Korea Convenience Store Sector

Korea Consumer Discretionary / Consumer Staples 13 April 2016

Initiation: the most convenient way to play Korea retail

 Convenience stores meet the demand from the over-65s/single-or-

dual households for nearby stores that sell small portions

 Korea’s demographic changes and economic slowdown offer limited room for other retail segments to expand  Iris Park Initiating on BGF Retail with an Outperform (2) and GS Retail with a (82) 2787 9165 Hold (3); we forecast double-digit EPS growth for both over 2016-18 [email protected]

Investment case: After our first-hand look at the Japanese convenience New Prev. store (CVS) market, we believe Korea’s CVS market is in the early growth BGF Retail (027410 KS) phase, about 10-15 years behind Japan. We see the Korean retail market Rating Outperform developing in the same way as Japan’s, where the CVS format has Target 194,000 gradually taken over as the prominent retail form. From 2005-15, Japan’s Upside  8.7% retail revenue saw a CAGR of 0.4%, yet the CAGR for its CVS segment GS Retail (007070 KS) was 4.1%. In our view, this growth was driven by the CVS segment’s Rating Hold stronger fresh-food and private-brand businesses capitalising on the Target 49,500 Upside  4.3%

growing number of people over 65 and small-sized households. We see a similar trend unfolding in Korea, with the CVS operators starting to Source: Daiwa forecasts outperform other retailers on the back of their better product mixes.

Korea’s CVS industry is still feeling the positive top-line impact of an 80% rise in the price of tobacco in early-2015, with franchisees keen to take on CVS stores to benefit in 2016 (both mom-and-pop revamps [c.35,000] and newly developed locations). As the effect wears off, we expect CVS revenue growth to slow to 7-8% YoY for 2017 and 6% for 2018 (from c.10% for 2016, c.30% for 2015 and 3-4% for 2013-14), with growth being supported by increasing demand for private-label and fresh-food products attracting new customers (as has been the trend in Japan).

Catalysts: We believe the recent implementation in Korea of a tax-refund system for tourists who spend KRW30,000-200,000 (USD25-165) will be a short-term catalyst. When the same system was implemented in Japan, Seven Eleven Japan’s SSS spiked by up to 10% YoY during the first year. We expect the Korean CVS industry to see a similar acceleration in SSSG once stores are equipped with the system.

Valuation: Within the CVS subsector, we see the top players BGF Retail (027410 KS, KRW178,500, Outperform [2]) and GS Retail (007070 KS, KRW47,450, Hold [3]) benefiting the most from the trends outlined above and initiate coverage of the sector with a Positive rating. We have a 12-month TP for BGF Retail of KRW194,000 and value it at a target PER of 25.8x, applying the average global CVS peer PER. For GS Retail, we have a 12-month TP of KRW49,500, for which we apply the global peer 2016E PER to each business segment: 25.8x to the CVS business, 17.9x to the supermarket business and 22.3x to the hotel operation, but see its uncompetitive supermarket business dragging down overall earnings over the next 2 years.

Risks: We believe an expanding fresh-food business could be a drawback for companies, as it could trigger extra costs for the companies if the franchisees fail to meet the right order amount. Also, unfavourable weather conditions could drag down the sales of these off-line retailers.

See important disclosures, including any required research certifications, beginning on page 40

Korea Convenience Store Sector: 13 April 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Revenue trend for BGF Retail and GS Retail We forecast the top-2 CVS operators, GS Retail and BGF (KRW bn) 9,000 8,377 Retail, to record an aggregate revenue CAGR of 9.4% from 7,790 2016-18, and expect each company to add 700-900 new 8,000 7,122 7,000 6,273 6,257 stores this year alone. In addition, with better product 5,835 6,000 4,962 5,131 offerings, we forecast sales per CVS store to increase by 5,000 4,334 6.2% YoY for BGF Retail and 5.9% YoY for GS Retail in 4,000 3,368 2016, with their improved product line-ups contributing to 3,000 better margins for both companies. Excluding one-off 2,000 factors, we forecast 2016E EPS growth of 20.4% YoY for 1,000 BGF Retail and 18.2% YoY for GS Retail, higher than the 0 2014 2015 2016E 2017E 2018E global peer average of 7.6% (Bloomberg forecast, BGF Retail GS Retail excluding Family Mart Japan, which saw unusual EPS Source: Company, Daiwa forecasts growth for 2016 due to extraordinary losses from asset disposal and impairment write-downs).

Valuation Peer valuation PER (x) PBR (x) EPS growth (%) ROE (%) We initiate coverage of BGF Retail with an Outperform (2) Company rating and 12-month TP of KRW194,000. We apply the FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 BGF Retail* 23.7 20.2 5.3 4.3 20.4 17.4 22.3 21.5 global peer average PER to BGF Retail’s 2016E EPS to GS Retail* 20.6 18.3 1.7 1.5 18.2 12.0 9.9 10.8 derive our TP, as we see the company only starting to post Seven & I Holdings 21.1 18.7 1.7 1.6 24.1 12.6 8.7 9.2 strong EPS growth from 2017 (the high base from 2015 Lawson 22.1 20.0 3.1 2.9 26.3 10.7 15.3 15.5 FamilyMart-JP 24.3 21.5 1.9 1.8 13.4 13.0 6.3 5.8 distorted the 2016 growth number). Meanwhile, we apply a FamilyMart-TW 31.5 25.2 9.1 8.3 18.4 24.8 28.5 32.4 Hold (3) rating to GS Retail and 12-month TP of President Chain Store 26.5 24.2 8.3 7.6 11.1 9.3 31.9 32.3 KRW49,500 based on SOTP methodology given its Global average 25.8 22.4 5.5 5.0 18.0 14.6 20.2 21.3 different retail formats (CVS, supermarkets, hotels). Our TP Source: Bloomberg, Daiwa forecasts Note: * are Daiwa forecasts/ 2016E EPS growth for BGF Retail and GS Retail excludes 2015’s implies a 2016E PER of 21.4x, which is below the peer one-off gain. Our global peer group multiple is the average of the Japan- and Taiwan-listed average, as we expect its supermarket operation to peer group averages. continue to drag down its overall business.

Earnings revisions Korea CVS sector: Bloomberg consensus 2016E EPS revisions The Bloomberg-consensus earnings forecasts for BGF (KRW) Retail have been on the rise since last year, due we 8,000 7,000 believe to market expectations of better margins after the 6,000 company improved its product offerings. As for GS Retail, 5,000 4Q15 earnings were a trigger for EPS downward revisions, 4,000 with the company recognising more losses in the 3,000 supermarket division than expected. 2,000 1,000 Our 2016 EPS forecast for BGF Retail is 9% higher than 0 (1,000) consensus as we are more bullish on the company’s fresh Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 food business. For GS Retail, our 2016E EPS is 3% lower BGF Retail GS Retail than consensus as we are more conservative on the Source: Bloomberg outlook for the company’s supermarket business.

Korea Convenience Store Sector: 13 April 2016

Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg BGF Retail 027410 KS 178,500 Outperform 194,000 7,517 8,827 GS Retail 007070 KS 47,450 Hold 49,500 2,308 2,586

Source: Bloomberg, Daiwa forecasts

CVS sector: peer valuations PER (x) PBR (x) EPS Growth(%) ROE (%) Company FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 BGF Retail* 23.7 20.2 5.3 4.3 20.4 17.4 22.3 21.5 GS Retail* 20.6 18.3 1.7 1.5 18.2 12.0 9.9 10.8 Seven & I Holdings 21.1 18.7 1.7 1.6 24.1 12.6 8.7 9.2 Lawson 22.1 20.0 3.1 2.9 26.3 10.7 15.3 15.5 FamilyMart-JP 24.3 21.5 1.9 1.8 13.4 13.0 6.3 5.8 FamilyMart-TW 31.5 25.2 9.1 8.3 18.4 24.8 28.5 32.4 President Chain Store 26.5 24.2 8.3 7.6 11.1 9.3 31.9 32.3 Global average 25.8 22.4 5.5 5.0 18.0 14.6 20.2 21.3 Source: Bloomberg, Daiwa forecasts (*) 2016E EPS growth for BGF Retail and GS Retail excludes 2015’s one-off gain. Our global peer group multiple is the average of the Japan- and Taiwan-listed peer group averages

Korea CVS sector: key assumptions Revenue (KRWbn) 2014 2015 2016E 2017E 2018E BGF Retail 3,368.0 4,334.2 5,130.5 5,834.9 6,257.3 CVS 3,303.1 4,257.6 5,043.2 5,728.5 6,148.0 YoY 7.4% 28.9% 18.5% 13.6% 7.3% Golf course 8 16 16.8

YoY 100.0% 5.0%

Others 64.9 76.7 79.3 90.4 92.5 YoY 20.2% 18.2% 3.4% 2.5% 2.2% GS Retail 4,962.4 6,273.2 7,121.6 7,790.4 8,377.5 CVS 3,502.0 4,652.5 5,298.1 5,897.3 6,422.9 YoY 8.8% 32.9% 13.9% 11.3% 8.9% Supermarket 1,331.3 1,389.3 1,450.0 1,494.7 1,533.9 YoY -2.9% 4.4% 4.4% 3.1% 2.6% Hotel 66.4 212.0 229.0 242.7

YoY 219.3% 8.0% 6.0%

Others 129.1 165.0 161.5 169.5 178.0 YoY 8.9% 27.9% -2.2% 5.0% 5.0% Source: Companies, Daiwa forecasts

Korea Convenience Store Sector: 13 April 2016

Table of contents

CVS likely to outperform other retail formats ...... 5 Japan CVS market a good proxy for the Korea industry ...... 5 Korea’s CVS sector: better product offerings should boost SSSG and pace of new store openings ...... 6 Valuations ...... 12 Risks to our Positive sector rating ...... 13

Company Section BGF Retail ...... 14 GS Retail ...... 25

Korea Convenience Store Sector: 13 April 2016

CVS likely to outperform other retail formats Japan CVS market a good proxy for the Korea industry In Japan, CVS are We recently went to Japan to learn more about the CVS market there in order to better outperforming within the understand the Korean CVS market as it appears to be evolving along the same lines. retail sector due to From what we saw in Japan, we estimate that Korea’s CVS market is still in the early favourable demographic growth phase. changes We see long-term earnings growth momentum for Korea’s CVS operators. In the case of Japan, whose retail industry is 10-15 years ahead of Korea’s, while overall retail industry earnings have declined, the CVS format has continued to outperform the market, taking over 8.5% of the total market in 2015. From 2005-15, Japan’s total retail market only expanded in sales value terms by 0.4% per year, whereas the CVS format saw 4.1% growth. We attribute this outperformance by the CVS format to changes in demographics in Japan and the CVS operators improving their product offerings.

In Japan, there are 2 notable demographic trends: 1) an aging population, and 2) an increasing number of single/dual households. These 2 population groups require shopping areas that are close to where they live, and where they can buy small portions of food. Department stores and general merchandise stores do not suit these demographic groups, as they are usually located far from where they live and cater more to bulk shopping, but CVSs fit right into this category. There is nearly always a CVS located nearby that sells small portions/snacks, including categories that are sold in big supermarkets (fresh food and household goods).

Japan’s CVS sector revenue growth has been outpacing that of its general merchandise stores (GMS) (equivalent to hypermarkets in Korea) since 1998, as the demand for smaller-portioned goods has shifted from GMS to CVS, especially for food. This transition in consumption patterns has supported the increase in the pace of CVS store openings and single-digit revenue growth over the past 15 years despite the overall downturn in Japan’s retail industry.

