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10 January 2011 Nomura

N O M U R A F I N A N C I A L I N V E S T M E N T ( K O R E A ) C O L T D

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Nomura Anchor Reports examine the key themes and value drivers that underpin our sector views and stock recommendations for the next 6 to 12 months.

Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 76 to 80.

Consumer Staples | K O R E A

CONSUMER RELATED

Cara Song +82 2 3783 2328 [email protected] Stacey Kim +82 2 3783 2333 [email protected]

Finding younger markets Korea’s population isn’t getting any younger. With the absolute number of Koreans aged 25-49 having peaked in 2008, we believe the onus is on FMCG companies to nurture new drivers before changing demographics start to impact growth in established segments. To offset otherwise slowing volume growth, we look for Korean players to expand addressable markets (tapping new segments and going for M&A), shift to the premium end, and broaden footprints in China. Segments where growth prospects appear relatively good for Korean players are cosmetics and confectionary, where we see resilient market volume expansion, a strong presence in China, and success in premium brand strategies. But tobacco and liquor players with relatively weak brands and no growth base in China, such as KT&G and Hite, look exposed to the effects of ageing in their home market. We like Lock&Lock and Orion for their strong earnings prospects (30%-plus y-y in FY11F) underpinned by growth spurts in their China operations as well as relatively attractive valuations (20x FY11F P/E, 0.6x FY11F PEG). We remain NEUTRAL on LGHH and Amorepacific despite strong business fundamentals, owing to unappealing valuations. We are NEUTRAL on KT&G, given sluggish earnings momentum. We initiate coverage of Hite Brewery with a REDUCE on account of weak earnings momentum and rich-looking valuations.

Consumer profile changing alongside demographic changes

Overseas expansion looks critical to sustain growth

Top picks: Lock&Lock and Orion

NEW THEME

Stocks for action We recommend a switch from KT&G

and Hite to China plays such as Orion

and Lock&Lock. Although Amorepacific

and LGHH have strong business

fundamentals, we are NEUTRAL, on

unattractive valuations.

Stock Rating PricePrice

targetPotential

upside

Hite (103150 KS) REDUCE* 123,000 100,000 (18.7)

KT&G (033780 KS) NEUTRAL 65,600 66,000 0.6

AP (090430 KS) NEUTRAL 1,130,000 1,120,000 (0.9)

LG HH (051900 KS) NEUTRAL 392,000 440,000 12.2

Orion (001800 KS) BUY 405,000 470,000 16.0

L&L (115390 KS) BUY 35,900 52,000 44.8

* Initiating coverage; pricing as of 4 January, 2011

Analysts Cara Song

+82 2 3783 2328

[email protected]

Stacey Kim

+82 2 3783 2333

[email protected]

10 January 2011 Nomura 1

Consumer Staples | K O R E A CONSUMER RELATED

Cara Song +82 2 3783 2328 [email protected]

Stacey Kim +82 2 3783 2333 [email protected]

Action We like Lock&Lock and Orion for their strong earnings growth, while we remain

NEUTRAL on KT&G due to its weak earnings momentum. We initiate coverage of Hite with a REDUCE rating. We like the cosmetics and beverage sectors, but we are NEUTRAL on Amorepacific and LGHH on unattractive valuations.

Catalysts Potential price hikes that could more than offset declines in sales volumes.

Anchor themes

Demographic change (the number of consumers aged 25-49, an age group that has higher spending power, is dropping) will affect the growth outlook of consumer-related companies in Korea. Like Japan, we believe demand for tobacco and liquor (beer) in Korea will gradually fall, but we see the cosmetics and soft drink markets benefitting from the demographic change.

Finding younger markets Consumer profile changing alongside demographic changes

With Korea experiencing a rapidly ageing population, the absolute population aged 25-49 peaked in 2008, according to UN statistics, and is likely to continue to decline, in our view. Apart from affecting economic growth, demographic changes could have a positive impact on the cosmetics and beverage sectors as the ageing population turns more health conscious and looks to maintain youth and beauty. In our opinion, the tobacco and liquor industries in Korea could be hurt by this change.

Overseas expansion looks critical to sustain growth

In our opinion, Korean FMCG companies need to focus on finding new markets (e.g., new segments, M&A) to offset their slowing volume growth. We find that companies with a better growth outlook are those in the cosmetics and confectionary segments (for example, Orion has successfully created a premium segment; Lock&Lock and Orion have also expanded their footprints in China, which has significant growth potential, in our view) and capable of strengthening their core competitiveness to gain market share, such as Amorepactific and LGHH. In our view, companies losing market share and which have no growth base in China, such as KT&G and Hite, are likely to suffer as a result of Korea’s demographic changes.

Top picks: Lock&Lock and Orion

We like China plays for their strong earnings growth potential (above 30% y-y in FY11F) and relatively attractive valuations (~20x FY11F P/E, ~0.6x FY11F PEG). We maintain NEUTRAL on LGHH and Amorepacific despite strong business fundamentals, as valuations look unattractive. We are NEUTRAL on KT&G due to its weak earnings momentum. We initiate coverage of Hite Brewery with a REDUCE rating due to its weak earnings momentum and expensive valuation.


Stocks for action We would recommend a switch from KT&G and Hite to China plays such as Orion and Lock&Lock. Although Amorepacific and LGHH have strong business fundamentals, we are NEUTRAL, on unattractive valuations.

Stock Rating PricePrice

targetPotential

upside

Hite (103150 KS) REDUCE* 123,000 100,000 (18.7)

KT&G (033780 KS) NEUTRAL 65,600 66,000 0.6

AP (090430 KS) NEUTRAL 1,130,000 1,120,000 (0.9)

LG HH (051900 KS) NEUTRAL 392,000 440,000 12.2

Orion (001800 KS) BUY 405,000 470,000 16.0

L&L (115390 KS) BUY 35,900 52,000 44.8

* Initiating coverage; pricing as of 4 January, 2011

NEWTHEME

Analysts Cara Song

+82 2 3783 2328

[email protected]

Stacey Kim

+82 2 3783 2333

[email protected]

Consumer Staples | Korea Cara Song


Contents

What changes will Korea see? 4

The Japan experience 4

Same challenges but less serious for Korea 4

Structurally new demography in Korea 6

Cosmetics: Healthy growth to continue 9

Resilient growth in Japan 9

Korea’s demographic trends similar to that of Japan 10

Skin care to lead growth 10

Channel diversification good for major brands 11

Premium cosmetic sector to grow steadily 12

Rising per capita soft drink consumption 13

Bigger per capita consumption helped drinks market in Japan 13

Very similar trends in Korea 14

More changes in product mix expected in Korea 15

Tobacco: the most challenged 17

Japan tobacco market was severely hit by ageing 17

The smoking population has started to fall in Korea 18

Media encouraging smokers to quit 19

Taste shifting more from slim to regular in Korea 19

The faster-growing high-end segment 20

Price hikes not imminent 21

Beer: facing unfavourable changes too 22

Beer volume declines in Japan 22

Korea: tough to fight demographic trends 23

Product mix – premium growth 24

Price hikes could hurt beer consumption further 24

Confectionery: targeting adults 25

Japan: less demand due to a falling young population 25

Korea already trying to overcome difficulties brought by demographic changes 25

Implications to our stock view 27

Orion (BUY) and Lock & Lock (BUY) our top picks 27

NETURAL on LGHH and Amorepacific 27

Negative on KT&G (NEUTRAL) and Hite (REDUCE) 28



Ageing population 31

Korea rapidly heading towards an aged society 31

Two fundamentals trends in ageing 32

Ageing of the society and the consumer industry 33

Baby boomers, becoming aged consumers 33

Demographic model of Korea, resembles that of Japan 34

Consumer industry in Korea to follow Japan’s 35

Latest company views Hite Brewery: Little to cheer about 36

KT&G: Weaker domestic tobacco (III) 61

Amorepacific: It’s valuation that counts (II) 64

LG H&H: Unattractive valuation (II) 67

Orion: Premium play going big in China (V) 70

Lock & Lock: Not just china, all emerging China (I) 73



Investment summary

What changes will Korea see? Over the past decade, almost all Korean consumer sub-sectors have showed strong sales volume, supported by the country’s fast economic growth and an increased number of consumers aged 25-49, the age group deemed more knowledgeable about product choices, conscious of product trends, with more social activities and higher spending power. However, in 2009-10, the liquor and tobacco markets in Korea posted their first negative growth in two decades. Other fast moving consumer goods (FMCG) companies also witnessed slowing volume growth. While the global economic crisis in 2008 was responsible for the slowdown, we also attribute the weakness to Korea’s demographic changes. The number of consumers aged 25-49 peaked in 2008, according to UN statistics, and we believe this will have a significant impact on the Korean consumer industry.

The Japan experience Economic growth has always been a key indicator for FMCGs’ market growth. However, we expect demographic trends to become increasingly important for various consumer-related industries. With Korea’s rapidly ageing population, we expect more distinct impacts on sectors that are likely to benefit/suffer from demographic changes.

Japan experienced it 15-20 years ago

Over the past 15-20 years, Japan has continued to face the challenge of an ageing population, with the absolute population aged 25-49 in a rapid decline. This has had an adverse impact on the country’s tobacco and liquor markets, the only two consumer sub-sectors to witness structural volume declines despite relatively low pricing. On the other hand, the cosmetics and beauty industry witnessed resilient growth due to the country’s increased aged female population. Meanwhile, the confectionery market suffered on a declining number of young children. With increased health consciousness, Japan saw rising demand for functional beverages and mineral water during the period.

Japan is an example: Japan and Korea have similar weather patterns and lifestyles. Besides demographic changes, Japan also faced deflation during the period, which dampened the growth of consumer-related markets. However, we would not be assuming the same growth rates for Korea since both countries have different industry developments and competitive landscapes. Still, we believe that the overall growth trend of FMCG companies in Korea is likely to weaken owing to the ageing population.

Same challenges but less serious for Korea Many of the consumer-related industries in Korea are consolidated and thus they are exposed to a less competitive environment, in our view. However, we caution that shrinking or slower market growth could also prompt competition.

We believe Korea’s FMCG firms will face less impact from the ageing population compared to Japan due to the following:

The industry is more consolidated in Korea. Many consumer-related industries in Korea are very much consolidated and thus, price wars are a low possibility even when market growth becomes stagnant, in our view.

Korea’s economic growth is faster: Japan’s economic growth has been weak over the past ten-15 years, as the country continues to counter deflation. Nomura’s economic team forecasts Korea to see long-term GDP growth of 3-4% vs –1-3% for Japan over the past ten years (we see an approximate ten-year lag for Korea in terms of consumption trends).

The number of consumers aged 25-49 peaked in 2008; we believe this will have a significant impact on the Korean consumer industry

Many of the consumer-related industries in Korea are consolidated



Korean players have more revenue contribution from China: China’s population is 27x that of Korea, and its demographic structure is much more favourable since it has a greater proportion of younger generation and aged generation. China is located adjacent to Korea and both countries have relatively similar consumption patterns (see details in our note The Great Leap into China dated 8 January 2008). As such, a successful entry into the Chinese market would likely bring great growth opportunities for Korean companies, in our view.

Exhibit 1. Japan: market consolidation (FY2001)

0102030405060708090

100

Tob

acco

Bee

r

Con

fect

ione

ry

Be

vera

ges

Cos

met

ics

(%)

Note: breakdown and sum of market shares of top-3 players in each sub-sector Source: Euromonitor database, Nomura estimates

Exhibit 2. Korea: market consolidation (FY09)

0

20

40

60

80

100

Bee

r

Bev

erag

e

Tob

acco

Con

fect

ione

ry

Cos

met

ics

(%)

Note: breakdown and sum of market shares of top-3 players in each sub-sector Source: Euromonitor database, Nomura research

Exhibit 3. Japan: real GDP growth

(10)

(5)

0

5

10

15

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(growth % y-y)

Source: Euromonitor database

Exhibit 4. Korea: real GDP growth

(8)

(6)

(4)

(2)

0

2

4

6

8

10

12

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

F

2011

F

2012

F

(growth % y-y)

Source: Euromonitor database, Nomura estimates

Exhibit 5. Korea: China expansion (FY09)

0

10

20

30

40

50

Orio

n

Am

orep

aci

fic

KT

&G

Hite

CC

B

(%)

Note: % of China sales to consolidates sales; Source: Company data

Exhibit 6. Japan: China expansion (FY09)

0

10

20

30

40

50

Shiseido Suntory Meiji Kirin JTI

(%)

Note: % of China sales to consolidates sales; Source: Company data



Structurally new demography in Korea In order to secure a strong base for sustainable growth ahead of a more difficult business environment due to an ageing population, we believe successful operations in faster-growing overseas markets, creating new product segments, and/or entering new markets are important for FMCG companies in Korea. Since it is usually very difficult to build brands in new markets, unless the company enjoys an early-mover advantage, those that have a presence in overseas markets are likely to see significant growth vs those that operate in their home base only.

Demographic trend changing. Consumers aged 25-49 are deemed to have more spending power and more social and economic activities. The number of consumers in this age group in Korea peaked in 2008 (see below) and with this age group continuing to grow older, many FMCG companies in Korea find themselves facing a different business environment with customers profiles changing and have to face the challenge of slowing sales growth and declining demand.

Tobacco, liquor: In Japan, the tobacco and liquor markets were the only consumer sub-sectors to see declining volume growth over the past decade due to an unfavourable population structure change. Moreover, as its general population on average gets older, increased concerns over health issues are putting pressure on the per-capita consumption of tobacco and liquor. Unless Korean tobacco and liquor players gain market share, create a new segment (e.g. premium segment), and/or enter a new overseas market, it is likely that their sales would decline too.

Cosmetics, beverages. In our opinion, the cosmetic industry is likely to benefit most from Korea’s ageing female population. Although the growth rate of the industry is unlikely to be as fast as that seen in the past, we expect it to continue to show resilient growth. For the beverage market, again taking Japan as a reference, we see no clear correlation between population trends and beverage consumption. However, when there are increased outdoor activities, per-capita consumption of beverage increases in Japan.

Finding new markets. When room for growth becomes limited, FMCG companies looking to sustain growth will need to look for new markets, new products or segments or new brands, in our view. Japanese beer companies have introduced new concept beers with inexpensive prices in the past to overcome their falling market share. Japan cosmetic company Shiseido has also actively expanded in China to sustain growth. In Korea, we expect FMCG companies to explore new markets actively.

Companies that have a presence in overseas markets are likely to see significant growth vs those companies operating in their home base only



Exhibit 7. Korea: population trend

16.5

17.0

17.5

18.0

18.5

19.0

19.5

20.0

20.5

21.0

1997

1999

2001

2003

2005

2007

2009

201

1F

201

3F

201

5F

201

7F

201

9F

(mn)

44

45

46

47

48

49

50

(mn)Age 25-49 (LHS) Total (RHS)

Source: UN statistics

Exhibit 8. Japan: population trend

40

41

42

43

44

45

46

198

1

198

3

198

5

198

7

198

9

199

1

199

3

199

5

199

7

199

9

200

1

200

3

200

5

200

7

200

9

(mn)

112

114

116

118

120

122

124

126

128

130

(mn)Age 25-49: LHS Total: RHS


Exhibit 9. Korea: FMCG market growth (rebased: 1998 = 100)

80

100

120

140

160

180

200

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

(%) Cosmetics Beverage

Confectionery Beer

Tobacco


Exhibit 10. Japan: FMCG market growth (rebased: 1998 = 100)

50

70

90

110

130

150

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

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7

200

8

200

9

(%) Cosmetics Beverage

Confectionery Beer

Tobacco


Exhibit 11. Korea: sector CAGR: (1997-2009)

(%)

(4)

(2)

0

2

4

6

8

Tob

acco

Cos

met

ics

Bee

r

Bev

erag

e

Con

fect

ione

ry


Exhibit 12. Japan: sector CAGR: (1997-2009)

(4)

(3)

(2)

(1)

0

1

2

3

4

Cosmetics Beverage Confectionery Tobacco Beer

(%)




Exhibit 13. Korea: premium market size (FY09)

0

5

10

15

20

25

30

35

40

45

Cosmetics Beer Tobacco

(% of premium sales)

Source: L’Oreal

Exhibit 14. Japan: premium market size (FY09)

0

5

10

15

20

25

30

35

40

45

Cosmetics Tobacco Beer

(% of premium sales)




Cosmetics: the best

Cosmetics: healthy growth to continue We think the cosmetics segment in Korea will have one of the most resilient growth markets in the next ten years on an increased number of cosmetics users and a rising female population. Nevertheless, we believe changes in product mix and distribution channel developments are unlikely to grow at as a fast pace as before. The development of distribution channels is likely to slow alongside with the development of the Korean retail market, which is moving towards newer retail formats. Given our view that strong brands could enjoy greater pricing power due to their diversified distribution channels, we remain positive on the fundamentals of major cosmetics brands in Korea.

Resilient growth in Japan Between 1999 and 2009, the beauty and personal care market in Japan saw a revenue rise of 11%, and if personal care products, which are seen as necessities, are excluded, the cosmetics markets in Japan grew at a faster pace of up to 15% over the same period, according to Euromonitor database. During the period, the number of consumers aged 30-69, which is the market’s major consuming age group for cosmetic products, increased by 2.7% (source: UN statistics). This does not look to be a drastic change. The more important change was the structure of age. The number of consumers aged 50-69, deemed to spend much more than those in their 30s and 40s, rose quicker than the average (see below).

Exhibit 15. Japan: cosmetics market growth (% y-y)

32.5

33.0

33.5

34.0

34.5

35.0

35.5

199

7

199

8

199

9

200

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1

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200

9

(mn)

3.0

3.5

4.0

(¥ trn)Age 30-69 (LHS)

Cosmetics market (RHS)


Exhibit 16. Japan: female demographic structure

0

10

20

30

40

50

60

70

80

90

100

1990 2000 2010F

(%) 30-39 40-49 50-59 60-69


Exhibit 17. Global: cosmetics spending by age

0

20

40

60

80

100

120

140

160

180

30-39 40-49 50-59 60-69

(%)


Exhibit 18. Korea vs Japan: age 30-69

0

50

100

150

200

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

F20

12F

2014

F20

16F

2018

F20

20F

Korea Japan(Rebased to 100 =1980)

Note: Year 1980 = 100 Source: UN statistics

We remain positive on the fundamentals of major cosmetics brands in Korea



Korea’s demographic trends similar to that of Japan Korea’s female population structure now looks like Japan’s in the ‘90s. We expect Korea’s female population trend to be similar to that seen earlier in Japan. We expect the absolute female population aged 30-69 to increase by 7% in the next decade and support growth of the cosmetic industry in Korea. Although 7% is small compared to the 17% increase seen in the past ten years, the Korean cosmetic industry is one of the very few sectors that will likely benefit from the ageing female population, in our view.

Exhibit 19. Korea: cosmetics market growth

8

9

10

11

12

13

14

15

16

1997

1999

2001

2003

2005

2007

2009

201

1F

201

3F

201

5F

201

7F

201

9F

(mn)

0

2

4

6

8

(W trn)Age 30-69 (LHS)

Cosmetics market (RHS)


Exhibit 20. Korea: female demographic structure

0

10

20

30

40

50

60

70

80

90

100

2000 2010F 2020F

(%) 30-39 40-49 50-59 60-69


Exhibit 21. Korea: estimated change in female population structure

(30)

(20)

(10)

0

10

20

30

40

50

60

2000-2010F 2010F-2020F

(%) 30-39 40-49 50-59 60-69 Average


Skin care to lead growth Currently, skin care sales takes the biggest market share of about 40% in each of the cosmetic and beauty industry in Korea and Japan (see exhibits overleaf). Skin care is a big market in Asia, as with consumer confidence and spending power rising alongside the region’s economic recovery, maintaining an extensive facial care regime has become increasingly important, and cosmetic companies are launching more sophisticated products to meet the market’s rising demand. We estimate that growth of skin care sales in Korea will likely normalise now, after having reached a market share of 40% in 2009. Moreover, as the sector is already largely explored by major Korean players, we are not expecting any major change in the product mix.

We expect the absolute female population aged 30-69 to increase by 7% in the next decade and support growth of the cosmetic industry in Korea

Skin care is big in Asia



Exhibit 22. Japan: category mix (2009)

% 0 10 20 30 40 50 60 70 80 90100

Japan, FY09

Bath and Shower Colour CosmeticsFragrances Hair CareOral Care Skin CareOthers

(%)


Exhibit 23. Korea: category mix (2009)

% 0

20

40

60

80

100

Korea, FY09

Bath and Shower Colour CosmeticsFragrances Hair CareOral Care Skin CareOthers

(%)


Channel diversification good for major brands Over the past 15 years in Japan, the most interesting change seen in the cosmetics distribution channel development was declining direct sales (including the door-to-door [D2D] network). Our Japanese consumer analyst, Keiko Y., attributes the weakened D2D market to strong growth seen in other modern retail distribution channels, such as hypermarts and specialty stores, as well as the increased number of women entering the workforce. D2D sales dropped from 19.4% of total in 1997 to 15.7% of total in 2009, according to Euromonitor database. We see no major decline in direct sales in the near term.

D2D should remain as a major distribution channel in Korea: Unlike Japan, where people can buy premium cosmetics in many distribution channels such as department stores, drug stores and specialty stores, etc, there are only two major channels in Korea for premium cosmetics − department stores and D2D. As we expect no new distribution channel for high-end cosmetics in Korea and we expect slower growth for department stores due to saturation, we see limited downside in Korea’s D2D market in terms of its proportion to the total market.

Further channel diversification good for strong brands: The distribution channel looks to be more diversified in Japan than in Korea, in our view, largely due to different retail market development. Due to regulations, Korea has no drugstores. It is common for convenience stores (CVS) in Japan to sell cosmetics but this can be hardly seen in Korea. Even if there is a distribution channel diversification, strong brands are likely to benefit given their higher bargaining power and less margin pressure from distribution channels, in our view.

