14 December 2010 Produced by: RBS Asia Limited (Seoul) Branch
Kumho Petrochemical Initiation of coverage
Buy Reborn as a core chemical player
Target price Kumho Petrochem is one of the least covered chemical stocks in Korea. W119000 However, with apparently diminishing risk related to the Kumho Asiana group, we Price W79300 believe it's time to focus on Kumho Petrochem's strong fundamentals and Short term (0-60 days) attractive valuation. Buy. n/a Market view Key forecasts Underweight
FY08A FY09A FY10F FY11F FY12F Revenue (Wb) 3,182 2,802 3,853 4,470 4,821 Price performance EBITDA (Wb) 353.5 218.0 458.1 564.1 626.4 Reported net profit (Wb) -19.7 -614 317.7 418.5 488.7 (1M) (3M) (12M) Normalised net profit (Wb)¹ -19.7 -614 317.7 418.5 488.7 Price (W) 79400 66800 23950 Equity | Korea | Materials Equity | Korea Normalised EPS (W) -777 -24,183 12,497 14,537 16,041 Absolute (%) -0.1 18.7 231.1 Rel market (%) -4.3 8.1 174.8 Dividend per share (W) 750.0 0.00 750.0 1,000 1,000 Rel sector (%) -1.3 6.0 173.3 Dividend yield (%) 0.95 0.00 0.95 1.26 1.26
Normalised PE (x) n/m n/m 6.35 5.46 4.94 Dec 07 Dec 08 Dec 09 100000 EV/EBITDA (x) 11.20 19.10 8.79 6.00 5.03 Price/book value (x) 1.73 3.77 2.41 1.69 1.28 ROIC (%) 8.78 2.70 10.30 12.60 14.50
1. Post-goodwill amortisation and pre-exceptional items year to Dec, fully diluted Accounting standard: Local GAAP Source: Company data, RBS forecasts
A leading synthetic rubber manufacturer globally 0 011780.KS Korea Composite We expect Kumho Petrochem to benefit from strong tyre demand given its leading position in
synthetic rubbers (57% of total sales annually). Kumho’s market shares in butadiene rubber Market capitalisation (BR) and styrene butadiene rubber (SBR) are around 10% and 9%, respectively. Potential W2.02t (US$1.76bn) growth in replacement tyre demand in China, combined with limited capacity additions for BR Average (12M) daily turnover W10503.23m (US$9.00m) and SBR in 2011 and 2012, should push up the synthetic rubber price, helped by strong natural rubber prices. Sector: BBG AP Chemicals RIC: 011780.KS, 011780 KS Priced W79300 at close 13 Dec 2010. 56.4% CAGR 2010-13F in equity method gains from subsidiaries Source: Bloomberg Another positive development by Kumho is the rapidly growing equity method gains it
receives from its chemical-related subsidiaries after spinning off from the Kumho Asiana group in early 2010. We expect equity method gains to see a 56.4% CAGR over 2010-13 due to significant operational improvements at Kumho P&B, which produces phenol, bisphenol- A (BPA) and epoxy resin, due mainly to strong polycarbonate demand related to smartphones. Analysts
Angela Choi Fast deleveraging and improving corporate governance South Korea We expect Kumho Petrochem to deleverage quickly given its EBITDA of W500bn pa and +82 2 2131 6459 [email protected] possible sale of assets related to the Kumho Asiana group (W545bn book value as of 3Q10). We expect its ratio of net debt to equity to decline from 402% in 2009 to around 60% in 2012. Avin Sony Thailand Kumho Petrochem’s spin-off from Kumho Asiana group reduces corporate governance +66 2 680 1264 uncertainties; hence we focus on the company’s strong fundamentals. [email protected] David Johnson Initiating coverage with a Buy Hong Kong We value Kumho Petrochem on sum of the parts, based on 2011F EV/EBITDA multiples for +852 3988 7185 [email protected] the core operation and other chemical subsidiaries, and calculate a target price of W119,000 (equivalent to 8.2x 2011F PE and 2.4x 2011F P/B, with 36.9% 2011F ROE). Currently, 6/F, Seoul Finance Center, 84, Taepyeogno 1-ga, Jung-gu, Seoul 100- Kumho trades at 5.5x 2011F PE, a 59% discount to the petrochemical sector average in Asia 768, South Korea for companies under our coverage.
http://research.rbsm.com Important disclosures can be found in the Disclosures Appendix.
The basics
Versus consensus Catalysts for share price performance We believe strong price spreads in synthetic rubbers will be the key catalyst for the share price. EPS Ours Cons % diff This may come with a natural rubber price increase, or tyre price hikes by tyre makers. Growing 2010F 12,497 11,549 8.2% replacement tyre demand in China following strong original equipment tyre demand in the past 2011F 14,537 12,305 18.1% 2012F 16,041 13,032 23.1% three to four years, and fast deleveraging and possible sale of idling assets (eg Asiana, Kumho Industrials) are other potential catalysts. Source: Reuters, RBS forecasts Earnings momentum
Despite a maintenance shutdown in the synthetic rubber division in October 2010, we expect 4Q10 results to show 358.4% yoy growth in operating profit, led by strong prices in synthetic rubbers and synthetic resins. This trend should continue, and we expect 16.3% and 10.3% EPS growth yoy in 2011 and 2012, respectively, given a capacity addition in high-butadiene rubber (HBR) of 120,000 tonnes on top of the current 167,000 tonnes and strong tyre demand globally. Valuation and target price We derive our W119,000 target price from our sum-of-the-parts valuation, which we believe Forced ranking* properly reflects the value of hidden assets (eg the three petrochem subsidiaries, treasury assets, etc). Company Rec Upside/ downside How we differ from consensus Kumho Buy 50% Besides our bullish assumptions for earnings (18% and 23% higher than consensus in 2011 and PTT Chem Buy 28% LG Chem Buy 24% 2012, respectively), we are the first foreign broker covering Kumho Petrochemical. It has in the Honam Buy 24% past been an under-covered stock due to risks related to Kumho Asiana Group. After almost completed spinning off from the group, Kumho Petrochemicals’ balance sheet is clean and *by difference to target price as at time of publication. Recommendations may lie corporate governance has improved. We focus on the company’s strong fundamentals and outside the structure outlined in the disclosure page. attractive valuation. Source: RBS forecasts Risks to central scenario
The major downside risk we see is the company’s self-sufficiency in BR (one of the key raw materials in synthetic rubbers) falling from the current 40% to 20% in 2011 as Kumho renewed its contract with Honam Petrochemical (011170 KS). According to our regional analyst Sony Avin, large capacity additions in butadiene are due to come online from 2011; therefore, we don’t worry about the supply of butadiene. However, without efficient control over the butadiene supply because so much has to be bought in, Kumho’s earnings could be hurt to some degree.
Key events Upside risk stems from an abrupt surge in tyre replacement demand in China, which we don’t reflect in our models even though we comment on it in the text of this report. Date Event End of Jan 4Q10 result
Source: Company
Kumho Petrochemical | The Basics | 14 December 2010 2
Key assumptions and sensitivities
Kumho Petrochemical’s major products are styrene butadiene rubber (SBR), butadiene rubber (BR), polystyrene (PS) and acrylonitrille butadiene styrene (ABS).
Table 1 : Basic assumptions on major petrochemical products
(US$/tonne) 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F SBR 1,600 1,500 1,600 2,360 1,440 2,220 2,553 2,834 2,692 BR 1,820 1,745 1,760 2,960 1,590 2,900 3,248 3,573 3,573 PS 1,170 1,248 1,435 1,413 1,055 1,341 1,400 1,550 1,550 ABS 1,408 1,528 1,701 1,848 1,358 1,900 2,000 2,020 2,020 BD 929 1,055 1,205 1,753 894 1,800 1,700 1,700 1,500
Source: Company data, RBS forecasts
Table 2 : Revenue and operating profit breakdown
(Wbn) 2006 2007 2008 2009 2010F 2011F 2012F 2013F CAGR Sales 1,753.0 2,124.5 3,182.5 2,801.7 3,853.3 4,470.4 4,821.0 4,777.1 15.4% Synthetic rubber 892.1 1,095.7 1,886.0 1,478.7 2,222.2 2,679.9 2,901.8 2,766.9 Synthetic resin 720.5 877.8 1,027.7 1,010.2 1,185.3 1,233.4 1,250.7 1,207.9 Others 140.4 151.0 268.8 312.8 445.7 557.1 668.5 802.3 Operating profit 86.9 160.8 281.3 116.2 356.2 464.0 525.6 459.5 26.9% Synthetic rubber 46.4 120.0 241.6 54.3 207.2 278.9 312.1 235.0 Synthetic resin (8.6) (5.1) (27.6) 37.3 67.9 76.5 83.8 66.4 Others 49.1 45.9 67.3 24.6 81.1 108.6 129.7 158.0 OPM (%) Synthetic rubber 5.2% 11.0% 12.8% 3.7% 9.3% 10.4% 10.8% 8.5% Synthetic resin -1.2% -0.6% -2.7% 3.7% 5.7% 6.2% 6.7% 5.5% Others 35.0% 30.4% 25.0% 7.9% 18.2% 19.5% 19.4% 19.7%
Source: Company data, RBS forecasts
Kumho’s earnings are highly dependent upon the prices of SBR, BR and BR.
