Retailing / Korea & Japan 24 May 2012

Counter cultures

 An aisle-by-aisle walk through the Korea and Japan retail sectors  Korea leads in department store profitability. Japan’s CVS segment has room to grow. Overseas earnings are long-term drivers  Our Pan-Asia pick is Hyundai Department Store. We also favour Lotte Shopping and Seven & i Holdings

Kazunori Tsuda Sang Hee Park (81) 3 5555 7133 (82) 2 787 9165 [email protected] [email protected]

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Trading Places 24 May 2012

Table of contents

Counter cultures ...... 3

Executive summary ...... 4

About Trading Places ...... 7

Tsuda’s and Sang Hee’s pre-job-swap views ...... 10 Korea retail industry ...... 10 Japan’s retail industry ...... 15 Korea retail companies ...... 18 Japan retail companies ...... 20 Pre-job-swap summary ...... 23

On the ground in Japan and Korea ...... 26 How Sang Hee spent her time in Japan ...... 26 How Tsuda spent his time in Korea ...... 32

Post-job-swap view ...... 38 Key highlights in Japan and Korea ...... 38 Finding value among the similarities and differences ...... 44 Food for thought ...... 52 Reassessing our views on the companies we cover ...... 55 Revisions to Daiwa forecasts ...... 62 Implications for the Pan-Asia Retail Sector ...... 65 Company Section Lotte Shopping (023530 KS) ...... 70 E-Mart (139480 KS) ...... 73 Hyundai Department Store (069960 KS) ...... 76 GS Retail (007070 KS) ...... 79 J. Front Retailing (3086 JP) ...... 82 Seven & i Holdings (3382 JP) ...... 85 Aeon (8267 JP) ...... 88 FamilyMart (8028 JP) ...... 91

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Retailing / Korea & Japan 24 May 2012

Counter cultures

 An aisle-by-aisle walk through the Korea and Japan retail sectors  Korea leads in department store profitability. Japan’s CVS segment has room to grow. Overseas earnings are long-term drivers  Our Pan-Asia pick is Hyundai Department Store. We also favour Lotte Shopping and Seven & i Holdings

Korea 15-20 years from now, Korea’s  Pan-Asia picks leading retailers should fare well, Our job-swap has strengthened our backed by expansion plans designed conviction in our Buy (1) call on to overcome the hurdles that Hyundai Department Store (HDS).

Japan’s department stores now face As we see it, HDS’s expansion into Kazunori Tsuda as society greys and economic malls and its decision to acquire an (81) 3 5555 7133 [email protected] growth slows, 2) Korea’s CVS and apparel company leave it well- drugs-store segments are likely to be placed to overcome the issues now key growth areas in the next five to facing Japan’s department stores. 10 years, and 3) discount stores in Korea face a more challenging We are now more positive on Lotte environment, with regulations being Shopping’s aggressive expansion

tightened in a maturing industry. plans (shopping malls, super Sang Hee Park supermarkets, CVS, electronic (82) 2 787 9165 [email protected] Tsuda: 1) unlike Korea, it is difficult category killer) and its overseas to expect Japan’s retail market to moves. In our view, these plans show meaningful expansion. But foreshadow changes in consumer  Talking shop top-tier firms have room to gain behaviour and will deliver sales As part of Daiwa’s Trading Places market share through store growth once the domestic market project, we swapped jobs and hit the openings and M&A, 2) given macro reaches maturity. streets in the other’s market. We uncertainties, retailers need to visited department stores, general hammer out clear growth strategies Seven & i is upgraded to Outperform merchandise and discount stores, and and step up execution, 3) Japan’s (2), from Hold (3), with our target convenience stores (CVS), met with department stores must solve price rising to ¥2,850, from ¥2,450. company representatives, and spoke structural problems and become We believe the stock’s conglomerate to clients. And then we compared our more responsive to market changes, discount is narrowing, and we think findings and reassessed our own assumptions and stock calls. 4) the general merchandiser and the market will start pricing in the supermarkets segments are ripe for firm’s earnings growth potential, reorganisation, and 5) the CVS mainly for its CVS operations.  Similarities and differences 1) Korea and Japan retail firms have format has room to expand its share Key stock calls much to learn from each other, 2) of Japan’s retail sector. New Prev. investors have not yet fully Hyundai Department Store (069960 KS)  Overseas prospects recognised the growth potential of Rating Buy Buy the leading companies, and 3) We expect growth in both Korea and Target price W210,000 W210,000 among subsectors, discrepancies in Japan retailers’ overseas profit Up/downside  46.3% profitability are biggest for the contributions over the medium to Lotte Shopping (023530 KS) department stores — the Korea long term. We see strong potential Rating Buy Buy players are far more profitable. in: 1) suburban areas of China’s Target price W440,000 W480,000 first-tier cities, 2) China’s second- to Up/downside  40.8%  Key takeaways fourth-tier cities, and 3) ASEAN. Seven & i Holdings (3382 JP) Sang Hee: 1) while Japan’s retail Competition is intense. But, if they Rating Outperform Hold industry, demographics and Target price ¥2,850 ¥2,450 succeed, we think the Japan players Up/downside  22.0% consumer behaviour are a leading could become leading Asian retailers. Source: Daiwa forecasts indicator of what we will see in Note: Please refer to page 6 for details

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Trading Places 24 May 2012

Executive summary

Counter cultures In retail, Japan is widely seen as a leading indicator for Korea. But Korea arguably stands as a benchmark for the Japan department stores and general merchandise stores. Overseas earnings are one growth area, though competition is tough.

 What led us to undertake a job swap? The Japan and Korea retail industries are at different stages of growth, and have differing levels of competition and market sizes. Furthermore, the earnings of retail companies in both countries are driven domestically — they do not compete against one another. On the macroeconomic side, private-consumption growth in Japan has been stagnant for the past few years, whereas in Korea it has seen healthy growth. But comparing and contrasting the two sectors is meaningful for three reasons: 1) many investors see Japan as a leading indicator of what will happen in Korea in the future, given its similar demographic trends and business models, 2) Korea arguably serves as a benchmark for the Japan department stores and the general merchandise stores (GMS), given the high profitability and efficient management decision-making in Korea, and 3) overseas operations (including those in China and ASEAN) are one of the earnings-growth areas, although competition remains fierce.

This report comprises three sections: in the first we outline our pre-job-swap views, in the second we detail what we saw on the ground, and in the third we discuss the areas in which our job swaps led us to reassess the stocks we cover, based on our job-swap experiences.

 Finding value in the similarities and differences between Japan and Korea The domestic economies and retail-market histories of Korea and Japan have several similarities. Retail is a classic domestic demand-oriented industry, strongly affected by domestic economic and social conditions. Both countries’ economic growth is export-driven, and they face maturing economies and ageing societies. But they are at different stages in these processes, with Japan about a decade or two ahead of Korea, in our view. Consumer-spending momentum is stronger in Korea than in Japan, though spending is polarised in both countries. Korean and Japanese consumers are both price-conscious and attracted to high-end and new items. In both countries, the governments have legislated on store openings. However, regulatory policy in Japan has oscillated between tightening and easing over the past 20 years, while in Korea the trend has been towards tighter regulation.

 Japan and Korea: retail industry development time line Prior to the 1960s 1960s-70s 1980s-90s 2000s 2010s-

Rapid economic High economic Post-bubble period growth Bubble economy Japan Earthquake growth Lost decades: 1964 Tokyo 1997 Asia Financial and post global -Department-store macroeconomic Olympics/1970 Expo Crisis financial crisis period industry ex pansion environment gets Osaka 1999-2000 dot.com -CVS market and SPA -The current format tougher, deflation, - GMS expansion bubble, deflation sales growth despite Japan was established in the and an ageing - Large Scale Retail -CVS industry falling private early 1900s population Store Law enacted in ex pansion consumption -Department-store law -GMS and department 1974 and started to -Specialty store -Priv ate-label brands comes into force in store industry sales slow GMS industry ex pansion gain in strength 1956 decline sharply sales growth

Economic boom Post global financial Rapid economic 1988 Seoul Olympics crisis period growth and 1997 Asia Financial -Shopping malls gain in Post Asia Financial industrialisation Crisis popularity and Crisis, active industry -Retail industry GDP per capita department-store Undeveloped consolidation undev eloped reaches W10,000 in openings resume economy -Discount-store Korea -First deomstic late 1990s -Discount-store Korean War expansion department store -Department-store industry matures - Department-store openings by Lotte and industry expansion -CVS openings industry matures Shinsegae in the -Retail market is accelerate 1970s opened up to foreign -SPAs starting to gain play ers in 1996 momentum

Source: Compiled by Daiwa - 4 - Trading Places 24 May 2012

However, when it comes to operating and management styles, the two countries differ greatly. The department stores, discount stores, and CVS segments are each dominated by three major players in Korea. Industry consolidation over the past decade has resulted in the leading players facing less market competition and enjoying greater bargaining power, resulting in higher profitability, better cash flow, and the ability to seek more investment opportunities than the Japan retailers. Japan’s retail industry is characterised by fierce competition resulting from the emergence of new retail channels, but the leading retailers have a diversified group structure. In terms of management styles, we believe Korean companies have clearer business growth strategies and faster decision- making than their Japanese counterparts. While leading Korean retail firm Lotte Shopping has a more aggressive track record for overseas expansion, Japanese retail companies enjoy better profitability offshore.

 Reassessing our views based on our findings Business diversification by the leading Korea retailers — into shopping-mall projects, investments in apparel companies, and into new types of store format — aims to head off competition from the emergence of new retail channels, as has been the case in Japan. This diversification reduces the chances of market competition, as companies will try to establish optimised merchandising, pricing, and marketing strategies for each of the channels in which they have a presence.

In addition, the long-term earnings growth outlook for the CVS and super supermarket (SSM) (a supermarket chain owned by a large retailer) industries appears promising, based on the structural changes in the retail industry and demographic changes, with a rising number of single-person households and consumers’ desire for greater convenience.

However, following the job swaps, Sang Hee has become concerned about the business-growth prospects of the Korean discount-store industry. She believes the segment is facing the challenges of tightening government regulations from large-store expansion, a mature industry, and sluggish same-store-sales (SSS) growth. Furthermore, as consumers become more price-conscious and look to shop in small stores due to their convenience, competition with the other retail channels could intensify.

Unlike Korea, we think it is difficult to expect a meaningful expansion of Japan’s retail market. Despite this, the market is large, and top-tier firms still have room to increase market share through store openings and M&A. We envisage benefits from restructuring (such as profitability improvements and greater capital efficiency), and boosts to earnings from overseas operations. Given the uncertainties about the macroeconomic environment, we believe retailers need to develop clear-cut business growth strategies and improve management execution.

 Reassessing Daiwa’s investment view of Pan-Asia retail companies following Trading Places Bloomberg Target price Company code Rating Change (local curr.) Daiwa comment Positive – business diversification in preparation for structural changes in the retail Lotte Shopping 023530 KS Buy 440,000 industry Less positive – likely to be the most exposed to challenges from the emergence of new E-Mart 139480 KS Hold 250,000 channels; premium to other retailers likely to narrow Hyundai Department Store 069960 KS Buy 210,000 Positive – to benefit from the polarisation of society

Positive – a key beneficiary of the increasing number of single-person households and GS Retail 007070 KS Outperform Initiation 27,000 consumers looking for greater convenience Unchanged – profit remains low, but profit recovery should accelerate going forward, with J Front Retailing 3086 JP Hold 400 progress in shift to new department-store business model More positive – likely to attract buying interest from investors on increasing earnings Seven & i Holdings 3382 JP Outperform 2,850 growth potential, especially for mainstay CVS operation Positive – to expand business backed by edge in large shopping-centre development, but Aeon 8267 JP Outperform 1,150 concerns associated with callable convertible bonds weighing on share price Positive – potential to enhance competitiveness in key Japan market, while expanding its FamilyMart 8028 JP Outperform 3,800 business in growing markets in the rest of Asia Source: Compiled by Daiwa Note: Symbols indicate changes in Daiwa’s stock rating

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 Our post-job-swap picks Hyundai Department Store (069960 KS) We believe that HDS’s expansion strategy to open new stores in shopping-mall centres and the group’s decision to acquire an apparel company will mean the company is well-placed to meet competition from other retail channels (department stores in Japan are currently facing just such competition). In an ageing society, the income gap among households is likely to widen, and high-end retailers should fare well relative to their industry peers. HDS has one of the most aggressive store-opening plans among its peers over the next three years, with the openings all in attractive sites. We find the stock’s current PER, at 8x based on our 2012 EPS forecast, attractive. We reiterate our Buy (1) call on the stock, backed by an ROIC-based six-month target price of W210,000.

Lotte Shopping (023530 KS) We have become more positive on Lotte Shopping’s expansion strategy, which we believe is a concern for investors as it is likely to reduce the company’s ROIC in the next few years. We are convinced that, in the grand scheme of things, Lotte Shopping’s aggressive expansion plans in various retail formats (such as shopping mall outlets, SSM, CVS, electronics specialty stores) and its overseas expansion make sense. We recommend that investors who can weather near-term cuts in the Bloomberg-consensus earnings forecasts for 2012 do so, as we believe the current consensus numbers do not factor in fully the earnings disappointments in 1H12 given a lack of improvement in the economy and Lotte Shopping’s high earnings sensitivity to the macroeconomic conditions. As we see it, the company’s moves appear to foreshadow likely changes in consumer shopping behaviour and should help it to achieve earnings growth once the domestic retail market matures. We reiterate our Buy (1) rating and have lowered our ROIC-based six-month target price modestly to W440,000 from W480,000.

Seven & i Holdings (3382 JP) Following our job-swap, we are upgrading our rating for Seven & i Holdings to Outperform (2), from Hold (3). We believe the market will price in the company’s increasing earnings growth potential, especially in its CVS operation. We are raising our six-month target price to ¥2,850 (from ¥2,450) by applying a PER of 14.7x, based on our FY12 EPS forecast before goodwill amortisation, as we expect the stock to regain the 15% premium to the sector average PER of 12x. In addition, we expect the NAV discount to narrow. We also take into account the company’s leading position in the retail industry, as well as the high liquidity of the stock. We applaud Seven & i Holdings’ increasingly clear stance on boosting investment in its CVS operation, a growth area. In Japan, the company is adding to its 7- Eleven network. In North America, it is improving the quality of its 7-Eleven Inc. stores through renovations and infrastructure improvements, while also expanding the chain through store openings and M&A. For the stock to be rerated, we believe Seven & i Holdings needs to enhance the earnings growth of the overall group by outlining a clear picture for business growth in North America, while stepping up the ongoing restructuring of general merchandiser Ito-Yokado in Japan. Also essential, in our opinion, is improving capital efficiency with the help of financial strategies.

 Daiwa stock calls upon conclusion of Trading Places Share prices Bloomberg 23-May-12 Target +/- Market cap Year PER (x) PBR (x) EV/EBITDA ROE (%) EPS growth (%) Company code (local curr.) Rating price (%) (US$bn) end 2012E 2013E 2012E 2013E 2012E 2013E 2012E 2013E 2012E 2013E Lotte Shopping 023530 KS 312,500 Buy 440,000 41% 7.7 Dec 8.4 7.5 0.6 0.6 7.2 6.7 7.5 7.8 16.2 12.1 E-Mart 139480 KS 253,500 Hold 250,000 -1% 6.1 Dec 13.1 12.3 1.2 1.1 8.6 8 9.2 8.9 -0.5 6.2 Hyundai Department Store 069960 KS 143,500 Buy 210,000 46% 2.8 Dec 8.2 7.5 1.0 0.9 6.4 5.7 13.0 12.5 1.2 9.5 GS Retail 007070 KS 24,050 Outperform 27,000 12% 1.6 Dec 15.0 12.1 1.2 1.1 7.3 6.0 8.4 9.6 32.2 23.8 J Front Retailing 3086 JP 367 Hold 400 9% 2.5 Dec 15 12.8 0.6 0.6 7.4 6.6 3.8 4.4 -31.5 17.8 Seven & I Holdings 3382 JP 2,337 Outperform 2,850 22% 26.0 Mar 13.2 12 1.1 1.0 4.1 3.8 8.7 9 20.9 9.6 Aeon 8267 JP 960 Outperform 1,150 20% 9.7 Mar 8.7 7.4 0.7 0.7 5 4.5 8.8 9.6 26.7 17.6 FamilyMart 8028 JP 3,475 Outperform 3,800 9% 4.3 Jun 14.8 12.4 14 1.3 3.6 3.4 9.9 11.2 34.5 19.7 Source: Bloomberg, Daiwa forecasts, financial year-ends: FY12 = year ending 28 February 2013 for the Japan companies, FY12 = year ending 31 December 2012 for the non-Japan companies

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About Trading Places

The concept is simple: two Daiwa analysts swap markets and responsibilities for a short period, and then apply to Daiwa’s coverage what they learned while away from their home market. The goal is to present a genuinely cross-country analysis of a sector as our analysts gain first-hand experience of covering companies they may previously have viewed only from afar.

In this report, Sang Hee Park and Kazunori Tsuda visit the other’s companies, get a feel for the other’s market first-hand, and speak to the other’s clients. And then each returns home and revisits her/his own assumptions.

Also see Daiwa’s Trading Places reports on Korea’s and Japan’s auto and Internet/game segments:

5 January 2012 4 April 2012 Trading Places 1: Trading Places 2: Trading Places 3: Trading Places 4: Trading Places: Job swap: in Job swap: in SY’s Bringing our Japan Bringing our Korea Pushing the right Hakomori’s shoes shoes experience home experience home buttons Sung Yop Chung (82) 2 787 9157 Eiji Hakomori (81) 3 5555 7072 Sung Yop Chung (82) 2 787 9157 Eiji Hakomori (81) 3 5555 7072 Thomas Y. Kwon (82) 2 787 9181 ([email protected]) ([email protected]) ([email protected]) ([email protected]) ([email protected]) Koki Shiraishi (81) 3 5555 7083 ([email protected])

Please also see:

Taiwan Convenience Store Sector: GS Retail: Margins set to expand despite short-term woes Initiation: outperformance at your convenience 24 May 2012 24 May 2012 Yoshihiko Kawashima, CFA (886) 2 8780 5987 (y.kawashima@daiwacm- cathay.com.tw) Sang Hee Park (82) 2 787 9165 ([email protected]) Linda Chin (886) 2 8780 1469 ([email protected])

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Tsuda’s and Sang Hee’s pre-job-swap views

Could Korea tomorrow be the Japan of today?

Korea retail industry

 Korea: retail industry Sang Hee Tsuda Department stores - Korean consumers’ widening income disparity positive for the high-end luxury - Consistently lead in the Korea retail sector, with strong consumer support. department stores despite the economic slowdown. - Asian financial crisis of the late 1990s narrowed the playing field, with three - A rising number of female workers and getting married later allows greater majors left standing. spending affordability among the female population. - Three majors very profitable, with sales growing. - Increase in the number of stores drives higher sales growth than the industry average. GMS/discount stores - Industry sales growth at saturation in number of store openings. - Narrowing of the field in the mid-2000s, with three majors left standing. Largest - Price competition to intensify. market scale in retail subsector. - Government’s tightening of regulations on restricting new store openings and - Competition fiercer than for department stores, but profitability still high. the number of operating days and hours to protect the traditional market places Profitability of super- and super-supermarkets lower than discount stores to hinder near-term industry sales growth. - Impression of aggressive business expansion in Asia. CVS - Ageing demographics, rising number of retirees, increase in single-person - Impression of different business model than for Japanese convenience stores. households to positively affect industry sales growth in the next two years. - Growth strategy seems to emphasise widening store networks more than - Sustaining strong earnings growth in years beyond 2014 will depend on product improving SSS growth. mix improvement. - The flip side of very rapid store openings is low sales per store. Other issues (regulation, etc.) - Biggest threat to the institutional retail companies: regulations imposed by the - Given the small market scale and progress with sector realignment, scope for government to protect SMEs and traditional market places. Complaints have domestic growth is limited. been raised by consumer groups on the new regulations due to the - Powerful zaibatsu-type majors greatly overshadow smaller firms such as inconvenience caused. However, the regulations are likely to be in place in the specialty-store operators. near term given various political bodies’ interests and the populist agenda in an - As with Japan, ‘aging society’ demographic trends a concern for the future. election year. - Japanese firms moving into the market via mergers, but none have become major players. Source: Daiwa

Sang Hee’s view  Korea: the first department store in the country was Mitsukoshi Kyungsung in 1930 Foundations of Korea retail industry The Korean retail industry is based on the Japanese retail format. The first department store to open its doors in Korea was Mitsukoshi’s Kyungsung branch in 1930, while the first CVS was 7-Eleven, which opened in 1989. Given the similarities between the two nations and the people, many investors have expected the Korea retail industry’s long-term business growth track to follow that of the Japan retail market.

Source: Dongah Ilbo

Long-term demographics likely to mirror Japan’s Before my job swap, I believed the Korea retail industry’s long-term sales-growth outlook was likely to mirror that of the Japan retail industry, due to the similarity in demographic trends, such as the decline in the population, and as Korea appeared on its way to becoming an aged society like that in Japan.

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In addition, up until the mid-1990s, Japan had set Consumer Sentiment Index (measures consumer cultural trends in Korea, and Koreans were avid expectations on the current and future economic consumers of Japanese movies, music, and fashion. situation and purchase outlook) remains above 100 (a Many investors and I worry that the Korea retailers’ level above 100 indicates a positive outlook in terms of earnings growth will fall over the long term due to a private consumption). declining population and an increasing aged population. Prior to my job-swap, I had expected Korea retail- industry sales growth to pick up gradually from May  Japan and Korea: number of people of working age (20-64) per 2012 after hitting a low for the year in 1Q12. A wide person of pensionable age (65+) number of macroeconomic data points (ie, leading

16 economic indicators, consumer sentiment, wage- Japan Korea income growth, and employment growth) suggest that 14 the worst for the retail sector may be behind us. 12 However, there could be near-term bumps given the 10 uncertainties in Europe; should these uncertainties

8 Korea is what Japan was like in continue for a prolonged period of time, the positive 1990 in terms of demographic mix trend in consumer sentiment could be reversed. 6 Japan's current demographic mix 4 may be Korea's future in 2030  Korea: GDP growth (YoY and QoQ) 2 11% 0 9% 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 7% Source: OECD 5% 3%  Japan and Korea: demographics data 1% Japan Korea Note (1%) Decline in population From 2005 From 2030 Korea 25 years behind Japan No. of households From 2015 From 2030 Korea 15 years behind Japan (3%) Ageing society From 1994 From 2018 Korea 24 years behind Japan (5%) Super-aged society From 2006 From 2026 Korea 20 years behind of Japan Source: Korea Housing Institute 1Q01 3Q01 1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 YoY growth (real) QoQ growth Note: A super-aged society is defined as one where the population of people aged 65 and over comprises over 20% of the total population. Source: Statistics Korea  Japan and Korea: demographic trends  Korea: composite economic leading indicators vs. department (index)Korea population index (LHS) (%) store sales YoY growth Japan population index (LHS) 140 40 Credit card Strong property Fall property prices Equities drive Korea elderly dependency ratio (RHS) (%) crisis market results in diminishes wealth higher financial (%) Japan elderly dependency ratio (RHS) wealth effect effect asset value 30 4 20 120 3 15

20 2 10 1 5 100 10 0 0 (1) (5) Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 80 0 (2) (10) (3) (15) 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012E 2014E 2016E 2018E 2020E 2022E 2024E 2026E 2028E 2030E MoM changes of the leading composite index YoY growth rate (LHS) Source: Statistics Korea Department store sales index YoY growth (%)

Source: Statistics Korea Overall retail sales growth likely to pick up moderately from late 2Q12 Sales growth in the Korea retail industry slowed throughout 2011 due to consumers’ concerns about the global macro environment. Despite this, the Korea market sales growth was more resilient than in the markets of the Western world. Although both GDP growth and private-consumption growth decelerated on a sequential basis in 1Q12, they rose YoY and the

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 Korea: Consumer Sentiment Index But, in Korea, department stores have high sales (index) exposure to luxury goods and high-end apparel. 130 Consumers in the top income groups, whose spending 120 is not so sensitive to economic conditions, are the main 110 customers of department stores in Korea. Furthermore, the widening income gap between the rich and poor, 100 according to Statistics Korea, is likely to benefit 90 department stores. 80 70 In addition, the top-3 department stores have 60 announced plans to open new stores up until 2015. 50 Therefore, in an environment where the dependency Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 ratio is likely to continue to drop until 2016 (as forecast Source: Statistics Korea by Korea Statistics), we had forecast the leading department-store companies to deliver annual sales  Korea: wage-income growth and employment growth (YoY) growth of 8-10% from 2012-15. (%) (%) 5 25 In Korea, the department-store industry was generally 4 20 considered to have reached maturity up until 2008, 3 15 with industry sales growth broadly in line with private- 2 10 consumption growth. But, following the aggressive 1 5 store expansion since 2009 and the introduction of 0 0 shopping mall-style concept stores, department-store (1) (5) industry sales growth has been rising faster than sales (2) (10) growth for the overall retail industry.

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11  Korea: department-store industry growth vs. private- Employment growth 3MMA (LHS) Wage income growth 3MMA (RHS) consumption growth Source: Statistics Korea (%) 35  Korea: retail industry subsector market size 30 25 (W tn) (%) 20 15 40 30 10 5 20 30 0 (5) 10 (10) 20 (15) 0

10 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (10) Department store YoY sales growth 0 (20) Nominal private consumption growth Source: Statistics Korea 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Department store (LHS) Discount store (LHS) CVS (LHS) Retail industry YoY growth (RHS) Mature discount-store industry faces Source: Ministry of Knowledge and Economy, Korea Association of Convenience Store regulatory hurdles (KACS) Discount-store stocks are considered safe havens in Department-store industry in a growth phase times of economic uncertainty, as basic daily again necessities account for more than half of these stores’ total sales. However, the Korea discount stores’ Before my job swap, I was of the view that Korean monthly SSS growth has been weaker than that of department-store industry sales growth would be department stores over the past year due to the former resilient despite the weak macroeconomic conditions. having matured (they have seen flat to low single-digit- This is unusual as in other developed countries percentage SSS growth YoY since 2008). Although the department-store sales growth is sensitive to the discount stores’ SSS growth recovered temporarily economic conditions as it is discretionary items that from 2010 to 1H11 due to the implementation of an are sold. everyday low price strategy, sales growth started to

slow again from 2H11.

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 Korea: discount stores’ three-month moving average (MMA) of fresh food in the product mix compared with other SSS growth vs. department stores’ three MMA SSS growth countries in Asia, an effort to improve the sales mix by (%) the Korea CVS companies could help drive better 20 profitability for the CVS companies. 15 10  Korea: CVS industry growth in terms of sales and no. of store 5 openings 0 (%) (5) 30,000 30 (10) 25,000 25 (15) 20,000 20 Jun/02 Jun/03 Jun/04 Jun/05 Jun/06 Jun/07 Jun/08 Jun/09 Jun/10 Jun/11 Dec/01 Dec/02 Dec/03 Dec/04 Dec/05 Dec/06 Dec/07 Dec/08 Dec/09 Dec/10 Dec/11 15,000 15

Discount store 3mma yoy Dept store 3mma yoy 10,000 10 Source: Statistics Korea 5,000 5

My view on the earnings outlook for the discount-store 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012E industry in Korea is negative, due to the slower store No. of CVS stores (LHS) No. of stores YoY growth (RHS) expansion currently compared with the past few years, CVS industry sales growth (RHS) rising price competition as it is a mature industry, a Source: Statistics Korea lack of improvement in SSS growth, and in particular for E-Mart, operating-profit margin compression, as its  Korea: number of single-person households low-margin new business divisions continue to see (m households) (%) faster sales growth than higher-margin E-Mart stores. 20 30

25 One of the biggest threats to the discount store- 15 industry was the government’s tightening of 20 regulations at the end of last year to protect mom-and- 10 15 pop stores. Regulations governing openings hours, new 10 5 store openings, and the number of days a store must be 5 closed are likely to hinder industry growth, in my view. 0 0 1980 1985 1990 1995 2000 2005 2010 Sales growth in the Korea discount-store industry Total no. of households (LHS) growth resulted from two factors in the 1990s. The Proportion of single households to the total (RHS) retail market was opened up to foreign players in 1996, Source: Statistics Korea which allowed companies such as Wal-Mart, Carrefour, and Tesco to enter the market. Meanwhile, the Asian Tsuda’s view Financial Crisis from 1998-99 allowed the leading I break down my view of the Korean retail market into: retailers to acquire land at low prices and accelerated 1) the macro economy, 2) the overall retail industry, industry growth. Almost 25 years after the first and 3) industry subsectors. discount store was opened by E-Mart in 1993, the discount-store industry has now reached saturation. Macro economy brisker than Japan’s

Growth potential remains high in the CVS Korea lags Japan in terms of the size of the economy channel and GDP per capita, but boasts favourable macroeconomic conditions. Although the pace of I expect that demographic trends in Korea — with the economic growth has been slowing since late 2011, increase in the number of baby-boomers retiring, rise GDP and personal consumption in Korea have been in the number of single-person households, and increasing since the late 1990s (excluding the period of consumers looking for convenience — will drive the Lehman shock). CPI has also remained on a modest demand for small retail formats located close to one’s uptrend. The Korean economy is a far cry from Japan’s, home, and that the number of these smaller stores will which has been stuck in stagnation and deflation for grow faster than large-type grocery stores. Therefore, the past 15 years. store growth prospects appear promising for the CVS and SSM. However, on the basis of the population per number of stores, the Korea CVS market appears to Korea is similar to Japan in terms of having a mature have reached maturity already as compared with Japan. economy and an aging population, but appears to be at On the other hand, given the relatively low proportion an earlier stage of these phenomena. The population in - 13 - Trading Places 24 May 2012

Japan has been decreasing slightly since 2005, but that Industry realignment at an advanced stage in Korea is likely to continue growing, albeit slowly. Among the subsectors, department stores appear to The productive portion of the population (aged 15-65) have a dominant position, consistently leading Korea’s should decline in Japan ahead of Korea. retail industry. Other key subsectors include discount stores (instead of discount stores, general  Korea and Japan: comparison of macroeconomic data (2011) merchandisers is a key subsector in Japan), super Korea Japan supermarkets/supermarkets, convenience stores, and ㎡ Area (1,000,000 ) 100.2 378.0 TV shopping channels/shopping websites. Population (m) 49.8 127.8 Population density 496.7 338.1 (persons per k ㎡) As a result of the business shakeout, the department Nominal GDP W1,237.1tn ¥468.4tn store, discount store and convenience store industries Compare 2011 and 2000 205.1% 91.2% Nominal GDP per capita W24.84m ¥3.64m have three majors each in dominant positions. The Compare 2011 and 2000 189.70% 90.80% industry realignment progressed for department stores CPI 4.0% -0.3% during the financial crisis of the late 1990s, for Source: Statistics Bureau, Cabinet Office, Statistics Korea, Bank of Korea, compiled by discount stores around 2005, and for convenience Daiwa stores around 2005-09. Korea’s retail market smaller and younger than Japan’s The combined market sales share of the three majors in each sector is very high, at over 80% for the Korea’s retail industry is much smaller and younger department store and discount store sectors, and over than Japan’s. Korea’s retail market is worth W217tn 90% for the convenience store sector. Many of these (¥15.4tn based on W1:¥0.071) vs. Japan’s ¥134tn.Until top players belong to huge conglomerate groups. In around 1990, the image of Korea’s retail industry was Korea, speciality stores and other up-and-coming strongly of a market polarised into small, traditional formats have much less of a profile than in Japan. businesses and modern department stores. Discount stores and convenience stores only emerged from 1996 on the complete liberalisation of foreign investment. As such, compared with Japan, the retail industry in Korea is at an earlier stage of development.

