The Rise of Daigou As a New Buying Force

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)

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

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)

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.

Korea Consumer: 28 June 2018

Weishang: market size and forecast (CNYbn) 1,200 300% 980.4 1,000 250%

800 707.0 200%

600 496.5 150%

400 328.7 100% 194.0 200 82.0 50%

0 0% 2014 2015 2016 2017 2018E 2019E Market size (LHS) YoY (RHS)

Source: China Information Industry Network (中国产业信息网)

The weishang sales channel From social platform to The weishang channel started out using a C2C model, where individual resellers sold e-commerce platform products via social networking services. However, as the sales value ballooned, successful weishang went on to establish their own brands, which in turn prompted online commerce companies to enter the market by setting up their own weishang stores. The boom started in 2015, when Tencent’s CEO, Jack Ma, spoke of the growth potential of weishang and indicated that he wanted to work more closely with the channel.

Weishang can be broken down into 2 categories: direct sales and reseller sales; both channels have similar sales values currently. Direct sales are usually made through corporate accounts (公众号) and sold in the B2C format. By contrast, reseller sales involve individuals opening up an account to sell via the C2C format.

Since 2014, online commerce companies such as JD.com and Taobao have allowed weishang sellers onto their platforms, while weishang-focused online companies have also established the infrastructure needed to sell their products. The result has been a rise in weishang sales, as shown in the chart above.

Weishang: C2C vs. B2C Customer-to-customer (C2C) Business-to-customer (B2C) Supplier Multi-level agent / upper-level daigou Company Major Consumer Followers (friends) General customers Logistics Delivery available for more than two items Delivery available for one item Refund/exchange available After sales service After-sales service and refunds not available Similar to general e-commerce

Source: China Weishang Association

Weishang: distribution structure

Weishang SNS

Brand Weishang Platform Weishang

Personal Weishang

Organisations

rd Logistics Payments 3 Party platform

Source: iResearch

Korea Consumer: 28 June 2018

Weishang-based platforms Platform Introduction Characteristics Weimob, a WeChat-based marketing service provider that helps businesses to build m-commerce platforms on WeChat at A partnership with Guangdiantong, a SNS advertising platform Weimob low cost. Weimob is a third-party platform that primarily by Tencent which has over 12 billion viewers on a daily basis. provides enterprises with WeChat-based development, training, and promotional solutions. Weidian helps weishang open mobile stores. If a person has a Allows for a quick and affordable way to open a mobile store mobile phone number, they can easily open their own mobile Weidian since it is free. Does not charge any service fee; money is store and promote it by forwarding it to friends or groups using transferred within two days to weishang. SNS like Weibo or QQ. Mogujie shaodian is a weishang platform made by Mogujie, a Role as an information sharing platform. Mogujie shaodian social fashion app targeting young women. Weishang sell clothes, shoes, bags, accessories and cosmetics. Is designed from a user perspective. Paipai, originally Tencent's c2c marketplace, is a weishang Free to open mobile stores Paipai platform acquired by JD. Major categories include clothes, Do not need to register as connected via QQ accessories, baby products, groceries and furniture. Its C2C site was closed in 2015 Managed by Yihaodian Yihao vdian was launched in April 2014 by Yihaodian, a B2C Yihao vdian based e-commerce company in China. All companies are managed by Yihaodian and registered on its e-commerce platform Jiuguanjia Jiuguanjia is a weishang specialising in liquor sales. Combined B2C with O2O

Source: Ministry of Agriculture, Food and Rural Affairs

Is the daigou business model sustainable? Government turning its attention to the daigou channel Daigou becoming more We believe that the Chinese government will seek to legitimise the daigou channel as part influential in China of a broader effort to discourage overseas spending by Chinese consumers. In January 2015, China’s State Administration for Market Regulation declared that daigou would be supervised by the authorities. All daigou must disclose product details to consumers and pay import tariffs. The implication is that the government will acknowledge daigou as a retail industry format and attempt to standardise it, and of course collect taxes. Despite these taxes, we believe the channel is a viable and sustainable format given the differences in price and product availability in China compared with overseas. Daigou are also eligible for a tax refund in the countries where they source products. The 3 layers of taxation in China are also another reason for this price competitiveness, while the wide variety of products on offer allows for a sustainable business model, in our view.

China: government policies on daigou Date Organisation Policy Description It stated that relevant laws and regulations also grant industrial and commercial State Administration Opinions on Vigorous Jan authorities to carry out market inspections, product quality monitoring, and other for Industry and development of E- 2015 regulations. The directional monitoring of online trading commodities is an important way Commerce (SAIC) commerce of working to assess market risks and warn against illegal operations. State Administration Sep As the sellers in daigou are considered as the same with sellers in other sales channels, for Industry and New Advertising law 2016 they are subject to advertising law. Commerce (SAIC) Dec 13th Five-Year The Ministry of The plan set out three principles: "development and standardisation parallelism, 2016 Development plan for Commerce competition and coordination coexistence, openness and safety." Electronic Commerce Jan China Electronic The regulations are to define daigou, limit the range of daigou trade, to clarify the Daigou business 2017 Commerce boundaries between daigou and multi-level sales and to protect the legitimate rights of Industry Standard Association (CECA) consumers.

Source: China Information Industry website (中国产业信息网)

Creating jobs for 20-30 year olds More freelance exporters Another reason we believe the Chinese government will ultimately take a more favourable in the daigou business view of daigou is that the industry is a source of job creation. It is becoming easier to due to the growing become a daigou, as there are now more platform providers in the field. According to the number of Chinese living China Information Industry website (中国产业信息网), there were 10.2m daigou in 2014, overseas and the number doubled to 20.2m in 2017. Around 88% of these sellers were born between 1980 and 1990, which suggests that the daigou industry is creating jobs for the younger generation.

Korea Consumer: 28 June 2018

Number of employees in weishang business (ppl mn)

25 20.2 35 30 20 15.4 25 15 12.6 20 10.2 10 15 10 5 5 0 0 2014 2015 2016 2017 Number of workers YoY

Source: China Information Industry website (中国产业信息网)

Attractive price point appeals to consumers Price differs significantly We believe weishang will be able to maintain their price competitiveness in online by channel and country channels, despite having to pay tax to the government. One good example would be in cosmetics, one of the most popular items for sale among weishang. The import tax on cosmetics ranges from 7.5% to 19%, depending on the category. In addition, the retail price includes value-added tax, at 17%, in China. This leads to a 20-40% price gap between the retail price in the country of origin and the effective retail price in China, even without factoring in consumption tax and shipping costs.

China: import tariff on major cosmetics goods (2017) HS code Product description Applied Tariff (%) 3303 Perfumes and toilet waters 10 3304 Beauty or make-up products 10.3 3305 Hair products 11.6 3306 Oral or dental hygiene products 10 3307 Shaving products, personal deodorants, bath products 9.8 3401 Soap; organic surface-active products and preparations for use as soap 11.9 3402 Organic surface-active agents (other than soap). 7.5

Source: WTO

Cosmetics: price comparison among channels TAO China official Original country Shilla Lotte Brand Item BAO (C2C) T-mall (B2C) website website DFS DFS Sulwhasoo Essential Balancing Emulsion 125ml 299 379 400 334 298 298 WHOO Cheongidan Set 1398 1599 1540 1574 1495 1495 Innisfree Green tea serum 80ml 148 119 210 141 123 123 Laneige Skin veil base 30ml 169 169 245 199 148 148 SUM Sum 37 water full 3pcs promotion Set 539 609 800 691 621 621 Benefiance wrinkle resist 24 eye contour Shiseido 439 439 520 318 329 329 cream Lancome Advanced Genifique sensitive 20ml 420 690 690 405 530 530 ESTEE LAUDER Advanced Night Repair Eye 2pcs Set 690 980 980 775 803 803

Source: Data piled by Daiwa Note: All in CNY

Sales via weishang in lower-tier cities look poised to surge Online sales in rural One source of growth for weishang is rural areas, where, according to iResearch, areas look set to boom weishang sales amounted to CNY153bn in 2017, up 23.1% YoY. According to iResearch, weishang sales growth in rural areas will outpace that of urban areas from 2016 through to 2019, as rural consumers’ access to offline stores is limited and consumer brands can sell products without having physical stores in rural parts of the country.

Korea Consumer: 28 June 2018

China: weishang sales trend in rural areas (CNYbn) 1,200 35%

1,000 30% 25% 800 20% 600 15% 400 10% 200 5% 0 0% 2014 2015 2016 2017 2018E 2019E urban rural* % of rural

Source: iResearch Note: Rural indicates from tier 3 to 5 cities

What impact will daigou have on Korea’s consumer sector going forward? DFS: stable revenue stream looks assured Downtown DFS have We believe Korea is one of the most attractive markets for Chinese professional shoppers historically been the to visit given its geographic proximity to China, as well as its price competitiveness. most popular Indeed, Korea has the largest DFS market in the world, as highlighted by the number of distribution channel for DFS stores in downtown areas. Globally, airports are the main channel for duty-free sales tourists in Korea (USD36bn, or 57% of the total, in 2016). But Korea has a long history of downtown DFS going back to 1980. Of the KRW14.7tn duty-free market in Korea last year, KRW11.1tn was attributable to downtown DFS. Around 70% of downtown DFS sales are made in the Seoul area, where there are 10 large-scale duty-free stores.

Korea: duty-free store market size trend (USDbn) (% ) 30,000 60

25,000

20,000 40

15,000

10,000 20

5,000

0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (LHS) YoY (RHS)

Source: KFDA, Daiwa forecasts

Seoul area: DFS comparison (2017) Company Store Area Store size (m²) Revenue (KRWbn) Hotel Lotte Sogong Jung-gu 13,236 3161.9 Hotel Lotte Coex** Gangnam-gu 5,828 n.a.** Hotel Lotte WorldTower Songpa-gu 17,334 572.1 Hotel Shilla Shilla DutyFree Jung-gu 7,270 2123.9 Shinsegae Myeongdong Jung-gu 13,884 1351 HDC shilla Shilla I park Yongsan-gu 27,400 832.6 Doota Doota Jung-gu 16,825 443.6 Galleria Galleria Seoul Yeongdeungpo-gu 10,072 359.5 Donghwa Donghwa Jongno-gu 6,460 321.7 SM SM DFS Seoul Jongno-gu 9,977 143.1 Shinsegae Central city* Seocho-gu 13,350 n.a. Hyundai Trade Center* Gangnam-gu 14,005 n.a. Topcity Sinchon* Seodaemun-gu 6,600 n.a.

Source: Companies Note: *to be opened **Lotte Coex reopened in December 2017

Korea Consumer: 28 June 2018

Downtown DFS in Seoul

Source: Companies Note: Red (Lotte), Green (Shilla), Orange (Shinsegae), Yellow (Doota), Black (Galleria), Blue (Donghwa), light green (SM), light blue (Hyundai); a black outline denotes a store that is yet “to be opened”

Korea offers a Compared with Japan, Korea provides a better shopping environment for professional convenient and shoppers like daigou, in our view. The Japanese market is more focused on the tax-free accessible shopping rather than duty-free element due to the low tax rate in Japan (5% in Japan vs 10% in experience for visitors Korea). However, tax-free shops in Japan are not clustered in one place but scattered throughout the city, which does not make for a convenient shopping experience. While there are one-stop duty-free stores in Japan, similar to the ones in Korea, there are more restrictions when purchasing goods at Japanese stores. For example, when buying at Tokyo duty-free stores, a consumer can only pick up his/her purchased goods at Narita or Haneda airport, and not at other airports. In Korea, there are no such restrictions. And in Korea, for domestically produced goods, consumers can take the goods with them immediately after purchase.

Duty free vs. tax free Type Range Rules Consumption tax Customs duty - All taxes are exempted from the payment Duty Free Liquor tax - Customers can collect purchased product at the pick-up area in each departure on customs regulations Tobacco tax Tax Free Consumption tax - Claims for a tax refund can be made at the counter

Source: National Tax Service, KDFA, Japanese Ministry of Tourism, DFSA

No. of duty free and tax free stores: Korea vs Japan Type Korea Japan Duty Free 52* 43* Tax Free 17,759** 42,791***

Source: National Tax Service, KDFA, Japanese Ministry of Tourism, DFSA Note: *As of Jan 2018, **As of Aug 2017, ***As of Oct 2017

Daigou make up a In addition, Korea offers more price advantages for daigou than any other country. Due to crucial customer base in the competitive landscape, Korea’s DFS operators, especially those in the Seoul area, pay Korea commissions to daigou directly, or to the travel agencies that book the tours for these daigou. This gives the daigou a greater incentive to shop in Korea rather than elsewhere. Moreover, there is a negligible price difference between the after-tax price in the goods’ country of origin and the price at Korea DFS, and items can be even cheaper after the commission is given to the daigou.

While DFS companies do reduce their commission rates from time to time, as they did in 1Q18, given the rapid increase in commission rates over the past 2 years, we would not expect rates to drop markedly as such a change would discourage daigou, which are clearly an important customer base in Korea. We estimate that in 2017, daigou sales were around KRW6.9tn — nearly half of all DFS sales in Korea. With the Chinese government’s ongoing efforts to further legitimise daigou, the price incentives offered by Korea DFS companies will become even more attractive to the daigou, in our opinion, as the daigou will be more price sensitive since they need to pay tax in China.

Korea Consumer: 28 June 2018

Korea DFS: commission paid to travel agencies (USDbn) 1,500 10% 1,148 1,200 8% 967 900 6% 549 563 600 4% 297 300 2%

0 0% 2013 2014 2015 2016 2017 Sales commission % of Revenue

Source: Korean Customs

Korea DFS: operating margin comparison 8%

(2%)

(4%) 1Q17 2Q17 3Q17 4Q17 1Q18 Shinsegae Shilla Lotte

Source: Companies

Korea vs. Japan: comparison of shopping expenditure by Chinese tourists (KRW bn) 30,000

25,000

20,000

15,000

10,000

5,000

0 2013 2014 2015 2016 2017 Expenditure in Korea Expenditure in Japan

Source: Data compiled by Daiwa

Cosmetics: price comparison — country of origin vs. Korea DFS 900 775 800 706.6 700 600 500 400 318 289.5 300 200 100 0 Eye cream(SHISEIDO) Night Repair Eye 2pcs Set(ESTEE LAUDER) Official site in origin country DFS*

Source: Data compiled by Daiwa Note: ex-tax in origin country, ex-commission in Shilla, all in CNY

Korea Consumer: 28 June 2018

Cosmetics: more opportunities in China Korea’s cosmetics We believe these resellers provide opportunities for Korean companies to expand their companies are sales in the Mainland China market. Compared with other global cosmetics companies, the strengthening their Korean cosmetics players have less of a presence in China due to their shorter history in presence in the China the country. In fact, we believe this rapid channel shift now under way in China gives the market with the ongoing Korean cosmetics companies an opportunity to expand their China footprints at a lower channel shift cost than that borne by their global peers in recent decades.

China cosmetics: market share by company (2017) 12 10.2 10 8.5 8 6 3.1 4 2.8 2.8 2.6 2.5 2.5 2.3 2.2 2.2 1.9 2 1.1

LGH&H

Shiseido

MaryKay

United

Cosmetics

UnileverGroup

L'Oréal Groupe

Jala(Group) Co

ShanghaiJahwa

Procter& Gamble

DailyChemical

Colgate-Palmolive

EstéeLauder Cos

AmorePacificCorp

ShanghaiChicmax ShanghaiPehchaolin

Source: Euromonitor

China cosmetics: market share by skin care brand (2017) (%) 5 4.5 4.2 4 3.6 3.1 2.8 3 2.7 2.5 2.5 2.1 2 1.8 1.8 1.8 2 1.7 1.7 1.6 1.5 1.5 1.5 1.1 1

Olay

SK-II

KanS

Nivea

Proya

Artistry

Perfect Aupres

Inoherb

Chando Hanhoo

Pechoin

Beautrio

Innisfree

Herborist

Lancôme One Leaf

Mary Kay

L'OréalParis Estée Lauder

Source: Euromonitor

China: number of stores by brand Country No. of stores in China Tier 1 tier 2, 3 Under tier4 Total Sulwhasoo 81 47 20 148 Korea Whoo 136 88 18 242 Innisfree 308 112 5 425 LANCOME 313 357 180 850 France Loreal Paris 63 14 4 81 U.S Estee Lauder 177 153 55 385 Shiseido 225 192 60 477 Japan Za 359 348 92 799 Shanghai Jahwa 563 5 2 570 China Herborist 547 401 118 1066 Aupres 457 520 178 1155

Source: Data compiled by Daiwa

Cosmetics are ranked in Among the products that weishang sell, cosmetics is a top-3 category, namely because: 1) the top-3 purchases cosmetics items are easy to physically carry, 2) they are characterised by repeat from weishang purchases, and 3) they generate repeat demand. According to iResearch, cosmetics goods made up 35% (CNY173bn) of all weishang sales in 2017, and increased at a rate of 29% pa from 2015-17.