Japan: retail market revenue value (JPYbn) (%) 150,000 9 8 140,000 7 6 130,000 5 4 120,000 3 110,000 2 1 100,000 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Retail (LHS) % of CVS (RHS)

Source: Japanese Ministry of Economy, Trade and Industry

Korea Convenience Store Sector: 13 April 2016

Japan retail market: CVS vs. GMS Japan CVS market: sales by category (JPY bn) (JPY bn) 25,000 12

20,000 10 8 15,000 6 10,000 4

5,000 2

0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 CVS General Merchandise store Fresh food Processed Foods Non-foods Services

Source: Japanese Ministry of Economy, Trade and Industry Source: Japanese Ministry of Economy, Trade and Industry

Japan: number of CVS outlets Japanese retail sales growth: CVS vs. others (store) 10% 55,000 8%

50,000 6% 4% 45,000 2% 40,000 0% 35,000 (2%) (4%) 30,000 (6%) 25,000 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 CVS Other retailer

Source: Japanese Franchise Association Source: Japanese Ministry of Economy, Trade and Industry

Korea’s CVS sector: better product offerings should boost SSSG and pace of new store openings The Korean CVS players The Korean CVS industry’s revenue amounted to KRW16tn as at the end of 2015, still have room for accounting for 4.5% of the total retail market. According to the Korea Association of growth, unlike other Convenience Stores, 93.2% of all CVS stores in the country were taken on a franchise retailers basis by individuals, while the rest were operated by the operators in 2014. Of these franchised stores, 83% of the franchisees paid rent directly to the landlord, while the rest were sub-let by the operators to the franchisees. Either way, all franchisees are required to pay the initial costs for refurbishment and equipment, and according to both companies, franchisees have to pay KRW60-70m to set up a CVS (either a mom-and-pop revamp or taking on a new store in a new location).

CVS industry: Korea vs. Japan (2015) Korea Japan

CVS market size (KRWtn) 16 90 CVS as a % of total retail revenue 4.5% 8.5% Average area per store 66m² 132m² No. of stores 28,994 52,725 No. of customers covered by one store 1,968 2,411 Revenue per store (KRWbn) 0.5 1.7 SKU 1,300 2,800

Source: industry data from Japanese Franchise Association and the Korea Association of CVS as compiled by Daiwa

We believe the Korean retail industry is following the same trend as Japan did, driven by similar demographic trends. The population is aging rapidly in Korea, with 13% of the total population already aged over 65. This percentage is on track to be over 20% in 10 years, whereas in Japan it took 13 years for the percentage of 65 year-olds and over to increase to 20%, from 13%. In addition, the percentage of single/dual households was over 50% as at the end of 2015, topping the level in Japan. Yet, the retail contribution from the CVS sector in Korea, as a percentage of the whole, is only about half that of Japan for 2015 (4.5% for Korea and 8.5% for Japan, see the table above).

Korea Convenience Store Sector: 13 April 2016

Korea vs. Japan: % of the population aged over 65 Korea vs. Japan: single/dual households 45% 70% 40% 60% 35% 50% 30% 25% 40% 20% 30% 15% 10% 20% 5% 10% 0% 0%

1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 2021 2025 2029 2033 2037 2041 2045 2049 1980 1985 1990 1995 2000 2005 2010 2015 2020E 2025E 2030E Japan Korea Korea Japan

Source: OECD Source: Statistics Bureau of Japan and KOSIS forecasts

In our view, the lower CVS contribution in Korea is due to the different sales portions of the 2 countries’ CVSs. In Japan, we noticed that CVSs have been strengthening their fresh- food business, which has thus attracted the elderly population and single/dual households. The biggest-selling product in the CVS space is fresh food in Japan, whereas it is still tobacco in Korea.

Japan: CVS sales by product category Korea: CVS sales by product category 100% 100% 4.0% 4.0% 4.0% 5.5% 8.5% 8.0% 7.6% 6.7% 90% 90% 25.0% 27.0% 80% 32.0% 30.7% 80% 39.1% 39.0% 39.0% 70% 70% 50.1% 60% 60% 35.0% 33.0% 50% 30.0% 26.7% 50% 40% 40% 30% 30% 45.6% 46.9% 47.2% 38.2% 20% 35.0% 36.0% 34.0% 37.2% 20% 10% 10% 0% 0% 6.8% 6.1% 6.2% 5.1% 2000 2005 2010 2015 2012 2013 2014 2015 Fresh food Processed food Non-food products Service Fresh food Processed food Non-food product Others

Source: Japanese Ministry of Economy, Trade and Industry Source: KOSIS

Diversified product mix The more limited product variety has limited the customer base for the Korean CVS in the should attract older past. According to GS Retail, in Korea, CVS customers are mainly in their 20-40s, a group customers to Korean that accounted for around 80% of Korea’s CVS customers in 2013, whereas this CVS percentage is just 30% in Japan, according to Seven & I Holdings. In our view, the divergence is not only because of the difference in population distribution, but also because the Korean CVS lack products aimed at the 65-plus age group.

However, as the Korean CVS have been strengthening their product line-ups since 2013 (led by GS Retail) to offer items like lunch boxes (which are popular with the older generation), they should start attracting more consumers aged 65-plus to their stores. According to BGF Retail, the company’s lunch-box sales portion to those over 50 increased from 11.0% in 2014 to 12.5% in 2015.

Korea Convenience Store Sector: 13 April 2016

CVS customer by age: Japan CVS customer by age: Korea

FY2014 2013 FY2012

FY2010 2009 FY2005 FY2000 2004 FY1995 1996 FY1990

0% 20% 40% 60% 80% 100% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Less than 20 years old 20-29 years old 30-39 years old Less than 20 years old 20-29 years old 30-39 years old 40-49 years old Over 50 years old 40-49 years old Over 50 years old Source: Seven & I Holdings Source: GS Retail

Lunch boxes are a good example of the Korean CVS widening their product mixes, with the focus of the products moving from quantity to quality these days. In particular, the top CVS players are competing to launch hit lunch boxes that could bring traffic to their stores. GS Retail started this lunch box boom with its ‘Heja lunch box’, which it launched in 2010. BGF Retail also launched its own lunch box in 2016 in conjunction with celebrity chef Mr. Baek Jong Won, which has been well-received by customers.

We have been monitoring the development of lunch boxes in Korea and have been impressed at how much the quality has improved. For USD3-5, a consumer can now get a decent lunchbox from the leading CVS operators, vs. USD7-8 for a similar-quality lunchbox from a restaurant, leading us to believe that the future bodes well for the 2 stocks under our coverage.

Thanks to these efforts to develop quality lunch boxes, the CVS sold KRW300bn worth of lunch boxes last year, and we expect this figure to expand to KRW500bn in 2016. On the back of the success of these lunch boxes, the CVS operators have also started to sell coffee, bakery items and ice cream, which are all receiving a positive response.

Examples of CVS lunch boxes

Source: Companies

Korea: CVS lunch-box market size Lunch-box sales growth by company (2015) (KRW bn) 100% 90.2% 600 90% 500 80% 500 70% 65.8% 56.7% 400 60% 300 50% 300 40% 200 200 150 30% 20% 100 10% 0 0% 2013 2014 2015 2016E Seven Eleven Korea BGF Retail GS Retail Source: Company data compiled by Daiwa Source: Companies

Korea Convenience Store Sector: 13 April 2016

Private-brand products Strengthening private-brand products can also lead to a more diversified customer base. In to be strengthened early 2016, both BGF Retail and GS Retail started to brand their own products. Previously, further this year they sold their products under their company name, assigning no separate brand name to private-brand items. Compared with their Japanese peers, the Korean CVS lag behind in terms of private-brand sales, and this was particularly noticeable during our visit to Japan. Seven & I Holdings, the parent company of Seven Eleven Japan, derives more than half of its sales from private-brand products, whereas for the Korean operators this range is only 10-20%. As the CVS format is the fastest-growing in the retail sector, we believe the Japanese operators have significant bargaining power over the manufacturers, enabling them to procure a wider range and better quality of products, and higher margins.

Korea: private-brand sales contribution comparison (2015) (%) 60 53.7

30 20.4 20.7 20 13.6

0 BGF Retail Seven-Eleven Korea GS Retail Seven&I Holdings

Source: Companies Note: Seven-Eleven Korea’s numbers are estimated by Daiwa

We believe these products will contribute to accelerated SSSG for the stocks that we cover. Even excluding the tobacco price hike, BGF Retail’s SSSG accelerated to 5.0% in 2015 from 4.0% in 2014. We believe that better product offerings brought in more traffic, as seen in the statistics provided by the government (see the following chart on the left). We forecast 2016 SSSG for BGF Retail at 6.2% YoY and 5.9% YoY for GS Retail (for 2017-18 numbers see the following chart on the right).

Korea CVS: YoY growth in the total number of purchases BGF Retail and GS Retail: CVS SSSG trend and forecasts (%) (%) 25 20 18.6 18 20 16 14 17.4 15 12 10 10 8 6.2 5 6 4.0 5.0 4 5.9 4.0 0 2 2.0 (5) 0 2014 2015 2016E 2017E 2018E Jul-14 Jul-15 Apr-15 Oct-14 Oct-15 Jan-15 Jun-15 Jan-16 Jun-14 BGF Retail GS Retail Mar-15 Feb-15 Feb-16 Nov-14 Dec-14 Nov-15 Dec-15 Aug-14 Sep-14 Aug-15 Sep-15 May-14 May-15 Source: Ministry of Trade, Industry and Energy Source: Companies, Daiwa forecasts

We see more room for Better product offerings will also add to the new store opening momentum for this year. As CVS to open in Korea at 2014, there were nearly 70,000 mom-and-pop stores in Korea, although we think that currently only 35,000 of them are viable for the CVS operators. In 2015, the government raised the price of tobacco by 80%, which saw a rush of franchisees looking to take on CVS stores, leading to more stores opening than in any other year since the first CVS opened in Korea in1992.

Both BGF Retail and GS Retail added nearly 1,000 stores each for 2015, compared to 400-500 additions each in 2014. We believe the positive effect of the tobacco price hike will continue in 2016, as wannabe franchisees are realising that the CVS format promises the most revenue of all the franchise retail formats (ie, versus the bakery, restaurant, coffee

Korea Convenience Store Sector: 13 April 2016

shop formats. According to the government (which has yet to release 2015 figures on sales per franchise format), even before the tobacco price hike last year, sales per store were higher for the CVS format than for any other retail franchise format, and we believe the gap will have widened further since the tobacco price hike in early 2015

The higher revenue has contributed to the longevity of the CVS business in Korea, attracting more individuals to the CVS franchise model than to other formats. Of all the franchise formats, the CVS operators have the highest survival rate within the first 3 years of opening, which we attribute to this format’s high revenue vs. that of the other franchise formats. Given the higher profitability and greater survival rate of this sub-segment, we forecast BGF Retail to add net 900 stores and GS Retail 700 stores for 2016. We also assume that both operators will close non-profitable stores (200 for BGF Retail and 250 for GS Retail in 2016; 150 for BGF Retail and 200 for GS Retail for 2017, and 100 for BGF Retail and 150 for GS Retail for 2018, as we expect both operators to become more discerning in their choice of new stores on the back of the increasing CVS density).

Korea: revenue by type of franchise (2014) Korea: Survival rate for various self-owned businesses (2014) (KRW 100mn) (%) 5 80 4.31 72.6 4.05 70 4 60 49.3 3 50 46.1 43.8 2.48 2.3 40 2 1.68 31.6 1.32 1.14 30 1 20 10 0 CVS Bakery Korean Pizzas, Coffee Pubs Fried- 0 restaurants hamburgers chicken CVS Pubs Restaurants Cell-phone Internet cafés restaurants dealers Source: Seoul Metropolitan Government Source: Seoul Metropolitan Government Note: the rate is based on 3 years after opening

We believe the rate of new store openings will slow in 2017, due to the high base in 2016. However, we do still see opportunities for the operators to take over, revamp and franchise out the mom-and-pop stores (giving the franchise to the mom-and-pop to run), and expect 1,000 of these mom-and-pop stores to be converted into CVS each year until 2020.

Of the 70,000 mon-and-pop stores that KOSIS said were in existence as at the end of 2014, we think about half of them are viable locations for the CVS operators. For 2016, we expect both BGF Retail and GS Retail to replace 400 mom-and-pop stores (of the 900 new stores we forecast for BGF Retail and the 700 for GS Retail). The remainder will come from new stores being opened by both operators in newly developed areas close to the metropolitan area, as well as in rural areas where there are fewer CVS overall.

