Warren Buffett’s South Korean Bet

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

The Oracle of Omaha recently placed one of his biggest bets on South Korea-based Posco (PKX). Since 2005, Buffett has built up a 4% stake in Posco, the world’s third-largest steel producer. Despite the value of his original investment already doubling, Buffett continues to be very bullish about Posco. He recently described its business prospects as "outstanding."

Indeed, you don’t need to look too hard to realize that Posco is probably the premier steel company in the globe. Standard & Poor’s recently upped the company’s credit rating to A (stable) from A- (positive). That’s the highest of any company in the steel industry.

Posco’s profit margins also consistently rank among the best of so-called non-integrated steel producers — companies that don’t have their own iron-mining operations. Posco’s high margins have been underpinned by the company’s strategy to cut costs and shift its product mix to more lucrative, "value-added" products, tailored to customers’ specific needs. By the end of 2008, Posco aims to get 80% of its revenue from value-added products. That’s up from 60% last year. The benefits of this strategy are heading straight to the bottom line. Posco’s net profits for Q4 of 2006 increased a whopping 148% year-over-year.

Posco also benefits not only from a virtual monopoly on its fast-growing domestic South Korean market, but also from a rapidly expanding international presence throughout Southeast Asia, Mexico and India. In fact, with the recently announced expansion of its $12 billion investment in India, Posco will become the largest single foreign investor in that fast growth market.

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Posco’s debt-free balance sheet also gives it plenty of room to borrow money for more India-style acquisitions. Analysts estimate that Posco has about $10 billion to put to work and already is considering two acquisitions this year, including one outside of South Korea.

Despite its impressive achievements, Posco has traditionally traded at a significant discount to its global peers. What’s the source of this conundrum? Investors for years have criticized weak accounting and disclosure standards in South Korea. Companies trading in Korea have been saddled with the "Korea discount." That’s about to change. Although Posco itself already adheres to International Accounting Standards, all major South Korean companies will have to come up to snuff starting in 2011. That alone will act as a tailwind to Posco’s stock price.

So let’s place our bet alongside Warren Buffett and buy Posco (PKX) at market today. Place your stop at $86.00. Based on Friday’s closing price of $102.22, you are risking just about $16.00 per share, assuming you adhere to the stop price. That means for every $100 you are willing to risk on this trade, you can purchase about six shares. ($100/$16.00 risked per share = 6.25 shares). If you want to play the options, I recommend the August $100 calls (PKX-HT).

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