Cosmetics was the best-selling category for Chinese shoppers and the top-selling category for Korea DFS last year, with sales amounting to KRW7.6tn (USD7.1bn) and contributing 53% of all DFS sales. Sales to Chinese shoppers are worth highlighting. In 2017, cosmetics accounted for 91% of all online DFS sales made to Chinese. Chinese

Korea Consumer: 28 June 2018

consumers’ preference for Korean cosmetics remains firm, as shown in the import data, which not only benefits the cosmetics players but also the DFS operators.

Weishang: focus categories China: top-3 products consumers buy from weishang 50% 60%

40% 34.2% 31.5% Cosmetics 29.7% 29.2% Groceries 30% 22.8% 22.4% 40% Clothes 18.7% 17.8% Sheet Masks Clothes 20% 3C products

6.8% 46.5% 10% 20% 41.6% 33.7% 32.6% 31.2%

0% 28.8% Books

Clothes 0% Groceries

Cosmetics Women Men

3C products3C

Shoes/Bags

SheetMasks Babyproducts

Health Supplies top1 top2 top3

Source: Henkuai (很快) , KOTRA Source: Henkuai(很快) , KOTRA Note: 3C products include Computers, Consumer Electronics and Communications

Korea DFS: sales and contribution from cosmetics Korea online DFS cosmetics sales to Chinese

(KRWbn) (KRWbn) 7,588.4 8,000 55% 600 550.0 100% 526.3 506.1 7,000 6,273.3 486.5 500 6,000 372.6 50% 400 5,000 4,193.5 4,000 300 80% 3,000 45% 200 2,000 100 1,000 0 40% 0 60% 2015 2016 2017 1Q17 2Q17 3Q17 4Q17 1Q18 Sales (LHS) % of sales (RHS) DFS cosmetics slaes % of Chinese DFS sales

Source: KOTRA Source: Statistics Korea

ODM companies may The increasing number of weishang is bringing business opportunities in China for ODM seek business companies, too. Since 2016, Cosmax (192820 KS, KRW156,500, Buy [1]) has made opportunities with products for weishang which are sold on its own mobile sales platform. Although this client weishang base doesn’t provide a stable revenue stream (because these are not brand companies that can sustain long-term businesses), it can bring new revenue streams for ODM companies from time to time. Weishang tend to sell limited SKUs, due to the inventory burden. Small SKU requirements are helpful to ODM companies’ margins, as these companies can produce a small number of items in bulk and hence realise economies of scale.

China: number of weishang stores Korea: ODM companies’ China production capacity (2017)

(stores mn) (unit bn) 16 50% 0.6 0.6 14 40% 0.5 12

10 30% 0.4 8 0.3 6 20% 4 10% 0.2 2 0.1 0.1 0.1 0 0% 2014 2015 2016 0.0 Number of Weishang YoY Cosmax Shanghai Cosmax Guangzhou Kolmar Beijing

Source: iResearch Source: Companies

Korea Consumer: 28 June 2018

120%

100% Recovery in Mainland Chinese visitor numbers6.90% 80% 42.80% 39.40% 40.90% 37.40% Mild recovery in There has been a mild recovery in the number of tourists from Mainland China visiting 60% Mainland visitors Korea since the beginning of this year. Given a low base from mid-March 2017,91.70% when numbers recently, with political40% relations between China and Korea were particularly strained, the growth in 53.80% 57.80% 56.70% 56.60% signs of a relaxation of Chinese20% visitor numbers has been strong (40-60% YoY) since March 2018. However, we China’s restrictions on believe0% that the key to more sustained growth in the number of Mainland visitors will be the group tours full-fledged return2013 of tourists travelling2014 on group2015 tours. 2016 2017 Independent Group tour

Chinese tourists: trend to Korea Chinese tourists: travel type trend 100% (ppl thousands) 6.9% 10,000 300% 90% 250% 80% 39.4% 40.9% 8,000 42.8% 37.4% 200% 70% 6,000 150% 60% 100% 50% 91.7% 4,000 50% 40% 0% 30% 2,000 53.8% 57.8% 56.7% 56.6% -50% 20% 0 -100% 10%

Jul-16 Jul-17

Jan-16 Jan-17 Jan-18

Mar-16 Mar-17 Mar-18

Nov-16 Nov-17

Sep-16 Sep-17

May-16 May-17 May-18 2013 2014 2015 2016 2017 Chinese inbound to Korea YoY Independent Group tour

Source: Korea Tourism Organisation Source: Korea Tourism Organisation

As it stands, the authorities in Beijing, Shandong, Wuhang and Chongqing permit locally based travel companies to sell Korea-related products. Besides, we note that large travel companies such as Ctrip have started selling Korea-related group tours in some of these areas. We believe that Mainland visitor numbers will pick up in earnest upon a more widespread recovery in group tourism to Korea, and we have seen signs of this happening in June.

In May 2018, the number of China/Korea passenger flights from Incheon, Korea’s largest international airport, stood at 81% of the May 2016 figure. While this marks a rise from January 2018, Jeju Island, a popular destination for group tourists visiting Korea, has yet to see signs of a recovery in Mainland visitor numbers. The positive news is that the number of overseas tourists visiting Jeju Island in late-June 2018 exceeded the June 2017 figure.

Given our view that group package tours from China to Korea are set to expand further in the coming months, we believe there are positive business and share-price catalysts on the horizon for Korea’s cosmetics and DFS segments.

China: permission for group tours to Korea Areas Date permission granted Description Beijing November 2017 Not permitted to include Lotte Hotel or Lotte DFS in itinerary Shandong November 2017 Not permitted to include Lotte Hotel or Lotte DFS in itinerary Wuhan May 2018 Not permitted to include Lotte Hotel or Lotte DFS in itinerary Chongqing May 2018 Not permitted to include Lotte Hotel or Lotte DFS in itinerary

Source: The Chinese Ministry of Culture and Tourism

Korea Consumer: 28 June 2018

China: group tour packages offered by C-trip and CITS (from Wuhan to Seoul)

Source: Ctrip.com, CITS

Incheon International Airport: number of flights from China (2016 vs. 2018) (flights) 9,000 8,018 7,601 8,000 7,223 7,404 7,352 6,966 6,847 7,039 6,945 7,000 6,245 6,000 5,000 4,000 3,000 2,000 1,000 0 Jan Feb Mar Apr May 2016 2018

Source: Korea Airports Corporation

Korea Consumer: 28 June 2018

Jeju Island: number of daily arrivals foreigners (2016 vs. 2018) (ppl) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000

3/Apr

5/Jun 2/Jan 9/Jan

6/Mar 6/Feb

1/May 8/May

10/Apr 17/Apr 24/Apr

12/Jun 19/Jun 16/Jan 23/Jan 30/Jan

13/Feb 20/Feb 27/Feb 13/Mar 20/Mar 27/Mar

15/May 22/May 29/May 2016 2018

Source: Jeju Special Self-Governing Provincial Tourism Association

Jeju Island: number of daily arrivals foreigners (2017 vs. 2018) (ppl) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000

3/Apr

9/Jan 2/Jan 5/Jun

6/Mar 6/Feb

1/May 8/May

24/Apr 10/Apr 17/Apr

16/Jan 23/Jan 30/Jan 12/Jun 19/Jun

27/Feb 13/Mar 20/Mar 13/Feb 20/Feb 27/Mar

15/May 22/May 29/May 2017 2018

Source: Jeju Special Self-Governing Provincial Tourism Association

Korea: Mainland China arrivals by area (May 2016) Korea: Mainland China arrivals by area (June 2018)

Others, 20.0% Others, 21.0%

Incheon Int'l Airport, 43%

Jeju Airport , 12% Port of Jeju, Incheon Int'l 19% Airport, 62% Gimpo Airport, 5% Jeju Airport , Gimpo Airport, 15% 3%

Source: Korea Tourism Organization Source: Korea Tourism Organization

Korea Consumer: 28 June 2018

Ratings, valuations and earnings outlook

We now have Buy (1) We maintain our positive view of Amorepacific, for which we reaffirm our Buy (1) rating and ratings on Amorepacific, raise our 12-month TP to KRW440,000 (from KRW430,000), based on the average of our LG H&H, and Hotel Shilla 2018E-19E EPS (from 2018E EPS). We upgrade LG H&H to Buy (1) from Outperform (2), as we contend that there is now more visibility on the company’s revenue growth from the daigou channel. We also initiate coverage of Hotel Shilla with a Buy (1) rating and a 12- month TP of KRW165,000. In our view, Hotel Shilla stands to benefit from the burgeoning daigou demand in Korea, while an easing of competition among DFS operators should see the company expand its 2018E EPS by more than 6x YoY, on our forecasts.

Korea Consumer Sector: peer valuations Market Cap PER (x) PBR (x) EPS growth (%) ROE (%) Company USD mn 18E 19E 18E 19E 18E 19E 18E 19E Amorepacific* 16,164 25.9 20.2 3.9 3.3 74.8 28.6 15.8 17.5 LG H&H* 20,038 25.4 21.8 5.9 4.7 33.7 16.7 24.4 22.6 Cosmax* 1,268 32.8 21.4 5.8 4.6 155.2 53.6 19.6 24.0 Korea Kolmar* 1,739 26.0 20.6 4.6 3.8 37.8 26.1 19.3 20.3 Sub Average 27.6 21.0 5.1 4.1 75.4 31.3 19.8 21.1 L'oreal 135,635 29.8 27.9 4.3 4 4.7 6.8 14.9 14.8 Estee Lauder 53,859 32.9 29.1 11.7 10.6 28.7 12.8 35.4 41.4 Shiseido 31,159 47.7 38.5 7.3 6.3 215.6 23.9 16.1 17.6 Kao 38,006 27.0 25.0 4.7 4.3 4.9 8.1 18.5 18.4 Kose 12,930 38.4 38.4 7.4 6.5 41.3 14 16.9 18.1 Sub Average 35.2 31.8 7.1 6.3 59.0 13.1 20.4 22.1 Total Average 31.8 27.0 6.2 5.3 66.3 21.2 20.1 21.6 Hotel Shilla* 4,092 27.9 18.8 4.6 3.7 517.6 48.4 19.6 22.1 DUFRY AG-REG 6,951 13.1 11.4 2.2 2.2 42.7 15 15.9 18.9 Japan Airport Terminal 4,184 14.1 14.1 3.4 2.8 71 166.5 9.1 21.4 Marriott International 45,735 23.2 20.2 17.2 25 27.8 15.2 62.6 112.3 Hilton Worldwide 23,790 29.2 24.9 28.3 54.1 35.6 17.4 57.2 179 Hyatt 8,783 52.4 40.4 2.5 2.6 -16 29.7 14.9 6.8 Average 26.7 21.6 9.7 15.1 113.1 48.7 29.9 60.1

Source: Bloomberg, *Daiwa forecasts

Amorepacific has the Among the cosmetics companies, Amorepacific stands to benefit the most, in our view, as highest exposure to DFS it has the highest exposure of all its domestic peers to DFS revenue and Mainland Chinese revenue and Mainland tourists. In 2017, the company derived nearly half of its revenue from DFS. Moreover, of Chinese tourists Amorepacific’s retail formats in Korea, DFS carries the highest operating margin, at 25- 30%, meaning that an upswing in revenue from this channel should have a significant earnings impact. In addition, we believe that Amorepacific is considering lifting its DFS purchase limits once Mainland visitors to Korea return in earnest. As a result of what would be an effective rise in ticket price, we believe the company’s DFS revenue growth will significantly outperform the growth in Mainland visitor numbers in 2H18. We believe that such strong growth has yet to be reflected in the market’s expectations for Amorepacific for 2018, which could well herald upward earnings-forecast revisions by the market in the next few months.

LG H&H’s relatively We are now more positive on LG H&H given our view of enhanced visibility on daigou flexible DFS sales policy channel sales growth. The daigou channel is important to LG H&H because of the has spillover effects company’s relatively flexible DFS sales policy. Compared with Amorepacific, LG H&H has been less rigid on sales restrictions on DFS since 2017, even after daigou became a dominant force in the market. For this reason, LG H&H has realised stronger revenue growth and higher DFS revenue (in absolute and growth terms) than Amorepacific since 2Q17. We believe this sales advantage has had a spillover effect in raising the popularity of the company’s brands in China. We see this virtuous cycle of DFS sales lifting Mainland China sales spreading to other LG H&H brands, such as Sum from 2018E — a development that we expect to sustain LG H&H’s high-end cosmetics revenue growth over our forecast horizon.

Korea Consumer: 28 June 2018

Hotel Shilla should see Hotel Shilla’s margins have been deteriorating for the past 3 years, as competition margins expand on the intensified with the opening of its downtown DFS store in Seoul in 2016. However, the back of its enhanced competition looks to have eased in recent months after top DFS player Lotte DFS recorded buying power in its first-ever operating loss in 2Q17. We are now seeing major DFS companies, including cosmetics and perfume Hotel Shilla, pay lower commission rates to lure traffic — a trend we expect to continue throughout the year. Moreover, we expect Hotel Shilla’s DFS operating margin to expand from 1.6% in 2017 to 4.9% in 2018E on the back of the company’s enhanced buying power in cosmetics and perfumes (it operates DFS concessions at Asia’s 3 major hub airports of Incheon, Singapore and Hong Kong, having opened its third store at the start of 2018).

Valuations We find that Amorepacific is trading currently at 25.2x 12-month forward PER, below its past-5-year average of 32.5x. Meanwhile, LG H&H is trading currently at 24.6x 12-month forward PER, compared with its past-5-year average of 12-month forward PER 28x. We look for both stocks to be rerated as the market recognises the likely return of Mainland Chinese visitors in 2H18, along with continued strong growth from daigou.

Meanwhile, Hotel Shilla shares traded at 12-month forward PERs of 50-250x in 2013, 2015, and 2016, when the company’s earnings were volatile. Given our forecast for a recovery in the company’s DFS operation’s margins this year, we believe the stock will be rerated to its historical average forward PER (31.5x since 2011). Also factoring in our outlook for its hotel business, we forecast Hotel Shilla to realise EPS growth of 526% YoY in 2018E and 50% YoY in 2019E. In our view, such earnings growth should support a valuation premium over the company’s global peers, as has been the case in the past 5 years. Hence, we have a 12-month TP for Hotel Shilla of KRW165,000, derived by applying the stock’s past-5-year average 12-month forward PER of 31.5x (excluding outlier periods) to the average of our 2018E-19E EPS forecasts.

Besides, we revise our 12 month TP for Cosmax, which supplies some weishang in China, from KRW163,000 to KRW196,000. Our TP is based on an unchanged target PER of 32.5x applied to our revised 2018-19E EPS (from 2018E only). In our view, the company’s strong earnings growth (a CAGR of 32% for 2018E-20E, on our forecasts) on the back of positive industry-level changes argues for a premium valuation relative to brand companies such as Amorepacific and LG H&H.

Amorepacific: 12-month forward PER band LG H&H: 12-month forward PER band

(KRW) (KRW) 800,000 2,500,000 700,000 2,000,000 600,000 500,000 1,500,000 400,000 1,000,000 300,000 500,000 200,000 100,000 0

Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18

Jun-15 Jun-16 Jun-17 Jun-18

Feb-16 Feb-17 Feb-18

Dec-15 Aug-16 Dec-16 Aug-17 Dec-17 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Aug-15 Price 17.5x 25.0x Price 22.0x 25.0x 28.0x 31.0x 34.0x 32.5x 40.0x 47.5x

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

Korea Consumer: 28 June 2018

Risks to our Positive sector stance

Forex swings can affect We see 2 risk factors associated with the Korean cosmetics and DFS sector. First, we travel and DFS demand believe that forex volatility poses a risk to the sector. Forex movements can alter travel demand from time to time, especially for Chinese travellers and particularly for daigou because they buy in bulk and hence they are more sensitive than regular consumers to forex rates. Meanwhile, DFS operators buy almost half of their items in foreign currency. As most of their items are sold in forex, the risks are mitigated but the companies are nevertheless exposed to risks associated with forex swings. This stands as the primary risk to our view on the Korea Consumer Sector.

Another risk is unforeseen policy changes by the Chinese government, such as the ban on group tours to Korea, which was implemented without warning in March 2017. As things stands, such risks appear to be receding. However, the imposition of similar policies in the future would pose a threat to Korea’s consumer space, including its cosmetics and DFS companies.

