts stainless steel prices 10%

Dec 2008 – Announces 1st ever production cut at 10%

Korea64%Japan

6%

China14%

Asia/Pacific6%

North America2%

Others8%

Steel72%

Engineering and Construction

9%

Trading10%

Other9%


Sector Recap – Current Holdings…Posco vs. S&P Valuation

High Low Mean Current∆ From Mean

Opinion

P/Forward E 0.76 0.12 0.34 0.62 79.4% Overvalued

P/S 1.37 0.22 0.47 0.66 40.4% Overvalued

P/B 0.74 0.13 0.31 0.45 45.2% Overvalued

P/EBITDA 0.67 0.13 0.31 0.29 -6.5% Fair Value

P/CF 0.77 0.16 0.31 0.39 25.8% Overvalued

P/E/G 2.60 0.09 0.47 1.46 211% Overvalued

ROE 1.80 0.42 0.92 1.08 17.4% Overvalued

Posco vs. Materials Valuation


Opinion


P/S 1.44 0.42 0.65 0.76 16.9% Overvalued

P/B 0.71 0.28 0.36 0.41 13.9% Overvalued

P/EBITDA 0.71 0.18 0.36 0.19 -47.2% Undervalued

P/CF 0.81 0.25 0.45 0.48 6.7% Fair Value

P/E/G 2.38 0.12 0.40 1.10 175% Overvalued

ROE 1.76 0.63 0.99 0.95 -4.0% Fair Value


Sell Recommendation

Faces Many Economic Challenges Global Slowdown

Steel prices have fallen dramatically

Slowdown in global & domestic demand

Ailing auto industry

Increase in raw materials prices

South Korean Slowdown

` G DP Y -o-Y G rowth

2008 2009

B raz il 4.80% 4.00%

R us s ia 6.80% 5.70%

India 7.90% 7.10%

C hina 9.30% 6.70%

` G DP Y -o-Y G rowth

2008 2009

B raz il 4.80% 4.00%

R us s ia 6.80% 5.70%

India 7.90% 7.10%

C hina 9.30% 6.70%

Oct

NovDec

Jan

-35.00%

-30.00%

-25.00%

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

1


Sell Recommendation…

Comparables Analysis

Entity NameEnterprise

ValueTotal Debt

Equity Value

EBITDA SalesEV /

EBITDAEV /

SalesP / E

Debt / EBITDA

EBITDA Margin

POSCO $16,830 $4,850 $14,480 $5,390 $22,810 3.12x 0.74x 5.46x 0.90x 23.63%US Steel $4,720 $3,160 $2,010 $3,410 $23,750 1.38x 0.20x 0.96x 0.93x 14.36%Nucor Corporation $11,490 $3,280 $9,650 $3,850 $23,660 2.98x 0.49x 5.13x 0.85x 16.27%Arcelor Mittal $52,900 $34,080 $25,250 $18,140 $124,940 2.92x 0.42x 2.62x 1.88x 14.52%AK Steel $756 $633 $607 $941 $7,640 0.80x 0.10x N/M 0.67x 12.32%Timken $2,320 $624 $1,120 $753 $5,660 3.08x 0.41x 4.21x 0.83x 13.31%Gedau AmeriSteel $4,110 $3,070 $1,630 $1,470 $8,530 2.80x 0.48x N/M 2.09x 17.23%

As of March 2, 2009. Data provided by Yahoo Finance


Sell Recommendation…

DCF Analysis

DCF Sensitivity Analysis

Terminal Value 22,531 NPV of free cash flows 5,349 NPV of terminal value 9,555 Projected Equity Value 14,904

Shares Outstanding 301.6

Current Price 52.11$

Implied equity value/share 49.42$

Upside/(Downside) to DCF -5.16%

DCF Value Per ShareTerminal Discount

FCF Growth 8% 9% 10% 11% 12%1% $56.61 $48.32 $41.90 $36.79 $32.632% $63.14 $52.87 $45.19 $39.24 $34.503% $72.28 $58.94 $49.42 $42.30 $36.774% $86.00 $67.43 $55.06 $46.23 $39.625% $108.86 $80.17 $62.95 $51.48 $43.28


Sell Recommendation…Absolute Valuation

Absolute Valuation

High Low Mean CurrentYour

Target Multiple

Your Target E,

S, B

Your Target Price

P/Forward E 18.50x 2.10x 7.30x 6.60x 6.60x $6.75 $44.55P/S 2.18x 0.36x 0.74x 0.41x 0.74x $62.34 $46.13P/B 2.30x 0.60x 1.00x 0.70x 1.00x $69.89 $69.89P/EBITDA 5.40x 1.10x 2.70x 1.30x 1.00x $37.63 $37.63