Table 3 : Kumho Petrochemical: sensitivity analysis, FY11F
Impact on net profit from changes in +10% -10% SBR 7.8% -7.8% BR 13.6% -13.6% BD -5.2% 5.2%
Source: RBS estimates
Kumho Petrochemical | The Basics | 14 December 2010 3
Reborn as a core chemical player
We expect Kumho Petrochem to post a 26.7% EBITDA CAGR over 2010-13, based on its strong synthetic rubber business and increasing equity method gains from subsidiaries. Fast deleveraging should also raise the overall value of the company.
Leading synthetic rubber manufacturer globally
9~10% global market share of We expect Kumho Petrochemical to benefit from strong tyre demand, given its leading position in synthetic rubber sales synthetic rubbers. Kumho’s market shares in BR and SBR are around 10% and 9%, respectively. Separately, synthetic rubber accounts for 57% of total sales annually.
Due to solid tyre demand and a possible surge in replacement tyre demand in China, we expect prices of SBR and BR to stay higher than the price of butadiene, the raw material, given the limited SBR and BR capacity addition planned.
Furthermore, Kumho stands to benefit from a 120,000-tonne BR capacity addition in 2010. The company plans to begin commercial production from early 2011. Based on our rough calculations, this should add around W350bn revenue and W45bn operating profit.
The strong natural rubber price also supports synthetic rubber prices. Market specialists expect the tight supply of natural rubber to continue in 2011 due to adverse weather conditions in Thailand, one of the biggest exporters, and declining yields from ageing trees.
Chart 1 : Price trends in SBR, BR and butadiene
4,000 (US$/tonne)
3,500
3,000
2,500
2,000
1,500
1,000
500 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
SBR BR Butadiene
Source: Company data, RBS forecasts
Kumho Petrochemical | Investment View | 14 December 2010 4
Chart 2 : Natural rubber price
25,000 (INR/MT)
20,000
15,000
10,000
5,000
0 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10
Source: Bloomberg
56.4% CAGR over 2010-13F in equity method gains from subsidiaries
Rapidly increasing equity Another positive development is the rapidly increasing equity method gains Kumho is receiving method gains from core chemical from its subsidiaries. Currently, Kumho has six subsidiaries in its holding structure. It spun off subsidiaries subsidiaries related to the Kumho Asiana group, such as Kumho Industrials, Kumho Tire and Daewoo E&C, in 2010, which had previously reflected an equity method loss in its accounts. The remaining subsidiaries are chemical-related entities (eg Kumho Polychem, Kumho Mitsui Chem and Kumho P&B) and Kumho’s Chinese subsidiaries (eg five JVs under Kumho Petro Holdings and one JV name, Shanghai Kumho).
We expect equity method gains to see a 56.4% CAGR in 2010-13 due to significantly improved operations in Kumho P&B, which produces phenol, bisphenol-A (BPA) and epoxy resin. We expect Kumho P&B (78.2% owned by Kumho Petrochem) to post around W1tn in revenue and more than W200bn operating profit in 2010, far beyond its W60bn record operating profit in 2006.
Chart 3 : Increase in equity method gains
250 (Wbn) 56.4% CAGR
200
150
100
50
0
(50) 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
Kumho Polychem Kumho Mitsui Chem Kumho P&B Shanghai Kumho Kumho Port Management
Source: Company data, RBS forecasts
Fast deleveraging
Fast deleveraging given W500bn We expect Kumho Petrochem to deleverage quickly given its EBITDA of W500bn pa and the annual EBITDA and possible sale possible sale of assets related to the Kumho Asiana Group. On the other hand, we expect major of idling assets creditors to convert its W200bn CBs into equity in May 2011, given the surge in the company’s share price in 2010. The conversion price is W39,657. With the conversion, we expect the net- debt-to-equity ratio to decline from 150.5% to 114.9% in 2011.
Reflecting all these efforts, we expect the net-debt-to-equity ratio to decline from 401.8% in 2009 to 60% in 2012, which is required under the MOU with creditors.
Kumho Petrochemical | Investment View | 14 December 2010 5
Chart 4 : Net debt and net debt/equity ratio
2,500 (Wbn) (%) 450
400
2,000 350
300 1,500 250
200 1,000 150
500 100 50
0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
Net debt Net debt/equity
Source: Company data, RBS forecasts
Spin-off from Kumho Asiana Group: Focusing on core business
Likely re-rating under improving Kumho Petrochemical has already announced its spin-off from Kumho Asiana Group (please refer corporate governance to the ‘Management’ section). This means investors no longer need to worry about any risks related to the Kumho Asia Group, which has in the past been a concern hanging over Kumho Petrochemical. In other words, we believe investors should focus on its core chemical business, which should mean the shares will be rerated in the future.
Kumho Petrochemical | Investment View | 14 December 2010 6
Valuation
We initiate coverage at Buy. Our W119,000 target price is based on a sum-of-the-parts valuation. Kumho has had little broker coverage in the past; however, based on improving corporate governance, we focus on the company’s strong fundamentals.
Sum-of-the-parts valuation
W119,000 target price, which is We believe our SOTP valuation method reflects the hidden value in Kumho Petrochemical, such equivalent to a 8.2x 2011F P/E as the three major petrochemical-related subsidiaries and treasury shares (22% outstanding and 2.4x 2011F P/B shares). Our target valuation is equivalent to 8.2x 2011F PE and 2.4x 2011F P/B with 36.9% 2011F ROE.
Core operation – We apply a multiple of 5.5x EV/EBITDA to 2011F EBITDA, which is 36% lower than our 8.6x 2011F market cap weighted EV/EBITDA for the regional petrochemical sector under our coverage, because Kumho has a relatively narrow product scope focusing on synthetic rubber. However, we are more positive on the price spread on synthetic rubber than other petrochemical products. LG Chem (with a varied product mix from polyolefin to synthetic rubbers) has confirmed that it expects more upside from its own synthetic rubber division than from other products.
Kumho P&B – We apply a multiple of 5x EV/EBITDA to 2011F EBITDA, 10% lower than the multiple that we used for the core operation, to be conservative. The company manufactures phenol and bisphenol-A with around 50% domestic market share by volume. This dominant market position seems to afford the company some advantage in pricing.
Other petrochemical subsidiaries – We apply book value as of 3Q10 for other petrochemical subsidiaries, such as Kumho Polychem, Kumho Mitsui Chem and Kumho Petro Holdings, to be conservative. Kumho Chemical has six JVs in China, mostly focusing on synthetic rubber products. We believe the value added by these subsidiaries will grow quickly. We may need to revisit our valuation methodology for these subsidiaries if earnings change.
Table 4 : Sum-of-the-parts valuation
Company Business Stake Valuation methodology (Wbn) Main operation Synthetic rubbers, synthetic resin 5.5x 2011F EV/EBITDA 3,103 Other assets Kumho Polychem EPM (Copolymer of ethylene and propylene), EPDM (Terpolymer 50% Book value 61 of ethylene, propylene and a non-conjugated diene) Kumho Mitsui Chem MDI (Methylene diphenyl diisocyanate), Aniline 50% Book value 69 Kumho P&B Cumene, Phenol, BPA, Epoxy resins 78% 5x 2011F EV/EBITDA applying 10% 938 discount to reflect narrow production scope Kumho Petro Holdings Holding companies of five JVs in China 100% Book value 71 Subtotal 1,139 Treasury shares 22% of total shares Based on W79,300 share price 443 Other assets Assets related with Kumho Asiana group 3Q10 book value 313 Net debt (1,370) Equity value 3,628 No of shares 30,467,693 Per share equity value (Rounding from W119,089) 119,000 Current share price 79,300 Upside potential 50.1%
Priced as of 13 December 2010 Source: Company data, RBS forecasts
Kumho Petrochemical | Valuation Comment | 14 December 2010 7
EV/EBITDA looks attractive
Improving operations are not yet We draw EV/EBITDA and P/B band charts to trace the historical valuation range. We find Kumho fully priced in attractive in terms of EV/EBITDA. We believe the recent share price surge just reflects the removal of the risk overhang from the old Kumho Asiana Group and the lack of equity method losses from the recently disposed businesses. In our view, the price does not yet fully reflect the company’s improving operations. Therefore, we see further upside potential.