 Korea and Japan: consumption market comparison (2011) Korea Japan Consumption market volume W654.9tn ¥282.5tn Comment Domestic private consumption Accounts for just over 60% of accounted for around 53% of consumer spending. Has the total GDP in 2011. remained roughly flat over the past 15 years. Retail market size W217tn ¥134.0tn (excl. restaurant) Comment Retail market sales grew by Retail accounts for nearly 50% 5.5% per year from 2006-11. of consumer spending. Has declined slowly over the past 15 years. Services account for the remaining 50%+. Retail market size W286.9tn Under ¥160tn (incl. restaurant) comment The actual retail market size Market size nearly ¥160tn, may be higher than W287bn including restaurants, which and excludes revenue from are included in services. small scale stores. Based on the reported figures, the retail market accounts for 44% of the total consumption market. Source: Statistics Bureau, Cabinet Office, Statistics Korea, Bank of Korea, compiled by Daiwa.

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Japan’s retail industry

 Japan: retail industry Tsuda Sang Hee Department stores - Most powerful force in the retail sector until the mid-1970s, lost market share to other - Weak industry sales growth to have been driven from weak private formats, still declining in relative influence. consumption growth, Japan consumers shift away from luxury goods as - Still addressing structural problems such as high cost structure and slow response to consumers become more frugal and given the deflationary environment. change. - Lack of attractive merchandise sourcing a negative in terms of attracting - With profitability and capital efficiency low, hard to expect a major improvement. customer traffic to stores. GMS/discount stores - Very wide business scale thanks to major convenience store subsidiaries. Second-tier - Deflationary environment and lack of price competitiveness compared to the majors entrenched regionally. other retail channels viewed as the key negative drivers for the industry - Profitability of general merchandisers low due to oversupply and competition with specialty growth. stores. Great variation of performance by company and by store in some cases. Big-box - Price discrepancies among the different retail channels not so wide. general merchandisers struggling, shopping centres doing well. CVS - Japan is the world’s most successful market for convenience stores. Brand power high - The Korean CVS players follow the Japanese CVS players closely given the elsewhere in Asia. Japanese companies’ advanced business model - Expanding share of retail market by becoming fixture of daily life. Natural selection ongoing. - One of the faster growing retail channels in Japan - Rapid store network expansion ratcheting up competition, and this could work to - Well-developed ready-to-eat section helps the channels’ profitability counterbalance this format’s seizure of retail sector market share. Other issues - Aging society and deflation are ongoing issues. - A much stronger overseas market presence. (regulation, etc.) - Serious recovery in individual consumption will require increase in disposable income and - Lack of improvement on consumer sentiment given the nation’s lack of reassurance about the future. conviction in an economic turnaround, - Overall profitability improvement for the sector will require further narrowing of playing field. Source: Daiwa

Tsuda’s view In 1974, the Department Store Law was replaced by the Large market, little growth Large Scale Retail Store Law. The new regulation restricted the opening of large stores not only for The Japanese retail market has not grown since the late department stores, but also general merchandise stores. 1990s, mainly because of: 1) the tough environment for Store openings slowed down as the new law required employment and household incomes, 2) the aging general merchandisers to obtain approval from local population, and 3) deflation. However, the market is businesses. However, their sales continued to expand large, worth ¥134tn in 2011 (down 1.2% YoY). Japan on the back of economic growth and overtook those of boasts the largest retail market in the world after the US. department stores. From the 1980s, growth shifted to convenience and speciality stores. By 2007, Changes in the retail industry landscape convenience stores had overtaken department stores in Japan’s retail market has seen many changes in growth terms of market size. areas, which have shifted from department stores, to general merchandisers, and then convenience stores and  Japan: retail industry subsector market size specialty retailers. Department stores held their (¥bn) dominant position until the mid-1970s (started around 18,000 the mid-1950s). Many of them are long-standing firms 16,000 founded between the 17th and early 20th century, and 14,000 the formats that exist today were established around 12,000 1900. A department store law came into force in 1956, 10,000 regulating store openings, but department stores 8,000 continued to grow as they attracted customers as 6,000 somewhere families could enjoy a day out, picking up 4,000 everything from high-end luxuries to daily commodities. 2,000 0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 In the 1960s and 1970s, young entrepreneurs inspired Department stores GMS(DS)･SM CVS (CY) by US chain stores launched a succession of companies, Source: Japan Department Store Association, Japan Chain Store Association, and Conveni and expanded the retail landscape. General by Shogyokai; compiled by Daiwa. merchandisers, one of the new formats, initially sold mainly food items, but later developed into hypermarkets also offering clothing and household items. These stores were labelled junior departments stores, and attracted customers with discounts on national brands in an era when manufacturers ruled the roost.

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Firms with the largest market caps  Japan: recurring profit/total assets at five major department stores The line-up of the top-30 companies in terms of market cap changed drastically between 1980 and 2011. The Recurring profit/Sales (%) top spot was held by department store operator 5.0 Mitsukoshi (now Isetan Mitsukoshi Holdings) at the 4.0 end of 1980, general merchandiser Ito-Yokado (Seven 05 90 & i Holdings) at the end of 1990, and convenience store 3.0 FY10 operator Seven Eleven Japan (also Seven & i Holdings) 08 00 2.0 FY85 at the end of 2000. Seven & i Holdings was still the 09 largest name at the end of 2010 and the end of 2011. 1.0 95 In the top-30, the number of department stores, 0.0 general merchandisers and supermarkets declined, 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 Total assets turnover (X) while the number of speciality retailers increased. This Source: Company material compiled by Daiwa change was partly attributable to a business shakeout in the department store, general merchandiser and General merchandisers become retail supermarket industries, but also to specialty retailers conglomerates eating into their market share. The major general merchandisers are struggling in the  Market cap of top-30 Japan retailers by subsector business they started with. Profitability peaked around

(No.) 1990, after which accelerated store openings led to oversupply, and margins shrank as competition 30 intensified on the emergence of speciality retailers and 25 discount stores. Several major and semi-major general 20 merchandisers fell by the wayside in the late 1990s and early 2000s. 15 10 However, the picture is different if we look at group 5 operations. General merchandisers widened their 0 business scopes by investing in subsidiaries operating end-1980 end-1990 end-2000 end-2010 end-2011 convenience stores, supermarkets, and specialty stores Department stores GMS(DS), SM CVS Speciality stores, Restaurants as well as those engaged in finances and shopping

Source: Daiwa centre developments. Sales of the two major names, Seven & i Holdings and Aeon, are a hefty ¥5tn each The decline of department stores currently. Department stores have continued to lose market share to formats such as shopping centres, retail buildings Japan: operating profit of the five major general merchandisers by segment adjacent to railway stations, specialty stores, city- centre redevelopments, and outlet malls. Profitability (¥bn) 700 improved between the late-1990s and 2006, thanks to restructuring and an economic recovery. Department 500 stores then upped capex, but intensifying competition 300 with other formats and the Lehman crisis significantly 100 hurt earnings – they struggled to cope with these (100) negatives due to their costly business model and slow

reaction to changes. A full-fledged improvement still FY96 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E seems elusive given the low margins and poor capital Eliminations and unallocated General merchandisers/supermarkets efficiency. Convenience stores Specialty stores Other Financial services Department stores Source: Companies, Daiwa forecasts

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Convenience stores a part of daily life Sang Hee’s view Japan’s convenience store market is the most Negative dynamics for private consumption successful in the world. Convenience stores have growth increasingly become an intrinsic part of day-to-day life On the surface, declining retail industry sales in Japan by improving their merchandising and diversifying the seems to have a correlation to the sharp fall in asset services on offer. This trend became more evident after prices since the early 1990s and the deflationary the Great East Japan Earthquake in March 2011. environment on the macroeconomic front. These factors, coupled with unfavourable demographic Convenience stores bounced back from apparent changes, a rise in the dependency ratio, and a greying market maturation around 2000, and are enjoying society, are all negative for private-consumption sustained growth as they increase their share of the growth, particularly discretionary spending. retail market. They boast high profitability, capital efficiency and cash flow. Japanese names also enjoy In addition, I had believed that the earthquake in strong brand recognition and competitive clout in the March 2011 had weighed on consumer sentiment and rest of Asia. hit consumer spending. Prior to my job swap in Japan, I had believed that Japanese consumers’ desire for  Japan: no. and rate of increase of convenience stores luxury goods had diminished and that the earthquake (# of Stores) and tsunami had made people more frugal. 50,000 40 35 Meanwhile, I had the impression that department 40,000 30 stores had failed to implement the right marketing 25 30,000 20 tactics with consumers, and had not been proactive in 15 launching the right merchandise to attract customers. 20,000 10 10,000 5 GMS channel most affected by deflationary 0 environment 0 (5) The deflationary environment would naturally have

FY82 FY83 FY84 FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 had the most negative impact on the GMS channel, as Number (Conveni*; left) Y/y % (Conveni*; right) sales for this channel are mostly basic necessities. Source: Conveni by Shogyokai; compiled by Daiwa Furthermore, my understanding of the industry was that there were no major differences in prices among Discrepancies among firms to increase further the different retail channels for merchandised goods in Although the Japanese retail market is unlikely to Japan — one reason why the GMS channel had not expand much further, given the country’s declining and been able to do as well as in other countries. aging population, its size remains large by international standards. With competition fierce even among CVS format most closely followed subsectors, we expect further industry reorganisation Among the retail formats in Japan, CVS is the one that as earnings discrepancies among firms and stores the Korea retailers most closely follow. Therefore, I had widen. A consumption tax hike and Japan’s expected the CVS format there to be much more participation in the Trans-Pacific Partnership (TPP) advanced than the average CVS store displays, logistics, would also likely prompt reorganisation. We think and merchandise I usually see in Korea. economies of scale in procurement (including up/midstream operations) will become an increasingly vital source of competitiveness.

Because both nationwide and regional market share is important in Japan, major nationwide chains and semi-major ones with leading regional market shares seem well positioned to overcome the competition. In analysing market share, we believe the figures should be based on the total market size, which includes rival subsectors, rather than just a single one. Winners in the Japanese market will probably step up overseas expansion, especially in Asia, in pursuit of growth opportunities.

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Korea retail companies

 Korea companies Sang Hee Tsuda Hyundai Department Store Positive Positive - Growth strategy Most aggressive amongst its peers in the number of new department store openings Concentrating on expanding its domestic department store network. Not a flashy in the high-end department store channel. strategy, but one that makes most of its strengths. Takes a cautious approach to opening stores overseas, where culture and customer needs will be different. - Earnings outlook Forecast teen percentage earnings CAGR for 2012-14 on the back of new store Stores very competitive and enjoy an excellent customer base. openings. Sensitive to economic winds; should continue to grow earnings at a good pace. - Valuation PERs should correlate with the retail sales cycle given the cyclicality of the No overseas expansion, but scope for growth domestically. department store business. Profitability and capital efficiency high. Attractive medium-term investment. Lotte Shopping Positive Positive - Growth strategy Overseas expansion is the core growth strategy for Lotte group overall. Korea’s largest retailer, involved in a wide range of businesses. M&A opportunities are actively considered, particularly during the economic Mainstays are department and discount stores. Keen appetite for growth, aggressive downturn. with M&A. Going for growth in other parts of Asia. - Earnings outlook Forecast earnings to rise at around 10% driven by the department store division and Anticipate strong growth thanks to agile management. As part of its large-scale, discount store operation. multi-faceted development, one of the firm’s strengths is its infrastructure arm. Credit card and overseas operations to remain unexciting in 2012-13. Our focus is on how the firm balances investment and earnings. - Valuation Currently trading at a trough value with the worst case scenarios fairly reflected in Has the potential to be seen not as a Korean retailer but more broadly as an Asian the share price. retailer. Given the heavy capex, the ROIC trend should be the key matrix in determining a It may soon be time for a complete reassessment of the firm’s growth potential. rerating, but a lack of an imminent recovery means the stock is unlikely to trade at the highs seen 1H11. E-Mart Neutral Neutral - Growth strategy Future growth opportunities to be sought in new businesses (ie, on-line shopping Korea’s largest discount store operator, part of Shinsegae but operates mall operation, wholesale store formats) and carefully considering overseas independently of the department store business. expansion in Vietnam and China. Three-pillar growth strategy: opening discount stores domestically, expanding into other retail formats domestically, and expanding into Asia. - Earnings outlook Forecast to post the lowest earnings growth within the Korea retail sector at a single Domestic discount stores likely to maintain high profitability relative to peers. digit earnings CAGR for 2012-14, given the slow increase in the number of store Taking a fresh shot at its Chinese operations through restructuring, generating a additions and lack of margin expansion given the increase in costs for the new profit there may take time. businesses. - Valuation Derated from the peak in 2007 as the discount store industry reaches maturity and In terms of growth and profitability, discount stores definitely run second to ROIC tapers off, but still trading at a higher valuation multiple than the industry department stores. average. Intensifying competition also a concern. We see few catalysts to reverse this situation. Source: Daiwa

Sang Hee’s view The negative is that, at times, strong earnings at one Lotte Shopping division can be diluted by the weak earnings performance of another. I expect Lotte Shopping’s department store Lotte Shopping is the largest retail conglomerate in division to post better earnings growth in 2H12 on the Korea with exposure to various retail formats. The back of the completion of store openings and store company also owns a credit-card business, Lotte Card. renovations. In addition, I see further room for Lotte It perhaps resembles a Japanese retail company as the Mart’s hypermarket operations to improve, in terms of its owner’s family background is linked with Japan Lotte. margins and sales, as it catches up with its competitors in Following the company’s listing in 2006, it has been 2012 on the back of its larger scale. aggressive in expanding the number of discount stores, adding a new retail format (a home-shopping business) On the other hand, I expect the credit-card division to and undertaking M&A that would allow it to gain post weak earnings due to the government’s tightening market share in the department-store, discount-store, of regulations. CVS and SSM channels. Despite strong bargaining power, the company’s overall Lotte Shopping is also active in emerging market M&A. returns are diminishing due to its low returns from the The Lotte group’s strategy is to become a global company high capex required in the overseas business in the with an Asian base. Therefore, I anticipate more M&A for initial stages. This has resulted in a derating of the the group in Asia in the future. Lotte Shopping ranks in stock over the past three years; it is trading at close to the top-3 in terms of sales in all the off-line retail channels all-time low PERs currently. Investors appear to be in which it has a presence. The benefit of a diversified penalising the stock for the lack of an immediate business mix is that it allows the company to enjoy strong recovery in its ROIC. bargaining power over vendors in all product categories.

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E-Mart The business model for the Korea department stores is While the discount-store industry in Korea is mature, I based on that of their Japan counterparts. In Korea, a believe E-Mart deserves to trade at a higher PER than maximum 10% of the gross sales mix is accounted for the overall retail industry average, since its bargaining by merchandise procured by department stores (non- power over vendors in procuring the basic necessities is returnable, carries inventory risk), with 90% or more among the strongest, as it operates the largest number accounted for by in-store concessions (no inventory of discount stores in the country. Given the maturity of risk). At Japan department stores, company-managed the discount-store industry, E-Mart has been sales floor accounts for 10-15% of gross sales, but expanding its business to include wholesale stores and procured merchandise for less than 10%, while Internet shopping malls to seek future earnings growth. concessions and returnable merchandise account for 55-85% and 10-35%, respectively. However, we have been concerned by: 1) it having a slower SSS growth rate than the industry average in the Korea discount stores, referred to as general past one year, 2) the lack of operating-profit margin merchandise stores (GMS) in Japan, are similar to ones expansion as the low-margin new businesses grow, 3) in Japan but have slightly smaller floor space and fewer the slow overseas expansion and failure to turn around mid-range offerings. the business, and 4) slow discount-store industry sales growth. I forecast E-Mart to post the lowest earnings We believe the CVS model is different in the two growth for 2012 in our retail sector coverage. The countries. We think that in Korea earnings growth company’s management expects gross sales to rise to strategies prioritise new store openings rather than W23tn with an operating-profit margin of 6.1%. For improving sales at existing stores. While store numbers 2011, gross sales amounted to W12tn. are increasing rapidly, store fronts are small, and sales per store are about one fifth of those in Japan. Hyundai Department Store HDS, the No.2 department-store player in terms of Little direct competition between Japan and number of stores, is the most high-end department Korea store in Korea in terms of sales exposure to wealthy Typically with both Japanese and Korean retailers residential areas. The company is highly regarded by catering to domestic demand, the incidences of direct investors for its cost control on the labour front. It has competition between the two are few and far between. the most aggressive new store opening plans among its Some Japan CVS, specialty stores, and restaurant peers in attractive site locations. HDS’s new store operators have expanded into Korea. FamilyMart and openings are due to add a low-teen percentage earnings Mini Stop (9946 JP, \1,346, Hold [3]) are operating in CAGR for 2012-15, based on our forecasts. Currently, Korea through joint ventures with local firms. In terms as department-store industry SSS growth is weakening of specialty stores, ABC Mart (2670 JP, \2,837, Hold on the back of weak private-consumption growth, the [3]), a shoe retailer, has entered the Korea market stock’s PER has contracted over the past year and is under its own steam, but apparel retailer Fast Retailing currently in line with slowing SSS growth. The stock is (9983 JP, \16,710, Hold [3]) and Ryohin Keikaku (7453 trading at a PER of 8x on our 2012 EPS forecast. JP, \4,000, Outperform [2]), a seller of apparel and

Tsuda’s view miscellaneous items, are operating in alliance with Lotte Shopping. South Korea retailers expanding aggressively Before undertaking this project, my impression of There are hardly any examples of Korean retailers Korea retailers was that: 1) the industry realignment entering the Japanese market. Although Korean pop phase was at an advanced stage, 2) the profitability of culture and cuisine are enjoying a boom in Japan, this the department stores and discount stores was much has not translated into retail, where Japan firms form a better than in Japan, 3) the companies had clear heavy wall of resistance. earnings-growth strategies and management acted swiftly, 4) companies were expanding aggressively From a Pan-Asia perspective, Korea and Japan overseas as the scope for domestic earnings growth discount stores and apparel retailers are competing in was limited, and 5) the major conglomerates dominate China. Going forward, we believe competition between the market, with speciality retailers and other new Korea and Japan firms will increase in the region, as players taking only small market shares. they aim to benefit from market growth there.

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Japan retail companies

 Japan companies Tsuda Sang Hee J. Front Retailing Neutral Neutral - Growth strategy Aims to become the leading firm in Japan’s retail sector, spearheaded by its Floor expansion and restructuring at the main stores to provide sales growth department stores. for the company despite declining department-store industry growth. Concentrating on a new department-store paradigm that will solve structural Efforts to attract young customers and broaden customer base to secure long- problems and establish an efficient management structure. term sales growth are positive. - Earnings outlook We expect the earnings recovery to continue, centred on the mainstay Successful store integration between Daimaru and Matsuzakaya likely to department-store business. provide a boost to the company’s earnings and profitability. We expect contributions from refurbishment and the expansion of the flagship store, as well as SG&A cuts. Concerned about intensifying competition around Osaka from 2H FY12. - Valuation Profit levels low, even assuming an upcoming earnings recovery. PBR Active restructuring and merchandise strategy to expand customer base currently a more appropriate valuation multiple than PER. appear a more convincing earnings growth strategy than its department-store We are monitoring the progress on the management overhaul and allocation peers, which seem to lack growth strategies. A higher PER valuation than its of cash flow. department-store peers is warranted, but a lower PBR than the retail-industry average given the lacklustre industry growth. 7&i Holdings Neutral Positive - Growth Strategy Aiming to become ‘a new, comprehensive lifestyle industry’. Strong competitive edge over its peers based on its long-established history Working to maximise corporate value through group synergies, a combination and merchandising know-how. of convenience-store, general-merchandise, supermarket, and department- Differentiation with the peers given its strong private-label brands. store operations. Innovative business strategy (price adjustments to narrow the price Growth investment focused on earnings pillar: convenience stores. discrepancy with the other retailers, partial reimbursement of disposal losses) puts the company clearly ahead of its peers. - Earnings outlook Mainstay domestic convenience stores solid. Domestic CVS growth and operating-profit margin remain strong but are Same-stores sales posting growth due to attracting new customer groups, partially diluted by other businesses (supermarkets and department stores). while pace of new store openings is picking up. Profit growth may slow in FY12 as the profit improvement at troubled domestic general merchandiser winds down. Reform of domestic general merchandiser is entering a crucial stage. - Valuation The share price may be affected by a conglomerate discount. From a core operational standpoint, its strong cash flow and global brand We await an improvement in group earnings and capital efficiency. recognition warrant a higher PER than the retail-sector average. Aeon Positive Neutral - Growth strategy The company’s medium-term business plan (FY11-13) aims to lay the Its diversified group structure resembles that of Lotte Shopping in Korea. Its groundwork for earnings growth in the next decade. leading market position gives it strong buying power and makes it difficult for Aiming for business growth in Asia, with a focus on the shopping-centre rivals to compete against it. business, the company’s strong point. Targeting an FY13 operating profit of Well-positioned in a relatively fast-growing retail channel: shopping-mall ¥270bn. outlets. The company appears to be the most forward-looking in terms of corporate strategy. - Earnings outlook Profitability improving driven by mainstay general-merchandising operation. Overseas market presence seems is clearer and immediate returns are visible We forecast double-digit-percentage operating profit growth to continue over compared with its peers. Further success in the overseas operation should FY11-13. Preparations are ongoing for widening the store network in Asia. help offset weak domestic earnings. - Valuation Looking for domestic restructuring to provide springboard for expansion The complicated group structure is likely to drive a PER discount for the group elsewhere in Asia. We think the stock deserves to trade at a premium to the as earnings predictability is low. sector average P/E given high liquidity. FamilyMart Positive Positive - Growth strategy Aiming for a network of 25,000 stores, recurring profit of ¥60bn, and net Efforts focus on expanding the domestic market through product development income of ¥30bn in FY15, and overseas operations to account for 20% of and increasing the number of stores overseas. profit (8% for FY10). - Earnings outlook We are concerned about increased competition, as all the major players are Earnings-growth outlook remains solid as its CVS business is exposed to expanding their store networks. emerging markets where the CVS industry is still growing, and the leading We expect steady earnings expansion to continue from FY12, although players are gaining share in the Japan CVS industry. attention must be paid to same-store sales growth trends. - Valuation From a medium/long-term perspective, we highly rate the firm’s enhanced Successful overseas expansion and a meaningful earnings contribution from competitiveness in the mainstay domestic market and its expansion into Asia, emerging markets compared with its Japan peers warrant higher valuation a growth area. We therefore think the stock deserves to trade at a premium to multiples than its Japan CVS peers. the sector average P/E. Source: Daiwa

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Tsuda’s view attracting new customers with its handy locations, and Specific growth strategies needed has been more successful than its rivals in terms of SSS growth these two years. In addition, it plans to The domestic retail market is mature, and earnings accelerate store openings. growth prospects for the overall sector are narrowing. Moreover, visibility is poor regarding external The domestic general-merchandiser business is seeing conditions. We believe managements need to hammer the decline in earnings coming to an end, but profit is out clear strategies for growth under such still low. We believe its status as a conglomerate is circumstances. We cite domestic market-share negatively affecting the share price currently. For this expansion, restructuring, and overseas expansion as to change, we think the group’s earnings growth three key concepts, with the importance of the last of prospects and capital efficiency need to improve – as a these likely to rise from a medium- to long-term result of financial strategy. Seven & i Holdings needs to perspective. demonstrate a growth scenario for its US CVS subsidiary and substantially improve the performance J. Front Retailing of the domestic general-merchandiser business. J. Front Retailing focuses primarily on department stores, and aims to be a leading retailer. Management  Seven & i Holdings: operating profit by segment (consolidated) acts swiftly and its reforms centred on a new business (¥bn) model have been successful. Earnings should continue 320 280 to recover, especially for department stores. Additional 240 floor space/renovation at flagship stores and cost cuts 200 160 should contribute. 120 80 40 From 2H FY12 competition could intensify in the 0 Osaka area. We will monitor cash-flow distribution. We (40)

would like to see a change of tack from an investment FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E portfolio weighted toward the department-store Superstores Convenience stores business. Furthermore, for ROE and EPS to increase, Restaurants Financial service Other Eliminations / unallocated we think shareholders’ equity and shares outstanding, Department stores Total both inflated by business the integration in 2007, need Source: Companies, Daiwa forecasts to be reduced. Aeon  J. Front Retailing: new department store model Aeon shifted to a holding-company structure in 2H New formats for JFR group dept. stores FY08, and is in the process of group-wide restructuring. Structural problems Market changes The company’s mainstay is large shopping centres, and it boasts strong competitive clout both in terms of the Unresopnsive to market Tastes becoming more casual quantity and quality of these centres. The medium- Cost-consciousness, term business plan (FY11-13) aims to lay the High cost structure desire to save groundwork for business growth over the next decade. The company is focusing on expansion in Asia ex- (Develop new department store model) Japan, especially for its shopping-centre operations.

Widen custmer base Earnings are brisk and the company is readying itself Expand merchandising, esp. price ranges for store openings across Asia. Our attention is on the Develop “specialty zones” prospects for earnings growth driven by Asia business

Efficient management structure expansion, together with domestic restructuring. The share price is likely to remain capped, reflecting Source: Companies, compiled by Daiwa investor concerns about the possibility of the firm exercising the call option built into its convertible

Seven & i Holdings bonds. Once this factor plays out, we see considerable Under the slogan of ‘a new, comprehensive lifestyle scope for the stock to rise. industry’, the company is aiming to be a global purveyor of convenient, comfortable, and enriched lifestyles. It is striving to maximise its value through a variety of operations and group synergies. In the mainstay domestic CVS operation, the company is

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 Aeon: operating profit by segment (consolidated) Sang Hee’s view (¥bn) I had expected to hear about proactive strategies from 310 the Japan retail companies in order to overcome the 270 weak macroeconomic environment during my job swap. 230 Japanese retail companies have been the pioneers in 190 developing a retail business model in Asia. Therefore, prior to my job swap, I was eager to hear what 150 expansion strategies, store renovations, and marketing 110 the retail companies were adopting to overcome the 70 demographic and economic hurdles the country is 30 facing. Such strategies could help other companies in

(10) Asia that face similar demographic challenges in the 10 11E 12E 13E future. General merchandising Supermarkets Strategic small-size stores Comprehensive financial services Despite the retail industry being mature, not all Shopping center development Services companies were restructuring. But for those that were, Specialty stores ASEAN I was keen to know how much room there might be for China Other costs savings, and what level of profitability the Korean Adjustments Total retailers might expect based on their Japanese Source: Companies, compiled by Daiwa counterparts.

FamilyMart For some retail companies, complicated conglomerate FamilyMart is a major CVS operator with a clear-cut group structures make earnings predictability low. earnings growth strategy that is yielding fruit in Japan and the rest of Asia. The company is expanding in other In terms of my perception of the Japan retailers’ countries in Asia through alliances with local firms, presence in overseas markets, I have visited many building up strong regional ties. In its medium-term Japanese retail stores in Asia outside Japan since the business plan, the company targets to have 25,000 CVS early 1990s, and believe they have always come across (10,000 in Japan) and net income of ¥30bn (recurring as being the most international among all the Asian profit of ¥60bn) in FY15. We forecast the overseas retailers. operations to account for 20% of profit by then (8% in FY10).

Competition could intensify as other major CVS groups accelerate store openings, but FamilyMart’s earnings should remain on a firm uptrend from FY12.

 Japan: comparison of consolidated operating profit of five major CVS operators

(FY00 = 100) 240

190

140

90

40 00 01 02 03 04 05 06 07 08 09 10 11E 12E 13E Lawson Circle K Sunkus FamilyMart Seven-Eleven Ministop Source: Companies, compiled by Daiwa

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 Lotte Shopping: 12-month forward PER bands

(W) Pre-job-swap summary 600,000

500,000 Korea/Sang Hee Core earnings growth forecasts of 0-14% 400,000 depending on store expansion 300,000

For the department-store and discount-store 200,000 companies we cover, I forecast core earnings growth to 100,000 range from flat YoY to 14% YoY for 2012, with E-Mart 2006 2007 2008 2009 2010 2011 2012 at the bottom of the range and HDS at the top. I do not Price PER 6x PER 8x expect any of the companies I cover to record PER 10x PER 13x PER 16x operating-profit margin expansion due to the Source: FnGuide, Daiwa tightening of government regulations to protect SMEs. Therefore, most of the difference in my earnings  HDS: 12-month forward PER bands growth forecasts results from the level of (W) aggressiveness in store expansion. 300,000 250,000 Most retail stocks have been derated due to slowing SSS growth 200,000 During an economic downcycle, it is natural for cyclical 150,000 retail stocks to trade at the low end of their historical 100,000 valuation ranges. 50,000

0 Lotte Shopping, whose earnings are highly geared to 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 department stores, saw a greater decline in earnings Price PER 5x PER 7x and steeper multiple contraction than its retail peers PER 9x PER 11x PER 13x during the 2008-09 economic downturn because it has Source: FnGuide, Daiwa a greater number of regional department stores which are more sensitive to economic conditions. With the stock trading close to a PER of 8x based on our 2012 forecast, I believe Lotte Shopping’s current valuation reflects most of the negatives and that it is currently trading close to its lowest level (ie, during the 2008-09 economic downturn).