Exhibit 24. Japan: cosmetics distribution channel (%)

0

10

20

30

40

50

60

70

80

90

100

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Direct Selling Beauty Specialist Retailers

Department Stores Others


Exhibit 25. Korea: cosmetics distribution channel (%)

0102030405060708090

100

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Direct Selling Beauty Specialist Retailers

Department Stores Others


Declining direct sales seen in Japan’s cosmetics distribution channel in the past 15 years



Premium cosmetic sector to grow steadily Korea faces bi-polarisation of income and we believe high-income consumers should be able to support growth of the premium cosmetic segment. However, we believe further growth is likely to be in-line with overall market growth since it has already commanded a significant market share – the premium cosmetics segment took a 40% share of the total cosmetics market share in 2009 (vs 27% in 1997), same as that in Japan (40% in 2009), according to Euromonitor.

Exhibit 26. Japan: premium cosmetics

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(¥bn)

30

32

34

36

38

40

42

44

46

48

50

(%) Premium cosmetics sales (LHS)

% of total cosmetics (RHS)


Exhibit 27. Korea: premium cosmetics

0

500

1,000

1,500

2,000

2,500

3,000

3,500

199

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199

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(Wbn)

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45

(%) Premium cosmetics sales (LHS)

% of total cosmetics (RHS)




Beverages: the second best

Rising per capita soft drink consumption The soft drink market (i.e. non-alcohol drink market) is likely to continue to expand over the next ten years, in our view, driven by increased sales of “healthier” drinks, such as teas and bottled water, on growing health consciousness among Korean consumers and increased activity outside the home. Korea’s demographics also point to a changing product mix. As seen earlier in Japan, growth in “healthier” drinks is outpacing growth in carbonated drinks, which we believe is due to a decline in the target age group (15-29 years) for carbonated drinks as well as an ageing population that is becoming increasingly health conscious. Consumption volume growth for the next ten years could be as fast as it was in Japan over 1997-2009 (a 3.1% sales volume CAGR, according to Euromonitor) considering the increasing consumption per capita in Korea.

Bigger per capita consumption helped drinks market in Japan Japan’s population increased 1.1% from 126.1mn in 1997 to 127.5mn in 2009. During the same period, soft drink volume sales grew by 2.5%, led by a 7.4% rise in bottled water sales and a 3.7% rise in ready-to-drink (RTD) tea sales (exhibit below left). Along with increasing outdoor activities (including dining out), we believe that better understanding of the health benefits of drinking water helped to drive soft drink demand in Japan, considering the historical trends of a decline in carbonated drinks and a growing demand for water and tea. Further, we believe that demographics are another key factor that has determined the market mix by product.

We believe that the decline in the carbonated drink segment and the increase in the RTD segment in Japan have largely been due to changes in the population structure. According to LGHH (owns 90% of Coca Cola Beverage in Korea), the market’s major consumption age groups are the late teens to late 20s for carbonated drinks and the 30s to early 40s for RTD coffee.

Exhibit 28. Japan: beverage market sales revenue and volume growth

0

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3

4

5

6

7

8

9

1997

1998

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2009

(¥ trn)

0

5

10

15

20

25

30

(trn litres)Revenue

Volume

(LHS)

(RHS)

Source: Euromonitor

Exhibit 29. Japan: ’97-09 beverage market sales value CAGR (%)

(2)

0

2

4

6

8

10

Bot

tled

wat

er

RT

D T

ea

RT

D c

offe

e

Juic

e

Fun

ctio

nal

drin

ks

Car

bon

ates

Source: Euromonitor

More and more Koreans are quenching their thirst healthily as are their Japanese neighbours …



Exhibit 30. Japan: carbonated drink sales volume growth

0

5

10

15

20

25

30

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(mn)

1.30

1.35

1.40

1.45

1.50

1.55

1.60

1.65

(¥ trn)15-29

Carbonated drinks

(LHS)

(RHS)

Source: Euromonitor

Exhibit 31. Japan: RTD coffee sales volume growth

22.5

23.5

24.5

25.5

26.5

27.5

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(mn)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

(¥ trn)30-45

RTD coffee

(LHS)

(RHS)

Source: Euromonitor

Very similar trends in Korea We expect the per capita consumption of soft drinks in Korea to continue to grow, considering that the current social and demographic trends look very similar to those seen earlier in Japan. Meanwhile, we believe that the weaker volume growth in carbonated drinks in recent years comes on growing consumption of bottled water and soft drinks with increased activity outside the home, as well as demographic changes including a decline in the younger population (i.e., 15-29 years old) which consumes the most carbonated drinks and an increase in the mid-aged group which consumes the most coffee and mineral water.

Exhibit 32. Korea: beverage market sales revenue and volume growth

0

1

2

3

4

5

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

(W trn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

(trn litres)Revenue

Volume

(LHS)

(RHS)

Source: Euromonitor

Exhibit 33. Korea: ’97-09 beverage market sales volume CAGR (%)

0

4

8

12

16

20

RT

D T

ea

Bot

tled

Wat

er

RT

D c

offe

e

Car

bona

tes

Fu

nctio

nal

drin

ks

Juic

e

Source: Euromonitor

… and the healthier, the better



Exhibit 34. Korea: carbonated drink sales volume growth

0

2

4

6

8

10

12

14

199

7

199

9

200

1

200

3

200

5

200

7

200

9

2011

F

2013

F

2015

F

2017

F

2019

F

(mn)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

(W trn)15-29

Carbonated drinks

(LHS)

(RHS)

Source: Euromonitor

Exhibit 35. Korea: RTD coffee sales volume growth

13.0

13.5

14.0

14.5

15.0

15.5

16.0

16.5

17.0

199

7

199

9

200

1

200

3

200

5

200

7

200

9

2011

F

2013

F

2015

F

2017

F

2019

F

(mn)

0

100

200

300

400

500

600

700

(W trn)30-45

RTD coffee

(LHS)

(RHS)

Source: Euromonitor

More changes in product mix expected in Korea Korea, like Japan, has seen a rapid change in product mix away from ‘unhealthy’ drinks (i.e., carbonated drinks and juice) to ‘healthier’ drinks such as tea and water. Importantly, the market in Korea for unhealthy drinks remains much bigger than that in Japan (see the exhibit below). While soft drink consumption varies from country to country, depending in part on each country’s distinctive demand, weather and/or lifestyle (e.g., Japanese typically drink more tea than Koreans), one trend Korea and Japan seem to share is that people tend to prefer to consume healthier drinks as they get older, as indicated by the increase in bottled water and RTD tea-related proportion within the product mix for beverage (exhibits overleaf).

Exhibit 36. Soft drink market sales volume mix by product: Japan (1997) vs Korea (2009)

716

19

3413

19

18

12

20

523

14

0

10

20

30

40

50

60

70

80

90

100

Japan Korea

Bottled Water Carbonates Juice RTD coffee RTD tea Other

Source: Euromonitor



Exhibit 37. Japan: change in beverage market sales value mix (%)

4 7

26 19

1413

1818

1820

20 23

0

10

20

30

40

50

60

70

80

90

100

1997 2009


Source: Euromonitor

Exhibit 38. Korea: change in beverage market sales value mix (%)

716

3834

31 19

6 121 5

16 14

0

10

20

30

40

50

60

70

80

90

100

1997 2009


Source: Euromonitor



Tobacco: the worst sector

Tobacco: the most challenged In the tobacco market, we expect Korea to follow a similar market trend as Japan’s given that we see similarities in demographic trends. Over 1997-2009, the tobacco market in Japan saw the worst declines in both sales revenue and volume growth among the consumer-related sectors. Despite having relatively loose regulations (compared with other developed markets) and low prices (relative to price parity), Japan’s tobacco market has shrunk to 80% of what it was in 1997. We attribute this mainly to: 1) the decline in the absolute population aged 20-30 years, which has the highest smoking ratio (50-60%); and 2) the increase in the absolute population aged 50-60 years, which has a lower smoking ratio (<40%). In addition to the simple demographics, we note that the business environment in the Korean tobacco industry is changing owing to a structural shift from slim-type to regular-type cigarettes, difficulty in raising product prices and no solid growth base in overseas markets. Gone are the days of resilient growth stemming from solid volume growth and the structural shift to higher-end products, in our view.

Japan tobacco market was severely hit by ageing Over the past ten years (1999-2009), Japan’s tobacco market declined by 20% in revenue terms (-2.2% CAGR), and by a much sharper percentage in volume terms of nearly 30% (-3.4% CAGR). Meanwhile, the smoking ratios for all age groups have gradually declined, making for a less favourable population mix (i.e., the absolute number of major consumption age groups with smoking ratios of more than 45% has declined, while the number of age groups with lower smoking ratios has increased). We have also found a very high correlation between market volumes and the number of smoking population (exhibit below left) in Japan. In calculating the smoking population, we multiply the smoking ratio to the number of people that are of legal age to smoke.

Exhibit 39. Japan: smoking population and market volume

20

22

24

26

28

30

32

34

36

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

(mn)

200

220

240

260

280

300

320

340

360

(bn sticks)Smoking population (LHS)

Market volume (RHS)

Source: Euromonitor, Nomura research

Exhibit 40. Japan: smoking ratio

0

5

10

15

20

25

30

35

40

45

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

(%)


The tobacco segment faces an increasingly challenging business environment as well as less favourable demographics



The smoking population has started to fall in Korea In Korea, the smoking ratio has declined to 25% (vs 24% in Japan in 2009), from 35% a decade ago (i.e., in 1998), mainly owing to government efforts to curb smoking through increased regulations (including price hikes) and the growing health consciousness in Korea (next exhibit). Despite declines in the smoking ratios among the different age groups, tobacco market volumes have steadily increased (aside from a sharp drop in 2004 following a steep price hike of 25%), supported in our view by the growing population of smokers. However, the economic slowdown and spread of the N1H1 virus in FY09 appear to have had a negative impact on tobacco consumption of late, resulting in a 5.6% y-y decline in market volumes for 1Q-3Q10. Although we are positive on domestic consumption and economic growth, we remain cautious on tobacco volume growth in Korea, given that we expect the absolute number of smokers to decline after peaking in FY10F

Assuming no change in the smoking ratios for each age group and no price hikes, we forecast the smoking population in Korea will decline by 4.6% over the next ten years (-0.5% CAGR in smoking population) on growing health consciousness.

Exhibit 41. Korea: smoking ratio by age group

0

10

20

30

40

50

60

70

20s 30s 40s 50s 60s 70s

(%)


Exhibit 42. Korea: smoking ratio by sex

0

10

20

30

40

50

60

70

80

1998 2001 2005 2008

(%) Total Male Female


Exhibit 43. Korea: smoking population and market volume

9.0

9.1

9.2

9.3

9.4

9.5

9.6

9.7

2002

2003

2004

2005

2006

2007

2008

2009

201

0F20

11F

201

2F20

13F

201

4F20

15F

201

6F20

17F

201

8F20

19F

(mn)

0

20

40

60

80

100

120

(bn sticks)Smoking population

Market volume

(LHS)

(RHS)


Exhibit 44. Korea: market volume growth trend

(0.8)

(0.6)

(0.4)

(0.2)

% 0.0

% 0.2

% 0.4

% 0.6

% 0.8

% 1.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

F20

11F

2012

F20

13F

2014

F20

15F

2016

F20

17F

2018

F20

19F

Market volume growth (y-y)(%)




Media encouraging smokers to quit In 2009, the tobacco market in Korea saw its first ever volume decline without any price change, albeit minimal at 0.2% y-y compared with a 3-4% CAGR over 2005-08. Despite a quick recovery from the global economic crisis, market volumes declined by 5.6% y-y in 1Q-3Q10, compared to only gradual changes in the demographic trends. KT&G ascribed this to the unusually cold weather and the outbreak of the N1H1 virus. We believe that the decline in volumes was at least partly attributable to a combination of outbreaks of flu and cold viruses and recent media reports highlighting the harmfulness of smoking to the immune system.

A local TV programme called Zero Complaints broadcasted its “Adieu, smoking” episode on 23 December, 2009, reporting on the harmfulness of smoking to smokers and their families. The report indicated that third-hand smoke is harmful, after having tested accumulated nicotine levels on the hairs of infants with smoking parents.19 out of the 24 infants tested had twice the amount of nicotine as the average infant on their hair, with a six-month old having the highest level of nicotine among those tested of 6.436 Nic (ng/mg), which was found to be well above the levels found on soft smokers (i.e., those who smoke 1-2 cigarettes per day).

Overall, although the speed of decline in tobacco market volumes will vary depending on tobacco regulations, the level of price hikes and media influence, we think the decline in tobacco volumes in general will decline in the long term in Korea considering the ageing population and growing health concerns.

Exhibit 45. TV Shows featuring Anti smoking themes

Programme Date aired Episode Summary

Zero Complaints 2009-03-12 The truth of low-tar cigarettes

Low-tar cigarettes trigger heavy smoking. According to WHO standards, cigarettes labelled as containing 0.1mg based on local ISO standards contain 13.9mg of tar.

Happy Sunday 2009-04-06 24 hours without smoking

This prime-time programme followed six well-known TV personalities for 24 hours without smoking. The programme also discussed extensively the harm tobacco and nicotine can do to one’s body.

Zero Complaints 2009-12-23 Adieu, smoking Third-hand smoking is harmful, as indicated by testing for accumulated nicotine on the hairs of infants with smoking parents. 19 out of the 24 infants tested had twice the amount of nicotine as the average infant in their hair, with a six-month old baby having the highest level of nicotine of 6.436 Nic (ng/mg), which is higher the 5.0Nic(ng/mg) found on the hair of a soft smoker (i.e., smokes 1-2 cigarettes per day).

Secret of Life, Age, Illness and Death

2010-03-18 Periodontal disease Smoking was shown as a direct cause of periodontal disease. The show featured a well-known actor who had to remove 1/3 of his teeth due to periodontal disease caused by smoking.

Secret of Life, Age, Illness and Death

2010-04-22 Hyperlipidemia Smoking was proven as one of the two main causes for Hyperlipidemia.

Note: programme and episode titles translated from Korean

Source: Nomura research

Taste shifting more from slim to regular in Korea With a difficult market environment, tobacco companies in Korea can gain market share or sustain earnings growth by creating new products, conduct effective branding exercise, and/or successfully enter a fast-growing overseas markets, in our view. In Japan, slim-type cigarettes have not captured much market share while menthol cigarettes have continued to see decent growth over the past 15 years. Compared to Japan, the slim-type cigarettes in Korea have a sizeable market share (34% in FY09) but the growth rate was slower than that of the regular-sized cigarettes. We believe KT&G will be able to maintain its strong position in the slim-type cigarette market in Korea. Note that the sales of regular cigarettes are declining fast in Korea although its market share still grows faster than that of the slim-type cigarettes.

Compared to Japan, slim-type cigarettes in Korea have a sizeable market share, but the growth rate is slower than that of regular-sized cigarettes



Exhibit 46. Japan: market mix by product type

3.6 4.4 5.0 5.1% 0

% 10

% 20

% 30

% 40

% 50

% 60

% 70

% 80

% 90

100

2006 2007 2008 2009

Slim/Superslim Regular(%)

Source: Euromonitor

Exhibit 47. Japan: market mix by product type

12.8 14.0 17.4 20.5

% 0

% 10

% 20

% 30

% 40

% 50

% 60

% 70

% 80

% 90

100

1997 2001 2005 2009

Menthol Standard(%)

Source: Euromonitor

Exhibit 48. Korea: tobacco market mix by product

31.0 32.1 32.9 32.1

56.0 59.3 61.3 62.1

0

10

20

30

40

50

60

70

80

90

100

2006 2007 2008 2009

(%) Slim/Superslim Regular

Source: Euromonitor

Exhibit 49. KT&G: domestic sales mix by product

30 31 31 3122

33 32 31 28

18

0

10

20

30

40

50

60

70

80

90

100

2006 2007 2008 2009

(%) Slim/Superslim Regular

3Q YTD

Source: Euromonitor

The faster-growing high-end segment The premium segment currently accounts for 4% of total market from less than 1% in 2002 (source: Euromonitor). With KT&G actively introducing premium brands, the segment has been able to grow faster than average, at a 20% CAGR over 1997-2009 vs a -0.4% CAGR for the average market during the same period (source: Euromonitor). While growth has been fast in the past, the market size is still very small. Note that the segment’s growth has slowed recently, suggesting difficulties for it to win more market share. In Japan, the premium segment accounts for 20% of total market. The price difference between premium and mid-priced cigarettes is just about 6-7% while that in Korea is a minimum 20%. Considering this, we believe growth of the high-end segment would not have a material impact on the market in general.



Exhibit 50. Japan: market mix by segment

% 0

20

40

60

80

100

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Mid-Priced Premium Economy(%)

Source: Euromonitor

Exhibit 51. Korea: market mix by segment

% 0

% 20

% 40

% 60

% 80

100

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Mid-Priced Premium Economy(%)

Source: Euromonitor

Price hikes not imminent Over the past 15 years in Japan, the market size of tobacco players has declined less than that of sales volume due to price hikes. The price hikes, which were more than able to offset the declines in sales volumes, have helped to improve profitability. In our opinion, however, it is difficult for Korean players to hike prices to offset rising costs due to the following:

The government is likely sensitive to inflation issues: In Korea, the last tobacco tax hike was in 2004. Hence, it will be difficult for tobacco companies to raise product prices without any changes in the tax structure, in our view. The government appears sensitive to inflation.

Market volume falling: In Korea, the sales volume of tobacco has fallen over the past two years despite lack of tax hikes. We believe the Korean government would not be keen to hike tax since the demand for cigarettes is already falling.

As we have mentioned in our previous note Seeing limited growth, dated 10 March 2010, a tax hike would be positive only if KT&G passes a further W27/pack price hike on top of the tax hike (for instance, tax hike: W273/pack, price hike: W300/pack) to offset the impact of a declining sales volume. In our view, a 20% tax hike (W500/pack) and an 8% volume decline seem most likely. If KT&G could raise prices by more than W27/pack, this would have a positive impact on its earnings, on our estimates. A further hike of W5/pack would have a 1.3% positive impact on its FY10F net profit.

Exhibit 52. Japan: historical market growth

2.0

2.5

3.0

3.5

4.0

4.5

5.0

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

(W trn)

200

220

240

260

280

300

320

340

360(sticks trn)

Sales (LSH)

volume (RHS)

Source: Euromonitor

Exhibit 53. Korea: historical market growth

2

3

4

5

6

7

8

9

10

11

12

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

(W trn)

0

20

40

60

80

100

120

140

160

180

(sticks trn)Sales (LSH)

volume (RHS)

Source: Euromonitor



Beer: facing unfavourable changes too

Beer: facing unfavourable changes too We expect beer (along with liquor in general) to be one of the negatively affected FMCG industries in Korea on the market’s falling number of consumers. Unlike Japan, where severe competition has hurt the sector’s product mix (due to the introduction of low-end beer segment), we see no emergence of inexpensive beer in Korea, thanks to its duopoly competitive structure. However, excessive price hikes could hurt market volume when the number of beer consumers continues to fall. As the premium segment looks to have been already taken by multinational beer companies, Korean consumers tend to perceive imported beer as a premium drink. In our opinion, the beer industry in Korea will likely continue to struggle for sustainable growth.

Beer volume declines in Japan Beer is still the most consumed liquor in Japan in terms of sales volume although growth slowed in 1997-2009 (albeit still better than that of wine consumption) due to emergences of new liquor segments. According to market research data provided by Synovate, men accounted for 83% of beer sales in FY08, among which 92% is consumed by aged 24-49. Over the past 13 years, Japan’s population aged 25-49 has declined by 5.3% from 44.6mn to 42.2mn (a -0.5% CAGR). During the same period, the market volume of beer also declined. To make matters worse, Japanese players introduced inexpensive beers with a less malt barley content. As such, the sales amount of beer declined much more than that in market volume. The newly introduced beer, apart from being inexpensive, also contains less malt barley and less alcohol. This inexpensive beer, which soon became popular, helped support sales volume in Japan.

Exhibit 54. Japan: market volume and population

41.0

41.5

42.0

42.5

43.0

43.5

44.0

44.5

45.0

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(mn)

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

(¥bn)Age 25-49 (LHS)

Beer market (RHS)

Source: UN statistics, Euromonitor

Exhibit 55. Japan: Beer market trend

2

3

4

5

6

7

8

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(bn litres)

0

1

2

3

4

5

6

7

8

9

(¥ trn)market volume (LHS)

Market sales (RHS)

Market volume (LHS)

Source: Euromonitor



Exhibit 56. Japan: market volume and population

0

2000

4000

6000

8000

10000

12000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(¥ trn) Beer Spirit Wine Other

Source: Euromonitor

Exhibit 57. Japan: market CAGR by segment (1997-2009)

(6)

(4)

(2)

0

2

4

6

8

10

12

Other Spirit Beer Wine

(%)

Source: Euromonitor

Korea: tough to fight demographic trends We do not expect Korean beer sellers to introduce inexpensive beer to the market, as the Korean beer market is a duo-poly structure and looks to have less price competition than in Japan. However, Korea’s demographic trends are very similar to those seen earlier in Japan. Korea’s absolute population aged 25-49 peaked in 2008 and declined 1% y-y over 2008-10F. During the same period, the sales volumes of Korea’s liquor market saw its first ever decline (3.8% y-y) in a decade. While economic growth looks to be the major driver for beer consumption, it will be hard to overcome the country’s inevitable population structure change, in our view. Furthermore, population forecasts from UN show a further decline in the absolute population aged 25-49 over the next two years (a 1.3% y-y fall in 2010-12F vs a 1% y-y decline in 2008-10F), so we expect Korea’s beer market volume to continue to drop.

Exhibit 58. Korea: population and market growth

17.0

17.5

18.0

18.5

19.0

19.5

20.0

20.5

21.0

199

7

199

9

200

1

200

3

200

5

200

7

200

9

201

1F

201

3F

201

5F

201

7F

201

9F

(m liter)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(mn) Age 25-49 (LHS)

Beer market (RHS)

Source: UN statistics, Euromonitor

Exhibit 59. Korea: liquor market CAGR by segment

(10)

(5)

0

5

10

15

20

25

30

35

Malgulri Wine Beer Soju Total

(%) CAGR (00-08) CAGR (08-10F) CAGR (10F-12F)

Source: Euromonitor

Fewer drinkers, lower sales



Product mix – premium growth In Korea, the premium beer market accounted for 5.3% of total market in terms of volume sales in FY09 and clocked a CAGR of 5.1% over FY07-09 while the regular (standard) beer witnessed a CAGR of 1.2% during the same period, according to Euromonitor . We attribute the faster growth rate of premium beer to imported sales, which saw a sales (denominated in US$) CAGR of 10.2% over FY07-09. Imported beer is positioned as a premium beer (priced +70% higher than regular beer) in Korea, due to its higher prices pushed up by transportation costs and import duty.