Korea Consumer Staples 28 June 2018

Amorepacific (090430 KS) Amor epacific

Target price: KRW440,000 (from KRW430,000) Share price (27 Jun): KRW309,000 | Up/downside: +42.4%

Expect a major turnaround in 2H18

 Potentially the biggest beneficiary of the return of Mainland tourists Iris Park (82) 2787 9165  Strong brand awareness should support gradual margin expansion [email protected]  Reiterating Buy (1); fine-tuning 12 month TP to KRW440,000

What's new: We believe that Amorepacific’s business earnings upside has Forecast revisions (%) yet to be reflected in the share price or the consensus earnings forecasts. Year to 31 Dec 18E 19E 20E Given the company’s high exposure to the duty-free store channel and Revenue change (1.4) (1.7) (1.9) Net profit change (11.0) (1.8) (0.5) Mainland consumers, we believe it is set to stage the biggest turnaround in Core EPS (FD) change (11.0) (1.8) (0.5) earnings growth and share price among its cosmetics peers in 2018. Source: Daiwa forecasts Hence, Amorepacific remains our top pick in the Korea Cosmetics Sector. Share price performance What's the impact: Upside from duty-free stores. Amorepacific appears (KRW) (%) to be softening its position on purchase limit policies, intending to loosen 355,000 110 them once Mainland tourists return to Korea. We expect Mainland tourists 321,250 101 to return in 2H18, which should pave the way for an acceleration in the 287,500 93 253,750 84 company’s revenue growth. LG H&H (051900 KS, KRW1,433,000, Buy[1]) 220,000 75 has benefited since 2H17 from the fact that its purchase limits are less Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 strict than Amorepacific’s. After Amorepacific relaxes its purchase limits, we Amore (LHS) Relative to KOSPI (RHS) look for it to see much higher growth in revenue and earnings than LGH&H from 2H18. 12-month range 239,500-351,500 Market cap (USDbn) 16.16 New CEO, new initiatives. Ahn Se-hong, former CEO of Amorepacific’s 3m avg daily turnover (USDm) 49.33 sister company Innisfree, has headed Amorepacific since the start of this Shares outstanding (m) 58 Major shareholder Amorepacific Group (35.4%) year. Under Mr Ahn, Amorepacific is aiming to have a more nimble product line-up (even for high-end brands, it will focus on introducing new products Financial summary (KRW) while limiting the number of SKUs). In our view, this strategy is the right Year to 31 Dec 18E 19E 20E approach at a time when consumers are increasingly exposed to new Revenue (bn) 6,078 7,046 7,982 brands and products, particularly Chinese consumers who are not fiercely Operating profit (bn) 929 1,166 1,351 Net profit (bn) 696 895 1,035 loyal to certain brands. Since the start of the year, Amorepacific has rolled Core EPS (fully-diluted) 11,908 15,318 17,715 out new product lines for major brands including Sulwhasoo and Hera. EPS change (%) 74.8 28.6 15.7 These products look to have been well received by consumers, and Daiwa vs Cons. EPS (%) 22.6 30.1 27.6 PER (x) 25.9 20.2 17.4 brought about a turnaround in the company’s domestic market growth from Dividend yield (%) 0.6 0.6 0.7 2Q18 (our estimates). We expect Amorepacific to pursue a similar strategy DPS 1,850 2,000 2,120 in China, which should support an acceleration in revenue growth in 2H18. PBR (x) 3.9 3.3 2.7 EV/EBITDA (x) 15.1 12.0 9.9 ROE (%) 15.8 17.5 17.1 What we recommend: We reiterate our Buy (1) rating on Amorepacific, Source: FactSet, Daiwa forecasts with a revised TP of KRW440,000 (from KRW430,000). Our TP is based on an unchanged target PER of 32.5x (the stock’s past-5-year average) on the average of our 2018-19E EPS (from 2018E EPS). We revise down our 2018E EPS by 11% to reflect our lower forecast of Mainland visitors to Korea for 3Q18 (we were expecting a full recovery from July, but this may be delayed to late 3Q18). We believe the strength of the company’s brand positions it to sustain its growth momentum in the coming years. Key risk: slower-than-expected recovery in Mainland visitors to Korea.

How we differ: Our revised 2018-20E forecasts are 23-30% higher than the consensus, likely as we are more bullish on DFS revenue.

See important disclosures, including any required research certifications, beginning on page 50

Amorepacific (090430 KS): 28 June 2018

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Duty-free store revenue (KRW bn) 347.8 702.9 1,069.0 1,499.3 1,102.2 1,608.6 2,062.3 2,494.9 China cosmetic revenue (KRW bn) 338.8 464.5 765.8 1,090.9 1,258.0 1,547.2 1,837.5 2,132.9 Chinese inbound YoY growth to Korea 52.5 41.6 (2.3) 34.8 (47.1) 53.0 35.0 24.0 Overseas (ex-China) cosmetic revenue 206.0 365.1 442.1 554.2 473.9 600.0 727.7 859.4 (KRW bn)

Profit and loss (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Korea cosmetics 2,556 3,041 3,559 4,001 3,644 3,889 4,477 4,995 Others 545 833 1,208 1,645 1,480 2,188 2,570 2,987 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 3,100 3,874 4,767 5,645 5,124 6,078 7,046 7,982 Other income 124 136 147 181 224 220 231 249 COGS (912) (1,028) (1,169) (1,425) (1,380) (1,538) (1,691) (1,891) SG&A (1,819) (2,282) (2,824) (3,373) (3,148) (3,610) (4,190) (4,740) Other op.expenses (124) (136) (147) (181) (224) (220) (231) (249) Operating profit 370 564 773 848 596 929 1,166 1,351 Net-interest inc./(exp.) 9 11 22 13 11 18 26 29 Assoc/forex/extraord./others (15) (45) (17) (5) (40) (17) 1 6 Pre-tax profit 364 530 778 857 567 931 1,193 1,386 Tax (96) (145) (194) (211) (169) (235) (298) (351) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 267 385 585 646 398 696 895 1,035 Net profit (adjusted) 267 385 585 646 398 696 895 1,035 EPS (reported)(KRW) 45,761 65,919 10,009 11,052 6,812 11,908 15,318 17,715 EPS (adjusted)(KRW) 45,761 65,919 10,009 11,052 6,812 11,908 15,318 17,715 EPS (adjusted fully-diluted)(KRW) 45,761 65,919 10,009 11,052 6,812 11,908 15,318 17,715 DPS (KRW) 6,500 9,000 1,350 1,580 1,280 1,850 2,000 2,120 EBIT 370 564 773 848 596 929 1,166 1,351 EBITDA 493 700 920 1,029 820 1,149 1,397 1,600

Cash flow (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax 364 530 778 857 567 931 1,193 1,386 Depreciation and amortisation 124 136 147 181 224 220 231 249 Tax paid (78) (123) (171) (227) (169) (235) (298) (351) Change in working capital (18) (0) (167) (163) (93) (71) (139) (176) Other operational CF items 36 43 41 29 (16) 128 310 313 Cash flow from operations 427 586 628 677 513 972 1,297 1,421 Capex (326) (321) (274) (495) (769) (500) (450) (400) Net (acquisitions)/disposals (2) (1) 2 0 0 0 0 0 Other investing CF items (20) (169) 56 (115) 368 (71) (85) (33) Cash flow from investing (349) (491) (217) (610) (401) (571) (535) (433) Change in debt 90 (3) (7) (5) (3) 0 0 0 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (45) (46) (63) (95) (109) (158) (170) (181) Other financing CF items 4 2 0 (34) 1 0 0 0 Cash flow from financing 49 (46) (69) (133) (111) (158) (170) (181) Forex effect/others (4) (1) 3 0 0 0 0 0 Change in cash 123 49 345 (66) 1 244 592 808 Free cash flow 100 266 353 182 (256) 472 847 1,021 Source: FactSet, Daiwa forecasts

Amorepacific (090430 KS): 28 June 2018

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment 434 636 933 1,089 666 922 1,526 2,345 Inventory 283 305 324 410 375 419 476 539 Accounts receivable 223 228 317 340 369 347 381 431 Other current assets 27 258 259 278 268 304 352 399 Total current assets 968 1,427 1,833 2,116 1,677 1,992 2,735 3,715 Fixed assets 1,936 1,744 1,871 2,359 2,613 2,894 3,112 3,263 Goodwill & intangibles 133 174 212 228 240 240 240 240 Other non-current assets 366 509 528 478 845 932 1,035 1,084 Total assets 3,402 3,855 4,443 5,182 5,376 6,058 7,122 8,302 Short-term debt 82 34 118 145 87 85 85 85 Accounts payable 298 367 383 565 554 657 762 863 Other current liabilities 162 250 371 462 406 486 564 639 Total current liabilities 543 651 872 1,171 1,046 1,229 1,411 1,587 Long-term debt 80 125 57 10 62 55 57 43 Other non-current liabilities 211 200 142 104 92 83 75 66 Total liabilities 834 976 1,071 1,285 1,200 1,367 1,543 1,696 Share capital 35 35 35 35 35 35 35 35 Reserves/R.E./others 2,520 2,824 3,311 3,844 4,119 4,633 5,519 6,544 Shareholders' equity 2,554 2,859 3,346 3,879 4,154 4,668 5,554 6,578 Minority interests 14 20 27 18 22 23 25 27 Total equity & liabilities 3,402 3,855 4,443 5,182 5,376 6,058 7,122 8,302 EV 17,798 17,604 17,331 17,144 17,565 17,303 16,703 15,872 Net debt/(cash) (272) (477) (758) (934) (518) (782) (1,384) (2,217) BVPS (KRW) 436,058 488,114 57,140 66,262 70,965 79,757 94,913 112,441

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) 8.8 25.0 23.0 18.4 (9.2) 18.6 15.9 13.3 EBITDA (YoY) 5.7 41.8 31.4 11.9 (20.3) 40.1 21.6 14.5 Operating profit (YoY) 1.2 52.4 37.1 9.7 (29.7) 55.8 25.4 15.8 Net profit (YoY) (0.7) 44.1 51.8 10.4 (38.4) 74.8 28.6 15.7 Core EPS (fully-diluted) (YoY) (0.7) 44.1 (84.8) 10.4 (38.4) 74.8 28.6 15.7 Gross-profit margin 70.6 73.5 75.5 74.8 73.1 74.7 76.0 76.3 EBITDA margin 15.9 18.1 19.3 18.2 16.0 18.9 19.8 20.0 Operating-profit margin 11.9 14.6 16.2 15.0 11.6 15.3 16.5 16.9 Net profit margin 8.6 9.9 12.3 11.4 7.8 11.4 12.7 13.0 ROAE 11.0 14.3 18.9 17.9 9.9 15.8 17.5 17.1 ROAA 8.3 10.6 14.1 13.4 7.5 12.2 13.6 13.4 ROCE 14.4 19.5 23.5 22.3 14.2 20.3 22.1 21.7 ROIC 12.4 17.4 23.2 22.9 12.6 18.4 21.6 23.5 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 26.5 27.4 24.9 24.6 29.8 25.3 25.0 25.3 Accounts receivable (days) 20.1 21.3 20.9 21.2 25.2 21.5 18.9 18.6 Current ratio (x) 1.8 2.2 2.1 1.8 1.6 1.6 1.9 2.3 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 14.2 13.7 13.5 14.3 18.8 15.5 13.1 12.0 Free cash flow yield 0.6 1.5 2.0 1.0 n.a. 2.6 4.7 5.7 Source: FactSet, Daiwa forecasts

Company profile

Amorepacific is the leading cosmetics company in Korea, with a 29% market share (2017). Cosmetics accounted for 91% of the company’s sales in 2017, and household goods and green tea the remainder. Amorepacific, Laneige, IOPE, Hera, Sulwhasoo, and Etude are its major cosmetics brands. The company also has operations in China, Southeast Asia, Europe and North America.

Korea Consumer Discretionary 28 June 2018

Hotel Shilla (008770 KS) Shilla

Target price: KRW165,000

Share price (27 Jun): KRW116,500 | Up/downside: +41.6%

Initiation: set to become a top cosmetics DFS player

 Key beneficiary of a return of Chinese visitors to Korea from 2H18E Iris Park (82) 2787 9165  Earnings to increase more than 6x for 2018E [email protected]  Initiating with a Buy (1) rating and 12-month TP of KRW165,000

Investment case: We initiate coverage of Hotel Shilla, the 2nd largest Share price performance duty-free store (DFS) player in Korea, with a Buy (1) rating. In our view, the (KRW) (%) company stands to benefit from a recovery in DFS sales to Chinese visitors 135,000 235 and professional shoppers (weishang) over the next 3 years. We forecast 113,750 196 its EPS to rise at a CAGR of 38% over 2018-20 on an improvement in 92,500 158 71,250 119 margins as it gains scale with its new overseas concessions. As such, our 50,000 80 2018-20E EPS are 28-30% higher than the Bloomberg consensus. Jun-17 Sep-17 Dec-17 Mar-18 Jun-18

H Shilla (LHS) Relative to KOSPI (RHS) Catalysts: Serves individual and professional Chinese shoppers. A likely recovery in demand from weishang (to which Korea offers benefits 12-month range 52,500-132,000 like price and a compact geographic layout) and individual Chinese tourists Market cap (USDbn) 4.09 to Korea from 2H18 bodes well for Shilla, in our view. After cutthroat 3m avg daily turnover (USDm) 40.23 Shares outstanding (m) 39 competition among Korea’s DFS retailers in 2016 and 2017 to attract Major shareholder NPS (12.0%) Chinese tourists and amid political tensions, the situation improved in early 2018, with top-tier players curtailing their competitive activity in anticipation Financial summary (KRW) of a rise in Chinese arrivals in Korea. Hence, we expect Shilla’s overall Year to 31 Dec 18E 19E 20E margins to improve, while rising demand from an inflow of Chinese visitors Revenue (bn) 4,727 5,660 6,616 Operating profit (bn) 234 333 430 will see Shilla’s 2018E EPS rise 6-fold YoY, on our forecasts. Net profit (bn) 156 232 296 Core EPS (fully-diluted) 4,177 6,197 7,928 Hotel business also stands to benefit. Shilla’s low-margin hotel business EPS change (%) 517.6 48.4 27.9 Daiwa vs Cons. EPS (%) 27.9 29.6 30.4 should also see occupancy rates, and as such margins, rise with a return of PER (x) 27.9 18.8 14.7 Chinese visitors to Korea from 2H18E. The company established this Dividend yield (%) 0.4 0.5 0.6 business in expectation of a surge in Chinese tourists, but the opportunity DPS 500 600 700 PBR (x) 4.6 3.7 3.0 was significantly impacted by political tensions and the subsequent slump EV/EBITDA (x) 15.6 11.6 9.0 in Chinese patrons. The current occupancy rate of 70% is not enough to ROE (%) 19.6 22.1 22.6 cause any meaningful margin improvement, but we expect this situation to Source: FactSet, Daiwa forecasts reverse once price-sensitive Chinese tourists return to Korea in 2H18E.

Becoming ‘the’ DFS retailer of cosmetics and perfume. Shilla runs DFS concessions for cosmetics and perfume at Asia’s top-3 airports: Incheon, Singapore and Hong Kong. With the addition of the Hong Kong DFS in early 2018, we expect Shilla to become the largest cosmetics and perfume DFS carrier globally. We believe this scale will give Shilla bargaining power over suppliers, and lead to its DFS operating margin expanding to 6.3% in 2020E from 1.9% in 2017.

Valuation: Our 12-month TP of KRW165,000 is based on a target PER of 31.5x, the stock’s past-5-year average (excluding outlier periods), applied to the average of our 2018-19E EPS forecasts. Given our outlook for high EPS growth over 2018-20E, we believe this multiple is justified.

Risks: Heightened competition from new DFS openings, slow growth in visitor numbers, volatile and forex.