The contraction in HDS’s valuation was similar to that for Lotte Shopping during 2008-09 as can be seen in the following PER band chart. However, given its planned store expansion, the market perceives HDS as a growth stock; and during the 2008-09 period, while its valuation declined, it remained resilient, and did not hit the lowest lower point of past troughs. In addition, downward revisions to HDS’s earnings by the Bloomberg consensus during the 2008-09 financial crisis were not sharp due to the company’s high sales exposure to high-income groups, with its SSS growth remaining in positive territory.

E-Mart’s stock has been derated from a peak PER multiple in the mid to high teens in 2007 (ie, Shinsegae’s PER prior to the demerger in 2011) to a low-teen figure currently, as the discount-store industry has reached maturity and is seeing slower SSS growth than the discount-store industry average.

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Japan/Tsuda to see companies use the increased cash flow generated Earnings forecasts by a recovery in earnings in new ways.

Japan’s economy seems to be on a moderate growth General merchandisers likely to undergo trajectory for the next few years, supported by further restructuring reconstruction demand following the Great East Japan At general merchandisers and supermarkets, SSS Earthquake. While the private sector is recovering, there growth is weakening, but we expect a rebound once the are general concerns that the economy has been hollowed tough YoY comparisons due to post-earthquake demand out, and tax hikes will lead to a decline in disposable in 2011 play out. Consumers are increasingly price- income over the medium to long term. With a weak job conscious with respect to frequently purchased items. market, lacklustre household income, and a number of More than ever, it is important that retailers get their factors eroding consumer sentiment, personal spending is product pricing right, in our view. Safety remains a likely to stall. The retail sector is likely to remain polarised, pressing issue, especially for food items. We expect a with consumers tightening their purse strings. boost in efficiency, plus strength in procurement Competition is fierce with no borders between formats, including upstream and mid-stream fields. The gaps in and the gaps between the earnings performance of terms of earnings between the companies are likely to companies and stores are widening. We expect a further widen. Store openings are limited for shopping centres shakeout and restructuring of the industry. and general merchandisers, while supermarkets are a

mixed bag. Many non-listed companies – the majority – Earnings are steady. Momentum is slowing, but we are having trouble finding successors to the presidents, forecast profits for the Japan retailers we cover to and the industry looks set for further restructuring. remain on an uptrend from FY12-13. We had forecast the 15 major retailers to see aggregate operating profit CVS segment could expand market share rise by 17.7% YoY for FY11, 9.0% YoY for FY12, and 10.0% YoY for FY13. CVSs increased their profile as an intrinsic part of daily life in Japan in the aftermath of the Great East Japan Department-store earnings potential unlikely Earthquake. In conjunction with better merchandising, to recover in earnest the crisis helped CVSs widen their customer bases and increase footfall. This format could increase its share of Earnings at department stores continue to recover, but the retail market. SSS growth is losing momentum, as we do not expect profitability to improve in earnest the benefits of cigarette price hikes taper off, but over the medium term, in view of the competition from should remain solid, especially for mainstay ready- other formats. There are structural problems to be made food. Operating-profit growth should resume resolved before department stores can stem the decline normal rate from FY12. Meanwhile, risks include an of their share of the retail market, in our opinion. These increase in domestic competition resulting from the problems include a high-cost earnings model and slow ongoing acceleration of store openings by the majors, responses to changing external factors. We would like as well as an erosion in profitability. We will continue to monitor developments in these areas.

 Japan Retail Sector: subsector operating profit

（％） Department stores General merchandisers Convenience stores Total 36.9 40

30 24.7 20.7 17.3 18.5 17.6 19.3 17.7 20 14.5 11.5 9.5 9.8 10.0 8.1 8.7 6.9 9.0 10 5.1 5.3 2.2 0 (0.8) (10) (3.5) (8.0) (7.3) (11.6) (12.0) (11.8) (14.6) (20) (14.8) (8.1) (30)

(40) (39.7) (50) (42.5) FY06 FY07 FY08 FY09 FY10 FY06 FY07 FY08 FY09 FY10 FY06 FY07 FY08 FY09 FY10 FY06 FY07 FY08 FY09 FY10

FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E Source: Companies, Daiwa forecasts

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On the ground in Japan and Korea

Our analysts swapped jobs and hit the stores

How Sang Hee spent her time in Japan

Sang Hee: itinerary in Japan Company background Key issues discussed Aeon - The competitive GMS industry landscape and corporates’ strategies implemented to overcome competition - The sales growth outlook for the shopping-mall channel, for which Aeon has been seeing higher-than-industry average SSS growth - Overseas performance and its expansion strategy in the future Lawson - Ways to expand the customer base, and how the rollout of the different CVS store formats has resulted in the customer base expanding - How the company manages to deliver SSS growth in a mature market - Ways to expand the operating-profit margin to 5% and achieve an ROE of 15-20% over the medium term Isetan Mitsukoshi - The difficulties the industry faces with procuring merchandise from vendors - Ways to overcome the department-store market’s declining position in the total retail industry - Status of its overseas operation, which accounts for about 10% of operating profit, and the biggest hurdles in expanding the overseas operation Seven & i Holdings - How the CVS market size can be doubled from the current level - How the CVS pricing strategy has worked in favour of the company, allowing it to gain market share in the retail industry - What the competitive advantage from a franchisee perspective is to becoming a 7-Eleven franchisee vs. its competitors - The management’s view of Korea’s CVS industry J Front Retailing - Ways to transform itself into a low-cost operation, and how has the company managed to have the highest operating-profit margin among its peers - Restructuring efforts to expand its customer base - How Japanese consumers’ spending habits have changed since the 2011 earthquake Takashimaya - How the overseas stores have managed to deliver better profitability than the domestic operation despite their smaller scale - Ways the company’s points cards are used at its department stores FamilyMart - Future M&A activity - How the earthquake has affected CVS sales growth - Growth drivers behind FamilyMart’s success in overseas markets vs. its peers and the key strategies for overseas expansion - Views on the CVS operation in Korea

 Sang Hee: on-the-ground research in Japan On the ground Key findings Lawson (Gate City Ohsaki Store) - Wide range of product categories available. Items that would be available at a discount store or a supermarket in Korea are available at a regular CVS in Japan - Private-label brands under Lawson Select available in a wide selection, ranging from ready-to-eat meals to basic household-good items - A variety of ticketing services and postal services are available at the stores - Large oden (fish cakes) and hot snack bars are common - Has a hanryu (Korean wave) corner, with stationery items featuring Korean celebrities and DVDs available Isetan Shinjuku Main - The spending power of young men is rising, and one of Isetan Shinjuku’s buildings features only men’s collections, like that of Barney’s Men in New York Department Store - Japanese consumers are known to be sophisticated when selecting luxury goods, thus consumers’ decision making is based on design and quality rather than the brand name. Therefore, there are no walls between the brands, which makes it convenient for consumers when choosing a product from a wide range - As the industry is declining, department stores are focused on store renovation and less on store expansion - In order to attract young people (who are important as the future consumers), the department store has designated the second floor of the basement as Isetan Girl, which caters to young consumers and offers more affordable pricing - Grocery items in the department stores are in many cases double the prices of those in the GMS and CVS, but are widely regarded as being of higher quality 7-Eleven Chiyoda Nibancho - A large proportion of the display shelves are allocated to lunch boxes. Home-meal replacement turnover appears to be high, with the staff continuously filling up Store the displays - At its directly operated stores, 7-Eleven tests various services, including laundry services - As the traffic flow tends to become quite heavy during the lunch hours as bentos and home meal replacements (HMR) are popularly sold, several self check out registers are available - Private-label brands that are sold in the CVS are also available at Ito Yokado stores, which are under Seven & i Holdings Store visit to FamilyMart located - Fresh food and HMR appeared to occupy about 20% of the store’s shelf space, with a wide range of choices, from cold salad to a hot gratin dish. There were more in Sunshine South store food choices available than at from a small-sized restaurant - Various services, including ticketing, faxing, photocopying, and photo printing Store visits to Aeon in - During a week day, when daily sales are weakest, the company has designated a TopValu day, when some private-label brands are heavily discounted to attract Shinsagawa Seaside and Ito customers Yokado Kida branch - Customer traffic flow at the apparel and electronic sections was extremely low and the apparel designs did not seem on trend - Private-label brands were available in a wide range of choices and easily seen - A ¥100 shop around the corner from the Aeon Shop seemed to have more traffic flow for household-good appliances Source: Daiwa - 26 - Trading Places 24 May 2012

360-degree view of Japan retail Through the store visits, I was able to see firsthand: I spent about a week in Japan on my job swap, visiting  merchandising strategies, the department-store companies (Isetan Mitsukoshi, Takashimaya, and J Front Retailing), three leading  store-layout strategies, CVS companies (Seven & i Holdings, Lawson, and  innovative promotional tactics, and FamilyMart), as well as Aeon, whose strength lies in general merchandise stores. At the meetings, the key  the new business initiatives to attract a wider cross- issues discussed with the managements were: section of customers.  The sales growth prospects for each retail format, Through the site visits it was clear to me that some of and detailed discussions about whether the current the strategies taken by these companies were likely to retail environment in Japan could represent the be introduced by Korea stores in the future. future in Korea. Here I highlight some of the main differences that I  Getting a sense of the new type of retail formats that encountered at these stores relative to the Korea have emerged in Japan to determine whether similar retailers. trends would take hold in Korea.  Assessing if there were any ways for the Japanese Snapshots from department stores in retailers to improve operating-profit margins, and Japan analysing why the margins are so different from Japanese department stores believe that consumers are those of the Korea retail companies. sophisticated in terms of their perception of luxury goods. Therefore, at the department stores in central  Discussing the relative success of the Japan retailers Tokyo, where customer sophistication levels are high, in overseas markets, and their ability to deliver the stores put less emphasis on displaying brands. decent profitability. There are no clear boundaries between different brand  Discussing the impact of various regulations that products, as shown in the following photos. This have been imposed on the Japan retail industry, in suggests that a consumer’s decision to buy a product is order to gauge the potential results of new based on product design and quality rather than the regulations being introduced in Korea. name.

In addition, I had the opportunity to go on store tours Still, other than luxury brands, I thought the of Aeon in Shinsagawa Seaside, Isetan Shinjuku Main merchandise available at an average store was not Store, Takashimaya Tokyo Store, as well as Lawson and particularly trendy, especially given the sophistication 7-Eleven stores located near each of the respective of an average Japanese consumer. The merchandise headquarter offices in Gate City Ohsaki Store and also appeared to be less sophisticated and trendy than Chiyoda Nibancho with company representatives. that featured in Korean department stores, where merchandise tends to be more upscale and on trend.  Locations of the stores visited by Sang Hee in Tokyo  Takashimaya: men’s cosmetics corner – there are no big signs showing the brand names

Source: Daiwa

Source: Daiwa - 27 - Trading Places 24 May 2012

 Takashimaya: women’s shoes collection section – no Snapshots from GMS in Japan walls/partitions separating the brands GMS industry sales growth has been falling in Japan since the mid-1990s. Therefore, the discount stores are looking for ways to increase customer traffic. The most notable things at the GMS stores were the wide selection of private-label brands and the variety and large displays allocated to the ready-to-eat meals sections. It was clear that the GMSs’ main focus was to offer affordable, quality private-label brands in order to differentiate themselves and generate better operating profit margins.

The GMSs were also keen to try new store layouts in order to compete with other retail channels. As demand for bicycles is rising, Aeon’s Shinagawa Seaside store has rented out additional space just

Source: Daiwa outside of its main store for the sale of bicycles. Inside the store, the company has rearranged its alcoholic  Takashimaya Tokyo has a separate men’s building catering to drinks section, and has designated a special corner high-end consumers outside the grocery section that sells all types of alcohol in one place, replacing the previous merchandise, as the vendors’ sales performances had been weak.

I felt that much more improvement was needed in the apparel section, as the apparel designs seemed to lack price competitiveness compared with the specialty retailers of private label apparel (SPA) brands, and customer traffic in the apparel sections of the GMSs appeared to be low compared with the busy grocery areas.

 At Aeon stores, Tuesday is TopValu day, on which private- label brands are offered at large discounts to attract customers on the lowest sales day of the week

Source: Daiwa

 Merchandise was not as ‘on trend’ as I had expected in the apparel sections on the upper floors

Source: Daiwa

Source: Daiwa

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 Customer traffic at a GMS food space was heavy  Three different private-label brands are available at an AEON store

Source: Daiwa Source: Daiwa  Japanese consumers seem very concerned about food safety.  Hardly any customer traffic in the apparel space A label at an Aeon store declares a ‘zero’ radiation target in the food section

Source: Daiwa Source: Daiwa

 Fresh food selection at an AEON store  Due to high demand for bicycles, Aeon has a separate space that sells only bicycles

Source: Daiwa Source: Daiwa

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Snapshots from CVS in Japan  Private-label brands in the delicatessen and household- In my opinion, there are many interesting features the product sections Korean CVS stores can learn from the Japanese CVS stores. The most interesting points were: 1) the well- ordered and wide range of ready-to-eat meals, 2) the spaciousness of the store areas, 3) the availability of high-quality private-label brands in a wide range of product categories, and 4) the area dedicated to fresh food sales. In addition, the CVS stores in Japan offer a range of interesting customer services which are generally not available in other countries.

We think the Korean CVS companies may try to implement many of these strategies in Korea, but execution is likely to take time.

 Range of fresh food at a FamilyMart store

Source: Daiwa

Source: Daiwa

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 Postal services available at a Lawson store

Source: Daiwa

 Faxing and printing services are available at a typical Japanese CVS store

Source: Daiwa

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How Tsuda spent his time in Korea

 Tsuda: itinerary in Korea Key issues discussed E-Mart - Discount-store business model: store format, merchandising, procurement, logistics, customer demographics, and earnings mix - Business climate: SSS growth, competitive conditions, competitive advantage, Japan’s general merchandisers - Management: growth strategy, reasons for going independent from Shinsegae, store openings, new businesses, M&A, overseas expansion, investment benchmarks Lotte Shopping - Department-store and discount-store business models: store formats, merchandising, procurement, logistics, customer demographics, earnings mix - Business climate: reasons for rapid earnings growth, why department stores perform so strongly in Korea, competitive conditions, competitive strengths, CVS operation, Japan retail sector - Management: growth strategy, optimisation of business portfolio, M&A, overseas expansion, investment benchmarks Hyundai Department Store - Department store business model: store format, merchandising, procurement, logistics, customer demographics, earnings mix - Business climate: why department stores perform so strongly in Korea, competitive conditions, competitive strengths, Japan department stores - Management: growth strategy, store openings, M&A, overseas expansion, investment benchmarks E-Mart - Business climate: impact of domestic economic slowdown, SSS growth, consumption patterns, supplier relations - Management: growth strategy priorities, overseas expansion, business challenges GS-Retail - CVS business model: store format, merchandising, daily sales, customer demographics, earnings mix, franchising package, owner characteristics - Business climate: competitive conditions, SSS growth, product development, Japan CVS - Management: growth strategy, store openings, M&A, overseas expansion, investment benchmarks, business challenges Lotte Shopping - Business climate: impact of domestic economic slowdown, SSS growth, shifts in consumption, supplier relations - Management: growth-strategy priorities, store openings, overseas expansion, business challenges Hyundai Department Store - Business climate: impact of domestic economic slowdown, SSS growth, shifts in consumption, supplier relations - Management: growth strategy priorities, store openings, business challenges Shinsegae - Department-store business model: store format, merchandising, procurement, logistics, customer demographics, earnings mix - Business climate: impact of domestic economic slowdown, competitive advantage, why operating profit is lower than major peers, Japan department stores - Management: growth strategy, store openings, new businesses, overseas expansion, investment benchmarks, business challenges Source: Daiwa

 Tsuda: on-the-ground research in Korea On the ground Key findings E-Mart Seongsu store Visited a large-scale discount store that was quite up-market for E-Mart Myeongdong Visited CVS, specialty retailers in Myeongdong, Seoul’s largest retail district Department stores Visited iconic Lotte flagship store, Shinsegae flagship and Gagnam stores, and Hyundai Apgujeong location Times Square Visited large mixed-use facility in Seoul developed by Shinsegae; includes department stores, discount stores, specialty retailers, office units, hotels, and cultural facilities Seoul commercial facilities Visited Lotte department stores, Lotte Mall Gimpo Airport (large mixed-use facility), former Walmart discount store acquired by E-Mart, Tesco discount store and hypermarket Source: Daiwa

Visits to major Korea retailers of developing new commercial facilities, such as On my job-swap in Korea, I visited the country’s shopping centres, a major difference with Japan retailers and commercial facilities. In all, I visited six department-store operators. With group companies companies, which are major operators of department operating discount stores, the department-store majors stores, discount stores, and/or CVS. Three of these have advantageous positions vis-à-vis suppliers firms operate department stores, and discount stores compared to other retail formats. Discount stores are and CVS are run by two of them. locked in intense competition as one-stop-shopping destinations, but the competition is not as fierce as in Interviews with department-store and discount-store Japan. officials confirmed that the Korea companies have significantly higher operating-profit margins than their The two firms operating CVS that I spoke with seemed Japan counterparts. This has to do with Korea’s more optimistic than me about their rapid store- expanding economy, as well as a few key differences. opening strategies. One major driver of this trend is the For one, the industry has undergone significant strong desire to open franchises among sole restructuring, resulting in more favourable competitive proprietors in traditional markets and retirees from conditions. Second, the managerial decision-making large corporations. Nevertheless, the company officials process is faster. And third, the Korea firms face lower appeared to understand the debilitating effects of personnel and facilities-related costs. competing without achieving differentiation. To ensure medium- to long-term business growth, improving the Department stores attract customers with a quality of existing stores will be crucial, in my opinion, combination of high-priced luxury goods and a broad as it has been in Japan. product selection. These firms are also at the forefront - 32 - Trading Places 24 May 2012

In mid-March 2012, the situation for retailers had  Lotte Department Store: entrance to duty-free store changed in two respects since the first phase of my job- swap (in 2011). First, SSS growth momentum had lost steam amid the domestic economic slowdown, a trend more prominent at department stores than discount stores. Second, the government was tightening regulations in order to protect small retailers. Discount stores and supermarkets were facing restrictions on store openings and operating hours, fuelling concerns for the road. Department stores were required to rein in the discounts they demanded from small- and medium-sized suppliers.

Destinations ranged from department stores to city storefronts My job-swap included visits to a wide range of retail establishments in the centre of Seoul and the surrounding areas. The department stores were located in prime spots and exuded a sense of high class both inside and out. The stores had a wide range of products available, from luxury items to apparel, handbags, accessories, and food – those you would expect in a department store. They also offered home appliances and furniture — two categories that have nearly disappeared from Japan department stores as specialty stores have eaten away their shares of these markets. In my view, Japan flagship stores are a class above their Korea rivals in terms of merchandising, including store-curated apparel and handbag/accessory installations, and prepared food areas. Source: Daiwa

 Lotte Department Store: entrance to main building of flagship  Lotte Department Store: home appliance sales floor, main store building of flagship store

Source: Daiwa Source: Daiwa

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 Shinsegae Department Store: flagship store  E-mart Seongsu store: fresh fish sales floor

Source: Daiwa Source: Daiwa

Discount stores adopt differing merchandising  E-mart Seongsu store: children’s wear sales floor strategies depending on the location. On the whole, however, household goods have a higher weighting in sales than in Japan. They also offer more or less the full line-up of home appliances. I visited major mixed-use developments Times Square (Shinsegae) and Lotte Mall Gimpo Airport (Lotte Shopping). Both had group department stores and discount stores as anchor tenants alongside luxury brands, specialty shops, restaurants, cinemas, hotels, and cultural facilities.

 E-mart: entrance (formerly Walmart store)

Source: Daiwa

Source: Daiwa

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 Homeplus Express store  7-Eleven convenience store

Source: Daiwa Source: Daiwa

The streets were dotted with convenience stores,  FamilyMart convenience store including many common to Japan, such as 7-Eleven, FamilyMart, and MiniStop. The store signs were the same, but the stores themselves were generally smaller and had fewer prepared food items. MiniStop in Korea is operated by a consolidated subsidiary of the Japan company, but FamilyMart’s Korea operations are run through an equity-method affiliate led by Korea’s Bokwang Group. Korea Seven, a subsidiary of Lotte Shopping, runs 7-Eleven’s Korea locations as an area licensee. Japan specialty shops and restaurants are increasing in Korea, but still have a small presence, with a few exceptions.

 GS-25 convenience store

Source: Daiwa

‘Traditional’ marketplaces packed with individually run shops are a constant sight in Korea. These markets often consist of low-rise buildings with small storefronts, and run the gamut of business lines. The sole proprietors that run these small shops are prime candidates to become CVS franchisees.

Source: Daiwa

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 Building with individually run shops Korean investors somewhat cautious on domestic retailers I also visited five Korea institutional investors to discuss the Korea and Japan retail industries. Many of the concerns of investors overlapped with those of the company officials. Specifically, they were interested to know: 1) whether Korea department stores would follow the Japan example and see their market positions erode, 2) if Korea CVSs have the same business-growth potential that their Japan counterparts have currently, and 3) how the Japan retail industry changed once the market matured and restrictions were placed on opening new locations.

Institutional investors seemed to have a somewhat cautious outlook on the domestic retail sector, viewing department stores negatively and CVS positively. This Source: Daiwa is the opposite of Japanese institutional investors’ opinion of Korea’s retail sector. They like department Heard on the street stores for their high operating-profit margins, and are Tsuda finds plenty of interest in Japan as a concerned about CVS due to potential negative effects retail forerunner from the rush to open new stores. In my discussions with company officials, it appeared that Korea companies were extremely interested in Japan. Indeed, Korea businesses have long drawn lessons from Japanese business models. As they develop strategies going forward, Korea firms continue to view Japan as a critical forerunner in retail. They are eager to gather information on Japan firms, partly because there are only a few cases in which they are direct competitors.

Specifically, Korea firms appeared to be interested in: 1) the impact of Japan’s laws on large stores and urban planning, 2) major subsectors and the fates of individual companies, 3) the impact of Japan’s ageing society, and 4) Japan firms’ overseas-expansion strategies. Restrictions on large retailers are a particularly pressing concern for discount stores and hypermarkets, and as such we fielded a variety of questions on this topic.

On the other hand, there was little interest in Japan as a destination for overseas expansion. The market is large, but competition is fierce, and Japan rivals are well entrenched. Korea companies are targeting Asia markets, but these include China and ASEAN — not Japan.

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Post-job-swap view

Looking to new horizons

Key highlights in Japan and Korea

  Key highlights: Japan Findings in line with our view Findings running counter to our view Department stores - The bursting of the asset bubble, deflationary environment and declining - Industry consolidation progressing at a much slower pace than expected. population are negative for department store’s industry growth. - Lacks a long-term growth strategy. - Weak merchandise sourcing ability due to the lack of the channel’s - Absence of a differentiated special marketing strategy to attract key top competitiveness. customers. GMS /discount stores - Deflationary market environment negative for same store sales growth. - More intense market competition with emerging specialty retail channels which - Lacking pricing power with vendors. offer better quality at a lower price negatively impact industry sales. - Narrowing the price gap with the other retail channels. - Stronger-than-expected emerging market operation with higher profitability than the domestic operations implies Japanese retailers are likely to remain interested in gaining a presence in the overseas markets, which in turn means Korean retailers will have to compete not only against the global players but also with the Japanese players. CVS - Demographic trend and changes in consumer behaviour of desiring convenience - Bigger market size than expected and more store openings. should favour industry growth. - Much more optimistic long-term growth strategy than we expected. - Private-label brand product availability was as wide and of as high a quality as we had expected.

Source: Daiwa

Sang Hee: highlights in Japan retail industry has been shrinking for the past two Following on from the bursting of the asset bubble in decades, the department store industry and the GMS the early 1990s, and coupled with the declining industry remain fragmented. population and deflationary environment, private- consumption growth and retail industry sales in Japan Department store and GMS industry consolidation has in 2011 were little changed from those in 1995. In 2011, become active only since mid 2000s and despite such, consumer sentiment was dampened further by the the top-three leading players’ market share is still less earthquake. than 50%. Even at this stage, competition remains intense. We believe industry consolidation and the Given this, the following structural changes are under closure of non-performing stores will be an ongoing way in Japan. The retail channel is going through theme in Japan, benefitting companies with scale and industry-wide consolidation, with value-oriented capital. This could help lift the profitability of channels and products emerging and growing as companies that undertake restructuring exercises. consumers become more value-conscious. Retail companies are focusing on expanding their target Highlight 2: expanding target customer customer bases to include the senior population, which segments up to now they had been relatively less focused on. And Many companies I visited in Japan had started some companies, not all, are considering overseas expanding their target customer segment to include the markets as future growth opportunities. senior population. In my view, companies whose strategy it is to expand to attract older people will Highlight 1: industry consolidation still in deliver better earnings growth than those solely progress concentrating on their existing customer bases, In a shrinking market, industry consolidation is one of particularly in a market where disposable incomes are the key positive factors in potentially providing a not expanding and the population is on the decline. turnaround for the industry. Industry consolidation The market size of the senior age group holds huge had been quite slow in Japan, in our view. Although the sales-growth potential for the retail companies in Japan, in my view. This is evident from the faster sales - 38 - Trading Places 24 May 2012

CAGR from 1995-2007 in the drug-store channel than  Examples of retailers’ strategies to focus on older age groups other retail formats (older people consume more Convenience stores Supermarket Department stores Others pharmaceuticals and medicines than younger people), -Seven & i Holdings -Aeon launched a -Isetan Mitsukoshi -Aeon Delight acquired and for which we expect to see greater demand in the launched a mobile regional online Holdings' ‘Isetan household cleaning service ‘Seven Anshin supermarket service Mitsukoshi MI Deli’ service provider future. Otodokebin’ in May and plans to expand and H2O KAJITAKU in April 2011 to capture the service to areas -J Front Retailing's’ 2011 to provide living  Japan: 1999-2007 sales CAGR comparison by the retail demand from seniors. with high a Hankyu Kitchen Yell’ assistance services to - Seven & I Holdings concentration of seniors. channel set up food delivery reduced Seven Meal's seniors. service shops in the 10% minimum purchase greater Tokyo metro amount required for area, targeting seniors 8% free shipping to attract who find it difficult to demand from older go shopping. 6% people. -FamilyMart acquired a 4% home delivery company 2% Source: Companies, compiled by Daiwa 0% Highlight 3: robust sales performance in value- (2% ) oriented channels as consumers become more (4% ) price-sensitive Dept stores GMS Supermarkets CVS Drug stores Japanese consumers have become more price-sensitive Source: Companies over the past two decades due to the lack of signs of economic recovery, falling disposable incomes and In emerging markets, companies’ strategies tend to concerns about the future. SPAs, ¥100 shops, shopping focus on capturing the younger age segment who later mall outlets and Internet shopping malls have taken on become the core customer group as the age group market share from the department stores and GMS migrates. But in a super-aged society (when the 65 age stores. group and over reaches more than 20% of the total population), retail companies’ strategies evolve and Also, Japanese consumers have become more frugal. they seek growth by catering to the senior age brackets, The importance of saving appears to be widely accepted the group retailers were less focused on in the past by many young Japanese consumers, which is in stark given its weak spending power. In doing so, new retail contrast to the mindsets of young Koreans, who tend to formats are being introduced, stores are being opened spend most of their earnings. We acknowledge that close to the seniors’ homes, and home delivery services rising housing prices and inflation are some of the key are being offered, together with online supermarkets factors responsible for the falling household saving rate and home delivery services. in Korea; nonetheless, the financial crisis in 2008-09 seemed to bring about a change in Japanese  Three different store formats introduced by Lawson to capture consumers’ mindset of the need to save for the future. a wider income bracket Lawson Store  Household saving rates comparison Regular Lawson Natural Lawson 100/Shop99 Launch of format 1975 2001 2005/2001 (% ) Target customers men in 20-50s, Working singe women Fresh foods and daily 8.0 housewives, seniors in 20-30, health delivered foods for 7.0 conscious customers housewives, and older people 6.0 Area of target store 200-300 200-300 5.0 openings 4.0 Total no. of stores 8,965 100 1,172 3.0 % of franchised stores 98.8 41.0 30.4 % which are company 1.2 59.0 69.9 2.0 operated 1.0 Source: Company 0.0 2006 2007 2008 2009 2010 2011 Japan Korea

Source: OECD Economic Outlook No. 90, OECD Economic Outlook: Statistics

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Anecdotally, I have also seen in Korea changes in Highlight 5: growing desire to expand overseas Japanese tourists’ spending behaviour. When Japanese The move of Japan retailers into overseas markets tourists visited Korea in the 1990s, many shopped for started much earlier than for the Korea retailers in all luxury goods given the low prices as a result of the retail formats, and many companies now seem to favourable won/yen rate and tourists were mostly spotted generate a decent proportion of earnings from overseas. in duty-free shops. Now, however, popular shopping Indeed, for some companies, the profitability of the items for Japanese tourists seem to be low-end cosmetics, overseas operation is greater than that of the domestic such as THEFACESHOP and Missha, confectionery, and operation. Indeed, the Japan retailers with an overseas apparel sold at the Dongdaemoon market. presence are keen on expand their business in emerging markets. Highlight 4: retailers with strong private label brands have a competitive advantage  Overseas earnings contribution for the Japan retailers

Japanese retail companies have put a lot of effort into Ministop constantly developing and improving their private label brands. The private label brands offer consumers value Family Mart and quality and are viewed in Japan no less favourably than national brands in terms of quality. Private label Aeon brands are easily seen in retail channels such as GMS, Seven & I Holdings CVS, supermarkets and drugstores, and are offered in a wide range of categories from food, to household goods Takashimaya and apparel. Isetan Mitsukoshi Holdings

 Some of the private-label brands available at retail stores in 0 1020304050 Japan 2011 2010 2009 (% ) Source: Companies

What was quite surprising to me was that the Japan retailers are criticised by investors for being slow to expand overseas. To my mind they seem much more aggressive than other Asia retailers, including those in Korea. For the Japan retailers, overseas expansion has added incremental value. This compares with the Korea retailers, which do not have a meaningful presence overseas. And even if they do, Lotte Shopping, which has been the most aggressive of them all in this respect, has seen its shares derated on the back of heavy overseas capex, as this has led to an overall deterioration in the company’s ROIC.