Average $49.55

Comparables Analysis Blended Multiples Price Target – Abs. & CompEntity Name P / E

2009E P/ E

POSCO 5.46x 6.60xUS Steel 0.96x 3.76xNucor Corporation 5.13x 7.40xArcelor Mittal 2.62x 4.58xAK Steel - 3.88xTimken 4.21x 8.21xGedau AmeriSteel - 3.85x

Averages 2.63x 5.47x


Sell Recommendation…EPS vs. Volume & Steel Price – Sensitivity Analysis

Steel Price per TonPKX Steel Output (In millions of tons)

2007 32.11 Y-oY ∆

2008 32.48 1.2%2009 29.00 -10.7%

Implied Price per Ton2009E Sales $18,801Volume $29

Sales / Volume $648.32

*2009 Volume Projection per CEO

Income Statement2009E

Volume 29Steel 648.3

Sales $18,801Operating Expenses $15,919

EBIT $2,883Non-Op Expenses -$209

EBT $2,674

Taxes $692Net Income $1,982

Shares 302EPS $6.57

EPS Sensitivity AnalysisSteel Price per Ton

% ∆ from Dec 08 -20% -8% 4% 16% 28%Volume $500 $575 $648 $725 $800

25 $4.20 $4.90 $5.59 $6.32 $7.0227 $4.57 $5.34 $6.08 $6.86 $7.6329 $4.95 $5.77 $6.57 $7.41 $8.2331 $5.33 $6.20 $7.06 $7.96 $8.8333 $5.70 $6.64 $7.55 $8.50 $9.43

*Volume in millions of tons*December 2008 price of $625 per ton

Target EPS

2009E EPS Multiple PriceEPS Sensitivity Analysis Price Target $6.08 6.9x $41.95

Price Target


Conclusion

SELL

US$ 45.00: Blended price target based on

DCF

EPS Sensitivity Analysis

Comparable & Absolute Multiple Valuation


Buy Recommendation

DOW Chemical

Engages in manufacture and sale of chemicals, plastic materials, agricultural, and other specialized products

