May 31, 2011 Company Report

Lotte Confectionery (004990 KS) Food & Beverage

Three drivers for earnings and shares Woon-mok Baek +822-768-4158 [email protected]

Maintain Buy; Raise TP to W2,000,000 Amy Lee We reiterate our Buy call on Lotte Confectionery, and raise our target price from +822-768-3066 W1,850,000 to W2,000,000 in light of upward revisions to our earnings forecasts. [email protected]

In the domestic front, the company is expected to maintain solid earnings thanks to its strong market position. In addition, overseas sales are anticipated to take off in line with the companyÊs strong performance in China. The company aims to become the largest confectionary company in Asia by 2018 with consolidated sales of W7.6tr (including overseas sales of W4.4tr).

1Q11 Review: Earnings in line with expectations Lotte ConfectioneryÊs 1Q11 IFRS-based consolidated results came in line with our Buy (Maintain) expectations, with sales, operating profit and net profit climbing 13.6%, 23.9%, Target Price (12M, W) 2,000,000 and 46.2% YoY, respectively. Domestic sales from Lotte Confectionery, Kirin, and Share Price (05/30/11, W) 1,574,000 Lotte Pharm each grew 10% thanks to the launch of new products and a steady Expected Return (%) 27.1 increase in major product sales. Growth was robust in overseas markets, including EPS Growth (11F, %) -7.0 China, India, and Pakistan (acquired in 2010). Although the COGS-to-sales ratio Market EPS Growth (11F, %) 26.4 inched up due to higher raw material prices, including dairy products, operating P/E (11F, x) 17.0 profit improved on a limited increase in SG&A. Net profit growth outpaced Market P/E (11F, x) 10.5 operating profit growth due to gains of W1.5bn on the disposal of tangible assets. KOSPI 2,093.79 Market Cap (Wbn) 2,237 Three drivers for earnings and shares from 2Q onward Shares Outstanding (mn) 1 Avg Trading Volume (60D, '000) 2 1) Confectionery price hikes: Lotte Confectionery raised confectionery prices, Avg Trading Value (60D, Wbn) 3 excluding gums and chocolates, by an average of 8% in May. Unless sales volume Dividend Yield (11F, %) 0.3 falls, sales are projected to increase by W27.5bn in 2011. The price hikes should Free Float (%) 49.0 also absorb higher production costs in 1Q and 2Q. 52-Week Low 1,218,000 2) Potential ice cream price hikes: F&B companies are increasingly passing higher 52-Week High 1,650,000 raw material costs to consumers through price hikes. If Lotte Confectionery is able Beta (12M, Daily Rate of Return) 0.6 to increase ice cream prices (accounting for about 40% of sales) before the high Price Return Volatility (12M Daily,%,SD) 1.7 demand season of 3Q, its earnings and shares should get a big boost. Foreign Ownership (%) 41.1 Major Shareholder(s): 3) Overseas market performance: Lotte ConfectioneryÊs 2011 overseas sales target Lotte Aluminum et al. (49.97%) stands at W500bn (up 67% YoY: 75% in China, 45% in India, 33% in Pakistan, and Silchester International Investors LLP (9.7%) 22% in Vietnam). We believe that the company is on track to achieve that target. In Arnhold and S. Bleichroeder Advisers , LLC (6.5%) particular, its Chinese market performance is anticipated to take off this year, based Price Performance on: 1) the liquidation of its non-performing bonds and reduction of ailing customers (%) 1M 6M 12M in 2010, 2) localization, 3) the expansion of direct operations, and 4) product Absolute -0.9 13.7 25.8 portfolio diversification. Relative 3.6 3.8 -3.2

§ Earnings & Valuation Metrics Share price 160 KOSPI OP EV/ Sales OP NP EPS EBITDA FCF ROE P/E P/B FY Margin EBITDA 140 (Wbn) (Wbn) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) (%) (x) 120