Exhibit 60. Japan: beer market mix (%) Exhibit 61. Korea: beer market mix (%)

0

10

20

30

40

50

60

70

80

90

100

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

Premium Standard Economy

0

10

20

30

40

50

60

70

80

90

100

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

Premium Standard Economy

Source: Euromonitor Source: Euromonitor

Price hikes could hurt beer consumption further Any further price hikes are likely to cut beer consumption in Korea further. With malt barley prices up 40% YTD in 2010, according to Hite, beer sellers in Korea will need to pass through the higher raw material costs to customers to maintain profitability. However, as canned beer is one of 48 items which the Korean government is monitoring their prices to control inflation, it will be difficult for beer sellers to hike prices to more than offset their increased costs, in our view. We see this a “double whammy” for Korean beer sellers, who are already facing a declining sales volume.



Confectionery market: flattish growth

Confectionery: targeting adults Demography does not look to support the structural growth of the Korean confectionery market, in our view. However, expanding the target customer base from young children to adults could rejuvenate the market. Japanese confectionery has tried to expand their customer base by introducing healthier products and we believe Korean confectionery companies, which are doing the same, will need to continue to introduce new segment for different age groups to sustain growth.

Japan: less demand due to a falling young population Japan’s confectionery market underscores our view that the population structure of a country will have an impact on market growth. In Japan, the confectionary market suffered due to the country’s falling declining young population. Japanese confectionary makers saw flat growth despite taking steps to sustain growth, such as offering products suitable for adults and focusing on high-end/premium products.

Overall, we believe companies are becoming adept at capitalising on increasing health-consciousness to increase sales. For example, as staying fit became a nation-wide interest in many countries, candy-makers quickly launched products with a supposed healthier content. Dark chocolate was launched to exploit the same trend towards healthier products as it is rich in cocoa polifenols, organic chemicals believed to support health.

Exhibit 62. Japan: confectionery market

0

5

10

15

20

25

30

198

6

198

8

199

0

199

2

199

4

199

6

199

8

200

1

200

3

200

5

200

7

200

9

(mn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

(¥ trn)Population of childhood (RHS)

Confectionery market (LHS)

Source: Euromonitor, UN statistics

Exhibit 63. Japan: CAGR by segment (97-09)

(0.5)

0.0

0.5

1.0

1.5

2.0

Sna

ckba

rs

Bis

cuits

Cho

cola

te

Can

dy

Gum

Sna

cks

(%)


Korea already trying to overcome difficulties brought by demographic changes Like other FMCG firms, the confectionary industry in Korea is also facing threats due to the country’s declining number of young children. Chewing gum and candy, which saw fast sales growth in the past, are likely to be most negatively affected by the country’s demographic change, in our view. Meanwhile, we believe confectionary companies that produce biscuits and snacks targeted at adults are able to ride through difficulties, following the path of their Japanese counterparts 13 years ago, which saw sales of biscuits outgrow other segments in the confectionary market on growing demand from adults (more adults consuming biscuits to substitute main meals).



Exhibit 64. Korea: confectionery market

2

3

4

5

6

7

8

9

10

11

12

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

(mn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

(Wtn)Population of childhood (RHS)

Confectionery market (LHS)


Exhibit 65. Korea: CAGR by segment (97-09)

(0.5)

0.0

0.5

1.0

1.5

2.0

Sna

ckba

rs

Bis

cuits

Cho

cola

te

Can

dy

Gum

Sna

cks

(%)

Source: Euromonitor

Exhibit 66. Soft drink market mix by product type (Japan vs Korea)

1832

15

157

1313

12

47

28

0

10

20

30

40

50

60

70

80

90

100

Japan Korea

(%) Biscuits Chocolate Gum Candy Snacks




Investment summary

Implications to our stock view Our study of Korea’s population structural change and its impacts on the FMCG industry provides a base for our stock selection. We are not concerned about excessive price competition is this industry, which is already well consolidated. We take into consideration the sub-sectors’ market growth outlook, core competitiveness, market-share gain, and potential for price hikes in our stock selection.

Market growth: Unlike the past when most FMCG enjoyed sound market demand growth, we believe growth momentum of consumer-related industries will now depend on the country’s demographic change.

Market share gain: Even if sales volumes were to decline, successful market share gain could help to offset the decline. Since many of Korea’s FMCG firms are consolidated, we see no drastic change in their market share. Interestingly, the companies that are gaining market shares, such as cosmetic and confectionery firms, are those that have successfully built strong brand power, entered into new markets, and created premium market growth.

Price hike: Increased pricing power could help offset potential earnings decline from falling market volume. We believe that many FMCG firms in Korea with a consolidated industry structure, strong brand power, and control over distribution channels have already secured good pricing power. However, products with a sales tax, such as tobacco and liquor, look relatively difficult to achieve price hikes especially when the Korean government is sensitive to inflation. Raising product prices to more than offset rising raw material costs, in our view, will be difficult for Korean FMCG firms given the Korean government’s concern over inflation.

Room for premium growth: Improving product mix looks to be an easier option to increase ASP, therefore creating a new segment with a higher pricing is important for an FMCG firm to maintain pricing power, in our view.

Overseas growth: Overseas expansion is important for Korea FMCG firms in the long term, especially those with a presence in China, given that China has faster economic growth than Korea and has a population size 27x that of Korea’s. As mentioned earlier, China also has a favourable population structure.

Exhibit 67. Korea: areas to focus in order to sustain

Industry Company Market growth Market share gain Price increase China growth Premium growth

Cosmetics AP, LGHH

Other Lock&Lock

Beverage LGHH

confectionery Orion

Tobacco KT&G

Beer Hite


Orion (BUY) and Lock & Lock (BUY) our top picks Lock&Lock (L&L) and Orion are our top picks for FY11F in the Korea’s FMCG segment, as we like their potential earnings growth in China. Although demographic changes do not look very favourable for these companies in Korea, with their presence in China and plans to expand further, we expect them to have faster earnings growth compared to Korean peers.

NETURAL on LGHH and Amorepacific While we have a favourable outlook for the cosmetics and beverage markets, and like the competitive strength of Amorepacific and LGHH, we believe their valuations have already factored in their strong earnings growth outlook. We also believe their earnings growth could slow from FY10’s.



Negative on KT&G (NEUTRAL) and Hite (REDUCE) We remain negative on the fundamentals of KT&G, given its weak market volume, continuous market share decline, weak product mix structure, unfavourable currency trends (a stronger won) and slower earnings growth from its subsidiary. While M&A could help the company to find a new growth segment, we remain cautious due to its lack of experience in the M&A field.

Hite: initiating coverage with a REDUCE rating

We initiate coverage of Hite with a REDUCE rating. Korea’s young generation is declining (aged below 25-49 is falling) and this is likely to hurt Hite’s sales volume. Moreover, its market share is falling due to a weakening brand. We do not expect Hite to have a competitive edge in the faster-growing premium segment, and given that the company has no presence in China and has limited benefits from its distribution integration with Jinro, we see it negatively affected by rising raw material costs.

Exhibit 68. Korea: key assumptions for FY11F

Market growth Market share gain ASP growth China contribution Premium contribution

Industry Company (% y-y) (pp, y-y) (% y-y) (%) (%)

Cosmetics AP 6.5 1.0 n/a 7 52

LGHH 6.5 3.0 n/a 3 54

Other Lock&Lock 5.0 5.0 2.5 34 20

Beverage LGHH (CCB) 5.0 2.0 2.0 0 8

confectionery Orion 6.0 1.0 2.0 34 20

Tobacco KT&G (1.5) (2.5) 2.0 3 6

Beer Hite (0.5) (0.5) 3.8 0 1

Source: Nomura estimates

Exhibit 69. Korea: FY11F net profit growth forecast

(10)

(5)

0

5

10

15

20

25

30

35

40

45

Lock&Lock Orion LGHH Amore Pacific The Hite KT&G

(%) FY11F EPS growth FY11F P/E

Source: Nomura estimates



Exhibit 70. Korea: % of foreign shareholdings

0

10

20

30

40

50

60

70

KT&G LGH&H Amore Pacific The Hite Orion Lock&Lock

(% of foreing holdings)

Note: As of 30 December, 2010 Source: Nomura research

Exhibit 71. AP and LGHH: global peer valuation comparison

Bloomberg Nomura Price Mkt cap EV/EBITDA (x) EBITDA

CAGR (%)EBITDA PEG (x) P/E (x)

EPS CAGR (%)

EPSPEG (x) ROE (%)

Company code rating 4-Jan (US$mn) FY10F FY11F FY10-12F FY11F FY10F FY11F FY10-12F FY11F FY11F

Amorepacific 090430 KS NEUTRAL 1,130,000 5,870 16.2 13.5 4.2 3.2 21.7 20.7 16.5 1.3 20.0

LG HH 051900 KS NEUTRAL 392,000 5,440 14.6 11.9 18.5 0.6 24.5 20.0 23.3 0.9 28.8

Shiseido 4911 JP NEUTRAL 1,790 8,753 9.9 8.4 12.6 0.7 26.9 26.9 10.5 2.6 7.8

Kao 4452 JP BUY 2,198 14,514 6.4 6.2 4.4 1.4 21.2 21.2 16.3 1.3 9.2

Estee Lauder EL US Not rated 82 16,030 12.8 11.5 12.2 0.9 25.5 25.5 16.6 1.5 30.4

L'OREAL OR FP REDUCE 85 67,847 13.4 12.4 7.9 1.6 21.0 21.0 10.1 2.1 16.5

P&G PG US Not rated 65 181,808 10.5 9.9 4.0 2.5 16.3 16.3 9.2 1.8 19.1

Avon AVP US Not rated 30 12,888 10.3 9.0 12.5 0.7 15.7 15.7 13.3 1.2 47.7

Beiersdorf BEI GR BUY 42 13,974 11.0 11.4 4.2 2.7 22.7 22.7 5.9 3.9 13.4

Global peer valuation 11.7 10.5 8.9 1.6 21.7 21.1 13.5 1.8 21.4

Source: Nomura estimates, Bloomberg consensus for not rated stocks

Exhibit 72. KT&G: global peer valuation comparison



EPSCAGR (%)

EPSPEG (x)

ROE (%)


KT&G Corp 033780 KS NEUTRAL 65,600 8,003 6.5 6.6 (0.5) (12.3) 10.2 10.9 0.4 25.1 16.2

British American Tobacco BATS LN BUY 2,488 77,442 10.7 9.9 7.0 1.4 14.3 13.0 9.5 1.4 43.5

Imperial Tobacco Group IMT LN BUY 1,985 31,511 9.4 8.5 4.9 1.7 11.1 10.4 7.9 1.3 24.8

Altria MO US Not rated 24 50,922 9.0 8.3 5.8 1.4 12.8 12.0 6.6 1.8 84.0

Reynolds American Inc RAI US Not rated 33 19,147 7.9 7.5 4.6 1.6 13.1 12.3 5.5 2.2 22.2

Gudang Garam GGRM IJ Not rated 41,100 8,801 12.0 10.2 13.1 0.8 18.7 15.6 15.8 1.0 21.4

British American Tobacco ROTH MK REDUCE 46 4,319 12.7 12.6 1.6 7.7 18.2 18.0 1.4 13.3 131.5

Japan Tobacco Inc 2914 JP BUY 304,000 37,164 7.1 7.1 4.5 1.6 21.6 20.6 24.3 0.8 9.2





Exhibit 73. Hite: global peer valuation comparison



EPSCAGR (%)

EPSPEG (x)

ROE (%)


HITE 103150 KS REDUCE 123,000 1,045 8.7 8.1 3.6 2.3 16.6 16.2 5.3 3.1 8.1

ASAHI 2502 JP NEUTRAL 1,583 9,358 7.1 6.6 7.8 0.8 14.0 12.9 8.3 1.6 9.2

KIRIN 2503 JP BUY 1,144 13,496 7.2 6.7 2.2 3.0 33.3 14.2 62.5 0.2 8.0

TSINGTAO 168 HK REDUCE 41 7,120 15.3 12.7 16.0 0.8 29.9 25.0 18.7 1.3 18.4

FOSTER'S FGL AU NEUTRAL 6 10,979 10.8 10.0 5.6 1.8 16.0 15.2 6.4 2.4 26.2

CARLSBERG CARLB DC BUY 571 15,608 8.6 7.8 7.1 1.1 15.6 13.7 14.3 1.0 9.8

HEINEKEN HEIA NA NEUTRAL 33 12,680 5.8 4.7 12.5 0.4 10.2 8.4 20.4 0.4 13.5

MOLSON C. TAP US Not rated 49 9,091 9.6 8.4 7.9 1.1 13.6 12.7 7.0 1.8 9.1



Exhibit 74. Orion: global peer valuation comparison



EPSCAGR (%)

EPSPEG (x)

ROE (%)


Orion 001800 KS BUY 405,000 2,146 18.6 14.2 7.9 1.8 12.3 20.5 28.1 0.7 15.3

Nong Shim 004370 KS Not rated 205,000 1,108 5.1 4.4 5.0 0.9 10.7 10.1 8.6 1.2 9.4

Lotte Confectionery 004990 KS Not rated 1,474,000 1,862 11.3 10.5 4.7 2.2 15.3 13.9 10.8 1.3 5.2

Lotte Chilsung 005300 KS Not rated 937,000 1,030 9.2 8.8 3.3 2.7 33.7 23.6 29.0 0.8 2.5

China Agri-Industries 606 HK BUY 9 4,699 11.7 10.0 21.8 0.5 13.3 11.1 19.2 0.6 15.8

China Foods 506 HK REDUCE 5 1,808 13.3 11.0 22.9 0.5 28.5 21.8 28.7 0.8 10.3

China Huiyuan Juice 1886 HK NEUTRAL 5 1,025 18.8 10.9 39.1 0.3 56.8 24.6 76.0 0.3 4.9

China Mengniu 2319 HK BUY 21 4,720 11.9 8.9 23.7 0.4 23.6 18.5 24.5 0.8 17.4

China Resources 291 HK NEUTRAL 33 10,109 12.3 10.8 14.0 0.8 37.0 28.9 24.9 1.2 8.7

China Yurun Food 1068 HK BUY 26 6,107 16.6 13.4 23.0 0.6 20.4 16.9 20.8 0.8 21.5

Huabao International 336 HK BUY 12 4,954 24.8 20.0 24.9 0.8 29.3 24.6 19.4 1.3 36.0

Tingyi 322 HK BUY 21 14,956 15.8 12.8 20.9 0.6 33.2 28.0 20.4 1.4 28.3

Coca-cola KO US Not rated 64 148,308 14.2 12.1 12.6 1.0 18.3 16.6 9.9 1.7 29.0

General Mills GIS US Not rated 36 22,692 9.4 9.2 3.8 2.4 15.4 14.4 7.9 1.8 29.6

Kellogg K US Not rated 51 18,886 10.1 9.8 4.2 2.3 15.5 14.9 7.7 1.9 53.5

Kraft Foods KFT US Not rated 32 55,198 10.3 9.1 10.1 0.9 15.6 13.6 13.2 1.0 12.4

Nestle NESN VX BUY 55 199,538 11.0 10.8 5.2 2.1 17.0 15.8 9.2 1.7 18.4

Pepsico PEP US Not rated 65 103,664 10.3 9.3 9.4 1.0 15.9 14.3 10.9 1.3 33.3

Hershey HSY US Not rated 46 10,161 9.6 9.0 5.2 1.7 18.2 16.8 8.1 2.1 63.0



Exhibit 75. L&L: global peer valuation comparison



EPSCAGR (%)

EPSPEG (x)

ROE (%)


L&L 115390 KS BUY 35,900 1,595 20.1 14.9 39.5 0.4 26.7 19.2 43.1 0.4 23.9

Samkwang Glass 005090 KS Not rated 68,600 296 12.3 7.9 29.8 0.3 11.5 7.5 36.0 0.2 20.1

Church&Dwight CHD US Not rated 69 4,916 9.2 8.1 7.3 1.1 17.4 15.8 10.0 1.6 15.7

Tupperware TUP US Not rated 49 3,093 8.5 7.4 10.7 0.7 13.4 11.6 14.0 0.8 32.3

Alberto-Culver ACV US Not rated 37 3,667 13.2 12.1 9.7 1.2 23.5 20.3 14.9 1.4 15.4

Enegizer ENR US Not rated 73 5,151 8.2 7.4 6.9 1.1 12.6 11.8 10.4 1.1 16.1

Newell NWL US Not rated 18 5,254 8.3 7.3 6.5 1.1 12.2 10.8 11.9 0.9 29.9

Weight WTW US Not rated 37 2,731 na na (1.3) nm 15.1 13.7 6.4 2.1 nm





Drilling down

Ageing population Korea is facing a rapid demographic transition driven by the ageing of its population, which in turn is expected to affect its consumer markets.

Korea rapidly heading towards an aged society Korea is already an ageing society based on definitions set by UN. Indeed, by entering into an ageing society in 2001, Korea became one of the first countries in the world to experience an ageing population. According to forecasts from UN, Korea is expected to rapidly advance into an aged society by 2018, when the population aged 65+ and above occupy more than 14% of the total population. In only 26 years since becoming an ‘ageing society’, Korea is expected to progress rapidly into a being a ‘super-aged’ society.

Whereas the rise in median age is a worldwide transition, the speed of such transition in Korea is one of the fastest and is 6x the speed of ageing compared to that of France (vs 154 years for France, 94 years for the US, 77 years for Germany and 36 years for Japan).

Exhibit 76. Definition of ageing, aged, and super aged society

Population aged 65+ and above (%)

Ageing society 7

Aged society 14

Super aged society 20

Source: UN, Nomura research

Exhibit 77. Pace of ageing

Years in between Total years Year of entry

Country Ageing ► Aged Aged ► Super-aged Aged ►super-aged Aged society Super-aged society

South Korea 18 8 26 2018 2026

Germany 40 37 77 1972 2009

France 115 39 154 1979 2018

United states 73 21 94 2015 2036

Japan 24 12 36 1994 2006

Source: UN, KOSIS, Nomura research

Exhibit 78. Aged population (2010F)

23.116.4 13.8 13.5 13.1 11.0 9.7 7.9 7.4

0

5

10

15

20

25

30

35

Japa

n

Wes

tern

Eur

ope

Eas

tern

Eur

ope

Aus

tral

asia

Nor

thA

mer

ica

Sou

thK

orea

Chi

na

Wor

ld

Asi

aP

acifi

c

(%)

Note: Aged = 65-plus population

Source: UN, KOSIS

Exhibit 79. Aged population (2020F)

28.9

18.7 16.6 16.4 16.0 15.6 13.19.6 9.4

0

5

10

15

20

25

30

35

Japa

n

Wes

tern

Eur

ope

Eas

tern

Eur

ope

Aus

tral

asia

Nor

thA

mer

ica

Sou

thK

orea

Chi

na

Wor

ld

Asi

aP

acifi

c

(%)

Note: Aged = 65-plus population

Source: UN, KOSIS



Two fundamentals trends in ageing The ageing of the Korean society is due to: 1) a steep drop in total fertility rate and 2) increase in longevity. The result of ageing stemming from these is amplified by the ageing of the baby boom generation. As a result, a structural change in the demographic model is expected.

Exhibit 80. Drop in fertility rate

0.00.51.01.52.02.53.03.54.04.55.0

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

201

1F20

13F

201

5F20

17F

201

9F

World

South Korea

Japan

(Children born per female)


Exhibit 81. Life expectancy

4045

5055

6065

7075

8085

90

196

5

197

0

197

5

198

0

198

5

199

0

199

5

200

0

200

5

201

0F

201

5F

202

0F

202

5F

203

0F

203

5F

204

0F

204

5F

205

0F

World South Korea Japan

10 year lag between Japan and South Korea, while both countries are


Meanwhile, year 2016F is seen (see exhibit, below right) as the turning point when the number of senior population outgrows that of the youth population.

Steep decrease in fertility rate: Fertility rate (child born per female) of Korea fell to 1.3 in FY09, which is almost the lowest, second to Greece, Bosnia-Herzegovina and Singapore’s 1.2 according to the statistics released by UN. It is a rate that is 58% lower than the world average fertility rate of 3.1, lower than the sustainable birth rate 2.1.

Steady increase in life expectancy: Besides having fewer babies, rising longevity is also accelerating Korea’s advancement into an aged/ super aged society. Various medical factors have contributed to rising longevity over the years, raising the survival rates after the age of 65.

Exhibit 82. Shift in the majority age segment

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

196

0

196

6

197

2

197

8

198

4

199

0

199

6

200

2

200

8

201

4F

202

0F

202

6F

203

2F

203

8F

204

4F

205

0F

('000) 0-14 65+

Year FY2016F

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

196

0

196

6

197

2

197

8

198

4

199

0

199

6

200

2

200

8

201

4F

202

0F

202

6F

203

2F

203

8F

204

4F

205

0F

('000) 0-14 65+

Year FY2016F


Exhibit 83. Ageing scenario in Korea




Ageing of the society and the consumer industry Along with the many areas where a demographic change may have an impact on, such as the educational system, policy enactments regarding different age segments, etc., the consumer industry is largely susceptible to a country’s demographic change.

Baby boomers, becoming aged consumers The term “baby boomers” in Korea refer to those who were born in 1955-1964, those who turned 45-54 years old in 2010. This population segment, which occupied 33.9% of the total population as of 2010, (according to UN statistics) is not far from reaching their retirement age. The “baby boom” generation makes a strong presence in the demographic pyramid in Korea (occupied 29% of the consumer segmentation in 2010 (see exhibits below), and hence are the largest spenders. Therefore, this “baby boom” generation has played a significant role in directing the consumption trends in Korea. As the “baby boom” generation ages, we believe a shift in consumption trends is inevitable.

