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.

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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. Processed food CPI slowing down Figure 444.4. Food shipment growth slowing down

(2010=100) (%) (2010=100) (%) 125 Processed food CPI (L) 20 120 Food shipment (L) YoY growth (R) 15 YoY growth (R) 10 115 15 110 5 105 10 100 0

95 5 -5 90 85 0 -10

75 -5 80 -15 08 09 10 11 12 13 14 15 09 10 11 12 13 14 15

Source: Statistics Korea, KDB Daewoo Research Source: Statistics Korea, KDB Daewoo Research

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March 9, 2015 Ottogi

Ottogi (007310 KS/Not Rated)

Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/13 12/14F 12/15F 12/16F (Wbn) 12/13 12/14F 12/15F 12/16F Revenue 1,7281,7281,728 1,7821,7821,782 1,8371,8371,837 1,8971,8971,897 Current Assets 501501501 571571571 634634634 718718718 Cost of Sales 1,3371,3371,337 1,3691,3691,369 1,4041,4041,404 1,4381,4381,438 Cash and Cash Equivalents 177 241 292 365 Gross Profit 391391391 413413413 433433433 459459459 AR & Other Receivables 118 120 124 128 SG&A Expenses 286286286 297297297 308308308 319319319 Inventories 119 121 126 130 Operating Profit (Adj) 105105105 116116116 125125125 141141141 Other Current Assets 87 89 92 95 Operating Profit 105105105 116116116 125125125 141141141 NonNonNon-Non ---CurrentCurrent Assets 705705705 748748748 788788788 819819819 NonNonNon-Non ---OperatingOperating Profit 212121 999 131313 171717 Investments in Associates 150 152 158 163 Net Financial Income 3 2 3 4 Property, Plant and Equipment 508 549 583 610 Net Gain from Inv in Associates 16 8 12 12 Intangible Assets 17 18 17 16 Pretax Profit 126 125 138 158 Total Assets 1,2061,2061,206 1,3191,3191,319 1,4221,4221,422 1,5381,5381,538 Income Tax 33 31 35 40 Current Liabilities 292292292 324324324 340340340 349349349 Profit from Continuing Operations 92 94 103 117 AP & Other Payables 218 221 230 237 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 21 49 54 54 Net Profit 92 94 103 117 Other Current Liabilities 53 54 56 58 Controlling Interests 91 94 102 117 NonNonNon-Non ---CurrentCurrent Liabilities 173173173 176176176 174174174 177177177 Non-Controlling Interests 1 0 0 1 Long-Term Financial Liabilities 92 93 88 88 Total Comprehensive Profit 100100100 909090 103103103 117117117 Other Non-Current Liabilities 81 83 86 89 Controlling Interests 99 89 102 116 Total Liabilities 465465465 500500500 514514514 526526526 Non-Controlling Interests 1 0 1 1 Controlling Interests 736736736 814814814 902902902 1,0061,0061,006 EBITDA 133 146 157 174 Capital Stock 17 17 17 17 FCF (Free Cash Flow) 59 35 71 90 Capital Surplus 10 10 10 10 EBITDA Margin (%) 7.7 8.2 8.5 9.2 Retained Earnings 699 777 866 969 Operating Profit Margin (%) 6.1 6.5 6.8 7.4 NonNonNon-Non ---ControllingControlling Interests 555 555 666 666 Net Profit Margin (%) 5.3 5.3 5.6 6.2 Stockholders' Equity 741741741 819819819 908908908 1,0121,0121,012

Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/13 12/14F 12/15F 12/16F 12/13 12/14F 12/15F 12/16F Cash Flows from Op Activities 118 109 136 150 P/E (x) 15.0 17.8 20.1 17.7 Net Profit 92 94 103 117 P/CF (x) 9.7 11.3 12.3 11.0 Non-Cash Income and Expense 49 54 64 70 P/B (x) 1.8 2.0 2.3 2.0 Depreciation 27 29 31 33 EV/EBITDA (x) 9.3 10.2 11.7 10.1 Amortization 1 1 1 1 EPS (W) 26,557 27,253 29,716 33,881 Others 21 24 32 36 CFPS (W) 41,071 43,189 48,452 54,304 Chg in Working Capital 4 -12 4 4 BPS (W) 216,534 239,103 264,893 294,847 Chg in AR & Other Receivables -4 -2 -5 -4 DPS (W) 3,500 4,000 4,000 4,000 Chg in Inventories -6 -1 -5 -4 Payout ratio (%) 12.8 14.4 13.2 11.5 Chg in AP & Other Payables 11 2 7 6 Dividend Yield (%) 0.9 0.8 0.7 0.7 Income Tax Paid ---27 -272727 ---28-282828 ---35-353535 ---40-404040 Revenue Growth (%) 2.4 3.1 3.1 3.3 Cash Flows from Inv Activities -53 -87 -61 -54 EBITDA Growth (%) -0.7 9.8 7.5 10.8 Chg in PP&E -59 -67 -65 -60 Operating Profit Growth (%) -3.7 10.5 7.8 12.8 Chg in Intangible Assets 0 0 0 0 EPS Growth (%) 22.2 2.6 9.0 14.0 Chg in Financial Assets 10 -1 -3 -3 Accounts Receivable Turnover (x) 15.3 15.3 15.3 15.3 Others ---4 -444 ---19-191919 777 999 Inventory Turnover (x) 14.9 14.8 14.9 14.8 Cash Flows from Fin Activities -35 13 -18 -18 Accounts Payable Turnover (x) 7.7 7.6 7.6 7.5 Chg in Financial Liabilities -14 29 0 0 ROA (%) 8.0 7.5 7.5 7.9 Chg in Equity 0 0 0 0 ROE (%) 13.2 12.1 11.9 12.2 Dividends Paid -10 -12 -14 -14 ROIC (%) 15.1 16.4 16.3 17.5 Others ---11 -111111 ---4-444 ---4-444 ---4-444 Liability to Equity Ratio (%) 62.7 61.0 56.5 52.0 Increase (Decrease) in Cash 30 65 51 73 Current Ratio (%) 171.5 176.2 186.8 205.8 Beginning Balance 146 177 241 292 Net Debt to Equity Ratio (%) -19.3 -21.9 -25.7 -30.5 Ending Balance 177177177 241241241 292292292 365365365 Interest Coverage Ratio (x) 25.8 27.9 28.9 32.6 Source: Company data, KDB Daewoo Securities Research estimates

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March 9, 2015 Ottogi

APPENDIX 1

Important Disclosures & Disclaimers

Disclosures As of the publication date, Daewoo Securities Co., Ltd and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the subject company's shares outstanding.

Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein.

Disclaimers This report is published by Daewoo Securities Co., Ltd. (“Daewoo”), a broker-dealer registered in the Republic of Korea and a member of the . Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith, but such information has not been independently verified and Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the . If this report is an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising from the use hereof. This report is for general information purposes only and it is not and should not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws and regulations or subject Daewoo and its affiliates to registration or licensing requirements in any jurisdiction should receive or make any use hereof. Information and opinions contained herein are subject to change without notice and no part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Daewoo. Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. The price and value of the investments referred to in this report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur

Distribution United Kingdom: This report is being distributed by Daewoo Securities (Europe) Ltd. in the United Kingdom only to (i) investment professionals falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”), and (ii) high net worth companies and other persons to whom it may lawfully be communicated, falling within Article 49(2)(A) to (E) of the Order (all such persons together being referred to as “Relevant Persons”). This report is directed only at Relevant Persons. Any person who is not a Relevant Person should not act or rely on this report or any of its contents. United States: This report is distributed in the U.S. by Daewoo Securities (America) Inc., a member of FINRA/SIPC, and is only intended for major institutional investors as defined in Rule 15a-6(b)(4) under the U.S. Securities Exchange Act of 1934. All U.S. persons that receive this document by their acceptance thereof represent and warrant that they are a major institutional investor and have not received this report under any express or implied understanding that they will direct commission income to Daewoo or its affiliates. Any U.S. recipient of this document wishing to effect a transaction in any securities discussed herein should contact and place orders with Daewoo Securities (America) Inc., which accepts responsibility for the contents of this report in the U.S. The securities described in this report may not have been registered under the U.S. Securities Act of 1933, as amended, and, in such case, may not be offered or sold in the U.S. or to U.S. persons absent registration or an applicable exemption from the registration requirements. Hong Kong: This document has been approved for distribution in Hong Kong by Daewoo Securities (Hong Kong) Ltd., which is regulated by the Hong Kong Securities and Futures Commission. The contents of this report have not been reviewed by any regulatory authority in Hong Kong. This report is for distribution only to professional investors within the meaning of Part I of Schedule 1 to the Securities and Futures Ordinance of Hong Kong (Cap. 571, Laws of Hong Kong) and any rules made thereunder and may not be redistributed in whole or in part in Hong Kong to any person. All Other Jurisdictions: Customers in all other countries who wish to effect a transaction in any securities referenced in this report should contact Daewoo or its affiliates only if distribution to or use by such customer of this report would not violate applicable laws and regulations and not subject Daewoo and its affiliates to any registration or licensing requirement within such jurisdiction.

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March 9, 2015 Ottogi

KDB Daewoo Securities International Network

Daewoo Securities Co. Ltd. () Daewoo Securities (Hong Kong) Ltd. Daewoo Securities (America) Inc. Head Office Two International Finance Centre 320 Park Avenue 34-3 Yeouido-dong, Yeongdeungpo-gu Suites 2005-2012 31st Floor

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