In terms of P/B, the stock doesn’t seem that attractive. Kumho’s book value has halved in recent years due to consecutive net losses in 2008 and 2009 arising from equity method losses related to the Kumho Asiana Group. In 2008, total shareholders’ equity was W1.2trn, but this declined to W0.5trn in 2009. Total shareholders’ equity is now improving, but it is still far below W1trn. This is the main reason for Kumho Petrochemical’s slightly higher P/B ratio.
Chart 5 : EV/EBITDA band Chart 6 : P/B band
8,000 (Wb) 100,000 (W) 2x 7,000 12.8x
11.3x 80,000 1.7x 6,000 9.8x 5,000 1.4x 60,000 8.3x 4,000 1.1x 6.8x 40,000 3,000 5.3x 0.8x
2,000 20,000 0.5x 1,000
0 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Source: Company data, RBS forecast Source: Company data, RBS forecast
Inexpensive vs peers
2011F PE of 5.5x is 39% lower In terms of relative valuation with domestic and global peers, Kumho Petrochem still looks than domestic peers attractive. Its 2011F PE multiple of 5.5x is 39% and 59% lower than its domestic and global peers, based on RBS and Bloomberg forecasts. Its 2011F EV/EBITDA multiple of 6.0x is 14% lower than its domestic and 30% lower than global peers. A proportion of earnings comes from equity method gains in Kumho Petrochem; therefore, a PE comparison is more relevant than a simple EV/EBITDA comparison.
Kumho Petrochemical | Valuation Comment | 14 December 2010 8
Table 5 : Valuation with domestic peers
Kumho Petrochem LG Chem Honam Petrochem Hanwha Chem* SK Energy* GS Holdings* Ticker 011780 KS 051910 KS 011170 KS 009830 KS 096770 KS 078930 KS Rating Buy Buy Buy NR NR NR Price (W) 79,300 370,000 261,500 31,900 168,000 64,600 Mkt cap (Wb) 2,016.2 24,520.3 8,331.4 4,475.0 15,534.2 6,002.3 P/E (x) 09A -3.3 15.9 10.5 13.1 23.0 12.1 10F 6.3 10.7 10.1 10.1 11.6 8.1 11F 5.5 9.4 7.0 9.1 9.8 8.9 12F 4.9 8.3 5.6 8.1 8.6 8.0 P/BV (x) 09A 3.8 4.5 2.2 1.7 2.0 1.5 10F 2.4 3.3 1.9 1.5 1.6 1.3 11F 1.6 2.5 1.5 1.3 1.4 1.1 12F 1.3 2.0 1.2 1.1 1.2 1.0 EV/EBITDA (x) 09A 19.1 8.9 8.4 11.3 13.9 14.2 10F 8.8 6.8 7.8 10.2 9.2 8.4 11F 6.0 5.7 6.3 9.5 7.9 9.2 12F 5.0 4.9 5.3 8.6 6.9 8.2 EPS growth (%) 09A 3,013.8 68.8 n/a 647.1 (24.3) 3,267.7 10F n/a 48.3 3.2 30.4 98.2 50.3 11F 16.3 14.4 44.2 10.7 18.8 (9.7) 12F 10.3 13.0 25.9 12.4 13.5 12.0 ROE (%) 09A (72.4) 30.0 24.4 13.6 9.0 12.8 10F 46.3 35.6 20.0 16.0 15.5 16.9 11F 36.9 30.5 23.4 15.5 15.4 13.4 12F 29.5 26.8 23.6 15.4 15.2 13.2
Source: Company data, RBS forecasts for Honam, LG Chem, Bloomberg consensus for Hanwha Chem, SK Energy, GS Holdings
Table 6 : Valuation comparison with global peers
Rec Price Mkt cap Target Up Company PE (x) PBV (x) EV/EBITDA (x) ROE (LC) (US$m) price (LC) side 2010F 2011F 2012F 2010F 2011F 2012F 2010F 2011F 2012F 2010F 2011F 2012F Kumho Petrochemical Buy 79,300 1,762 119,000 50% 6.3 5.5 4.9 2.4 1.6 1.3 8.8 6.0 5.0 46.3% 36.9% 29.5% LG Chemical Buy 370,000 21,424 460,000 24% 10.7 9.4 8.3 3.3 2.5 2.0 6.8 5.7 4.9 35.6% 30.5% 26.8% Honam Petrochemical Buy 261,500 7,280 325,000 24% 10.1 7.0 5.6 1.9 1.5 1.2 7.8 6.3 5.3 20.0% 23.4% 23.6% PTT Chemical Buy 151 7,576 192 28% 16.9 6.6 6.0 2.1 1.8 1.5 10.5 4.6 3.8 13.1% 29.3% 26.9% Indorama Ventures Buy 58 8,285 76 32% 31.3 18.4 15.1 8.3 6.7 5.7 23.5 14.1 12.4 31.3% 40.4% 40.6% PTT Aromatics Buy 39 3,872 43 10% 19.5 11.0 7.5 1.8 1.6 1.3 12.9 8.6 6.3 9.6% 15.4% 18.9% PTT Pcl Buy 328 31,032 368 12% 12.2 9.1 7.8 1.8 1.5 1.2 6.4 4.6 3.6 15.4% 17.5% 17.0% Reliance Industries Sell 1,016 73,733 855 -16% 18.3 15.8 15.0 2.7 2.4 2.1 12.5 10.1 9.3 15.5% 15.9% 14.8% Formosa Petrochemical Sell 89 28,128 77 -13% 23.6 21.7 18.3 3.5 3.4 3.3 13.6 12.6 11.0 15.2% 16.0% 18.3% Formosa Plastics Buy 94 19,072 107 14% 12.4 10.2 9.6 2.2 2.0 1.9 10.0 7.4 6.9 18.4% 20.3% 19.9% Formosa Chem* Buy 94 17,750 105 12% 11.9 10.1 9.3 2.0 1.8 1.7 12.3 9.2 8.1 17.6% 18.7% 18.5% Formosa Group** na na 64,949 na na 17.2 15.3 13.4 2.7 2.6 2.4 12.2 10.2 9.0 16.7% 17.9% 18.8% Thai Oil Sell 74 5,036 42 -43% 18.7 14.3 10.3 2.1 2.0 1.8 9.9 7.3 5.6 11.7% 14.3% 18.5% IRPC Pcl Buy 5 3,621 6 9% 14.1 10.7 8.5 1.3 1.2 1.1 10.4 7.3 5.6 10.1% 11.8% 13.2% Weighted average 16.4 13.3 11.9 2.7 2.4 2.1 11.1 8.6 7.6 18.3% 19.7% 19.2%
Note: Weighted average is market cap weighted average and Formosa Group is weighted average of Formosa Petrochemical, Formosa Plastics and Formosa Chem. Source: Company data, RBS forecasts, Bloomberg consensus for Formosa Chem
Kumho Petrochemical | Valuation Comment | 14 December 2010 9
Financial analysis
We expect the operating margin (OPM) to improve from 3.7% in 2009 to 10.9% in 2012, led by solid revenue growth and efficient SG&A costs. Increasing equity method gains from its core petrochemical subsidiaries should boost EPS growth.
We expect Kumho to post a 41.0% CAGR in operating profit in 2010-13 due to a solid top-line CAGR of 14.3% and margin expansion led by stable raw material prices and SG&A cost-cutting.