Exhibit 84. Ageing of baby boom generation: 1990

0

1,000

2,000

3,000

4,000

5,000

0-4

5-9

10-1

415

-19

20-2

425

-29

30-3

435

-39

40-4

445

-49

50-5

455

-59

60-6

465

-69

70-7

475

-79

80-8

485

-89

90-9

495

-99

100-

('000)

Baby boomers % of total population = 40.5


Exhibit 85. Ageing of baby boom generation: 2000

0

1,000

2,000

3,000

4,000

5,000

0-4

5-9

10-1

415

-19

20-2

425

-29

30-3

435

-39

40-4

445

-49

50-5

455

-59

60-6

465

-69

70-7

475

-79

80-8

485

-89

90-9

495

-99

100-

('000)



Exhibit 86. Ageing of baby boom generation (2010)

0

1,000

2,000

3,000

4,000

5,000

0-4

5-9

10-1

415

-19

20-2

425

-29

30-3

435

-39

40-4

445

-49

50-5

455

-59

60-6

465

-69

70-7

475

-79

80-8

485

-89

90-9

495

-99

100

-

('000)



Exhibit 87. Ageing of baby boom generation (2020F)

0

1,000

2,000

3,000

4,000

5,000

0-4

5-9

10-1

415

-19

20-2

425

-29

30-3

435

-39

40-4

445

-49

50-5

455

-59

60-6

465

-69

70-7

475

-79

80-8

485

-89

90-9

495

-99

100

-

('000)Baby boomers % of total population = 32.6




Exhibit 88. Consumer segmentation: Korea (2000) vs Japan (1990)

4 38 75 5

10 108 7

14 12

2116

2228

10 11

0 10 20 30 40 50 60 70 80 90 100

South Korea: 2000 Japan: 1990

Babies/Infants KidsTweenagers TeensStudents Generation YGeneration X Baby Boomers (40-60)Pensioners

(%)


Exhibit 89. Consumer segmentation: Korea (2010F) vs Japan (2000)

2 35 55 49 86 6

11 12

19 17

29 29

14 17

0 10 20 30 40 50 60 70 80 90100

South Korea: 2010 Japan: 2000

Babies/Infants KidsTweenagers TeensStudents Generation YGeneration X Baby Boomers (40-60)Pensioners

(%)


Exhibit 90. Shifts in consumer segmentation: Japan (1990~2010)

0 10 20 30 40 50 60 70 80 90100

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Babies/Infants Kids Tweenagers

Teens Students Generation Y

Generation X Baby Boomers (40-60) Pensioners(%)


Demographic model of Korea, resembles that of Japan Fortunately for the consumer related companies, there is a model to benchmark in order to prepare themselves for the soon to emerge, aged society.

Korea is expected to become the second country after Japan in Asia to see a decline in total population, according to UN forecasts. Interestingly, while Korea rapidly progresses into an aged society, we expect the domestic demographic model to experience similar changes that Japan has gone through and eventually merges into a model of Japan from a decade ago. As shown in the exhibits overleaf, the ageing pyramid of South Korea in 2010F looks very similar to that of Japan in 2000, and the ageing pyramid of South Korea in 10 years time is likely to closely resemble the ageing pyramid of Japan as of today. There is a 10-year lag in the elongation of Korean and Japanese life expectancies, as shown in the exhibits below. Hence, we believe Korea will follow the footsteps of Japan in terms of its demographic shift.



Exhibit 91. Korea: ageing pyramid (2010F)

(6,000) (4,000) (2,000) 0 2,000 4,000 6,000

0-9

10-19

20-29

30-39

40-49

50-59

60-69

70-

('000)

Male Female

Source: KOSIS

Exhibit 92. Korea: ageing pyramid (2020F)

(6,000) (4,000) (2,000) 0 2,000 4,000 6,000

0-9

10-19

20-29

30-39

40-49

50-59

60-69

70-

('000)

Male Female

Source: KOSIS

Exhibit 93. Japan: ageing pyramid (2000)

(15,000) (10,000) (5,000) 0 5,000 10,000 15,000

0-9

10-19

20-29

30-39

40-49

50-59

60-69

70-

('000)

Male Female

Source: Japan Ministry of Internal Affairs and Communications, and National Institute of Population and Social Security Research

Exhibit 94. Japan: ageing pyramid (2010F)

(15,000) (10,000) (5,000) 0 5,000 10,000 15,000

0-9

10-19

20-29

30-39

40-49

50-59

60-69

70-

('000)

Male Female

Source: Japan Ministry of Internal Affairs and Communications, and National Institute of Population and Social Security Research

Consumer industry in Korea to follow Japan’s When observing the correlation between the ageing pattern of South Korea and that of Japan and based on the rationale that ageing consumers will lead consumption trends, increasingly playing a more significant role in shaping the consumer industry, we believe Korean ageing consumers will also likely increase their spending in sectors that saw similar increased spending in Japan by its ageing population 10 years ago.

In our opinion, products that are likely to be affected due to the demographic shift are:

Products with nutritional supplements, health enhancement factors, i.e. the so called “silver industry”;

Products that relate to the enhancement of health (nutritional supplement) will draw attraction from seniors;

Industries (beer, confectionary, traditional soft drinks) that are driven by younger generation may face challenges as the average consumers get older; and

Premium brands and products will see grow in demand as the ageing generation seeks products to assist their well being and enhance their quality of living.

In this report, we review and analyze the implications of an ageing society on Korean consumer companies by analyzing the industry trends of Japanese FMCG firms in the past decades.


Hite Brewery 103150 KS

CONSUMER RELATED | SOUTH KOREA



Little to cheer about Persistently tough business environment

In Korea, the absolute number of those aged 25-49 years old (a group that accounts for 92% of total beer consumption as of FY08) peaked in 2008, hitting volume growth, which has seen a 4.8% compound annual decline over FY08-10F. This, coupled with new brands not yet building strength and the “HITE” brand being affected by heated competition, bodes poorly in terms of Hite’s likelihood of gaining market share in the near term, we believe.

Lack of presence in premium and overseas business The fast-growing premium-beer segment accounts for 5% of the total beer market and is dominated by imported beers. With Hite lacking a presence in the premium-beer segment, as well as in the ever-growing China market, we believe it stands to miss out on the anticipated growth in these segments.

Rising costs another concern We expect Hite to hike prices by 5% in April 2011F to offset a more than 40% y-y rise in malt prices in FY10F (we estimate raw material costs equal 14% of FY10F sales). On our analysis, every 1pp shortfall from our anticipated price hike of 5% would shave 6% off our FY11F net profit forecast. We also note that beer in cans is one of the 48 items the government ‘monitors’ in an attempt to control inflation.

Initiate with REDUCE rating We initiate coverage with a REDUCE rating. Our PT of W100,000 is based on the stock’s historical low P/E of 12.5x P/E and 12-month forward EPS, implying 17% potential downside. With a faster decline in market volume and growing competition ahead, we forecast earnings growth of only 2% y-y and a further decline in ROE to 8.1% for FY11F. The prevailing 15.6x FY11F P/E (1.9 PEG) looks high vs global peers (1.4 PEG with 14% average earnings growth). We see limited benefits from the distribution integration with Jinro as a potential downside risk.

Key financials & valuations31 Dec (Wbn) FY09 FY10F FY11F FY12FRevenue 1,018 1,003 1,028 1,030

Reported net profit 99.2 72.2 73.9 80.1

Normalised net profit 99.2 72.2 73.9 80.1

Normalised EPS (W) 10,186 7,410 7,582 8,224

Norm. EPS growth (%) (26.2) (27.2) 2.3 8.5

Norm. P/E (x) 12.1 16.6 16.2 15.0

EV/EBITDA (x) 7.6 8.7 8.1 7.6

Price/book (x) 1.4 1.4 1.3 1.2

Dividend yield (%) 0.0 0.0 0.0 0.0

ROE (%) 13.6 8.4 8.1 8.4

Net debt/equity (%) 88.9 79.7 70.1 59.2

Earnings revisions

Prev ious norm. net profit na na na

Change from previous (%) na na na

Prev ious norm. EPS (W) na na na

Source: Company, Nomura estimates

Share price relative to MSCI Korea

1m 3m 6m

3.8 (4.3) (11.2)

5.4 (3.7) (2.5)

(2.6) (17.2) (41.1)


1,050

50.8

3-mth avg daily turnover (US$mn)

Absolute (W)

Absolute (US$)

Relative to Index

Estimated free float (%)

Market cap (US$mn)

168,000/116,000

2.34

52-week range (W )

Lazard Asset Management

Stock borrowability

15.6

Major shareholders (%)

Hite Holdings 40.2

110,000120,000130,000140,000150,000160,000170,000180,000

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Closing price on 4 Jan W123,000

Price target W100,000

Upside/downside -18.7%Difference from consensus -29.3%

FY11F net profit (Wbn) 73.9Difference from consensus -28.3%Source: Nomura

Nomura vs consensus We think the market has not picked up on the faster decline in market volume in 4Q10F, and is simply too optimistic on the benefits of distribution integration with Jinro.

Initiation

REDUCE


Action We initiate coverage of Hite with a REDUCE call and PT of W100,000. With the 25-

49 year-old age group in Korea shrinking, volumes are likely to take a hit, and Hite is losing market share on a weakening brand. We see little advantage for it in the fast-growing premium segment, and its lack of presence in China and limited benefit from distribution integration with Jinro pose further risks amid climbing costs.

Catalysts Higher-than-expected price hikes in 2Q11F are an upside risk. Faster declines in

market share and further increases in raw material prices are downside risks.

Anchor themes

Alcohol and tobacco stocks are most vulnerable in an ageing demographic, going by our analysis of Japan over the past 15 years. Incidentally, Korean alcohol and tobacco companies have minimal presence in China, which is unusual in a Korean consumer universe that generally has a formidable influence there.

Hite Brewery Cara Song


Business environment

Persistently tough business environment We see an even tougher business environment ahead for Korea’s beer industry owing to unfavourable demographic trends sapping beer consumption volume, weakening brand power of the flagship “Hite” brand, and rapidly rising raw material prices. The segment of the Korean population that drinks the most beer (those in their 30s and 40s) has peaked and a more health-conscious nation is drinking less. In addition, when Koreans do drink, they are turning to other alcoholic beverages and drinking less beer. As the biggest player in the Korean beer market, Hite Brewery stands to lose the most, in our view. What might turn things around? Tapping its brand power to gain market share, a nimble overseas move to offset the decline in Korea or a debut in the premium beer segment could offset these risks, in our view.

Market volume continues to contract Over 2008-10F, the total liquor market in Korea declined by 2.4% on a compound annual basis, which we attribute to the trends noted above. This is for a market that has seldom seen volumes decline in the beer segment, owing to the country’s rapid growth in disposable income per capita and the growing weight of population in the major consuming age groups over the past decade (except in 2005, when there was when a sudden drop in the volume of beer sales, triggered by a significant inventory adjustment by local beer makers). Since 2008, we note a somewhat surprising decline in some sub-sectors in consumer-related industries, such as tobacco and liquor. However, with the shrinking ‘consumption segment’ of the population, and growing health concerns as the population ages, market volumes in these consumer sub-sectors look set to decline still further.

Tough to argue with demographics

According to market research data provided by Synovate Korea, men drink 83% of the beer in Korea, and men aged 25-49 drink 92% of that beer. The absolute number of those aged 25-49 peaked in 2008 and declined by 1% y-y over 2008-10F. During the same period, volumes in Korea’s liquor market also started to decline (at a rate of 3.8% y-y) for the first time in a decade (bar 2005). Economic growth looks to be the major growth driver of beer consumption, but it will be hard to overcome the all-but-inevitable consequences of a changing population structure, in our view. Furthermore, population forecasts show an even more rapid decline in the absolute number of those aged 25-49 over the next two years (a 1.3% pa fall in 2010-12F vs a 1% pa decline in 2008-10F), so we expect market volume to continue to ebb.

Not just beer, but all liquors facing structural decline

It is not just beer; all major liquor segments have lost ground over the past two years. This supports our view that unfavourable demographics have been the major reason liquor consumption has fallen (amid a quick recovery in the economy). At the same time, we have seen faster growth in makgulri consumption. Makgulri is Korea’s traditional rice wine (but it is milky, quite unlike sake), and is regarded as healthier, not unlike how red wine is often viewed in the West, so it has been taking share from beer and soju (which is Korea’s white spirit). Even so, the 30% volume CAGR in makgulri cannot by itself explain the overall decline in other strong drinks.

We see a 0.5% compound annual decline for beer in next two years

While Hite estimates 1% y-y growth in beer sales volume in Korea in 2011F, based on regression analysis and various other forecasting methods, we assume a 0.5% y-y sales decline as a result of demographic factors and slower economic growth. Although our forecasts could be wrong, as it might depend largely on how hard industry players push sales, we think falling demand is a secular trend that cannot be ignored for long.

Sometimes the biggest has the most to lose, and Hite is the biggest

The demographics are not leaning toward beer consumption, or other vices

Fewer drinkers mean lower sales

Only Korea’s traditional rice wine is growing

The company is more optimistic than we are on the sales volume trend



Why we forecast a 0.5% y-y decline in beer sales. We assume a 0.5% y-y fall in beer sales solely on the basis of an absolute decline in the consuming population over the next two years (a 1.3% compounded fall). We regard this as a conservative measure, as we see a more meaningful decline in consumption per capita, with beer market volume declining faster than the actual decline in the major consuming age group (a 3.9% compound annual fall in beer market volume in 2008-10F vs a 1.0% compound annual fall in the number of those aged 25-49). We note that if market volume falls by 1pp more than we forecast, our earnings forecasts stand to fall by 1% in FY11F (see sensitivity analysis).

Exhibit 95. Korea: liquor market growth Exhibit 96. Korea: beer market/private consumption

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(mn liter) Beer Soju Wine Makgulri Other

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Source: Nomura research, Euromonitor Source: Nomura research, Euromonitor

Exhibit 97. Korea: consumption age group trend Exhibit 98. Korea: beer consumption by age (2008)

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(mn) Age 25-49 (LHS) Total (RHS)

Age 35 - 4940%

Age 25 - 3452%

The rest8%

Source: Nomura research, Euromonitor

Note: male population




Exhibit 99. Korea: liquor market mix Exhibit 100. Korea: liquor market CAGR by segment

Other3%

Makgulri8%

Soju34%

Beer53%

Wine2%

(10)

(5)

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Malgulri Wine Beer Soju Total

(%) CAGR (00-08) CAGR (08-10F) CAGR (10F-12F)


Exhibit 101. Hite: sensitivity analysis — market volume growth to net profit

(%) Base

Market volume growth 2.5 1.5 0.5 (0.5) (1.5) (2.5) (3.5)

Sales revenue (domestic) 998 988 978 968 958 949 939

Operating profit (Wbn) 152 151 149 148 147 145 144

Net profit (Wbn) 76 75 75 74 73 72 72

Impact to net profit 2.9 1.9 1.0 0.0 (1.0) (1.9) (2.9)

Source: Company data, Nomura estimates

Competition heating up As well as beer market volumes starting to peak, Hite’s market share has fallen to 55% in 2010 from 58% in 2008, with Oriental Breweries (OB) capturing the market share lost by Hite over the period. We believe Hite’s major brand “THE HITE” has continued to lose its brand appeal and that Hite’s new brand, “MAX”, launched in 2006, has not been able to offset the decline in “THE HITE” sales; historical data appear to back our contention. In August 2010, Hite launched a new brand, “Dry Finish D (D)”. Four months after the launch, the jury is still out on whether the new brand will provide the sales momentum the company badly needs and we are still cautious on its success: at present “D” is contributing to losses, not profits.

Losing market share: is difficult branding the culprit?

We attribute Hite’s market share slump to stiffening competition and new brands not yet big enough to cover the sales volume fall of major brand “Hite”. While Hite tried to create new beer brands such as “MAX” (launched in 2006), “Beer S” (2007) and “Dry Finish D” (August 2010), it appears not to have promoted its major brand, “THE HITE”, which accounted for nearly 90% of total sales in 2007. As creating a brand costs much more than maintaining the appeal of an existing brand, Hite’s marketing efficiency (sales per marketing cost) seems to have deteriorated and resulted in a diminishing marketing cost allocation to “THE HITE” brand, in our view. This could explain why the amount of sales increase generated by the new brands over the past two years has not been able to offset the decline in the amount of “THE HITE” that the company has sold.

Bear market in beer: OB taking market share from Hite



Exhibit 102. Korea: beer market-share trends Exhibit 103. Hite: “THE HITE” losing its brand power

5558 57 56

5553

4139 40 41

42 43

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(%) Hite OB

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(Wbn) THE HITE MAX Other

Source: Nomura Seoul, Company data, FSS Source: Nomura Seoul, Company data

Exhibit 104. Hite: sales mix by brand

(Wbn) FY06 FY07 FY08 FY09 CAGR (FY08-10F) Decline (Wbn, FY08-10F)

THE HITE 832 881 907 849 (5.0) (88.5)

New brands 43 66 87 119 21.5 41.6

Total 875 947 995 967 (2.4) (46.9)

Mix (%)

THE HITE 95 93 91 88

New brands 5 7 9 12

Total 100 100 100 100


Exhibit 105. OB: CASS Light Exhibit 106. Hite: THE HITE

Source: Nomura Research, Company data Source: Nomura Research, Company data

OB gaining momentum through a smart move

While Hite is going through the trouble of creating and managing new brands, OB wisely took a “mega brand” strategy, focussing on its major brand “CASS” and strengthening this brand via overall marketing and by launching extension lines such as “Cass Light” with innovative product concepts. While we believe that depending on a single brand to spur sales momentum can be a risky move, there are times when it can work effectively. Hite’s major brand “THE HITE” has been losing out as the company divides its resources among its many brands. Without improved brand equity and growing popularity among consumers, we think that it will be that much harder for Hite to increase its volume and win back market share from OB. At OB, effective end-demand marketing and branding have helped poach market share from Hite, and all this without an increase in marketing and administration costs.

OB has been able to win market share without an increase in marketing costs



Exhibit 107. Hite: sales mix by brand trends

Hite Brand concept OB Brand concept FY09

Existing THE HITE, STOUT OB, CASS, CAFRI

2006 MAX 100% malt barley beer 849

2007 S Beer A high-fibre, low-calorie beer Cass Red Beer with high alcohol content (6.9%) 119

2008 Cass Lemon Beer with lemon taste 967

2009 Cass 2X High carbonic acid and low alcohol (2.9%)

2010 Dry Finish D The only 100% dry type beer Cass Light A low-calorie beer (33% less), taste improved y ripening at zero temperature


Exhibit 108. Hite vs OB: historical earnings trends

OB Hite

(Wbn) FY07 FY08 FY09 FY07 FY08 FY09

Net sales 662 751 816 963 1,027 1,018

Growth (%) 12.6 13.4 8.7 7.8 6.6 (0.9)

Gross profit 397 439 469 527 533 518

GPM (%) 60.0 58.5 57.5 54.8 51.9 50.9

SG&A 253 269 273 297 319 335

Labour 61 72 71 74 76 78

Commission 44 45 43 38 36 62

Advertising 47 45 46 90 90 90

Other 101 108 113 95 117 106

SG&A (%) 38.2 35.8 33.5 30.8 31.1 33.0

Labour 9.2 9.6 8.7 7.6 7.4 7.7

Commission 6.7 5.9 5.3 4.0 3.5 6.1

Advertising 7.1 6.0 5.6 9.3 8.8 8.8

Other 15.2 14.4 13.8 9.9 11.4 10.4

Operating profit 144 170 196 231 214 183

OPM (%) 21.7 22.7 24.1 24.0 20.9 17.9


Exhibit 109. Hite vs OB: marketing-cost comparison Exhibit 110. Hite vs OB: operating-profit margin

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(%) OB Hite

Source: Company data, Nomura research Source: Company data, Nomura research



Weak position in premium and overseas market

Not ready to break through With the beer industry facing a tougher business environment amid structural declines in market volume and growing competition, we think Hite must make inroads (in fact should have already made inroads, in our view) into the rapidly-growing premium segment or the promising overseas market. Hite looks unlikely to capture growth in these areas soon, in particular ceding the premium segment at home to imports. Nor is Hite making traction overseas. All this has the company looking vulnerable in a tough environment, in our view.

We see very little room for Korean premium market to expand The premium-beer market accounted for 5.3% of the total market in terms of volume sales in 2009 and put up a greater CAGR of 5.1% in 2007-09; sales of standard beer declined 1.2% y-y over the same period, according to the Euromonitor database. In Korea, the faster growth in premium beer looks to have been led by sales of imported beer, which saw a CAGR of 10.2% by sales revenue (on a US-dollar basis) in 2007-09. Imported beer, unsurprisingly, is premium beer that can command 70%-plus higher pricing (see below).

No substantial growth: If we look at Japan’s beer preferences (we have long found consumer tastes in Japan to be a good rough guide of what is coming to Korea) we see that premium beer comprises 5.9% of the beer market, not much different from Korea’s 5.3% in 2009. As such, we do not see too much volume growth left for the premium beer market in Korea. We acknowledge that Japan’s market is different in many respects, not least the long-running deflation in a fragmented and very competitive market (vs an inflationary market Korea where the beer market is a duopoly); however, we think that Japan, with higher GDP per capita, should indeed support a deeper premium market, and this seems to balance the view.

Premium growth insufficient to save weakening beer market: Despite its faster growth (and this has much to do with the base effect), the growth in the volumes of premium beer sold does not look enough to make up for the general weakness in beer sales overall, in our view. The absolute increase in premium beer was 0.9mn litres during 2008-10, while the decline in standard beer sales was 18.0mn litres over the same period. Even if growth in premium-beer sales were to continue at a 6% CAGR in FY11F, the absolute decline in standard beer sales volume would still exceed the increase by a factor of five.

Premium does not look profitable: Given its relatively small sales (or with the higher transportation and tariffs that imports face) premium beer looks either loss-making or low-margin, in our view. It would be different and could show higher profit if there were bigger brands that could command scale, but that is not the reality.

Hite has no major premium brand: Hite tried to launch a premium beer, “HITE PRIME”, four years ago — with 10% higher pricing for the 100% malted barley beer, a new concept in Korea — but the brand did not return a profit. Two years later, Hite launched another 100% malted barley beer, “MAX”, but at standard beer pricing. This seems to have worked better than “HITE PRIME”, with the sales volume of “MAX” reaching 11% of total sales revenue in FY10F. However, as “MAX” has a lower margin but higher raw-material costs, the faster growth here is essentially just cannibalising “HITE” sales but at the same time returning a lower margin.