See important disclosures, including any required research certifications, beginning on page 50

Hotel Shilla (008770 KS): 28 June 2018

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

Growth outlook Shilla: revenue trend by business We forecast Shilla’s revenue to rise at a CAGR of 18.8% (KRWbn) over 2018-19, driven primarily by its travel retail (duty-free) 7,500 30% business, with renewed demand from Chinese buyers 6,000 likely to kick in from 2H18. We forecast revenue from the 20% travel retail segment to rise by 20.9% YoY for 2019, while 4,500 that from the hotel and leisure segment increases by 9.8% 3,000 YoY. We expect the decline in margins for its DFS business 10% over 2016-17 to recover from 2018 on easing competition. 1,500

As a result, we see the company’s 2018 operating margin 0 0% returning to its 2014 level of 5%. Going forward, Shilla 2013 2014 2015 2016 2017 2018E 2019E 2020E plans to expand its margins by gaining scale as the largest Travel Retail (LHS) Hotel&Leisure (LHS) YoY(RHS) cosmetics and perfume DFS operator globally. Source: Company, Daiwa forecasts

Valuation Shilla: 12-month-forward PER band Shilla’s share price has seen a meaningful uptrend after (KRW) the company strong 3Q17 results and a recovery across its 350,000 businesses. We believe the shares have been rerated on 300,000 the prospect of the company’s DFS business’ operating 250,000 margin improving from 2018. We project continued strong 200,000 quarterly earnings and margins based on the likely 150,000 recovery in the number of Chinese visitors to Korea from 100,000 2H18. We derive our TP by applying the stock’s past-5- 50,000 year average PER of 31.5x (excluding outlier periods) to 0

our 2018-19E average EPS.

Oct-11 Oct-13 Oct-15 Oct-17

Jun-10 Jun-12 Jun-14 Jun-16 Jun-18

Feb-13 Feb-15 Feb-17 Feb-11 Price 11.5x 21.5x 31.5x 41.5x 51.5x Source: Bloomberg, Daiwa forecasts

Earnings revisions Shilla: consensus EPS revisions

Revisions to the market’s earnings forecasts for Shilla have (KRW) been positive over the past 12 months, with the Bloomberg 7,000 consensus EPS forecast having being revised up for 2018 6,000 and remaining positive for 2019. We forecast the 5,000 company’s 2018 EPS to rise by 518% YoY and its 2019 4,000 3,000 EPS by 48% YoY, given our expectation of a normalisation 2,000 of margins and recovery in its hotel business. Our 2018- 1,000 19E EPS are 28-30% above the consensus figures, likely 0

as we are more bullish about the margin improvement for

Jul-16 Jul-17

Oct-16 Apr-17 Oct-17 Apr-18

Jun-16 Jan-17 Jun-17 Jan-18 Jun-18

Mar-17 Mar-18

Feb-17 Feb-18

Aug-16 Sep-16 Nov-16 Dec-16 Aug-17 Sep-17 Nov-17 Dec-17 May-18 Shilla’s DFS business. May-17 Bloomberg estimate 2018 Bloomberg estimate 2019 Daiwa estimate 2018 Daiwa estimate 2019 Source: Bloomberg, Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Korea DFS revenue (KRW bn) 2,078.4 2,502.8 2,474.4 2,815.0 2,521.2 3,232.5 4,040.5 4,887.8 Singapore revenue (KRW bn) 8.0 90.0 427.5 496.5 547.4 594.5 630.3 656.8 Hong Kong revenue (KRW bn) n.a. n.a. n.a. n.a. n.a. 391.2 430.4 466.9

Profit and loss (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E DFS 2,086 2,612 2,931 3,339 3,576 4,221 5,104 6,014 Hotel & leisure 211 297 321 376 435 506 556 602 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 2,297 2,909 3,252 3,715 4,011 4,727 5,660 6,616 Other income 51 64 74 74 71 73 70 69 COGS (1,327) (1,613) (1,762) (2,040) (2,363) (2,613) (3,150) (3,705) SG&A (883) (1,157) (1,412) (1,597) (1,576) (1,880) (2,177) (2,481) Other op.expenses (51) (64) (74) (74) (71) (73) (70) (69) Operating profit 87 139 77 79 73 234 333 430 Net-interest inc./(exp.) (7) (10) (18) (10) (15) (11) (9) (20) Assoc/forex/extraord./others (64) (16) (15) (16) (13) (18) (19) (21) Pre-tax profit 16 114 44 52 45 205 305 390 Tax (5) (40) (26) (25) (19) (49) (73) (93) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 11 73 18 28 25 156 232 296 Net profit (adjusted) 11 73 18 28 25 156 232 296 EPS (reported)(KRW) 280 1,903 479 744 676 4,177 6,197 7,928 EPS (adjusted)(KRW) 280 1,903 479 744 676 4,177 6,197 7,928 EPS (adjusted fully-diluted)(KRW) 280 1,903 479 744 676 4,177 6,197 7,928 DPS (KRW) 150 350 350 350 350 500 600 700 EBIT 87 139 77 79 73 234 333 430 EBITDA 138 203 151 153 145 307 403 499

Cash flow (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax 16 114 44 52 45 205 305 390 Depreciation and amortisation 51 64 74 74 71 73 70 69 Tax paid (25) (17) (45) (28) (21) (52) (77) (99) Change in working capital 31 (62) 1 (29) 59 (1) (123) (101) Other operational CF items 55 24 44 45 45 55 68 74 Cash flow from operations 129 122 118 114 200 279 243 333 Capex (224) (133) (107) (68) (65) (65) (65) (65) Net (acquisitions)/disposals (62) (13) (97) 181 2 0 0 0 Other investing CF items 1 (0) 1 33 (100) (14) (19) (19) Cash flow from investing (285) (146) (203) 146 (163) (79) (84) (84) Change in debt 143 16 261 (98) 129 (200) 0 0 Net share issues/(repurchases) 0 0 0 101 0 0 0 0 Dividends paid (12) (6) (14) (14) (13) (19) (23) (27) Other financing CF items (22) (24) (25) (225) (22) (20) (20) (20) Cash flow from financing 109 (14) 223 (236) 94 (239) (43) (47) Forex effect/others (0) (0) 1 (3) 0 0 0 0 Change in cash (48) (39) 139 21 130 (39) 116 202 Free cash flow (95) (11) 11 47 135 214 178 268 Source: FactSet, Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment 226 187 326 347 474 435 552 754 Inventory 337 494 471 471 500 563 643 719 Accounts receivable 104 106 138 184 160 175 210 245 Other current assets 43 37 90 77 64 95 113 132 Total current assets 709 823 1,024 1,079 1,198 1,268 1,518 1,851 Fixed assets 643 704 736 707 693 696 698 700 Goodwill & intangibles 23 33 30 48 44 34 26 20 Other non-current assets 336 348 388 207 315 347 408 470 Total assets 1,712 1,907 2,177 2,041 2,250 2,345 2,650 3,041 Short-term debt 140 0 160 153 222 22 22 22 Accounts payable 187 237 239 256 322 657 716 797 Other current liabilities 106 198 184 331 367 57 68 79 Total current liabilities 433 435 583 740 910 735 806 898 Long-term debt 588 724 834 629 663 667 671 675 Other non-current liabilities 13 18 16 11 9 7 6 5 Total liabilities 1,034 1,177 1,433 1,379 1,582 1,410 1,483 1,578 Share capital 200 200 200 200 200 200 200 200 Reserves/R.E./others 479 530 544 462 467 734 966 1,262 Shareholders' equity 679 730 744 662 667 934 1,166 1,462 Minority interests 0 0 0 0 1 1 1 1 Total equity & liabilities 1,712 1,907 2,177 2,041 2,250 2,345 2,650 3,041 EV 5,070 5,104 5,199 4,972 4,950 4,794 4,681 4,483 Net debt/(cash) 502 537 668 435 410 254 141 (58) BVPS (KRW) 17,481 18,813 19,175 17,729 17,889 25,081 31,325 39,314

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) 3.5 26.6 11.8 14.3 8.0 17.8 19.7 16.9 EBITDA (YoY) (20.9) 47.3 (25.5) 1.5 (5.8) 112.1 31.6 23.7 Operating profit (YoY) (33.0) 60.5 (44.5) 2.4 (7.4) 220.1 42.3 29.2 Net profit (YoY) (89.3) 579.7 (74.8) 50.6 (9.1) 517.6 48.4 27.9 Core EPS (fully-diluted) (YoY) (89.3) 579.7 (74.8) 55.5 (9.1) 517.6 48.4 27.9 Gross-profit margin 42.2 44.6 45.8 45.1 41.1 44.7 44.4 44.0 EBITDA margin 6.0 7.0 4.6 4.1 3.6 6.5 7.1 7.5 Operating-profit margin 3.8 4.8 2.4 2.1 1.8 4.9 5.9 6.5 Net profit margin 0.5 2.5 0.6 0.7 0.6 3.3 4.1 4.5 ROAE 1.6 10.5 2.5 4.0 3.8 19.6 22.1 22.6 ROAA 0.7 4.1 0.9 1.3 1.2 6.8 9.3 10.4 ROCE 6.5 9.7 4.8 5.0 4.9 14.7 19.1 21.4 ROIC 5.4 7.3 2.4 3.3 3.8 15.7 20.3 24.1 Net debt to equity 74.0 73.6 89.8 65.7 61.4 27.1 12.1 n.a. Effective tax rate 32.5 35.4 58.0 46.9 43.5 23.9 23.9 23.9 Accounts receivable (days) 9.8 13.1 13.6 15.8 15.7 12.9 12.4 12.5 Current ratio (x) 1.6 1.9 1.8 1.5 1.3 1.7 1.9 2.1 Net interest cover (x) 12.5 14.5 4.2 7.6 4.9 21.1 35.7 21.4 Net dividend payout 53.6 18.4 73.1 47.0 51.7 12.0 9.7 8.8 Free cash flow yield n.a. n.a. 0.2 1.0 2.9 4.7 3.9 5.9 Source: FactSet, Daiwa forecasts

Company profile

Hotel Shilla mainly operates duty-free stores and luxury hotels. The company conducts its business in both the domestic and overseas markets, including the Americas, Asia and Europe. It has 2 downtown DFS in Seoul and 2 airport concessions in Korea, as well as operating airport concessions in Singapore, Hong Kong and Macau.

Hotel Shilla (008770 KS): 28 June 2018

Record-high earnings in 2018E

Initiating with a Buy (1) rating and 12-month TP of KRW165,000 Significant EPS growth We initiate coverage of Hotel Shilla with a Buy (1) rating and 12-month TP of KRW165,000. forecast for 2018-20E on Our TP implies 46% upside potential from the current share price. We expect the margin normalisation company’s margins to expand in 2018 as competition among DFS players eases and and the scale effect Shilla benefits from economies of scale to become ‘the’ cosmetics and perfume DFS operator. Thus, we forecast its EPS to rise by 518% YoY for 2018 and at a CAGR of 38% over 2018-20E.

We recommend Shilla for the following reasons:

3 reasons for our Buy (1)  First, we expect earnings growth momentum for Shilla’s main business, DFS, to resume rating in 2018. In 2017, major DFS operators’ profitability deteriorated as new duty-free store licences were given out while the broader political environment became unfavourable. However, starting with the No.1 player, Lotte DFS, which moved to close 3 of its 4 stores at Incheon International Airport, the game of chicken among DFS players came to an end at the beginning of 2018. As a result, we forecast Shilla’s DFS operating margin to improve to 4.9% for 2018, up 3.0pp YoY. Our 2018E EPS incorporates this expectation, calling for the company’s EPS to rise more than 6-fold YoY.

 Second, we expect Shilla’s hotel business to normalise in 2018 as Chinese tourists return to Korea from 2H18E. While occupancy rates at the company’s Seoul hotels and business hotels have not yet reached levels that would lead to meaningful earnings growth, we expect its hotel business to recover in 2H18, as Chinese visitors start to return to Korea in earnest. In particular, tourists from Mainland China tend to spend less on accommodation and more on shopping, which we think bodes well for Shilla considering it operates the largest business hotel chain in Korea, which can accommodate these price-conscious travellers.

 Finally, we believe Shilla is on track to become the largest cosmetics and perfume DFS retailer in the world, as it benefits not only from the return of Chinese visitors to Korea in 2H18 but also from its overseas operations (Singapore and Hong Kong airports). Shilla operates in 3 hub airports in Asia: Incheon, Singapore and Hong Kong. Shilla will sell cosmetics worth KRW3.3tn through DFS in 2018, on our forecasts, outpacing Switzerland’s Dufry (DUFN SW, Not rated), the No.1 DFS retailer in the category. Having a competitive edge in this category should give the company greater bargaining power over its suppliers, allowing further margin improvements. As such, we forecast Shilla’s EPS to expand at a robust CAGR of 38% over 2018-20.

Hotel Shilla (008770 KS): 28 June 2018

Strong earnings growth momentum from 2018E We forecast strong earnings growth for Shilla from 2018E, driven by: 1) expected high top- line growth on increased demand from Mainland Chinese tourists and professional shoppers (weishang/daigou), 2) easing competition, allowing the company to improve its margins, and 3) a better outlook for its hotel business as a result of increased demand from tourists.

Shilla: earnings forecasts (KRWbn) 2017 2018E 2019E 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18E 3Q18E 4Q18E Revenue 4,012 4,727 5,660 879 900 1,067 1,166 1,126 1,092 1,350 1,160 Travel Retail 3,079 4,221 5,104 783 691 824 776 1,014 969 1,216 1,022 Downtown 1,860 2,476 3,219 477 398 510 475 581 538 739 618 Airport 1,214 1,745 1,885 306.2 292.3 314.5 300.9 432.3 431.6 476.8 403.9 Incheon 661 756 821 169 161.7 171 140.3 189.9 182.8 222.3 161.3 Singapore 547 595 630 135 129 142 141 148 148 150 148 Hong Kong 19.3 391.2 430.4 n.a. n.a. n.a. 19.3 94.2 98.9 103.9 94.2 Hotel & Leisure 468 506 556 96 110 118 145 112 123 134 138 Growth (YoY) 8.0% 17.8% 19.7% -1.2% -5.7% 13.8% 24.8% 28.1% 21.4% 26.5% -0.5% Travel Retail 10.8% 37.1% 20.9% 15.5% -4.8% 15.1% 7.3% 29.5% 40.4% 47.5% 31.6% Downtown -1% 33.1% 30.0% 31.8% -1.8% 25.8% 15.3% 22.0% 35.0% 45.0% 30.0% Airport -3.5% 43.7% 8.0% -3.1% -8.5% 1.1% -3.2% 41.2% 47.7% 51.6% 34.2% Incheon -11% 14.4% 8.6% -12.0% -11.5% -16.5% -22.7% 12.4% 13.0% 30.0% 15.0% Singapore 10.3% 8.6% 6.0% 8.5% -5.6% 34.0% 9.3% 10.0% 15.0% 5.0% 5.0% Hong Kong n.a. 1927% 10.0% n.a. n.a. n.a. n.a. n.a. n.a. n.a. 388.1% Hotel & Leisure 14.0% 8.1% 9.8% 11.8% 13.8% 8.9% 46.1% 16.6% 11.7% 13.3% -4.4% Operating Profit 73.1 234 332.9 10 17.3 30.3 15.5 44.2 61.5 80 48.3 Travel Retail 58.3 205.8 296 16.8 8.1 23.4 9.9 47.6 50.4 66.9 40.9 Hotel & Leisure 14.6 28.2 36.9 -6.9 9.1 6.8 5.6 -3.4 11.1 13.1 7.4 OPM 1.8% 4.9% 5.9% 1.1% 1.9% 2.8% 1.3% 3.9% 5.6% 5.9% 4.2% Travel Retail 1.9% 4.9% 5.8% 2.2% 1.2% 2.8% 1.3% 4.7% 5.2% 5.5% 4.0% Hotel & Leisure 1.2% 1.6% 6.6% -7.2% 8.3% 5.8% 3.9% -3.1% 9.1% 9.8% 5.4%

Source: Company, Daiwa forecasts

With DFS margins Shilla’s DFS margin has been deteriorating since 2015, but seemed to bottom out in 1Q18. having bottomed in The main reason for this margin erosion was the company’s DFS business, where 2H17, we look for Shilla’s competition among operators intensified in 2016-17 as new players entered the market earnings to increase 6- while the number of Chinese tourists dropped off. In order to attract business, the DFS fold in 2018E operators offered excessive commissions to weishang, which exacerbated their margin decline. However, starting in 1Q18, Lotte DFS, the largest DFS operator in Korea, moved to reduce its excessive commissions and Shilla followed suit. We believe this trend to pare commissions will continue going forward, given that: 1) DFS operators are now focusing on profitability as the new players’ businesses have stabilised, and 2) the number of Chinese visitors is likely to recover from 2H18. Therefore, we forecast Shilla’s DFS operating margin to improve by 3.0pp YoY to 4.9% for 2018.

Further overseas expansion should provide extra catalysts In our view, Shilla winning the bid for Taiwan’s Taoyuan Airport DFS would provide the company with an additional share-price catalyst. Taiwan airport terminal 2’s C and D concessions are due to be put out for tender shortly. The contracts are expected to run for 12 years, with a possible 3-year extension. We think this represents a good opportunity for Shilla to further expand its scale at global airports, though we are unlikely to know the results of the bidding process until later this year.