Highlight 6: department stores and GMS lack long-term business-growth strategies, while CVS players have concrete plans Source: Daiwa One of the most surprising things I learned about the retail companies was that many of the Japan The earthquake in 2011 resulted in consumers department stores and GMS did not seem to provide becoming more conscious about food safety. This has medium- to long-term earnings guidance. Given fierce led to greater demand for private-label brands market competition, protecting market share appeared (especially in the fresh-food and ready-to-eat to be the key focus. Furthermore, most companies did categories). Consumers feel more comfortable buying not appear to be looking at cutting costs to improve products offered by the leading retail companies, as profitability. This was perhaps because one area where their manufacturing, packaging and distribution costs needed to decline was on the labour front, and operations are regarded as reliable. reducing staff numbers is not easy due to the country’s labour laws. The establishment of strong private-label brands not only results in higher profit margins for a company, but allows it to differentiate itself from competitors and helps attract customers to its stores. - 40 - Trading Places 24 May 2012

Meanwhile, the CVS players were able to provide  Points cards and electronic money by major distributors concrete expansion goals and seemed to be aggressive Cards issued by in their business-growth targets through market-share Name Main companies partner stores Ponta gains from the restaurant industry, the strengthening Lawson, 39.05m Geo, of sales of private-label brands, and the introduction of and others. 15,700 new types of store formats. T Card FamilyMart, 38.5m Tsutaya, In my view, one of the key success factors behind the and others 42,100 Japan CVS industry compared with the other retail Waon 23.2m channels, such as GMS and department stores is that Aeon Group, the companies seem to be looking continuously at and others 134,000 providing innovative services and products to Nanaco customers. For instance, Lawson categorises its CVS Seven & I Holdings, 15.97m store into three types, each catering to different market Seven & I Group, and others 99,600 segments and offering different kinds of merchandise at each of store types. All CVS have managed to Source: The Asahi Shimbun strengthen the brand power of their private-label products to secure a loyal customer base. In addition, the introduction of new customer services, such as postal services, printing services, and ticketing services, seems like an innovative strategy.

Highlight 7: customer-loyalty programmes for marketing and collecting customer information to win share in a competitive market The use of customer-loyalty programmes is widespread and quite advanced, especially in the CVS channel, compared with other parts of the world. Based on the purchase amount, consumers can earn points that can be used as cash in partner stores, while the retailers are able to better understand customers’ purchasing behaviour, which helps them reduce lost sales opportunities and better manage their inventory. Retailers also engage in promotions through the loyalty programmes.

The points-card distributors, such as Ponta, partner with Lawson, Geo and over 40 other brands at more than 15,500 stores, while Family Mart uses T Card, which has over 100 brands and more than participating 35,000 stores.

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 Key highlights: Korea Findings in line with our view Findings running counter to our view Department stores - Have the biggest presence in the Korea retail market. - Greater-than-expected room for new store openings within Korea. - The three majors enjoy strong profitability, which they invest for more growth. - Department stores actively developing shopping centres. - Little earnings downside, excluding economic fluctuations. - Approaches to overseas development differ by company. Those that have forayed overseas have not made a profit. GMS /discount stores - Convenience, pricing of one-stop shopping formats supported by consumers. - Trend toward greater regulation becoming a risk factor. - Making a profit on apparel and household goods as they face little competition - Department stores are leading the development of large shopping centres. from the specialty stores. - Overseas businesses not making a profit, mainly because competitive factors - Actively developing the business in Asia. differ from Korea. CVS - Store networks expanding fast. Earnings could deteriorate as store numbers - Operating-profit margin greater than expected relative to overall field of chain- saturate the market. store formats. - Current merchandising power not strong enough to win share from other - Room for domestic store openings greater than expected. Franchise owner categories or maintain growth. candidates abundant, store costs low. - Overseas development a low priority for growth. Other issues (regulation, etc) - Strong specialty retailers are rare, so department and discount stores are - Stronger-than-expected interest in Japan (social, industrial, corporate) as a unlikely to lose market share to specialty stores. model. - Focus on overseas development in China, ASEAN; Japan not included. - Regulation increasing. Political considerations being made for traditional markets (small mom & pop stores) ahead of the elections in December 2012. Source: Daiwa

Tsuda: highlights in Korea With rich cash flow, the three majors tend to own the My overall view of the Korean market has not changed land and buildings for their shopping centres as well as significantly compared to before undertaking this the retail sections of larger-scale complexes. In this project. Indeed, I have seen much evidence supporting context, the firms require heavy initial investment but my positive view on the department stores. Also, I are then poised to enjoy high profitability over the think top-tier firms in each subsector have strong medium term given the absence of rents. growth potential on the domestic front. Meanwhile, moves for stricter regulations warrant caution. Firms From a supply perspective, department stores taking have yet to generate profits overseas — markets for initiatives in shopping centre development can control which investor expectations are high. the sales floor of specialty stores. Lotte Shopping operates discount stores, and Shinsegae Department Store has Korea’s biggest discount store operator, E- Highlight 1: department stores stronger than mart, in its group. Hyundai Department Store Group previously thought also owns firms operating other retail business formats. Department stores have led the way in the Korean Thus, we infer that the most important business retail industry since the 1980s, and I believe this partners for merchandise suppliers (including apparel) position will remain intact due to: 1) their commercial are department stores, as they own the major domestic developer function, which provides them with a sales channels. substantial number of domestic new store locations, 2) the group power resulting from their being backed by Highlight 2: retail market growth potential huge conglomerates, and 3) their strong ties with bigger than previously estimated merchandise suppliers. Following on from my experience in Korea, the growth

potential of the Korean retail market is bigger than I Over the past few years, locations for department store previously thought. With the economy stronger than in openings have shifted from city centres to more Japan, personal consumption is likely to continue suburban areas. The department store operators are increasing. Also, there is still considerable room for also seeing increased store openings as core tenants new store openings. Margins for convenience store within shopping centres, rather than as standalone operations are higher than we had estimated, and there operations. The three major firms have quickly adapted appear to be many potential franchisees. We see a to the new trend, aggressively developing shopping likelihood of convenience stores capturing demand centres themselves. The grade of merchandise at stores from customers familiar with conventional stores. in these areas is lower than in urban stores, but such shopping centres have gained popularity as commercial We expect domestic conglomerates to achieve sales facilities where families can enjoy a whole day. growth going forward. Department stores, discount Department stores are also taking part in developing stores, and convenience stores are all oligopolistic large-scale complexes, which include shopping centres, markets, with little room for entry by Japanese and offices, hotels, and condominiums. other overseas firms. Also, we see little likelihood of

domestic specialty retailers emerging and taking

market share from department stores and discount stores. Department stores and discount stores have

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gained consumer support for their usefulness as a one- Both Lotte Shopping and E-mart booked losses for stop shopping experience, and they are leading the their Asian operations in FY11. E-mart committed to industry in terms of store development. In apparel, restructuring, closing 11 of its 27 stores in FY11. The overseas specialty retailers of private labels are gaining slack profits in Asia likely reflect unfavourable ground, as seen in other Asian countries. However, conditions compared with the companies’ domestic these stores are not in competition with the operations in terms of relationships with suppliers and department stores as they are major tenants of the store opening costs. department stores. It is difficult for Korean convenience stores to foray Highlight 3: regulations, overseas profitability into overseas markets. Bokwang FamilyMart (ranked warrant caution No. 1) and Korea Seven (ranked third; under Lotte We have seen a trend of stricter regulations governing Shopping) have area-licence restrictions. GS Retail the sector since 2011. We attribute this to the (ranked second) operates its own brand and is government’s consideration for SMEs prior to the therefore able to expand overseas. However, priority presidential election slated for December 2012. for overseas operations is likely low given competition Discount stores and super supermarkets have been with Japanese rivals and the growth potential of the most affected by the said regulations. domestic market.

Discount stores with a sales floor of over 3,000m2 and super supermarkets with a sales floor of over 500m2 cannot open stores within a 1km radius of conventional local stores unless they receive the consent of local residents. In Seoul, discount stores and super supermarkets have recently been ordered to close their stores for two Sundays every month. The authorities have also requested that department stores lower the concession ratios for small/mid-size merchandise suppliers (tenants). We are concerned about the effects of any further restrictions on discount stores and super supermarkets.

Discount stores are the most aggressive in overseas development. The industry leader, E-mart, and Lotte Shopping (ranked third) consider the Asian market a business growth area (the No. 2 player, Home plus [formerly known as Samsung Tesco], is the Korean joint venture of a UK-based operation, with little likelihood of overseas development). This likely reflects that the discount stores face tougher competition and weaker growth potential on the domestic front than do the department stores and convenience stores.

Among department stores, Lotte Shopping has been making aggressive forays into Asian market for the past several years. HDS and Shinsegae Department Store are more focused on domestic store openings. Rather than department stores, Shinsegae Group is expanding into the Asian market via E-mart, its discount store arm.

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Finding value among the similarities and differences

  Retail sector: key similarities and differences in Korea and Japan (Sang Hee) Similarities Differences Consumers, - Japan’s demographic trends and economic development stage are more than ten years - The macro environment is still healthy enough to support solid private consumption consumer ahead of Korea’s. As Korea society greys, Korea’s overall consumer spending behaviour growth in Korea, with the nation’s GDP growth rising and large conglomerates gaining spending is likely to follow the footsteps of Japan’s. market share. - The business models of the two countries share many similarities, with the Japan retail - Japanese consumers seem to have become more value-oriented and thrifty. The industry leading the historical development of the industry but the Korean retailers having younger generations are more conscious about saving for the future, whereas in Korea, a better cost structure. the demand for luxury goods is booming among income earners who cannot afford - Bi-polarization in consumer spending. such luxury goods. The younger generations are saving less, as unlike the parents’ generations, who saved to purchase homes, house prices have risen so much in Korea that buying a home is out of the reach of most young people — therefore the money they might have saved, they tend to spend on themselves. Industry - Specialty stores and category killers which drove the decline in market share of the - Korean retailers are still in the expansionary stage, whereas the Japanese retailers are structure, discount store and department store industries since the mid-1990s in Japan are in the closing down unprofitable stores and are seeing a decline in number of stores. business early stages of gaining customers traction in Korea. - With the exception of the CVS channel, the Asian economic crisis drove department conditions, - The top-3 leading CVS players in the Japanese and Korean CVS industries enjoy a store industry consolidation in the late 1990s. Following this consolidation, in the Korea competition market share of over 70%, and continue to widen the market-share gap relative to the department store and discount store industry, the leading players now account for more weak players. than 70% of the market in each respective industry, whereas in Japan the competition is intense, as the Japan market is more fragmented. - The business diversification of the leading retailers in Korea is likely to result in less market competition with the specialty retailers and category killers. Others - Emphasis on private label brands is important for both nations. The key value proposition - Korean retailers have bargaining power over their suppliers due to their economies of for consumers is to offer quality products and provide value for money. In Korea, growing scale and dominant role in the retail channels, whereas the lack of efficient private-label product sales are seen by companies as helping to improve overall margins, merchandising has driven consumers away from the department store and discount given the higher profit margin on such products, whereas in Japan, the importance of store channels in Japan since the mid-1990s. private-label brands lies in the fact that they enable a company to differentiate itself, as - The apparel companies’ dependency on the retail channels for sales performance is procuring quality products from suppliers is difficult and incurs high costs. high given the limited distribution channel selection in Korea. Source: Daiwa

Sang Hee on the similarities… Just like Japanese consumers in the 1980-90s, Korean consumers perceive wearing/carrying a luxury brand as Demand for luxury goods is booming in Korea, a symbol of social acceptance and/or social status. In just as it was in Japan in the 1980-90s my view, there is an emotional attachment to owning a I believe Japan is about 20 years ahead of Korea in luxury brand, whereas prior to the 1990s, luxury terms of the way consumers perceive luxury goods, brands were mainly bought by high-income households given its higher GDP growth and women’s earlier active that could readily afford such items — therefore, luxury participation in society and the later average marriage brand sales were driven more by practical shoppers. age, among other factors. Korean consumers’ shopping However, owning luxury brands has become more patterns mirror those of Japan in the 1980-90s, in my widespread, and now middle-income groups are willing opinion. to go through the effort of cutting down on other

expenses to save up to buy a luxury brand.

 Luxury market sales cycle comparison between Korea and Japan c c

20-year gap

b b

a a

1970 1980 1990 2000 2010 2020 2030

a Rational shopping. European luxury b Emotional shopping. Carrying/wearing a luxury brand can signal c Practical shopping. M ost of the sales growth brands are regarded as special, with higher quality social acceptance and represents social status. M iddle-income groups is driven by price increase rather than volume growth. and greater durability than domestic brands. Only will reduce other expenses and save up to buy luxury brands. The luxury Any macroeconomic headwinds would affect sales high-income households would buy them. market booms and sales are immune to the macroeconomic conditions. negatively. Consumers prefer a luxury experience more than luxury goods. Source: Daiwa - 44 - Trading Places 24 May 2012

With the rise in the number of women in the workforce,  Gini coefficient comparison among OECD countries the average ages for marrying and giving birth (Index ) increasing, a strong propensity to spend rather than 50 save, growing brand consciousness, and healthy economic growth, Korea’s luxury market is in a growth 40 OECD average stage. We see this trend continuing for quite a while. 30

As shown in the following chart, luxury goods are 20 seeing stronger sales growth than other product 10 categories in Korea department stores. 0 UK US

 Korea department stores: luxury brand sales growth vs. other Italy Spain Korea Japan France

product categories (YoY) Sweden Germany

(% ) Source: OECD 2010 Factbook 40 30 As a result, the Japan and Korea consumer-product companies have been focusing on launching products 20 in the high-end or the low-end channels, and sales of 10 products in the mid-range segment are being affected 0 as consumers are either trading up or down. (10) -06 -11 The popularity of SPAs and private-label brands has r-09 y g p Jul-07 Oct-05 A Jun-10 Jan-11 Mar-12 Mar-05 Feb-08 Dec-06 Sep-08 Nov-09 Au Ma been rising in Japan over the past decade. The size of Accessories Women's wear Men's wear the apparel market in the country peaked in 1991 with a Lux ury goods Food value of W13tn. Since then, the size of the market has Source: Ministry of Knowledge and Economy been shrinking, and stands currently at only W9tn. Given this, the sales growth of SPA companies such as For Japan, it was not until 2008-09 that the luxury Fast Retailing and Shimamura (8227 JP, ¥8,910, market started to see YoY falls in sales, due to the Outperform [2]) has been rising at 7-12% annually financial crisis and the weak Yen. Some consumers who since 2000. traded down during the period have not traded up fully yet. While luxury goods sales slumped immediately We see a similar trend in Korea, where the financial following last year’s earthquake, retailers said that luxury economic crisis has driven an acceleration in the goods sales started to pick up soon after. The recovery in growth of the SPA market. The Uniqlo brand was consumer spending by those in the high-income groups introduced to Korea in 2005, and Zara was launched in has been faster than in other income brackets. 2008. The SPA market was worth some W500bn for 2008; by 2011, it had expanded to more than W1.2tn. For 2012, Japan is likely to remain the third-largest The SPA market currently accounts for about 6.4% of luxury goods market in the world after the US and China, the Korea apparel market. according to the World Luxury Association. For obvious reasons, luxury brands’ sales growth in Japan is slower Compared with 4% annual apparel industry sales than in Korea and China, thus the proportion of sales in growth over the past four years, the SPA market is Japan to total sales has been dropping gradually in recent expanding by 56% a year, according to Samsung years. Even so, Japan still accounts for 10-18% of the Economics Research Institute (SERI). SPAs accounted luxury goods market worldwide, and has one of the most for only 6-7% of the total apparel market in Korea for diverse ranges of merchandise available. 2011, below the equivalent proportion in Japan. Based on the current rate of sales growth, it is highly likely the Consumer spending rising in value-oriented SPAs will account for more of the total apparel market, channels as they do currently in the other developed countries. Just like other countries with an ageing population, the income gap is widening in Korea currently. In an ageing  Fast-fashion market comparisons society, a greater proportion of older people are unable Korea Japan Spain UK to generate income, the working population has to pay Market share of total retail market by sales (2010) (%) 2 11 20 16 Fast fashion sales CAGR (2006-10) (%) 77.4 14.7 16.1 13.5 more tax, and average household incomes become Apparel industry sales CAGR (2006-10) (%) 4.7 -3 4.5 3.5 squeezed. The rich are likely to continue to spend less of Note: 1) Korea based on 2008-10 data (after entry of INDITEX) their income, generating returns on their assets. 2) Spain (INDITEX, Mango, H&M), UK (Topshop, Newlook, George, INDITEX, H&M), Japan (INDITEX, H&M, Fast Retailing, Shimamura), Korea (Fast Retailing, INDITEX, H&M) Source: Thomson Research, NATIXIS, Korea Fashion Association, Euromonitor, SERI

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As in Japan, the emergence of SPAs in Korea is likely to Tightening of regulations in Korea mirrors have a negative impact on discount-store sales, as Japan prior to the 1990s; will impact discount- apparel sales account for about a low-teens percentage store and SSM sales growth of overall sales. Based on their brand equity and In Korea, the Retail Industry Development Law was product designs, discount stores’ apparel sections enacted in 2011 (and is similar to the Large Scale Retail should find it difficult to achieve strong sales Law that was tightened in Japan in 1974), and focuses momentum compared with the SPAs. on ensuring sales growth for small- and medium-sized retailers. This law prohibits discount stores of more However, the strong sales-growth performance of the than 3,000 sq m and SSMs of more than 500 sq m SPAs in the future is likely to benefit the department from being opened within 1km of traditional market stores, unlike what has happened in Japan. This is places without the approval of the local government. because, in Korea, many SPA brands are imported by a subsidiary operated under the leading retail company. In Japan, the Large Scale Retail Store Law that came Popular SPA brands such as Zara, Uniqlo, and Muji are into effect in the 1950s was aimed at protecting the imported by a subsidiary under Lotte group, while interests of small retailers. The law required large Banana Republic and Gap are imported by Shinsegae retailers to seek local government approval when International, an affiliate of Shinsegae. opening a store. It was strengthened in 1974, and obtaining approval to open a store became more In Korea, branded apparel sales are concentrated in the difficult, as the criteria for what was considered a large department-store channel, with standalone shops less retailer was broadened. It was amended throughout the popular than in other countries. This is perhaps 1990s in step with social and economic developments because Korea’s population density is higher than other in Japan, and in response to political pressure from the large countries. Therefore, opening standalone high- US. In 1991, the definition of a Category I large store street shops in areas with high consumer traffic can be was altered to one with a sales area of 3,000 sq m costly due to high real-estate prices and the limited (from 1,500 sq m) and operating hours were extended. availability of retail space. As a result, a shop-in-shop In addition, the maximum period for an application to concept becomes important and working with the be approved was changed 12 months (compared with a leading retailers makes distribution easier from the worst case of 10 years previously). A second round of point of view of overseas foreign apparel companies. reform took place in 1994, with an additional relaxation in operating hours and stores of up to 1,000  International brands imported by the leading retailers in Korea sq m were exempted from the law. The Large Scale Retail Store Law was abolished in 1998.

As clearly shown in the following chart, as a result of the progressive relaxation in regulations the number of new store openings since 1990 has increased significantly.

Source: Companies, compiled by Daiwa

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 Japan: number of registered large-scale retail stores

Source: Ministry of Economy, Trade and Industry from Seven & i Holdings corporate outline 2011

With the Retail Industry Development Law in Korea, I consumers are highly price sensitive – generating believe SSM and the discount-stores expansion will be meaningful returns is easier said than done. The pure affected: we are already seeing a slowdown in the Internet shopping malls are the leading Internet number of stores being opened. In addition, I do not shopping mall companies in both Korea and Japan. But believe the regulatory environment in the discount- off-line retailers are actively seeking opportunities to store industry and SSM industry is likely to be relaxed expand their presence in this area. Although the by the government, especially in an election year. immediate returns are low, it is a market difficult to ignore given the strong sales growth on the back of new Store openings by Lotte Shopping, Shinsegae, and media developments and consumers’ desire for Tesco in 2H11 fell short of these companies’ respective shopping convenience. plans, as the law restricts store openings in many regions. For 2012, we expect one to two fewer discount- …and the differences store openings compared with last year for Lotte Mart Some of the questions most commonly asked by and E-Mart. investors and investor relations team were ‘what

actually differentiates the Korea retailers from those in In an increasing number of municipalities, discount Japan so that they can enjoy high profitability’ and stores and SSMs will be forced to close 1-2 days a ‘what do the Japan companies need to do in order to month in order to protect small- and medium-sized improve profit margins’. retailers. Recently, the number of discount stores closed for one day of the month (usually a Sunday) has The much greater profitability of the Korea retailers now reached half of the total number. We expect this to compared with their Japan peers is driven by the have a marginally negative impact on sales. differences in the industry landscapes, group structures,

cost-efficiency measures, property ownership The regulations should accelerate consolidation in the structures, and customer-marketing strategies. We SSM industry. The discount-store industry is mature expect these factors to continue to be the drivers for the and consolidated in Korea, with the top-three players Korea retailers to enjoy better profitability than their accounting for more than 80% of the market. But the Japan peers going forward. supermarket industry is highly fragmented, with the leading three players accounting for only 20% of the Highly consolidated Korea retail market vs. market. I see the leading retail companies becoming fragmented Japan retail market more active in M&A in the SSM industry in order to tap The Asia Financial Crisis from 1997-98 and resultant business-growth opportunities, as obtaining approval industry consolidation led the Korea retailers to to open new SSM and discount stores becomes difficult. become more advanced in cost efficiencies than their

Japan peers, in my view. The consolidation of the Fast-growing Internet shopping malls Korea department-store industry has been ongoing Internet shopping channels in Japan and Korea have since the late 1990s. The weaker players during the seen double-digit-percentage sales growth YoY in the Asia Financial Crisis went bankrupt or were acquired past decade regardless of the macro conditions in the by the leading players. As a result of consolidation, the countries. However, due to intense competition – as top-three department stores now account for 70% of

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the market. Much of the industry consolidation in  Top-three discount-store players: market-share comparison Korea took place when asset prices were depressed between Japan and Korea (2011) during the Asia Financial Crisis. The leading retailers (% ) were able to secure the assets at low prices, supporting 100 Others mid-teen ROICs for the department-store operations in 90 80 Lotte Mart Korea once the industry starting seeing robust sales Others growth on the back of strong macro growth. 70 60 Homeplus-Tesco 50 Korea’s discount-store industry is also highly Uny 40 Ito-Yokado consolidated, with the top-three players accounting a 30 more than 80% of the market. Following the Asia 20 E-mart Aeon Financial Crisis, there was a series of rapid store 10 openings by both domestic and overseas players. By the 0 mid-2000s, Wal-Mart and Carrefour had exited the Japan Korea market due to failed localisation attempts. There was Source: Companies consolidation among the domestic players, with the  Top-three CVS players: market-share comparison between leading companies acquiring the smaller players. The Japan and Korea (2011) discount-store business cannot operate without scale. And so the small players lost their market positions as (% ) 100 they were not able to offer low prices. Others 90 Others 80 Industry consolidation is ongoing in Korea and small- Seven-Eleven 70 FamilyMart sized M&A take place once or twice a year. The 60 consolidation helps reduce market competition and 50 Lawson GS25 reduce marketing expenses — one of the key drivers 40 behind the improvement in department stores’ 30 20 operating profit margins over the past decade. Seven-Eleven FamilyMart 10 Compared with Korea, Japan’s department store and 0 Japan Korea GMS industries remain highly fragmented, and the Source: Companies pace of industry consolidation seems to be much slower than in Korea over the past decade. Compared with the Japan companies, the highly consolidated industry in Korea allows retailers there to Relative to the department-store and the discount- enjoy: store industry, the CVS market in Japan is highly consolidated, which perhaps explains the higher  less intense market competition, profitability of the CVS stores compared with the other  lower marketing expenses, retail channels.  stronger bargaining power with vendors, and  Top-three department-store companies: market-share comparison between Japan and Korea (2011)  better cash flow and higher profitability.

(% ) As a result, they have sufficient capital to undertake 100 acquisitions when an asset comes up for sale. This 90 Others allows them to shore up their dominant positions. 80 70 Others Shinsegae Leading retailers’ business diversification in 60 Korea alleviates market competition Hyundai Department Store 50 Business diversification by the leading Korea retailers 40 J. Front Retailing is one of the key reasons the department stores are 30 unlikely to face same headwinds as the Japan 20 Sogo & Seibu Lotte Department Store department stores from the emergence of shopping 10 Isetan Mitsukoshi Holdings 0 mall outlets and SPAs. Japan Korea Source: Companies It is understandable for the leading Korea retailers to expand into shopping malls, premium outlets, SSM, and Internet shopping malls despite the returns being lower than from their core businesses. This approach - 48 - Trading Places 24 May 2012

means they are well-prepared for changes in consumer Some of the main differences between the Korea and spending behaviour, with a widening income gap Japan (department stores and hypermarkets) retailers resulting in more consumers becoming value-oriented in terms of the SG&A mix are: 1) rental expenses, 2) and consumers looking for greater convenience. labour expenses, and 3) marketing expenses.

As shown in the following table, the leading Korea The Japan departments stores tend to operate many of retail groups have diversified group structures. Lotte their stores on a leased basis, while many Korea group is by far the most diversified, followed by department and discount stores wholly own their Shinsegae group. The two operate a wide range of properties. Thus, the Japan retail companies’ different retail formats, which helps them to operating-profit margins are exposed to rising rental complement one channel’s weakness with other retail prices in attractive store sites. If the Korea department formats, in terms of store locations, merchandise stores were operated under lease contracts as in Japan, strategies, pricing, and logistics. the Korea department stores’ operating-profit margins would not be as high as they are today, as property  Leading Korea retailers: group structures prices in the country have more than doubled (up by Shinsegae Hyundai Dept 7.6% a year) since 2000 compared with a department- Lotte Group Group Store Group GS Retail Department stores ◎ ◎ ◎ store sales CAGR of 5% for 2000-11. Discount stores ◎ ◎ SSM ◎ ◎ ◎ Due to fierce competition in the fragmented Japan CVS ◎ ◎ department-store industry, marketing expenses as a Home shopping ◎ ◎ ◎ percentage of SG&A costs are higher than in Korea. At Shopping mall/outlet ◎ ◎ ◎ Internet shopping mall ◎ ◎ ◎ ◎ HDS (on a parent basis), marketing and promotions expenses were equivalent to 2.4% of total sales for 2011, Electronic category killer ◎ while Isetan Mitsukoshi’s (3099 JP, ¥778, SPA apparel ◎ ◎ Underperform [4]) marketing expenses alone Imported luxury brands ◎ ◎ amounted to 2.6% of total sales for FY11. The top-three Drug stores ◎ ◎ Korea department stores have been gradually reducing Source: Daiwa the proportion of marketing and promotional expenses to sales since the Asia Financial Crisis. For instance, Leaner costs structures for the Korea retailers advertising and promotional expenses as a percentage It was clear after my job swap that it would be impossible of total sales fell to 4% for 2011, compared with about for the Japan department stores and GMS to match the 6% in 2003 for HDS (on a parent basis). In terms of profitability level of the Korea retailers. Three distinct promotional activity, the Korea department stores do disadvantages for the Japan department stores/GMS not try to overspend their competitors. In addition, the stores compared with the Korea retailers are: department stores have become more efficient in  most stores are leased, therefore lease costs account marketing tactics, such that they differentiate the for a large proportion of SG&A expenses, degree of promotion based on a customer’s spending. Marketing tends to be intense only at about the time of  reducing the number of staff compared with the fall a new store opening. in sales has been slow, and  their marketing expenses are slightly higher. The Korea department stores have also been quite efficient in reducing labour costs by converting many  Japan and Korea: department-store SG&A breakdown regular sales-counter, parking, and cashier jobs into comparison, 2011 (percentage of sales) part-time outsourced roles.

(% ) 30 25 20 15 10 5 0 HDS Isetan Mitsukoshi Salaries, payroll costs and bonuses Advertising and promotions ex pense Depreciation and amortisation Leases Others Source: Companies - 49 - Trading Places 24 May 2012

 Retail sector: key similarities and differences in Korea and Japan (Tsuda) Similarities Difference Consumers, - Domestic economies and retail industries have developed similarly. - Market size, growth stage, macro environment differ considerably. Japan is suffering consumer - Both dealing with issues relating to an aging society. from sluggish household incomes and deflation. Korea is seeing growth in household spending - Spending polarisation. Consumers are sensitive to prices but are also seeking novelty incomes and inflation despite a slowing economy. and quality. - Dining alone not as widespread in Korea as Japan. Industry - Domestic firms have high market shares. - New players continue to emerge in Japan, whereas the department stores remain the structure, - Customer base and merchandise similar for department stores, and similar for general leaders and specialty stores remain undeveloped in Korea. business merchandising/discount stores, super supermarkets/supermarkets. - Difference in profitability between the department stores and general conditions, - Few cases where firms compete directly in both Japan and Korea. merchandisers/discount stores is larger in Korea than Japan. competition - Industry realignment progressing in Korea, where conditions for deals are more favourable than in Japan. - Korea companies are faster to develop overseas than the Japanese, but the Japan players are more profitable overseas. Others - Government focuses more on protecting small mom-and-pop stores than backing retail - Greater regulation in Korea a concern going forward. industry growth. - Japanese companies have room to expand their domestic market share; overall retail - Investors expect less growth from retailers as the domestic market matures. market has room for growth in Korea. Source: Daiwa

Tsuda on the many apparent similarities... name in the market through its acquisition of Seiyu. Domestic economy and industry structure Links with Japanese companies are strong in the Korean convenience store subsector, with two of the The growth paths over the past 50 years of the three major convenience stores in Korea operated domestic economies and retail markets of Korea and under licence from Japanese firms. Japan resemble one another. The retail market is a classic domestic demand-oriented industry, strongly In both countries, European and US names have strong affected by domestic economic and social conditions. profiles in terms of luxury brands and specialty store Both countries have mature economies and aging retailers of private-label apparel (SPA). SPAs include societies, but are at different stages in these areas, with Zara, operated by Spain’s Inditex (ITX SM, Not rated), Japan a decade or more ahead of Korea, in our view. H&M, operated by Sweden’s Hennes & Mauritz (HMB From a medium-term perspective, it is important for SS, Not rated), Gap (US, GPS US$26.76, Hold[3]) , and the retail industries of both countries to address the Uniqlo, operated by Japan’s Fast Retailing (9983 JP). issue of their populations aging.

