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Ottogi (007310 KS) Investment Strategy and Risk Evaluation Ottogi (007310 KS) Investment strategy and risk evaluation Food & Beverage 4Q14 review: OP continues steady growth In 4Q14, Ottogi’s revenue edged up 1.5% YoY and operating profit jumped 21.5% YoY. Company Report The modest revenue growth seems attributable to less-than-usual channel stuffing in March 9, 2015 4Q in light of robust revenue expansions in 1Q-3Q. Sales of noodles (including ramen, 28% of sales), condiments (mayonnaise, ketchup , etc., 15%) and rice (instant rice, etc., 6%) are estimated to have climbed, but sales of oil Not Rated products (cooking oil, etc., 17%), seafoods (tuna, etc., 5%) and frozen foods (dumpling, etc. 4%) are estimated to have declined slightly. Target Price (12M, W) - Decreased competition in major product categories, improved sales channel efficiency, Share Price (03/05/15, W) 598,000 cost cuts and lower raw ingredient prices helped drive operating profit. Expected Return - Investment points and concerns For 2015, we expect Ottogi to post revenue and operati ng profit growth of 3.1% and 7.8%, respectively. OP (14F, Wbn) 116 Consensus OP (14F, Wbn) 117 Positives are: growing single-person households, expansion of the home meal replacement (HRM) market, decreased competition in major product categories (curry, EPS Growth (14F, %) 2.6 ketchup, mayonnaise, etc.), market share gain in ramen, increasing canned tuna profits, Market EPS Growth (14F, %) -2.0 overall stabilization of raw material prices, steady cost cuts, shift to more profitable P/E (14F, x) 17.8 sales channels, and improvements in the subsidiary’s operating results. Market P/E (14F, x) 13.9 KOSPI 1,998.38 However, there are concerns as well, including slower growth in shipments amid Market Cap (Wbn) 2,057 weakening domestic demand, slower price hikes (some product prices may even be Shares Outstanding (mn) 3 lowered), a likely increase in the US$/W rate, and passive overseas expansion. Free Float (%) 34.7 Factors that will likely affect investors’ investment strategies and Ottogi’s operating Foreign Ownership (%) 16.1 results are addressed in pages 2 and 3. Beta (12M) 0.87 52-Week Low 371,000 Conclusion 52-Week High 649,000 We believe that Ottogi has the strongest food business in Korea with competitive product (%)(%)(%) 1M1M1M 6M6M6M 12M12M12M lineups (steady-selling items by category). The company stands to benefit from ongoing Absolute 0.7 1.4 52.7 growth in single-person households and the HRM market. Dividend per share holds room Relative -1.6 3.9 50.7 for significant upside, in light of the firm’s smooth cash flow. But weak overseas presence (including exports) is a negative. The stock is trading a 2015F P/E of 20.1x. 180 Ottogi KOSPI 160 140 120 100 80 2.14 6.14 10.14 2.15 Daewoo Securities CCo.,o., Ltd. FY (12) 12/11 12/12 12/13 12/14F 12/15F 12/16F Revenue (Wbn) 1,601 1,687 1,728 1,782 1,837 1,897 [F&B/Tobacco] OP (Wbn) 84 109 105 116 125 141 Woon-mok Baek OP Margin (%) 5.2 6.5 6.1 6.5 6.8 7.4 +822-768-4158 NP (Wbn) 70 75 91 94 102 117 [email protected] EPS (W) 20,343 21,725 26,557 27,253 29,716 33,881 ROE (%) 13.3 12.1 13.2 12.1 11.9 12.2 Jungyeon Kwon +822-768-4161 P/E (x) 7.6 10.1 15.0 17.8 20.1 17.7 [email protected] P/B (x) 0.9 1.1 1.8 2.0 2.3 2.0 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURESDISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. March 9, 2015 Ottogi 2015 ramen business strategy Ottogi’s noodle business, which includes cellophane noodles and ramen, contributes 20% of the company’s total revenue. Of note, ramen has been delivering double digit growth. The company appears to have raised its share of the ramen market (estimated at around W2tr) from 16.4% in 2013 to 19-20% in 2014 thanks to its aggressive marketing campaigns, including increased ads, a price cut, and giveaways. We believe that the company has solidified its second place in the ramen market following Nongshim. We expect Ottogi’s aggressive marketing campaigns to continue into 2015. The company will likely maintain a low-price policy for Jin Ramen in order to raise its market share, while highlighting the unique taste of its Sesame Ramen. The company is unlikely to release new ramen products in 2015. The number of those aged between ten to twenties, the main age group for ramen consumption, is decreasing, making it difficult to increase sales volume. Typically, price and marketing competition is avoided during a fall in sales volume. However, the ramen market is currently seeing competition intensify. The only positive development is stable raw material prices. The likelihood