Hotel Shilla (008770 KS): 28 June 2018

Looking to meet growing demand from Chinese tourists

Daigou: too big to ignore Daigou have grown Daigou (代工) literally means ‘buying on behalf of’, and refers to shoppers who purchase rapidly in number and commodities for customers in Mainland China. Among the daigou formats, a new format are poised to become a known as weishang has emerged. Weishang sell their products through popular mobile full-fledged commerce chatting applications such as WeChat. We believe that the weishang business model is channel sustainable: according to iResearch, China’s weishang market was valued at c.CNY496bn (+51% YoY) in 2017 and is expected to nearly double by 2019 (CNY980bn). We believe this format cannot be ignored in the context of Chinese consumers.

One reason for the growth of the weishang business model is social media platforms, like Wechat and Weibo. Daigou can initiate contact with a wide network in China on a personal recommendation of a brand or product for instant results. For instance, the use of WeChat allows direct payment for consumers; thus, daigou can have regular and instant conversations with their customer base by offering an instant purchasing option. The Chinese government plans to legitimise the daigou market by creating policies for weishang. China’s State Administration for Market Regulation declared that from January 2015 weishang would be supervised by the authorities, implying that the government would acknowledge weishang as a legitimate retail industry format while subjecting them to taxation.

China: weishang market size (CNY bn) 1,200 300%

1,000 250%

800 200%

600 150%

400 100%

200 50%

0 0% 2014 2015 2016 2017 2018E 2019E Market size YoY

Source: China Information Industry Network (中国产业信息网)

Even after paying taxes to the government, weishang can maintain their price competitiveness in online channels, especially for cosmetics, which are among the best- selling items in the weishang format. The import tax on cosmetics ranges from 7.5-19%, depending on the specific category. In addition to this tax, the retail price incorporates a value-added tax of 17% in China. These taxes result in retail prices of imported cosmetics in China being 20-40% higher than those in the country of origin, even without factoring in shipping costs. Among all the categories, Chinese consumers in rural areas prefer to buy cosmetics, luxury products and groceries from weishang, as these consumers have more limited access than their urban counterparts to retail channels such as department stores.

We expect the weishang format to grow rapidly in rural areas. According to iResearch forecasts, weishang sales in rural areas will increase by a 60% CAGR over 2017-19E to CNY391bn. It also forecasts weishang sales growth in rural areas to outpace that in urban areas over the same time frame. We believe that rural consumers’ limited access to offline stores will spur this growth, allowing consumer brands to sell products without having physical stores in these areas.

We expect daigou (代工), individual resellers from China, to become a sustainable revenue stream for Korean DFS operators, including Shilla. Korean DFS operators have an opportunity to tap into the wants and needs of the massive China population in the growing daigou market.

Hotel Shilla (008770 KS): 28 June 2018

Korea is the most attractive place to buy goods Korea DFS allows one-stop shopping with price advantages Korea DFS is the We believe Korea is one of the most attractive markets for professional shoppers from cheapest retail channel China to visit, given the proximity of stores to one another, as well as price in Asia competitiveness. Korea has the largest DFS market in the world, led by its huge downtown duty-free stores. Globally, airports are the main channel for duty-free sales (USD36bn, 57% of the total in 2017). However, Korea’s downtown duty-free stores have a long history dating back to around 1980. Of the KRW14.7tn duty-free market in Korea in 2017, downtown DFS sales contributed KRW11.1tn. By region, c.70% of downtown DFS sales are from the Seoul area, with 10 large-scale DFS available for shoppers.

Compared with Japan, Korea provides a better shopping environment for professional shoppers like daigou, in our view. The Japanese market is more focused on the tax-free rather than duty-free element due to the low tax rate in Japan (5% in Japan vs 10% in Korea). However, tax-free shops in Japan are not clustered in one place but scattered throughout the city, which does not make for a convenient shopping experience. While there are one-stop duty-free stores in Japan, similar to the ones in Korea, there are more restrictions when purchasing goods at Japanese stores. For example, when buying at Tokyo duty-free stores, a consumer can only pick up his/her purchased goods at Narita or Haneda airport, and not at other airports. In Korea, there are no such restrictions. And in Korea, for domestically produced goods, consumers can take the goods with them immediately after purchase.

In addition, Korea offers more price advantages than any other country. On average, the Seoul area offers a comparatively generous 20-26% commission rate to daigou, providing more incentives for these individuals to shop in Korea than other countries. Moreover, there is a negligible price difference between the after-tax price in the goods’ country of origin and the price at Korea DFS, and items can be even cheaper after the commission is given to the daigou.

Cosmetics: price comparison among channels TAO T-mall China official Original country Shilla Lotte Brand Item BAO (C2C) (B2C) website website DFS DFS Sulwhasoo Essential Balancing Emulsion 125ml 299 379 400 334 298 298 WHOO Cheongidan Set 1398 1599 1540 1574 1495 1495 Innisfree Green tea serum 80ml 148 119 210 141 123 123 Laneige Skin veil base 30ml 169 169 245 199 148 148 SUM Sum 37 water full 3pcs promotion Set 539 609 800 691 621 621 Benefiance wrinkle resist 24 eye contour Shiseido 439 439 520 318 329 329 cream Lancome Advanced Genifique sensitive 20ml 420 690 690 405 530 530 ESTEE LAUDER Advanced Night Repair Eye 2pcs Set 690 980 980 775 803 803

Source: Companies Note: all in CNY

Hotel Shilla (008770 KS): 28 June 2018

Why Hotel Shilla? Product offerings fit both bulk and small buyers Competitive prices and a We believe that Shilla’s product offerings meet the demand of daigou and individual wide range of goods tourists alike. Daigou purchases are made in bulk, which explains the significant increase make Shilla a leading in foreigner shoppers’ ticket prices since April 2017. Daigou prefer to sell cosmetics, the travel retail operator in very category in which Shilla has a competitive edge, in our view. Shilla operates Korea cosmetics and perfume concessions at Singapore, Macau and Hong Kong international airports, which gives it more bargaining power over cosmetics suppliers compared with other DFS players. This scale explains the higher gross margin of Shilla (54% for 2017) vs. peer Hotel Lotte (not listed) (37%), in our view, despite Shilla having a smaller revenue base. We believe that as the company expands in Hong Kong (the concession is set for its grand opening in June 2018), its product offerings and margins for the DFS business will improve further.

Korea DFS: foreigners’ ticket price trend Weishang: top-10 product sales categories (2017) (USD) Rank Item 900 120% 1 Sheet mask 2 Skin care 800 100% 700 3 Colour makeup 80% 600 4 Detergents 500 60% 5 Baby products 400 40% 6 Health foods 300 7 Clothes 20% 200 8 Groceries 100 0% 9 Electronic devices 10 Services (e.g. travel)

0 (20%)

Jul-16 Jul-17

Jan-16 Jan-18 Jan-17

Mar-16 Mar-17 Mar-18

Nov-16 Nov-17

Sep-16 Sep-17

May-16 May-17 Ticket Price(LHS) YoY (RHS)

Source: Korea Duty Free Association Source: Weishang Startup Network, Baidu

Shilla: DFS operating in international airports Country Area Type Jan-13 Singapore Changi Airport Airport Nov-14 Macau International Airport Airport Nov-16 Thailand Phuket Downtown Apr-17 Japan Tokyo Downtown Dec-17 Hong Kong Terminal 1, Chep Lak Kok Airport Airport

Source: Company

Shilla vs. Hotel Lotte: DFS gross margin comparison 70% 60.3% 60% 53.5% 49.6% 51.0% 50% 37.8% 37.5% 37.3% 40% 36.0%

30%

20%

10%

0% 2014 2015 2016 2017 Hotel Shilla Hotel Lotte

Source: Companies Note: GPM of Shilla incorporates hotel business

Luxury brands are For individual shoppers, brand offering is the priority, especially when it comes to luxury essential to luring DFS brands. The 3 main luxury brands favoured by Chinese shoppers – Louis Vuitton, Hermes traffic and Chanel – are available in only 4 downtown DFS in Seoul, including at The Shilla. For a DFS operator, offering these top-3 brands is crucial to attracting Chinese tourists; and Shilla has successfully managed to do so. In fact, scarcity is an important factor in maintaining the appeal of a luxury brand; thus, we believe these luxury brands will not be aggressively expanded into more DFS stores in Korea, namely Seoul.

Hotel Shilla (008770 KS): 28 June 2018

Brand comparison of top-5 Seoul DFS Availability No. of brands Company Louis Vuitton Chanel Hermes Luxury Cosmetics Watches/Jewellery Lotte Sogong O O O 20 147 57 Lotte WorldTower O O O 26 122 41 The Shilla O O O 18 274 72 Shinsegae Myeongdong O O 17 460 158 HDC Shilla I Park 10 328 60

Source: Companies

DFS margin should improve gradually as competitive intensity has eased We expect Shilla to We expect Shilla’s DFS operating margin to improve from 2018, namely as a result of the benefit from easing of competition among major DFS operators going forward. Since mid-2016, two fundamental changes to new DFS licences have been given out by the government, intensifying the competition in the domestic DFS the DFS industry. In addition, the decline in Chinese tourist numbers from March 2017 has industry in 2018 compelled DFS operators to become more competitive to attract daigou. However, the situation changed in late 2017 after Hotel Lotte, the largest DFS player in Korea, incurred losses in DFS for the first time in 2Q17. To combat these losses, Lotte reduced its commission to resellers, allowing other players (like Shilla) to follow suit. For Shilla, its DFS commission rate to revenue fell by 4.4pp YoY for 1Q18, and we forecast it to decline by 3pp YoY for 2018, leading to the company’s DFS operating margin rising to 4.9%.

Korea DFS: market share by company (2017) Lotte DFS: revenue and operating margin trends (KRW bn) 1,600 15% 1,400 1,200 10% Lotte 34% 38% 1,000 Hotel Shilla 800 5% 600 Shinsegae 400 0% Others 6% 200 0 (5%) 21% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 Revenue(LHS) OPM(RHS)

Source: Companies, Korea Duty-free Association Source: Company

Lotte DFS: sales promotion cost trend Shilla: DFS commission rate

(KRWbn) (KRWbn) 80 6.0% 90 10% 80 70 70 8% 60 60 4.0% 6% 50 50 40 40 4% 30 30 2.0% 20 2% 20 10 10 0 0%

0 0.0%

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18

3Q18E 4Q18E 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18E Sales promotion (LHS) % of revenue (RHS) Sales Commission(LHS) % of sales(RHS)

Source: Company Source: Company, Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Shilla: DFS operating-margin trend 7%

0% 1Q 2Q 3Q 4Q

2015 2016 2017 2018*

Source: Company, *Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Hotel business turning around Another angle by which to benefit from a revival in Chinese tourist growth Paved its way in the In our view, Shilla also stands to benefit from growth in visitor arrivals from China through business hotel industry its hotel business. While its luxury Jeju Hotel operation has maintained a fairly stable in Korea occupancy rate of 85% over the past 8 quarters thanks to domestic demand, both its Seoul and Shilla Stay hotels saw occupancy rates decline in 1Q18, likely due to the political tensions arising from the US THAAD missile defence system. We expect this negativity to fade from 2H18 with the likely return of Chinese tourists to Korea. In particular, we expect a rebound in occupancy for the company’s business hotels, Shilla Stay, which are popular with Chinese tourists who tend to economise on accommodation. Moreover, a higher occupancy rate should mitigate the fixed costs for the hotel business, leading to an improvement in Shilla’s hotel business over our forecast horizon.

Shilla: hotel and leisure business revenue and operating-margin trend (KRWbn) 600 12%

500 8% 400 4% 300 0% 200

100 (4%)

0 (8%) 2012 2013 2014 2015 2016 2017 2018E Revenue (LHS) OPM (RHS)

Source: Company, Daiwa forecasts Note: Seoul hotel was under renovation during 1H13

Seoul: number of business hotels by operator 12 11

8 6 6

4 2 2 1

0 Shilla Stay Hotel Lotte* Parnas Chosun Hotel Source: Companies Note: *Hotel Lotte includes L7 and Lotte City Hotel

Shilla: number of hotels Shilla: hotel occupancy rate 16 100% 14 12 80% 10 8 6 60% 4

2 40%

1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18

3Q18E 4Q18E 2014 2015 2016 2017 2018(1Q) 2Q18E Seoul Jeju China Geojae Shilla Stay Seoul Jeju Stay

Source: Company Source: Company, Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Specialising as cosmetics and perfume DFS player Off to a good start in Hong Kong Continued expansion Shilla opened its DFS outlet at Hong Kong’s international airport in December 2017. In its overseas first quarter of operation, the Hong Kong store brought in KRW94bn in revenue and was profitable. We note that the store was not fully operational in the first quarter, and the company had expected the store to be unprofitable initially. Indeed, we believe the store’s former operator, DFS, made losses despite selling goods in the same cosmetics and perfume category. We believe Shilla was able to generate earnings from the store, even ahead of its soft opening at the start of this year, on the back of a comparatively low cost base. Besides, the company has recorded 3 straight years of losses at its DFS store at Singapore’s Changi Airport, which may have made the company more strategic in bidding for the Hong Kong outlet at a commercially viable level, in our view.

Shilla: airport DFS operations Shilla: overseas DFS revenue trend Airport Area Date Category (KRWbn) Terminal1 Sep-15 All categories Incheon Int'l Airport 1,200 Terminal2 Jan-18 Cosmetics & Perfumes Cosmetics, Perfumes, 1,000 Singapore Changi Terminal1,2,3 Oct-14 Fashion, Accessories Int'l Airport Terminal4 Oct-17 Cosmetics & Perfumes 800 Hong Kong Cosmetics, Perfumes, Dec-17 Chep Lak Kok Airport Fashion, Accessories 600 Macau Int'l Airport Nov-14 All categories 400

200

0 2014 2015 2016 2017 2018E 2019E 2020E Singapore Changi Hong Kong others

Source: Company Source: Company, Daiwa forecasts

With the addition of the Hong Kong airport store, and a rebound in domestic DFS business, we believe that Shilla will become the world’s largest DFS operator by revenue in the cosmetics and perfume category. Compared with other duty-free items, cosmetics are more scalable, as there is a more diverse range of brands relative to other luxury goods. Moreover, the major cosmetics brands have sister companies which operate duty-free stores, which give them an advantage over other players.

Shilla vs Dufry: cosmetics and perfume revenue Weishang: purchase rate through weishang by category (2015)

(KRWbn) 50% 3,500 40% 34.2% 31.5% 3,000 29.7% 29.2% 30% 2,500 22.8% 18.7% 17.8% 2,000 20%

1,500 10% 6.8% 1,000 0% 500

0 Books Clothes

2016 2017 2018E Groceries

Cosmetics

Shoes/Bags

SheetMasks Baby products

Dufry Hotel Shilla HealthSupplies

Source: Companies Source: HenKuai(很快), KOTRA Note: Assumes Dufry’s cosmetics sales growth will be the same as in 2017

Daigou tend to focus on buying cosmetics, not just in Korea but generally. Around 35% of all weishang sales are in the cosmetics category, underlining the strength of demand. Unlike other luxury goods, cosmetics goods provide stable revenue streams for these resellers, as consumers come back for repeat purchases. Given its role as a major DFS operator in cosmetics and perfume, we believe Shilla is positioned to expand its reach to global travellers via its 3 Asian hub airports, while tapping into the rise of daigou.

Hotel Shilla (008770 KS): 28 June 2018

Valuation and risks Initiating coverage with Buy (1) and TP of KRW165,000 Outlook for high We initiate coverage of Shilla with a Buy (1) rating and 12-month TP of KRW165,000. Our earnings growth argues target price is derived by applying the stock’s past-5-year average 12-month forward PER for premium valuation, in of 31.5x (excluding outlier periods) to the average of our 2018-19E EPS forecasts. The our view shares traded at 12-month forward PERs of 50-250x in 2013, 2015, and 2016, when the company’s earnings were volatile.

Given our forecast recovery in the company’s DFS operation’s margins this year, we believe the stock will be rerated to its historical average PER (post 2011) of 31.5x. Also factoring in our outlook for its hotel business, we forecast Hotel Shilla to realise EPS growth of 518% YoY in 2018E and 48% YoY in 2019E. In our view, such earnings growth should support a valuation premium over the company’s global peers, as has been the case in the past 5 years.