Table 7 : Revenue and operating profit breakdown
(W bn) 2006 2007 2008 2009 2010F 2011F 2012F 2013F CAGR Sales 1,753.0 2,124.5 3,182.5 2,801.7 3,853.3 4,470.4 4,821.0 4,777.1 15.4% Synthetic rubber 892.1 1,095.7 1,886.0 1,478.7 2,222.2 2,679.9 2,901.8 2,766.9 Synthetic resin 720.5 877.8 1,027.7 1,010.2 1,185.3 1,233.4 1,250.7 1,207.9 Others 140.4 151.0 268.8 312.8 445.7 557.1 668.5 802.3 Operating profit 86.9 160.8 281.3 116.2 356.2 464.0 525.6 459.5 26.9% Synthetic rubber 46.4 120.0 241.6 54.3 207.2 278.9 312.1 235.0 Synthetic resin (8.6) (5.1) (27.6) 37.3 67.9 76.5 83.8 66.4 Others 49.1 45.9 67.3 24.6 81.1 108.6 129.7 158.0 OPM (%) Synthetic rubber 5.2% 11.0% 12.8% 3.7% 9.3% 10.4% 10.8% 8.5% Synthetic resin -1.2% -0.6% -2.7% 3.7% 5.7% 6.2% 6.7% 5.5% Others 35.0% 30.4% 25.0% 7.9% 18.2% 19.5% 19.4% 19.7%
Source: Company data, RBS forecasts
We expect the gross margin to improve steadily, to 16.6% in 2012 from a dip of 11.2% in 2009, similar to the level in the beginning of 2000. In the same vein, the OPM should improve to 10.9% in 2012F.
Chart 7 : Gross and operating margin trend
21%
18%
15%
12%
9%
6%
3%
0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
Gross margin Operating margin
Source: Company data, RBS forecasts
We expect OPM improvement to be faster than gross margin improvement due to Kumho’s tightening control over SG&A, which was effected by the MOU with creditors. We forecast the ratio of SG&A costs to total revenue will decline to 5.4% in 2010, from 7.1% in 2011. From 2011, this may go up, but we believe will not exceed 6% of total revenue. In 2010, the company has shown strong control over its commission and advertisement costs, while maintaining strong revenue growth.
Kumho Petrochemical | Company Outline | 14 December 2010 10
Chart 8 : SG&A costs and ratio to total revenue
300 (Wbn) 12.0%
250 10.0%
200 8.0%
150 6.0%
100 4.0%
50 2.0%
0 0.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
SG&A costs SG&A to total revenue
Source: Company data, RBS forecasts
Recurring margins have fluctuated in the past, mostly due to gains/losses related to associated income. However, going forward, we expect equity method gains to stabilise as the company has divested itself of Kumho Asiana group-related assets, such as Daewoo E&C, Kumho Industrials and Kumho Tire. Earnings (or losses) from these companies will no longer be reflected in Kumho Petrochemical; Kumho Petrochem now has just core petrochemical related companies as subsidiaries.
Chart 9 : Recurring margin trend and equity method gain/loss
20.0% 400
15.0%
10.0% 200
5.0% 0 0.0%
-5.0% (200) -10.0%
-15.0% (400) -20.0%
-25.0% (600) -30.0%
-35.0% (800) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
Equity method gains/loss Recurring margin
Source: Company data, RBS forecasts
Table 8 : Equity method gain/loss trend
(W bn) 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F Kumho Polychem 8.1 4.7 2.2 5.5 11.8 22.2 27.2 30.3 29.7 Kumho Mitsui Chem 20.7 8.5 8.0 4.4 12.0 2.9 14.6 17.0 14.9 Kumho P&B 1.1 (3.4) 35.3 4.6 11.0 111.6 144.3 158.7 162.1 Shanghai Kumho 1.5 0.4 0.5 0.7 3.5 2.1 3.4 4.5 4.4 Kumho Petro Holdings --(0.4)(2.1)(2.8)---- Kumho Port Management ----(0.2)(0.3)(0.2)(0.1)- Total 31.3 10.1 45.5 13.1 35.3 138.5 189.3 210.4 211.1
Source: Company data, RBS forecasts
Kumho Petrochemical | Company Outline | 14 December 2010 11
We believe the EBITDA margin will improve from 7.8% in 2009 to 13.0% in 2012, in line with OPM expansion. Therefore, we forecast a 26.7% EBITDA CAGR in 2010-13.
Chart 10 : EBITDA and EBITDA margin trend
700 (Wbn) 16.0%
600 14.0%
12.0% 500 10.0% 400 8.0% 300 6.0% 200 4.0%
100 2.0%
0 0.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
EBITDA EBITDA margin
Source: Company data, RBS forecasts
After completing a 120,000-tonne high-butadiene rubber (HBR) manufacturing facility at the end of 2010, Kumho has no plans to expand its capacity for the time being. This would reduce capex from the average W240bn in 2007-10F to W80bn-100bn in 2011-13F, in turn boosting free cash flow and reducing outstanding debt.
Chart 11 : Capex trend Chart 12 : Free cash flow trend
400 400 (Wbn) (Wbn)
350 300
200 300
100 250 0 200 (100) 150 (200)
100 (300)
50 (400)
0 (500) 2001 2003 2005 2007 2009 2011F 2013F 2001 2003 2005 2007 2009 2011F 2013F
Source: Company data, RBS forecasts Source: Company data, RBS forecasts
We expect ROE to improve from -72.4% in 2009 to 46.3% in 2010, mainly due to EBIT margin improvement. A drop in ROE in 2011F stems from our assumption of W200bn debt conversion into equity by creditors.
Table 9 : Return ratio
2007 2008 2009 2010F 2011F 2012F 2013F Return on capital employed 7.0% 10.2% 4.0% 12.8% 16.3% 17.9% 14.6% Return on average assets 7.0% 1.3% -15.6% 12.2% 13.4% 13.7% 11.3% Return on average equity 15.7% -1.9% -72.4% 46.3% 36.9% 29.5% 21.3%
Source: Company data, RBS forecasts
Kumho Petrochemical | Company Outline | 14 December 2010 12
Business description
Kumho is the world’s leading synthetic rubber manufacturer, with a global market share of 9% and 10% in BR and SBR, respectively by volume.
Revenue breakdown Synthetic rubber and resin accounts for 57% and 32% of annual revenue, respectively. In synthetic rubber, SBR and BR are the company’s main products; in synthetic resin, it is polystyrene (PS) and acrylonitrile butadiene styrene (ABS). In addition, Kumho has a specialty chemicals division that focuses on antioxidant and vulcanisation accelerators. Currently, its utilisation rate is around 50%, but the company plans to increase this, which may provide a future growth driver. The combined heat and power plant (or steam turbine) has W200bn revenue in 2010 with W75bn operating profit. We expect this to rise to W250bn revenue with W95bn operating profit in 2011, as a second plant begins selling electricity. We expect revenue and operating profit to reach W300bn and W120bn respectively in 2011.
Chart 13 : Revenue breakdown by products (9M10)
Ot her (Combined heat & p ower plant ) 7.1%
Specialt y chemicals 4.0%
Synt het ic resin Synt het ic rubber 31.6% 57.4%
Source: Company data
In synthetic rubber, exports account for 73% of annual sales, with China, India and Southeast Asia some of the biggest users of synthetic rubber. In synthetic resin, exports account for 66% of total sales and China is the biggest importer.
Chart 14 : Synthetic rubber revenue breakdown by region Chart 15 : Synthetic resin revenue breakdown by region (9M10) (9M10)
South America Australia 3.3% 0.7% Europe South America Africa US, Africa 5.9% Europe 2.2% 0.7% Canada 5.3% Domestic Malaysia, 3.3% Domestic 2.6% US, Canada 27.2% Indonesia 34.0% 6.6% 4.0% Malaysia, India Indonesia 7.3% 16.2%
India China 17.6% 23.5% China 39.6%
Source: Company data Source: Company data
Kumho Petrochemical | Company Outline | 14 December 2010 13
Seventy per cent of Kumho Petrochemical’s synthetic rubber is used to manufacture tyres, 22% for shoes and other items. Fifty-eight per cent of synthetic resin goes to the electronics industry and 13% is related to automobiles. In tyres, Kumho supplies most of the major tyre makers (Bridgestone, Michelin, Goodyear, Hankook and Kumho), but no one customer exceeds 10% of sales.
Chart 16 : Synthetic rubber revenue breakdown by final Chart 17 : Synthetic resin revenue breakdown by final goods (9M10) goods (9M10)
High Impact Polystyrene Building 8.0% Electronics Shoes and materials 58.0% others 29.0% 22.0%
Tire Automobille 70.0% 13.0%
Source: Company data Source: Company data
Chart 18 : Kumho's diversified revenue portfolio of major tyre makers (9M10)
Bridgestone 9.8% Kumho Tire 9.7%
Hankook Tire 8.0%
Others 52.0% Good Year 7.5% Michelin Nexen Tire 7.3% 5.7%
Source: Company data
Production capacity Kumho Petrochem has capacity to manufacture 481,000 tonnes of SBR, 167,000 tonnes of HBR and 55,000 tonnes of LBR. By the end of 2010, the company plans to add capacity for 120,000 tonnes of HBR to meet strong tyre demand. Separately, Kumho has 250,000 tonnes of ABS capacity.