Korea CVS Sector: number of CVS by company (stores) 12,000 10,309 10,859 9,409 9,985 10,585 10,000 8,408 9,285 7,939 8,290 7,938 7,202 7,729 8,000 8,000 6,686 7,138 7,160 7,194 6,326 5,345 6,050 6,000 5,026 4,596 4,000

2,000

0 2010 2011 2012 2013 2014 2015 2016E 2017E BGF Retail GS Retail Seven-Eleven

Source: Companies, Daiwa forecasts Note: Seven-Eleven Korea’s numbers are actual as at end-2015

Korea Convenience Store Sector: 13 April 2016

Korea: number of mom-and-pop stores Korea: CVS market share (store) 100% 100,000 18.3% 21.1% 17.3% 80% 87,271 6.8% 6.5% 10.0% 21.8% 79,193 79,043 60% 21.1% 20.1% 80,000 73,101 72,391 69,570 40% 25.7% 23.8% 24.5%

60,000 20% 27.5% 27.5% 28.2%

0% 40,000 2013 2014 2015 GS Retail BGF Retail Seven Eleven Mini Stop Others 2008 2010 2011 2012 2013 2014 Source: Ministry of Economy, Trade and Industry Source: Companies, Daiwa

If we look at the number of people that one CVS covers, the Korean CVS industry is more saturated than Japan’s (see the following chart on the left). However, we still believe that there is more room for transition from mom-and-pop stores to CVS in that these rather old fashioned channels sell different types of product category (i.e. unprocessed fresh food- fruit, vegetable, meat, etc) take most of the sales. With changing demographics, spending on processed food (including fresh food of CVS) is increasing as more people are less willing to cook from scratch but rather eat the ready-cooked meals like lunch boxes. We believe that this bodes well for the CVS industry, thus supporting the transition going forward.

Korea vs. Japan: number of people covered by one CVS Korea: annual consumption per average household (ppl/store) (KRW) 6,000 250,000 228,450

5,000 200,000 148,978 4,000 137,681 150,000 112,461 3,000 2,364 100,000 2,000

1,000 50,000

0 0 2005 2006 2007 2008 2009 2011 2012 2013 2014 2015 2010 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Japan Korea Fresh food Processed food

Source: Data from KOSIS, Japanese Franchise Association and the Korea Association of CVS Source: KOSIS as compiled by Daiwa

Increased exposure to Meanwhile, the Korean Government is endorsing a tax-refund system, which came into tourists could be a play at the beginning of 2016, and is something that we see as a short-term catalyst for the potential catalyst sector.

This system applies to foreign tourists who spend between KRW30,000 and KRW200,000 (from USD25-165) per purchase and KRW1m in total per visit at non-duty-free stores in Korea. Under the scheme, tourists are exempt from the average of 8% tax (which includes VAT and individual consumption tax) on the goods if they spend less than KRW200,000, which should encourage more tour groups (especially those from Mainland China) to shop in the CVS. A similar system was implemented in Japan in 2014 where Seven Eleven Japan’s SSS spiked by up to 10% YoY, with sales of cosmetics and perfume doing well, as these were the main products bought by the tourists.

Of the Korean CVS players that we cover, GS Retail is the most active in implementing such a system and it plans to have all of its franchisees ready to participate in the scheme during 1H16. BGF Retail is being more cautious in implementing this format, with at least 20 stores ready in prime tourist hotspots in 1H16. Both operators could see imminent upside earnings revisions from the implementation of the system as we don’t think the market has factored it in yet for either operator.

Korea Convenience Store Sector: 13 April 2016

Valuations

Initiating on BGF Retail We initiate coverage of the Korean CVS sector with a Positive rating, as we see both with an Outperform (2) revenue and earnings growth momentum for the stocks operating in this space. We rating and GS Retail with forecast the top-2 CVS operators, GS Retail and BGF Retail, to record an aggregate a Hold (3) rating revenue CAGR of 9.4% from 2016-18, and expect each company to add 700-900 new stores this year alone.

In addition, with better product offerings, we forecast sales per store to increase by 6.2% YoY for BGF Retail and 5.9% YoY for GS Retail in 2016, with their improved product line- ups contributing to better margins for both companies. Excluding one-off factors, we forecast 2016E EPS growth of 20.4% YoY for BGF Retail and 18.2% YoY for GS Retail, which are higher than the global peer average of 18.0%.

Peer valuation PER (x) PBR (x) EPS Growth(%) ROE (%) Company FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 BGF Retail* 23.7 20.2 5.3 4.3 20.4 17.4 22.3 21.5 GS Retail* 20.6 18.3 1.7 1.5 18.2 12.0 9.9 10.8 Seven & I Holdings 21.1 18.7 1.7 1.6 24.1 12.6 8.7 9.2 Lawson 22.1 20.0 3.1 2.9 26.3 10.7 15.3 15.5 FamilyMart-JP 24.3 21.5 1.9 1.8 13.4 13.0 6.3 5.8 FamilyMart-TW 31.5 25.2 9.1 8.3 18.4 24.8 28.5 32.4 President Chain Store 26.5 24.2 8.3 7.6 11.1 9.3 31.9 32.3 Global average 25.8 22.4 5.5 5.0 18.0 14.6 20.2 21.3 Source: Bloomberg, Daiwa forecasts (*), 2016E EPS growth for BGF Retail and GS Retail excludes 2015’s one-off gain. Our global peer group multiple is the average of the Japan- and Taiwan-listed peer group averages

We initiate on BGF Retail with a 12-month target price of KRW194,000. To derive our target price, we apply the global peer average 2016E PER (25.8x) to our 2016E EPS forecast, which we think is justified by the double-digit EPS growth we forecast for the next 3 years.

As for GS Retail, we begin coverage with a Hold (3) rating and 12-month target price of KRW49,500 using a SOTP valuation for each operation (CVS, supermarket and hotel). Our target price for GS Retail implies a 2016E PER of 21.4x which is below the global average. We believe the discount is justified given the company’s supermarket business is struggling amid both competitive and regulatory issues, dragging down the overall growth and margins of the company.

BGF Retail: 12-month forward PER bands GS Retail: 12-month forward PER bands (KRW) (KRW) 250,000 80,000 70,000 200,000 60,000 150,000 50,000 40,000 100,000 30,000 20,000 50,000 10,000 0 0 Jul-14 Jul-15 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Jun-14 Jun-15 Jun-13 Jan-15 Jan-16 Feb-13 Feb-14 Feb-15 Feb-16 Mar-15 Mar-16 Dec-13 Dec-14 Dec-15 Aug-13 Aug-14 Aug-15 Nov-14 Nov-15 Sep-14 Sep-15 May-14 May-15 Price 18.0x 21.0x Price 15.0x 18.0x 24.0x 27.0x 30.0x 21.0x 25.0x 28.0x

Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Korea Convenience Store Sector: 13 April 2016

Risks to our Positive sector rating

Expanding fresh-food We see 2 risk factors associated with the Korean CVS players. First, these main operators business could increase may face an increased burden in terms of inventory due to their expanding fresh-food the burden on business. Although the overall sales portion of the product category is low and has more franchisees, while growth potential, the inventory burden from this category’s sales could rise in the short unfavourable weather term. Currently, it is the franchisees that bear the cost of unsold food inventory. If they end could affect sales up with too much waste, this could put them off ordering more fresh-food items in the future, thus limiting the expansion potential for the fresh-food business.

Also, unfavourable weather conditions could drag down the sales of these off-line retailers. This is especially the case during the summer, with the monsoon season hindering outside activities or cooler-than-expected weather discouraging sales of beverages and ice-cream. According to the Korea Meteorological Administration, rain and weather temperatures in 2016 are expected to be similar to those in 2015 (ie, favourable to CVS sales). However, extreme changes in the weather may hurt high-season sales for both BGF Retail and GS Retail.

Korea Consumer Staples 13 April 2016

BGF Retail (027410 KS) BGF Retail

Target price: KRW194,000 Share price (12 Apr): KRW178,500 | Up/downside: +8.7%

Initiation: making life more convenient

 900 new store openings should boost revenue growth for 2016E Iris Park (82) 2787 9165  Higher-margin private-brand business is a positive [email protected]  Initiating with Outperform (2) rating and target price of KRW194,000

Investment case: BGF Retail is Korea’s leading CVS operator, with Share price performance around 10,000 stores under its CU brand as at February 2016. Given that (KRW) (%) the CVS operators in Korea are transforming into more modern retailers, as 235,000 190 well as the ample supply of mom-and-pop stores that could be snapped up, 201,250 163 167,500 135 refurbished and franchised to the mom and pops under the CVS operator 133,750 108

(around 35,000 viable stores, on our estimates, based on KOSIS numbers), 100,000 80 we think 2016-17 bodes well for the company. Apr-15 Jul-15 Oct-15 Jan-16 BGF Retail (LHS) Relative to KOSPI (RHS) Rapid new store openings. BGF Retail has been on a rapid expansion path since the start of 2015, driven mainly by the hike in the price of tobacco 12-month range 96,100-231,500 (inspiring new franchisees to take on stores), but also backed by the growing Market cap (USDbn) 3.80 3m average daily turnover (USDm) 15.80 demand for its private-brand and fresh-food products. Accordingly, we expect Shares outstanding (m) 25 it to continue to expand its network, opening 900 new stores for 2016E, Major shareholder Hong, Seok-jo (34.8%) contributing 10% of the company’s top-line growth for the year. The pace of new-store opening growth will likely slow in 2017 from the high base in 2016 Financial summary (KRW) as the impact of the tobacco price hike fades, but we still like the store Year to 31 Dec 16E 17E 18E expansion story going forward. We are also impressed by its growing private- Revenue (bn) 5,131 5,835 6,257 brand offering, especially its fresh-food items (ie, lunch boxes). As such, we Operating profit (bn) 207 239 268 Net profit (bn) 186 218 242 see these contributing to its EPS growth of 20.4% YoY for 2016E (if we strip Core EPS (fully-diluted) 7,517 8,827 9,822 out the one-off gain from the 2015 results; 8% YoY if we include it), 17% YoY EPS change (%) 7.8 17.4 11.3 for 2017E and 11% YoY for 2018E. Daiwa vs Cons. EPS (%) 8.7 9.5 12.5 PER (x) 23.7 20.2 18.2 Dividend yield (%) 0.8 1.1 1.4 Catalysts: The implementation of the government’s tax-refund policy is likely DPS 1,500 2,000 2,500 to boost BGF Retail’s revenue, in our view. When tourists buy goods in store PBR (x) 5.2 4.3 3.6 EV/EBITDA (x) 10.9 10.3 9.0 worth KRW30,000-200,000 (USD25-165) they receive the tax back ROE (%) 24.1 23.3 21.6 immediately (average: 8%). When Seven-Eleven Japan implemented this Source: FactSet, Daiwa forecasts system in 2014, daily sales rose by 10% YoY for 2014. BGF Retail plans to employ this system in at least 20 stores in 1H16, which could trigger imminent upside earnings revisions as we don’t think the market has yet factored this in.

Valuation: We initiate coverage on BGF Retail with an Outperform (2) rating and 12-month TP of KRW194,000, based on a 2016E PER of 25.8x, the average of its global CVS peers. As we forecast strong EPS growth for the company in 2017 (2016 numbers are distorted by the high base in 2015), we believe a target PER in line with its global peers is justified. We forecast an EPS CAGR of 14.3% over 2016-18E.

Risks: The main risk to our call relates to the increased penetration of the company’s fresh-food business, and how well it can predict what customers want. Franchisees bear the cost of disposing of fresh food, and if they fail to order correctly, this could lead to lower overall sales for BGF Retail. Unforeseen weather conditions could be another reason for sales to slow.