Shilla stands out from other Korean DFS companies for its focus on the downtown duty- free store business, in our opinion. This business is supported by the established duty-free store infrastructure in Korea, where downtown duty-free shops have been the norm for over 4 decades thanks to government backing. Compared with airport concessions, downtown duty-free stores have longer business operating licences (10 years vs. 5-7 years on average) and pay negligible royalty fees to the government (0.1% of sales for DFS with sales exceeding KRW1tn). The result: downtown stores appeal strongly to daigou, which allows the stores to expand their sales and increase their scale in the long term.

We forecast Shilla’s earnings to grow 6-fold in 2018E and by 48% YoY in 2019E. On Bloomberg consensus forecasts, peer Dufry is set for EPS growth of 45% YoY in 2018E and 15% YoY in 2019E. In contrast to Shilla, Dufry focuses mainly on airport concessions (91% of its revenue in 2017). Further, Dufry’s exposure to the high-growth travel retail region of Asia is limited, at only 10% of revenue in 2017; Shilla’s airport concessions, all of which are in Asia, contributed 34% of its total revenue in 2017.

Shilla continues to focus on the growing Asia market. By moving into Hong Kong and other regional markets such as Singapore, the company should be better placed to tap into the increasing number of Mainland Chinese tourists, in our view. Hence, Shilla looks on course to outperform Dufry, in terms of earnings growth, over the next 3 years, which we believe would justify a valuation premium over Dufry. We find Shilla is trading currently at a 12- month forward PER of 21.4x, while Dufry is trading at a 12-month forward PER of 12.4x (Bloomberg consensus numbers).

Shilla: PER bands (KRW) 350,000 300,000 250,000 200,000 150,000 100,000 50,000

Jul-12 Jul-17

Apr-11 Oct-13 Apr-16

Jun-10 Jan-15 Jun-15

Feb-12 Mar-14 Feb-17

Nov-10 Sep-11 Dec-12 Aug-14 Nov-15 Sep-16 Dec-17

May-13 May-18 Price 11.5x 21.5x 31.5x 41.5x 51.5x

Source: Bloomberg, *Daiwa forecasts

Hotel Shilla (008770 KS): 28 June 2018

Peer valuations Mkt Cap Revenue(USD m) PER (x) PBR (x) EPS growth (%) ROE (%) Div. Company USD m 18E 19E 18E 19E 18E 19E 18E 19E 18E 19E DFS/Hotel Hotel Shilla* 4,092 4,395 5,065 27.9 18.8 4.6 3.7 517.6 48.4 19.6 22.1 DUFRY AG-REG 6,995 9,026 9,523 13.3 11.5 2.2 2.2 42.7 15.0 15.9 18.9 DFS Japan Airport Terminal 4,168 2,464 2,535 14.1 14.1 3.4 2.8 71.0 166.5 9.1 21.4 Marriott Int’l 44,855 22,778 23,866 22.8 19.8 16.8 24.5 27.8 15.2 62.6 112.3 Hotel Hilton Worldwide 23,511 9,492 10,189 28.9 24.6 28.0 53.4 35.6 17.4 57.2 179.0 Hyatt 8,607 4,494 4,694 51.3 39.6 2.4 2.5 -16.0 29.7 14.9 6.8 Average 26.4 21.4 9.6 14.8 113.1 48.7 29.9

Source: Bloomberg, *Daiwa forecasts

Risks to our call Slower-than-expected growth in Mainland visitor numbers Time lag between policy A major risk factor would be slower-than-expected growth in visitors from Mainland China. softening and visitor We believe that in 2H18 the number of Mainland visitors to Korea will rebound sharply from arrivals the low base of a year ago. Recent moves by the Chinese government suggest it is now softening its stance on Korea, some months after political relations between the 2 countries hit a low. However, policy risk is a perennial factor for any China-related business. We look for a gradual recovery in Mainland visitor numbers from 3Q18 and a full recovery by the time of the peak season in 4Q18. Recent data show there has been a recovery in arrivals from China through to June. However, if this recovery does not accelerate in the coming months, our company-level earnings forecasts would be at risk of downward revisions. This is the primary risk to our call.

Korea: number of visitors from Mainland China (people) 3,000 168% 200%

2,500 150% 85% 77% 2,000 100% 51% 17% 36% 1,500 7% 50% -9% 1,000 -44% 0% -63% -66% 500 -66% -50%

0 -100% 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18

Chinese inbound (LHS) YoY (RHS) Source: Korea Tourism Organization, Daiwa forecasts

2 new duty-free stores to open before year-end New downtown duty-free There are 2 new duty-free stores slated to open in Korea. In July, Shinsegae (004170 KS, stores on the way not rated) plans to open its 2nd duty-free store in the Gangnam district of Seoul. At the end of the year, Hyundai Department Store (069960 KS, not rated) will open its first DFS store, also in the Gangnam district. There is a risk that these new stores trigger a new wave of competition in the DFS segment.

As it stands, we believe that while the new openings may curb the decline in commission rates, they won’t increase overall costs. Shinsegae is now a top-3 player in the duty-free store segment and turned profitable in this segment in 2017. It seems unlikely that Shinsegae would jeopardise its own margins by seeking to aggressively expand its market share. Further, we note that Shinsegae recently won an Incheon airport concession, and the related cost burden means that the company is unlikely to want to heighten competition in the downtown area, in our view. Besides, Hyundai Department Store has a relatively conservative corporate culture, such that we do not expect it to seek aggressive market expansion in the DFS segment, to which the company is a newcomer.

Hotel Shilla (008770 KS): 28 June 2018

Shinsegae: DFS revenue and operating profit trend (KRWbn) 400 350 300 250 200 150 100 50 0 (50) 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 Revenue Operating Profit

Source: Company

Forex changes may bring volatility Swings in forex rates are another risk factor. In the DFS business, most merchandise is bought and sold in USD. Forex movements in the past few quarters have been favourable to Shilla, but there has been a swing in the other direction recently. Also, since Mainland China visitors are a key component of DFS shoppers, a weakening of the CNY against other currencies could prompt Mainland Chinese to defer their travel plans, which would be negative for the company.

Shilla: USD/KRW and gross-margin correlation 60% 1,250

50% 1,200

40% 1,150 30% 1,100 20%

1,050 10%

0% 1,000 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 GPM (LHS) USD/KRW (RHS)

Source: Company, Bloomberg

Hotel Shilla (008770 KS): 28 June 2018

Company background

Shilla mainly operates Shilla is mainly engaged in the operation of duty-free shops, and is the 2nd largest DFS duty-free shops and operator in Korea and the 5th largest globally by revenue. The company was established in hotels in domestic and March 1979 as The Shilla Seoul and became publicly traded on the Korea Exchange in overseas markets, February 1991. It operates its business through 2 segments: 1) travel retail, and 2) hotel including the Americas, and leisure. Asia and Europe Travel retail segment Shilla has operated duty-free shops since 1986 and has grown to become one of the world’s major travel retail companies. The company operates 2 downtown DFS in Korea, one in Japan, and 4 airport DFS in Korea, Singapore, Hong Kong and Macau. DFS contributed 89% of the company’s revenue in 1Q18, comprising sales of foreign-branded products and local products. Shilla’s Incheon International Airport DFS opened in 2008, and the company launched the first-ever Louis Vuitton boutique in a DFS in 2011 at its Incheon International Airport DFS. The company opened its first overseas store airport DFS at Singapore’s Changi Airport in 2013.

Hotel and leisure segment The company operates its hotel and leisure business in the domestic market and overseas, including the Americas, China and Singapore. The property was recently renovated into a luxury hotel. In addition, Shilla has 1 overseas location, in Suzhou, China. In 2014, Shilla Stay, the company’s business-focused brand, opened in Yeoksam, Seoul. It currently operates 11 branches in Korea.

Shilla: revenue breakdown by business (2017) Global travel retail: market share (2017)

Hotel & Leisure, Dufry, 13% 13.2%

Others, 40% Lotte Duty Free, 8%

DFS, 7%

Lagardere TR, 6% China DF Travel Retail, Group, 2% Heinemann, 5% 86.8% Shilla DF, 5% Shinsegae DF, 2% Dubai Duty Ever Rich King Power, 3% Free, 3% Group, 3% Sunrise DF, 3% Source: Company Source: Companies

Korea Consumer Staples 28 June 2018

LG Household & Health Care (051900 KS) LG H ousehold & H ealth C are

Target price: KRW1,710,000 (from KRW1,430,000)

Share price (27 Jun): KRW1,433,000 | Up/downside: +19.3%

Upgrading: focus on luxury cosmetics pays off

 Earnings growth likely to continue regardless of Chinese tourists Iris Park (82) 2787 9165  Cosmetics margins already ahead of global peers’ [email protected]  Upgrading to Buy (1) from Outperform (2); raising TP to KRW1.71m

What's new: We upgrade our rating on LG H&H to Buy (1) given its strong Forecast revisions (%) growth momentum due to increased demand in China. Despite the Year to 31 Dec 18E 19E 20E absence of Chinese group tourists, we expect robust earnings growth in Revenue change - - - Net profit change - - - 2018 given its flexible sales policy in DFS. Core EPS (FD) change - - -

Source: Daiwa forecasts What's the impact: Flexible purchase policy allows daigou access. Since 3Q17, LG H&H has started outpacing Amorepacific (090430 KS, Share price performance KRW309,000, Buy [1]) in terms of DFS revenue. We believe the key reason (KRW) (%) for this was the different purchase limits for each company; Amorepacific 1,500,000 155 pursued stricter rules from 3Q17, while LG H&H was more flexible. This 1,325,000 136 allowed LG H&H to benefit from the influx of reseller sales, in our view. 1,150,000 118 Given that the company has no plans to change its sales policy in DFS, we 975,000 99 800,000 80 believe LG H&H will continue to outperform Amorepacific in DFS revenue Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 until a visible recovery in the number of Chinese group tourists. DFS is the LG H&H (LHS) Relative to KOSPI (RHS) largest contributor to LG H&H’s OPM at c.30%; thus, we believe strong growth in this channel will help the company post robust earnings growth in 12-month range 851,000-1,480,000 2018. Market cap (USDbn) 20.03 3m avg daily turnover (USDm) 32.97 Focus on high-end cosmetics resulting in higher margins. In China, Shares outstanding (m) 16 Major shareholder LG Corp (34.0%) LG H&H has been focusing mainly on high-end cosmetics, namely Whoo and Sum. This allowed it to post high margins not only in China but also in Financial summary (KRW) Korea from 2016. As these luxury brands are well known to consumers, Year to 31 Dec 18E 19E 20E there is robust demand from both individual tourists and diagou. As a result, Revenue (bn) 7,206 8,270 9,152 LG H&H posted record-high revenue in its cosmetic business in 2017. The Operating profit (bn) 1,178 1,368 1,552 Net profit (bn) 827 965 1,098 cosmetic business’ OPM was c.20% in 2017, higher than that of global Core EPS (fully-diluted) 56,411 65,815 74,928 peers like L’Oréal (Not rated) and Estee Lauder (Not rated). LG H&H plans EPS change (%) 33.7 16.7 13.8 to continue to focus on luxury cosmetics with brand diversification, which Daiwa vs Cons. EPS (%) 12.5 17.4 23.1 PER (x) 25.4 21.8 19.1 will enable its OPM to expand by 1.5pp YoY in 2018E, on our estimates. Dividend yield (%) 0.7 0.8 0.9 DPS 10,500 12,000 13,500 What we recommend: We raise our 12-month TP to KRW1.71m (from PBR (x) 5.9 4.7 3.8 EV/EBITDA (x) 16.4 13.7 11.6 KRW1.43m) and upgrade our rating to Buy (1) from Outperform (2). To ROE (%) 24.4 22.6 20.7 derive our TP, we applied its past-5-year average PER of 28x to our 2018E- Source: FactSet, Daiwa forecasts 19E average EPS. Since 2016, LG H&H has been trading at par with global luxury cosmetics companies (average PER of 28x), as cosmetics contribute 67% to its earnings. We believe the stock should be evaluated on earnings growth; thus, we change the valuation method from DCF. We expect higher earnings growth in 2018, led by its luxury cosmetics growth outperforming its global cosmetics peers, allowing the stock to be re-rated. We see higher demand for Sum in DFS as a share-price catalyst. Key risk: slower-than- expected revenue growth at the household goods division.

How we differ: Our 2018-20E EPS are 13-23% above the Bloomberg consensus likely as we are more bullish on the DFS outlook for LG H&H.

See important disclosures, including any required research certifications, beginning on page 50

LG Household & Health Care (051900 KS): 28 June 2018

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Household revenue (KRW bn) 1,468.2 1,502.4 1,513.2 1,594.5 1,517.7 1,553.6 1,549.7 1,550.8 Cosmetics revenue (KRW bn) 1,661.7 1,955.9 2,533.0 3,155.6 3,279.9 4,292.4 5,321.7 6,169.0 Beverage revenue (KRW bn) 1,221.5 1,218.6 1,282.2 1,344.2 1,307.7 1,360.2 1,398.7 1,432.0 China cosmetics revenue (KRW bn) 82.2 121.3 201.8 269.0 362.6 529.7 725.1 939.0 Duty-free store revenue (KRW bn) 99.3 299.8 637.5 1,030.4 1,034.7 1,776.0 2,376.5 2,971.0 Chinese inbound growth (YoY %) 52.5 41.6 (2.3) 34.8 (33.6) 75.0 35.0 18.5

Profit and loss (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cosmetics 1,662 1,956 2,533 3,156 3,280 4,292 5,322 6,169 Others 2,665 2,721 2,795 2,938 2,825 2,914 2,948 2,983 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 4,326 4,677 5,328 6,094 6,105 7,206 8,270 9,152 Other income 110 121 127 134 146 173 186 199 COGS (2,032) (2,102) (2,226) (2,434) (2,610) (2,831) (2,948) (3,151) SG&A (1,798) (2,064) (2,418) (2,779) (2,566) (3,197) (3,954) (4,448) Other op.expenses (110) (121) (127) (134) (146) (173) (186) (199) Operating profit 496 511 684 881 930 1,178 1,368 1,552 Net-interest inc./(exp.) (34) (32) (27) (16) (10) (13) (11) (9) Assoc/forex/extraord./others 11 1 (12) (112) (58) (13) (13) (14) Pre-tax profit 473 480 645 753 861 1,152 1,344 1,530 Tax (108) (126) (174) (173) (243) (325) (379) (431) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 366 355 470 579 619 827 965 1,098 Net profit (adjusted) 366 355 470 579 619 827 965 1,098 EPS (reported)(KRW) 24,943 24,186 32,085 39,512 42,194 56,411 65,815 74,928 EPS (adjusted)(KRW) 24,943 24,186 32,085 39,512 42,194 56,411 65,815 74,928 EPS (adjusted fully-diluted)(KRW) 24,943 24,186 32,085 39,512 42,194 56,411 65,815 74,928 DPS (KRW) 3,750 4,000 5,500 7,500 9,000 10,500 12,000 13,500 EBIT 496 511 684 881 930 1,178 1,368 1,552 EBITDA 607 632 811 1,015 1,077 1,350 1,553 1,751

Cash flow (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax 473 480 645 753 861 1,152 1,344 1,530 Depreciation and amortisation 110 121 127 134 146 173 186 199 Tax paid (123) (137) (161) (165) (235) (314) (366) (417) Change in working capital (92) (32) (16) (135) (108) (37) (99) (72) Other operational CF items 20 34 43 128 71 240 259 262 Cash flow from operations 390 466 638 713 735 1,214 1,323 1,501 Capex (137) (183) (292) (332) (284) (480) (350) (350) Net (acquisitions)/disposals (8) 0 (3) (3) 0 0 0 0 Other investing CF items (348) (95) (52) (71) (50) (13) (13) (11) Cash flow from investing (493) (278) (347) (406) (334) (493) (363) (361) Change in debt 260 72 (162) (274) (188) (260) (150) (100) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (63) (64) (68) (93) (134) (156) (179) (201) Other financing CF items (11) (0) (2) 1 (29) 0 0 0 Cash flow from financing 185 8 (232) (367) (351) (416) (329) (301) Forex effect/others (0) 0 (1) 0 0 0 0 0 Change in cash 82 196 59 (59) 51 305 632 839 Free cash flow 252 283 346 382 451 734 973 1,151 Source: FactSet, Daiwa forecasts