Both countries impose regulatory restrictions on store Consumer spending momentum is stronger in Korea openings. Japanese policies have oscillated between than in Japan, although spending is polarised in both tighter and softer regulations. November 2007 marked countries. Korean and Japanese consumers are a new period of regulatory tightening with the simultaneously price-conscious and lured by the enactment of three laws on urban development. Korea attraction of high-end and new items. Value for money has also been in a phase of increasing regulation since is the priority when shopping for daily commodities, 2011. The regulations exist to preserve small businesses but the purse strings are looser when it comes to rather than to support retail industry growth. shopping for much-prized luxury items.

The main retailers are mainly focused on the domestic … and on differences in operating markets, and foreign companies have a low profile in conditions and management styles both Japan and Korea. Consumer needs, business Operating conditions and management styles differ practices and store-development regulations differ greatly between the two retail industries. Korea boasts widely between the two countries. Overseas companies better operating conditions than Japan in terms of thus stand little chance of achieving sales growth in macroeconomics, industry shakeout and competition. Japan or Korea, unless armed with a huge brand name. The Korean economy turned downward in late-2011, As a result, there is little direct competition between but GDP and consumer spending remain on an uptrend, the Japanese and Korean retail markets. and CPI continues to demonstrate moderate inflation. This stands in contrast with Japan, which is mired in In both countries, the department store subsector is economic stagnation and deflation. devoid of foreign names. In the discount store/general merchandiser arena, US Walmart (WMT US, US$64.58, Korea’s retail industry has undergone more of a Hold[3]) and French Carrefour (CA FR, Not rated) shakeout than Japan’s has. In Korea, the department pulled out of Korea in 2006, leaving the UK’s Tesco store, discount store, and convenience store subsectors (TSCO LN, Not rated) the only success story, through are each dominated by three major players. Poor its tie-in with Samsung. Carrefour and Tesco have performers started to be squeezed out of the pulled out of Japan, leaving Walmart as the only major - 50 - Trading Places 24 May 2012

department store subsector during the Asian currency been the case, as department store stalwarts have crisis in the late 1990s, out of the discount store remained at the helm. Department stores see discount subsector in the mid-2000s, and out of the stores as mere cogs in their group operations and convenience store subsector in the late 2000s. The overseas SPA names as major tenants. market share held by the top three players in each subsector is over 80% for department stores and In terms of management styles, Korean companies discount stores, and over 90% for convenience stores. boast clearer business-growth strategies and faster decision making. Able to learn lessons from Japan’s In Japan, the only subsector where the top three track record, Korean firms look to have an edge in players command more than 70% of the market is the terms of decision-making. convenience store business. Japanese convenience stores enjoy brand recognition and competitive clout While Korean firms have a faster track record for elsewhere in Asia as well. The department store overseas expansion, Japanese firms enjoy better subsector was whittled down to six groups after a spate profitability offshore. We think this is because of mergers in 2000-10. Even after that shakeout, the competition is tougher for retailers outside Korea, top three players account for less than 40% of the where conditions differ in terms of relationships with market, as there are several local and railway-linked suppliers, store expansion, and store opening costs. department stores. In the general Japanese firms may be slower at making decisions, but merchandiser/supermarket subsector, the top three they are successful in booking profits. We attribute this companies commanded 47.2% of the market in FY11. first and foremost to so-called “soft” qualities, such as strong brand power, customer service, and Competition among retailers is more intense in Japan merchandising expertise honed by the highly than in Korea, where huge conglomerates now rule the competitive domestic market. We think another roost. There are more dramatic victories and defeats success factor is a management style that encourages among subsectors and firms in Japan. The Japanese first developing a profitable model and then rolling out retail industry generally operates in cycles, with each a large number of stores. This delays store openings, cycle giving rise to new, innovative retailers, thus but runs a low risk of making losses. upsetting existing hierarchies. In Korea this has not

 Japan: overseas weighting in the operating profit of Japanese firms Operation profit (consolidated) From overseas North America China Asia excl. China Growth Growth Growth Growth Growth

FY10 FY11 rate FY10 FY11 rate FY10 FY11 rate FY10 FY11 rate FY10 FY11 rate Note 3099 Isetan Mitsukoshi HD Overseas equity-method income of (¥m) 10,993 23,834 116.8% 2,008 1,646 -18.0% 245 248 1.2% 387 58 -85.0% 1,376 1,340 -14.6% ¥4.9bn in FY10 Weighting 18.3% 6.9% 2.2% 1.0% 3.5% 0.2% 12.5% 5.6% 8233 Takashimaya Overseas includes real-estate (¥m) 18,173 21,099 16.1% 3,660 4,522 23.6% -171 0 Profit -84 -300 Loss 3,915 4,822 -2.1% development division Weighting 20.1% 21.4% -0.9% - -0.5% -1.4% 21.5% 22.9% FY10 Chinese figure is an estimate 3382 Seven & I HD (¥m) 259,492 304,975 17.5% 35,305 34,125 -3.3% 33,448 32,801 -1.9% 1,857 1,324 -28.7% 0 0 - Weighting 13.6% 11.2% 12.9% 10.8% 0.7% 0.4% - - 8267 Aeon China and other Asian country (¥m) 179,379 203,108 13.2% 15,688 18,209 16.1% 0 0 - 4,548 4,551 0.1% 11,140 13,658 36.0% figures are estimates Weighting 8.7% 9.0% - - 2.5% 2.2% 6.2% 6.7% 8270 Uny (¥m) 36,816 45,896 24.7% 4 -88 Loss 0 0 - 4 -88 Loss 0 0 - Weighting 0.0% -0.2% - - 0.0% -0.2% - - 8276 Heiwado (¥m) 10,783 11,992 11.2% 1,715 1,874 9.3% 0 0 - 1,715 1,874 9.3% 0 0 - Weighting 15.9% 15.6% - - 15.9% 15.6% - - 2651 Lawson Equity-method affiliate in Shanghai (¥m) 56,238 62,717 11.5% -47 -309 Loss 0 0 - -47 -309 Loss 0 0 - became a consolidated subsidiary Weighting -0.1% -0.5% - - -0.1% -0.5% - - in 4Q FY11 8028 Family Mart Overseas ops contributed ¥900m (¥m) 38,640 42,786 10.7% 2,956 3,170 7.2% -369 -238 Loss 0 0 - 3,325 3,408 19.9% in equity-method income, nearly Weighting 7.7% 7.4% -1.0% -0.6% - - 8.6% 8.0% ¥500m in parent royalty income in FY11 9946 Ministop (¥m) 7,646 7,712 0.9% 887 694 -21.8% 0 0 - 0 -233 - 887 927 10.7% Weighting 11.6% 9.0% - - - (-) 11.6% 12.0% Source: Companies, compiled by Daiwa

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Food for thought

 SWOT analysis of Korea and Japan retail markets – Sang Hee About Japan Sector S - Value-oriented retail channels (SPA) gaining momentum W - Lack of SSS growth from conventional retail formats such as department stores and GMS. O - Industry consolidation to help reduce market competition and lift T - Unfavourable demographic trend; decline in the population and greying society profitability Company S - Long-established history and vast customer database W - High cost structure for labour and rents unlikely to be turned around immediately O - Store refurbishments/introduction of new store formats to provide T - Customers’ lack of conviction regarding economic growth recovery fresh look for consumers and create traffic. Additionally, improving merchandise that will better communicate with the customers - Decent size overseas operation and some markets with better profitability Korea Sector S - Relatively solid macroeconomic conditions compared with the global W - Highly dependent on domestic market and minimal presence in the fast-growing economic market, with the leading conglomerates gaining further emerging markets global market shares in the retail industry subsectors where the Japanese retailers have a presence. - Declining dependency ratio until 2016-17 - Ongoing boost in the luxury goods market O - Further industry consolidation likely as 10-20% of the market is still T - Declining asset prices and lower disposable income for the average household operated by the weaker players in the major retail channels - Rapidly aging society Company S - Consolidated industry landscape allows high profitability and healthy W - Lack of scope for margin improvement as costs are already efficiently managed and balance sheet structure the scope for commission-rate increases seem limited due to government pressure O - Has enough funding capability for a decent-sized M&A if the T - Tightening government regulation to protect the traditional mom and pop stores opportunity arrives - Integrated corporate structure allows for many business opportunities through integration and synergies by sharing a retail platform Source: Daiwa

 SWOT analysis of Korea and Japan retail markets – Tsuda About Korea Sector S - Consumer spending growing despite slowing economy. Competition W - Scale expansion limited as domestic market small. relatively mild as industry realigning, with market dominated by few players. O - Considerable room remains for domestic store openings. Possible to T - Population aging. Regulation increasing. take in demand from traditional markets. Company S - Agile management with clear business-growth strategy. Can invest W - Struggling elsewhere in Asia, where competition factors differ. Conglomerate ties rich cash flow into growth areas thanks to high profitability. based not on capital but human (including family) relationships (governance issues). O - Development of new business categories domestically; store network T - Slow response to change. Specialty stores gaining traction. expansion elsewhere in Asia. For Japan Sector S - Large market size. Number of households likely to grow until 2015, W - Growth in consumer spending unlikely, deflation hard to combat. Cross-business single person households until 2030. category competition severe. O - Improvement in profitability and capital efficiency through industry T - Decline in disposable income due to deindustrialisation, tax hike. Aging population. realignment. Plenty of growth opportunities due to considerable Political and fiscal problems. changes in consumer demand. Company S - Merchandising and operations sophisticated due to strict consumer W - Slow management decisions, poor awareness of return on investment. Department scrutiny, severe competition. Rich management resources. stores, general merchandisers generate low profitability due to high cost structure. O - Top general merchandisers, (super) supermarkets, convenience T - Many factors inflating raw material and SG&A costs. Deflation could lead to war of stores have potential for growth. Customer loyalty in Asia is high, an attrition. advantage for companies looking to open more stores. Source: Daiwa

Tsuda’s view following the job swap 1) Both countries’ firms have a lot to learn This section gives a summary of my views on the retail from each other sector in Korea and how this project has changed my While the macroeconomic environments for retailers in views of the Japanese sector. Based mainly on a SWOT Japan and Korea share some features, a SWOT analysis (strengths, weaknesses, opportunities, threats) analysis, of the two groups differs in many areas. Notable I arrive at three key findings: 1) Korean and Japanese differences include the domestic market size and growth firms have a lot to learn from each other, 2) stock potential, growth in consumer spending, and scope for markets have not yet fully recognised the strengths and industry reorganisation, as well as companies’ scope for growth potential of the leading companies in both market share expansion, profitability, growth strategies, countries, and 3) among the subsectors, discrepancies management styles, and overseas business development. in profitability are greatest for the department stores between Korea and Japan. Korean firms could learn from the precedents set in Japan in terms of: 1) how to cope with an aging society, 2) a shift in business locations and development of new formats, and 3) changes in the winners/losers among

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subsectors and companies. There are also more than a through industry reorganisation or market share few areas where they could benefit by imitating Japanese expansion, given Japan’s large domestic market. They companies. These include merchandise appeal, ability to could also enjoy profit contributions from business meet consumer requirements, and customer service. expansion elsewhere in Asia.

On the other hand, Japanese firms also have much to 3) Big difference in department store learn from their Korean counterparts, which boast high profitability profitability, clear growth strategies, and speedy Korean department stores are much more profitable management practices. My time in Korea reminded me than their Japanese peers. Lotte Shopping and of the need for industry reorganisation in Japan. In my Hyundai Department Store’s FY11 operating profit view, the department store subsector that has the most margins each reached 10%, while that for the three to learn from Korea – whereas the Korean department Japanese majors only came at 0.9-2.5%. This is due to stores once looked to the Japanese stores for guidance, the difference in economic environment, the level of the situation has now been reversed. progress in industry realignment, and cost structures.

2) Strengths, growth potential of top Korean firms can put higher mark-up rates on companies in both countries not fully concession merchandise than their Japanese peers recognised because they have higher market shares. Moreover, their Because retail is a domestic demand-oriented industry, personnel costs are much lower. Hyundai Department investors tend to focus on its vulnerability to Store’s number of full-time employees per store dropped macroeconomic changes. However, we do not think the considerably from 285 (556 including other staff) in overall industry’s vulnerability to the macroeconomic FY03 to 78 (462) in FY11. With personnel costs environment necessarily determines the underlying transformed into variable costs, the firm’s personnel strengths/growth potential of the leading companies in cost-to-sales ratio was a low 3.7% in FY11. In contrast, the industry. Takashimaya (8233 JP, ¥542, Hold[3]), which has roughly the same number of stores and retail floor space, Because they still have significant scope to expand their had 370 full-time employees per store (779) and a domestic and overseas operations, as well as high personnel cost-to-sales ratio of 9.0% in the same period. profitability, Korea’s leading retail firms can allocate Facility costs are also low for Korean department stores their abundant cash flows to areas that promise as they own the land and buildings. revenue growth at home and/or abroad. Meanwhile, for the leading Japanese companies, growth is possible

 Japan vs. Korea profitability comparison for department stores Hyundai Department Isetan Company Store Group Lotte Shopping Shinsagae J. Front Retailing Mitsukoshi HD Takashimaya Name Hyundai Lotte Department Shinsagae Daimaru, Isetan, Mitsukoshi Takashimaya Department Store Store Matsuzakaya No. of department store locations 13 39 10 22 24 18 Selling floor space (m2) 446,489 1,031,404 503,000.0 663,474 610,693 517,075 Consolidated gross sales W 4,337bn W 8,310bn W3,900bn ¥941bn ¥1,240bn ¥858bn No. of overseas locations - 3 - - 11 1 Overseas sales - W9bn - - ¥63.1bn ¥37.5bn

Daimaru, Matsuzakaya Isetan, Mitsukoshi Parent No. of department store locations 13 39 10 10 9 14 Consolidated gross sales W4,337bn W 8,310bn W3,900bn ¥ 643bn ¥ 660bn ¥ 648bn Sales ratio Apparel 30.3% 37.5% 29.5% 40.1% 36.5% 31.4% Accessories, misc. items 21.3% 22.1% 19.7% 20.7% 24.8% 27.2% Foods 17.3% 9.5% 13.0% 25.6% 22.4% 29.2% Household products 8.9% 8.8% 7.3% 5.2% 5.3% 7.8% Luxury 8.0% 9.5% 18.0% - - - Others 14.1% 12.7% 12.5% 8.4% 7.6% 2.9% Other revenue - - - - 3.4% 1.5% Gross margin on sales 31.0% 31.6% 30.4% 23.9% 26.8% 25.6% Gross margin 29.0% 31.4% 28.2% 24.2% 28.1% 26.7% *including other operating revenue SG&A cost 17.4% 19.8% 22.3% 22.4% 25.6% 25.8% Personnel cost 3.7% 2.9% 3.9% 6.4% 9.2% 9.0% Operating profit margin 10.1% 10.4% 5.5% 1.8% 2.5% 0.9% Same-store sales growth (YoY) 6.0% 8.5% 12.2% - - - Sales per m2 W10.2m W8.1m W7.7m ¥1.1m ¥1.5m ¥1.5m Source: Company data; compiled by Daiwa

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Discount stores in Korea are also more profitable than Profitability for the Korean convenience stores is general merchandisers in Japan, though the gap is not as surprisingly high. While sales per store at GS Retail are big as for the department stores. The Korean discount equivalent to only a fifth to a sixth of those at its stores’ FY11 operating profit margin was 5-7%, compared Japanese peers, the operating profit-to-sales (all chain with 1-2% for the Japanese general merchandisers. The stores) margin of FY11 is 3.9%, surpassing that for difference was mostly due to SG&A, mainly personnel Lawson (2651 JP, ¥5,340, Hold[3]) and FamilyMart. costs. While the Japanese general merchandisers suffer This is because the profitability of processed food and from low profitability on a non-consolidated basis, sundries in the country is higher than in Japan, and consolidated margins are not bad thanks to contributions because the Korean firms have lower facility costs as from other group firms. Operating profit margin was 6.1% 60% of the stores are owned by franchisees. for Seven & I Holdings, 3.8% for Aeon, and 4.1% for Uny (8270 JP, ¥815, Outperform[2]).   Japan vs. Korea profitability comparison for discount store operators and general merchandisers Company E-Mart Lotte Shopping Aeon Seven & i HD Uny Name E-Mart Lotte Mart Aeon Ito-Yokado Apita, Piago No. of discount store locations 135 (excluding Traders) 95 536 188 227 Consolidated gross sales W12,347bn W8,521bn ¥5,206bn ¥4,786bn ¥1,079bn No. of overseas locations 16 124 54 13 3 Overseas sales W540bn W2,230bn ¥190bn ¥78bn ¥15bn

Aeon Retail Ito-Yokado Parent No. of discount store locations 135 (excluding Traders) 95 338 173 227 Selling floor space (sq m) 1,329,527 892,562 3,974,299 1,665,268 1,708,818 Consolidated gross sales W12,347bn W8,521bn ¥2,200bn ¥1,361bn ¥788bn Sales ratio Apparel 14.0% 19.2% 17.8% 17.6% 14.6% Foods 56.0% 47.6% 50.5% 47.6% 63.3% Household products 30.0% 28.0% 19.5% 12.7% 15.7% Tenant 0.0% 0.0% - 18.6% - Others 0.0% 5.2% 12.2% 3.5% 6.4% Gross margin on sales 25.1% 25.4% 26.8% 25.1% 24.6% Gross margin 24.2% 23.0% 32.8% 26.6% 28.2% *including other operating revenue SG&A cost 17.3% 18.8% 30.8% 25.8% 25.9% Personnel cost 5.4% 4.8% 12.7% 10.5% 12.6% Operating profit margin 6.9% 5.7% 2.0% 0.8% 2.3% Same-store sales growth (YoY) 3.3% 4.5% 0.3% -2.6% -1.6% Sales per sq m of directly operated stores W9.3m W7.1m ¥0.5m ¥0.6m ¥0.4m Source: Companies, compiled by Daiwa

 Japan vs. Korea profitability comparison for convenience store operators Korea Seven Bokwang Company GS Retail (Subsidiary of Lotte Shopping) FamilyMart Seven & i HD Lawson FamilyMart Name GS25 Seven-Eleven FamilyMart Seven-Eleven Lawson FamilyMart No. of total stores 6,307 6,200 6,584 140,005 10,457 8,834 Subsidiaries of total domestic stores 0 0 0 14,005 10,310 8,164 Associated companies accounted for the 0 0 0 - 147 555 equity method of the total stores Area franchised of the total stores 0 0 0 - - 115 Chain store sales W2,595bn W1,993bn W2,602bn ¥3,281bn ¥1,848bn ¥1,658bn No. of overseas locations 0 0 0 30,980 370 11,245 Subsidiaries of total overseas stores 0 0 0 7,395 355 3,504 Associated companies accounted for the 0 0 0 0 15 7,741 equity method of the total stores Area franchised of the total stores 0 0 0 23,585 0 0

Seven-Eleven Japan Parent Parent No. of total stores 6,307 6,200 6,584 14,005 9,065 8,164 Directly-run total stores 1.4% 1.5% 2.0% 2.8% 1.9% 4.7% Area franchised of the total stores 98.6% 98.5% 98.0% 97.1% 98.1% 95.3% Chain store sales W2,595bn W1,993bn W2,602bn ¥3,281bn ¥1,621bn ¥1,535bn Operating revenue W2,595bn W1,993bn W2,602bn ¥576bn ¥272bn ¥274bn Operating profit W102bn W77bn W94bn ¥183bn ¥56bn ¥38bn Operating margin 3.9% 3.9% 3.6% 5.6% 3.5% 2.5% Sales ratio Ready-to-eat 8.0% 7.0% 7.0% Over 34% Around 30% Around 30% Cigarette 37.0% 38.0% 38.0% 25.0% 28.3% 26.5% Average daily sales per store W1.5m - - ¥0.7m ¥0.5m ¥0.5m Average gross profit margin at stores 29.0% 29.0% 30.0% 29.7% 30.1% 27.6% Same-store sales growth (YoY) 4.0% - - 6.7% 5.4% 4.4% SSG Except cigarette 4.3% - - 1.9% 0.5% Over 0% Source: Companies; compiled by Daiwa - 54 - Trading Places 24 May 2012

Reassessing our views on the companies we cover

 SWOT analysis of Korea retail players — Sang Hee’s and Tsuda’s views Sang Hee Tsuda Hyundai S - Strong position in the high-end department store business S - Good quality customer base, highly competitive stores. High profitability and Department Store - Operates more stores in attractive areas compared with competitors capital efficiency. - Most efficient cost management among its peers - Faster breakeven point compared with peers due its disciplined ROIC metrics W - Less diversified group portfolio compared with peers: HDS group’s presence W - Has not ventured overseas. has narrowed to department store, apparel and online retailing O - Future store locations more attractively located than those of its peers O - Domestic store network expansion. - New store openings in shopping malls, the emerging retail channel - Handsome acquisition will allow HDS group to gain merchandising competitiveness T - Demand for luxury goods could weaken in the future T - Relatively vulnerable to economic change as focused on department stores. - New store openings schedule being delayed or cancelled Lotte Shopping S - One of the most diversified retail companies in Asia, with a dominant market S - Scale merit, group synergy. Major complex development. position in the well positioned retail channel - Strong bargaining power over vendors given its scale merits - Ahead of peers in terms of emerging market expansion W - Solid domestic earnings diluted from its loss-making overseas operations due W - Investing in Asia has not led to profit growth. to intense market competition - Diversified business mix can at times offset strong earnings from one business division from the weak operation of another O - Solid earnings growth from the domestic retail operation on the back of new O - Business expansion in Asia and through M&A. store openings and a sound long-term private consumption growth outlook - Easy funding capability on the back of its strong credit rating (AA+) should an M&A opportunity rise - Well-delivered execution for its overseas operations should become an earnings catalyst given the company’s greater presence in China in terms of number of stores compared with Aeon. T - Lower-than-expected margins for its overseas operation when benchmarking T - Balance between investment and return. against Japanese peers - Shares suffering from conglomerate discount. - Near-term earnings under risk due to ongoing expansion and uncertainty about the company’s ability to generate returns for its overseas business E-Mart S - Strong buying power over vendors given its number one market position in the S - Industry leader and makes good use of group clout. Highly competitive due to low discount store industry cost structure. - Low cost base as many stores were secured during the late 1990s to early 2000s. W - Weak SSS growth as the industry is reaching saturation. W - Domestic competition intensifying, struggling elsewhere in Asia. - Lack of innovative new business platform, hence lack of next earnings growth driver - Focus on Internet shopping mall inevitable for the company’s future market presence but high profitability unlikely to be achievable as consumers remain extremely price conscious O - Efforts to diversify the business mix to seek long-term business growth O - Expanding operations in emerging economies, developing new domestic - Strong private label brand development should lead to strong competitive businesses. advantage T - May face tougher market competition in the future should various forms of T - Intensifying competition, increasing regulation. specialty channel (SPA, electronic category killers, shopping mall, etc) gain more market popularity with consumers - Narrowing price gap among the retail channels on basic necessities (supermarket, Super supermarket (SSM) GS-Retail S - Demographic trends and industry’s structural change favourable for CVS S - Accelerating store openings by directing managerial resources to mainstay industry growth convenience stores. - Offers higher guaranteed income to the franchisee given the absence of loyalty income fees to the headquarter, unlike the other foreign players in the market W - Stores are slightly smaller than those of its peers, meaning the company may W - Maturing market. Competing with major rivals on similar products/services. face hurdles in expanding its ready-to-eat meals Merchandising an issue. O - Introduction of differentiated types of CVS format could provide a window of O - Expanding through store openings, improving quality by scrap & build. opportunity to expand the customer base and the reason customers got to - Strengthening merchandising clout, expanding product line-up. CVS - Ready-to-eat product portfolio and profit margins still relatively weaker than in Japan and Taiwan, which suggests strong product development could potentially change the landscape T - No. of people per CVS close to reaching maturity and competition likely to T - Weakening profitability after store expansion ends. Higher burden on franchise intensify from 2014 support. - Existing regulation on the SSM industry likely to hinder SSM expansion in the near term Source: Daiwa

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What has made Sang Hee more positive on terms of culture, economic-growth background, and the Korea retail companies? history. In addition, Korea seems to be following the My concerns about the leading Korea retailers have path of Japan in demographic trends. Therefore, it mostly dissipated following my job swap in Japan. The seems that what is happening today in the Japan retail two countries share many similarities on the surface in market is what we will see in Korea 20 years from now.

 Japan and Korea: retail industry cycle timeline Prior to the 1960s 1960s-70s 1980s-90s 2000s 2010s-

Rapid economic High economic Post-bubble period growth Bubble economy Japan Earthquake growth Lost decades: 1964 Tokyo 1997 Asia Financial and post global -Department-store macroeconomic Olympics/1970 Expo Crisis financial crisis period industry ex pansion environment gets Osaka 1999-2000 dot.com -CVS market and SPA -The current format tougher, deflation, - GMS expansion bubble, deflation sales growth despite Japan was established in the and an ageing - Large Scale Retail -CVS industry falling private early 1900s population Store Law enacted in ex pansion consumption -Department-store law -GMS and department 1974 and started to -Specialty store -Private-label brands comes into force in store industry sales slow GMS industry ex pansion gain in strength 1956 decline sharply sales growth

Economic boom Post global financial Rapid economic 1988 Seoul Olympics crisis period growth and 1997 Asia Financial -Shopping malls gain in Post Asia Financial industrialisation Crisis popularity and Crisis, active industry -Retail industry GDP per capita department-store Undeveloped consolidation undev eloped reaches W10,000 in openings resume economy -Discount-store Korea -First deomstic late 1990s -Discount-store Korean War expansion department store -Department-s tore industry matures - Department-store openings by Lotte and industry expansion -CVS openings industry matures Shinsegae in the -Retail market is accelerate 1970s opened up to foreign -SPAs starting to gain play ers in 1996 momentum

Source: Daiwa

However, I came to realise that the Korea retail each of the channels it is involved in. Thus, cost savings industry has modernised and advanced considerably from marketing and strong buying power can be better since the Asia Financial Crisis, and department stores allocated for funding investments, which could then and discount stores (and even online shopping) have increase earnings growth for the company. evolved into more developed business models than in Japan. Investors need to recognise that though department stores’ gross-profit margins will likely narrow as a Korea department stores heading in the right result of investments in shopping malls, premium direction by learning lessons from Japan shopping-mall outlets, and Internet shopping malls, department stores’ missteps the slight drop in margins is likely to translate into It is clear to me that the expansion and investment long-term earnings growth for the companies strategies of the leading retailers in Korea are aimed at concerned, based on how the Japan retail markets have overcoming the hurdles that the Japan department evolved. stores are facing currently, with the retail industry landscape changing as the society greys and economic In addition, in order to maintain their market growth slows. dominance, heavy capex by the leading companies seems inevitable over the near term, and a drop in I have become confident about the leading retailers’ ROIC unavoidable for long-term earnings growth to be business diversification into shopping malls, achieved. investments in apparel companies, and business diversification into new store formats, as they appear to CVS and drug stores are the retail markets be aimed at reducing the risk of competition from new likely to grow over the next 5-10 years in Korea retail channels, such as we have seen in Japan. The drug-store and the CVS markets are more Business diversification leads to reduced market developed in Japan than in Korea, perhaps due to the competition as companies will try to set up optimised current demographic mix. merchandising, pricing, and marketing strategies for

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The Korea CVS industry’s long-term sales-growth membership cards to keep customers loyal. Based on outlook appears promising on the back of structural annual purchase amounts, the department stores are changes in the retail industry and demographic able to identify VIP customers and provide gifts on changes. Clearly, consumers will seek small-sized store birthdays and special holidays. In addition, when formats as convenience becomes important for older visiting the stores, VIP customers are given access to customers in Korea as well. VIP lounge services. Merchandise differences among the different companies need further development, I believe that if the Korea CVS companies manage to which I believe the retail companies will seek through improve their merchandise and strengthen the brand their apparel affiliates by importing luxury brands, power of their private-label products to the levels of launching SPA apparel, and developing domestic high- their Japan peers, there would be more upside to their end brands. margins and earnings. Still, several things are needed for this to happen: 1) CVS store sizes would have to be What has led Sang Hee to become more larger in order for ready-to-eat sections to expand, and cautious on the prospects for Korea retail 2) a variety of new customer services would have to be stocks? introduced. Operational environment likely to become challenging for the discount stores… Where could they improve? Following my job swap, I became more concerned Strengthening the brand power of private-label about the earnings-growth prospects of the Korea products and introducing differentiated hypermarket industry. In my view, the segment faces merchandise several challenges: I believe that the Korea retail companies are unable to differentiate themselves too much from their  tightening government regulations related to the competitors. In an expanding retail market, expansion of large stores, and differentiation is perhaps less important, since  the industry maturing and sluggish SSS growth. everyone should benefit from industry sales growth. I believe consumers’ purchasing habits with respect to But, once the retail industry is mature, market-share basic necessities are likely to remain similar to those of gains as well as gains in shares from other retail Japanese consumers: becoming more price-conscious channels will be driven by differentiated merchandise and looking to shop in small store formats for and customer services. convenience. If the Japan market today is a reflection of what discount stores in Korea will face in the coming While the retail companies realise the importance of years, it is clear to me that: expanding their private-label brands to improve operating-profit margins and to secure loyal customer  the industry will face challenges from other retail bases, we believe the power of the brands is not as channels (SSM, online shopping, specialty apparel strong as in Japan. retailers, electronic category killers, and to some extent CVS) due to the proliferation of channel The discount-store industry has been much more active options, in terms of developing private-label brands than other  consumers are likely to shift to small-format stores retail channels. On average, private-label brands given their convenience, and account for 25% of total industry sales. However, this is lower than in some developed countries where private-  there could be price competition as other retail label brands account for about 30% of total sales (in channels try to reduce prices and introduce private- Europe the ratio can be as high as 40%). label brands.