Kumho Petrochemical | Company Outline | 14 December 2010 14
Table 10 : Production capacity
Category Product Capacity (000 tonnes) Comment Synthetic rubber SBR 481.0 HBR 167.0 Add 120,000 tonnes capacity by end-2010 LBR 55.0 NBR 50.0 HSR 10.0 SB Latex 70.0 SBS 70.0 Total 903.0 Synthetic resin PS 227.5 ABS 250.0 EPS 73.8 PPG 52.0 Total 603.3
Source: Company data
Table 11 : Total domestic production capacity
Total domestic Kumho LG Chem Portion (%) Kumho LG Chem (000 tonnes) production Petrochem Petrochem SBR 616 481 135 78.1% 21.9% BR 322 222 150 68.9% 46.6% NBR 100 50 50 50.0% 50.0%
Source: Company data, RBS forecasts
Capacity addition in synthetic rubber As shown in Charts 19 and 20, BR and SBR capacity will increase 3.5% and 4.6%, respectively, in 2010 and 5.7% and 0% in 2011, according to capex plans announced by producers to date. This is lower than the 10% yoy increase in demand.
Chart 19 : Capacity addition in BR Chart 20 : Capacity addition in SBR
350 8% 300 (k tons) 5% (k tons)
300 7% 250 4% 6% 250 200 5% 3% 200 4% 150 150 2% 3% 100 100 2% 1% 50 50 1%
- 0% - 0% 2010F 2011F 2012F 2010F 2011F 2012F
Actual capacity addition (LHS) % of increase (RHS) Actual capacity addition (LHS) % of increase (RHS)
Note: 120k tonne capacity addition in 2010 is coming from Kumho Petrochem and 50k Source: CMAI, company data tonne capacity addition (out of total 210k tons) is from LG Chem. Source: CMAI, company data
Kumho Petrochemical | Company Outline | 14 December 2010 15
Butadiene: Key raw material One of Kumho Petrochem’s risks is that it is highly affected by increasing raw material prices, especially butadiene, because it doesn’t have its own naphtha crackers.
Kumho Petrochem needs about 600,000 tonnes of butadiene to produce synthetic rubber. Until 3Q10, it manufactured 237,000 tonnes of butadiene in-house, after purchasing mixed C4 from Honam Petrochemical, Korea Petrochemical Industrials and overseas. To make 237,000 tonnes of butadiene, Kumho needs to purchase 600,000 tonnes of mixed C4. According to the company, it purchased 40% of mixed C4 from overseas and the remaining 60% from both Honam Petrochemical and Korea Petrochemical Industrials. However, from 4Q10, Honam announced it would sell butadiene but not mixed C4 to Kumho Petrochem through Honam’s internal processing. Currently, mixed C4 has a price around US$1,000-1,100/tonne, whereas butadiene costs about US$1,800/tonne. Through the process from mixed C4 to butadiene, Honam can make an additional W20bn-25bn operating profit, whereas Kumho would lose the same amount. This could dampen Kumho’s earnings slightly. However, given increased capacity (around 12% of the total market), butadiene prices should stabilise and we don’t expect any more negative impact from Honam’s decision. Hence, the self-sufficiency ratio of butadiene will fall from the current 40% to 20% in 2011. Another concern regards the renewal of a long-term supply contract with Korea Petrochemical Industrials (KPI). (We will provide an update when the details are available.).
Chart 21 : Price trend of butadiene
3,500 (US$/tonne)
3,000
2,500
2,000
1,500
1,000
500
0 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10
Source: Datastream
Rapidly increasing equity method gains Currently, Kumho has six subsidiaries in its holding structure. It spun off subsidiaries related to the Kumho Asiana Group, such as Kumho Industrials, Kumho Tire and Daewoo E&C, in 2010, eliminating these equity method losses. The remaining subsidiaries are chemical-related entities (eg Kumho Polychem, Kumho Mitsui Chem, and Kumho P&B), Kumho’s Chinese subsidiaries (eg five JVs under Kumho Petro Holdings and one JV named Shanghai Kumho) and Kumho Port Management.
Kumho Petrochemical | Company Outline | 14 December 2010 16
Table 12 : Major subsidiaries
Subsidiaries Business description Stake Acquisition Book value Comment (%) costs (Wm) (Wm, 3Q10) Kumho Polychem EPM (copolymer of ethylene and propylene), EPDM 50.0 5,375 61,044 50% owned by JSR Corporation (terpolymer of ethylene, propylene and a nonconjugated diene with residual unsaturation in the side chain) Kumho Mitsui Chem MDI (methylene diphenyl diisocyanate) Aniline 50.0 17,500 68,823 50% owned by Mitsui Chemicals Kumho P&B Cumene, Phenol, BPA, Epoxy resins 78.2 97,587 194,414 21.8% owned by Nippon Steel Chemical Shanghai Kumho ABS compounding 50.0 1,025 8,615 50% stake owned by the Chinese JV partner Kumho Petro Holdings Holding company of five J/Vs in China 100.0 66,185 70,818 Kumho Port Management Unloading bituminous coal 85.0 5,185 4,750 Total 192,857 408,464
Source: Company data, RBS summary
We expect equity method gains to show a 56.4% CAGR over 2010-13 due to significant operational improvement at Kumho P&B, which produces phenol, bisphenol-A (BPA) and epoxy resin. We expect Kumho P&B to post around W1tn revenue and more than W200bn operating profit in 2010, far beyond the record operating profit of W60bn achieved in 2006.
We believe this trend will continue, given limited capacity addition in BPA and strong demand for polycarbonates related to smartphones. In phenol and BPA, Kumho P&B’s domestic market share is more than 50%, and in epoxy resin, Kumho’s market share is 30% after Kukdo Chemical (around 40% market share) in terms of volume. Kumho has a leading position in its products, which allows the company to control prices to some degree.
Table 13 : Production capacity of Kumho P&B
Product Capacity (000 tonnes) Cumene 440 Phenol 345 Bisphenol-A 280 Epoxy resin 62 Acetone 215 MIBK 30
Source: Company data
Chart 22 : Capacity additions in BPA Chart 23 : BPA price trend
600 (k tons) 9% 3,000 (US$/tonne)
8% 500 2,500 7%
400 6% 2,000 5% 300 4% 1,500 200 3%
2% 1,000 100 1% 500 0 0% 2010F 2011F 2012F 0 Actual capacity addition (LHS) % of increase (RHS) 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F
Source: CMAI, company data Source: ICIS, company data
Kumho Petrochemical | Company Outline | 14 December 2010 17
Possible sale of assets We expect Kumho Petrochem to divest the remaining assets related to Kumho Asiana Group in a rapid deleveraging. Investment securities that the company has said are available for sale are as follows.
Table 14 : Investment securities available for sale
Listed Acquisition costs (Wm) Book value (as of 3Q10, Wm) Koentec 800 2,192 Kumho Industrial (Comm) 9,666 39,420 Kumho Industrial (Pref) 6,471 Asiana 105,595 231,670 Daewoo E&C 263,189 164,493 Sub-total 379,250 444,246 Unlisted Korean economic daily 44 44 Hanju 624 624 Columbian Chemicals Korea 11,446 18,572 Chemcross.com (Korea branch) 958 958 Yeosu Petro 60 60 KDB Consus Value PEF 61,848 61,848 KDB Life (prev. Kumho Life) 9,692 18,336 Sub-total 84,672 100,442 Total 463,922 544,688
Source: Company data
Conversion bonds Major creditors issued W200bn in CBs in May 2010, which can be converted into equity from May 2011. The conversion price is W39,657. Out of a total W200bn, W170bn is held by KDB. With the conversion, we would expect the net-debt-to-equity ratio to decline from 150.5% to 114.9%.
Table 15 : Convertible bonds
Category Contents Issue date 3 May 2010 Maturity 3 May 2013 Coupon rate 2% YTM 7.00% Conversion price 39,657 Conversion period 3 May 2011-2 May 2013 Other condition Put option Creditors can exercise the put option prior to the maturity date if Kumho Petrochemical successfully complies with the MOU between the creditors and the company. Call option Kumho Petrochemical can exercise the call option fully or partly two years after the issuance if the share prices are 150% above the conversion price for the 10 trading days or liability ratio is below 200%.
