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Korea Consumer Discretionary 28 June 2018 Korea Consumer The rise of daigou as a new buying force Daigou demand has become integral to Korea’s duty-free industry Easing competition in the DFS segment to lead to improving margins from 2018E; we expect rapid earnings growth from this channel Reiterating Positive sector rating; initiating coverage on Hotel Shilla with a Buy (1) rating; Amorepacific is our top cosmetics pick Iris Park (82) 2787 9165 [email protected] What's new: With the decline in visitors from China to Korea since March Key stock calls 2017, Korea’s duty-free stores (DFS) have sharpened their focus on New Prev. attracting daigou, a Chinese term for personal shoppers. We estimate that Amorepacific (090430 KS) in 2017, daigou sales totalled KRW6.9tn — nearly half of all DFS sales in Rating Buy Buy Korea. The daigou segment has become an important source of cash flow Target 440,000 430,000 Upside p 42.4% for Korea’s DFS and cosmetics players, and we look for it to support LG Household & Health Care (051900 KS) double-digit revenue growth for both groups over our forecast horizon. Rating Buy Outperform Target 1,710,000 1,430,000 What's the impact: Chinese government taking steps to legitimise Upside p 19.3% daigou. We expect the daigou channel to evolve into a legitimate channel, Hotel Shilla (008770 KS) as the Chinese government has been taking measures since 2015 to Rating Buy legalise the grey market created by personal shoppers. At the same time, Target 165,000 we believe the continued growth of mobile commerce will support weishang Upside p 41.6% (online micro-shops) sales. According to iResearch, sales through Source: Daiwa forecasts weishang totalled CNY497bn in 2017, or c. 6.9% of online sales in China. The China Information Industry Network forecasts for this figure to almost double in the next 2 years. Positive for DFS and cosmetics names. The rise of daigou will continue to benefit DFS operators and cosmetics manufacturers, in our view. Korean DFS offer attractive prices, backed by their scale and due to easing competition as companies pay lower (though still generous) commissions to daigou ahead of a likely upswing in visitors. This approach also attracts daigou, allowing DFS to gain further scale and bringing about a virtuous cycle. Besides, the cosmetics companies benefit as daigou focus on selling cosmetics, particularly Korean ones. What we recommend: Amorepacific now derives nearly half of its earnings from DFS, and we look for its earnings to recover significantly in 2H18 on increased Mainland Chinese arrivals. The stock remains a Buy (1), with a TP of KRW440,000 (from KRW430,000) based on the average of our 2018-19E EPS (from 2018E only). LG H&H has a comparatively flexible DFS sales policy, which effectively gives daigou better access to its brands. We upgrade LG H&H to Buy (1) from Outperform (2) and lift our TP to KRW1.71m (from KRW1.43m), as we expect its diagou sales to be sustained. For Hotel Shilla, we look for its main DFS business to see a return in 2018E to its 2014 operating margin of 5%, on the likely inflow of Mainland visitors and daigou. We initiate on Shilla with a Buy (1) call and forecast its earnings growth to resume in 2018 and continue through 2020E. Risk: tax policy changes in China that weigh on daigou demand. How we differ: We are more bullish than the market on the cosmetics names and Shilla, as we assume higher Chinese visitor growth in 2H18. See important disclosures, including any required research certifications, beginning on page 50 Korea Consumer: 28 June 2018 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 Amorepacific 090430 KS 309,000 Buy Buy 440,000 430,000 2.3% 11,908 13,385 (11.0%) 15,318 15,603 (1.8%) Cosmax 192820 KS 156,500 Buy Buy 196,000 164,000 19.5% 4,767 5,046 (5.5%) 7,321 7,936 (7.8%) Hotel Shilla 008770 KS 116,500 Buy 165,000 4,177 6,197 LG Household & Health Care 051900 KS 1,433,000 Buy Outperform 1,710,000 1,430,000 19.6% 56,411 56,411 0.0% 65,815 65,815 0.0% Source: Bloomberg, Daiwa forecasts Korea: DFS market size China: weishang market size (USDbn) (% ) (CNYbn) 30,000 60 1,200 300% 980.4 25,000 1,000 250% 20,000 40 800 707.0 200% 15,000 600 496.5 150% 328.7 10,000 20 400 100% 194.0 5,000 200 82.0 50% 0 0 0 0% 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E 2014 2015 2016 2017 2018E 2019E Market size YoY Sales (LHS) YoY (RHS) Source: KDFA, Daiwa forecasts Source: China Information Industry Network (中国产业信息网) 2 Korea Consumer: 28 June 2018 Table of contents Chinese resellers: coming in from the dark ........................................................... 