In the CVS industry, private-label brands account for a … and E-Mart likely to be exposed to greatest teen level of sales, compared with 30-35% in the Japan risk CVS industry. Following the job swap, I believe the road ahead for E- Mart is likely to be challenging. E-Mart’s main Although private-label brands have a limited presence competitors, such as Lotte Mart and Tesco, have in department stores, given their longer history than diversified retail portfolios within their respective other retail formats, the department stores’ strategies groups in anticipation of changes in consumers’ to gain a loyal customer base are perhaps more spending power. In addition to operating the third- advanced than the other retail channels as a result of largest discount-store chain in Korea, Lotte Shopping marketing tactics. The Korea department stores use runs the second-largest SSM and the third-largest CVS. The group also imports SPA brands and aims to expand - 57 - Trading Places 24 May 2012

aggressively into an electronic category killer. Tesco It won’t be easy to raise overseas profitability to Homeplus operates a diversified retail portfolio that the level of the domestic operation includes discount stores and SSM, which are No.1 and I believe it will become increasingly important for the No.2 in their respective markets in terms of the retail companies to expand into emerging markets as number of stores. The company is planning trial a the domestic market reaches saturation point, and move into the CVS channel. given that private-consumption growth is unlikely to be rosy in a greying society. E-Mart is trying to expand into wholesale warehouse- type stores (similar to the Costco store format) and However, we think overseas market revenue growth Internet shopping. The company also recently will be challenging for the Korea players. Even the announced it was entering the drug-store market. Japan companies that have had a presence overseas for much longer struggle to generate lucrative returns in In addition, it plans to refocus on its overseas most markets with the discount-store model, due to expansion in China and Vietnam. E-Mart’s strategy is fierce market competition with international players to seek earnings-growth opportunities in second- and and difficulties in localisation. Although still at a low third-tier cities in China, as the company is behind the level in terms of total group profit, the Japan retailers’ curve in gaining a presence in first-tier cities. It plans overseas profitability is not substantially lower than to enter Vietnam, which has been a less developed that of the domestic business. But it is lower than the market due to the government regulations. Following profitability of the Korea retailers in their domestic restructuring, E-Mart now operates only 16 stores in market. On the flip side, this may imply there is some China. We believe it will be challenging for the room for Lotte Shopping to generate a profit (as company’s plans for its overseas operation to bear fruit opposed to its current losses) if it executes on its based on its current size. Competition with its overseas strategy successfully, given that in countries international peers overseas is challenging, and the such as China, Lotte has more discount stores than company has been cautious in its expansion strategy, Aeon. resulting in it being behind the Japan players as well as other international names. The profitable Japan retailers have operating-profit margins of 2-9% in Asia. The most profitable store is Over the past six years, E-Mart’s PER multiple (using Singapore Takashimaya, which generated an Shinsegae’s PER prior to the demerger in 2011) has operating-profit margin of 9% for FY11, and Aeon in traded at a premium to that of the KOSPI based on the ASEAN, with 8%. Seven & i Holdings’ overseas GMS high returns and rapid earnings growth in the Korea stores have operating-profit margins of about 1-5% retail sector. The company’s aggressive store expansion (1.5% if the losses from new stores are included). The since the Asia Financial Crisis in 1998 allowed it to Japan shopping-mall centres have better margins than make market-share gains in Korea’s overall retail the discount stores in the overseas markets. industry. But, judging from the experience of Aeon, it seems certain that slower earnings growth will lead to a Tsuda’s view of the Korean retail market contraction in E-Mart’s PER multiple. following his job swap

The Korean retail market has made progress in terms  E-Mart: PER multiple discount/premium to the KOSPI of industry realignment and still has room for domestic (% ) (% ) growth. This contrasts with Japan, which faces tough 150 ROE drops from 16-20% from 2001-08 to 9% in 2012E 25 competition in a mature market. By subsector, the 100 20 Korean department stores look attractive as an

50 15 investment. Japan’s department stores were slow in adapting to changes in customer behaviour and lost 0 10 market share to general merchandisers, shopping -50 5 centres, and specialty retailers from the 1990s. The

-100 0 Korean department stores operate discount stores and have also taken the initiative to develop large shopping -08 -03 g y Jul-04 Jul-11 Apr-06 Oct-09 Oct-02 Jun-07 Jan-08 Jan-01 Feb-05 Mar-09 Feb-12 Mar-02 Dec-03 Sep-05 Nov-06 Au Dec-10 Aug-01 May-10 Ma centres. They also respond quickly to changes in Relative to KOSPI/PE (LHS) ROE (RHS) customer demand. Given this, together with their brand power and strong positions with suppliers, we Source: Bloomberg Note: Shinsegae’s PER used in calculating E-Mart’s PER prior to the demerger in 2011 expect the Korean department stores to sustain earnings growth over the medium to long term. Korea’s discount stores are facing tougher competition than the department stores, as well as concerns over

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increasing regulation. Still, we see little risk of discount stores suffering the sort of profitability erosion seen at the Japanese general merchandisers over the future. That said, we also doubt that the discount stores can achieve meaningful profit growth via the expansion of subsidiaries, new operations, and shopping centre development over the mid and long term.

We expect the Korean convenience stores to sustain revenue growth continue to several years, buoyed by store openings. That said, as room for store openings becomes scarce, franchise support costs may rise, possibly eroding profitability. Population per store was down to 2,412 as at the end of 2011, below Japan’s 2,718 and near Taiwan’s 2,357. We believe a figure of around 2,000 would be the trough, even considering Korea’s high population density and abundance of franchisee candidates. In order for the Korean convenience stores to secure medium- to long-term revenue growth, they need to strengthen the competitiveness of existing stores and increase the format’s share of the overall retail market. We think firms will scrap and build stores and increase their size, and also add new offerings such as take-out meals.

 Population per convenience store 14,000

12,000

10,000 8,000 6,000 4,000

2,000

0 Japan Korea Taiwan

2001 2006 2011

Source: Companies, compiled by Daiwa

Overall, the Korean CVS firms have yet to generate a profit in Asia. However, they may continue to invest their abundant domestic cash flow there. If firms can get their Asian operations big enough, they may be able to enjoy economies of scale in terms of procurement, distribution, and sales promotion. We believe the medium- to long-term revenue-growth potential of the Korean CVS firms hinges on their success in Asia.

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 SWOT analysis of the Japan retail players — Tsuda’s and Sang Hee’s view Tsuda Sang Hee J. Front Retailing S - Leadership of top management. Active structural reforms at the department S - Most proactive among the peers in its cost restructuring efforts, particularly in stores. terms of labour, which is one of the key factors behind improving profitability by the Korean retailers - Visible restructuring efforts W - Low profitability. Operations other than department stores weak; overseas W - Supermarket and the wholesale businesses have low profitability despite various development lagging. Shareholder equity and number of shares inflated restructuring efforts through merger. O - Enhancing department store competitiveness, improving profitability. O - Active store remodelling compared with peers in an effort to capture new and Expanding group operations through M&A and other means. broader customer base - More focused than peers in trying to implement a strategy to appeal to young customers who are its future key customers. T - Further downfall of overall department store sector. Intensifying competition in T - Declining population and weak consumer sentiment continue to weigh negatively Osaka area. on private consumption growth 7&i HD S - Highly competitive mainstay convenience store business leads domestic S - The largest GMS and supermarket player in Japan in terms of number of stores market. Profit in North American convenience store business also expanding. - Strong presence in the shopping mall outlets, a channel which is exhibiting growth in sales W - Domestic general merchandising business on downtrend since early 1990s. W - Weak balance sheet and high debt level. Profitability at department stores also low. - Complicated group structure O - Expand domestic share using convenience store business. North American O - Cost efficiencies from the integration of the three GMS units into one convenience store business promising. - Restructuring efforts to reduce non-performing stores T - Failing to reform domestic general merchandising store business. Shares T - Price competition with the other retail channels to add pressure on profitability suffering from a conglomerate discount. Aeon S - Domestic shopping centre business highly competitive, reforms progressing in S - Strong brand power helps franchisee to earn the most earnings compared with general merchandising business. Track record improving elsewhere in Asia. peers - Strong private label brands. Items only available at 7-Eleven accounts for 60% [of what? -sales] - Offers attractive benefits to franchisee (high commission split, utility cost subsidies, etc) W - Profitability of general merchandising business improved but low. Lagging in W - Weak GMS operation and lack of signs of a recovery in a structurally declining streamlining group operations. industry - Weaker infrastructure at the GMS operation O - Increasing domestic market share, expanding Asian operations. New O - Proactive product launches and structural industry growth should provide market- shopping centre openings likely to accelerate from 2013 in Japan, from 2014 share gain opportunities from the restaurant market given its advanced elsewhere in Asia. merchandising, logistics and solid relationship with suppliers - Gaining shares in the CVS business from expanding target customer segments T - Return to weakening investment/return balance. Consistency an issue in T - Ongoing market competition with specialty channels in its GMS operation group company capital measures. - Intense market competition with the CVS business due to competitors’ aggressive expansion, as CVS is one of the few retail sectors to exhibit sales growth FamilyMart S - Enhancing domestic competitiveness. Expanding profit contributions from S - Improving profitability (excluding cigarette sales) due to better procurement costs elsewhere in Asia, partly thanks to successful tie-ups with local firms. based on scale merits - Most successful out of all the Japanese players in the overseas market and high sales exposure in the emerging markets W - Profitability of domestic convenience store business lagging top two players. W - Overall profits are weaker than the other leading players Delays in expanding service offerings. O - Improving domestic profitability, expanding size along with industry O - Further CVS industry consolidation likely to drive widening market share gap realignment. Expanding Asian operations. between the strong and the weak players - Expanding customer base, with strong collaboration with suppliers to strengthen the ready-to-eat meal category and successful product developments - March 2011 earthquake has driven consumers to flight for quality T - Intensifying competition on increased store openings within the sector. Higher T - Intensifying CVS market competition costs from supporting franchises. Delays in attracting customers to its service offerings. Source: Daiwa

Tsuda’s view of the Japan retail industry Department stores must solve structural problems and following his job swap become more adept at responding to market changes in order to prevent the subsector from losing further ground Unlike Korea, it is difficult to expect Japan’s retail within the retail sector. We think they need to capitalise market to show meaningful expansion. On the other on their inherent strengths to capture new customers by hand, the scale of the market is large, and the top-tier expanding their product line-ups across a wider price firms still have room to increase their market shares range. Corrections to investment portfolios currently via store openings and M&A. We envisage benefits weighted heavily toward store development should also from restructuring (profitability improvement, higher improve capital efficiency. In this regard, we think J. capital efficiency) and earnings boosts from overseas Front Retailing (3086 JP, ¥367, Hold[3]) warrants the operations. Given uncertainties over the macro most attention of the three major department store environment, we believe retailers need to hammer out operators. It is quickly correcting its high-cost structure, clear-cut earnings growth strategies and step up and revamping sales floors in new ways. management execution now.

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The general merchandiser and supermarkets are the subsectors we consider most ripe for industry reorganisation. While the first- and second-tier companies are likely to enjoy sustained earnings growth, the small and mid-size supermarkets, and privately owned shops, will probably remain at a disadvantage due to their limited financial muscle and a lack of successors to take over family businesses. We thus expect the shakeout within the industry to gain momentum in future. This could provide first- and second-tier firms with an opportunity for market share expansion, which could improve distribution efficiency in up/midstream operations, boost buying power, and increase sales of private-brand goods. In our view, industry leader Aeon will probably play a key role in the sector reorganisation.

We think the convenience store format still has room to expand its share of Japan’s retail sector. While we expect the top three players to continue tightening their grip on the market, we doubt this will reach the point of driving out the second-tier operators. Fourth- ranked Circle K Sankus (3337 JP, ¥1,767, Hold [3]) is to become a wholly owned subsidiary of parent Uny in the middle of July 2012 , with Uny shifting to a holding company structure under Uny Group Holdings from FY13. The number five player, Ministop (9946 JP, ¥1,331, Hold [3]), is a subsidiary of Aeon, and the number six player, Daily Yamazaki, is a subsidiary of Yamazaki Baking (2212 JP, ¥1,049, Buy[1]).

We expect profit contributions from the Japanese retailers’ overseas operations to grow over the medium to long term. The big winners are likely to be Aeon’s large shopping centres in Asia, Seven & i Holdings’ convenience stores in North America, and FamilyMart’s convenience stores in Asia. We also note that Lawson is starting to invest money in Asian operations.

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Revisions to Daiwa forecasts

 Revisions to Sang Hee’s forecasts following her job swap: Korea Revenue (W bn) Operating profit (W bn) EPS (W) 2012E 2013E 2012E 2013E 2012E 2013E Hyundai Previous 1,588 1,735 478 528 17,589 19,257 New 1,588 1,735 478 528 17,589 19,257 Lotte Shopping Previous 25,688 28,316 1,865 2,033 40,179 43,994 New 24,638 27,051 1,668 1,865 37,283 41,811 E-mart Previous 11,497 12,432 840 871 19,676 21,331 New 11,497 12,431 829 862 19,356 20,551 GS Retail Previous n.a. n.a. n.a. n.a. n.a. n.a. New 4,659 5,287 136 172 1,603 1,984 Source: Daiwa forecasts

 Revisions to Tsuda’s forecasts following his job swap: Japan Revenue (¥ bn) Operating profit (¥ bn) EPS (¥) 2012E 2013E 2012E 2012E 2013E J. Front Previous 957 961 24.8 27.0 25.7 28.3 New 966 970 26.0 29.0 24.4 28.8 7&i Previous 4,990 5,175 306.0 326.0 167.5 186.8 New 5,065 5,270 316.0 338.0 177.7 194.7 Aeon Previous 5,605 5,850 225.0 254.0 116.3 135.9 New 5,680 5,920 222.0 252.0 110.5 130.0 FamilyMart Previous 330.5 343 45.8 49.4 248.6 282.3 New 335 349 45.8 49.4 234.9 281.3 Source: Daiwa forecasts

Korea: earnings-forecast revisions, target  Korea Retail Index performance vs. KOSPI price changes, and company initiation Rebased 100 = May 9, 2011 As the Japan and Korea retail companies compete 140 within their domestic markets, we believe our job 130 120 swaps have given us real insight into the mid- to long- 110 term retail industry landscape for the subsectors. 100 90 The revisions to my earnings forecasts for 2014 result 80 from what I learned in Japan based on the likely mid- 70 to long-term industry landscape, while the revisions to 60 -11 y

my near-term earnings forecasts are based more on Jul-11 Apr-12 Apr-12 Oct-11 Oct-11 Jun-11 Jan-12 Feb-12 Feb-12 Mar-12 Nov-11 Dec-11 Dec-11 Aug-11 Aug-11 Sep-11 May-11 Ma changes in macro conditions. Retail Index Retail index relative to KOSPI

Source: Bloomberg, compiled by Daiwa Note: Retail Index comprises Lotte Shopping, E-Mart, Hyundai Department Store, and Shinsegae

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Lotte Shopping: affected by weak traditional mom-and-pop stores to convenience stores, macroeconomic conditions in 1H12 and the increasing number of retirees. Based on what is I am cutting my earnings forecasts for Lotte Shopping happening in Japan, and depending on how by 7% for 2012 and 5% for 2013, and lowering the successfully GS Retail expands into the ready-t0-eat ROIC-based six-month target price to W440,000 (from meals, there could be upside to our earnings forecasts. W480,000). The changes to my earnings forecasts Among the three retail formats (department stores, result from the weak 1Q12 earnings results announced discount stores, and CVS), the CVS industry is less on May 22. In addition, based on what we saw during developed than in Japan, and again there could be the financial crisis from 2008-09, the company’s upside to our earnings forecasts if GS Retail were to earnings are the most sensitive to economic conditions, execute well on its expansion strategy. We initiate as it has more store exposure to the regional areas, coverage with an Outperform (2) rating and forecast a where weak economies tend to have a more direct 20% EPS CAGR for 2012-14. We have a six-month impact on department-store sales. Furthermore, the target price of W27,000, based on a 2012E PER of 17x. tightening of government regulations on credit-card companies is likely to negatively affect Lotte Card’s Japan: revising earnings forecasts, earnings this year. The number of shop openings in the changes to target prices discount-store industry is likely to slow YoY for 2012 Raising our revenue growth outlook due the Retail Industry Development Law, but Lotte We are revising our earnings forecasts for the four Mart should continue to see a stronger-than-industry companies we looked at during our job swap (ie, J. average SSS growth. I now forecast a 9% EPS CAGR for Front Retailing, Seven & i Holdings, Aeon, 2012-14 compared with 11% previously. FamilyMart) in light of the FY11 results and follow-up interviews with company officials. The most notable E-Mart: factoring in an increase in competition difference between our pre-job-swap and post-job- I am cutting my 2013-14 earnings forecasts by 3-4%, swap views is that we are now raising our FY12-13 but maintaining the SOTP-based six-month target revenue growth forecasts. The management teams of price of W250,000. I believe that competition with all four companies have switched to aggressive other retail channels, such as supermarkets, electronic business outlooks and adopted plans to prioritise top- category killers, and SPAs, will intensify. I am cutting line growth, with increases in capex and SG&A outlays my SSS growth forecast to 1.5% YoY for 2014, from planned for FY12. 2.5% YoY. Furthermore, should government regulations be tightened, discount-store and SSM Insights gleaned from Korean companies suggest the market sales growth is likely to become more difficult, Japanese players’ plans to prioritise top-line growth is and E-Mart is likely to see lacklustre earnings growth a positive that would lead to increased market share compared with other retail channels. We forecast core going forward. Market share expansion should in turn earnings growth to rise by less than 4% a year from boost profit growth, as well as profitability 2012-14. improvement over the mid to long term. We have raised our FY12 and FY13 operating-profit forecasts for HDS: relatively immune to the emergence of J. Front Retailing by 4.8% and 7.4%, and our new retail channels and beneficiary of corresponding figures for Seven & i Holdings by 3.3% polarisation as society greys and 3.7%. We have fine-tuned our forecasts for Aeon For HDS, I am not changing my earnings forecasts as I and FamilyMart. We are raising our FY12-13 do not see any immediate impact from the emergence operating-profit forecasts for two of the four firms, and of other retail channels. This is because the high-end fine-tuning our figures for the other two. We think all luxury goods and branded apparel companies rely of them aside from J. Front Retailing will continue to heavily on department stores for distribution coverage. set new records in terms of operating profit for FY12-13. Any earnings risks to HDS are likely to be driven by the macro environment. I forecast a core-earnings CAGR of J. Front Retailing 10% for 2012-14. I also maintain the ROIC-based six- Overall, we are raising our FY12-13 forecasts slightly, month target price of W220,000. but lowering our FY12 net income forecast to reflect an increase in extraordinary losses. We are increasing our Initiation of coverage on GS Retail: beneficiary FY12 and FY13 operating profit forecasts by ¥1.2bn and of demographic changes ¥2bn, mainly because we see an accelerated pace of I believe the CVS industry will continue to see strong earnings recovery, backed by progress in implementing sales growth over the near term, given the rising the new department store business model. The number of single-person households, consumers’ likelihood of fiercer competition in the Osaka area from desire for convenience, the ongoing conversion of 2H FY12 warrants caution, however. Hankyu, the

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largest department store in the region, is set to expand Marunaka Group (major supermarket chain) more the retail floor space at its flagship Umeda store. We than offsetting a heavier investment burden for the will keep an eye on J. Front Retailing’s sales trends at domestic and Chinese operations. stores in the Kansai area. We are lowering our six- month target price from ¥440 to ¥400, representing a FamilyMart target PBR of 0.64x on our end-FY11 BVPS forecast. We are leaving our FY12-13 operating-profit forecasts intact, but are narrowly raising our recurring profit Seven & i Holdings forecasts to reflect an increase in equity-method We are raising our FY12 and FY13 operating-profit income. We are also raising our target price to ¥3,800 forecasts by ¥10bn and ¥12bn, mainly to reflect the from ¥3,600, representing a PER of 15.7x on our FY12 brisk earnings that we see for the mainstay EPS forecast. On the other hand, we are paring our convenience store segment. We are also raising our six- FY12 net income forecast due to likely increases in month target price to ¥2,850 from ¥2,450, based on a extraordinary losses and goodwill amortisation over target PER of 14.7x on our FY12 EPS forecast. that period. In FY12, management will apparently focus Operating-profit growth is likely to top our earlier on stepping up new store openings in Japan, and estimate by 2pp on the back of SSS growth for Seven- improving store-level gross margins through structural Eleven Japan and a boost from stepped-up new store reforms. Negatives from stepped-up store openings by openings. Profit contributions from 7-Eleven Inc in the major players are likely to be offset by convenience US are also increasing. While there is still concern over stores capturing a greater share of the overall retail a possible earnings shortfall for domestic general market. In our view, overall profit contributions from merchandiser operations FY12, this would probably not overseas subsidiaries should rise, even with earnings have a significant impact on overall earnings. sluggish for Taiwan FamilyMart (5903 TT, NT$143.5, Operating-profit growth is likely to slow to 8.2% in the Hold[3]). absence of year-earlier one-off boosts.  Japan: new store openings by the five major convenience Aeon stores We are paring our operating-profit forecasts for FY12 (# of Stores) and FY13 to reflect FY11 earnings, and lowering our six- 1,400 1,200 month target price from ¥1,400 to ¥1,150, based on a 1,000 multiple of 12x (sector average) on our FY12 diluted 800 EPS estimate. However, our basic earnings outlook for 600 the period remains unchanged. The company’s large- 400 200 scale shopping centres are extremely competitive, and 0 we expect ongoing improvements in general FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 merchandiser operations. Management plans to invest FY12E FY13E aggressively in refurbishments and power-saving Seven-Eleven Lawson FamilyMart measures such as LED lighting FY12. It also intends to Circle K Sunkus Circle K Sunkus step up new openings of large shopping centres from Ministop FY13 in Japan, and from FY14 elsewhere in Asia. In our Source: Company, compiled by Daiwa view, the firm should maintain double-digit operating- profit growth in FY12 on a year-on-year basis, with full- year contributions from the recently acquired

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Implications for the Pan-Asia Retail Sector

 Pan-Asia Retail Sector: market comparison Korea Japan China Consumers, Widening gap between rich and poor Middle class contracting Increase in middle class (urbanization, higher incomes) consumer spending Consumption increasing Consumption flat Consumption up around 15% annually Polarisation Polarisation Inflation, cost increases Inflation Deflation Industry structure, Led by conglomerates, industry realignment in progress Majors include various players, industry realignment slow State-owned firms strong business condition Department stores strong, specialty retailers yet to Convenience stores, specialty retailers, shopping centres Department stores strong, brisk sales of luxury items competition establish presence strong Entry by overseas major firms; severe Domestic firms; relatively moderate Mainly domestic firms; severe Others High growth potential in domestic market Room for increasing share in Japan Government supporting increase in consumption Moves to tighten regulations Ageing population Human network key; domestic firms, ethnic Chinese firms overseas enjoy advantages Source: Daiwa

Pan-Asia marketing to accelerate as firms eye  China: store development scheme further growth The Pan-Asian retail market faces significant Land Central government, state-owned enterprises differences in terms of customer demand and culture Acquisition of long-term use rights for land by region, and is a domestic demand-oriented industry. (40 yrs for paid contracts, commercial use) Given this, Korean and Japanese firms have rarely Developers competed against each other and we expect this trend Buildings Master lease agreement (typically 15-20 yrs) to remain largely intact. (commercial facilities) However, this is not the case for China and ASEAN Developers, retailers countries, which are huge growth markets. Lease agreement Lease agreement (typically 2-5 yrs) Competition is fierce in these areas, with entries by (typically 2-5 yrs) firms from Korea, Japan, Hong Kong, Taiwan, and Tenants Retailers Europe, together with local firms. Consumption is growing at around 15% annually in China, the core Source: Company data, compiled by Daiwa market. Still, China’s total consumption is only around one-third of GDP, and the PRC Government eyes Korean firms are struggling in China at the moment, consumption as a key pillar for economic growth. but they are capable of continuing investments, using Given this, together with a larger middle class resulting abundant cash flows earned on the domestic front. If from urbanisation and higher income, we expect business scale expands, profits may improve on consumer spending in China to keep growing at an economies of scale. As for the Japanese firms, annual average of around 15% over the medium term. convenience stores boast strong competitiveness in China and ASEAN nations. General merchandisers are In China, agreements on land use, including ownership generating profits via their strength in store operations, and lease, will be a crucial factor in terms of and the same applies for department stores. competition for large-scale retailers such as department stores, discount stores and general We see strong growth potential for Korean and merchandisers. This is particularly the case in the Japanese retailers in: 1) suburban areas of China’s so- central areas of major cities such as Beijing and called first-tier cities, 2) China’s second- to fourth-tier Shanghai. Opening an outlet will need relatively small cities, and 3) ASEAN. Competition is tough, involving initial investments but will lead to high running costs, both overseas and local players, but firms can become with risks of an increase. State-owned firms in China leading Asian retailers if they succeed. Retailers in own land (it is typically difficult for foreign-capital Korea and Japan are trading at lower PERs than those firms to acquire long-term land-use rights). Private- in Hong Kong, Mainland China, and Taiwan, likely sector firms also receive tender support from the PRC reflecting the difference in revenue growth Government. Furthermore, firms in Hong Kong and expectations. Possible catalysts to turn this around ethnic-Chinese companies located overseas have an would be for Korean and Japanese firms to expand edge over Korean, Japanese, and European players, in profits in China and ASEAN countries. terms of language, culture, and relationship with the authorities as the human network has a great impact.

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Pan-Asia marketing to accelerate as firms eye further growth Just as the Korean retail market has developed in much the same way as Japan’s did earlier, so too will retail markets in China and the ASEAN region, in our view. What will likely differ is the pace of development, and the intensity of competition, given the involvement of foreign-capital companies.

Based partly on findings from my job swap, I have inferred that key factors behind success in the Pan-Asia region include: 1) a highly competitive business model, 2) alliances with powerful local companies and amicable relationships with local authorities, 3) fast business expansion, and 4) strong domestic operations and overall group competitiveness.

The first three factors are intimately connected. Without a competitive business model, companies cannot hope to develop strong relationships with local companies and authorities. There are many protectionism and employment issues surrounding the retail market, given the high number of small/mid- sized players. Most countries have therefore established restrictions on investment and new store openings by foreign-capital companies.

Because of this, firms attempting to make forays into overseas markets need cooperation from local companies and authorities in order to: 1) develop products that meet the needs of local consumers, 2) establish solid supply chain management systems, and 3) open new stores without violating regulations. Strong relationships also lead to fast business expansion. Meanwhile, firms need solid domestic operations and strength of the group as a whole to support heavy investments and maintain business expansion.