Not defending share and not winning new markets

We see the premium market in Japan as defining the top end of what is likely in Korea

Not defending share and not winning new markets



Exhibit 111. Korea: retail sale price comparison

Domestic Pack size (ml) Price (W) Price/ ml Imported Pack size (ml) Price (W) Price/ ml

Hite Brewery Asahi SD 350 2,490 7.1

THE HITE 6x250 5,520 3.7 Beck’s 330 2,450 7.4

MAX 330 1,750 5.3 Corona Extra 330 2,450 7.4

Dry Finish 330 1,750 5.3 Heineken 330 2,200 6.7

S Beer 330 1,500 4.5 Miller 355 1,990 5.6

OB Brewery Miller Lite 355 2,250 6.3

CASS 500 1,660 3.3 San Miguel 330 2,500 7.6

CASS light 330 1,750 5.3 Sapporo 651 3,500 5.4

CAFRI 330 1,050 3.2 Tsing Tao 330 2,250 6.8

OB Blue 6x355 5,600 2.6 Guinness 330 4,500 13.6

Average 4.2 Average 7.4


Exhibit 112. Korea: premium vs regular Exhibit 113. Japan: premium vs regular

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Exhibit 114. Korea: imported beer sales growth Exhibit 115. Korea: imported beer market share

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FY05 FY06 FY07 FY08 FY09 FY10F

Imported beer Domestic beer (%)

Miller20%

Sapporo9%

Corona extra8%

Others29%

Heineken20%

Asahi Super 14%




Nearly no presence overseas China is the biggest beer market in the world and accounts for 24% of global volume. Given China’s favourable demographic trends and growing income per capita, it should also be among the world’s fastest-growing beer markets. The case is not much different for other staples or near staples in the consumer-related segment such as tobacco, cosmetics and food — areas in which many other Korean consumer companies (such as Lock&Lock and Orion) have successfully been operating and strengthening their positions with aggressive distribution expansion and effective brand building (see below).

No presence in China, either

Unlike Korea’s other China plays, Hite has nearly no presence in what we think is easily the most rapidly expanding consumer market in the region, China. Although Hite’s export growth has been quite rapid over the past few years (44% CAGR in FY06-10F), sales volume still looks negligible in the big picture (6.4% of total sales volume in FY10E). Moreover, 70% of total exports are OEM sales to Japanese beer companies 3rd beer (3rd beer refers to beer that contains no malt. 2nd beer called “Happoshu” contains less than 25% malt.), and this means that while Hite is selling beer in Japan, it is not building brand equity there. China’s beer market is already competitive and as at present Hite has no plans to enter the market there, we believe we can rule out exports turning things around for Hite.

Exhibit 116. Global beer market by country (FY09)

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Exhibit 117. Korean staple goods: China plays China sales revenue (FY10F)

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Lock & Lock Orion Amorepacific Nong Shim LG H&H Hite

(%)

Source: Company data, Nomura research, FSS

No surprise to see that China is among the fastest-growing beer markets in the world

Missing out on the export market next door



Exhibit 118. Hite: China presence comparison Exhibit 119. Hite: overseas sales revenue

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(Wbn) Domestic sales Export sales

Japan72%

China2%

Mogolia8%Other

18%

Source: Nomura research, Company data Source: Nomura Seoul, Company data



Rising cost pressure in short term

Rising raw-material prices On top of everything else, the price of malted barley is rising fast. Malted barley accounts for 24% of Hite’s COGS and nearly 35% of its total raw materials, including packaging (see below). According to Hite, the price of malted barley has risen by 40% since May 2010 (as of 22 November 2010). Since Hite must import some 80% of its total malt from overseas, if we assume a 10% y-y rise in the Korean won against the US dollar and with no increase in the price of local malt, we see a minimum rise in the price of malted barley of 15% over the year in 2011F (note: contract prices here are set each November and come into effect each March).

Exhibit 120. Malted barley price (spot) Exhibit 121. Hite: COGS mix

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Labor9%

Malt24%

Packaging25%

Others21%

Depreciation

13%

Depreciation13%

Source: Bloomberg Source: Company data, Nomura research

Price hikes did not help in the past Assuming a 1.3% y-y decline in sales volume, an 18% y-y increase in malt price, no increase in cost per unit production for packaging material, and 3% wage growth for the production labour force, we see a W16bn y-y net increase in COGS in FY11F. In order to cover an estimated W28bn cost increase, Hite would need to raise product prices by 3.04%, we believe.

A 2.8% ASP CAGR since 2005: As a result of regulations related to the acquisition of Jinro in 2005, Hite’s ASP CAGR over the past five years from 2005 to 2010 has been 2.8%, which has been within the range of average inflation in Korea. This means that annual price rises have just kept up with inflation, and the gross-profit margin has fallen steadily (below, right).

We assume 3.8% ASP growth in FY11F: As the conditions imposed with the move on Jinro will be lifted from FY11F we forecast a 5% increase in 2Q11F, when higher malt prices will be reflected. On an annualised basis, a 5% price hike in April 2011 would mean a 3.8% y-y ASP rise in FY11F, which would lift estimated profit by W35bn. This would more than offset the estimated W28bn rise in costs.

We see malt prices rising 15% in 2011F

Needs a 2% price rise to cover creeping costs



Exhibit 122. Hite: ASP and gross margin trends Exhibit 123. Hite: gross profit margin comparison

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GPM (RHS)

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(%) Hite OB

Source: Nomura Research, Company data Source: Nomura Research, Company data

However, government is still keen on limiting inflation The government appears to be keen to limit price increases on necessities in order to support lower-income groups and manage inflationary pressure. It has announced a list of items in a price-monitoring basket in attempt to control inflation. Initially, the government designated 30 items that were to be watched closely for inflation control purposes. However, due to growing concerns over possible inflation, 18 new items that are considered to be potentially inflationary items have been added to the list. The 48 items in the price monitoring basket are a mixed lot: 1) 11 items (canned beer, skin toner, nourishing cream for skin, gasoline, diesel, snacks, milk, detergent, etc) whose price and competitive environment have been observed since 2008; 2) 19 items (digital cameras, bottled water, ice cream, acetaminophen, cream for atopic dermatitis, apparel for kids, strollers, etc) that reflect recent trends in consumer patterns, and 3) 18 newly-added items (flour, instant noodles, bread, beef, etc.).

Canned beer is one of the 48 items: Canned beer is one of the items on the government’s monitoring list, making it difficult for Hite to raise its product prices to offset rising costs. If Hite is unable to raise its product prices and increase them by only 2.8%, which has been the ASP increase per annum for the past five years, this would cut our net profit forecast for FY11F by 6%. An ASP increase of less than 3.8% is the risk to our earnings forecast and 0.5pp less price increase could impact our net-profit forecast for FY11F by 3% based on our analysis.

Exhibit 124. Items the prices of which are to be closely monitored

Initially included items (11 items) Canned beer, skin toner, nourishing cream for skin, gasoline, diesel, LPG, detergent, snacks, milk, vitamins, orange juice, branded coffee.

Existing items Digital devices (5 items) i-phones, digital cameras, net-books (mini laptops), portable video games, LCD LED TVs.

Groceries (5 items) Bottled water, ice cream, cheese, fried chicken, chocolate.

Medical devices (4 items) Tylenol, soft contact lenses (disposable), digital hematomanometers, cream for atopic dermatitis

Everyday goods (5 times) Children’s apparel, strollers, essences (cosmetics), shampoos, baby lotions.

Items newly added (18 items) Flour, instant noodles, bread, beef, pork, onions, garlic, eggs, sugar, trousers, tissues, sanitary napkins, tomatoes, coke, pizza, kerosene, cooking oil, powdered formula (for babies).

Source: Ministry of Knowledge Economy



Exhibit 125. Hite: sensitivity to earnings on price hike assumption

FY11F ASP growth (% y-y)

Worse 2 Worse 1 Base Better 1 Better 2

ASP growth 2.8 3.3 3.8 4.3 4.8

Operating profit (Wbn) 136 140 145 149 154

Net profit (Wbn) 67 69 72 74 76

Impact to net profit (%) (6.4) (3.2) 0.0 3.2 6.4

Note: Hite ASP CAGR for the past five years was 2.8%


We forecast 3.6% y-y operating-profit growth in FY11F We forecast 3.6% y-y operating-profit growth based on our assumption that Hite’s declines in market volume and market share are likely to continue in FY11F, although a 3.8% y-y ASP increase could do more than offset an 20% y-y rise in raw material costs. Integration with Jinro could save W9bn in selling and administration costs in FY11F, and we have included this in our forecast. If Hite cannot increase its product prices by 3.8%, and manages an increase of only 2.8% (the five-year historical average), it would lower our operating profit forecast by 6.4% (see our sensitivity table above), translating into a 2.9% y-y decline in operating profit in FY11F.

Exhibit 126. Hite: key assumptions

(% y-y) FY08 FY09 FY10F FY11F FY12F

Domestic

Market volume 5.69 (6.8) (2.8) (1.5) (1.5)

Market share (pp change) (1.1) (1.8) (1.2) (0.5) 0.00

Sales volume 3.73 (9.7) (4.9) (2.4) (1.5)

ASP 1.23 7.75 2.80 3.75 2.80

Sales revenue 5.01 (2.7) (2.2) 1.27 1.26

Export

Export volume 90.9 28.7 22.0 20.0 20.0

ASP 26.1 27.7 (6.0) (7.4) (7.0)

Export sales 140.6 64.4 14.7 11.1 11.5

(Wbn)

Sales revenue (net) 1,027 1,018 1,003 1,021 1,040

Beer 1,023 1,014 999 1,017 1,036

Domestic 995 968 947 959 971

Export 28 46 53 58 65

Other 4 4 4 4 4

COGS 490 500 499 525 517

Melt 116 156 140 164 152

Packaging 129 125 127 128 129

Depreciation 67 67 70 70 70

Labour 45 45 54 56 57

Other 134 107 108 108 108

Gross profit 536.4 517.8 503.7 495.3 522.4

Margin (%) 52.2 50.9 50.2 48.5 50.3

Growth (% y-y) 1.7 (3.5) (2.7) (1.7) 5.5

SG&A 319 335 364 350 358

Labour 74 44 78 88 89

Marketing 111 56 116 130 121

Commission 38 36 62 64 65

Other 97 199 108 68 82

Operating profit 218 183 140 145 164

Margin (%) 21.2 17.9 13.9 14.2 15.8

Growth (% y-y) (5.6) (16.2) (23.4) 3.6 13.6




Weak 4Q10F, the market looks too optimistic We forecast 7.8% y-y growth based on our assumption that Hite’s decline in market volume and market share is likely to continue in FY11F, while a 3.8% y-y ASP increase could do more than offset a 20% y-y rise in raw-material costs. Integration with Jinro could save W9bn in selling and administration costs in FY11F. If Hite cannot increase product price by 3.8% and instead increases by just 2.8% (five-year historical average), this could cut our operating profit forecast by 6.4% (see sensitivity table). This translates into 0.0% y-y growth in operating profit in FY11F.

Exhibit 127. Hite: quarterly forecast

1Q09 2Q09 3Q09 4Q09 FY09 1Q10 2Q10 3Q10 4Q10F FY10F Consensus Var. (%)

Net sales 230 273 295 220 1018 212 273 303 215 1003 235 (9)

(% growth) 8.0 (1.1) (2.7) (6.3) (0.9) (7.9) (0.1) 2.9 (2.1) (1.4)

GP 116 144 154 104 518 101 144 152 106 504

(% margin) 51 53 52 47 51 48 53 50 49 50

(% growth) 1.9 (2.2) (4.1) (9.6) (3.5) (13.4) 0.0 (0.8) 2.4 (2.7)

Operating profit 49 58 62 13 183 25 46 53 16 140 31 (48)

(% margin) 21 21 21 6 18 12 17 17 7 14

(% growth) 2.8 (15.9) (17.6) (49.0) (16.2) (48.3) (21.6) (15.7) 25.6 (23.4)

Net profit 27 25 39 (3) 99 7 25 33 7 72 14 (49)

(% margin) 12 9 13 (1) 10 4 9 11 3 7 235 (9)

(% growth) (7.0) (51.7) (13.6) (133.0) (26.2) (72.2) (1.9) (15.0) (353.6) (27.3)




Investment risks

Downside risks Synergy with Jinro may disappoint We see no major upside risks as we have already reflected into our forecast the expected synergies that Hite should enjoy from integrating its distribution network with Jinro from FY11F onwards. Hite acquired 100% of Jinro, Korea’s largest soju maker, in 2005, in a bid to take advantage of Jinro’s strong position in Seoul and the metropolitan area. However, the company has not been allowed to integrate the distribution channel with Jinro due to conditions imposed by the government when it approved the acquisition. From FY11F onwards, we believe Hite will be free from the regulatory conditions for integrating Jinro and will start to operate a new ERP (enterprise resourcing plan) system to control integrated business with Jinro, to integrate distribution and marketing.

Hite expects 5% market share gain

The biggest synergy that Hite expects from the integration is market share gain in the beer market. Hite has a weaker market position in metropolitan areas, with a lower market share than OB (see below). Since Jinro has an 80% market share in the metropolitan area, Hite should be able to benefit from Jinro’s bargaining power in Seoul.

5% market share gain until FY15F: Hite and Jinro have 600 sales people each. As it can be difficult to layoff employees post integration, Hite plans to use 200-300 sales people out of a total 1,200 to improve services (eg, increase in-store marketing) to retail stores. Through this, Hite plans to reduce advertising costs and increase market share. Helped by the acquisition, Hite expects 5% total market share gain to 60% by FY15F and W9bn pa cost saving.

We assume 2.5% market share gain: We assume a 2.5% total market share gain over the next five years, lower than Hite’s guidance. Hite’s guidance was set at the time of the Jinro acquisition in 2005 without the expectation that its share in the beer market would decline. Over the past five years, Hite’s market share fell 4.6% overall (minus 0.9pp pa). Given our view that OB’s push to gain market share will bear fruit, we think Hite will find it more difficult to gain market share than it originally estimated. Hence, we forecast only a 2.5% total market share gain rather than the guided increase of 5%. As synergy may take time to emerge, we assume an -0.5% market share decline in FY11F (compared with 1.2% y-y decline in FY10F and 1.8% y-y decline in FY09) and no market share change in FY12F.

If Hite achieves less synergy than it expects, this is a downside risk to our forecast. If Hite sheds the same percentage market share as it did in the past few years despite the integration, FY11F net profit could drop by 2.1%. If Hite achieves the amount of synergy it expects and sees market share rise by 0.5% in 2011F (compared with -1.2% in 2010F and -0.5% in 2011F, per Nomura forecast), FY11F net profit could increase by 11%.

Not much upside expected from integration with Jinro



Exhibit 128. Hite and Jinro market share by region

Gyeonggi

Hite: 50.1%

Jinro: 84.2%

Seoul

Hite: 47.6%

Jinro: 78.1%

Chungnam

Hite: 52.2%

Jinro: 48.8%

Jeonbuk

Hite: 86.6%

Jinro: 49.5%

Jeonnam

Hite: 71.2%

Jinro: 19.0%

Jeju

Hite: 46.2%

Jinro: 11.6%

Gyeongnam

Hite: 90.6%

Jinro: 6.8%

Busan

Hite: 83.5%

Jinro: 5.8%

Gyeongbuk

Hite: 79.7%

Jinro: 12.7%

Gangwon

Hite: 59.7%

Jinro: 59.0%

Militaries

Hite: 52.8%

Jinro: 63.3%

Chungbuk

Hite: 79.7%

Jinro: 12.7%

Note: As of FY08


Exhibit 129. Hite: market share by region (FY09) Exhibit 130. Hite: market share assumption

45

80

20

65

0

20

40

60

80

100

120

Hite Jinro

(%) Metro Local

515253545556575859606162

FY

06

FY

07

FY

08

FY

09

FY

10F

FY

11F

FY

12F

FY

13F

FY

14F

FY

15F

Nomura forecast Company guidance

Source: Nomura research, Company data Source: Nomura research, Company data



Greater competition set to emerge

Lotte Group aiming to produce beer

Lotte Group’s stated plan to produce beer is a well-known downside risk as various media outlets have frequently highlighted the strong intent and desire of the Lotte management to enter this segment. Lotte Group could either acquire OB or build its own factory to start a new beer business in an attempt to own one of the largest share within consumer-related products (source: Hankyung, “Lotte Chilsugn, expanding into beer market”, as of May 6, 2010). Lotte Group’s strategy is to own as many as consumer product manufacturing businesses in order to create synergy with its retail business in Korea. The beer market is a major consumer-related industry and there looks to be an opportunity for Lotte Group to acquire OB from KKR (a private equity), the current owner of OB Brewery.

KKR owns OB but will put it on sale: Kohlberg Kravis Roberts and Company (KKR) paid US$1.8bn (W2.3tn) to acquire a 100% stake of the Korean beer-maker Oriental Breweries (OB) from Anheuser-Busch InBev on 7 May, 2009 (announcement date). The deal was an all-cash deal, priced at W27.94 per share according to Bloomberg. OB, alongside Hite, is one of Korea's largest breweries. As well as Cass, it produces other lagers such as OB Lager and Cafri. It was purchased by InBev in 1998. InBev booked a non-recurring capital gain of approximately US$500mn from the transaction.

OB to be acquired by Lotte is the most likely scenario: The alcoholic drink manufacturing industry in Korea is already very saturated, and so building a brand and achieving scale from scratch for a newcomer could prove to be highly challenging (more price discount pressure from retailers on smaller scale), building a factory and creating new distribution network would be capital intensive, so it looks more likely Lotte would seek to acquire OB from KKR, in our view. Depending on the price of the deal, Lotte could go with building its own business rather than acquiring the business, in either case, we think heated price competition looks likely.

Upside investment risks

Higher-than-expected price hike We assume a 5% price hike in 2Q11F (3.8% ASP growth y-y in FY11F), as guided by the company, for all beer products on rising raw material prices. As analysed above, every 1pp higher price hike could change our FY11F net profit forecast by 6%. We think it will be difficult for companies to pass more than the cost rise to the product price due to tight price control by the government (Recall: Beer in cans is one of the 48 items the government ‘monitors’ in an attempt to control inflation), and as such the likelihood that Hite can benefit from price hikes looks slim, in our view.

Raw material price decline If raw material prices suddenly start to fall and Hite manages to maintain price levels despite cost declines, this could be positive to our long-term earnings forecasts. With raw material prices likely to continue to climb in FY11F, we think the possibility of a decline in malt barley prices would have an impact only beyond April 2012F (yearly raw material price contracts are rebased every April). Currently, we assume no change in malt barley price (US$) in FY12F and assume only 7% y-y won appreciation against the greenback. On our analysis, a further 5% decline in malt barley price would lift our net profit forecast for FY12F by 9%.

A 1pp bigger-than-expected price hike is 6% positive to our FY11F net profit forecast

Raw material price fall is an upside risk



Valuation

Initiate with REDUCE rating We initiate our coverage of Hite with a REDUCE rating. Our PT of W100,000 implies 19% potential downside. We expect the ongoing tough business conditions to persist with a structural decline in consumer demand and, despite the expected synergy with the distribution integration with Jinro, aggressive market share gains by competitors. And with no presence in both overseas markets and Korea’s premium segment, Hite may find it difficult to sustain growth. We see more risks, especially in our ASP growth assumptions, given the government’s close watch on consumer prices. Given our view that KKR will most likely try to raise sufficient profit before possibly reselling OB, we expect aggressive marketing efforts to boost OB’s sales. Thus, we see less potential for market-share gains for Hite from its distribution integration with Jinro. Our forecasts for net profit growth of 3% y-y in FY11F, after a 21% y-y decline in FY10F, are more pessimistic than consensus.

Exhibit 131. Hite: consensus estimate vs Nomura forecast

Market consensus Nomura forecast Variance (%)

(Wbn) FY10F FY11F FY12F CAGR 10-12F FY10F FY11F FY12F CAGR 10-12F FY10F FY11F FY12F

Sales revenue 1,025 1,067 1,106 3.9 1,003 1,020 1,020 0.9 (2.1) (4.4) (7.8)

Operating profit 163 188 200 10.8 146 157 160 4.8 (10.7) (16.3) (20.0)

Net profit 84 103 117 18.0 79 83 92 8.3 (6.2) (19.7) (21.0)

Source: Company data, Bloomberg, Nomura estimates

19% implied downside We derive our PT of W100,000 by applying the stock’s two-year low average P/E multiple of 12.5x to our forecast 12-month forward EPS of W7,887. We peg the shares to the two-year low average P/E multiple given our view of structurally weak business fundamentals, no potential growth in the new areas and potential downside from price hikes. Note: 12.5x P/E translates to 2.4 PEG based on a two-year earnings CAGR of 5.3%. The global peer PEG average is 1.45x. We think the market is underestimating the company’s fundamental weakness and overestimating potential synergies from the Jinro integration.

Exhibit 132. Hite: historical average multiple

(W) FY09 FY10

High 184,000 170,000

Avg 158,476 139,915

Low 123,000 116,000

P/E (x) FY09 FY10 Avg.

High 17.7 19.3 18.5

Avg 15.3 15.9 15.6

Low 11.9 13.2 12.5

EV/EBITDA (x) FY09 FY10

High 9.9 10.7 10.3

Avg 8.9 9.4 9.2

Low 7.6 8.4 8.0

P/B (x)

High FY09 FY10

Avg 2.1 1.8 2.0

Low 1.8 1.5 1.7

Source: Company data, Bloomberg, Nomura estimates



Exhibit 133. Hite: P/E band Exhibit 134. Hite: net profit and ROE

0

50,000

100,000

150,000

200,000

250,000

Dec

-08

Mar

-09

Jun-

09

Sep

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Price (W)

22x

18x16x

12x14x

20x

0

20

40

60

80

100

120

140

160

FY

08

FY

09

FY

10F

FY

11F

FY

12F

0

5

10

15

20

25

(%)Net profit (LHS) ROE (RHS)


Global peer comparison In the Korea consumer staple sector, Hite does not appear to be the most unattractive. Nong Shim (not covered), with a similar earnings growth outlook per consensus, is at slightly lower valuations (according to consensus) than Hite. Hite looks to have the weakest earnings growth compared with other staples names, as in our view other companies are strengthening their core brand, expanding overseas or creating new product segments like premium products.