Source: Company data, RBS
Kumho Petrochemical | Company Outline | 14 December 2010 18
Global tyre market
We expect the global tyre market to see a 7.2% CAGR, after a 10% decline in 2009 following the global financial crisis.
For the first 10 months of 2010, tyre sales growth in China totalled 36.6% for original equipment and 20.2% for replacement. We expect replacement demand in China to grow faster in the future, followed by a big jump in the original equipment demand in the past three years. Industrial sources (including Tire Business) have said replacement demand occurs three years after the original tyre purchase due to relatively poor road conditions in China. Revenue breakdown by sales channel shows that replacement sales are 57.9% of total tyre sales in Asia-Pacific (vs 81.4% and 82.1% in Europe and North America, respectively). We believe this will rise to match the level of developed countries.
Chart 24 : Global tyre market growth
200 (US$ bn) 180
160 7.2% CAGR 140
120
100
80
60
40
20
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F 2011F 2012F 2013F 2014F 2015F
Source: Tire Business, Global Insight, RBS forecasts
Chart 25 : Chinese tyre market growth by sales channel Chart 26 : Revenue breakdown by sales channel (2010)
70% 65.1% 100% 90% 60% 80%
50% 70% 57.9% 73.5% 60% 81.4% 82.1% 40% 36.3% 50%
30% 40% 20.2% 30% 20% 16.9% 20% 42.1% 26.5% 10% 10% 18.6% 17.9% 0% 0% Asia Pacific Europe (incl. US and Canada Latin America Original Equipment Replacement Middle East)
2009 10M10 Original Equipment Replacement
Source: Michelin Source: Michelin
Kumho Petrochem supplies synthetic rubber to most major global tyre makers, not one of which contributes more than 10% of revenue in Kumho Petrochemical’s synthetic rubber division. This means Kumho has a well-diversified customer base and is why it has not been heavily affected by the workout (or restructuring programme) in Kumho Tire.
Kumho Petrochemical | Company Outline | 14 December 2010 19
Chart 27 : 2009 global tyre market share by sales volume Chart 28 : 2009 Korean tyre market share by sales volume
M ichelin 15 . 5 % Bridgestone Nexen Tire 16 . 2 % 21.1% Ot hers 32.6%
Kumho Tire 1. 8 %
Cooper Tire Goodyear Hanko ok Tire 2.2% Pirelli Co nt inent al 12 . 4 % Kumho Tire 54 .0% 4.4% 5.1% Hankook Y okohama 24.9% 3.0% 3.1% Sumit o mo 3.7%
Source: Tire Business Source: Company data
Natural rubber accounts for around 31% of total raw material costs and synthetic rubber for 27%. However, as the price of natural rubber remains high, tyre makers are switching from natural rubber to synthetic, up to maximum 10pp absolute, and this will raise synthetic rubber demand.
Chart 29 : Raw material breakdown in tyres (2008)
Tire cord 15.6% Natural rubber 31.2%
Carbon black 26.6%
Synthetic rubber 26.6%
Source: Chemlocus
Kumho Petrochemical | Company Outline | 14 December 2010 20
Management
Kumho Petrochem was spun off from Kumho Asiana Group in early 2010 and focuses mainly on the core petrochemical business. Diminishing risk overhang from Kumho Asiana Group is another reason for re-rating.
History of Kumho Asiana group The Kumho Asiana Group went boom and bust when it decided to acquire Daewoo E&C. To finance the acquisition, the group depended on the put-back option of Daewoo E&C, with a guaranteed return of about 9%. On top of this, Kumho Asiana Group acquired Korea Express in 2008. This came to be a burden to the group. The global financial crisis that began in 2008 hit the group and Kumho Asiana had to sell Daewoo E&C and other assets. In addition, Kumho Industrials and Kumho Tire are in a workout, or restructuring programme and Kumho Petrochemical is under a MOU with the creditors.
Table 16 : History of Kumho Asiana group
Date Event 22 Jun 06 Kumho Asiana group announced as the preferred bidder for Daewoo E&C. 15 Nov 06 Kumho Asiana group signed main contract of Daewoo E&C. 17 Jan 08 Kumho Asiana group announced as the preferred bidder for Korea Express. 31 Jul 08 Kumho Asiana group announced plans to secure W4.5trn liquidity. 04 Feb 09 Daewoo E&C and Asiana Airlines secured W1.5trn liquidity through capital reduction of Korea Express. 01 Jun 09 Kumho Asiana group signed a financial structure improvement contract with KDB. Jun 09 Kumho Asiana group tried to find a financial investor to help pay Daewoo E&C put-back options. 28 Jun 09 Kumho Asiana group announced plans to re-sell Daewoo E&C 28 Jul 09 Conflict inside the owner family. Chairman Sam-gu Park and Chan-gu Park resigned. 09 Oct 09 Kumho Asiana group sold Seoul Express Bus Terminal. 02 Nov 09 Kumho Asiana group sold Kumho Life Insurance. 23 Nov 09 Javez Partners and TR America announced as the preferred bidder for Daewoo E&C. 30 Nov 09 Kumho Asiana group sold Kumho Rent-A-Car. 14 Dec 09 Financial Investors of Daewoo E&C delayed the exercise of put-back option for one month. 30 Dec 09 KDB announced plans to buy Daewoo E&C as the deal with preferred bidders broke down. 30 Dec 09 Kumho Asian group announced its work-out plan on Kumho Industrial and Kumho Tire. 08 Feb 10 Creditors took control of Kumho Industrial, Asiana Airlines and Korea Express.
Source: Maeil economic daily, RBS summary
Furthermore, during the divestiture process, Mr Sam-gu Park (chairman of Kumho Asiana Group, third son of the founder) and Mr Chan-gu Park (CEO and chairman of Kumho Petrochemical, fourth son of the founder) engaged in a dispute over the control the group. Currently, the conflict seem to be resolved to some degree – Mr Chan-gu Park controls Kumho Petrochemical Group, Sam-gu Park is responsible for Kumho Asiana Group, and Kumho Petrochemical Group no longer belongs to Kumho Asiana Group. Following this, Kumho Petrochemical Group changed its corporate symbol in December 2010.
Kumho Petrochemical | Management | 14 December 2010 21
Chart 30 : Kumho group structure
Under control of Park, Chan-gu Mr. Park Chul-wan and related parties 50.0 Kumho Polychem Treasury shares 42.1%
22.0% Korea Kumho 50.0 Kumho Mitsui Petrochemical Chemical
78.2 Kumho P&B Chemical
14.0% 2.5% 4.5% 1.5% 33.3% 18.6% 5.6% Asiana Airlines Kumho Industrial Daewoo E&C Kumho Tire 2.4%
1.3% 2.8% 1.2% 5.7%
24.0% 24.0% Korea Express
1.5%
Under control of creditors and Park, Sam-gu
Source: Company data, RBS summary
However, some feuding remains, as there are some cross-holdings by family members. Currently, Mr Chan-gu Park and his son own a 16.2% stake in Kumho Petrochemical. However, Mr Sam-gu Park and his son also have a 12.0% stake in this company. This is likely to be sold to separate Kumho Petrochem from Kumho Asiana group. Separately, Mr Chul-wan Park, son of the second son, also holds a 12% stake, which can be disposed of later.
Kumho Petrochemical | Management | 14 December 2010 22
Chart 31 : Stake holdings by family members on Kumho Petrochemical
Founder: Park, In-chun (Dead)
1st son: 2nd son: 3rd son: 4th son: Other related parties Park, Sung-yong Park, Jung-gu Park, Sam-gu Park, Chan-gu (1.94%) (Dead) (Dead) (5.30%) (7.61%)
Grandson: Grandson: Grandson: Park, Chul-wan Park, Sae-chang Park, Joon-kyung (11.96%) (6.66%) (8.59%)
Source: Company data, RBS summary
Shareholder structure Currently, Mr Chan-gu Pack and related parties own a 42% stake and treasury shares account for 22%. Samsung Asset Management owns 5.1%, and foreigners have 9.1%.