See important disclosures, including any required research certifications, beginning on page 40

BGF Retail (027410 KS): 13 April 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook BGF Retail: revenue and operating margin

We forecast BGF Retail’s top-line growth to be 13.7%- (KRW bn) Revenue (LHS) OPM (RHS) (%) 18.4% YoY for 2016E-17E, backed by new store openings 7,000 4.5% 4.1% 4.3% and product-mix improvements over this period. In January 6,000 4.0% 4.0% 6,257 2015, tobacco prices in Korea were raised by 80%, 5,835 3.5% 5,000 3.7% 3.8% meaning that retailers have been able to enjoy a margin 3.4% 5,131 3.0% 4,000 spread between the cheaper price of the inventory they 4,334 2.5% 2.0% bought in 2014 vs. the higher price they sold the tobacco at 3,000 3,368 3,130 1.5% in 2015. 2,000 1.0% 1,000 Excluding the one-off gains (KRW17-18bn) from this 0.5% spread, we forecast the company’s 2016 operating profit 0 0.0% 2013 2014 2015 2016E 2017E 2018E margin to widen by 1pp YoY on the back of a better product Source: Bloomberg, Daiwa forecasts mix. Note:2015 operating profit excludes one-off gains from tobacco

Valuation BGF Retail: valuations PER (x) PBR (x) EPS growth (%) ROE (%) We initiate coverage of BGF Retail with an Outperform (2) Company rating and 12-month target price of KRW194,000, based on FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 BGF Retail* 23.7 20.2 5.3 4.3 20.4 17.4 22.3 21.5 2016E PER of 25.8x. Our target PER is pegged at the GS Retail* 20.6 18.3 1.7 1.5 18.2 12.0 9.9 10.8 average of the global CVS players (on Bloomberg Seven & I Holdings 21.1 18.7 1.7 1.6 24.1 12.6 8.7 9.2 consensus forecasts). We forecast 8% YoY EPS growth for Lawson 22.1 20.0 3.1 2.9 26.3 10.7 15.3 15.5 FamilyMart-JP 24.3 21.5 1.9 1.8 13.4 13.0 6.3 5.8 2016E (20.4% if we strip out one-off gains from the 2015 FamilyMart-TW 31.5 25.2 9.1 8.3 18.4 24.8 28.5 32.4 results), 17% YoY for 2017 and 11% YoY for 2018, on new President Chain Store 26.5 24.2 8.3 7.6 11.1 9.3 31.9 32.3 store openings and an improved product mix. Global average 25.8 22.4 5.5 5.0 18.0 14.6 20.2 21.3 Source: Bloomberg, Daiwa forecasts Note: * are Daiwa forecasts/ 2016E EPS growth for BGF Retail and GS Retail excludes 2015’s one-off gain. Our global peer group multiple is the average of the Japan- and Taiwan- listed peer group averages.

Earnings revisions BGF Retail: Bloomberg consensus EPS forecast revisions (KRW) The Bloomberg consensus EPS forecast for BGF Retail for 10,000

2016 has been revised down by 1.4% since 4Q15 earnings 8,000 were announced in February 2016. This reflects the 6,000 weaker-than-expected operating profit in 4Q15, in our view. We believe the numbers also reflect the suspension of the 4,000 value-added network (VAN – payment gateway 2,000 companies) rebate from 3Q15. The company stopped 0 receiving rebate payments (about KRW35bn per quarter) from the VAN companies after the Korea government (2,000) Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 implemented a new law to stop kickbacks within the sector. Daiwa estimate 2016 Daiwa estimate 2017 Our 2016E EPS forecast is 8.7% higher than the Bloomberg estimate 2016 Bloomberg estimate 2017 Bloomberg consensus forecast, likely as we are more Source: Bloomberg bullish on the company’s fresh-food business.

BGF Retail (027410 KS): 13 April 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E No. of stores 6,686.0 7,938.0 7,939.0 8,408.0 9,409.0 10,309.0 10,859.0 11,209.0 Sales per store (KRW bn) 389.3 359.9 387.5 403.1 473.2 502.6 527.5 548.5 Other affilate sales (KRW bn) n.a. 55.0 53.9 64.9 76.7 79.3 81.2 83.0

Profit and loss (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E CVS 2,603 2,857 3,076 3,303 4,258 5,043 5,728 6,148 Other affiliates n.a. 55 54 65 77 79 90 93 Other Revenue n.a. 0 0 0 0 8 16 17 Total Revenue 2,514 2,912 3,130 3,368 4,334 5,131 5,835 6,257 Other income 69 99 108 105 99 130 100 96 COGS (2,041) (2,227) (2,387) (2,569) (3,434) (4,098) (4,685) (5,037) SG&A (380) (621) (638) (675) (716) (825) (910) (952) Other op.expenses (69) (91) (100) (95) (90) (130) (100) (96) Operating profit 93 64 105 124 184 207 239 268 Net-interest inc./(exp.) 6 (0) (7) 6 27 33 44 47 Assoc/forex/extraord./others 1 (11) (5) 6 5 0 0 0 Pre-tax profit 100 53 93 136 216 241 283 315 Tax (23) (17) (23) (35) (44) (55) (65) (72) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 77 35 70 101 172 186 218 242 Net profit (adjusted) 77 35 70 101 172 186 218 242 EPS (reported)(KRW) n.a. n.a. n.a. 4,118 6,970 7,517 8,827 9,822 EPS (adjusted)(KRW) n.a. n.a. n.a. 4,118 6,970 7,517 8,827 9,822 EPS (adjusted fully-diluted)(KRW) n.a. n.a. n.a. 4,118 6,970 7,517 8,827 9,822 DPS (KRW) n.a. n.a. n.a. 600 1,200 1,500 2,000 2,500 EBIT 93 64 105 124 184 207 239 268 EBITDA 162 155 205 219 282 337 340 364

Cash flow (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 100 53 93 136 216 241 283 315 Depreciation and amortisation 69 99 108 105 99 130 100 96 Tax paid 0 (28) (11) (28) (34) (45) (55) (62) Change in working capital 34 (3) 17 34 137 30 52 31 Other operational CF items (16) 29 40 10 (46) (30) (14) (14) Cash flow from operations 188 150 248 258 372 326 366 366 Capex (157) (173) (74) (77) (93) (130) (75) (78) Net (acquisitions)/disposals (1) 13 (46) (112) (271) (97) (85) (51) Other investing CF items (16) 0 1 (72) 0 0 0 0 Cash flow from investing (173) (159) (119) (261) (364) (227) (160) (129) Change in debt (0) 31 (12) (5) (33) 0 0 0 Net share issues/(repurchases) 0 26 0 10 0 0 0 0 Dividends paid (12) (12) (12) (10) (15) (30) (37) (49) Other financing CF items 0 (17) (4) 20 (10) 1 1 1 Cash flow from financing (12) 28 (27) 15 (58) (28) (36) (49) Forex effect/others 0 (0) (0) 0 0 0 0 0 Change in cash 2 20 101 12 (51) 71 170 188 Free cash flow 31 (22) 173 181 279 196 291 288 Source: FactSet, Daiwa forecasts

BGF Retail (027410 KS): 13 April 2016

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 114 147 290 475 748 819 989 1,177 Inventory 49 55 49 63 53 62 71 76 Accounts receivable 12 37 38 36 23 28 32 34 Other current assets 37 140 155 149 55 193 296 357 Total current assets 213 380 532 723 879 1,102 1,388 1,644 Fixed assets 272 407 388 369 374 386 371 360 Goodwill & intangibles 38 60 50 47 53 41 32 25 Other non-current assets 299 207 189 199 247 286 326 353 Total assets 823 1,054 1,160 1,338 1,553 1,816 2,117 2,382 Short-term debt 1 96 346 83 63 63 63 63 Accounts payable 293 321 349 412 564 667 759 814 Other current liabilities 85 76 100 105 63 40 44 47 Total current liabilities 379 493 795 600 690 770 866 923 Long-term debt 2 261 33 30 1 1 1 1 Other non-current liabilities 112 139 129 137 166 193 217 231 Total liabilities 493 893 957 766 857 964 1,084 1,156 Share capital 24 25 25 25 25 25 25 25 Reserves/R.E./others 306 125 169 534 671 823 1,002 1,193 Shareholders' equity 330 149 194 559 695 848 1,027 1,218 Minority interests 0 11 9 13 1 4 6 8 Total equity & liabilities 823 1,054 1,160 1,338 1,553 1,816 2,117 2,382 EV n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net debt/(cash) (112) 210 90 (362) (684) (755) (925) (1,113) BVPS (KRW) n.a. n.a. n.a. 22,686 28,073 34,220 41,442 49,150

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 8.7 15.8 7.5 7.6 28.7 18.4 13.7 7.2 EBITDA (YoY) 21.5 (4.3) 31.8 7.3 28.7 19.4 0.7 7.3 Operating profit (YoY) 17.0 (31.3) 64.7 18.2 47.9 12.9 15.5 11.9 Net profit (YoY) 14.7 (54.2) 97.4 44.9 69.6 7.8 17.4 11.3 Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. n.a. 69.3 7.8 17.4 11.3 Gross-profit margin 18.8 23.5 23.7 23.7 20.8 20.1 19.7 19.5 EBITDA margin 6.5 5.3 6.5 6.5 6.5 6.6 5.8 5.8 Operating-profit margin 3.7 2.2 3.4 3.7 4.2 4.0 4.1 4.3 Net profit margin 3.1 1.2 2.2 3.0 4.0 3.6 3.7 3.9 ROAE 26.1 14.8 40.8 27.0 27.4 24.1 23.3 21.6 ROAA 9.8 3.8 6.3 8.1 11.9 11.0 11.1 10.8 ROCE 28.3 15.0 19.1 19.6 25.4 24.7 23.8 22.5 ROIC 33.9 14.5 23.8 36.8 131.8 291.7 179.6 186.4 Net debt to equity n.a. 140.5 46.4 n.a. n.a. n.a. n.a. n.a. Effective tax rate 22.9 33.0 24.9 25.5 20.2 22.9 23.0 23.0 Accounts receivable (days) 2.0 0.8 2.2 4.0 2.5 1.8 1.9 1.9 Current ratio (x) 0.6 0.8 0.7 1.2 1.3 1.4 1.6 1.8 Net interest cover (x) n.a. 273.4 15.0 n.a. n.a. n.a. n.a. n.a. Net dividend payout n.a. n.a. n.a. 14.6 17.2 20.0 22.7 25.5 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

Company profile

BGF Retail engages in wholesale, commodity brokerage and chain of convenience stores in Korea. It has opened the largest number of stores in the industry in Korea. It sells cigarettes, liquors, fresh food, biscuits, lotto, magazines, stationeries and others. Moreover it offers ticketing, parcel pick-up, ATM and bill payment services. It only operates its businesses in domestic market.

BGF Retail (027410 KS): 13 April 2016

Initiating: making life more convenient The CVS sector is growing and BGF Retail stands to benefit We expect CVS the After visiting Japan to get an understanding of the CVS market there, and how it has format to expand its evolved (the Korea CVS market appears to be progressing along the same lines), we presence in the Korean believe that Korea’s CVS market is still in the growth phase. This should bode particularly retail market well for BGF Retail, which is the leading company in Korea’s CVS market, with its CU chain. Accordingly, we forecast SSSG of 6.2% YoY for 2016, 5.0% YoY for 2017 and 4.0% YoY for 2018 (GS Retail was operating 9,285 stores as at the end of 2015, while Seven- Eleven Korea had 8,000, according to both of the companies).

In Korea, even though sales in the CVS segment are still skewed to cigarette sales, the CVS operators have started to strengthen their product offerings by providing private-brand products, especially fresh food. For 2015, sales of fresh food through the CVS operators topped all other categories except for tobacco (even though the price was raised nearly 80% in January 2015). Given the growing demand for fresh food in the CVS segment, we expect the CVS companies to increase their share of the Korea retail sector to around 8.5% by 2020, the same level as it was for Japan in 2015. This would happen by the Korea stores opening new stores, including taking over some existing mom-and-pop stores, refurbishing them and giving the franchise to the mom and pop to run them under the CVS network. The CVS industry’s share of the total Korea retail market was only 4% for 2015.

According to KOSIS, there were nearly 70,000 mom and pop stores in Korea, as at the end of 2014, of which we believe 35,000 could be snapped up by the CVS operators (the remainder are unlikely to be touched as we think they are in unattractive locations). In our industry model we assume that 1,000 of these mom-and-pop stores are likely to be converted into CVS for each of the next 5 years, and that BGF Retail will be able to absorb 300 stores annually. This is central to our new-store opening assumptions of 550 for 2017E and 350 for 2018E; we expect the pace of new-location openings to decelerate due to the rapidly increasing CVS density in Korea.