of a ramen price hike remains intact in 2015, given that: 1) its price increase has been low among major F&B products since 2008; and 2) a price hike would not drive down consumption markedly in light of the prices of its replacements. However, a price hike needs to be initiated by the leading maker Nongshim. If Ottogi maintains a low price policy, Nongshim would find it difficult to push through a price hike. What are the strategies for the canned tuna business for 2015? Seafoods and canned tuna account for 5% of Ottogi’s revenue. The company takes up 14% of the Korean canned tuna market (about W440bn) with annual canned tuna sales of W60-70bn. Dongwon F&B dominates the domestic canned tuna market with a market share of 72-75%. Ottogi is believed to have enjoyed an increase in canned tuna earnings in 2014 thanks to a decline in tuna (skipjack) prices (US$2,008/tonne in 2013 US$138.4bn in 2014). As tuna prices are unlikely to rebound sharply in 2015 in light of the oil price downtrend and growth in catches, the company’s canned tuna earnings are anticipated to remain on the rise this year. Meanwhile, Ottogi cut its canned tuna prices by 10% in 2015. This move raised expectations that it could expand its market share as it had pushed up its ramen market share through aggressive price cuts in 2014. However, the company’s efforts to expand market share through price cuts should face limitations due to the small size of the domestic tuna market. What are the expected impacts of changes in distribution channel? We believe the current changes in the company’s distribution channels should benefit Ottogi. The company’s distribution channel breaks down into: hypermarkets (25%), sales agencies (20%), food ingredient supply (15%), mom-and-pop stores (11%), convenience stores (4%), and other (25%). While sales in hypermarkets are sliding, sales at mom-and-pop stores and convenience stores, and food ingredient sales are on the rise. Of note, growth in convenience store and food ingredient sales is accelerating thanks to an increase in single-person households and the development of the dining-out market, respectively. Meanwhile, margins are the largest for sales to sales agencies, followed by convenience stores and hypermarkets. Accordingly, the current changes in distribution channels are favorable to Ottogi’s margins, in our view. What is the prospect for price hikes in in 2015? Ottogi should face difficulties in raising prices this year in light of sluggish domestic demand and stable ingredient prices. In our view, the company will be able to raise prices for health supplements, eggs, and frozen foods. Meanwhile, the company appears to be able to cut prices for items, such as canned tuna, condiments, and soy oil, to expand market shares or reflect falling ingredient prices. KDB Daewoo Securities Research 2 March 9, 2015 Ottogi Shipments for 2015 In 2014, the company’s food shipments inched up 1.2% YoY. However, it should be noted that food shipments decreased for three consecutive months during October-December (roughly by 0.5- 1.0%), and also declined 0.4% in January 2015. Indeed, shipment growth seems unlikely in light of the economic slump and population aging. For 2015, we expect food shipments to shrink slightly (by 0.5-1%) as well. Ottogi’s products are mostly immune to economic conditions. Thus, we do not anticipate shipment contraction for 2015. However, we also do not expect shipment growth of more than 2%. Raw material prices for 2015 We estimate Ottogi’s annual raw material costs at W650bn (60% for imported raw materials; 40% for domestic). Prices of raw materials (e.g., refined soybean oil, sugar, ethanol, starch syrup, palm oil, and tuna) are currently stable, and we do not expect its raw material prices to rise this year. Meanwhile, given falling oil prices, the company might see prices of supplementary materials (e.g., packaging materials) decline. We estimate supplementary material costs account for 10% of overall production costs. In 2014, Ottogi’s production costs plummeted thanks to stable raw material prices and its cost reduction efforts. A decline in production costs is likely to continue this year, but not as significantly as in 2014. Figure 111.1. OttogiOttogi’’’’ss ramen M/SM/SM/S is rising Figure 222.2. Global grain prices decreasing (%) (%) (index) (%) 25 Ottogi (L) Samyang (L) Other (L) Nongshim (R) 70 800 Global grain price (L) 120 YoY growth (R) 68 20 600 80 66 15 400 40 64 10 200 0 62 5 60 0 -40 11 12 13 14 15F 10 11 12 13 14 15 Source: KDB Daewoo Research Source: Statistics Korea, KDB Daewoo Research Figure 333.3.
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