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 Retail: Global peers comparison Mkt cap Price PER (x) PBR (x) EV/EBITDA (x) ROE (%) EPS growth (%)

Company Code (US$bn) (LCY) 12E 13E 12E 13E 12E 13E 12E 13E 12E 13E Korea Lotte Shopping 023530 KS 7.7 312,500 8.4 7.5 0.6 0.6 7.2 6.7 7.5 7.8 16.2 12.1 E-Mart 139480 KS 6.0 253,500 13.1 12.3 1.2 1.1 8.6 8.0 9.2 8.9 (0.5) 6.2 Hyundai Dept Store 069960 KS 2.9 143,500 8.2 7.5 1.0 0.9 6.4 5.7 13.0 12.5 1.2 9.5 Shinsegae 004170 KS 1.9 230,000 12.5 11.3 1.0 0.9 9.3 9.0 7.9 8.1 7.6 11.0 CJ O Shopping 035760 KS 0.9 177,200 8.5 7.5 2.4 1.8 8.2 7.3 31.7 27.6 7.3 13.9 GS Retail 007070 KS 1.6 24,050 15.0 12.1 1.2 1.1 7.3 6.0 8.4 9.6 32.2 23.8 Hyundai Home Shopping 057050 KS 1.3 123,000 9.2 8.1 1.5 1.3 2.9 1.7 17.6 17.1 12.3 13.8 GS Home Shopping 028150 KS 0.6 98,900 6.4 5.9 0.9 0.8 1.1 0.4 15.0 14.5 (55.1) 8.4 Average 10.2 9.0 1.2 1.1 6.4 5.6 13.8 13.3 2.7 12.3 Japan Seven & i Holdings 3382 JP 26.0 2,337 13.2 12.0 1.1 1.0 4.1 3.8 8.7 9.0 20.9 9.6 Fast Retailing 9983 JP 22.3 16,710 21.0 19.1 4.5 3.9 9.7 8.5 23.4 21.8 49.0 9.9 Aeon 8267 JP 9.7 960 8.7 7.4 0.7 0.7 5.0 4.5 8.8 9.6 26.7 17.6 Lawson 2651 JP 6.7 5,340 16.1 14.7 2.4 2.2 4.6 4.4 15.2 15.5 33.4 9.0 Yamada Denki 9831 JP 4.9 4,065 6.9 6.7 0.7 0.6 3.8 3.4 10.2 9.6 (5.2) 2.9 Nitori Holdings 9843 JP 4.9 6,760 9.7 8.6 1.8 1.5 5.0 4.3 20.0 19.0 13.9 12.8 FamilyMart 8028 JP 4.3 3,475 14.8 12.4 1.4 1.3 3.6 3.4 9.9 11.2 34.5 19.7 Shimamura 8227 JP 4.1 8,910 11.8 10.4 1.3 1.2 4.6 3.9 11.7 12.0 10.3 12.9 Mitsukoshi Isetan Hldgs 3099 JP 3.9 778 9.7 16.7 0.6 0.6 8.5 7.5 6.7 3.7 (46.2) (42.0) Don Quijote 7532 JP 2.7 2,742 11.8 10.6 1.5 1.3 7.7 6.8 13.6 13.5 38.7 11.4 J.Front Retailing 3086 JP 2.5 367 15.0 12.8 0.6 0.6 7.4 6.6 3.8 4.4 (31.5) 17.8 Takashimaya 8233 JP 2.3 542 13.0 11.8 0.6 0.6 5.8 5.2 4.5 4.8 26.8 10.1 Marui group 8252 JP 2.2 552 13.4 10.9 0.5 0.5 10.9 10.0 3.8 4.6 115.0 23.0 Sundrug 9989 JP 2.1 2,430 10.6 9.5 1.5 1.3 5.0 4.3 15.2 15.1 14.5 12.5 Uny 8270 JP 2.0 815 4.4 8.5 0.6 0.6 5.3 5.0 14.1 6.7 338.9 (47.9) Izumi 8273 JP 1.8 1,516 8.4 7.6 1.0 0.9 6.3 5.8 12.1 12.1 46.1 10.4 H2O Retailing 8242 JP 1.6 633 18.3 8.2 0.7 0.7 5.4 3.1 4.0 8.4 505.4 122.4 Ryohin Keikaku 7453 JP 1.4 4,000 10.8 9.7 1.2 1.1 3.8 3.1 11.6 11.8 11.8 11.1 Average 12.1 11.0 1.3 1.1 5.9 5.2 11.0 10.7 66.8 12.4 Hong Kong/China Golden Eagle Retail 3308 HK 4.4 17.42 19.3 15.5 5.0 4.1 12.6 10.2 28.1 28.6 18.3 24.2 Lifestyle Intl 1212 HK 3.4 15.98 13.7 11.8 2.8 2.4 10.5 8.7 21.5 21.8 3.7 16.1 Parkson Retail 3368 HK 2.8 7.60 13.9 11.9 2.9 2.6 8.3 6.8 22.2 23.7 11.5 17.0 Wumart Stores 1025 HK 2.9 17.68 24.3 20.3 5.4 4.7 11.2 8.9 22.1 23.5 28.9 19.9 Intime Department 1833 HK 2.1 8.10 13.2 11.5 1.8 1.6 10.5 8.7 14.4 15.0 16.0 15.2 Beijing Wangfuji Department Store 600859 CH 2.0 27.76 16.4 13.0 2.0 1.8 4.1 2.4 12.0 13.2 23.6 26.5 Daphne International 210 HK 1.9 8.90 13.4 10.9 3.1 2.6 7.0 5.5 25.5 26.1 16.2 23.1 Rainbow Department 002419 CH 1.9 14.97 15.8 13.0 2.8 2.4 4.9 3.1 16.6 17.7 31.3 21.6 Chongquing Deptment Store 600729 CH 1.7 29.04 14.3 11.5 3.0 4.9 N/A N/A 20.8 21.5 25.2 24.4 Maoye International Holdings 848 HK 1.1 1.56 9.5 7.3 1.1 1.0 7.1 5.9 12.8 14.3 11.7 29.1 Far Eastern Department Store 2903 TT 1.2 26.90 13.4 12.5 1.3 1.2 9.9 8.2 9.0 10.2 22.4 7.2 New World Department Store 825 HK 1.0 4.42 11.9 10.4 1.2 1.2 4.7 3.8 11.0 11.9 (27.5) 15.1 Guangzhou Friendship 000987 CH 0.9 15.50 12.7 10.5 2.8 2.5 5.4 4.2 20.2 20.4 19.2 21.1 Average 14.8 12.3 2.7 2.5 8.0 6.4 18.2 19.1 15.4 20.0 Average - China 13.6 11.3 2.0 1.8 6.2 4.8 14.4 15.1 7.8 19.5 US Wal-mart WMT US 216.7 63.73 14.2 13.0 3.0 2.8 7.6 7.3 21.7 21.9 (1.2) 9.5 Home Depot HD US 73.5 48.26 20.2 16.5 4.2 4.1 10.2 9.0 19.3 25.7 (3.9) 22.5 Target TGT US 37.9 56.67 13.4 13.0 2.5 2.2 7.4 7.1 18.0 17.4 (1.6) 2.8 Costco COST US 36.2 83.38 21.7 19.2 2.9 2.6 9.2 8.2 13.5 14.5 14.8 13.2 Macy's M US 15.1 36.47 12.9 10.8 2.5 2.4 6.0 5.3 20.1 22.6 (4.7) 20.2 Kohls KSS US 11.8 48.66 11.3 10.3 1.9 1.8 5.2 5.1 16.3 17.5 (0.8) 10.0 Nordstrom JWN US 10.3 49.65 15.9 14.4 5.1 4.3 7.5 6.8 33.5 33.5 (2.1) 9.8 Average 15.6 13.9 3.2 2.9 7.6 7.0 20.4 21.9 0.1 12.6 Europe Tesco TSCO LN 39.2 310.10 9.5 9.0 1.4 1.3 6.0 5.8 15.8 15.1 (6.2) 4.9 PPR PP FP 19.2 120.35 12.7 11.0 1.3 1.2 8.8 7.6 10.4 11.3 21.2 15.3 Carrefour CA FP 12.7 14.71 10.3 9.4 1.2 1.2 4.6 4.3 11.8 12.8 154.3 10.4 Average 10.8 9.8 1.3 1.2 6.5 5.9 12.7 13.1 56.4 10.2 Global Average 12.9 11.3 2.1 1.9 7.1 6.2 16.2 16.8 18.6 13.8 Source: Bloomberg, Daiwa forecasts for Korean and Japanese companies Note: Updated as of May 23, 2012

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How Sang Hee justifies her Positive rating for the Korea Retail Sector

 Growth outlook  Valuation  Earnings revisions

 Growth outlook  Korea retail industry: sales breakdown and sales growth (YoY)

Bank of Korea and the OECD forecast Korea’s GDP to (Wtn) (% ) rise by 3.5% and 3.3% YoY, respectively, for 2012. We 250 10 forecast Korea retail-industry sales growth of 5% YoY 200 8 for 2012 (compared with 8% YoY for 2011). Among the retail channels, we forecast convenience stores (CVS) 150 6 and Internet shopping to continue to post double-digit- 100 4 percentage YoY sales growth. We forecast the discount- 50 2 store industry to see the slowest sales growth of all the 0 0 main retail channels, at 5-6% YoY, due to tightened 2006 2007 2008 2009 2010 2011 2012E government regulations. We forecast department-store Department stores Discount stores CVS sales to rise by 8% YoY for 2012 (due to new store Home Shopping Internet mall Supermarkets openings by HDS and Lotte), slower than last year’s Small sized retail store YoY growth level of 11% YoY. Source: Statistics Korea, companies, Daiwa forecasts

 Valuation  Korea Retail Sector: 2012E PER comparison

The Korea retail stocks are trading in the middle to low (x ) end of their past-seven-year trading range, reflecting the 16 current economic downcycle. However, the falls in the 14 retail companies’ PERs over the past year have not been 12 as sharp as during the global financial crisis from 2008- 10 09. In general, the retail stocks tend to trade in a PER 8 range of 8-12x depending on the retail-sales cycle. 6 Stocks such as E-Mart and Shinsegae have traded above 4 those levels, likely owing to their investment stakes in 2 0 Samsung Life Insurance (Not rated). Meanwhile, GS GS Retail E-Mart Shinsegae Hyundai HDS CJ O Lotte GS Home Retail is trading currently at the highest PER among its Home Shopping Shopping Shopping Shopping peers, reflecting the strong CVS-industry sales growth. Source: Daiwa forecasts

 Retail stocks: share-price performance vs. consensus EPS  Earnings revisions revisions

In the face of slow macroeconomic growth, the Rebased 100 = May 9, 2011 Bloomberg-consensus earnings forecasts for the retail 140 stocks for 2012 have been cut gradually over the past 130 year. However, the magnitude of the earnings cuts has 120 been relatively limited, with most of it driven by Lotte 110 100 Shopping. We see further downside risk for Lotte 90 Shopping and E-Mart’s earnings in 2Q12. We expect the 80 consensus earnings cuts for HDS in 2Q12 to be limited. 70 60 Jul-11 Apr-12 Oct-11 Jun-11 Jan-12 Feb-12 Mar-12 Aug-11 Sep-11 Nov-11 Dec-11 May-11 Retail Index Retail index relative to KOSPI 2012E EPS trend

Source: Bloomberg Note: For EPS we have used Lotte Shopping, HDS, and E-Mart. Retail Index comprises Lotte Shopping, HDS, E-Mart, and Shinsegae

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How Tsuda justifies his Neutral rating of the Japan Retail Sector

 Growth outlook  Japan: operating profit by subsector (FY=100)

Japan’s economy should rebound gradually in FY12, 220 backed by post-quake reconstruction-related demand.

Consumer spending is likely to languish. While we see 170 tension between a demand recovery and the tough personal income situation, we expect consumers to spend more defensively. In future, overall market 120 growth seems unlikely, as we think the largest retailers have strong earnings growth potential, underpinned by 70 wider domestic market shares, restructuring, and overseas expansion. We expect department stores’ 20 operating profit to grow most in FY12-13. Still, FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12EFY13E Department Stores GMS/DS CVS Total operating profits remain lower at department stores than general merchandisers and convenience stores, Source: Companies, compiled by Daiwa, Daiwa forecasts with these subsectors setting new profit records.

 Valuation  Retail sector performance relative to TOPIX

We have a Neutral stance on the Japan retail sector over 1,600 1.0 a three-month view. Earnings will remain solid, with 1,400 0.9 companies continuing to set new profit records. But 0.8 1,200 retailer earnings momentum in FY12 looks set to lag 0.7 that of exporters. Moreover, the retailers are trading at 1,000 0.6 an average FY12E PER of about 12x, against our all- 800 0.5 sector average FY12 PER forecast of just less than 12x. 600 0.4 0.3 The retail sector has outperformed the TOPIX by 10pp 400 in the past two months, making further rallies unlikely. 0.2 200 0.1 Sector and stock performances are likely to continue to 0 0.0 hinge on currency rates. Expansion in valuation metrics Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 in the medium to long term likely rests on clear growth TOPIX (LHS) Retailing (LHS) Retailing relative to TOPIX (RHS) prospects for leading companies, plus improvements in Source: compiled by Daiwa profitability and capital efficiency (particularly ROE).

 Earnings revisions  Operating profit of the 15 Japan retail majors

We are raising our operating-profit forecasts for FY12-13 (¥bn) slightly for the 15 main retailers (after intra-group 1,000 eliminations) following the FY11 results and our job swap. Our earnings-forecast revisions are relatively large for the 800 general merchandisers. We expect the leading companies 600 to be more aggressive, ramping up investment in core businesses and growth areas. Fierce competition and 400 rising SG&A costs warrant attention, but market-share 200 growth prospects are improving. Potential factors to support earnings beating our forecasts include better 0 FY07 FY08 FY09 FY10 FY11 FY12E FY13E SSS, underpinned by a humid summer and energy-saving Total Department Stores GMS/DS CVS demand. Undershoots could be due to adverse weather, blackout-related disruptions, and rising costs of raw Source: Companies, compiled by Daiwa, Daiwa forecasts materials and utilities.

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on expectation of overseas earnings-growth momentum. Currently, Lotte Shopping’s discount-store presence in China is greater than that of its Japan peers in terms of number of stores, but has a lower return.

Valuation Lotte Shopping We reiterate our Buy (1) rating. We value Lotte Shopping using an ROIC analysis and have lowered our six-month (023530 KS) target price modestly, to W440,000 from W480,000. Rating: Buy The stock has been derated over the past 12 months, Target price: W480,000  W440,000 from a 2012 PER of 13x to 8x currently, due to quarterly (40.8%) earnings disappointments last year as a result of weakening macroeconomic conditions and high levels of Sang Hee Park investment. However, we believe the current valuations (82) 2 787 9165 are at trough levels and the market is factoring in a bear- [email protected] case scenario for 2012 earnings. The main risks to our earnings forecasts would be the losses for the overseas operation increasing and the company’s recent Investing for long-term acquisitions delivering lower-than-expected returns. growth; at trough value now Forecast revisions (%) Year to 31 Dec 12E 13E 14E What we recommend Revenue change (4.1) (4.5) n.a. Following our job swap, we have become more positive Net-profit change (7.2) (5.0) n.a. on Lotte Shopping’s expansion strategy, which has been EPS change (7.2) (5.0) n.a. a cause for concern in the market given the fall in the Source: Daiwa forecasts company’s ROIC over the past three years. We are now Share price performance more convinced that the company’s aggressive expansion plans (shopping malls, SSM, CVS, electronic (W) (%) 560,000 130 category killer) and its overseas expansion make sense in 490,000 110 the greater scheme of things, as these foreshadow 420,000 90 changes in consumer shopping behaviour and seek to 350,000 70 achieve sales growth once the domestic market reaches 280,000 50 maturity. We recommend investors accumulate the May-11 Aug-11 Nov-11 Feb-12 May-12 Lotte Shopping (LHS) stock on the back of likely near-term share-price Relative to KOSPI (RHS) weakness based on the recently reported weak 1Q12 earnings results. 12-month range 301,500-532,000 Market cap (US$bn) 7.80 Key share-price catalysts Average daily turnover (US$m) 19.70 Better SSS growth in latter part of 2Q12. We Shares outstanding (m) 29 Major shareholder Dong-Bin Shin (14.6%) expect Lotte Shopping to deliver an improvement in

YoY department-store SSS growth in the latter part of Financial summary (W) 2Q12 as the base comparison becomes more favourable Year to 31 Dec 12E 13E 14E from May. Furthermore, we believe that because many Revenue (bn) 24,638 27,051 29,236 store renovations were completed by the end of 1Q12, Operating profit (bn) 1,668 1,865 1,982 investment costs will start to translate into a rise in Net profit (bn) 1,083 1,214 1,285 top-line growth and alleviate the fixed-cost burden. Core EPS 37,283 41,811 44,232 EPS change (%) 16.2 12.1 5.8 Ability to make the overseas operation Daiwa vs Cons. EPS (%) (4.2) (3.7) (7.6) profitable. In 2011, the overseas operation recorded PER (x) 8.4 7.5 7.1 disappointing profitability and sales. With the Dividend yield (%) 0.5 0.5 0.5 restructuring of the China discount stores now complete, DPS 1,500 1,500 1,500 should the company deliver strong SSS growth in the PBR (x) 0.6 0.6 0.5 EV/EBITDA (x) 7.2 6.7 6.4 future, we believe the market may start to rerate the ROE (%) 7.5 7.8 7.6 stock to trade at a low-teen PER should the company Source: Bloomberg, Daiwa forecasts generate any decent operating margins, as it did in 2H10

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 Key assumptions Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Same store sales growth - dept (%) (1.8%) 2.5% 6.1% 7.8% 8.5% 3.0% 4.0% 4.0% Same store sales growth - disct (%) 0.9% 0.8% (0.5%) 4.7% 5.0% 2.5% 2.5% 2.5% Number of stores - dept 21 22 23 26 28 29 30 31 Number of stores - disct 56 63 69 90 95 100 105 110

 Profit and loss (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Department store 5,374 5,657 6,148 7,510 8,133 9,354 10,598 11,367 Discount store 3,888 4,169 4,445 5,455 6,296 7,187 7,595 8,249 Others 1,801 3,013 5,417 7,366 7,824 8,098 8,857 9,620 Total revenue 11,063 12,839 16,010 20,331 22,253 24,638 27,051 29,236 Other income 0 0 0 0 0 0 0 0 COGS (7,581) (8,782) (10,788) (13,972) (15,251) (16,943) (18,613) (20,138) SG&A (2,610) (3,045) (4,074) (4,931) (5,183) (6,027) (6,573) (7,116) Other op. expenses 0 0 0 0 0 0 0 0 Operating profit 871 1,012 1,148 1,427 1,819 1,668 1,865 1,982 Net-interest inc./(exp.) 40 30 (40) (126) (72) (60) (62) (73) Assoc/forex/extraord./others 203 36 84 199 (192) 0 0 0 Pre-tax profit 1,115 1,079 1,193 1,500 1,555 1,609 1,803 1,909 Tax (362) (289) (360) (450) (543) (466) (523) (554) Min. int./pref. div./others (62) (43) (50) (43) (81) (59) (66) (71) Net profit (reported) 692 747 782 1,007 932 1,083 1,214 1,285 Net profit (adjusted) 692 747 782 1,007 932 1,083 1,214 1,285 EPS (reported) (W) 23,813 25,706 26,926 34,659 32,084 37,283 41,811 44,232 EPS (adjusted) (W) 23,813 25,706 26,926 34,659 32,084 37,283 41,811 44,232 EPS (adjusted fully-diluted) (W) 23,813 25,706 26,926 34,659 32,084 37,283 41,811 44,232 DPS (W) 1,250 1,250 1,250 1,500 1,500 1,500 1,500 1,500 EBIT 871 1,012 1,148 1,427 1,819 1,668 1,865 1,982 EBITDA 1,298 1,493 1,703 2,173 2,379 2,289 2,532 2,695

 Cash flow (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Profit before tax 1,115 1,079 1,193 1,500 1,555 1,609 1,803 1,909 Depreciation and amortisation 427 481 554 746 560 621 667 713 Tax paid (362) (289) (360) (450) (543) (466) (523) (554) Change in working capital (42) 28 47 15 (75) 66 59 56 Other operational CF items (244) (116) (480) (1,267) (1,030) (426) (202) (178) Cash flow from operations 895 1,182 954 543 468 1,403 1,804 1,946 Capex (1,043) (1,014) (1,033) (1,462) (1,592) (1,800) (1,800) (1,800) Net (acquisitions)/disposals (48) (159) (893) 386 (93) (100) (100) (100) Other investing CF items 844 (45) (66) (1,607) 550 315 (667) (475) Cash flow from investing (246) (1,217) (1,992) (2,682) (1,135) (1,585) (2,567) (2,375) Change in debt (298) 1,476 942 3,114 1,749 (329) 861 (608) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (36) (36) (36) (36) (54) (54) (54) (54) Other financing CF items (257) (1,300) 72 (193) (318) 312 314 315 Cash flow from financing (591) 139 978 2,884 1,377 (71) 1,121 (347) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 57 103 (60) 746 710 (253) 358 (776) Free cash flow (148) 168 (79) (918) (1,125) (397) 4 146

Source: Company, Daiwa forecasts

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 Balance sheet (Wbn) As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Cash & short-term investment 1,162 1,225 1,364 1,955 2,703 2,451 2,808 2,033 Inventory 1,057 1,130 1,251 1,714 2,042 2,261 2,483 2,683 Accounts receivable 193 195 382 432 637 705 774 836 Other current assets 3,193 3,300 4,036 5,859 7,346 7,666 8,033 8,262 Total current assets 5,605 5,850 7,033 9,961 12,728 13,083 14,097 13,814 Fixed assets 7,282 7,848 12,897 14,440 13,154 14,495 15,806 17,087 Goodwill & intangibles 560 1,009 856 2,226 2,707 3,107 3,507 3,907 Other non-current assets 1,559 2,201 3,637 3,624 4,416 4,123 4,327 4,483 Total assets 15,006 16,908 24,423 30,250 33,005 34,808 37,738 39,291 Short-term debt 1,627 1,483 1,733 3,016 3,447 2,657 3,718 1,610 Accounts payable 1,699 1,836 2,284 2,902 3,189 3,542 3,891 4,210 Other current liabilities 1,804 2,051 2,601 3,294 3,275 3,654 3,833 4,005 Total current liabilities 5,131 5,370 6,618 9,212 9,911 9,853 11,443 9,825 Long-term debt 950 1,919 2,987 5,097 6,739 7,200 7,000 8,500 Other non-current liabilities 491 462 1,653 1,793 1,676 1,988 2,301 2,616 Total liabilities 6,572 7,752 11,258 16,101 18,326 19,041 20,744 20,941 Share capital 145 145 145 145 145 145 145 145 Reserves/R.E./others 8,029 8,686 12,186 12,970 13,821 14,909 16,136 17,491 Shareholders' equity 8,175 8,831 12,332 13,115 13,966 15,055 16,281 17,637 Minority interests 259 325 834 1,033 713 713 713 713 Total equity & liabilities 15,006 16,908 24,423 30,250 33,005 34,808 37,738 39,291 EV 10,491 11,253 12,433 15,233 16,558 16,482 16,986 17,153 Net debt/(cash) 1,415 2,177 3,357 6,157 7,482 7,406 7,910 8,077 BVPS (W) 281,462 304,077 424,591 451,582 480,875 518,352 560,580 607,250

 Key ratios (%) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Sales (YoY) 10.6 16.1 24.7 27.0 9.5 10.7 9.8 8.1 EBITDA (YoY) 0.3 15.0 14.1 27.6 9.5 (3.8) 10.6 6.4 Operating profit (YoY) (10.2) 16.2 13.5 24.3 27.5 (8.3) 11.8 6.3 Net profit (YoY) (7.0) 7.9 4.7 28.7 (7.4) 16.2 12.1 5.8 EPS (YoY) (10.3) 7.9 4.7 28.7 (7.4) 16.2 12.1 5.8 Gross-profit margin 31.5 31.6 32.6 31.3 31.5 31.2 31.2 31.1 EBITDA margin 11.7 11.6 10.6 10.7 10.7 9.3 9.4 9.2 Operating-profit margin 7.9 7.9 7.2 7.0 8.2 6.8 6.9 6.8 ROAE 8.8 8.8 7.4 7.9 6.9 7.5 7.8 7.6 ROAA 4.7 4.7 3.8 3.7 2.9 3.2 3.3 3.3 ROCE 8.1 8.6 7.5 7.1 7.7 6.6 7.0 7.1 ROIC 6.5 7.0 5.8 5.4 5.6 5.2 5.5 5.5 Net debt to equity 17.3 24.7 27.2 46.9 53.6 49.2 48.6 45.8 Effective tax rate 32.4 26.8 30.2 30.0 34.9 29.0 29.0 29.0 Accounts receivable (days) 5.9 5.5 6.6 7.3 8.8 9.9 10.0 10.0 Payables (days) 55.0 50.3 47.0 46.6 50.0 49.9 50.2 50.6 Net interest cover (x) n.a. n.a. 28.7 11.3 25.4 28.0 30.2 27.2 Net dividend payout 5.2 4.9 4.6 4.3 4.7 4.0 3.6 3.4 Source: Company, Daiwa forecasts

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weaker sales growth than grocery items. Should the company manage to introduce SPA brands into its E- Mart stores in a shop-in-shop format, this could become an earnings driver for the company.

Valuation E-Mart (139480 KS) We maintain our SOTP-based six-month target price of Rating: Hold W250,000 and Hold (3) rating. The stock’s PER (using Target price: W250,000 (-1.4%) Shinsegae’s PER prior to the demerger in 2011) has dropped from a high-teen figure in 2007 to low teens Sang Hee Park currently, as the company’s ROIC has fallen from the (82) 2 787 9165 [email protected] maturity of the discount-store industry, a rise in costs from new store openings, and losses at the new businesses. We do not expect any improvement in the Facing challenges ROIC any time soon that would warrant a rerating. The main upside catalyst to our earnings forecasts would be What we recommend the company undertaking sizable M&A that proved to The current conditions in the Japan discount-store be value-accretive and help strengthen their business industry could be a precursor to the hurdles E-Mart portfolio. may face in the near future, in our view. We expect E- Forecast revisions (%) Mart to see the least exciting 2012 core-earnings Year to 31 Dec 12E 13E 14E growth among the retail stocks we cover due to slow Revenue change 0.0 0.0 (0.8) SSS growth. Government regulations are negative for Net-profit change (1.6) (3.7) (3.2) discount-store industry sales growth. Over the medium EPS change (1.6) (3.7) (3.2) term, we believe the company will face challenges from Source: Daiwa forecasts specialty stores (SPAs and electronic category killers). Consumers will look for greater convenience and there Share price performance is the risk of the price premium narrowing with other (W) (%) 360,000 200 retail channels, as is the case in Japan. Unless the 320,000 170 catalysts below become apparent, E-Mart’s share price is likely to remain under pressure. 280,000 140 240,000 110 200,000 80 Key share-price catalysts 6-11 9-11 11-11 2-12 5-12 Better SSS growth. E-Mart has had lower SSS E-MART (LHS) Relative to KOSPI (RHS) growth YoY than the industry average in the past two years. A gradual drop in customer foot traffic to stores 12-month range 222,000-331,000 is a concern as consumers seek greater convenience. Market cap (US$bn) 6.07 We believe efficient pricing and further strengthening Average daily turnover (US$m) 9.53 of the brand image of private-label products could lead Shares outstanding (m) 28 to improved SSS growth. For 2011, private-label brands Major shareholder Myung-Hee Lee (17.3%) accounted for 25% of its total sales, compared with Financial summary (W) 26.5% at Homeplus Tesco and 30-40% for discount Year to 31 Dec 12E 13E 14E store retailers in developed countries. Revenue (bn) 11,497 12,431 13,378 Operating profit (bn) 829 862 902 New businesses (Internet mall, Traders) Net profit (bn) 540 573 614 contribute meaningfully to total earnings. By Core EPS 19,356 20,551 22,024 2015, E-Mart aims for its new businesses to account for EPS change (%) (0.5) 6.2 7.2 35% of consolidated sales, up from 12% at present. Daiwa vs Cons. EPS (%) (9.9) (15.8) (14.0) However, the new businesses are currently loss-making PER (x) 13.1 12.3 11.5 and we do not expect an immediate turnaround in Dividend yield (%) 0.3 0.3 0.3 profits due to the nature of the Internet mall business. DPS 750 750 750 PBR (x) 1.2 1.1 1.0 Roll out of shop-in-shop format. Specialty stores EV/EBITDA (x) 8.6 8.0 7.3 ROE (%) 9.2 8.9 8.8 and electronic category killers are likely to be the Source: Bloomberg, Daiwa forecasts biggest threats to the company’s future earnings. Apparel and electronics goods sales are already seeing

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 Key assumptions Year to 31 Dec 2011 2012E 2013E 2014E Total number of stores 137 141 146 150 Number of store openings - disct 4 4 5 4 Same store sales (SSS) change (%) 3.3 0.0 2.0 1.5 Number of stores (China) 20 18 24 30 Discount stores sales growth (%) 5.2 1.8 3.8 3.5 New businesses sales growth (%) 99.5 40.0 30.0 Discount stores operating profit margin (%) 7.6 7.2 7.0 7.0

 Profit and loss (Wbn) Year to 31 Dec 2011 2012E 2013E 2014E Net sales 10,663 11,497 12,431 13,378 Other revenue 0 0 0 0 Others 0 0 0 0 Total revenue 10,663 11,497 12,431 13,378 Other income 0 0 0 1 COGS (7,667) (8,366) (9,102) (9,851) SG&A (2,138) (2,301) (2,467) (2,626) Other op. expenses 0 0 0 0 Operating profit 858 829 862 902 Net-interest inc./(exp.) (107) (100) (88) (73) Assoc/forex/extraord./others 24 (10) (10) (10) Pre-tax profit 775 719 764 818 Tax (232) (180) (191) (204) Min. int./pref. div./others 0 0 0 0 Net profit (reported) 542 540 573 614 Net profit (adjusted) 542 540 573 614 EPS (reported) (W) 19,454 19,356 20,551 22,024 EPS (adjusted) (W) 19,454 19,356 20,551 22,024 EPS (adjusted fully-diluted) (W) 19,454 19,356 20,551 22,024 DPS (W) 750 750 750 750 EBIT 858 829 862 902 EBITDA 1,074 1,170 1,220 1,278

 Cash flow (Wbn) Year to 31 Dec 2011 2012E 2013E 2014E Profit before tax 775 719 764 818 Depreciation and amortisation 216 341 358 377 Tax paid (232) (180) (191) (204) Change in working capital (48) (82) 0 0 Other operational CF items (115) (278) (23) 11 Cash flow from operations 595 520 908 1,001 Capex (383) (550) (500) (500) Net (acquisitions)/disposals (214) (80) (80) (80) Other investing CF items (7) (30) (30) (30) Cash flow from investing (604) (660) (610) (610) Change in debt (31) 177 (289) (369) Net share issues/(repurchases) 0 0 0 0 Dividends paid 0 (10) (10) (10) Other financing CF items 46 20 20 20 Cash flow from financing 15 187 (279) (359) Forex effect/others 0 0 0 0 Change in cash 6 47 18 32 Free cash flow 212 (30) 408 501

Source: Company, Daiwa forecasts

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 Balance sheet (Wbn) As at 31 Dec 2011 2012E 2013E 2014E Cash & short-term investment 96 143 161 193 Inventory 606 667 722 777 Accounts receivable 225 243 263 283 Other current assets 133 138 143 148 Total current assets 1,059 1,191 1,289 1,400 Fixed assets 7,634 7,852 8,004 8,138 Goodwill & intangibles 217 217 217 217 Other non-current assets 2,200 2,675 2,825 2,975 Total assets 11,110 11,936 12,335 12,730 Short-term debt 1,211 1,207 787 800 Accounts payable 839 837 910 985 Other current liabilities 990 1,078 1,098 1,145 Total current liabilities 3,040 3,121 2,796 2,930 Long-term debt 1,768 1,949 2,080 1,699 Other non-current liabilities 727 747 767 787 Total liabilities 5,535 5,817 5,643 5,415 Share capital 139 139 139 140 Reserves/R.E./others 5,436 5,980 6,553 7,174 Shareholders' equity 5,575 6,119 6,692 7,314 Minority interests 0 0 0 0 Total equity & liabilities 11,110 11,936 12,335 12,730 EV 9,949 10,080 9,773 9,372 Net debt/(cash) 2,883 3,013 2,706 2,305 BVPS (W) 200,008 219,511 240,063 262,359

 Key ratios (%) Year to 31 Dec 2011 2012E 2013E 2014E Sales (YoY) n.a. 7.8 8.1 7.6 EBITDA (YoY) n.a. 8.9 4.3 4.8 Operating profit (YoY) n.a. (3.3) 3.9 4.6 Net profit (YoY) n.a. (0.5) 6.2 7.2 EPS (YoY) n.a. (0.5) 6.2 7.2 Gross-profit margin 28.1 27.2 26.8 26.4 EBITDA margin 10.1 10.2 9.8 9.6 Operating-profit margin 8.0 7.2 6.9 6.7 ROAE n.a. 9.2 8.9 8.8 ROAA n.a. 4.7 4.7 4.9 ROCE n.a. 9.3 9.2 9.3 ROIC n.a. 7.0 6.9 7.0 Net debt to equity 51.7 49.2 40.4 31.5 Effective tax rate 30.0 25.0 25.0 25.0 Accounts receivable (days) 5.7 7.4 7.4 7.5 Payables (days) 25.2 26.6 25.6 25.9 Net interest cover (x) 8.0 8.3 9.8 12.3 Net dividend payout 3.9 3.9 3.6 3.4 Source: Company, Daiwa forecasts