Globally, Carlsburg and Kirin (both rated BUY by Nomura) look to be better investment options: Hite is the most expensive with EPS PEG of 2.9 (see below), in our view. Also, Hite’s ROE looks the lowest among global peers and we expect ROE to decline further, with no major turnaround from the integration with Jinro’s distribution network. Until we see major change in its brand strategy, we foresee lacklustre earnings growth for the next two years.

Exhibit 135. Hite: Domestic peer valuation

EV/EBITDA (x) P/E (x) P/BV (x)

Company Bloomberg

code Ratings Price

4 Jan 2011 Mkt cap

(US$mn) FY10F FY11F

EBITDA CAGR

FY10-12F (%)

EBITDA PEG

FY11F (x) FY10F FY11F

EPS CAGR

FY10-12F (%)

EPS PEG

(x) FY11F FY10F FY11F

ROE (%)

FY11F

Market P/E

FY11F

Premium to market

FY11F

HITE 103150 KS REDUCE 123,000 1,045 8.7 8.1 3.6 2.3 16.6 16.2 5.3 3.1 1.3 1.2 8.1 10.7 51.4

ORION 001800 KS BUY 405,000 2,146 18.6 14.2 7.9 1.8 12.3 20.5 28.1 0.7 3.7 3.2 15.3 10.7 91.6

NONG SHIM 004370 KS Not rated 205,000 1,108 5.2 4.4 5.0 0.9 10.7 10.1 8.7 1.2 1.0 0.9 9.4 10.7 (5.6)

LG HH 051900 KS NEUTRAL 392,000 5,440 14.6 11.9 18.5 0.6 24.5 20.0 23.3 0.9 7.3 5.8 28.2 10.7 86.9

AP 090430 KS NEUTRAL 1,130,000 5,870 16.2 13.5 4.2 3.2 21.7 20.7 16.5 1.3 4.2 3.6 20.0 10.7 93.5

LnL 115390 KS BUY 35,900 1,595 20.1 14.9 39.5 0.4 26.7 19.2 43.1 0.4 5.0 4.2 23.9 10.7 79.4

Domestic peer valuation 13.9 11.2 13.5 13.9 11.2 13.1 1.5 18.8 17.8 20.8 1.3 3.7 3.2

Source: Nomura research for Hite, Orion, LGHH, AP and LnL; Bloomberg estimates for others

Exhibit 136. Hite: Global peer valuation

EV/EBITDA (x) P/E (x) P/BV (x)

Company Bloomberg

code Ratings Price

4 Jan 2011 Mkt cap

(US$mn) FY10F FY11F

EBITDA CAGR

FY10-12F (%)

EBITDA PEG

FY11F(x) FY10F FY11F

EPS CAGR

FY10-12F (%)

EPS PEG

(x) FY11F FY10F FY11F

ROE (%)

FY11F

Market P/E

FY11F

Premium to market

FY11F

HITE 103150 KS REDUCE 123,000 1,045 8.7 8.1 3.6 2.3 16.6 16.2 5.3 3.1 1.3 1.2 8.1 10.7 51.4

ASAHI 2502 JP NEUTRAL 1,583 9,358 7.1 6.6 7.8 0.8 14.0 12.9 8.3 1.6 1.2 1.1 9.2 14.1 (8.3)

KIRIN 2503 JP BUY 1,144 13,496 7.2 6.7 2.2 3.0 33.3 14.2 62.5 0.2 1.1 1.0 8.0 14.1 0.9

TSINGTAO 168 HK REDUCE 41 7,120 15.3 12.7 16.0 0.8 29.9 25.0 18.7 1.3 4.9 4.3 18.4 12.2 104.1

FOSTER'S FGL AU NEUTRAL 6 10,979 10.8 10.0 5.6 1.8 16.0 15.2 6.4 2.4 3.8 3.8 26.2 12.2 25.1

CARLSBERG CARLB DC BUY 571 15,608 8.6 7.8 7.1 1.1 15.6 13.7 14.3 1.0 1.4 1.3 9.8 14.5 (5.7)

HEINEKEN HEIA NA NEUTRAL 33 12,680 5.8 4.7 12.5 0.4 10.2 8.4 20.4 0.4 2.3 2.1 13.5 10.2 (17.7)

MOLSON C. TAP US Not rated 49 9,091 9.6 8.4 7.9 1.1 13.6 12.7 7.0 1.8 1.2 1.1 9.1 12.9 (2.0)

Global peer valuation 9.1 8.1 7.8 1.4 18.6 14.8 17.9 1.5 2.2 2.0 12.8 12.6 18.5

Source: Nomura research for rated stocks, Bloomberg estimates for others



Exhibit 137. Hite: P/E vs EPS growth

Hite

Orion

Nong Shim

LGHHAP

LnL

0

5

10

15

20

25

0 10 20 30 40 50

EPS CAGR (FY10-12F, %)

P/E

(F

Y1

1F,

x)

Source: Nomura research, Bloomberg estimates

Exhibit 138. Hite: P/B vs ROE

Hite

Orion

Nong Shim

LGHH

AP

LnL

0

1

2

3

4

5

6

7

0 5 10 15 20 25 30

ROE (FY11F, %)

P/B

(F

Y1

1F,

x)

Source: Nomura research, Bloomberg estimates



Appendix 1

Company background Hite Brewery is the largest beer maker in South Korea, with a market share of 54.28% as of 3Q10 (source: company data, FSS). The company was spun off from Hite Holdings as a separate entity in 1 July 2008 and relisted on the KRX on 30 July 2008. Hite Brewery also distributes Soju, whisky and wine through affiliates. Main brands of the company include Hite, Max, Stout, Beer S, and Dry finish d. Park, Moon-deuk is the CEO/chairman, while Kim, Jee-Hyun and Ha, Jin Hong are presidents. The company has around 1,800 employees as of 3Q10.

Corporate and shareholding structure Hite Brewery was part of Hite Holdings, which was founded in August 1933 as a beer manufacturing and retailing company, headquartered in Seoul. Hite Holdings listed on the KRX in 1973. Jinro became a subsidiary of Hite Holdings in August 2005. Jinro specialises in manufacturing Soju (sort of a weak vodka) and produces and sells wine, whisky, ginseng liquor and non-alcoholic beverages.

In 2008, Hite Holdings saw a major restructuring, spinning off its liquor business as a separate entity, Hite Brewery. The corporate structure that stands today was completed in August 2009 when a share swap between the major shareholders (Park, Moon Deok and related party) and Hite Holdings took place. Hite Brewery became a subsidiary company of Hite Holdings. Hite Brewery and Jinro now trade as separate stocks after the relisting and initial listing of the companies in July 2008 and October 2010, respectively.

Exhibit 139. Corporate structure: Hite Holdings, Hite Brewery, and Jinro

Hite Holdings

Hite Brewery

JinroHite

AlcoholHite

IndustryHite

DistillersSewang

HisoctSeoksu& Purris

JinroSoju

JinroJapan

Foreign subsidiaries:

America, HK, Russia, UK, Japan, China etc.

Hite Development Kangwon/

Ceonju / SuyangLogistics

100%59.54% 100% 100% 24.85%40.19%

100%100% 80~100% 100%100% 100%100%

Hite Holdings

Hite Brewery

JinroHite

AlcoholHite

IndustryHite

DistillersSewang

HisoctSeoksu& Purris

JinroSoju

JinroJapan

Foreign subsidiaries:

America, HK, Russia, UK, Japan, China etc.

Hite Development Kangwon/

Ceonju / SuyangLogistics

100%59.54% 100% 100% 24.85%40.19%

100%100% 80~100% 100%100% 100%100%

Source: Nomura research, Company data

Hite brewery is the largest beer maker in Korea with market share of 54%



Exhibit 140. Hite Brewery: ownership structure Exhibit 141. Hite Holdings: ownership structure

KTCU9%

Others11%

Other foreigners

24%

Lazard AM16%

Hite Holdings

40%

Treasury shares0.06%

KTCU5%

Foreigners6%

Treasury shares

7%

Others15% Park, Mun

Deok and related party

67%


Product mix, cost items and competitive landscape We note that 99.6% of Hite’s net sales as of FY09 were generated through beer sales (95.1% from the domestic market; 4.5% from exports). Hite’s beer sales have seen a CAGR of 3% over FY07-09. Meanwhile, we think the beer industry in Korea is an oligopoly divided by two leading players, Hite and OB (Cass).

Representative brands of Hite are Hite, Max, Stout, Beer S, Dry finish d. Among those brands, Stout and S are recognised as premium beer brands, according to the company. Hite brewery also sells Foster’s (Australian beer), Kirin Ichiban (Japanese beer), Terroir (wine), Puriss (mineral spring water) and Hite Soju. Hite’s key cost items are malt, starch, packaging, depreciation and labour (see Exhibit).

Exhibit 142. Hite: Beer brands

Brand name Product image Description Year of launch

Premium/ regular

3Q10 sales(% of Hite Beer sales)

Hite

Hite is the focal brand of Hite Brewery that has maintained its number one position in the industry for the past 15 years.

1993 Regular 77.6

Max

Max is Korea’s only 100% pure barley beer. The brand’s sales grew 38.3% in 1H10, leading the growth momentum in the beer industry.

2006 Regular 15.7

Beer S

Beer S is a high-fibre, low calorie beer. It contains a dietary fibre that is known to enhance intestine movement to help people keep in shape.

2007 Premium 0.4

Stout

Stout is the only black beer in Korea. It uses high-quality black malt produced in Germany for richer taste and more froth.

2007 Premium 0.8

Dry finish D

Dry finish D’s distinctiveness comes from being the only 100% dry type beer in Korea. ‘Danbrew Alectia’, a well known consulting company specialising in beer, participated in the launch of the product. The beer is packaged in newly designed bottle that won the Asia package design award in November 2010.

August, 2010

Regular 0.5

Source: Company data, Nomura research



Exhibit 143. Beer Market: market share

57.09 59.73 59.15 58.15 56.32 54.28

42.91 40.27 40.85 41.85 43.68 45.72

0

10

20

30

40

50

60

70

80

90

100

FY05 FY06 FY07 FY08 FY09 3Q10

Hite OB(CASS)(%)


Exhibit 144. COGS breakdown (as of FY09)

Other raw materials

2%

Starch6%

Labor9%

Depreciation

13%

Others21%

Packaging25%

Malt24%

Depreciation13%




Financial statements

Lukewarm top-line growth on unfavourable demographics and loss of brand power

Limited net earnings growth on no contribution from overseas operation

The market consensus net profit in FY11F is W103bn, which is 28% higher than our forecast

Income statement (Wbn)

Year-end 31 Dec FY08 FY09 FY10F FY11F FY12F

Revenue 1,027 1,018 1,003 1,028 1,030Cost of goods sold (490) (500) (499) (527) (519)Gross profit 537 518 504 500 511SG&A (319) (335) (364) (352) (356)Employee share expenseOperating profit 218 183 140 148 155

EBITDA 290 255 217 225 233Depreciation (72) (72) (77) (77) (78)AmortisationEBIT 218 183 140 148 155Net interest expense (20) (46) (49) (44) (42)Associates & JCEsOther income (4) (9) 8 (3) (3)Earnings before tax 194 128 99 101 110Income tax (59) (29) (27) (27) (30)Net profit after tax 134 99 72 74 80Minority interestsOther itemsPreferred dividendsNormalised NPAT 134 99 72 74 80Extraordinary itemsReported NPAT 134 99 72 74 80

DividendsTransfer to reserves 134 99 72 74 80

Valuation and ratio analysisFD normalised P/E (x) 8.9 12.1 16.6 16.2 15.0 FD normalised P/E at price target (x) 7.2 9.8 13.5 13.2 12.2 Reported P/E (x) 8.9 12.1 16.6 16.2 15.0 Dividend yield (%) - - - - - Price/cashflow (x) 1.9 3.2 12.3 9.2 12.1 Price/book (x) 1.9 1.4 1.4 1.3 1.2 EV/EBITDA (x) 6.5 7.6 8.7 8.1 7.6 EV/EBIT (x) 8.6 10.5 13.5 12.4 11.3 Gross margin (%) 52.3 50.9 50.2 48.7 49.6 EBITDA margin (%) 28.2 25.0 21.6 21.9 22.6 EBIT margin (%) 21.2 17.9 13.9 14.4 15.0 Net margin (%) 13.1 9.8 7.2 7.2 7.8 Effective tax rate (%) 30.6 22.3 27.0 27.0 27.0 Dividend payout (%) - - - - - Capex to sales (%) 11.2 12.3 7.5 7.3 7.3 Capex to depreciation (x) 1.6 1.7 1.0 1.0 1.0

ROE (%) 13.9 13.6 8.4 8.1 8.4 ROA (pretax %) 9.6 8.9 6.3 6.6 7.0

Growth (%)Revenue 6.6 (0.9) (1.4) 2.5 0.3 EBITDA (3.4) (12.1) (14.8) 3.9 3.2

EBIT (5.6) (16.2) (23.4) 5.9 4.7

Normalised EPS 122.3 (26.2) (27.2) 2.3 8.5 Normalised FDEPS 122.3 (26.2) (27.2) 2.3 8.5

Per shareReported EPS (W) 13,802 10,186 7,410 7,582 8,224Norm EPS (W) 13,802 10,186 7,410 7,582 8,224Fully diluted norm EPS (W) 13,802 10,186 7,410 7,582 8,224Book value per share (W) 63,387 86,379 90,966 95,726 101,127DPS (W) - - - - - Source: Nomura estimates

ROE keeps falling on weakening fundamentals



Cashflow (Wbn)


EBITDA 290 255 217 225 233Change in working capital 336 123 (119) (95) (133)Other operating cashflowCashflow from operations 625 378 98 131 99Capital expenditure (115) (125) (75) (75) (75)Free cashflow 510 253 23 56 24Reduction in investments 940 (16) - - - Net acquisitionsReduction in other LT assets - - - - - Addition in other LT liabilities (771) (16) 103 85 132Adjustments (707) (182) (117) (100) (139)Cashflow after investing acts (27) 39 9 41 17Cash dividends (25) (27) (28) (28) (28)Equity issueDebt issueConvertible debt issueOthersCashflow from financial acts (25) (27) (28) (28) (28)Net cashflow (53) 12 (18) 13 (10)Beginning cash 76 24 35 17 30Ending cash 24 35 17 30 20Ending net debt 708 748 706 653 583Source: Nomura estimates

Balance sheet (Wbn)

As at 31 Dec FY08 FY09 FY10F FY11F FY12F

Cash & equivalents 24 35 17 30 20Marketable securities 0 10 10 10 10Accounts receivable 308 321 310 318 318Inventories 95 108 100 103 103Other current assets 64 51 86 86 86Total current assets 491 525 523 547 538LT investments 92 98 98 98 98Fixed assets 1,287 1,643 1,630 1,614 1,596GoodwillOther intangible assets 0 0 0 0 0Other LT assets - - - - - Total assets 1,871 2,268 2,253 2,260 2,233Short-term debt 382 534 474 434 354Accounts payable 114 94 95 96 96Other current liabilities 820 976 872 787 654Total current liabilities 1,316 1,604 1,441 1,316 1,104Long-term debt 349 249 249 249 249Convertible debtOther LT liabilities (412) (427) (324) (239) (106)Total liabilities 1,253 1,426 1,366 1,327 1,247Minority interestPreferred stock 2 2 2 2 2Common stock 564 565 565 565 565Retained earnings 53 127 171 218 270Proposed dividends

Other equity and reserves (1) 148 148 148 148Total shareholders' equity 618 842 886 933 985

Total equity & liabilities 1,871 2,268 2,253 2,260 2,232

Liquidity (x)

Current ratio 0.37 0.33 0.36 0.42 0.49 Interest cover 10.9 4.0 2.9 3.4 3.7

LeverageNet debt/EBITDA (x) 2.44 2.94 3.26 2.90 2.51

Net debt/equity (%) 114.6 88.9 79.7 70.1 59.2

Activity (days)Days receivable 105.9 112.8 114.8 111.5 113.0 Days inventory 62.1 74.3 76.2 70.2 72.4 Days payable 84.3 76.0 68.9 65.9 67.4 Cash cycle 83.8 111.1 122.1 115.8 118.0 Source: Nomura estimates

No major increase in dividend that we expect on high gearing (70% net debt to equity ratio in FY11F)


KT&G Corp 033780 KS

CONSUMER RELATED/GENERAL CONSUMER | SOUTH KOREA



Weaker domestic tobacco (III) Maintain NEUTRAL with revised PT of W66,000

We maintain NEUTRAL on KT&G, with our PT revised up by 1.5% to W66,000 on a shift in our earnings base by three months to March 2012. We continue to apply a P/E of 10.5x to our 12-month forward EPS of W6,303. We remain cautious on fundamentals in the domestic tobacco market, considering what we believe are unfavourable demographic trends plus increasing competition [Weaker domestic tobacco (II), 1 October, 2010]. Earnings growth from export markets and red ginseng is still insufficient to cover falling earnings in the domestic market, we believe. Price hikes that can more than cover the expected volume declines are a potential upside risk. Downside risks include continued market share loss and ineffective M&A.

Gloomy outlook for FY11F

With shrinking domestic volumes and a strengthening won diminishing export sales growth, we estimate that KT&G will see total tobacco sales fall by 3% y-y in FY11F. Red ginseng sales growth of 17% y-y and earnings growth of 14% y-y look insufficient to offset the weak performance in the tobacco business. For FY11F, we forecast overall net profit will decline further by 3% y-y, despite cost savings from falling raw material costs (on a stronger won against the US dollar).

Visibility on new business and M&A still unclear

We remain neutral on KT&G’s plan to start new businesses to drive growth given that none of the new businesses have materialised yet (ie, no factory or brand). While new businesses may be the right approach, they are still at very initial stages. Management is keeping cash on hold and not buying back shares as it is considering M&As, but these are unlikely to happen in the near future, according to the company. Potential M&A, depending on the price, could be an up/downside risk. Both M&A and new businesses would need a long lead time before making any real contribution, we believe.


Reported net profit 851 672 841 887

Normalised net profit 851 880 828 876

Normalised EPS (W) 6,164 6,406 6,028 6,381

Norm. EPS growth (%) (1.2) 3.9 (5.9) 5.8

Norm. P/E (x) 10.6 10.2 10.9 10.3

EV/EBITDA (x) 6.9 6.5 6.6 6.0

Price/book (x) 2.3 1.9 1.7 1.6

Dividend yield (%) 4.0 4.0 4.0 4.0

ROE (%) 21.4 14.3 16.2 15.5

Net debt/equity (%) net cash net cash net cash net cash

Earnings revisions

Previous norm. net profit 880 854 898

Change from previous (%) - (3.1) (2.5)

Previous norm. EPS (W) 6,406 6,223 6,543



1m 3m 6m

(0.3) (1.8) 7.4

1.2 (1.3) 17.7

(6.7) (14.7) (20.8)

Easy


8,037

93.1


Absolute (W)

Absolute (US$)

Relative to Index


Market cap (US$mn)

70,900/56,000

National Pension

Stock borrowability

4.4


Industrial Bank of Korea 6.9

22.09

52-week range (W)

54,000

59,000

64,000

69,000

74,000

Jan1

0

Feb

10

Mar

10

Apr

10

May

10

Jun1

0

Jul1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

70

80

90

100

110

120

Price

Rel MSCI Korea(W)


Price target W66,000(from W65,000)

Upside/downside 0.6%Difference from consensus -14.1%

FY11F net profit (Wbn) 841Difference from consensus 0.9%Source: Nomura

Nomura vs consensus Market expectations on new businesses look overly optimistic given our view that these likely won’t be earnings-accretive for another one or two years.

Maintained

NEUTRAL


Action We maintain our NEUTRAL call on KT&G given persistent weakness in domestic

tobacco fundamentals. FY11F net profit growth is likely to remain weak (-3% y-y) owing to zero construction earnings and unfavourable FX rates. New businesses look far from contributing to earnings. We revise up our PT by 1.5% to W66,000 on a shift in our earnings base by three months. We see little upside potential.

Catalysts Faster-than-expected decline in market share is a downside risk. Price hikes and

M&A could pose either upside or downside risks depending on price levels.

Anchor themes

Demographic change (ie, a shrinking target group) has a major influence on the growth outlook for consumer (near) staples companies in Korea. As learned from Japan’s case, we expect tobacco and liquor (beer) to see gradual declines in market demand, while the cosmetics and soft drink markets stand to benefit.