12/09 1,317 112 8.5 96 67,233 165 17 4.5 19.2 0.8 12.1 100

12/10 1,416 150 10.6 142 99,700 204 89 5.7 15.1 0.8 11.5 80 12/11F 1,562 177 11.4 132 92,678 244 89 5.0 17.0 0.8 9.8 60 12/12F 1,679 192 11.4 144 101,469 257 99 5.2 15.5 0.8 9.0 40 12/13F 1,796 205 11.4 157 110,707 273 112 5.4 14.2 0.7 8.0 5/10 9/10 1/11 5/11

Note: Based on K-GAAP; Excludes equity-method gains/losses since 2011F Source: Company data, Daewoo Securities Research estimates Please read carefully important disclosures at the end of this report. May 31, 2011 Lotte Confectionery

Table 1. Lotte ConfectioneryÊs 1Q11 earnings results (Wbn, %) 1Q10 1Q11 % YoY Parent Consolidated Parent Consolidated Parent Consolidated Sales 315.5 367.0 344.5 416.8 9.2 13.6 Operating profit 28.0 28.9 33.7 35.8 20.5 23.9 Pretax profit 30.9 34.1 37.0 49.0 19.8 43.8 Net profit 22.3 24.9 26.1 36.4 17.0 46.2 OP margin 8.9 7.9 9.8 8.6 - - Net margin 7.1 6.8 7.6 8.7 - - Source: Company data, Daewoo Securities Research

Table 2. Consolidated sales breakdown by country (Wbn, %) 1Q10 1Q11 % YoY Remarks Korea 328.3 361.1 10.0 Lotte Confectionery, Kirin Food, Lotte Pharm China 2.6 4.3 62.2 Lotte Food Holding, Lotte Qingdao Food, Lotte Ice India 12.1 15.8 30.3 Lotte India Europe 24.0 24.1 0.4 Lotte Confectionery Holdings (Guylian) Others - 11.6 - K.S. Sulemanji Esmailji & Sons (Pakistan) Total 367.0 416.8 13.6 Note: Most of the Chinese subsidiaries are under Lotte Food Holding, which is a holding company; thus, consolidated sales from China do not fully reflect the company's Chinese sales Source: Company data, Daewoo Securities Research

Table 3. Lotte ConfectioneryÊs 2011~2012F earnings revisions (Wbn, %) Previous Revised % Change % YoY 11F 12F 11F 12F 11F 12F 11F 12F Sales 1,543 1,659 1,562 1,679 1.2 1.2 10.3 7.5 Operating profit 168 182 177 192 5.4 5.5 18.4 8.4 Pretax profit 159 173 176 184 10.5 6.2 24.3 4.8 Net profit 122 136 132 144 8.3 6.2 22.4 9.5 OP margin 10.9 11.0 11.4 11.4 - - - - Net margin 7.9 8.2 8.4 8.6 - - - - Note: Based on K-GAAP; Excludes equity-method gains/losses Source: Daewoo Securities Research

Figure 1. Confectionery shipment growth Figure 2. Ice cream shipment growth

('000 tonnes) (%) ('000 tonnes) (%) 30 Confectionery shipments (L) 40 70 Ice cream shipments (L) 40 % YoY (R) % YoY (R) 60 30

25 20 50 20

40 10 20 0 30 0

20 -10 15 -20

10 -20

10 -40 0 -30 00 02 04 06 08 10 00 02 04 06 08 10

Source: Statistics Korea, Daewoo Securities Research Source: Statistics Korea, Daewoo Securities Research

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May 31, 2011 Lotte Confectionery

Figure 3. CPI for confectionery Figure 4. CPI for ice cream

(05=100) (05=100) 160 160 Ice cream Popsicles

140 140

120 120 100

100 80

60 80 00 02 04 06 08 10 00 02 04 06 08 10

Source: Statistics Korea, Daewoo Securities Research Source: Statistics Korea, Daewoo Securities Research