For BGF Retail, its tobacco sales still account for more than 40% of total sales, while its fresh-food products account for a relatively small (but growing in importance) slice of the pie. As the company started to focus more on its fresh-food business in 2015, we believe this category will account for a bigger revenue share over 2016-18, from 5.1% for 2015 to 6.9% for 2016E.

Korea CVS sector: sales growth by category (2015) BGF Retail: sales breakdown by category (% ) 100% 60 48.5 50 80% 40 60% 30 18.2 14.5 20 11.2 40% 10 0 20% (10) 0% 5.6 5.8 5.7 5.1 6.9 (20) 2012 2013 2014 2015 2016E (30) -20.2 Fresh food Processed food Dairy products Sna cks Tobacco Fresh Food Processed food Household Sundries goods Tobacco Liquor Sundries

Source: Ministry of Trade, Industry and Energy Source: Company, Daiwa forecast

BGF Retail (027410 KS): 13 April 2016

Rapid store additions likely to continue for 2016 We forecast BGF Retail Still room to open new stores in Korea to add 900 stores for The company currently operates around 10,000 CU stores and added around 1,000 stores 2016 for 2015, effectively taking over some mom-and-pop stores by giving the mom and pop the franchise, as well as developing new stores in new commercial areas. The company is targeting to add 900-1,000 additional CVS for 2016, which we see as achievable (we forecast 900). However, we expect the pace of growth to slow in 2017, given the high base from 2016 (due to the impact of the 80% increase in the price of tobacco, which triggered a rush by new franchisees to take on stores). We forecast 550 new stores opening for 2017, and 350 for 2018, driven by the shift in product mix to more private-brand food products.

2,000

0 2010 2011 2012 2013 2014 2015 2016E 2017E BGF Retail GS Retail Seven-Eleven

Source: Company, Daiwa forecasts

Korea: number of mom-and-pop stores Korea: CVS market share (store) 100% 100,000 18.3% 21.1% 17.3% 80% 6.8% 87,271 6.5% 10.0% 21.8% 79,193 79,043 60% 21.1% 20.1% 80,000 73,101 72,391 69,570 40% 25.7% 23.8% 24.5%

60,000 20% 27.5% 27.5% 28.2% 0% 2013 2014 2015 40,000 2008 2010 2011 2012 2013 2014 GS Retail BGF Retail Seven Eleven Mini Stop Others

Source: Ministry of Economy, Trade and Industry Source: Companies, Daiwa

Improving product mix should support SSSG Its private brands have In the past, the company focussed mainly on selling traditional CVS products (such as started to contribute to cigarettes and pre-packaged snacks). However, to keep up with the development of the its SSSG CVS industry in Korea, and globally (eg, Japan), it has moved into offering fresh-food products (such as pre-cooked meals) and private-brand products as well. Together, these products accounted for 13.6% of BGF Retails’ revenue for 2015, and we forecast this to increase to 15.4%, 16.3% and 17.2% for 2016E-18, respectively.

We believe the company’s efforts to develop its private-brand products, especially fresh- food items, are important to its SSSG, which we forecast at 6.2% YoY for 2016 vs. 5.0% YoY for 2015 (excluding tobacco, for which the price rose by nearly 80%; 17.4% YoY including tobacco) and 4.0% YoY for 2014. These numbers are still low as a percentage of the whole CVS revenue pie, as the company is just starting out in developing its own private brand, including fresh-food items.

The company’s revenue contribution from its private-brand products (ie, coffee, bakery goods and fresh food) reached 13.6% for 2015, vs. 14.8% for 2014 (a decline as tobacco

BGF Retail (027410 KS): 13 April 2016

accounted for a larger proportion of revenue following the price hike in early-2015), but this was still lagging both its Korean peers (20% for both Seven-Eleven Korea and GS Retail for 2015). However, despite being a late-mover into the private-brand business, the company is rapidly catching up, especially with its fresh-food business. From mid- December 2015, the company started its collaboration with celebrity Korean chef Mr. Baek to boost its lunch-box sales, and it sold 7m units in 1Q16 alone. This amounted to nearly KRW28bn of revenue and was equivalent to 63.2% of the company’s total lunch-box sales for 2015. We believe this trend will continue as the company will be launching more products with Mr. Baek in 2016 (from 4 currently to 7 different types of product), which should boost its private-brand revenue contribution going forward.

Furthermore, to boost the brand equity of its private brand, the company launched 2 own brands — “Hey-roo” (F&B, household goods and personal-care items) and “Café Get” (coffee drinks and bakery) — at the end of 2015. Previously, the company sold these products under the company name, assigning no separate brand name to its private-brand products. We believe the launch of these 2 private brands will boost the company’s private- brand revenue, contributing to the SSSG of 6.2% YoY that we forecast for 2016.

BGF Retail vs. Seven Eleven Japan: private-brand revenue BGF Retail: private-brand sales volume growth contribution: (2015) 60% 53.7% (YoY %) 35 50% 28.9 30

40% 25

30% 20 20.4% 20.7% 15 9.7 20% 7.6 13.6% 10

10% 5

0% 0 BGF Retail Seven-Eleven Korea GS 25 Seven & I Holdings 2013 2014 2015

Source: Companies Source: Company

Seven-Eleven Japan: annual store openings Seven-Eleven Japan: average daily sales per store (stores) (JPY'000) 1,400 680

1,200 660

1,000 640 800 620 600 600 400 580 200

0 560 1975 1980 1985 1990 1995 2000 2005 2010 2015 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Seven & I Holdings Source: Seven & I Holdings

BGF Retail (027410 KS): 13 April 2016

Seven-Eleven Japan: customer visits per store Japan vs. Korea CVS segment (2015)

(ppl) 3 1,080 2.4 1,060 2.0 1,040 2 1.7 1,020 1,000 980 1 960 0.5 940 920 0 900 Customer per store (1000 people) Revenue per store (KRWbn) 2000 2005 2010 2015 Korea Japan

Source: Seven & I Holding Source: Industry data compiled by Daiwa

Japan CVS sales breakdown (2015) BGF: retail sales breakdown (2015)

5.6%

10.0%

Fresh food Fresh food 35.7% 31.5% Processed food Processed food Non-food items 33.3% Non-food items 56.7% Services Services

27.2%

Source: Japanese Franchise Association Source: Company

Concerns about corporate governance should ease BGF Retail has Cutting business ties completely with Bokwang Group after the golf course deal committed to cutting BGF Retail announced in February 2016 that it plans to acquire a majority stake in all business ties with Bokwang Icheon (4.2% stake before the announcement), a public golf course operator that Bokwang Group is an affiliate of Bokwang Group (not listed). This decision sparked concerns in the market about BGF Retail’s corporate governance, resulting in the share price falling by over 33% over 4-12 February 2016. And, though we agree with the market that acquiring a larger stake in the golf course operator will bring limited synergies to GF Retail’s existing business, we believe the selloff has been overdone.

The Hong family (see the chart on page 25) has a 47% stake in BGF Retail (one of the Hong sons runs it) and owns 100% of Bokwang Group. Following the acquisition, which has now been finalised, BGF Retail has cut all formal business ties with Bokwang Group, and the chairman of BGF Retail has committed to selling his 23.7% stake in Bokwang Group this year. BGF Retail has made it clear it will provide no further funding or bailouts to the Bokwang Group after the golf course deal.

In order to cut the ties between BGF and Bokwang Group, Bokwang Group disposed of all its existing shares in Bokwang Icheon (without payment). The golf course operator has now been consolidated into BGF Retail, which has injected KRW140bn in capital into the company. Bokwang Group’s other struggling affiliates (Bokwang and Bokwang Jeju) will be merged under Joongang Media Network Company, which should ease any other fears in the market about BGF Retail taking over any of the other affiliates.

The golf course isn’t making an operating loss currently, just a net loss. And we attribute this primarily to the interest expenses on its heavy debt. The injection of the KRW140bn by BFG Retail into Bokwang Icheon will relieve the burden of its interest costs, which has been running at KRW10bn a year, as it will wipe out its debt. The company will also sell off unused land worth KRW30bn to fund its operating capital.

BGF Retail (027410 KS): 13 April 2016

Bokwang Icheon: income statement (KRWbn) 2013 2014 Revenue 4.5 17.0 Operating expense 6.1 13.4 Operating profit -1.6 3.6 Net profit -8.1 -6.6 Source: Company

Bokwang Icheon: balance sheet (2014) (KRWbn)

Quick assets 4.1 Current liabilities 34.7 Inventory 0.2 Non-current liabilities 206.2 Current assets 4.3 Total liabilities 240.9 LT investment 1.1 Share capital 0.2 Fixed assets 232.7 Reserves 17.1 Goodwill & Intangible assets 1.2 AOCI 42.4 Other non-current assets 0.0 Deficiencies 61.2 Non-current assets 235.0 Total equity -1.5 Total assets 239.3 Total equity & liabilities 239.3 Source: Company

Bokwang Icheon: shareholding structure Before (2014) After Shareholder % of shares Shareholder % of shares BGF Retail 4.2% BGF Retail 85.2% Bokwang Group 49.5% JoongAng Media 4.2% Affiliates 42.1% Affiliates 10.6% Others 4.2% - -

Source: Company

Bokwang Group: changes in company structure (effective as at 23 Feb 2016)

Source: Bloomberg, Daiwa forecasts

Valuation Initiating coverage with an Outperform (2) rating and 12-month target price of KRW194,000 Initiating coverage with We initiate coverage of BGF Retail with an Outperform (2) rating and 12-month target price an Outperform (2) rating, of KRW194,000, based on a 2016E PER of 25.8x (equivalent to the average of its global and KRW194,000 target peers, on the Bloomberg consensus forecasts. For 2016, we forecast EPS growth of 7.8% price YoY, vs. 69.3% YoY for 2015. We put the deceleration down to significant one-off gains in 2015 due to the company being able to sell off its tobacco inventory at a higher price than it paid for it on the back of the government raising cigarette prices (by nearly 80% in January 2015). Excluding the one-off gains from the 2015 results, we forecast EPS growth of 20.4% YoY for 2016E. For 2017E, we forecast EPS growth of 17% YoY and 11% for 2018, on the back of new store openings and an improved product mix.

BGF Retail (027410 KS): 13 April 2016

Global CVS operator peer valuation Stock Price Mkt Cap Total Return (%) PER (x) PBR (x) EPS Growth (%) ROE (%) Company (local Curr.) (M USD) 1M 3M 6M FY16 FY17 FY16 FY17 FY16 FY17 FY16 FY17 BGF Retail* 178,500 3,868 6.2 -8.9 4.8 23.7 20.2 5.3 4.3 20.4 17.4 22.3 21.5 Korea GS Retail* 47,450 3,196 -3.8 -19.4 -12.1 20.6 18.3 1.7 1.5 18.2 12.0 9.9 10.8 Seven & I Holdings 4,559 37,292 (0.8) (8.8) (14.6) 21.1 18.7 1.7 1.6 24.1 12.6 8.7 9.2 Japan Lawson 9,010 8,339 (1.2) (3.0) 4.0 22.1 20.0 3.1 2.9 26.3 10.7 15.3 15.5 FamilyMart-JP 5,930 5,345 3.8 9.1 11.7 24.3 21.5 1.9 1.8 13.4 13.0 6.3 5.8 FamilyMart-TW 210 1,450 (0.7) 5.8 0.7 31.5 25.2 9.1 8.3 18.4 24.8 28.5 32.4 Taiwan President Chain Store 232.5 7,460.0 1.5 15.8 6.2 26.5 24.2 8.3 7.6 11.1 9.3 31.9 32.3 Global peer average 25.8 22.4 5.5 5.0 18.0 14.6 20.2 21.3

Source: Bloomberg, Daiwa forecasts*, 2016E EPS growth for BGF Retail and GS Retail excludes 2015’s one-off gain. Our global peer group multiple is the average of the Japan- and Taiwan-listed peer group averages.