KT&G Corp Cara Song



Both domestic and export sales revenue should decline due to market share decline and unfavourable forex rates

Gross profit margin declines slightly owing to higher lower-margin construction sales growth in FY09



Revenue 3,312 3,626 3,440 3,483 3,639Cost of goods sold (1,312) (1,552) (1,426) (1,398) (1,439)Gross profit 2,000 2,073 2,014 2,085 2,199SG&A (810) (848) (886) (918) (984)Employee share expense 48 (69) 66 (55) (52)Operating profit 1,238 1,156 1,193 1,111 1,163

EBITDA 1,368 1,283 1,313 1,240 1,299Depreciation (130) (126) (120) (128) (137)AmortisationEBIT 1,238 1,156 1,193 1,111 1,163Net interest expense 21 6 274 24 35Associates & JCEs - - - - - Other income (14) (197)Earnings before tax 1,245 1,163 1,270 1,135 1,197Income tax (350) (312) (380) (294) (310)Net profit after tax 895 851 890 841 887Minority interestsOther itemsPreferred dividends (14) - (10) (13) (11)Normalised NPAT 881 851 880 828 876Extraordinary items - - (207) 13 11Reported NPAT 881 851 672 841 887

Dividends (340) (360) (360) (360) (360)Transfer to reserves 540 491 312 481 527

Valuation and ratio analysisFD normalised P/E (x) 10.3 10.6 10.2 10.9 10.3 FD normalised P/E at price target (x) 10.4 10.7 10.3 10.9 10.3 Reported P/E (x) 10.5 10.6 13.4 10.7 10.2 Dividend yield (%) 3.7 4.0 4.0 4.0 4.0 Price/cashflow (x) 13.5 10.9 7.0 10.1 10.3 Price/book (x) 2.6 2.3 1.9 1.7 1.6 EV/EBITDA (x) 6.6 6.9 6.5 6.6 6.0 EV/EBIT (x) 7.3 7.6 7.1 7.3 6.7 Gross margin (%) 60.4 57.2 58.5 59.8 60.4 EBITDA margin (%) 41.3 35.4 38.2 35.6 35.7 EBIT margin (%) 37.4 31.9 34.7 31.9 32.0 Net margin (%) 26.6 23.5 19.5 24.1 24.4 Effective tax rate (%) 28.1 26.8 29.9 25.9 25.9 Dividend payout (%) 38.7 42.4 53.6 42.8 40.6 Capex to sales (%) 6.2 4.2 7.3 4.3 4.1 Capex to depreciation (x) 1.6 1.2 2.1 1.2 1.1

ROE (%) 25.5 21.4 14.3 16.2 15.5 ROA (pretax %) 28.6 23.9 23.5 20.8 21.2

Growth (%)Revenue 8.8 9.5 (5.1) 1.3 4.5 EBITDA 33.7 (6.2) 2.4 (5.6) 4.8

EBIT 39.4 (6.6) 3.2 (6.9) 4.6

Normalised EPS 49.8 (1.2) 3.9 (5.9) 5.8 Normalised FDEPS 50.2 (2.3) 3.4 (5.9) 5.8

Per shareReported EPS (W) 6,240 6,164 4,895 6,126 6,462Norm EPS (W) 6,240 6,164 6,406 6,028 6,381Fully diluted norm EPS (W) 6,344 6,197 6,406 6,028 6,381Book value per share (W) 24,880 29,000 34,293 37,792 41,634DPS (W) 2,453 2,625 2,625 2,625 2,625Source: Nomura estimates

Slight gross margin decline owing to stronger lower-margin construction sales growth in FY09

KT&G Corp Cara Song


Cashflow (Wbn)


EBITDA 1,368 1,283 1,313 1,240 1,299Change in w orking capital (637) (187) 128 (27) (94)Other operating cashflow (48) (264) (159) (323) (328)Cashflow from operations 683 832 1,282 890 878Capital expenditure (206) (152) (250) (150) (150)Free cashflow 478 680 1,032 740 728Reduction in investments 310 (160) (375) - - Net acquisitionsReduction in other LT assets 1 (1) 0 - - Addition in other LT liabilities 61 - 0 - - Adjustments (378) 165 (0) - - Cashflow after investing acts 472 684 658 740 728Cash dividends (340) (360) (360) (360) (360)Equity issue (464) - - - - Debt issue 104 (10) - - - Convertible debt issueOthers 224 (107) (1) - - Cashflow from financial acts (477) (477) (361) (360) (360)Net cashflow (5) 206 296 379 367Beginning cash 115 110 317 613 992Ending cash 110 317 613 992 1,360Ending net debt 20 (197) (493) (873) (1,240)Source: Nomura estimates

Balance sheet (Wbn)


Cash & equivalents 110 317 613 992 1,360Marketable securities 2 2 2 2 2Accounts receivable 634 601 586 593 619Inventories 1,559 1,509 1,455 1,474 1,540Other current assets 261 272 229 231 232Total current assets 2,566 2,700 2,885 3,292 3,753LT investments 788 948 1,323 1,323 1,323Fixed assets 1,504 1,472 1,655 1,730 1,796Goodw illOther intangible assets 56 52 52 52 52Other LT assets (1) 0 - - - Total assets 4,913 5,172 5,915 6,396 6,923Short-term debt 104 95 95 95 95Accounts payable 483 362 406 406 406Other current liabilities 605 467 440 440 440Total current liabilities 1,192 924 940 940 940Long-term debt 26 25 25 25 25Convertible debt - - - - - Other LT liabilities 214 214 214 214 214Total liabilities 1,432 1,163 1,180 1,180 1,180Minority interest 28 27 27 27 27Preferred stockCommon stock 955 955 955 955 955Retained earnings 2,277 2,779 3,506 3,987 4,514Proposed dividends

Other equity and reserves 221 248 248 247 248Total shareholders' equity 3,453 3,982 4,709 5,189 5,717


Liquidity (x)

Current ratio 2.15 2.92 3.07 3.50 3.99 Interest cover na na na na na

LeverageNet debt/EBITDA (x) 0.01 net cash net cash net cash net cash

Net debt/equity (%) 0.6 net cash net cash net cash net cash



Amorepacific 090430 KS

CONSUMER RELATED/RETAIL | SOUTH KOREA



It’s the valuation that counts (II) The cosmetics industry in Korea looks favourable

Korea’s demographic change will likely benefit the cosmetic industry in Korea. In our opinion, greater demand for skin care products will come as the population ages. In Asia, skin care is a big market, especially in Korea, and given that Amorepacific is the biggest cosmetics company in Korea by sales value with strong brands, we expect the company to enjoy sound top-line growth in Korea.

China looks promising – a long-term positive

Amorepacific is the first Korean company to be granted a door-to-door (D2D) sales licence for its cosmetics line in Shanghai. It plans to acquire a D2D sales licence for other regions in China, according to management. In our view, this will help grow its long-term momentum in China as the cosmetics D2D market currently accounts for 15% of the total cosmetics market in China, according to the company. Meanwhile, as Amorepacific’s overseas subsidiaries’ earnings have recovered, we expect it to turn profitable in FY12F.

But valuation still unappealing; investment risks

We lift our PT by 6.7% to W1,120,000 to account for the roll forward of our earnings base by six months to March 2011 from September 2010, and we maintain our target P/E multiple of 19.6x. We reaffirm our NEUTRAL rating as the valuation looks unappealing with the stock trading at 20.7x FY11F P/E (higher than the historical average of 19.5x).

Weaker-than-expected 4Q10 results on special bonus and green tea inventory write-off, as well as higher-than-expected marketing costs for new brand launches in China are potential downside risks. Faster top-line growth in China is a potential upside risk.

Key financials & valuations31 Dec (Wbn) FY09 FY10F FY11F FY12F

Revenue 1,769 2,012 2,221 2,459



Normalised EPS (W) 38,661 52,167 54,494 65,399

Norm. EPS growth (%) 22.4 34.9 4.5 20.0

Norm. P/E (x) 29.2 21.7 20.7 17.3

EV/EBITDA (x) 18.9 16.2 13.5 11.0

Price/book (x) 5.1 4.2 3.6 3.0

Dividend yield (%) 0.5 0.5 0.5 0.5

ROE (%) 20.6 20.5 20.0 20.1

Net debt/equity (%) net cash net cash net cash net cash

Earnings revisions

Previous norm. net profit 278.3 321.0 na

Change from previous (%) 9.5 (0.8) na

Previous norm. EPS (W) 47,637 54,939 na



1m 3m 6m

5.6 2.3 11.0

7.2 2.8 21.7

(0.7) (10.6) (16.8)

Easy


5,891

56.1


Absolute (W)

Absolute (US$)

Relative to Index


Market cap (US$mn)

1,183,000/765,000

13.37

52-week range (W)

Mirae Asset

Stock borrowability

7.6


Seo Family related parties 48.6

720,000

820,000

920,000

1,020,000

1,120,000

1,220,000

Jan

10

Fe

b1

0

Ma

r10

Ap

r10

Ma

y10

Jun

10

Jul1

0

Au

g1

0

Se

p1

0

Oct

10

No

v10

De

c10

70

80

90

100

110

120

130Price Rel MSCI Korea(W)

Closing price on 4 Jan W1,130,000

Price target W1,120,000(from W1,050,000)

Upside/downside -0.9%Difference from consensus 11.4%

FY11F net profit (Wbn) 318.4Difference from consensus -2.9%Source: Nomura

Nomura vs consensus The market does not seem to have reflected Amorepacific’s special bonus and green tea write-off for FY10F.

Maintained

NEUTRAL


Action Although we like Amorepacific’s fundamentals, which should benefit from Korea’s

demographic change and China’s rising demand for cosmetics, we maintain our NEUTRAL rating given its unattractive valuation. We revise up our PT to W1,120,000 as we roll forward our earning base by six months to March 2011.

Catalysts Downside: weaker-than-expected 4Q10 results on special bonus and green tea

inventory write-off; upside: faster-than-expected top-line growth.

Anchor themes

Demographic changes (population of the major consuming age group of 25-49 is declining) should affect the growth outlook of FMCG companies in Korea, in our view. Like Japan, we expect the tobacco and liquor (beer) segments to see a gradual decline in demand. We expect the cosmetics and soft drink markets to benefit from Korea’s demographic change.

Amorepacific Cara Song



Positive net equity income from FY10F onwards



Revenue 1,531 1,769 2,012 2,221 2,459Cost of goods sold (465) (508) (564) (620) (684)Gross profit 1,066 1,261 1,448 1,601 1,775SG&A (692) (820) (954) (1,046) (1,145)Employee share expense (119) (140) (155) (170) (188)Operating profit 255 301 340 384 442

EBITDA 292 347 390 437 498Depreciation (31) (38) (41) (45) (48)Amortisation (6) (9) (9) (9) (9)EBIT 255 301 340 384 442Net interest expense 13 9 13 18 32Associates & JCEs (18) (5) 4 17 31Other income 9 (5) 2 2 2Earnings before tax 259 299 359 422 506Income tax (74) (73) (54) (103) (124)Net profit after tax 185 226 305 318 382Minority interests - - - - - Other items - - - - Preferred dividends - - - - - Normalised NPAT 185 226 305 318 382Extraordinary items (14) - (34) - - Reported NPAT 170 226 271 318 382



ROE (%) 18.5 20.6 20.5 20.0 20.1 ROA (pretax %) 19.1 21.2 22.0 24.0 27.8

Growth (%)Revenue 12.8 15.5 13.7 10.4 10.7 EBITDA 4.8 18.9 12.2 12.2 13.9

EBIT 2.6 17.8 13.1 13.0 14.9

Normalised EPS 3.8 22.4 34.9 4.5 20.0 Normalised FDEPS 3.8 22.4 34.9 4.5 20.0

Per shareReported EPS (W) 29,137 38,661 46,337 54,494 65,399Norm EPS (W) 31,585 38,661 52,167 54,494 65,399Fully diluted norm EPS (W) 31,585 38,661 52,167 54,494 65,399Book value per share (W) 191,062 222,968 268,052 315,633 374,119DPS (W) 5,000 6,000 6,000 6,000 6,000Source: Nomura estimates

Amorepacific Cara Song


Cashflow (Wbn)


EBITDA 292 347 390 437 498Change in w orking capital 23 (30) (46) (25) (29)Other operating cashflow (80) (39) (26) (5) (5)Cashflow from operations 235 279 318 407 464Capital expenditure (179) (171) (197) (75) (75)Free cashflow 56 108 121 332 389Reduction in investments (20) 15 (20) - - Net acquisitions - - - - - Reduction in other LT assetsAddition in other LT liabilitiesAdjustmentsCashflow after investing acts 36 123 101 332 389Cash dividends (35) (38) (40) (40) (40)Equity issue (7) - - - - Debt issue - - - - - Convertible debt issue - - - - - Others 37 (27) 21 (32) (23)Cashflow from financial acts (4) (65) (20) (72) (63)Net cashflow 31 58 82 260 326Beginning cash 105 137 195 276 536Ending cash 136 194 276 536 862Ending net debt (87) (138) (220) (480) (806)Source: Nomura estimates

Balance sheet (Wbn)


Cash & equivalents 137 195 276 536 862Marketable securities - - - - - Accounts receivable 109 114 119 132 146Inventories 142 138 187 207 229Other current assets 57 104 104 104 104Total current assets 445 550 687 978 1,341LT investments 207 192 212 212 212Fixed assets 779 893 1,010 1,003 990Goodw ill - - - - - Other intangible assets 24 29 29 29 29Other LT assets - - - - - Total assets 1,455 1,664 1,937 2,221 2,571Short-term debt - - - - - Accounts payable 172 181 190 196 204Other current liabilities 27 36 36 36 36Total current liabilities 199 217 226 232 240Long-term debt 50 56 56 56 56Convertible debt - - - - - Other LT liabilities 89 88 89 89 89Total liabilities 339 361 371 377 385Minority interest - - - - - Preferred stock 114 114 114 114 114Common stock 633 633 633 633 633Retained earnings 339 530 794 1,072 1,414Proposed dividends - - - - -

Other equity and reserves 31 26 25 25 25Total shareholders' equity 1,116 1,303 1,566 1,844 2,186


Liquidity (x)

Current ratio 2.23 2.53 3.04 4.21 5.60 Interest cover na na na na na

LeverageNet debt/EBITDA (x) net cash net cash net cash net cash net cash

Net debt/equity (%) net cash net cash net cash net cash net cash

Activity (days)Days receivable 23.8 23.0 21.2 20.6 20.7 Days inventory 100.8 100.8 105.3 115.8 116.4 Days payable 129.1 127.0 120.2 113.7 107.1 Cash cycle (4.5) (3.2) 6.2 22.8 30.0 Source: Nomura estimates


LG Household & Health Care 051900 KS




Unattractive valuation (II) Favourable change in population structure

LGHH’s cosmetics and beverage sector contributes 58% of its total sales revenue in 3Q10, so we think LGHH looks set to benefit from Korea’s ageing population for the next 10 years, which should support resilient sales volume growth for its cosmetics and beverage businesses. LGHH’s business fundamentals remain solid with above-industry-average sales growth in all divisions through effective branding and successful launches of premium products. Continued margin growth with market-share gains and growing scale should support a 25.5% net-profit CAGR for the next two years on our estimates.

Unattractive valuation despite strong fundamentals We remain NEUTRAL on LGHH purely on valuation (20x FY11F vs. historical average of 21x for the past 5 years); our PT is based on 21x FY11E EPS. But, we are positive on the rapid growth of LGHH’s new premium cosmetics and household goods brands (specially designed for discount stores to cope with discount pressures), and successful market-share gain in the beverage market from its effective building of distribution channels. We thus raise our price target for LGHH to W440,000 (from W410,000) on the profit increase that we expect from LGHH’s acquisition of Haitai Beverage [HB]; this implies 12% potential upside. Upside risks: new M&A (for details, see Growth, above the industry (I), 29 June 2010), earlier-than-expected turnaround at HB. Downside risks: lower-than-expected margin growth in the household goods segment due to continued price pressure from hypermarkets.

Limited gain from acquisition of HB LGHH intends to make HB profitable to contribute W15bn net profit in FY12F, representing a 3.8pp boost to LGHH’s FY12F net profit. We expect LGHH’s existing beverage operation (Coca Cola Beverage [CCB], unlisted) to become more active when it launches new premium cold beverages using HB’s cold distribution channels, so we have increased our FY11-12F sales forecast for CCB to a 13% CAGR (from 10%), which increases our earnings forecast for FY11F by 0.3%.




Normalised EPS (W) 9,794 16,026 19,571 24,280

Norm. EPS growth (%) 24.9 63.6 22.1 24.1

Norm. P/E (x) 40.0 24.5 20.0 16.1

EV/EBITDA (x) 20.3 14.6 11.9 9.9

Price/book (x) 9.3 7.3 5.8 4.5

Dividend yield (%) 0.7 1.1 1.4 1.8

ROE (%) 23.4 29.9 28.8 28.2

Net debt/equity (%) 33.7 52.5 28.2 7.3

Earnings revisions

Prev ious norm. net profit 250.3 304.9 na

Change from previous (%) (0.0) 0.3 na

Prev ious norm. EPS (W) 16,026 19,520 na



1m 3m 6m

0.4 (5.1) 12.8

2.1 (4.4) 23.9

(6.0) (18.0) (14.8)

Hard


5,473

66.0

437,500/270,000

First State Investment

Stock borrowability

7.3


LG Corp 34.0


Absolute (W)

Absolute (US$)

Relative to Index


Market cap (US$mn)

12.52

52-week range (W )

250,000

300,000

350,000

400,000

450,000

Jan1

0

Feb

10

Mar

10

Apr

10

Ma

y10

Jun1

0

Jul1

0

Au

g10

Sep

10

Oct

10

No

v10

De

c10

8090100110120130140150

Price

Rel MSCI Korea(W )


Price target W440,000(from W 410,000)

Upside/downside 12.2%Difference from consensus 31.0%

FY11F net profit (Wbn) 305.7Difference from consensus 20.2%Source: Nomura

Nomura vs consensus We are more positive on the earnings growth of TheFaceShop and newly acquired Haitai Beverage.

Maintained

NEUTRAL


Action We retain our NEUTRAL rating on LGHH, but raise our PT to W440,000, implying

12.2% potential upside. We like LGHH’s solid fundamentals, which benefit from 1) favourable demographics that should support market volumes for cosmetics and beverages; 2) increasing margins on above-industry-average sales growth; and 3) the addition of earnings from LGHH’s acquisition of Haitai Beverage.

Catalysts More M&A and an earlier-than-expected turnaround at Haitai Beverage may prove

to be catalysts for the share price.

Anchor themes

Demographic change (ie, a shrinking target group) has a major influence on the growth outlook for consumer staples companies in Korea. If Japan’s example is any guide, we expect demand for tobacco and liquor (beer) to decline gradually, but that for the cosmetics and soft drink markets to benefit.

LG Household & Health Care Cara Song


We expect ROE improvement through rapid earnings growth and effective M&A




Revenue 1,895 2,216 2,797 3,145 3,506Cost of goods sold (891) (1,087) (1,305) (1,463) (1,625)Gross profit 1,004 1,129 1,493 1,682 1,881SG&A (813) (887) (1,147) (1,262) (1,379)Employee share expense (11) (14) 10 14 14Operating profit 181 228 355 433 515

EBITDA 211 308 444 530 621Depreciation (34) (84) (93) (101) (110)Amortisation 4 4 4 4 4EBIT 181 228 355 433 515Net interest expense (17) (16) (23) (27) (7)Associates & JCEs 4 4 7 8 9Other income - (4) - - - Earnings before tax 167 212 338 414 518Income tax (45) (59) (88) (108) (139)Net profit after tax 122 153 250 306 379Minority interestsOther itemsPreferred dividendsNormalised NPAT 122 153 250 306 379Extraordinary items - - - - - Reported NPAT 122 153 250 306 379



ROE (%) 25.3 23.4 29.9 28.8 28.2 ROA (pretax %) 18.5 20.2 24.4 25.4 28.5


EBIT 47.6 26.2 55.5 22.1 18.9


Per shareReported EPS (W) 7,843 9,794 16,026 19,571 24,280Norm EPS (W) 7,843 9,794 16,026 19,571 24,280Fully diluted norm EPS (W) 7,843 9,794 16,026 19,571 24,280Book value per share (W) 31,032 41,933 53,560 67,876 86,188DPS (W) 2,152 2,689 4,399 5,416 6,928Source: Nomura est im ates

LG Household & Health Care Cara Song


Cashflow (Wbn)


EBITDA 211 308 444 530 621Change in working capital 82 (18) (25) (33) (35)Other operating cashflowCashflow from operations 292 290 418 497 586Capital expenditure (20) (67) (76) (82) (88)Free cashflow 272 223 342 415 498Reduction in investments (17) 337 - - - Net acquisitions 13 67 426 82 88Reduction in other LT assetsAddition in other LT liabilitiesAdjustments (62) (34) (7) (15) (15)Cashflow after investing acts 207 593 761 482 571Cash dividends (34) (42) (69) (85) (108)Equity issue (0) - - - - Debt issue (156) 27 210 (130) (200)Convertible debt issue - - - - - Others (5) (568) (911) (257) (262)Cashflow from financial acts (195) (583) (770) (472) (570)Net cashflow 12 11 (8) 10 1Beginning cash 11 23 34 25 36Ending cash 23 34 26 36 37Ending net debt 204 221 439 299 98Source: Nomura est im ates

Balance sheet (Wbn)


Cash & equivalents 23 34 25 36 37Marketable securities - - - - - Accounts receivable 152 213 231 259 289Inventories 123 161 179 202 225Other current assets 32 - - - - Total current assets 331 408 435 497 551LT investments 413 76 76 76 76Fixed assets 283 816 1,191 1,241 1,291Goodwill - - - - - Other intangible assets 13 13 13 13 13Other LT assets - - - - - Total assets 1,040 1,313 1,716 1,827 1,931Short-term debt 94 - - - - Accounts payable 204 253 263 281 299Other current liabilities 115 115 115 115 115Total current liabilities 413 368 379 396 415Long-term debt 133 255 465 335 135Convertible debt - - - - - Other LT liabilities 9 36 36 36 36Total liabilities 555 658 879 767 585Minority interest - - - - - Preferred stock 22 22 22 22 22Common stock 164 164 164 164 164Retained earnings 363 490 672 895 1,181Proposed dividends - - - - -

Other equity and reserves (64) (21) (21) (21) (21)Total shareholders' equity 485 655 837 1,060 1,346


Liquidity (x)



Net debt/equity (%) 42.2 33.7 52.5 28.2 7.3

Activity (days)Days receivable 28.4 30.1 28.9 28.4 28.6 Days inventory 44.3 47.7 47.6 47.5 48.0 Days payable 78.5 76.7 72.2 67.9 65.4 Cash cycle (5.9) 1.1 4.4 8.1 11.3 Source: Nomura est im ates


Orion Corp 001800 KS

CONSUMER RELATED/FOOD & BEVERAGE | SOUTH KOREA



Premium play going big in China (V)

Reiterating BUY with PT W470,000

We reiterate our BUY and our PT of W470,000, which implies 16% upside. China sales growth (37% y-y in RMB terms in FY10F) looks solid while resilient sales growth (+13% y-y in FY10F) in Korea is expected. We remain bullish and look for a 35% net profit CAGR in China, underpinned by product diversification and area expansion. Our PT is derived by using a SOTP valuation (Chinese 29x P/E to Chinese peer average, Vietnam 19 P/E on 30% earnings CAGR Russia no value). The stock is currently trading at 20.5x FY11F EPS, despite a 28% net profit CAGR in FY10-12F. FY11F EPS PEG is still 0.7x, which is lower than the global average (of 1.2x on Bloomberg estimates). News on property development and a China operations IPO at above 29x P/E would be upside risks. A sharp rise in raw material prices is a downside risk (See our note Premium play going big in China (IV), dated 21 November 2010).