Figure 5. Lotte ConfectioneryÊs overseas business profile

**Belgium **China - Acquired Guylian, - Entered Chinese market in 1994 a premium chocolate brand, in 2008 **Russia - Subsidiaries: Lotte Food Holding (owns stakes in - Established Asian headquarters in Shanghai, China - Lotte Europe Holdings Lotte China Investment and LH Food) - Subsidiary: Lotte Confectionery Holdings - Expected to generate Lotte China Investment (holding company) profit from 2014 Lotte China Foods, Lotte Qingdao Foods Lotte PengCheng, Lotte Packaging (Beijing) Lotte Shanghai Foods, Lotte Ice LH Foods (joint venture with HersheyÊs) **Pakistan - Operating branches: Beijing, Shanghai, Tianjin, Nanjing, Shenyang, Hangzhou, Qingdao, - Acquired Kolson in 2010 Guangzhou, Wuhan, Chengdu -MS: 2nd in snacks, 1st in pasta, 4th in biscuits **Vietnam - Acquired BIBICA, **India VietnamÊs 2nd largest confectionery company, in 2007 - Acquired Parrys in 2004 - Manufacturing base for Southeast Asia -MS: 3rd in Indian candy - Subsidiaries: BIBICA Corporation, - Subsidiaries: Lotte Foods India, Lotte Vietnam Lotte India **Indonesia - PT. Lotte Indonesia **Taiwan – Lotte Taiwan

Source: Company data, Daewoo Securities Research

Figure 6. 2011 Overseas sales and OP margin targets Figure 7. Lotte ConfectioneryÊs long-term sales target

(Wbn) (%) (Wtr) 150 12 8 Sales (L) Russia OP margin (R) Vietnam Pakistan 120 8 India 6 Guylian

90 4 China 4 60 0

2 30 -4 Domestic

0 -8 0 China Guylian India Pakistan Vietnam Russia 10 11F 18F

Source: Company data, Daewoo Securities Research Source: Company data, Daewoo Securities Research

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May 31, 2011 Lotte Confectionery

Lotte Confectionery (004990 KS/Buy/TP: W2,000,000)

Income Statement (Summarized) Balance Sheet (Summarized) (Wbn) 12/10 12/11F 12/12F 12/13F (Wbn) 12/10 12/11F 12/12F 12/13F Sales 1,416 1,562 1,679 1,796 Current Assets 519 607 732 861 Cost of Goods Sold 850 939 1,009 1,080 Cash and Cash Equivalents 152 208 297 396 Gross Profit 567 623 670 717 Accounts Receivable 154 176 189 202 SG&A 417 446 478 512 Inventories 119 132 142 152 Operating Profit 150 177 192 205 Other Current Assets 94 91 104 112 Non-Operating Income 36 -2 -8 -4 Non-Current Assets 3,185 3,274 3,342 3,410 Interest Income/Expense -11 -9 -6 -1 Investment Assets 2,233 2,316 2,343 2,369 F/X-Related Gain/Loss -41 21 2 2 Property, Plant and Equipment 950 957 998 1,039 Equity Method Gain/Loss 45 0 0 0 Intangible Assets 1 1 1 1 Asset Disposal Gain/Loss 4 1 0 0 Total Assets 3,704 3,881 4,074 4,271 Other Non-Operating Profit/Loss 39 -15 -4 -5 Current Liabilities 436 468 481 494 Pretax Profit 186 176 184 201 Accounts Payable 119 135 145 155 Tax 45 44 40 44 Short-Term Debt 0 -30 -30 -30 Profit from Continuing Operation 142 132 144 157 Current Long-Term Debt 154 194 184 174 Profit from Discontinued Operation 0 0 0 0 Other Current Liabilities 164 170 182 195 Tax Effect 0 0 0 0 Non-Current Liabilities 679 693 734 766 Net Profit 142 132 144 157 Bonds 272 272 282 282 Residual Income 142 75 84 94 Long-Term Debt 0 0 0 0 EBITDA 204 244 257 273 Other Non-Current Liabilities 407 420 452 484 Free Cash Flow 89 89 99 112 Total Liabilities 1,115 1,161 1,215 1,260 Gross Profit Margin (%) 40.0 39.9 39.9 39.9 Paid-In Capital 7 7 7 7 EBITDA Margin (%) 14.4 15.6 15.3 15.2 Capital Surplus 270 270 270 270 Operating Margin (%) 10.6 11.4 11.4 11.4 Retained Earnings 1,483 1,615 1,753 1,905 Net Margin (%) 10.0 8.4 8.6 8.8 Stockholders' Equity 2,589 2,721 2,859 3,011