LG Household & Health Care (051900 KS): 28 June 2018

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment 156 356 428 366 403 711 1,345 2,187 Inventory 376 411 441 536 547 611 683 738 Accounts receivable 424 427 436 493 540 572 646 704 Other current assets 26 20 26 30 24 28 32 36 Total current assets 981 1,214 1,331 1,425 1,513 1,921 2,707 3,665 Fixed assets 1,022 1,102 1,290 1,464 1,617 1,943 2,126 2,295 Goodwill & intangibles 1,286 1,346 1,380 1,420 1,393 1,374 1,355 1,337 Other non-current assets 146 166 213 194 255 274 300 321 Total assets 3,435 3,828 4,215 4,502 4,778 5,512 6,488 7,619 Short-term debt 398 369 373 277 336 226 176 76 Accounts payable 383 416 420 612 636 751 862 954 Other current liabilities 201 251 366 258 272 317 364 403 Total current liabilities 982 1,036 1,159 1,147 1,244 1,294 1,401 1,432 Long-term debt 746 861 733 549 288 147 51 55 Other non-current liabilities 232 223 207 185 163 167 172 175 Total liabilities 1,960 2,120 2,099 1,881 1,695 1,608 1,625 1,663 Share capital 89 89 89 89 89 89 89 89 Reserves/R.E./others 1,320 1,549 1,949 2,444 2,908 3,723 4,675 5,759 Shareholders' equity 1,409 1,637 2,037 2,532 2,997 3,812 4,764 5,848 Minority interests 67 71 78 88 86 92 100 108 Total equity & liabilities 3,435 3,828 4,215 4,502 4,778 5,512 6,488 7,619 EV 23,390 23,275 23,089 22,872 22,632 22,080 21,307 20,377 Net debt/(cash) 989 874 678 461 221 (338) (1,118) (2,056) BVPS (KRW) 89,534 104,169 129,772 161,469 191,224 243,379 304,352 373,768

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) 11.0 8.1 13.9 14.4 0.2 18.0 14.8 10.7 EBITDA (YoY) 9.5 4.2 28.3 25.1 6.1 25.4 15.0 12.7 Operating profit (YoY) 11.4 2.9 33.9 28.8 5.6 26.6 16.1 13.5 Net profit (YoY) 17.2 (3.0) 32.7 23.1 6.8 33.7 16.7 13.8 Core EPS (fully-diluted) (YoY) 17.2 (3.0) 32.7 23.1 6.8 33.7 16.7 13.8 Gross-profit margin 53.0 55.1 58.2 60.1 57.3 60.7 64.4 65.6 EBITDA margin 14.0 13.5 15.2 16.6 17.6 18.7 18.8 19.1 Operating-profit margin 11.5 10.9 12.8 14.5 15.2 16.3 16.5 17.0 Net profit margin 8.5 7.6 8.8 9.5 10.1 11.5 11.7 12.0 ROAE 28.2 23.4 25.7 25.5 22.5 24.4 22.6 20.7 ROAA 11.8 9.8 11.7 13.3 13.3 16.1 16.1 15.6 ROCE 21.4 18.4 22.2 26.4 26.0 29.5 29.2 27.8 ROIC 17.4 15.0 18.6 23.1 20.9 24.6 26.9 29.2 Net debt to equity 70.2 53.4 33.3 18.2 7.4 n.a. n.a. n.a. Effective tax rate 22.8 26.2 27.1 23.0 28.2 28.2 28.2 28.2 Accounts receivable (days) 23.3 33.2 29.6 27.8 30.9 28.1 26.9 26.9 Current ratio (x) 1.0 1.2 1.1 1.2 1.2 1.5 1.9 2.6 Net interest cover (x) 14.7 15.9 25.5 55.2 88.8 88.1 124.1 177.6 Net dividend payout 15.0 16.5 17.1 19.0 21.3 18.6 18.2 18.0 Free cash flow yield 1.1 1.3 1.5 1.7 2.0 3.3 4.3 5.1 Source: FactSet, Daiwa forecasts

Company profile

LG Household & Health Care, a Korea-based company, is focused on the manufacture of household goods, cosmetics and beverages. The household goods include laundry detergents, aromatics, and hygiene products under the brand names of Perioe, SAY, Elastine, TECH, Saffron, and others. The cosmetics, including skin care and hair care products, are provided under the names of O HUI, Whoo, SOORYEHAN, and ISA KNOX, while the beverages segment provides carbonated and non-carbonated beverages. The company operates in many overseas markets, such as the US, China, Taiwan, Vietnam, and European countries.

Korea Consumer Staples 28 June 2018

Cosmax (192820 KS) Cosmax

Target price: KRW196,000 (from KRW164,000) Share price (27 Jun): KRW156,500 | Up/downside: +25.2%

Growth in Korea and China likely to accelerate

 Higher factory utilisation in Korea should improve margins in 2H18 Iris Park (82) 2787 9165  Expanding client base in Korea and overseas to sustain high growth [email protected]  Reiterating our Buy (1) rating; raising TP to KRW196,000

What's new: We expect Cosmax to benefit from increased weishang Forecast revisions (%) demand from both Korea and China in 2018. Weak domestic revenue Year to 31 Dec 18E 19E 20E growth in 2017 hurt Cosmax’s margins as scale is the key. We forecast an Revenue change (5.6) (7.4) n.a. Net profit change (5.5) (7.8) n.a. upturn in margins for Cosmax in 2018 as revenue growth accelerates. Core EPS (FD) change (5.5) (7.8) n.a.

Source: Daiwa forecasts What's the impact: Korea: resuming double-digit growth from 2Q18. According to management, Cosmax’s domestic revenue growth Share price performance accelerated into double digits from April. We believe its diversifying client (KRW) (%) base is contributing to such fast growth. Also, single-brand shops, 180,000 145 Cosmax’s major client base, are trying to overcome their difficulties by 160,000 129 releasing new products with Cosmax. We expect this uptrend in domestic 140,000 113 120,000 96 revenue to continue in 2H18 given: 1) its low base in 2H17, 2) continued 100,000 80 client diversification effect, and 3) the return of Mainland Chinese tourists to Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Korea. We believe weak revenue from Korea was the major reason for Cosmax Inc (LHS) Relative to KOSPI (RHS) margin deterioration in 2017, which we expect to improve from 2H18 with better top-line growth. We forecast Cosmax’s Korea revenue growth to be 12-month range 102,500-179,000 15% YoY (KRW609bn) in 2018, vs. 4.5% YoY growth in 2017. Market cap (USDbn) 1.26 3m avg daily turnover (USDm) 13.15 China: seeking opportunities with new clients. Cosmax China has Shares outstanding (m) 9 Major shareholder Cosmax BTI (25.7%) steadily reduced its revenue exposure to its top client in China from 2016. Meanwhile, it has started supplying to retailers in China, including Financial summary (KRW) weishang. Although these sellers are small in terms of size, they tend to Year to 31 Dec 18E 19E 20E carry limited number of SKUs due to inventory burden. We believe this is Revenue (bn) 1,198 1,424 1,636 helpful for Cosmax’s margins as it increases the factory utilisation rate, Operating profit (bn) 66 91 115 Net profit (bn) 48 74 83 which is crucial to margins. We note that the development of the weishang Core EPS (fully-diluted) 4,767 7,321 8,276 channel in China is still an ongoing phenomenon. China Information EPS change (%) 155.2 53.6 13.0 Industry Network forecasts the weishang market to nearly double in value Daiwa vs Cons. EPS (%) 11.0 20.9 7.8 PER (x) 32.8 21.4 18.9 to CNY980bn in 2019 from CNY496bn in 2017. According to iResearch, Dividend yield (%) 0.4 0.6 0.8 33% of all weishang shops sell cosmetics, providing business opportunities DPS 700 1,000 1,300 for Cosmax. We think such opportunities will boost Cosmax China’s PBR (x) 5.8 4.6 3.7 EV/EBITDA (x) 19.9 14.6 11.2 revenue growth (+35% YoY to KRW604bn in 2019E). ROE (%) 19.6 24.0 21.6 Source: FactSet, Daiwa forecasts What we recommend: We reiterate our Buy (1) rating, and raise our 12- month TP to KRW196,000 (from KRW164,000), still based on an unchanged target PER of 32.5x, applied to our average 2018E-19E EPS (previously 2018E). We lower our 2018E EPS by 5.5% to reflect the likely cost increase of KRW2bn due to new government weekly working hour requirement to be implemented in 2H18. Key risks: higher-than-expected investments in production facilities and R&D.

How we differ: Our 2018-20E EPS are 11-21% above the consensus, as we are more bullish on Cosmax’s domestic earnings growth.

See important disclosures, including any required research certifications, beginning on page 50

Cosmax (192820 KS): 28 June 2018

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E One brand shop growth (yoy%) n.a. 22.1 15.5 15.5 15.0 12.0 9.6 8.0 China cosmetic market growth (yoy%) n.a. 14.8 12.1 8.5 15.0 12.8 10.8 9.2 Cosmax Korea export growth (yoy%) n.a. 54.5 93.2 36.2 36.3 18.4 22.1 17.7 Cosmax China growth (yoy%) n.a. 57.4 65.8 32.2 30.8 27.3 27.8 22.5

Profit and loss (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Korea n.a. 290 372 506 528 609 700 786 Others n.a. 98 161 251 356 589 723 850 Other Revenue n.a. 0 0 0 0 0 0 0 Total Revenue n.a. 389 533 757 884 1,198 1,424 1,636 Other income n.a. 7 9 13 20 18 18 19 COGS n.a. (323) (445) (639) (772) (1,031) (1,217) (1,390) SG&A n.a. (32) (52) (65) (77) (101) (116) (131) Other op.expenses n.a. (7) (9) (13) (20) (18) (18) (19) Operating profit n.a. 34 36 53 35 66 91 115 Net-interest inc./(exp.) n.a. (4) (5) (7) (10) (8) (6) (4) Assoc/forex/extraord./others n.a. 2 (1) 1 3 4 4 5 Pre-tax profit n.a. 31 29 46 28 62 89 116 Tax n.a. (6) (11) (15) (9) (13) (16) (32) Min. int./pref. div./others n.a. 0 0 0 0 (1) 0 (1) Net profit (reported) n.a. 25 19 31 19 48 74 83 Net profit (adjusted) n.a. 25 19 31 19 48 74 83 EPS (reported)(KRW) n.a. 2,770 2,099 3,398 1,868 4,767 7,321 8,276 EPS (adjusted)(KRW) n.a. 2,770 2,099 3,398 1,868 4,767 7,321 8,276 EPS (adjusted fully-diluted)(KRW) n.a. 2,770 2,099 3,398 1,868 4,767 7,321 8,276 DPS (KRW) 0 500 700 1,000 300 700 1,000 1,300 EBIT n.a. 34 36 53 35 66 91 115 EBITDA n.a. 40 45 65 55 83 109 135

Cash flow (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax n.a. 31 29 46 28 62 89 116 Depreciation and amortisation n.a. 7 9 13 20 18 18 19 Tax paid n.a. (2) (12) (13) (20) (28) (33) (68) Change in working capital n.a. (29) (40) (26) (41) 44 (12) (6) Other operational CF items n.a. (5) 7 3 6 61 73 104 Cash flow from operations n.a. 1 (7) 23 (7) 157 136 166 Capex n.a. (43) (45) (90) (81) (35) (35) (35) Net (acquisitions)/disposals n.a. 1 1 3 1 0 0 0 Other investing CF items n.a. (4) (3) (11) (92) 10 (2) (2) Cash flow from investing n.a. (46) (47) (98) (173) (25) (37) (37) Change in debt n.a. 44 65 39 160 (92) (76) (67) Net share issues/(repurchases) n.a. 0 0 93 0 0 0 2 Dividends paid n.a. 0 (4) (6) (10) (23) (33) (44) Other financing CF items n.a. (1) 0 (0) (0) (0) (0) (0) Cash flow from financing n.a. 44 60 125 150 (115) (109) (108) Forex effect/others n.a. 0 (0) 0 0 0 0 0 Change in cash n.a. (1) 7 51 (29) 16 (10) 21 Free cash flow n.a. (42) (52) (66) (88) 122 101 131 Source: FactSet, Daiwa forecasts

Cosmax (192820 KS): 28 June 2018

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment n.a. 15 21 70 44 59 50 71 Inventory n.a. 58 84 125 185 190 219 244 Accounts receivable n.a. 96 144 192 251 279 316 348 Other current assets n.a. 10 7 9 15 28 33 38 Total current assets n.a. 178 256 396 495 556 618 702 Fixed assets n.a. 132 163 240 302 320 337 353 Goodwill & intangibles n.a. 3 5 6 91 90 89 89 Other non-current assets n.a. 12 15 28 36 31 36 40 Total assets n.a. 326 439 670 923 997 1,081 1,184 Short-term debt n.a. 111 177 190 242 146 87 166 Accounts payable n.a. 75 103 166 264 357 424 488 Other current liabilities n.a. 14 17 29 16 28 36 44 Total current liabilities n.a. 199 296 385 521 531 548 698 Long-term debt n.a. 34 34 60 163 167 150 4 Other non-current liabilities n.a. 12 12 15 21 28 38 55 Total liabilities n.a. 245 343 459 705 727 737 757 Share capital n.a. 4 4 5 5 5 5 5 Reserves/R.E./others n.a. 76 92 206 213 265 339 422 Shareholders' equity n.a. 81 97 211 218 270 344 427 Minority interests n.a. 0 0 0 0 0 0 0 Total equity & liabilities n.a. 326 439 670 923 997 1,081 1,184 EV n.a. 1,539 1,599 1,587 1,769 1,662 1,595 1,507 Net debt/(cash) n.a. 130 190 180 362 254 188 99 BVPS (KRW) n.a. 8,949 10,725 23,438 21,704 26,893 34,214 42,467

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) n.a. n.a. 37.3 41.9 16.8 35.5 18.8 14.9 EBITDA (YoY) n.a. n.a. 12.4 44.6 (15.0) 50.7 30.7 23.5 Operating profit (YoY) n.a. n.a. 7.2 46.4 (33.2) 87.4 37.5 27.3 Net profit (YoY) n.a. n.a. (24.2) 66.5 (40.3) 155.2 53.6 13.0 Core EPS (fully-diluted) (YoY) n.a. n.a. (24.2) 61.9 (45.0) 155.2 53.6 13.0 Gross-profit margin n.a. 16.9 16.5 15.6 12.7 13.9 14.5 15.0 EBITDA margin n.a. 10.3 8.4 8.6 6.3 7.0 7.7 8.2 Operating-profit margin n.a. 8.6 6.7 7.0 4.0 5.5 6.4 7.0 Net profit margin n.a. 6.4 3.5 4.2 2.1 4.0 5.2 5.1 ROAE n.a. 61.9 21.3 20.5 8.8 19.6 24.0 21.6 ROAA n.a. 15.3 4.9 5.7 2.4 5.0 7.1 7.3 ROCE n.a. 29.7 13.5 13.7 6.5 10.9 15.6 19.6 ROIC n.a. 12.7 9.3 10.5 4.8 9.4 14.2 15.7 Net debt to equity n.a. 161.9 196.9 85.1 165.8 94.1 54.6 23.2 Effective tax rate n.a. 20.2 36.0 32.4 33.6 21.5 17.5 27.9 Accounts receivable (days) n.a. 45.0 82.2 81.1 91.5 80.7 76.3 74.1 Current ratio (x) n.a. 0.9 0.9 1.0 0.9 1.0 1.1 1.0 Net interest cover (x) n.a. 8.5 6.5 7.9 3.6 8.6 15.8 28.5 Net dividend payout n.a. 18.0 33.4 29.4 16.1 14.7 13.7 15.7 Free cash flow yield n.a. n.a. n.a. n.a. n.a. 8.6 7.2 9.3 Source: FactSet, Daiwa forecasts

Company profile

Cosmax was established in Korea in November 1992. As an original development and design manufacturing (ODM) company, Cosmax provides cosmetics products to both local Korean and foreign brands. The company launched its business in China in 2004 and is on the back of expanded manufacturing capacity and rise in orders. The company has Nu-World Corporation, Cosmax China, Cosmax Indonesia subsidiaries.