2008 Revenues of $57,514 billion: 7.4% increase

Strong growth expected in agriculture segments

Equity Trading Statistics

MarketPrice

% 52 Wk Hi P / E Market Cap 09 EPS est. Beta

$7.11 (84.0%) 11.52x $6.57 B $1.75/sh 1.48


Buy Recommendation…

Geographic Segments Revenue Segments

Performance Plastics, 27%

Performance Chemicals, 16%

Agricultural Sciences, 8%

Basic Plastics, 23%

Basic Chemicals, 10%

Hydrocarbons & Energy, 16%

Other, 1%

US32%

Europe38%

Rest of World30%

Feb 2009 – Announces top executives won’t get cash bonuses

March 2009 – S&P cuts two short-term ratings

Jan 2009 – Rohm & Haas sues Dow

Feb 2009 – Cuts dividend 64% to 15 cents a share

Dec 2008 – Announces it will cut 11% of workforce


Buy Recommendation…Dow vs. S&P Valuation


Opinion


P/S 0.83 0.16 0.58 0.16 -72.4% Undervalued

P/B 1.49 0.29 0.82 0.29 -64.6% Undervalued

P/EBITDA 99.90+ 0.31 0.69 0.31 -55.1% Undervalued

P/CF 1.19 0.27 0.63 0.27 -57.1% Undervalued

P/E/G 6.88 0.59 1.42 1.34 -5.6% Fair Value

ROE 1.84 0.23 0.93 0.58 -37.6% Undervalued

Dow vs. Materials Valuation


Opinion

P/Forward E 4.00 0.68 0.90 0.87 -3.3% Fair Value

P/S 1.07 0.29 0.87 0.19 -78.2% Undervalued

P/B 1.58 0.26 1.09 0.26 -76.1% Undervalued

P/EBITDA 99.90+ 0.20 0.74 0.20 -73.0% Undervalued

P/CF 1.47 0.33 0.94 0.33 -64.9% Undervalued

P/E/G 5.08 0.68 1.23 1.00 -18.7% Undervalued

ROE 1.72 0.34 1.09 0.54 -50.5% Undervalued


Infrastructure spending plays to strengths

Consumer spending is key

Product and geographic diversification

Decline in oil prices

Buy Recommendation…An Industry Bright Spot US - 2009 Economic Outlook

Economic Stimulus

-4.80%

1.80%

-1.30%

2.60%

-6.00%

-5.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

Q1 Q2 Q3 Q4

$787

$586

$167

$0$100$200$300$400$500$600$700$800$900

US China Eurozone



DOW Acquisition of Rohm & Haas ~$15 billion

Deeper Reach in DevelopingMarkets – Asia / Pacific

2007 – 2012E CAGR

Financing Mix

$3 billion preferred equity investmentfrom ROH Investors

Draw $10 billion from bank loan

Receive $4 billion from Berkshireand KIA

Divest $4 billion in ROH assets

Strategic Rationale

Grow performance and specialtychemicals

Strengthens competitiveness of basic chemicals

$1.3 billion in synergies

30% of synergies come frompurchasing of raw materials

$2.6 billion in additional value creation

$1.7 billion combined in R&D

Delivers more stable earnings withhigher growth

Dilution / Accretion-10% -5% 0% 5% 5%

EPS $ 0.52 $ 0.58 $ 0.61 $ 0.64 $ 0.67

Stock Price $ 8.61 $ 9.56 $ 10.07 $ 10.57 $ 11.10 16.5x

EPS Dilution / Accretion


Buy Recommendation…Absolute Valuation (50% mean reversion)

Entity Name P / E2009E P/ E

DOW 11.52x 14.80xDuPont 7.66x 7.24xRohn & Haas 26.01x 21.48xSherwin Williams 10.76x 10.38xAir Products & Chem. 14.07x 9.83x

` 14.00x 12.75x

Dow ChemicalAbsolute Valuation

High Low Mean Current #Your Target Multiple

*Your Target E, S, B, etc/Share

Your Target Price (F x G)

A. B. C. D. E. F. G. H.P/Forward E 99.9+ 8.8 17.7 14.8 8.85 0.61 $5.40

P/S 1.62 0.12 0.99 0.12 0.495 54.6 $27.03P/B 4.8 0.5 2.9 0.5 1.45 14.12 $20.47

P/EBITDA 99.9+ 1.6 5.2 1.6 2.6 4.41 $11.47P/CF 15.4 1.8 9.3 1.8 4.65 3.92 $18.23

P/E/G 8.6 0.7 1.9 1.6 0.95 4.4 $4.18ROE 31.1 3.2 16.7 8.0 8.35 0.88 $7.35

Average $13.45

Average

Comparables Analysis Multiples Price Target – Blended Abs. & Comp

2009E EPS Multiple Price$0.61 16.5x $10.07


Buy Recommendation…Discounted Cash Flow Analysis

DCF Value Per ShareTerminal Discount

FCF Growth 8% 9% 10% 11% 12%1% $14.56 $12.80 $11.44 $10.34 $9.452% $15.85 $13.69 $12.07 $10.81 $9.803% $17.65 $14.87 $12.89 $11.40 $10.234% $20.34 $16.53 $13.98 $12.15 $10.775% $24.84 $19.01 $15.50 $13.15 $11.47

DCF Sensitivity Analysis

Terminal Value 14,767 NPV of free cash flows 6,299 NPV of terminal value 5,693 Projected Equity Value 11,992 Free Cash Flow Yield -14.76%

Shares Outstanding 930.4

Current Price 7.11$

Implied equity value/share 12.89$

Upside/(Downside) to DCF 81.28%



Price Target Summary

US$ 12.00: Blended price target based on

DCF

Comparable & Absolute Multiple Valuation


New SIM Holdings

SELL POSCO AND BUY DOW

Conclusion:

Continue to hold underweight

Why not increase underweight? – Don’t want to miss an early economic rebound

Why not reduce underweight? – Basic materials as a whole still out of favor

SELL all of Posco holdings

BUY 125 bps of DOW Chemical


Supplement

Supplement: Key Economic Indicators


Supplement

Supplement: Key Economic Indicators


Possible Dilution from Merger

Supplement

Company project possible dilution of 5%

Dilution / Accretion

-10% -5% 0% 5% 5%

EPS $ 0.52 $ 0.58 $ 0.61 $ 0.64 $ 0.67

Stock Price $ 8.61 $ 9.56 $ 10.07 $ 10.57 $ 11.10

16.5x

Documents

Materials Stock Analysis