BGF Retail: 12-month forward PER bands (KRW) 250,000

200,000

150,000

100,000

50,000

0 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 Price 18.0x 21.0x 24.0x 27.0x 30.0x

Source: Bloomberg, Daiwa forecasts

Risks Growing fresh-food business could increase franchisees’ financial burden Growing fresh-food The main risk to our call on the stock relates to the increase in the company’s fresh-food business could increase business, and how well BGF Retail can accurately predict sales in this category and relay the inventory burden for that information to franchisees. The cost of disposing of fresh food is borne by the franchisees franchisee and if they continuously fail to order the correct quantities of food, the consequences will be lower orders and sales, and potentially disgruntled franchisees. In order for this segment to grow as we expect, the company’s ordering system needs to be efficient. We will be monitoring inventory levels closely.

BGF Retail: quarterly fresh-food sales trend (KRWbn) 70

0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

Source: Company

A secondary downside risk could come in the form of unforeseen weather conditions. For offline retailors, like the CU chain of stores, sales are influenced by outdoor activities, which are usually affected by the weather. According to the Korea Meteorological Administration, rain and weather temperatures in 2016 are expected to be similar to those in 2015, which bodes well for our earnings forecasts. However, extreme changes in the weather (ie, longer monsoon season, or a cooler-than-expected summer) could hurt the company’s revenue if overall customer traffic were to fall.

BGF Retail (027410 KS): 13 April 2016

Company background Leader in the domestic CVS market Making life easier No. 1 in terms of the BGF Retail is the leading company in Korea’s CVS segment. It started out as an affiliate of number of CVS outlets Bokwang Group and operated under a licence from Japan’s Family Mart (8028 JP, in Korea JPY5,930, Hold [3]). It brought the CVS business model to Korea in 1990, under the Family Mart Korea banner. BGF Retail was spun off from Bokwang Group (not listed) in 1994. In 2012, Family Mart Japan and BGF Retail terminated the licence agreement and BGF Retail changed its franchise name to CU. The company operated more than 10,000 stores in Korea, as at February 2016, with most of them under franchise (98%), which is the highest number of CVS franchisees in Korea. In early 2016, it acquired a larger stake in Bowkang Icheon.

The company’s CVS business accounted for 98.5% of its total revenue in 2015. Through its own stores and franchises, it sells general groceries, such as food and drink. In 2015, it started to focus more on developing and offering a wide range of private-brand products and services, such as lunch boxes (ie, Mr. Baek’s lunch box) and yogurt (BIG yogurt), both of which sold well in 2015.

The company has 6 business affiliates: BGF Cashnet, BGF Human-net, BGF DSnet, BGF Foods, BGF Logis and BGF Cashnet (involved in the provision of financial services through cash dispensers/ATMs.

CU: number of stores and market share (2015) CU: revenue breakdown (2015) 30,000 28,309 34% 26,020 24,559 24,859 1% Fresh food 25,000 6% 5% Dairy 5% 20,000 33% 8% Processed food

15,000 Snacks 25% 9,409 Tobacco 10,000 7,938 7,939 8,408 32% Liquor 5,000 42% 8% Miscellaneous 0 31% OTC drugs 2012 2013 2014 2015 Services BGF Retail (LHS) CVS market (LHS) BGF Retail's MS (RHS)

Source: Company Source: Company

BGF Retail and Bokwang Group: the Hong family’s shares

Bowkang Group

27.5% 23.75% 23.75% 23.75%

Seok-jun, Hong Seok-jo, Hong Ra-young, Hong Seok-gyu, Hong

5.0% 34.82% 6.45%

BGF Retail

Source: Company

Korea Consumer Staples 13 April 2016

GS Retail (007070 KS) GS Retail

Target price: KRW49,500 Share price (12 Apr): KRW47,450 | Up/downside: +4.3%

Initiation: selling differentiated merchandise

 Excels at private brands with its CVS and supermarket platforms Iris Park (82) 2787 9165  But growth from CVS dragged down by supermarket business [email protected]  Initiating with a Hold (3) rating and target price of KRW49,500

Investment case: In our view, GS Retail stands to be one of the biggest Share price performance beneficiaries of the convenience stores’ (CVS) expanding share of the (KRW) (%) Korea retail industry. At the end of 2014, there were at least 35,000 viable 70,000 210 existing mom-and-pop stores in the country that conceivably could be taken 60,000 178 50,000 145 over by GS Retail over the next 5 years, revamped into the CVS format and 40,000 113 then franchised to the mom and pop to run them. Through this transition, 30,000 80 we estimate that GS Retail will add 700 CVS stores this year, comprising Apr-15 Jul-15 Oct-15 Jan-16 400 mom-and-pop revamps and the rest new stores opening in new GS Retail (LHS) Relative to KOSPI (RHS) locations, which alone should contribute 7% YoY of its top-line growth for this year. Although we expect store additions to slow in 2017 (600 stores; 12-month range 33,900-66,800 due to the diminishing impact of the tobacco price hike in 2015), we believe Market cap (USDbn) 3.18 the company will add at least 400 mom-and-pop revamps per year and 3m avg daily turnover (USDm) 14.41 Shares outstanding (m) 77 fewer new stores in new areas until 2018. Alongside this expansion in its Major shareholder GS Corp (65.8%) CVS network, we are positive on the GS Retail’s CVS revenue growth over our forecast period on the higher SSSG of its better private-brand products. Financial summary (KRW) Year to 31 Dec 16E 17E 18E However, we are concerned about the supermarket business, which is Revenue (bn) 7,122 7,790 8,377 Operating profit (bn) 259 295 336 dragging down growth/margins due to the fierce competition from Net profit (bn) 178 199 237 hypermarkets and online retailers. We believe the negative earnings impact Core EPS (fully-diluted) 2,308 2,586 3,072 of this business will not be lifted for another 1-2 years. EPS change (%) 6.9 12.0 18.8 Daiwa vs Cons. EPS (%) (2.8) (8.7) (9.5) PER (x) 20.6 18.4 15.4 Catalysts: In 3Q16, GS Retail will add Parnas Tower to its existing hotel Dividend yield (%) 2.1 2.4 2.4 business. Normally, the operating profit margin for the hotel business is DPS 1,000 1,150 1,150 PBR (x) 1.7 1.5 1.4 high at 15-20% (vs. 3-4% for the CVS segment and 1% for supermarkets). EV/EBITDA (x) 10.9 9.7 8.5 We expect margins for this business to improve from 3Q16, leading to an ROE (%) 9.6 10.1 11.2 improvement in the company’s overall operating margin in 2016, and Source: FactSet, Daiwa forecasts offsetting the negative effect of the supermarket business.

Valuation: We initiate coverage of GS Retail with a Hold (3) rating and SOTP-based 12-month TP of KRW49,500. In our SOTP valuation, we apply a 2016E target PER for each business using global peer averages as a guide: 25.8x for the CVS business, 17.9x for the supermarket business, and 22.3x for the hotels. Our target price implies a 2016E PER of 21.4x, which is below the global peer average. We believe the company should trade at a discount to peers as its main earnings growth driver, the CVS business, will only account for 75% (vs. 100% for pure CVS peers) of 2016E operating profit. Moreover, we expect its supermarket business to continue to face uncertainty over the next 2 years.

Risks: 1) The company’s supermarket business continuing to drag down its overall operating margin, and 2) a number of hypermarkets and social commerce sites have recently announced plans to step up price competition, which could further hurt GS Retail’s supermarket business.

See important disclosures, including any required research certifications, beginning on page 40

GS Retail (007070 KS): 13 April 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook GS Retail: revenue and operating margin trend We forecast GS Retail’s revenue to see a CAGR of 8.5% (KRWbn) (%) from 2016-18, outperforming its domestic peers in the 9,000 5 8,000 Korea retail sector. The growth should be driven mainly by 7,000 4 CVS sales, where we still see room for new store 6,000 3 openings and same-store sales growth. We forecast the 5,000 operating profit margin for its CVS business to gradually 4,000 2 improve on the back of a better product mix (ie, more 3,000 private-label products). Meanwhile, the high-margin hotel 2,000 1 operation should start to contribute from 2017, after the 1,000 grand opening of the Parnas Tower scheduled for 3Q16. 0 0 2014 2015 2016E 2017E 2018E Revenue (LHS) OPM (RHS)

Source: Company, Daiwa forecasts Note:2015 OP excludes one-off gains from tobacco

Valuation GS Retail: SOTP valuation We initiate coverage of GS Retail with a Hold (3) rating (KRWbn) Value Note and 12-month target price of KRW49,500. We apply the CVS 4,223 Applied target PER 25.8x to 2016E NP SM 39 Applied target PER 17.9x to 2016E NP global peer average PER (25.8x) to the company’s CVS Hotel 444 Applied target PER 22.3x to 2016E NP operations, which we expect to continue to post double- Net debt -896 2016E Daiwa forecast Total value 3,810 digit earnings growth until 2018. Our target price implies a No. of shares (m) 77

2016E PER of 21.4x, which is below the global CVS Value per share (KRW) 49,542 average, on account of the drag from the company’s Source: Bloomberg, Daiwa forecasts struggling supermarket business.

Earnings revisions GS Retail: Bloomberg-consensus earnings revisions

The Bloomberg 2016E EPS forecast for GS Retail has 4,000 been trending higher since 2015, mainly because the 3,000 company’s CVS business is seeing margins improve on the back of an enhanced product mix. The recent 2,000

correction in the consensus 2016 forecast likely reflects 1,000 the difficulties being experienced by the supermarket business, as revealed in the company’s 4Q15 results. 0 (1,000) Our 2016E EPS forecast is 3% lower than Bloomberg Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Daiwa estimate 2016 Daiwa estimate 2017 consensus as we are more conservative on the Bloomberg estimate 2016 Bloomberg estimate 2017 company’s supermarket business. Source: Bloomberg, Daiwa forecasts

GS Retail (007070 KS): 13 April 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Number of CVS 6,326.0 7,138.0 7,774.0 8,290.0 9,285.0 9,985.0 10,585.0 11,085.0 Sales per CVS (KRW mn) 394.3 400.6 414.1 422.4 501.1 530.6 557.1 579.4 Number of supermarket 230.0 254.0 258.0 262.0 281.0 295.0 305.0 313.0 Sales per supermarket (KRW bn) 5.4 5.7 5.6 5.3 5.1 4.9 4.9 4.9 Hotel operating profit (KRW bn) n.a. n.a. n.a. n.a. 10.3 36.0 34.3 37.6

Profit and loss (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E CVS 2,494 2,860 3,219 3,502 4,653 5,298 5,897 6,423 Supermarket 1,302 1,412 1,371 1,331 1,389 1,450 1,495 1,534 Other Revenue 185 106 119 129 231 373 399 421 Total Revenue 3,982 4,378 4,709 4,962 6,273 7,122 7,790 8,377 Other income 121 153 172 180 185 189 191 193 COGS (3,136) (3,384) (3,647) (3,887) (5,034) (5,716) (6,264) (6,744) SG&A (752) (853) (906) (933) (1,013) (1,146) (1,232) (1,297) Other op.expenses (121) (153) (172) (180) (185) (189) (191) (193) Operating profit 94 140 155 143 226 259 295 336 Net-interest inc./(exp.) 18 (3) (13) (12) (18) (31) (22) (13) Assoc/forex/extraord./others 17 25 17 17 14 9 (8) (8) Pre-tax profit 129 162 159 149 221 237 265 315 Tax (36) (38) (40) (37) (55) (59) (66) (79) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 93 123 119 111 166 178 199 237 Net profit (adjusted) 93 123 119 111 166 178 199 237 EPS (reported)(KRW) 1,213 1,603 1,546 1,445 2,158 2,308 2,586 3,072 EPS (adjusted)(KRW) 1,213 1,603 1,546 1,445 2,158 2,308 2,586 3,072 EPS (adjusted fully-diluted)(KRW) 1,213 1,603 1,546 1,445 2,158 2,308 2,586 3,072 DPS (KRW) 300 400 450 600 850 1,000 1,150 1,150 EBIT 94 140 155 143 226 259 295 336 EBITDA 215 293 327 324 411 449 486 530