Cash Flow (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/10 12/11F 12/12F 12/13F 12/10 12/11F 12/12F 12/13F Cash Flow from Operating Activities 158 162 205 222 P/E (x) 15.1 17.0 15.5 14.2 Net Profit 142 132 144 157 P/CF (x) 10.9 10.5 10.0 9.3 Non-Cash Income and Expense 25 46 64 68 P/B (x) 0.8 0.8 0.8 0.7 Tangible Assets Depreciation 55 67 65 69 EV/EBITDA (x) 11.5 9.8 9.0 8.0 Intangible Assets Depreciation 0 0 0 0 EPS (W) 99,700 92,678 101,469 110,707 Others -30 -21 -1 -1 CFPS (W) 138,116 139,765 147,045 159,015 Chg in Working Capital -9 -15 -4 -4 BPS (W) 1,820,242 1,912,967 2,010,523 2,117,316 Chg in Accounts Receivable -17 -23 -15 -15 DPS (W) 4,000 4,000 4,000 4,000 Chg in Inventories -8 -13 -10 -10 Payout Ratio (%) 4.0 4.3 3.9 3.6 Chg in Accounts Payable 8 16 10 10 Dividend Yield (%) 0.3 0.3 0.3 0.3 Others 9 5 11 11 Sales Growth (%) 7.6 10.3 7.5 7.0 Cash Flow from Investment Activities -53 -150 -144 -142 EBITDA Growth (%) 24.0 19.5 5.2 6.3 Chg in Tangible Assets -69 -72 -106 -110 Operating Profit Growth (%) 33.4 18.4 8.4 6.5 Chg in Intangible Assets 0 0 0 0 EPS Growth (%) 48.3 -7.0 9.5 9.1 Chg in Investment Assets -91 -83 -27 -27 Accounts Receivable Turnover (x) 9.8 9.5 9.2 9.2 Others 107 4 -11 -5 Inventory Turnover (x) 12.3 12.4 12.3 12.3 Cash Flow from Financing Acitivities -5 44 28 18 Accounts Payable Turnover (x) 12.4 12.3 12.0 12.0 Chg in Borrowings 0 24 32 22 ROA (%) 4.0 3.5 3.6 3.8 Chg in Equity -5 0 -6 -6 ROE (%) 5.7 5.0 5.2 5.4 Dividends -5 0 -6 -6 ROIC (%) 17.7 21.8 23.2 24.0 Others 0 21 2 2 Liability to Equity Ratio (%) 43.1 42.7 42.5 41.8 Chg in Cash 100 56 89 98 Current Ratio (%) 119.0 129.7 152.3 174.4 Beginning Cash Balance 52 152 208 297 Net Debt to Equity Ratio (%) 7.9 6.0 2.2 -1.7 Ending Cash Balance 152 208 297 396 Interest Coverage Ratio (x) 8.0 8.9 9.5 10.2 Note: Based on K-GAAP, excludes equity-method gains/losses since 2011F Source: Company data, Daewoo Securities Research estimates

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May 31, 2011 Lotte Confectionery

Important Disclosures & Disclaimers As of the publication date, Daewoo Securities Co., Ltd and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the subject company's shares outstanding. Analyst of the subject company or member of the analyst's household does not have any financial interest in the securities of the subject company and the nature of the financial interest (including without limitation, whether it consists of any option, right, warrant, future, long or short position). This report reflects the sole opinion of the analyst without any external influences by third parties.

Buy Relative performance of 20% or greater (W) LotteConf Stock Trading Buy Relative performance of 10% or greater, but with volatility 2,500,000 Ratings Hold Relative performance of -10% and 10% 2,000,000 Sell Relative performance of -10% 1,500,000 1,000,000 Overweight Fundamentals are favorable or improving Industry 500,000 Neutral Fundamentals are steady without any material changes Ratings 0 6/09 11/09 5/10 11/10 5/11 Underweight Fundamentals are unfavorable or worsening * Ratings and Target Price History (Share price (----), Target price (----), Not covered (■), Buy (▲), Trading Buy (■), Hold (●), Sell (◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development.

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