Chart 32 : Shareholder structure
Others 21.8% Related party 42.0%
Foreigners 9.1%
Treasury shares Samsung Asset 22.0% Management 5.1%
Source: Company data, RBS summary
Kumho Petrochemical | Management | 14 December 2010 23
Income statement
Wb FY08A FY09A FY10F FY11F FY12F Revenue 3182 2802 3853 4470 4821 Cost of sales -2703 -2488 -3291 -3757 -4023 Operating costs -126.4 -96.2 -104.6 -149.6 -172.0 EBITDA 353.5 218.0 458.1 564.1 626.4 DDA & Impairment (ex gw) -72.2 -101.8 -101.9 -100.1 -100.8 EBITA 281.3 116.2 356.2 464.0 525.6 Goodwill (amort/impaired) n/a n/a n/a n/a n/a EBIT 281.3 116.2 356.2 464.0 525.6 Net interest -86.3 -105.6 -130.5 -106.4 -77.4 Associates (pre-tax) -169.1 -733.5 138.5 189.3 210.4 Forex gain / (loss) -110.2 26.8 2.00 -3.69 -4.24 Exceptionals (pre-tax) n/a n/a n/a n/a n/a Other pre-tax items 57.7 -145.8 41.3 -6.72 -27.7 Reported PTP -26.7 -841.9 407.3 536.5 626.6 Taxation 6.91 227.0 -89.6 -118.0 -137.8 Minority interests n/a n/a n/a n/a n/a Exceptionals (post-tax) n/a n/a n/a n/a n/a Other post-tax items 0.00 0.00 0.00 0.00 0.00 Reported net profit -19.7 -614.8 317.7 418.5 488.7 Normalised Items Excl. GW 0.00 0.00 0.00 0.00 0.00 Normalised net profit -19.7 -614.8 317.7 418.5 488.7
Source: Company data, RBS forecasts year to Dec
Balance sheet
Wb FY08A FY09A FY10F FY11F FY12F Cash & market secs (1) 13.1 80.4 197.6 298.7 449.4 Other current assets 770.2 695.4 868.5 940.9 977.0 Tangible fixed assets 1273 1357 1416 1406 1415 Intang assets (incl gw) 45.4 35.6 32.2 31.6 31.2 Oth non-curr assets 1613 1032 1174 1137 1354 Total assets 3715 3200 3688 3814 4226 Short term debt (2) 168.1 769.9 392.8 392.8 392.8 Trade & oth current liab 948.9 1289 1658 878.9 792.2 Long term debt (3) 1309 585.1 775.7 1088 1126 Oth non-current liab 126.0 20.9 23.2 26.4 29.5 Total liabilities 2552 2665 2850 2386 2340 Total equity (incl min) 1163 535.1 838.0 1428 1886 Total liab & sh equity 3715 3200 3688 3814 4226 Net debt 1956 2150 2010 1370 1132
Source: Company data, RBS forecasts year ended Dec
Cash flow statement
Wb FY08A FY09A FY10F FY11F FY12F EBITDA 353.5 218.0 458.1 564.1 626.4 Change in working capital -250.2 -49.0 32.3 0.48 2.08 Net interest (pd) / rec n/a n/a n/a n/a n/a Taxes paid n/a n/a n/a n/a n/a Other oper cash items -137.6 112.7 -187.2 -243.1 -243.2 Cash flow from ops (1) -34.4 281.7 303.2 321.5 385.3 Capex (2) -334.8 -264.1 -150.0 -80.0 -100.0 Disposals/(acquisitions) -43.0 -199.7 0.27 229.7 -2.09 Other investing cash flow -6.20 -4.55 -13.5 -15.8 -16.1 Cash flow from invest (3) -384.0 -468.4 -163.3 133.9 -118.2 Incr / (decr) in equity 0.00 0.00 0.00 200.0 0.00 Incr / (decr) in debt 435.4 129.3 -22.7 -539.4 -87.5 Ordinary dividend paid -17.3 -17.3 0.00 -14.9 -28.8 Preferred dividends (4) n/a n/a n/a n/a n/a Other financing cash flow 1.73 142.0 0.04 0.00 0.00 Cash flow from fin (5) 419.8 253.9 -22.7 -354.3 -116.3 Forex & disc ops (6) n/a n/a n/a n/a n/a Inc/(decr) cash (1+3+5+6) 1.40 67.3 117.2 101.1 150.8 Equity FCF (1+2+4) -369.2 17.6 153.2 241.5 285.3
Lines in bold can be derived from the immediately preceding lines. year to Dec Source: Company data, RBS forecasts
Kumho Petrochemical | Key Financial Data | 14 December 2010
Standard ratios Kumho Petrochem Honam Petrochemical LG Chem
Performance FY08A FY09A FY10F FY11F FY12F FY10F FY11F FY12F FY10F FY11F FY12F Sales growth (%) 49.8 -12.0 37.5 16.0 7.84 21.8 8.31 1.81 23.2 12.9 11.0 EBITDA growth (%) 62.1 -38.3 110.1 23.2 11.0 17.1 22.7 15.2 28.3 16.3 11.6 EBIT growth (%) 75.0 -58.7 206.6 30.3 13.3 22.1 25.6 18.0 32.0 17.0 13.4 Normalised EPS growth (%) n/a 3014 n/a 16.3 10.3 3.15 44.2 25.9 48.3 14.4 13.0 EBITDA margin (%) 11.1 7.78 11.9 12.6 13.0 15.3 17.4 19.6 18.8 19.3 19.5 EBIT margin (%) 8.84 4.15 9.24 10.4 10.9 12.1 14.0 16.2 15.2 15.7 16.1 Net profit margin (%) -0.62 -21.9 8.25 9.36 10.1 11.3 15.0 18.6 11.8 12.0 12.2 Return on avg assets (%) 1.34 -15.6 12.2 13.4 13.7 13.0 15.5 16.6 21.9 20.9 19.4 Return on avg equity (%) -1.93 -72.4 46.3 36.9 29.5 20.0 23.4 23.6 35.6 30.5 26.8 ROIC (%) 8.78 2.70 10.3 12.6 14.5 20.0 18.0 17.8 35.0 32.5 30.3 ROIC - WACC (%) -2.31 -8.38 -0.81 1.52 3.44 8.78 6.83 6.63 25.6 23.1 21.0 year to Dec year to Dec year to Dec
Valuation EV/sales (x) 1.25 1.49 1.04 0.76 0.65 1.20 1.09 1.05 1.28 1.11 0.96 EV/EBITDA (x) 11.2 19.1 8.79 6.00 5.03 7.83 6.30 5.33 6.83 5.73 4.94 EV/EBITDA @ tgt price (x) 14.1 23.7 11.0 7.79 6.64 9.64 7.78 6.61 8.47 7.14 6.20 EV/EBIT (x) 14.1 35.9 11.3 7.30 5.99 9.95 7.83 6.46 8.45 7.05 5.97 EV/invested capital (x) 1.26 1.54 1.40 1.20 1.03 1.78 1.46 1.18 3.01 2.42 1.98 Price/book value (x) 1.73 3.77 2.41 1.69 1.28 1.85 1.48 1.18 3.28 2.51 1.98 Equity FCF yield (%) -18.3 0.87 7.60 10.6 11.8 5.66 6.71 9.47 2.58 3.82 5.37 Normalised PE (x) n/m n/m 6.35 5.46 4.94 10.1 7.03 5.58 10.7 9.36 8.28 Norm PE @tgt price (x) n/m n/m 9.52 8.19 7.42 12.6 8.74 6.94 13.3 11.6 10.3 Dividend yield (%) 0.95 0.00 0.95 1.26 1.26 0.57 0.76 0.96 1.35 1.49 1.62 year to Dec year to Dec year to Dec
Per share data FY08A FY09A FY10F FY11F FY12F Solvency FY08A FY09A FY10F FY11F FY12F Tot adj dil sh, ave (b) 0.03 0.03 0.03 0.03 0.03 Net debt to equity (%) 168.2 401.8 239.9 96.0 60.0 Reported EPS (KRW) -777 -24183 12497 14537 16041 Net debt to tot ass (%) 52.7 67.2 54.5 35.9 26.8 Normalised EPS (KRW) -777 -24183 12497 14537 16041 Net debt to EBITDA 5.54 9.87 4.39 2.43 1.81 Dividend per share (KRW) 750 0 750 1000 1000 Current ratio (x) 0.70 0.38 0.52 0.97 1.20 Equity FCF per share (KRW) -14521 691 6024 8390 9363 Operating CF int cov (x) 0.00 0.00 0.00 0.00 0.00 Book value per sh (KRW) 45749 21047 32959 46858 61899 Dividend cover (x) -1.14 0.00 21.4 14.5 16.0 year to Dec year to Dec
Priced as follows: 011780.KS - W79300; 011170.KS - W261500; 051910.KS - W370000 Source: Company data, RBS forecasts
Valuation methodology
Company Business Stake Valuation methodology (Wbn) Main operation Synthetic rubbers, synthetic resin 5.5x 2011F EV/EBITDA 3,103 Other assets Kumho Polychem EPM (copolymer of ethylene and propylene), EPDM (Terpolymer 50% Book value 61 of ethylene, propylene and a non-conjugated diene) Kumho Mitsui Chem MDI (methylene diphenyl diisocyanate), Aniline 50% Book value 69 Kumho P&B Cumene, Phenol, BPA, Epoxy resins 78% 5x 2011F EV/EBITDA applying 10% 938 discount to reflect narrow production scope Kumho Petro Holdings Holding companies of five JVs in China 100% Book value 71 Sub total 1,139 Treasury shares 22% of total shares Based on W79,300 share price 443 Other assets Assets related with Kumho Asiana group 3Q10 book value 313 Net debt (1,370) Equity value 3,628 No. of shares 30,467,693 Per share equity value (Rounding from W118,611) 119,000 Current share price 79,300 Upside potential 50.1%
Priced as of 13 December 2010 Source: Company data, RBS forecasts
Kumho Petrochemical | Performance and Valuation | 14 December 2010
Company description Buy Price relative to country
Kumho Petrochem produces synthetic rubber (57% of total sales), synthetic resin (32%) and other specialty 140 chemicals. In synthetic rubbers (eg BR, SBR), Kumho's market share of sales is 9-10% globally. Seventy percent 120 of synthetic rubber revenue comes from the tyre market, which shows solid demand. In synthetic resin, Kumho 100 produces PS and ABS. In addition, Kumho has six chemical-related subsidiaries. One is Kumho P&B, which produces phenol, bisphenol-A and epoxy resin. Originally, the company originally was part of the Kumho Asiana 80