Fundamentals solid in all regions

Orion continued gaining market share (2pp gain in FY10F) in Korea with successful premium branding and resilient regular product sales growth. Its Vietnam operation became as profitable as China (10% operating profit margin in FY10F). Russia turned profitable after restructuring in FY09. Its China operations continued to clock above-30% top-line growth. We forecast Orion’s China business will grow at CAGRs of 23% in sales revenue and 34% in net profit over the next three years, FY10-FY13F, supported by product diversification and distribution network extension into the Shanghai and Guangzhou areas. The growing contribution of a rapidly growing China operation and Orion’s focus on core confectionery by selling loss-making non-core subsidiaries (Orion sold On*Media, Rise*On in FY09) should, in our view, spur a rise in ROE to 16.1% in FY12F from 8.8% in FY09.

Key financials & valuations31 Dec (Wbn) FY09 FY10F FY11F FY12FRevenue 598 666 732 791



Normalised EPS (W) 6,222 32,837 19,784 23,991

Norm. EPS growth (%) na 427.7 (39.8) 21.3

Norm. P/E (x) 65.1 12.3 20.5 16.9

EV/EBITDA (x) 28.8 18.6 14.2 12.0

Price/book (x) 5.2 3.7 3.2 2.7

Dividend yield (%) 0.4 0.4 0.4 0.4

ROE (%) 8.8 14.0 15.3 16.1

Net debt/equity (%) 98.7 29.9 24.6 19.6

Earnings revisions

Previous norm. net profit 193.4 114.8 138.5

Change from previous (%) 1.1 2.6 3.1

Previous norm. EPS (W) 32,480 19,282 23,266



1m 3m 6m

1.1 4.1 17.6

2.8 4.9 29.1

(6.0) (9.6) (10.6)

Hard


9.45

52-week range (W)


Absolute (W)

Absolute (US$)

Relative to Index


Market cap (US$mn) 2,156

68.4

428,500/244,500

Stock borrowability


Lee family 31.6

220,000

270,000

320,000

370,000

420,000

470,000

Jan1

0

Feb

10

Mar

10

Apr

10

May

10

Jun1

0

Jul1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

708090100110120130140150

Price

Rel MSCI Korea(W)


Price target W470,000(set on 12 Nov 10)



Nomura vs consensus We believe we are more positive than consensus on earnings growth in China

Maintained

BUY


Action We reiterate our BUY rating and our PT of W470,000, implying 16% upside from

current levels. Orion has been successful in finding new markets and creating new segments, clocking above-industry top-line growth in the past decade despite Korea’s unfavourable demographic trend. With a fast-growing China operation and a growing contribution from other emerging markets, Orion should see a 28% net profit CAGR in FY10-12F on our estimates.

Catalysts Government approval for Yongsan land development and IPO of China operations.

Anchor themes

Demographic change (ie, a shrinking target group) has a major influence on the growth outlook for consumer staples companies in Korea. If Japan’s example is any guide, we expect demand for tobacco and liquor (beer) to decline gradually, but that for cosmetics and soft drink markets to benefit.

Orion Corp Cara Song



Gross profit margin rose to 40% in FY10F from 38% in FY08, backed by successful premium branding



Revenue 558 598 666 732 791Cost of goods sold (345) (363) (399) (445) (480)Gross profit 214 235 267 287 311SG&A (99) (106) (138) (151) (163)Employee share expense (83) (75) (69) (72) (76)Operating profit 32 53 61 65 73

EBITDA 52 73 80 85 93Depreciation (19) (18) (18) (19) (19)Amortisation (1) (1) (1) (1) (1)EBIT 32 53 61 65 73Net interest expense (21) (24) (19) (11) (10)Associates & JCEs (2) 27 60 97 121Other income (6) 3 182 4 4Earnings before tax 3 59 283 155 188Income tax (17) (22) (87) (37) (45)Net profit after tax (14) 37 196 118 143Minority interests - - - - - Other items - - Preferred dividends - - - - - Normalised NPAT (14) 37 196 118 143Extraordinary items (15) - (118) (11) (11)Reported NPAT (29) 37 78 107 132

Dividends (9) (10) (10) (10) (10)Transfer to reserves (38) 27 67 96 121

Valuation and ratio analysisFD normalised P/E (x) na 65.1 12.3 20.5 16.9 FD normalised P/E at price target (x) na 75.5 14.3 23.8 19.6 Reported P/E (x) na 65.1 31.1 22.6 18.3 Dividend yield (%) 0.4 0.4 0.4 0.4 0.4 Price/cashflow (x) 29.2 26.2 51.9 30.1 25.1 Price/book (x) 6.3 5.2 3.7 3.2 2.7 EV/EBITDA (x) 59.0 28.8 18.6 14.2 12.0 EV/EBIT (x) 97.9 35.9 21.7 16.0 13.3 Gross margin (%) 38.2 39.2 40.1 39.2 39.3 EBITDA margin (%) 9.2 12.2 12.1 11.6 11.8 EBIT margin (%) 5.7 8.8 9.1 8.8 9.2 Net margin (%) (5.2) 6.2 11.6 14.6 16.7 Effective tax rate (%) 581.7 37.2 30.8 24.0 24.0 Dividend payout (%) na 28.3 13.5 9.8 8.0 Capex to sales (%) 3.3 8.4 3.1 2.8 2.6 Capex to depreciation (x) 1.0 2.7 1.1 1.1 1.1

ROE (%) (7.0) 8.8 14.0 15.3 16.1 ROA (pretax %) 3.0 7.4 10.9 14.5 15.7


EBIT 6.1 65.8 14.9 6.5 12.7

Normalised EPS (207.7) na 427.7 (39.8) 21.3 Normalised FDEPS (207.7) na 427.7 (39.8) 21.3

Per shareReported EPS (W) (4,883) 6,222 13,020 17,937 22,144Norm EPS (W) (2,328) 6,222 32,837 19,784 23,991Fully diluted norm EPS (W) (2,328) 6,222 32,837 19,784 23,991Book value per share (W) 63,870 77,282 108,477 126,667 148,896DPS (W) 1,542 1,762 1,762 1,762 1,762Source: Nomura estimates

Orion Corp Cara Song


Cashflow (Wbn)


EBITDA 52 73 80 85 93Change in w orking capital 11 55 (12) (2) 0Other operating cashflow 20 (36) (22) (3) 2Cashflow from operations 83 92 46 80 96Capital expenditure (18) (50) (20) (20) (20)Free cashflow 64 42 26 60 75Reduction in investments (54) (48) 87 (97) (121)Net acquisitionsReduction in other LT assets - - - - - Addition in other LT liabilities 7 18 - - - Adjustments 44 47 52 62 62Cashflow after investing acts 61 59 165 24 16Cash dividends (9) (10) (10) (10) (10)Equity issue 2 - - - - Debt issue 125 (64) (258) (10) (10)Convertible debt issueOthers (164) - 106 (6) 6Cashflow from financial acts (46) (74) (162) (27) (15)Net cashflow 15 (15) 3 (3) 2Beginning cash 8 23 8 11 8Ending cash 23 8 11 8 10Ending net debt 503 454 193 185 174Source: Nomura estimates

Balance sheet (Wbn)


Cash & equivalents 23 8 11 8 10Marketable securities 0 - - - - Accounts receivable 96 86 95 97 97Inventories 37 37 41 46 49Other current assets 8 49 49 49 49Total current assets 165 180 196 200 205LT investments 622 670 582 680 801Fixed assets 239 295 296 297 297Goodw illOther intangible assets 4 4 4 4 4Other LT assetsTotal assets 1,029 1,148 1,079 1,180 1,307Short-term debt 176 164 - - - Accounts payable 78 89 91 96 100Other current liabilities 12 87 87 87 87Total current liabilities 266 340 178 182 186Long-term debt 350 298 204 194 184Convertible debtOther LT liabilities 32 50 50 50 50Total liabilities 648 688 432 427 420Minority interestPreferred stockCommon stock 162 162 162 162 162Retained earnings 275 303 490 597 729Proposed dividends

Other equity and reserves (57) (5) (6) (5) (5)Total shareholders' equity 380 460 646 754 887


Liquidity (x)



Net debt/equity (%) 132.2 98.7 29.9 24.6 19.6



Lock & Lock 115390 KS




Not just China, all emerging Asia (I)

Reiterate BUY with PT of W52,000

We reiterate our BUY rating and our PT of W52,000 (derived by using 25x P/E to 12M fwd EPS of W2,087), suggesting 45% potential upside. With China and other emerging Asian markets contributing 75% of total consolidated earnings (FY10F) and rapid sales growth in these markets (30% CAGR in China and 50% in emerging Asia) on aggressive production capacity increases, well-established brands and an expanding distribution network, we forecast a 43% net profit CAGR for the next years FY10-12F. Therefore, we expect LnL to provide superior returns vs its Korean staples peers with limited earnings growth. Faster emerging market growth and a greater-than-expected benefit from the Taobao contract are upside risks. Slower-than-expected new city increase in China is a downside risk.

Turning more bullish on emerging Asia

We remain bullish on China and emerging Asia. In China, LnL’s plan to increase the number of cities covered is on track, while the new Taobao contract looks set to boost sales in China. Management’s focus is on emerging Asia, i.e., India and ASEAN countries, whose GDP is 3x that of Korea. Considering the firm’s aggressive capacity expansion plans for Vietnam (production hub) and the addition of new sales offices in each ASEAN country, we forecast sales from the region could match current figures from China by FY13F, posting an >60% sales CAGR (W115bn by FY13F). LnL’s experience and know-how gleaned from its China operations and its competitive product quality, coupled with the similar culture and lifestyle in Asian countries, should see the firm clock rapid sales growth in emerging Asia, in our view.

Key financials & valuations31 Dec (Wbn) FY09 FY10F FY11F FY12FRevenue 163.1 245.8 335.9 443.6



Normalised EPS (W) 960 1,344 1,865 2,751

Norm. EPS growth (%) 138.4 40.0 38.8 47.5

Norm. P/E (x) 37.4 26.7 19.2 13.0

EV/EBITDA (x) 30.8 20.1 14.9 10.0

Price/book (x) 8.2 5.0 4.2 3.5

Dividend yield (%) 0.4 1.1 1.6 2.3

ROE (%) 32.3 25.2 23.9 29.2

Net debt/equity (%) 14.5 net cash net cash net cash

Earnings revisions

Prev ious norm. net profit 67.2 93.3 137.6

Change from previous (%) 0.0 (0.0) (0.0)

Prev ious norm. EPS (W) 1,344 1,865 2,751



1m 3m 6m

(5.4) (2.4) 1.4

(3.8) (1.7) 11.4

(12.7) (16.2) (28.3)

Hard


1,605

56.1


Absolute (W)

Absolute (US$)

Relative to Index


Market cap (US$mn)

41,800/21,200

6.95

52-week range (W )

Stock borrowability


Junil Kim 54.5

19,000

24,000

29,000

34,000

39,000

44,000

Jan

10

Fe

b10

Mar

10

Ap

r10

Ma

y10

Jun

10

Jul1

0

Aug

10

Sep

10

Oct

10

No

v10

De

c10

80

100

120

140

160

180

Price

Rel MSCI Korea(W)


Price target W52,000(set on 4 Nov 10)



Nomura vs consensus We are more positive on the potential of emerging Asia market sales growth than the market.

Maintained

BUY


Action We reiterate our BUY on Lock & Lock (LnL) and our PT of W52,000, implying

potential upside of 45%. Besides the strong sales growth in China on rapid new city increases and new product launches, even-faster growth in the emerging Asian market should support a >30% net profit CAGR over the next three years.

Catalysts Accelerating earnings growth in China through expansion into tier 2 and tier 3 cities

is an upside catalyst.

Anchor themes

Demographic changes (i.e., a shrinking target group) have a major influence on the growth outlook for consumer staples companies in Korea. If Japan’s example is any guide, we expect demand for tobacco and liquor (beer) to decline gradually, but that for cosmetics and soft drinks to benefit.

Lock & Lock Cara Song


We assume a dividend payout ratio of 30% based on the average of Nomura’s Korea consumer universe

19x P/E vs. China peers’ P/E of 25x in FY11F




Revenue 159 163 246 336 444Cost of goods sold (104) (105) (152) (204) (271)Gross profit 54 58 94 132 173SG&A (24) (29) (50) (71) (87)Employee share expense (10) (10) (13) (16) (21)Operating profit 21 18 31 45 66

EBITDA 25 22 35 47 68Depreciation (4) (4) (4) (2) (2)Amortisation - - - - - EBIT 21 18 31 45 66Net interest expense (2) (2) 2 3 4Associates & JCEs 10 37 51 69 97Other income (5) 2 (10) (13) (13)Earnings before tax 24 55 74 103 153Income tax (4) (7) (6) (10) (16)Net profit after tax 20 48 67 93 138Minority interests - - - - - Other items - - - - - Preferred dividends - - - - - Normalised NPAT 20 48 67 93 138Extraordinary items - - - - - Reported NPAT 20 48 67 93 138

Dividends - (6) (20) (28) (41)Transfer to reserves 20 42 47 65 96

Valuation and ratio analysisFD normalised P/E (x) 89.1 37.4 26.7 19.2 13.0 FD normalised P/E at price target (x) 129.1 54.2 38.7 27.9 18.9 Reported P/E (x) 89.1 37.4 26.7 19.2 13.0 Dividend yield (%) - 0.4 1.1 1.6 2.3 Price/cashflow (x) 86.1 54.5 19.3 15.6 11.0 Price/book (x) 11.8 8.2 5.0 4.2 3.5 EV/EBITDA (x) 52.3 30.8 20.1 14.9 10.0 EV/EBIT (x) 59.1 33.2 21.1 15.2 10.2 Gross margin (%) 34.2 35.5 38.3 39.2 39.0 EBITDA margin (%) 15.5 13.7 14.2 13.9 15.3 EBIT margin (%) 13.0 11.0 12.5 13.3 14.8 Net margin (%) 12.7 29.4 27.3 27.8 31.0 Effective tax rate (%) 16.5 12.0 8.8 9.3 10.3 Dividend payout (%) - 13.3 30.0 30.0 30.0 Capex to sales (%) 0.3 3.7 13.6 2.1 1.6 Capex to depreciation (x) 0.1 1.4 7.8 3.6 3.6

ROE (%) 19.8 32.3 25.2 23.9 29.2 ROA (pretax %) 22.6 28.4 29.9 31.9 39.1

Growth (%)Revenue 39.4 2.8 50.7 36.6 32.1 EBITDA 1.6 (9.6) 56.8 33.3 45.5

EBIT 3.5 (12.7) 70.2 45.3 47.6


Per shareReported EPS (W) 403 960 1,344 1,865 2,751Norm EPS (W) 403 960 1,344 1,865 2,751Fully diluted norm EPS (W) 403 960 1,344 1,865 2,751Book value per share (W) 3,046 4,377 7,150 8,456 10,382DPS (W) - 160 403 560 825Source: Nomura est im ates

Equity gains mostly from China

Lock & Lock Cara Song


Cashflow (Wbn)


EBITDA 25 22 35 47 68Change in working capital (1) (7) (15) (18) (22)Other operating cashflow (3) 18 73 87 118Cashflow from operations 21 33 93 115 164Capital expenditure (1) (6) (33) (7) (7)Free cashflow 20 27 59 108 156Reduction in investments (40) (53) (48) (47) (5)Net acquisitions - - - - - Reduction in other LT assets (1) (1) - - - Addition in other LT liabilities - - - - - Adjustments 20 (7) 12 16 16Cashflow after investing acts (0) (34) 23 77 167Cash dividends - (6) (20) (28) (41)Equity issue - - 155 - - Debt issue 24 (6) (35) - - Convertible debt issue - - - - - Others (1) 29 (46) (54) (62)Cashflow from financial acts 23 16 54 (82) (104)Net cashflow 23 (18) 77 (5) 64Beginning cash 8 30 12 90 85Ending cash 30 12 90 85 149Ending net debt 15 25 (80) (75) (139)Source: Nomura est im ates

Balance sheet (Wbn)


Cash & equivalents 30 12 90 85 149Marketable securities - - - - - Accounts receivable 20 21 32 44 58Inventories 14 19 29 40 52Other current assets 8 15 19 25 32Total current assets 72 68 170 193 291LT investments 95 148 196 243 248Fixed assets 12 18 42 48 53Goodwill - - - - - Other intangible assets (3) (4) (4) (4) (4)Other LT assets 11 10 - - - Total assets 188 241 405 480 588Short-term debt 38 32 - - - Accounts payable 17 25 37 46 58Other current liabilities 4 3 1 1 1Total current liabilities 59 60 37 47 59Long-term debt 7 5 10 10 10Convertible debt - - - - - Other LT liabilities - - - - - Total liabilities 66 65 47 57 69Minority interest - - - - - Preferred stock - - - - - Common stock 54 54 209 209 209Retained earnings 43 102 149 214 310Proposed dividends - - - - -

Other equity and reserves 25 20 - - - Total shareholders' equity 122 175 357 423 519

Total equity & liabilities 188 240 405 480 588

Liquidity (x)

Current ratio 1.21 1.14 4.57 4.10 4.95 Interest cover 12.0 9.3 na na na

LeverageNet debt/EBITDA (x) 0.61 1.14 net cash net cash net cash

Net debt/equity (%) 12.3 14.5 net cash net cash net cash

Activity (days)Days receivable 50.4 46.9 39.7 41.1 41.8 Days inventory 43.1 57.0 57.9 61.2 62.0 Days payable 60.5 72.3 73.7 74.1 70.6 Cash cycle 33.0 31.7 23.9 28.1 33.2 Source: Nomura est im ates



Any Authors named on this report are Research Analysts unless otherwise indicated

Analyst Certification

We, Cara Song and Stacey Kim, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures

Issuer Ticker

Price(as at last close) Closing price date Rating Disclosures

Amorepacific 090430 KS 1130000.00 KRW 04 Jan 2011 Neutral

Hite Brewery 103150 KS 123000.00 KRW 04 Jan 2011 Not Rated

KT&G Corp 033780 KS 65600.00 KRW 04 Jan 2011 Neutral

LG Household & Health Care 051900 KS 392000.00 KRW 04 Jan 2011 Neutral

Lock & Lock 115390 KS 35900.00 KRW 04 Jan 2011 Buy

Orion Corp 001800 KS 405000.00 KRW 04 Jan 2011 Buy

Previous Ratings

Issuer Previous rating Date of change

Amorepacific BUY 25 Jun 2010

Hite Brewery Not Rated

KT&G Corp REDUCE 30 Mar 2010

LG Household & Health Care BUY 06 Aug 2010

Lock & Lock Not Rated 03 Feb 2010

Orion Corp STRONG BUY 26 Sep 2008

Three-year stock price and rating history

Hite Brew ery

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Orion Corp

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Lock & Lock

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LG Household & Health Care

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Amorepacif ic

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Important Disclosures Conflict-of-interest disclosures Important disclosures may be accessed through the following website: http://www.nomura.com/research/pages/disclosures/disclosures.aspx. If you have difficulty with this site or you do not have a password, please contact your Nomura Securities International, Inc. salesperson (1-877-865-5752) or email [email protected] for assistance. Online availability of research and additional conflict-of-interest disclosures Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Distribution of ratings (Global) Nomura Global Equity Research has 1937 companies under coverage. 48% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 41% of companies with this rating are investment banking clients of the Nomura Group*. 38% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 50% of companies with this rating are investment banking clients of the Nomura Group*. 12% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 13% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 December 2010. *The Nomura Group as defined in the Disclaimer section at the end of this report.



Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008 The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to price target defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research);Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Price Target - Current Price) / Current Price, subject to limited management discretion. In most cases, the Price Target will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008) STOCKS A rating of '1' or 'Strong buy', indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. A rating of '2' or 'Buy', indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '3' or 'Neutral', indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. A rating of '4' or 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '5' or 'Sell', indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Stocks labeled 'Not rated' or shown as 'No rating' are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector - Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia.



Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Buy' recommendation indicates that upside is between 10% and 20%. A 'Neutral' recommendation indicates that upside or downside is less than 10%. A 'Reduce' recommendation indicates that downside is between 10% and 20%. A 'Sell' recommendation indicates that downside is more than 20%. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Price targets Price targets, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any price target may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates. Disclaimers This publication contains material that has been prepared by the Nomura entity identified on the banner at the top or the bottom of page 1 herein and, if applicable, with the contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or elsewhere identified in the publication. Affiliates and subsidiaries of Nomura Holdings, Inc. (collectively, the 'Nomura Group'), include: Nomura Securities Co., Ltd. ('NSC') Tokyo, Japan; Nomura International plc, United Kingdom; Nomura Securities International, Inc. ('NSI'), New York, NY; Nomura International (Hong Kong) Ltd., Hong Kong; Nomura Financial Investment (Korea) Co., Ltd., Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at http://dis.kofia.or.kr ); Nomura Singapore Ltd., Singapore (Registration number 197201440E, regulated by the Monetary Authority of Singapore); Nomura Securities Singapore Pte Ltd., Singapore (Registration number 198702521E, regulated by the Monetary Authority of Singapore); Capital Nomura Securities Public Company Limited; Nomura Australia Ltd., Australia (ABN 48 003 032 513), regulated by the Australian Securities and Investment Commission and holder of an Australian financial services licence number 246412; P.T. Nomura Indonesia, Indonesia; Nomura Securities Malaysia Sdn. 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In addition, other members of the Nomura Group may from time to time perform investment banking or other services (including acting as advisor, manager or lender) for, or solicit investment banking or other business from, companies mentioned herein. Further, the Nomura Group, and/or its officers, directors and employees, including persons, without limitation, involved in the preparation or issuance of this material may, to the extent permitted by applicable law and/or regulation, have long or short positions in, and buy or sell, the securities (including ownership by NSI, referenced above), or derivatives (including options) thereof, of companies mentioned herein, or related securities or derivatives. In addition, the Nomura Group, excluding NSI, may act as a market maker and principal, willing to buy and sell certain of the securities of companies mentioned herein. 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Nomura Group produces a number of different types of research product including, among others, fundamental analysis, quantitative analysis and short term trading ideas; recommendations contained in one type of research product may differ from recommendations contained in other types of research product, whether as a result of differing time horizons, methodologies or otherwise; it is possible that individual employees of Nomura may have different perspectives to this publication. NSC and other non-US members of the Nomura Group (i.e. excluding NSI), their officers, directors and employees may, to the extent it relates to non-US issuers and is permitted by applicable law, have acted upon or used this material prior to, or immediately following, its publication. Foreign-currency-denominated securities are subject to fluctuations in exchange rates that could have an adverse effect on the value or price of, or income derived from, the investment. 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