Cash flow (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 129 162 159 149 221 237 265 315 Depreciation and amortisation 121 153 172 180 185 189 191 193 Tax paid (164) (33) (34) (46) (34) (73) (82) (98) Change in working capital (62) (82) (28) 59 27 7 13 (4) Other operational CF items (23) 21 25 27 44 46 53 45 Cash flow from operations 1 221 294 368 444 406 440 452 Capex (188) (193) (146) (187) (277) (180) (175) (170) Net (acquisitions)/disposals (20) (68) (18) 0 (766) 0 0 0 Other investing CF items (9) 238 43 7 157 (14) (11) (10) Cash flow from investing (216) (23) (121) (181) (886) (194) (186) (180) Change in debt 246 (153) (150) (93) 449 (170) (170) (170) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (39) (23) (31) (35) (46) (65) (85) (100) Other financing CF items 0 0 0 0 (0) 0 0 0 Cash flow from financing 208 (177) (181) (128) 403 (235) (255) (270) Forex effect/others (0) (0) 0 (0) 0 0 0 0 Change in cash (8) 21 (7) 60 (39) (23) (1) 2 Free cash flow (188) 29 148 181 167 226 265 282 Source: FactSet, Daiwa forecasts

GS Retail (007070 KS): 13 April 2016

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 767 477 425 433 154 131 130 132 Inventory 133 149 153 122 116 132 144 155 Accounts receivable 69 91 104 103 172 195 213 229 Other current assets 30 13 20 33 41 47 51 55 Total current assets 998 731 702 692 483 504 538 571 Fixed assets 683 749 707 749 2,095 2,126 2,152 2,172 Goodwill & intangibles 110 131 150 149 153 113 71 28 Other non-current assets 1,207 1,304 1,320 1,331 2,004 2,124 2,182 2,240 Total assets 2,998 2,914 2,880 2,920 4,736 4,867 4,944 5,012 Short-term debt 507 210 60 100 173 113 123 63 Accounts payable 393 321 361 391 665 774 866 931 Other current liabilities 57 72 59 54 37 57 62 67 Total current liabilities 957 602 480 545 876 944 1,051 1,061 Long-term debt 404 542 538 400 1,023 913 733 623 Other non-current liabilities 199 245 248 293 678 738 774 805 Total liabilities 1,559 1,389 1,265 1,239 2,576 2,596 2,559 2,490 Share capital 77 77 77 77 77 77 77 77 Reserves/R.E./others 1,358 1,447 1,538 1,605 1,716 1,835 1,961 2,110 Shareholders' equity 1,435 1,524 1,615 1,682 1,793 1,912 2,038 2,187 Minority interests 4 0 0 0 366 359 347 335 Total equity & liabilities 2,998 2,914 2,880 2,920 4,736 4,867 4,944 5,012 EV 3,789 3,917 3,811 3,709 5,043 4,887 4,706 4,521 Net debt/(cash) 144 275 173 67 1,043 896 727 555 BVPS (KRW) 20,969 21,838 22,320 23,558 25,881 28,472 31,329 34,434

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 21.4 9.9 7.6 5.4 26.4 13.5 9.4 7.5 EBITDA (YoY) 24.3 36.7 11.5 (1.0) 27.1 9.1 8.2 9.0 Operating profit (YoY) 17.9 49.6 10.4 (7.6) 57.6 14.8 13.8 13.9 Net profit (YoY) 23.5 32.2 (3.6) (6.5) 49.3 6.9 12.0 18.8 Core EPS (fully-diluted) (YoY) n.a. 32.2 (3.6) (6.5) 49.3 6.9 12.0 18.8 Gross-profit margin 21.2 22.7 22.5 21.7 19.8 19.7 19.6 19.5 EBITDA margin 5.4 6.7 6.9 6.5 6.6 6.3 6.2 6.3 Operating-profit margin 2.4 3.2 3.3 2.9 3.6 3.6 3.8 4.0 Net profit margin 2.3 2.8 2.5 2.2 2.6 2.5 2.6 2.8 ROAE 6.6 8.3 7.6 6.8 9.6 9.6 10.1 11.2 ROAA 3.3 4.2 4.1 3.8 4.3 3.7 4.1 4.8 ROCE 4.4 6.1 6.9 6.5 8.2 7.8 9.0 10.4 ROIC 5.2 6.3 6.5 6.1 6.8 6.1 7.0 8.1 Net debt to equity 10.0 18.0 10.7 4.0 58.2 46.8 35.6 25.4 Effective tax rate 27.7 23.7 25.3 25.1 24.9 24.9 25.0 25.0 Accounts receivable (days) 5.7 5.2 6.2 7.6 8.0 9.4 9.6 9.6 Current ratio (x) 1.0 1.2 1.5 1.3 0.6 0.5 0.5 0.5 Net interest cover (x) n.a. 42.4 12.2 11.8 12.4 8.3 13.4 26.7 Net dividend payout 24.7 24.9 29.1 41.5 39.4 43.3 44.5 37.4 Free cash flow yield n.a. 0.8 4.1 5.0 4.6 6.2 7.3 7.7 Source: FactSet, Daiwa forecasts

Company profile

GS Retail mainly operates CVS and supermarket. It also operates a drugstore through a joint venture with Watsons. The company acquired Parnas hotel in 2015 adding a new business to its portfolio.

GS Retail (007070 KS): 13 April 2016

Still room for revenue and profit growth New store openings to continue in 2016 CVS operators taking We believe GS Retail will meet its target of a 500-600 net increase in stores in 2016, which over mom-and-pop admittedly is behind the target of its main competitor, BGF Retail (027410 KS, KRW stores and offering a 178,500, Outperform [2]), which is targeting around 1,000 store additions this year. We wider range of products believe GS Retail company is being conservative in this year’s target and estimate it to open 700 new stores in 2016E, driven by the 80% tobacco price hike in 2015, and because the mom-and-pop stores offer good potential for the CVS operators to expand their revenue once the stores are revamped and start offering extended product lines under the CVS umbrella. GS Retail had 9,285 stores at end-2015, so store additions alone should contribute 7% YoY revenue growth in 2016, on our forecasts.

The reason we are confident about the company’s CVS store expansion plan is because there are around 35,000 viable mom-and-pop stores in Korea, in our view, that lag behind the CVS format in terms of product offerings (ie, fresh-food and private-label products). Although not all the mom-and-pop stores are in locations deemed attractive by the CVS operators, we think around half of them are viable.

Industry-wide, we believe that 1,000 mom-and-pop stores per year will be converted into CVS (whereby the mom and pops become franchisees) over the next 5 years, of which we expect GS Retail to absorb more than 400 a year.

Accordingly, we forecast the company to add 600 new stores in 2017E and 500 in 2018E, and assume that 400 of these per year will be revamped mom-and-pop stores. Korea’s CVS industry has been consolidating over the past 10 years with the 2 top-tier players, GS Retail and BGF Retail, having solidified their leading positions. GS Retail has among the most differentiated range of private-label products and fresh food in the sector, and we see it continuing with its strategy to take over mom-and-pop stores in Korea (the pace of new store openings in new locations should decelerate as the Korea CVS density is increasing rapidly).

GS retail: number of CVS stores Korea: mom-and-pop stores (Store) (store) 11085 100,000 12,000 10585 9985 87,271 10,000 9285 8290 7774 79,193 79,043 8,000 7138 80,000 6326 73,101 72,391 69,570 6,000 5026

4,000 60,000

2,000

0 40,000 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2008 2010 2011 2012 2013 2014

Source: Company, Daiwa forecasts Source: KOSIS

GS Retail (007070 KS): 13 April 2016

Korea: number of CVS stores by company Korea: CVS market-share trend in terms of sales (KRWbn) 100% 18.3% 17.3% 9343 21.1% 10,000 8369 80% 7917 6.8% 6.5% 10.0% 8,000 7774 21.8% 60% 21.1% 20.1% 7713 7901 6,000 7231 40% 25.7% 23.8% 24.5% 4,000 1913 2002 2179 20% 2,000 27.5% 27.5% 28.2% 0 0% 2013 2014 2015 2013 2014 2015 BGF Retail GS Retail GS Retail BGF Retail Seven Eleven Mini Stop Others Seven Eleven Mini Stop Source: Companies Source: Companies, KOSIS

GS Retail (007070 KS): 13 April 2016

Differentiated product offering through synergies between supermarkets and CVS More operating space We believe GS Retail is well positioned to differentiate itself from its peers because it has a from having CVS and bigger platform from which to sell differentiated products like private brands and fresh food supermarkets provides (ie, lunch boxes, rice balls, etc). Retailers like GS Retail and Seven Eleven Korea derive more room to sell its more sales from private-label products as they have larger platforms from which to sell own products such brands. As for GS Retail, the company was operating 9,285 CVS and 281 supermarkets in 2015. Considering that the store size of a supermarket is larger than that of a CVS, we believe GS Retail’s overall operating space would have topped BGF Retail’s in 2015.

The company is now being more aggressive in promoting its private-label brands. First, in 1Q16 it consolidated its private-label brands under the ‘You US’ label. Not only did the company name its private-label products, it also categorised them according to price points: 1) You US – a national brand (ie, brands made by large manufacturers, eg, Oreo from Nabisco or Chocopie from Orion (001800 KS, KRW915,000, Buy[1]) featuring quality but lower prices, 2) You US Premium – higher prices and better quality than national brands, 3) You US Gold Premium – high-quality products. In addition, the company is strengthening its fresh-food business. GS Retail sold KRW310bn worth of fresh food in 2015, the largest such figure among its peers. And to maintain this competitive edge, the company added a new fresh-food factory in 4Q15.

Korea: private-label sales contribution by company (2015)

60% 53.7%

50%

40%

30% 20.4% 20.7% 20% 13.6% 10%

0% BGF Retail Seven-Eleven Korea GS Retail Seven & I Holdings

Source: Companies

GS Retail: fresh-food production capacity GS Retail vs BGF Retail: sales of fresh food 2014 2015 (KRWbn) (m meals) Capacity Production Utilisation rate Capacity Production Utilisation rate 350 310.0 Riceballs 31.6 27.1 85.8% 31.6 29.0 91.8% 300 Sandwiches 8.4 5.6 67.0% 8.4 5.6 67.5% 234.1 250 222 216.3 197 Lunch box 6.2 5.0 80.2% 6.2 6.7 108.1% 181.5 186.4 200 163.1 Hamburger 14.2 7.8 55.2% 14.2 3.7 26.5% 150 Gimbap (rolled 10.5 9.6 91.9% 10.5 9.9 94.2% 100 rice) 50 HMR - - - 1.4 0.6 43.1% 0 2012 2013 2014 2015 GS Retail BGF Retail

Source: Company Source: Companies Note: GS Retail sales only captures those of CVS

GS Retail (007070 KS): 13 April 2016

We believe these original products will help GS Retail in the following ways: 1) generate higher sales per store, and 2) gain more franchisees as sales per store are higher. Compared with its peers, the company already has higher sales per store with the help of its original products (fresh-food and private-label products), which in turn helps it attract franchisees.

This higher sales per store is also the case for Seven Eleven Japan, which is leading the Japan market with more than 50% of its sales derived from private-label products. Not only does Seven Eleven Japan have higher sales per store on average than its domestic peers in Japan, it was also able to open more additional stores after the subsequent success of its private-brand products, which it launched in 2007. We believe GS Retail will follow the same path given it is the company leading the category in Korea, as Seven Eleven did in Japan.

Korea: sales per store by CVS operator Japan CVS: average daily sales per store (2015) (KRWm) (JPY tn) 600 700 655 501 500 453 600 416 491 400 500 400 300 300 200 200 100 100

0 0 GS Retail BGF Retail Seven Eleven Korea Seven Eleven Japan Industry average

Source: Companies Source: Seven & I Holdings

Seven Eleven Japan: private-label product sales Seven Eleven Japan: annual store openings (JPY bn) (stores) 1,400 55% 1,400 54% 1,200 1,200 53% 1,000 54% 52% 1,000 800 51% 800 600 51% 50% 49% 600 400 49% 48% 400 200 47% 0 46% 200 2013 2014 2015 0 SEJ original products (LHS) % of sales (RHS) 75 80 85 90 95 00 05 10 15 Source: Seven&I Holdings Source: Seven&I Holdings

More traffic from tax refund scheme and Internet banking Most rapid CVS to adapt a tax-refund system Tax-refund system to be The Korean Government is endorsing a tax-refund system, which came into play at the equipped in all stores by beginning of this year. This system applies to foreign tourists who spend between year end KRW30,000 and KRW200,000 (from USD25-165) per purchase and KRW1m in total per visit at non-duty-free stores in Korea. Under the scheme, tourists are exempt from the average of 8% tax (which includes VAT and individual consumption tax) on the goods if they spend less than KRW200,000.