group, but was spun off from the group early in 2010 and recently began to focus on the main chemical operation. 60
40
20 Dec Apr Jul Nov Mar Jun Oct Jan May Aug Dec 07 08 08 08 09 09 09 10 10 10 10
Price relative to country
Strategic analysis Average SWOT company score: 4 Sales breakdown, 9M10
Strengths 4 Other Specialty (Combined Kumho has a globally leading position in synthetic rubbers, with 9-10% market share of sales, and supplies its chemicals heat & 4% power plant) products to a diversified group of customers. 7% Weaknesses 3 Synthetic resin Synthetic Kumho is vulnerable to raw material price hikes, such as butadiene and styrene monomer. 32% rubber 57%
Opportunities 4 Kumho is likely to benefit from strong tyre demand, especially from tyre replacement demand in China. High Source: Company data natural rubber prices also increase substitute demand for synthetic rubbers. Threats 3 Market data Ambitous expansion plans by Middle East and China producers over the next five to seven years might cause Headquarters oversupply and lower profitability. 115 Shinmunno 1-ga, Jongono-gu, Seoul, Korea Scoring range is 1-5 (high score is good) Website www.kkpc.com
Shares in issue 25.4m Freefloat 58% Majority shareholders Related party (42%), Samsung Asset Management (5%)
Country view: Korea Country rel to Asia Pacific
The Korean market has experienced a relative bounce over the past quarter, effectively playing catch-up to 140 regional share prices. Nonetheless, we remain concerned over gearing to the global manufacturing cycle, 135 130 historically elevated valuations and relatively tight liquidity conditions. We concede, however, that with foreign 125 investors, in general, Underweight, the market might continue to benefit from rotational buying. 120 115 The country view is set in consultation with the relevant company analyst but is the ultimate responsibility of the Strategy Team. 110 105 100 95 90 Dec Apr Jul Nov Mar Jun Oct Feb May Aug Dec 07 08 08 08 09 09 09 10 10 10 10
MarketIndex
Competitive position Average competitive score: 3- Broker recommendations
Supplier power 3- 10 Honam's key raw material is butadiene, which is readily available. However, we are concerned about the declining 8 self-sufficiency ratio of butadiene from 40% to 20%. 6 Barriers to entry 3+ Relatively high capital costs of US$1bn and required economies of scale could be key barriers to new entrants. 4 Customer power 2- 2 Tyre-makers are more dependent on synthetic rubber providers to catch up rapidly growing demand, as there are 0 a few synthetic rubber suppliers. Buy Hold Sell
Substitute products 4- Source: Bloomberg There are no substitutes for synthetic rubbers, even though natural rubbers can replace them to some degree.
However, natural rubbers are more subject to tight supply. Rivalry 2- New capacity in China and the Middle East could pose a threat in the long term. However, we expect limited capacity addition in the near future.
Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse
Kumho Petrochemical | Strategic and Competitive Overview | 14 December 2010
Recommendation structure Absolute performance, short term (trading) recommendation: A Trading Buy recommendation implies upside of 5% or more and a Trading Sell indicates downside of 5% or more. The trading recommendation time horizon is 0-60 days. For Australian coverage, a Trading Buy recommendation implies upside of 5% or more from the suggested entry price range, and a Trading Sell recommendation implies downside of 5% or more from the suggested entry price range. The trading recommendation time horizon is 0-60 days. Absolute performance, long term (fundamental) recommendation: The recommendation is based on implied upside/downside for the stock from the target price and, except as follows, only reflects capital appreciation. A Buy/Sell implies upside/downside of 10% or more and a Hold less than 10%. For research produced by Nedbank Capital, a Buy implies upside in excess of 20%, A Sell implies an expected return less than 10%, and a Hold implies a return between 10% and 20%. For UK-based Investment Funds research, the recommendation structure is not based on upside/downside to the target price. Rather it is the subjective view of the analyst based on an assessment of the resources and track record of the fund management company. For research produced by Nedbank Capital and for research on Australian listed property trusts (LPT) or real estate investment trusts (REIT), the recommendation is based upon total return, ie, the estimated total return of capital gain, dividends and distributions received for any particular stock over the investment horizon. Performance parameters and horizon: Given the volatility of share prices and our pre-disposition not to change recommendations frequently, these performance parameters should be interpreted flexibly. Performance in this context only reflects capital appreciation and the horizon is 12 months. Market or sector view: This view is the responsibility of the strategy team and a relative call on the performance of the market/sector relative to the region. Overweight/Underweight implies upside/downside of 10% or more and Neutral implies less than 10% upside/downside. Target price: The target price is the level the stock should currently trade at if the market were to accept the analyst's view of the stock and if the necessary catalysts were in place to effect this change in perception within the performance horizon. In this way, therefore, the target price abstracts from the need to take a view on the market or sector. If it is felt that the catalysts are not fully in place to effect a re-rating of the stock to its warranted value, the target price will differ from 'fair' value.
Distribution of recommendations The tables below show the distribution of recommendations (both long term and trading). The first column displays the distribution of recommendations globally and the second column shows the distribution for the region. Numbers in brackets show the percentage for each category where there is an investment banking relationship. These numbers include recommendations produced by third parties with which RBS has joint ventures or strategic alliances.
Long term recommendations (as at 14 Dec 2010) Trading recommendations (as at 14 Dec 2010)
Global total (IB%) Asia Pacific total Global total (IB%) Asia Pacific total (IB%) (IB%) Buy 723 (0) 459 (0) Trading Buy 0 (0) 0 (0) Add 0 (0) 0 (0) Rec 00 (00) 00 (00) Hold 441 (0) 243 (0) Reduce 0 (0) 0 (0) Sell 116 (0) 72 (0) Trading Sell 0 (0) 0 (0) Total (IB%) 1280 (0) 774 (0) Total (IB%) 0 (0) 0 (0)
Source: RBS Source: RBS
Valuation and risks to target price
Kumho Petrochemical (RIC: 011780.KS, Rec: Buy, CP: W79300, TP: W119000): We value Kumho on a sum-of-the-parts basis. The downside risks to our target price is a surge in the butadiene price, raw material costs for synthetic rubber and a decreasing self-sufficiency ratio in dutadiene due to renewal of exising contract with major suppliers. The key upside risk is a strong price spread in synthetic rubbers led by tyre replacement demand in China.
Regulatory disclosures
RBS beneficially own 1% or more of a class of common equity securities of this company.: 011780.KS
Kumho Petrochemical | Disclosures Appendix | 14 December 2010
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Kumho Petrochemical | Disclosures Appendix | 14 December 2010