4 Daigou and weishang ........................................................................................................4 Is the daigou business model sustainable? ........................................................................7 What impact will daigou have on Korea’s consumer sector going forward? .......................9 Recovery in Mainland Chinese visitor numbers ...................................................14 Ratings, valuations and earnings outlook .............................................................17 Risks to our Positive sector stance .......................................................................19 Company Section Amorepacific .................................................................................................................... 20 Hotel Shilla ...................................................................................................................... 23 LG Household & Health Care........................................................................................... 40 Cosmax ........................................................................................................................... 43 3 Korea Consumer: 28 June 2018 Chinese resellers: coming in from the dark Daigou and weishang The daigou market has Daigou (代工), which means “to buy on behalf of”, refers to overseas shoppers who grown rapidly in the past purchase goods for customers in Mainland China. According to the China Information few years Industry (中国产业信息网), daigou sales were estimated to total CNY66bn (KRW113tn) in 2017. As of 2015, Korea was one of the top-6 destinations for daigou shoppers. Daigou: preferred markets (2015) Others, 1% Australia, 18% Japan & Korea, 34% U.S., 21% Hong Kong & Macau, 25% Source: Australia China Daigou Association (ACDA) These shoppers arbitrage the price difference between a product’s price in its country of origin and its price in Mainland China. According to various market sources, the average margin for a daigou is 20-30%. The price difference is due to 3 taxes levied on imported goods to China: an import tariff, value-added tax, and consumption tax. This leads to a large price gap between the price in China and the product’s country of origin, and creates business opportunities for daigou. The daigou channel is well accepted by consumers as items bought via daigou are perceived to be “authentic” — an important point given the prevalence of counterfeit goods in China. Daigou: development phase 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016~ Small Medium Large Lots of sellers, Few sellers and Many sellers and lot of buyers and lots few buyers many Buyers of third parties - Small quantities - Medium quantities - Large quantities - Limited product selection - More product selection - Diverse product selection - Limited channels - Medium channels - Large channels (Friends, family members and (Friends, family members, (All kinds of customers) relatives) relatives and own circles) - Standardised system - Word-of-mouth - Word-of-mouth - Involvement of third parties - Use of social media - Marketing/promotions - Use of social media and online platforms Source: National Chengchi University, Chongqing Daily News (Nov. 2013) 4 Korea Consumer: 28 June 2018 Daigou: distribution structure Manufacturer and brands l Tier 1 Daigou l Tier 2 Daigou l Tier 3 Daigou l Weishang platforms L Consumers Source: iResearch Daigou connect with Daigou distribution can involve more than 1 tier and as many as 5 tiers (see above chart). customers through For example, manufacturers and brands sell products to daigou at highest level (Tier 1), weishang platforms which then distributes the items to daigou one tier below, and so on. The price difference in each transaction is essentially the profit margin realised by daigou. Moreover, daigou at the upper level typically receive a cut of the total sales of lower-tier daigou. Further down the tree, by using weishang (微商) platforms, daigou can realise lower distribution costs than if they were to use offline channels. The main channel for daigou distribution is the online C2C channel. According to iResearch forecasts, China’s online C2C channel will record a gross merchandise value (GMV) of CNY4.7tn (up 23.7% YoY) in 2018, on the back of the increasing penetration of online retail. Further, we forecast China’s online C2C channel sales to expand by about 25% pa from 2018-20E, and to total CNY7.3tn in 2020E. And we see the weishang segment being one of the main drivers of this growth. China: online retail market size (CNY bn) 14,000 12,000 10,000 5,736 8,000 4,849 4,010 6,000 3,372 4,000 2,475 7,301 1,946 5,926 2,000 1,289 3,803 4,708 648 2,681 1,203 1,526 1,931 0 2013 2014 2015 2016 2017 2018E 2019E 2020E Total C2C GMV Total B2C GMV Source: Daiwa, iResearch forecasts Weishang operators sell their products through mobile chat applications such as WeChat. Weishang started out as a C2C channel but is becoming platform based. For example, the Weidian (微店) app launched by WeChat in 2013 allows WeChat users to purchase products from weishang and pay electronically via WeChat. According to the China Information Industry Network, China’s weishang market was worth around CNY496bn (up 51% YoY) at end-2017, and will almost double to CNY980bn by 2019E.
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