Until now, GS Retail had had limited exposure to tourists (tourists used to shop mainly in Korea’s duty-free stores), but considering the low KRW200,000 maximum purchase limit, we believe CVS will be a suitable channel for this tax refund. In order to reap the benefits, the company will have all its franchisees ready to participate in the scheme within 1H16 and plans to have equipped all its stores with the necessary platform within 2016. When

GS Retail (007070 KS): 13 April 2016

Seven-Eleven Japan implemented a similar tax scheme in its stores in 2014, daily sales at its stores rose by 10% YoY for 2014, with cosmetics and perfumes selling particularly well.

Taking part in Korea’s No.1 Internet banking consortium Using the CVS platform By participating in the Internet banking business, GS Retail should be able to lure more for Internet banking customers. In November 2015, the company took a 10% stake in the “K-bank” consortium, services one of the first 2 Internet banks to be opened in Korea, the other being Kakao Bank. For GS Retail’s part, it will provide space for ATM machines in 1,000 of its CVS outlets starting in 2H16. This will allow the company to catch up with arch-rival BGF Retail, which already has a financial business (CD VAN and ATM machine business). Through the automated machines to be placed in GS Retail’s CVS stores, K-bank’s clients will have 24-7 offline access to K-bank. In addition, the company will offer tax-refund services to foreign tourists using its platform. We believe this move will increase the traffic to GS Retail’s stores.

Internet banks in Korea: K Bank vs. Kakao Bank outline K-Bank Kakao Bank Share capital KRW250bn KRW300bn -GS Retail 10% -Woori Bank 10% -Korea Investment Holdings 50% Shareholders -Hanwha Life Insurance 10% -Kakao 10% -Danal 10% -KB Bank 10% -KT 8% -Mid-interest loans -Mid-interest loans -Wire transfers via e-mail, mobile -Wire transfers via Kakao Talk Main service -Asset management based on robot-advisor -Simple payments without Card/VAN/PG -Overseas wire transfers -Kakao Universal Point Plaforms Mobile, GS 25 CVS, public phone booth Kakao Talk

Source: Companies

GS Retail: role within K Bank GS Retail’s role -Cash payments and withdrawals Basic banking service -Wire transfers Individual certification service -Using biometrics system -Franchisees’ payment to HQ -Simple loans -File for financial products Specialised services -Simple overseas wire transfer -Tax-refunds for foreigners -Multi-language translation

Source: Company

GS Retail (007070 KS): 13 April 2016

Valuation Initiating coverage with a We initiate coverage of GS Retail with a Hold (3) rating and an SOTP-derived 12-month Hold (3) rating and target price of KRW49,500. To derive our target price, we apply the global peer average to 12-month target price each of the company’s operations. For the CVS business, we use a target 2016E PER of of KRW49,500 25.8x, in line with the average multiple of global peers. We conservatively value the company’s CVS business in line with its peers, as we expect it to see double-digit revenue growth until 2018 (the Bloomberg consensus forecasts for 2017 for its peers are below our forecast for GS Retail). For the supermarket and hotel businesses, we apply the global peer average PERs of 17.9x and 22.3x, respectively.

Our resulting target price of KRW49,500 implies a 2016E PER of 21.4x, which is below the average 25.8x 2016E PER multiple of GS Retail’s global CVS peers. Given that the company’s supermarket business is showing little sign of recovery at this stage, we believe the discount is reasonable.

GS Retail: SOTP valuation (KRWbn) Value Notes CVS 4,223 Applied target PER 25.8x to 2016E NP Supermarkets 39 Applied target PER 17.9x to 2016E NP Hotels 444 Applied target PER 22.3x to 2016E NP Net debt -891 2016E Daiwa forecast Total value 3,810

No. of shares (m) 77

Value per share (KRW) 49,542

Source: Bloomberg, Daiwa forecasts

GS Retail: 12-month forward PER bands (KRW) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Apr-15 Apr-13 Oct-13 Apr-14 Apr-16 Oct-14 Oct-15 Jun-13 Jun-15 Jun-14 Feb-13 Feb-14 Feb-15 Feb-16 Dec-13 Dec-14 Dec-15 Aug-13 Aug-14 Aug-15 Price 15.0x 18.0x 21.0x 25.0x 28.0x

Source: Bloomberg, Daiwa forecasts

Potential share-price catalyst Completion of Parnas Construction work is under way on Parnas Tower, which will be used as an office building. Tower should boost the The company added the hotel business to its portfolio in 3Q15, by acquiring Parnas Hotel hotel business from affiliate GS Engineering (006360 KS, KRW 28,250, Underperform [4]). At the time of the acquisition, GS Engineering was constructing a new building, Parnas Tower, next to the existing hotel (Parnas Hotel). Construction is still under way and is scheduled to be completed by 3Q16. Until the construction work is over, the operations of the Parnas Hotel and Parnas Mall will be disrupted, limiting the profitability of GS Retails’ hotel business.

Parnas Tower will be 46 stories tall with a total floor area of 104,373 sq m. According to a local realtor we spoke with, the annual rental income for the new building will be around KRW53bn in total, which is equivalent to around one-quarter of the hotel business’s annual sales. The building is located near COEX, the largest convention centre in Seoul. In 2021, Hyundai Motor Group is due to relocate its headquarters to the area, a move that will increase asset values in the area as well as demand for office space, in our view. In addition, GS Retail plans to open another business hotel in the Myung Dong area of the city, which is favoured by visitors from Mainland China. The company intends to announce further details regarding the hotel this year.

GS Retail (007070 KS): 13 April 2016

GS Retail: hotel business sales trend and margin trend (KRWbn) (%) 300 15.6 15.4 250 15.2 200 15.0 14.8 150 14.6 100 14.4 14.2 50 14.0 0 13.8 2015E 2016E 2017E 2018E Sales (LHS) OPM (RHS)

Source: Company, Daiwa forecasts

Risks Supermarket business The main downside risk that we see for GS Retail is its supermarket business. The facing competition company operates 281 supermarket outlets in Korea and plans to open 13-14 more this year. This business contributed 22.1% of 2015 revenue but made a minimal earnings contribution. The low profitability (0.1% operating margin in 2015) was due to the increasing competition from other retailers (hypermarkets and social commerce), which we do not see abating in the near term.

Following aggressive moves by social commerce operators selling household goods, the supermarkets and hypermarkets have lost considerable market share within the retail market as a whole. We believe the competition will continue this year as hypermarkets such as E-Mart (139480 KS, not rated) have announced plans to compete on price with these new market entrants.

In addition, there is the possibility of further regulations being imposed. The supermarket business has been tightly regulated by the government, since it is dominated by large conglomerates, and such measures have hindered store expansion for such platforms. With Korea counting down to its general election in April 2016, we would not rule out populist measures such as further government regulation of the supermarkets in Korea.

Korea: supermarket sales trend 16% 14% 12% 10% 8% 6% 4% 2% 0% 2010 2011 2012 2013 2014 2015

Hypermarket Supermarket Non-store retailer

Source: KOSIS

GS Retail (007070 KS): 13 April 2016

GS Retail: supermarket business sales and operating margin Sales(LHS) OPM(RHS) (KRW bn) 1,800 2.5% 1,600 1,400 2.0% 1,200 1.5% 1,000 800 1.0% 600 400 0.5% 200 0 0.0% 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E

Source: Company, Daiwa forecasts

GS Retail (007070 KS): 13 April 2016

Company profile A CVS and supermarket operator in Korea Comprehensive retail company No.1 CVS in Korea GS Retail started out as Goldstar Electric Engineering, a subsidiary of the LG Group’s in terms of sales former parent company, Lucky Goldstar Group, in 1971. Its main business was selling electronic wires and cables for communication. In 1974, the company started its retail business by opening its first supermarket, and in 1990, 1992 and 1996, respectively, it expanded by establishing CVS, department store and mart operations. These retail operations were then integrated into LG Retail, which became part of the GS Group in 2004. The company’s name was changed to GS Retail in 2005.

To strengthen its convenience store and supermarket operations, the company sold 2 of its companies, GS Department Store and Mart, to Lotte Shopping in 2010. This move cleared the way for the company to focus on the CVS segment, and by 2015 it had 9,285 CVS stores across the country, placing it second behind BGF Retail in terms of number of CVS outlets.

Korea CVS market: market share breakdown GS Retail: number of CVS (Store) 100% 11085 18.3% 21.1% 17.3% 12,000 10585 9985 80% 6.8% 10.0% 6.5% 10,000 9285 8290 60% 21.8% 21.1% 20.1% 7774 8,000 7138 6326 40% 25.7% 23.8% 24.5% 6,000 5026 20% 27.5% 27.5% 28.2% 4,000

0% 2,000 2013 2014 2015 0 GS Retail BGF Retail Seven Eleven Mini Stop Others 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E

Source: Companies Source: Company

GS Retail’s main business today is CVS, which accounted for 74.2% of its revenue and 83.5% of its operating profit in 2015. The company has been experimenting with several concepts, such as café-type CVS, in a bid to tap into emerging consumption trends. Away from its CVS business, GS Retail’s supermarket business contributed 22.1% of total revenue but had an operating margin of just 0.1% in 2015. Due to government regulations capping expansion in the number of supermarket stores, GS Retail is targeting to strengthen its private-brand products and online market. In 3Q15, the company acquired Parnas Hotel from its affiliate GS Engineering. The hotel operation contributed only 1.1% of GS Retail’s total sales in 2015 as it was only consolidated from September, though it had a high operating margin of 15.5%.

GS Retail: revenue by business GS Retail: operating margin by business (KRWbn) 18% 15.5% 7,000 16% 153.9 6,000 66.4 14% 1,389.3 12% 5,000 128.9 118.5 10% 4,000 1,331.4 1,370.6 8% 3,000 6% 3.7% 4.1% 4,652.5 3.2% 2,000 4% 3,219.4 3,502.1 1.1% 2% 1,000 0.1% 0.1% 0% 0 CVS Supermarket Hotel 2013 2014 2015 CVS Supermarket Hotel Others 2013 2014 2015

Source: Company Source: Company

GS Retail (007070 KS): 13 April 2016

Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware Kevin LAI (852) 2848 4926 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Junjie TANG (852) 2773 8736 [email protected] Kevin JIN (82) 2 787 9168 [email protected] Macro Economics (China) Small/Mid Cap Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property TAIWAN Cynthia CHAN (852) 2773 8243 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Property (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Leon QI (852) 2532 4381 [email protected] (Regional) Banking (Hong Kong/China); Broker (China); Insurance (China) Christie CHIEN (886) 2 8758 6257 [email protected] Anson CHAN (852) 2532 4350 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Consumer (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (PC Hardware) Gaming and Leisure (Hong Kong/China) Christine WANG (886) 2 8758 6249 [email protected] Dennis IP (852) 2848 4068 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Power; Utilities; Renewables and Environment (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] John CHOI (852) 2773 8730 [email protected] IT/Technology Hardware (Handsets and Components) Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Helen CHIEN (886) 2 8758 6254 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap Head of Automobiles; Transportation and Industrial (Hong Kong/China) Brian LAM (852) 2532 4341 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Transportation – Railway; Construction and Engineering (China) Jibo MA (852) 2848 4489 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group Thomas HO (852) 2773 8716 [email protected] Capital Goods; Utilities

Custom Products Group SINGAPORE Ramakrishna MARUVADA (65) 6499 6543 [email protected] PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Utilities and Energy Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods David LUM (65) 6329 2102 [email protected] Banking; Property and REITs Shane GOH (65) 64996546 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

GS Retail (007070 KS): 13 April 2016

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GS Retail (007070 KS): 13 April 2016

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GS Retail (007070 KS): 13 April 2016

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The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

GS Retail (007070 KS): 13 April 2016

Disclosure of investment ratings Rating Percentage of total Buy* 66.9% Hold** 19.7% Sell*** 13.5% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2016. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

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