Korea Consumer: 28 June 2018

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; Jiro IOKIBE (852) 2773 8702 [email protected] Shipbuilding; Steel Co-head of Asia Pacific Research Mike OH (82) 2 787 9179 [email protected] John HETHERINGTON (852) 2773 8787 [email protected] Banking; Capital Goods (Construction and Machinery) Co-head of Asia Pacific Research Josh RHEE (82) 2 787 9124 [email protected] Craig CORK (852) 2848 4463 [email protected] Chemicals Regional Head of Asia Pacific Product Management Iris PARK (82) 2 787 9165 [email protected] Paul M. KITNEY (852) 2848 4947 [email protected] Consumer/Retail Chief Strategist for Asia Pacific; Strategy (Regional) SK KIM (82) 2 787 9173 [email protected] Kevin LAI (852) 2848 4926 [email protected] IT/Electronics – Semiconductor/Display and Tech Hardware Chief Economist for Asia ex-Japan; Macro Economics (Regional) Thomas Y KWON (82) 2 787 9181 [email protected] Olivia XIA (852) 2773 8736 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Games Macro Economics (Regional/China) Kelvin LAU (852) 2848 4467 [email protected] TAIWAN Head of Automobiles; Transportation and Industrial (Hong Kong/China) Rick HSU (886) 2 8758 6261 [email protected] Jay LU (852) 2848 4970 [email protected] Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design (Regional) Automobiles and Components (Hong Kong/China) Nora HOU (886) 2 8758 6249 [email protected] Leon QI (852) 2532 4381 [email protected] Banking; Diversified financials; Insurance Regional Head of Financials; Banking; Diversified financials; Insurance (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (PC Hardware) Kylie HUANG (886) 2 8758 6248 [email protected] Consumer (Hong Kong/China) Adrian CHAN (852) 2848 4427 [email protected] IT/Technology Hardware (Handsets and Components) Consumer (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] John CHOI (852) 2773 8730 [email protected] Small/Mid Cap Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Fiona LIANG (852) 2532 4341 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Industrial (Hong Kong/China) Dennis IP (852) 2848 4068 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Regional Head of Power, Utilities, Renewable and Environment (PURE); PURE (Hong Kong/China) Capital Goods; Utilities Daniel YANG (852) 2848 4443 [email protected] Power, Utilities, Renewable and Environment (PURE) – Solar and Nuclear (China) SINGAPORE Don LAU (852) 2848 4469 [email protected] Ramakrishna MARUVADA (65) 6228 6742 [email protected] Power, Utilities, Renewable and Environment (PURE) – Utilities (Hong Kong) Head of Singapore Research; Telecommunications (China/ASEAN/India) Jonas KAN (852) 2848 4439 [email protected] David LUM (65) 6228 6740 [email protected] Head of Hong Kong and China Property Banking; Property and REITs Cynthia CHAN (852) 2773 8243 [email protected] Royston TAN (65) 6228 6745 [email protected] Property (China) Oil and Gas; Capital Goods Carlton LAI (852) 2532 4349 [email protected] Jame OSMAN (65) 6228 6744 [email protected] Small/Mid Cap (Hong Kong/China) Transportation – Road and Rail; Pharmaceuticals and Healthcare; Consumer (Singapore) Michelle WANG (852) 2773 8842 [email protected] Transportation (Hong Kong/China) JAPAN Yukino YAMADA (81) 3 5555 7295 [email protected] Strategy (Regional)

PHILIPPINES Renzo CANDANO (63) 2 737 3022 [email protected] Consumer Micaela ABAQUITA (63) 2 737 3021 [email protected] Property Gregg ILAG (63) 2 737 3023 [email protected] Utilities; Energy

Korea Consumer: 28 June 2018

Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc. New York Head Office Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100 Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935 Daiwa Capital Markets Europe Limited, London Head Office 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Neue Mainzer Str. 1, 60311 Frankfurt/Main, Germany (49) 69 717 080 (49) 69 723 340 Daiwa Capital Markets Europe Limited, Paris Representative Office 17, rue de Surène 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808 Daiwa Capital Markets Europe Limited, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441 Daiwa Capital Markets Europe Limited, Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, (7) 495 641 3416 (7) 495 775 6238 Moscow Representative Office Russian Federation Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, (973) 17 534 452 (973) 17 535 113 Manama, Bahrain Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621 Daiwa Capital Markets Singapore Limited 7 Straits View, Marina One East Tower, #16-05 & #16-06, (65) 6387 8888 (65) 6282 8030 Singapore 018936, Republic of Singapore Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, (61) 3 9916 1300 (61) 3 9916 1330 Victoria 3000, Australia DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, (632) 813 7344 (632) 848 0105 Makati City, Republic of the Philippines Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638 Daiwa Securities Capital Markets Korea Co., Ltd. 20 Fl.& 21Fl. One IFC, 10 Gukjegeumyung-Ro, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, Korea Daiwa Securities Co. Ltd., Beijing Representative Office Room 301/302，Kerry Center，1 Guanghua Road，Chaoyang District， (86) 10 6500 6688 (86) 10 6500 3594 Beijing 100020, People’s Republic of China Daiwa (Shanghai) Corporate Strategic Advisory Co. Ltd. 44/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road, Pudong, (86) 21 3858 2000 (86) 21 3858 2111 Shanghai China 200120 , People’s Republic of China Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, (66) 2 252 5650 (66) 2 252 5665 Lumpini, Pathumwan, Bangkok 10330, Thailand Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, (91) 22 6622 1000 (91) 22 6622 1019 Bandra East, Mumbai – 400051, India Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Hoan Kiem Dist. Hanoi, Vietnam

DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

New York Research Center 11th Floor, Financial Square, 32 Old Slip, NY, NY 10005-3504, U.S.A. (1) 212 612 6100 (1) 212 612 8417 London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550

Korea Consumer: 28 June 2018

Amorepacific: share price and Daiwa recommendation trend Date Target Price Rating Date Target price Rating Date Target price Rating 22/10/15 460,000 Buy 24/04/17 354,000 Buy 09/05/18 430,000 Buy 07/07/16 515,000 Buy 26/07/17 298,000 Hold

14/02/17 415,000 Buy 30/10/17 350,000 Outperform 550,000 515,000 500,000 500,000

460,000 450,000 440,000 430,000 415,000 400,000

350,000 354,000 350,000

300,000 298,000

250,000

200,000

Jul-15 Jul-16 Jul-17

Apr-16 Oct-15 Oct-16 Apr-17 Oct-17 Apr-18

Jun-15 Jan-16 Jun-16 Jan-17 Jun-17 Jan-18

Feb-16 Mar-16 Feb-17 Mar-17 Feb-18 Mar-18

Sep-17 Aug-15 Sep-15 Nov-15 Dec-15 Aug-16 Sep-16 Nov-16 Dec-16 Aug-17 Nov-17 Dec-17

May-18 May-16 May-17

Target price (KRW) Closing Price (KRW)

Source: Daiwa Note: where appropriate, historical target prices have been adjusted to reflect the current share count

LG Household & Health Care: share price and Daiwa recommendation trend Date Target Price Rating Date Target price Rating Date Target price Rating 13/10/15 1,040,000 Outperform 25/10/16 970,000 Outperform 18/01/18 1,300,000 Outperform 14/10/15 1,040,000 Buy 14/02/17 930,000 Outperform 16/04/18 1,430,000 Outperform 15/01/16 1,100,000 Outperform 25/07/17 1,040,000 Outperform

26/07/16 1,200,000 Outperform 24/10/17 1,200,000 Outperform 1,800,000

1,600,000

1,400,000 1,430,000 1,300,000 1,200,000 1,200,000 1,200,000 1,100,000 1,040,000 1,040,000 1,000,000 970,000 903,000 930,000 800,000 830,000

600,000

Jul-15 Jul-16 Jul-17

Oct-15 Oct-17 Apr-16 Oct-16 Apr-17 Apr-18

Jun-15 Jan-16 Jun-16 Jan-17 Jun-17 Jan-18

Feb-16 Mar-16 Feb-17 Mar-17 Feb-18 Mar-18

Aug-15 Sep-15 Nov-15 Dec-15 Aug-16 Sep-16 Nov-16 Dec-16 Aug-17 Sep-17 Nov-17 Dec-17

May-16 May-17 May-18

Target price (KRW) Closing Price (KRW)

Source: Daiwa Note: where appropriate, historical target prices have been adjusted to reflect the current share count

Korea Consumer: 28 June 2018

Cosmax: share price and Daiwa recommendation trend Date Target Price Rating Date Target price Rating Date Target price Rating 17/02/16 151,000 Outperform 29/11/16 201,000 Buy 06/06/17 160,000 Buy 01/07/16 223,000 Buy 10/02/17 193,500 Buy 09/08/17 151,000 Buy 13/09/16 230,000 Buy 14/02/17 201,000 Buy 13/11/17 166,000 Buy

04/11/16 198,000 Buy 15/02/17 194,000 Buy 13/02/18 164,000 Buy 240,000 230,000 220,000 220,000 223,000

200,000 198,000201,000 201,000 193,500194,000 180,000 165,000 166,000 160,000 160,000 164,000 151,000 151,000 140,000

120,000

100,000

80,000

Jul-15 Jul-16 Jul-17

Apr-16 Oct-15 Oct-16 Apr-17 Oct-17 Apr-18

Jun-15 Jan-16 Jun-16 Jan-17 Jun-17 Jan-18

Feb-16 Mar-16 Feb-17 Mar-17 Feb-18 Mar-18

Sep-17 Aug-15 Sep-15 Nov-15 Dec-15 Aug-16 Sep-16 Nov-16 Dec-16 Aug-17 Nov-17 Dec-17

May-18 May-16 May-17

Target price (KRW) Closing Price (KRW)

Source: Daiwa Note: where appropriate, historical target prices have been adjusted to reflect the current share count

Korea Consumer: 28 June 2018

Important Disclosures and Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. Daiwa Securities Group Inc., its subsidiaries or affiliates do and seek to do business with the company(s) covered in this research report. Therefore, investors should be aware that a conflict of interest may exist. The following are additional disclosures.

Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: PT Totalindo Eka Persada Tbk (TOPS IJ), PT Integra Indocabinet Tbk (WOOD IJ), PT Buyung Putera Sembada (HOKI IJ), Cromwell European REIT (CERT_SP), Beijing Enterprises Water Group Ltd (371 HK), Mirae Asset Daewoo Co Ltd (006800 KS).

*Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research.

Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.

Korea The developing analyst of this research and analysis material hereby states and confirms that the contents of this material correctly reflect the analyst’s views and opinions and that the analyst has not been placed under inappropriate pressure or interruption by an external party.

Name of Analyst : Iris Park

Disclosure of Analysts’ Interests If an analyst engaging in or a person who exercises influences on the preparation or publication of a Research Report containing recommendations for general investors to trade financial investment instruments with regard to which the analyst or the influential person has personal interests and if the recommendations contained in the Report may have impacts on the personal interests, Daiwa Securities Capital Markets Korea Co., Ltd.(“Daiwa Securities Korea”)shall ensure that the Analyst or the influential person notifies that he/she has personal interests with regard to:

1. The equity, the equity-linked bonds and the instruments with the subscription right to the equity issued by the legal entity covered in the Research Report (or the legal entity subject to the investment recommendations); 2. The stock option granted by the legal entity covered in the Research Report (or the legal entity subject to the investment recommendations); or 3. The equity futures, the equity options and the equity-linked warrants backed by the equity prescribed in the preceding Paragraph 1 as the underlying assets.

Legal Entities subject to Research Report Coverage Restrictions Daiwa Securities Korea hereby states and confirms that Daiwa Securities Korea has no conflicts of interests with the legal entity covered in this Research Report:

1. In that Daiwa Securities Korea does NOT offer direct or indirect payment guarantee for the legal entity by means of, for instance, guarantee, endorsement, provision of collaterals or the acquisition of debts; 2. In that Daiwa Securities Korea does NOT own one-hundredth (or 1/100) or more of the total number of outstanding equities issued by the legal entity; 3. In that The legal entity is NOT an affiliated company of Daiwa Securities Korea pursuant to Sub-paragraph 3, Article 2 of the Monopoly Regulation and Fair Trade Act of Korea; 4. In that, although Daiwa Securities Korea offers advisory services for the legal entity with regard to an M&A deal, the size of the M&A deal does NOT exceed five-hundredths (or 5/100) of the total asset size or the total number of equities issued and outstanding of the legal entity; 5. In that, although Daiwa Securities Korea acted in the capacity of a Lead Underwriter for the initial public offering of the legal entity, more than one-year has passed since the IPO date; 6. In that Daiwa Securities Korea is NOT designated by the legal entity as the ‘tender offer agent’ pursuant to the Paragraph 2, Article 133 of the Financial Services and Capital Market Act or the legal entity is NOT the issuer of the equity subject to the proposed tender offer; this requirement, however applies until the maturity of the tender offer period; or 7. In that Daiwa Securities Korea does NOT have significant or material interests with regard to the legal entity.

Disclosure of Prior Distribution to Third Party This report has not been distributed to the third party in advance prior to public release.

The following explains the rating system in the report as compared to KOSPI, based on the beliefs of the author(s) of this report.

"1": the security could outperform the KOSPI by more than 15% over the next 12 months, unless otherwise stated. "2": the security is expected to outperform the KOSPI by 5-15% over the next 12 months, unless otherwise stated. "3": the security is expected to perform within 5% of the KOSPI (better or worse) over the next 12 months, unless otherwise stated. "4": the security is expected to underperform the KOSPI by 5-15% over the next 12 months, unless otherwise stated. "5": the security could underperform the KOSPI by more than 15% over the next 12 months, unless otherwise stated.

“Positive” means that the analyst expects the sector to outperform the KOSPI over the next 12 months, unless otherwise stated. “Neutral” means that the analyst expects the sector to be in-line with the KOSPI over the next 12 months, unless otherwise stated. “Negative” means that the analyst expects the sector to underperform the KOSPI over the next 12 months, unless otherwise stated.

Additional information may be available upon request.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research.

Australia This research is distributed in Australia by Daiwa Capital Markets Australia Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act.

Korea Consumer: 28 June 2018

Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research.

India This research is distributed in India to Institutional Clients only by Daiwa Capital Markets India Private Limited (Daiwa India) which is an intermediary registered with Securities & Exchange Board of India as a Stock Broker, Merchant Bank and Research Analyst. Daiwa India, its Research Analyst and their family members and its associates do not have any financial interest save as disclosed or other undisclosed material conflict of interest in the securities or derivatives of any companies under coverage. Daiwa India and its associates, may have received compensation for any products other than Investment Banking (as disclosed)or brokerage services from the subject company in this report or from any third party during the past 12 months. Daiwa India and its associates may have debt holdings in the subject company. For information on ownership of equity, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report. Associates of Daiwa India, registered with Indian regulators, include Daiwa Capital Markets Singapore Limited and Daiwa Portfolio Advisory (India) Private Limited.

Taiwan This research is solely for reference and not intended to provide tailored investment recommendations. This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd. and it may only be distributed in Taiwan to specific customers who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd. and non-customers including (i) professional institutional investors, (ii) TWSE or TPEx listed companies, upstream and downstream vendors, and specialists that offer or seek advice, and (iii) potential customers with an actual need for business development in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research including non-customer recipients of this research shall not provide it to others or engage in any activities in connection with this research which may involve conflicts of interests. Neither Daiwa-Cathay Capital Markets Co., Ltd. nor its personnel who writes or reviews the research report has any conflict of interest in this research. Since Daiwa-Cathay Capital Markets Co., Ltd. does not operate brokerage trading business in foreign markets, this research is prepared on a “without recommendation” to any foreign securities basis and Daiwa-Cathay Capital Markets Co., Ltd. does not accept orders from customers to trade in such foreign securities that are without recommendation. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd. in respect of any matter arising from or in connection with the research.

Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE links at http://www.sec.gov.ph and http://www.pse.com.ph/ respectively.

Thailand This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”). This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither TNS, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, TNS, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user. TNS, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

United States This research is distributed into the United States directly by Daiwa Capital Markets Hong Kong Limited and indirectly by Daiwa Capital Markets America Inc. (DCMA), a U.S. Securities and Exchange Commission registered broker-dealer and FINRA member firm, exclusively to “major U.S. institutional investors”, as defined under Rule 15a-6 promulgated under the U.S. Securities Exchange Act of 1934, as amended, and as interpreted by the staff of the U.S. Securities and Exchange Commission (SEC). This report is not an offer to sell or the solicitation of any offer to buy securities. U.S. customers wishing to effect transactions in any designated investment discussed in this report should do so through a qualified salesperson of DCMA. Non-U.S. customers wishing to effect transactions in any designated investment discussed in this report should contact a Daiwa entity in their local jurisdiction. The securities or other investment products discussed in this report may not be eligible for sale in some jurisdictions. Analysts employed outside the U.S., as specifically indicated elsewhere in this report, are not registered as research analysts with FINRA. These analysts may not be associated persons of DCMA, and therefore may not be subject to FINRA Rule 2241 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. ADDITIONAL IMPORTANT DISCLOSURES CAN BE FOUND AT: https://daiwa3.bluematrix.com/sellside/Disclosures.action

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analyst is named on the report); and no part of the compensation of such analyst (or no part of the compensation of the firm if no individual analyst is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

Korea Consumer: 28 June 2018

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.

Disclosure of investment ratings Rating Percentage of total Buy* 68.4% Hold** 21.2% Sell*** 10.4% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2018. * 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.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association