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merchandise to consumers and allow the shop-in- shop format in HDS stores. Arguably some of the biggest challenges the department stores face in Japan are a lack of attractive merchandise and weaker bargaining power than in Korea. We believe Handsome’s existing workforce and strong presence Hyundai Department in the apparel market given its 25-year history, now backed by HDS’s capital, will create a win-win Store (069960 KS) strategy for Handsome and HDS. Rating: Buy Target price: W210,000 (+46.3%) Valuation We reiterate our Buy (1) call and six-month target price Sang Hee Park of W210,000, based on an ROIC analysis. Sales at new (82) 2 787 9165 [email protected] stores last year exceeded management’s expectations, and given enhanced economies of scale and tight cost control, newly opened stores managed to break even A high-quality name within a year of opening. The key risk to our target price would be if new stores were to deliver weaker- What we recommend than-expected earnings. Our job swap has strengthened our conviction in our Forecast revisions (%) Buy (1) rating for HDS. We believe the company’s Year to 31 Dec 12E 13E 14E expansion into shopping malls and the group’s decision Revenue change 0.0 0.0 0.0 to acquire an apparel company leave it well-placed to Net-profit change 0.0 0.0 0.0 overcome the issues that the Japan department stores EPS change 0.0 0.0 0.0 are facing currently. In an ageing society in which the Source: Daiwa forecasts income gap among households is likely to widen, we think high-end retailers should fare well within the Share price performance industry. (W) (%) 210,000 130

190,000 120 Key share-price catalysts 170,000 110  One of the most aggressive store-expansion 150,000 100 plans in the next few years among 130,000 90 5-11 8-11 11-11 2-12 5-12 department-store peers. Per the company’s Hyundai Department Store (LHS) Relative to KOSPI (RHS) plans, HDS’s floor space is due to rise by close to 80% between 2012 and 2o16, which translates into 12-month range 143,000-200,000 floor-space growth of about 15% a year. Market cap (US$bn) 2.80  Securing more attractive store sites than its Average daily turnover (US$m) 14.69 peers. For instance, the Cheongju branch, due to Shares outstanding (m) 23 Major shareholder Ji-Sun Chung (17.3%) open this year, will be the first department store

opened by a leading retailer in the area. The future Financial summary (W) planned Pangyo branch is located in a shopping mall Year to 31 Dec 12E 13E 14E close to an affluent neighbourhood. Revenue (bn) 1,588 1,735 1,867  Further cost efficiencies with new store Operating profit (bn) 478 528 575 openings. HDS has been disciplined in cost Net profit (bn) 399 437 477 Core EPS 17,589 19,257 21,022 management, particularly on labour and marketing EPS change (%) 1.2 9.5 9.2 costs. Although investment costs rise in the first year Daiwa vs Cons. EPS (%) 11.9 8.9 11.1 of a store opening, once sales rise, the company’s PER (x) 8.2 7.5 6.8 operating-profit margins should improve as the Dividend yield (%) 0.4 0.4 0.4 fixed-cost burden is relieved by economies of scale. DPS 600 600 600  Acquisition of Handsome by the group PBR (x) 1.0 0.9 0.8 EV/EBITDA (x) 6.4 5.7 5.1 should result in synergies. We believe HDS ROE (%) 13.0 12.5 12.1 group’s decision to acquire Handsome (not rated), Source: Bloomberg, Daiwa forecasts the leading designer apparel manufacturer in Korea, is likely to help HDS provide differentiated - 76 - Trading Places 24 May 2012

 Key assumptions Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Same store sales (SSS) change (%) 2.8 4.6 4.3 7.8 9.0 4.5 4.5 4.5 Number of stores (Multiline retail) 11 11 11 12 13 14 14 16

 Profit and loss (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Department store 2,447 2,541 2,701 2,849 1,439 1,588 1,735 1,867 Others 0 0 0 0 0 0 0 0 Others 0 0 0 0 0 0 0 0 Total revenue 2,447 2,541 2,701 2,849 1,439 1,588 1,735 1,867 Other income 0 0 0 0 0 0 0 0 COGS (982) (1,045) (1,074) (1,038) (248) (147) (157) (165) SG&A (1,016) (1,018) (1,102) (1,234) (755) (963) (1,050) (1,127) Other op. expenses 0 0 0 0 0 0 0 0 Operating profit 450 477 526 576 437 478 528 575 Net-interest inc./(exp.) 4 12 9 20 (7) (13) (8) 0 Assoc/forex/extraord./others 24 49 32 115 131 105 104 107 Pre-tax profit 477 538 567 711 561 571 625 682 Tax (164) (159) (155) (199) (166) (171) (187) (205) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 313 378 412 513 395 399 437 477 Net profit (adjusted) 313 378 412 513 395 399 437 477 EPS (reported) (W) 13,794 16,674 18,155 22,569 17,372 17,589 19,257 21,022 EPS (adjusted) (W) 13,794 16,674 18,155 22,569 17,372 17,589 19,257 21,022 EPS (adjusted fully-diluted) (W) 13,794 16,674 18,155 22,569 17,372 17,589 19,257 21,022 DPS (W) 600 600 600 600 600 600 600 600 EBIT 450 477 526 576 437 478 528 575 EBITDA 562 599 682 745 514 566 626 682

 Cash flow (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Profit before tax 477 538 567 711 561 571 625 682 Depreciation and amortisation 62 62 82 85 46 51 56 61 Tax paid (164) (159) (155) (199) (166) (171) (187) (205) Change in working capital 41 (4) (31) 41 (15) (1) 2 2 Other operational CF items 5 36 197 75 (78) 0 (91) (26) Cash flow from operations 420 472 661 712 347 449 404 514 Capex (223) (241) (466) (356) (733) (450) (600) (400) Net (acquisitions)/disposals (70) (14) (70) (26) (5) (5) (5) (5) Other investing CF items (55) (138) (217) (473) 59 33 225 32 Cash flow from investing (347) (393) (753) (855) (678) (422) (380) (373) Change in debt (9) 48 32 (66) 213 59 166 (18) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (21) (22) (26) (26) (17) (17) (17) (17) Other financing CF items (83) (31) 58 313 59 2 3 3 Cash flow from financing (113) (5) 65 220 255 44 152 (32) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (41) 74 (28) 78 (76) 71 175 109 Free cash flow 197 232 194 357 (386) (1) (196) 114

Source: Company, Daiwa forecasts

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 Balance sheet (Wbn) As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Cash & short-term investment 291 488 610 1,263 159 230 405 514 Inventory 69 71 52 64 41 45 50 53 Accounts receivable 526 517 532 623 544 601 656 706 Other current assets 63 93 69 168 104 151 155 156 Total current assets 949 1,169 1,263 2,119 849 1,027 1,266 1,429 Fixed assets 2,226 2,342 2,819 3,055 3,258 3,500 3,906 4,179 Goodwill & intangibles 158 74 197 236 39 39 39 39 Other non-current assets 528 630 431 553 574 606 638 674 Total assets 3,861 4,215 4,709 5,963 4,720 5,172 5,849 6,322 Short-term debt 282 198 278 335 115 252 538 470 Accounts payable 437 430 473 536 562 623 681 733 Other current liabilities 525 546 592 777 456 402 433 395 Total current liabilities 1,244 1,173 1,344 1,648 1,132 1,277 1,652 1,598 Long-term debt 70 256 232 125 399 320 200 250 Other non-current liabilities 240 187 266 314 297 299 302 304 Total liabilities 1,554 1,616 1,842 2,087 1,828 1,896 2,154 2,152 Share capital 113 114 114 114 117 117 117 117 Reserves/R.E./others 2,193 2,485 2,754 3,763 2,775 3,158 3,579 4,056 Shareholders' equity 2,307 2,599 2,867 3,876 2,892 3,275 3,696 4,173 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 3,861 4,215 4,709 5,963 4,720 5,171 5,850 6,325 EV 3,315 3,224 3,159 2,455 3,613 3,601 3,592 3,464 Net debt/(cash) 61 (34) (100) (804) 354 342 333 206 BVPS (W) 101,722 114,450 126,254 170,691 127,364 144,220 162,745 183,766

 Key ratios (%) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Sales (YoY) 2.1 3.8 6.3 5.4 (49.5) 10.4 9.2 7.6 EBITDA (YoY) (0.5) 6.5 14.0 9.2 (31.0) 10.1 10.5 9.0 Operating profit (YoY) (1.2) 6.1 10.3 9.6 (24.2) 9.6 10.4 8.8 Net profit (YoY) 4.3 21.0 9.0 24.3 (23.0) 1.2 9.5 9.2 EPS (YoY) 4.2 20.9 8.9 24.3 (23.0) 1.2 9.5 9.2 Gross-profit margin 59.9 58.9 60.3 63.6 82.8 90.8 91.0 91.2 EBITDA margin 23.0 23.6 25.3 26.1 35.7 35.6 36.1 36.5 Operating-profit margin 18.4 18.8 19.5 20.2 30.3 30.1 30.4 30.8 ROAE 14.4 15.4 15.1 15.2 11.7 13.0 12.5 12.1 ROAA 8.5 9.4 9.2 9.6 7.4 8.1 7.9 7.8 ROCE 17.8 16.7 16.4 14.9 11.3 13.2 12.8 12.3 ROIC 12.9 13.6 14.3 14.2 9.7 9.8 9.7 9.6 Net debt to equity 2.6 net cash net cash net cash 12.3 10.5 9.0 4.9 Effective tax rate 34.4 29.6 27.3 27.9 29.6 30.0 30.0 30.0 Accounts receivable (days) 77.1 74.9 70.9 74.0 148.1 131.6 132.2 133.2 Payables (days) 65.0 62.3 61.0 64.7 139.2 136.2 137.2 138.2 Net interest cover (x) n.a. n.a. n.a. n.a. 61.7 36.9 68.6 n.a. Net dividend payout 4.3 3.6 3.3 2.7 3.5 3.4 3.1 2.9 Source: Company, Daiwa forecasts

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Retail’s ability to increase the size of its CVS stores to display products and offer comfortable eating facilities, to expand the proportion of ready-to-eat meal sales to total sales, and to strengthen sales of private-label brands should be key factors in achieving sales growth beyond industry saturation GS Retail (007070 KS) point, in our view. Rating: Outperform Target price: W27,000 (+12.3%) Valuation We use a PER of 17x (using Shinsegae’s PER during its Sang Hee Park growth stage) on our 2012 EPS forecast to derive our (82) 2 787 9165 [email protected] six-month target price of W27,000. The stock is trading currently at about a 50% premium to the KOSPI based on the strong sales-growth outlook for the CVS Store additions to drive growth industry. The main downside risks to our target price would be store additions decelerating faster and the What we recommend industry reaching saturation earlier than we expect. A We forecast GS Retail to have the highest 2012-14 EPS failure to increase the proportion of sales of ready-to- CAGR, of 20%, within our Korea Retail Sector coverage eat meals to total sales could result in the company on the back of structural growth in the CVS industry. undershooting market expectations, in our view. We reaffirm our Outperform (2) rating on the stock Share price performance (see our report, Initiation: outperformance at your convenience). (W) (%) 29,000 130

26,000 120 Key share-price catalysts 23,000 110  CVS store opening active until 2013, with 20,000 100 room for growth in regions outside Korea. At 17,000 90 12-111-123-124-125-12 GS Retail we forecast 17% YoY sales growth for 2012 GS Retail (LHS) Relative to KOSPI (RHS) and 14% for 2013 on the back of new store openings. We see scope for new store openings in regions 12-month range 19,500-25,900 where the population per store is greater than 2,500, Market cap (US$bn) 1.59 ie, outside Korea. Average daily turnover (US$m) 1.89 Shares outstanding (m) 77  Demographic trends favourable for sales Major shareholder GS Holdings Corp (65.8%) growth in the CVS industry. We believe the

rising number of retirees, the increasing number of Financial summary (W) single-person households, and consumers’ desire for Year to 31 Dec 12E 13E 14E convenience will continue to drive strong CVS Revenue (bn) 4,659 5,287 5,822 industry-sales growth in Korea over the next two Operating profit (bn) 136 172 200 years. Net profit (bn) 123 153 178 Core EPS 1,603 1,984 2,314  Product-mix improvement is the key to EPS change (%) 32.2 23.8 16.6 earnings growth beyond market saturation Daiwa vs Cons. EPS (%) (3.9) (1.2) (0.8) point. The CVS industry in Korea is closely PER (x) 15.0 12.1 10.4 following in the footsteps of Japan, which has seen Dividend yield (%) 1.5 1.7 1.9 continued sales growth for three decades. Along with DPS 350 400 450 a favourable demographics mix, enhancing its range PBR (x) 1.2 1.1 1.0 of ready-to-eat meals has helped the company to EV/EBITDA (x) 7.3 6.0 5.0 gain market share from the restaurant industry, ROE (%) 8.4 9.6 10.3 while boosting the brand equity of private-label Source: Bloomberg, Daiwa forecasts products has helped narrow the price premium compared with other retail channels in Japan. GS

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 Key assumptions Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E No. of CVS stores 3,388 3,915 5,026 6,307 7,357 8,407 9,057 No. of SSM stores 103 138 205 230 255 280 305 CVS operating profit margin (%) 3.1 4.0 4.0 3.9 3.9 4.3 4.5 SSM operating profit margin (%) 2.5 2.6 2.6 2.6 2.6 2.6 2.7

 Profit and loss (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E CVS 1,332 1,622 1,859 2,089 2,595 3,122 3,595 3,974 Supermarket 645 749 903 1,112 1,310 1,457 1,611 1,765 Others 778 848 122 273 77 79 81 83 Total revenue 2,756 3,219 2,885 3,474 3,982 4,659 5,287 5,822 Other income 0 0 0 0 0 0 0 0 COGS (2,003) (2,362) (2,225) (2,665) (3,136) (3,670) (4,180) (4,614) SG&A (684) (500) (567) (716) (752) (852) (934) (1,009) Other op. expenses 0 0 0 0 0 0 0 0 Operating profit 69 357 92 92 94 136 172 200 Net-interest inc./(exp.) (23) 4 (8) 0 22 14 17 21 Assoc/forex/extraord./others 4 (305) 42 9 14 15 16 18 Pre-tax profit 50 57 127 101 129 166 205 239 Tax (14) (21) (31) (29) (36) (42) (52) (61) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 37 36 96 72 93 123 153 178 Net profit (adjusted) 37 36 96 72 93 123 153 178 EPS (reported) (W) 474 468 1,242 929 1,213 1,603 1,984 2,314 EPS (adjusted) (W) 474 468 1,242 929 1,213 1,603 1,984 2,314 EPS (adjusted fully-diluted) (W) 474 468 1,242 929 1,213 1,603 1,984 2,314 DPS (W) 0.000 0.000 0.000 0.000 300 350 400 450 EBIT 69 357 92 92 94 136 172 200 EBITDA 162 450 166 184 214 269 317 355

 Cash flow (Wbn) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Profit before tax 50 57 127 101 129 166 205 239 Depreciation and amortisation 93 93 74 92 121 133 145 156 Tax paid (14) (21) (31) (29) (36) (42) (52) (61) Change in working capital (11) (23) (38) 18 (63) 7 8 6 Other operational CF items (1) 120 84 6 (151) 1 0 30 Cash flow from operations 118 226 216 188 1 265 305 370 Capex (79) (168) (210) (112) (188) (200) (200) (200) Net (acquisitions)/disposals (7) (4) (4) (53) (5) (10) (10) (10) Other investing CF items (41) (124) (155) (44) (23) (5) (5) (12) Cash flow from investing (126) (296) (369) (209) (216) (215) (215) (222) Change in debt 22 88 145 (267) 246 8 (24) (70) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (8) (8) (8) (25) (39) (23) (27) (31) Other financing CF items 0 0 0 65 0 0 0 0 Cash flow from financing 14 80 138 (226) 208 (15) (51) (101) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 6 10 (16) (247) (8) 35 39 47 Free cash flow 39 58 6 76 (188) 65 105 170

Source: Company, Daiwa forecasts

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 Balance sheet (Wbn) As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Cash & short-term investment 24 31 16 985 762 796 836 883 Inventory 61 77 100 70 133 155 176 194 Accounts receivable 41 41 53 25 40 47 53 59 Other current assets 24 28 32 42 59 60 60 61 Total current assets 150 178 201 1,121 994 1,058 1,125 1,197 Fixed assets 927 1,358 1,488 743 683 770 846 912 Goodwill & intangibles 33 33 85 74 110 113 116 126 Other non-current assets 443 545 647 657 1,207 1,209 1,211 1,213 Total assets 1,554 2,114 2,421 2,596 2,994 3,150 3,299 3,448 Short-term debt 290 190 127 140 505 363 263 213 Accounts payable 213 245 301 188 215 252 287 316 Other current liabilities 25 267 321 401 237 245 253 259 Total current liabilities 528 702 749 730 957 859 802 788 Long-term debt 336 350 496 249 404 554 630 610 Other non-current liabilities 112 178 188 224 199 205 210 216 Total liabilities 976 1,230 1,433 1,203 1,559 1,618 1,643 1,614 Share capital 77 77 77 77 77 77 77 77 Reserves/R.E./others 501 807 911 1,315 1,353 1,450 1,572 1,749 Shareholders' equity 578 884 988 1,392 1,430 1,527 1,649 1,826 Minority interests 0 0 0 0 4 6 7 8 Total equity & liabilities 1,554 2,114 2,421 2,596 2,994 3,150 3,299 3,448 EV 973 880 978 (225) 1,999 1,972 1,909 1,792 Net debt/(cash) 602 509 607 (595) 147 121 57 (60) BVPS (W) 37,506 57,376 64,127 90,415 18,574 19,827 21,412 23,712

 Key ratios (%) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Sales (YoY) n.a. 16.8 (10.4) 20.4 14.6 17.0 13.5 10.1 EBITDA (YoY) n.a. 176.8 (63.1) 11.0 16.3 25.6 17.8 12.1 Operating profit (YoY) n.a. 415.0 (74.2) 0.0 1.7 45.3 26.5 16.2 Net profit (YoY) n.a. (1.3) 165.5 (25.2) 30.6 32.2 23.8 16.6 EPS (YoY) n.a. (1.3) 165.5 (25.2) 30.6 32.2 23.8 16.6 Gross-profit margin 27.3 26.6 22.9 23.3 21.2 21.2 20.9 20.8 EBITDA margin 5.9 14.0 5.8 5.3 5.4 5.8 6.0 6.1 Operating-profit margin 2.5 11.1 3.2 2.7 2.4 2.9 3.3 3.4 ROAE 12.6 4.9 10.2 6.0 6.6 8.4 9.6 10.3 ROAA 4.7 2.0 4.2 2.9 3.3 4.0 4.7 5.3 ROCE 11.5 27.2 6.1 5.4 4.5 5.7 6.9 7.7 ROIC 8.5 17.6 4.7 5.5 5.7 6.3 7.6 8.6 Net debt to equity 104.3 57.6 61.5 net cash 10.3 7.9 3.5 net cash Effective tax rate 27.6 36.8 24.5 29.0 27.7 25.5 25.5 25.4 Accounts receivable (days) 2.7 4.7 6.0 4.1 3.0 3.4 3.5 3.5 Payables (days) 14.1 25.9 34.5 25.7 18.5 18.3 18.6 18.9 Net interest cover (x) 3.0 n.a. 12.2 1,337.6 n.a. n.a. n.a. n.a. Net dividend payout 0.0 0.0 0.0 0.0 24.7 21.8 20.2 19.4 Source: Company, Daiwa forecasts

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Besides an earnings recovery, we believe that any increases in EPS and ROE would require a reduction in outstanding shares and shareholders’ equity, both inflated by business integration of 2007. The firm also needs to convert Parco into a consolidated subsidiary, in our view. Having spent ¥30.1bn to acquire Parco J. Front Retailing shares, the next challenge for management is greater contributions from Parco. We will keep a close eye on (3086 JP) the firm’s next move. Rating: Hold Target price: ￥440  ￥400 (+9.0%) Risk factors consist of: 1) competition among department stores intensifying beyond expectations in Kazunori Tsuda the Kansai area, and 2) the firm not increasing its stake (81) 3 5555 7133 in Parco to have controlling ownership. [email protected]  Valuation Earnings recovery should pick up Our target price represents a target PBR of 0.64x on our end-FY11 BVPS forecast. The applied multiple is on department store business based on the past three-year range of just over 0.5x to 1.0x and the multiple for other major department store  What we recommend operators (0.6x to less than 0.8x). With profit levels We maintain our Hold (3) rating on the stock. We are likely to remain low even as earnings recover in FY12, lowering our six-month target price from ¥440 to we think the stock will continue to trade at this PBR for ¥400, roughly to a PBR of 0.64x applied to end-FY11 the time being. BVPS of ¥629.8, to reflect multiple contraction for the Japan department store stocks overall. Share price performance

(Y) Relative to TOPIX 630 150 The company’s top management is characterised by its strong leadership and speedy decision-making, as 530 130 demonstrated by the ongoing reform of the department 430 110 store segment. We also positively view the acquisition 330 90 of Parco (8251 JP, Not rated) as an equity-method 230 70 affiliate. Among the three leading department store 5/09 12/09 8/10 3/11 10/11 5/12 operators in Japan, we see J. Front Retailing as the firm most likely to improve its business model to one Market data (consolidated) as profitable as those of its Korean counterparts. 12-month range (Y) 299-462 Market cap (¥m) 193,999  Key share-price catalysts Shares outstanding (’000; 23/5) 528,609 Recognising the need to expand its business portfolio, Foreign ownership (%;9/11) 13.3 the company has acquired stakes in two firms, making them equity-method affiliates. The new affiliates are: 1) Investment indicators (consolidated) 2/12 2/13E 2/14E Styling Life Holdings, operator of variety chain “Plaza”, PER (x) 10.3 15.0 12.8 popular with young women, and 2) Parco, a major EV/EBITDA (x) 7.8 7.4 6.6 fashion shopping mall operator with a firm customer PBR (x) 0.58 0.57 0.55 base of people in their 20-30s. Dividend yield (%) 2.18 2.18 2.18 ROE (%) 5.8 3.8 4.4 Our earnings forecasts for the company are unchanged following a slight increase in light of the FY11 results Income summary (consolidated) (¥m) 2/12 2/13E 2/14E and a follow-up interview with company officials. The Sales 941,415 966,000 970,000 earnings recovery has been picking up thanks to Op profit 21,594 26,000 29,000 progress in the shift to its new department store Rec profit 22,941 27,000 29,300 business model, designed to resolve structural Net income 18,804 12,900 15,200 problems plaguing the industry and improve EPS (¥) 35.6 24.4 28.8 DPS (¥) 8 8 8 managerial efficiency. That said, we forecast the FY13 Source: Company, Bloomberg, Daiwa forecasts operating profit to reach just over 60% of the FY07 record of ¥42.6bn.

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J. Front Retailing: income summary (¥m; YoY %) Year to Sales Op profit Rec profit Net income EPS (¥) CFPS (¥) DPS (¥) Consol 2/10 982,533 -10 18,584 -34 19,966 -29 8,167 14 15.5 40.6 7.00 2/11 950,102 -3 20,323 9 21,092 6 8,862 9 16.8 42.5 7.00 2/12 941,415 -1 21,594 6 22,941 9 18,804 112 35.6 60.8 8.00 2/13E 966,000 3 26,000 20 27,000 18 12,900 -31 24.4 51.4 8.00 2/14E 970,000 0 29,000 12 29,300 9 15,200 18 28.8 56.8 8.00 2/13CP 973,000 3 26,000 20 26,000 13 12,300 -35 23.3 - 8.00 Source: Company, Daiwa forecasts Note1: E: Daiwa forecasts, CP: company pojections Note2: We estimate negative goodwill amortization of Y1.16 billion in FY12 and Y0 in FY13. Note3: We estimate EPS of Y22.2 (before negative goodwill amortization) in FY12 and Y28.8 in FY13.

 J. Front Retailing: cash flow (¥bn) FY07 FY08 FY09 FY10 FY11 Cash flows from operating activities

Pre-tax income 35,314 8,459 13,822 14,652 16,714

Depreciation 11,301 13,257 13,295 13,610 13,347

Impairment losses 2,078 4,554 3,769 1,936 1,069

Negative goodwill amortization -1,199 -2,336 -2,326 -2,317 -2,286

Increase/decrease in allowance for doubtful accounts 30 476 409 23 -53

Interest and dividends income -643 -910 -756 -756 -809

Interest expenses 1,543 1,616 1,679 1,717 1,536

Impact of revised accounting for asset retirement obligations - - - - 2,254

Increase/decrease in accounts receivable, trade 3,854 12,115 2,310 5,660 -542

Increase/decrease in inventories -488 2,214 7,703 4,803 2,330

Increase/decrease in accounts payable -2,012 -10,264 -2,622 -645 -1,923

Other -6,199 7,181 -7,702 -12,914 -1,517

Sub total 43,579 36,362 29,581 25,769 30,120

Interest and dividends received 738 899 711 710 651

Interest paid -1,594 -1,641 -1,574 -1,728 -1,511

Income taxes paid -14,927 -12,934 -5,721 -3,480 -4,895

Net cash provided by/used in operating activities 27,796 22,686 22,996 21,270 24,365

Cash flows from investing activities

Payments for tangible fixed assets -16,122 -12,765 -55,748 -14,601 -15,686

Proceeds from sales of tangible fixed assets 21,322 526 7,971 3,359 2,853

Payments for investment securities -407 -1,903 -2,149 -1,538 -11,962

Proceeds from sales of investment securities 416 4,618 8,327 1,872 2,487

Extension of loans -23 -29 -36 -95 -36

Collection of loans 156 148 375 158 108

Other 450 -2,271 381 2,413 -4,545

Net cash provided by/used in investing activities 5,792 -11,676 -40,879 -8,432 -26,781

Cash flows from financing activities

Increase/decrease in short-term borrowings -15,889 16,699 2,184 -8,818 -14,998

Proceeds from long-term borrowings 8,499 1,500 47,450 2,500 14,000

Repayments of long-term borrowings -14,007 -26,563 -4,374 -5,960 -11,632

Redemption of bonds -13,500 - -14,000 -5,000 -

Dividends paid -3,722 -4,763 -1,858 -5,523 -3,693

Net cash provided by/used in financing activities -39,309 -13,510 29,212 -23,128 -6,872

Effect of exchange rates on cash and cash equivalents -73 -136 -121 -20 1 Net Increase/decrease in cash and cash equivalents -5,794 -2,636 11,208 -10,311 -9,286 Cash and cash equivalents at beginning of year 33,103 34,944 32,307 43,515 33,204 Cash and cash equivalents at end of year 34,944 32,307 43,515 33,204 24,204 Source: Company

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 J. Front Retailing: balance sheet (¥m) FY07 FY08 FY09 FY10 FY11 Assets Current assets 193,525 176,833 178,744 158,096 149,240 Cash and cash equivalents 37,562 32,858 44,103 34,087 24,204 Notes and accounts receivable 74,311 62,137 59,598 53,937 54,720 Marketable securities 1,531 1,093 776 1,484 1,769 Inventories 45,154 42,939 35,186 30,382 28,070 Deferred tax assets 10,349 10,993 13,295 13,020 12,457 Other 25,400 27,554 26,456 25,947 28,595 Allowance for doubtful accounts -784 -743 -673 -761 -575 Fixed assets 611,849 599,782 625,790 616,933 618,302 Tangible fixed assets 472,788 467,173 499,571 498,678 495,944 Buildings and other 136,716 130,540 138,524 138,302 141,786 Land 335,025 334,271 358,177 354,742 353,713 Construction in progress 1,047 2,362 2,870 5,634 445 Intangible fixed assets 20,423 20,285 18,951 18,466 17,694 Investments and other 118,636 112,323 107,267 99,787 104,664 Investment securities 48,416 34,031 28,405 26,884 33,983 Long-term loans 1,205 1,089 992 1,505 1,442 Guarantees and deposits 47,362 50,048 51,420 47,760 48,938 Deferred tax assets 10,008 12,263 11,251 7,764 4,687 Other 13,488 17,251 18,074 18,650 18,527 Allowance for doubtful accounts -1,843 -2,360 -2,840 -2,776 -2,913 Total assets 805,375 776,616 804,534 775,029 767,543 Liabilities Current liabilities 278,259 274,228 263,109 246,190 267,676 Notes and accounts payable 89,956 79,685 76,955 76,310 74,616 Bonds - 14,000 5,000 - - Short-term borrowings 47,968 42,556 46,324 43,181 58,940 Commercial paper - - - - 9,998 Unpaid taxes and other 11,314 3,563 2,972 3,296 4,657 Advances received 30,319 29,232 27,610 17,463 17,032 Merchandise coupon 36,844 35,275 33,311 41,727 39,374 Allowances for bonuses and sales promotions 8,478 8,274 7,550 6,853 6,668 Other 53,380 61,643 63,387 57,360 56,391 Long-term liabilities 211,260 186,118 217,918 201,596 157,305 Bonds 19,000 5,000 - - - Long-term borrowings 36,073 33,121 74,612 65,476 37,087 Deferred tax liabilities 103,437 99,564 99,823 97,209 84,565 Retirement benefit reserve 36,349 34,473 32,060 29,474 25,084 Negative goodwill 10,502 8,086 5,761 3,443 1,163 Other 5,899 5,871 5,660 5,994 9,406 Total liabilities 489,520 460,347 481,028 447,786 424,982 Net assets Shareholders' equity 306,753 308,987 315,231 318,523 333,764 Common stock 30,000 30,000 30,000 30,000 30,000 Capital surplus 209,787 209,657 209,636 209,605 209,598 Retained earnings 72,938 75,310 81,585 84,895 100,133 Treasury stock -5,973 -5,980 -5,991 -5,976 -5,967 Accumulated other comprehensive income 1,069 -1,125 -736 -490 -847 Stock options 136 130 124 115 99 Non-controlling interests 7,895 8,276 8,887 9,093 9,544 Net assets 315,854 316,268 323,506 327,242 342,561 Total liabilities and net assets 805,375 776,616 804,534 775,029 767,543 Source: Company

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earnings, partly fuelled by a reduction in Japan’s statutory tax rate. In order to lift the ROE to 10% and sustain that level in FY13, increasing cash returns to shareholders through share buybacks and higher dividend payout ratio (current target is 35% on a consolidated basis) would be indispensable, in our view. Seven & i Holdings Potential risks are: 1) greater-than-expected competition (3382 JP) in the domestic convenience store operations from Rating: Hold →Outperform accelerated store openings by the major players, and 2) Target price: ￥2,450  ￥2,850 (+22.0%) stalling reforms at Ito-Yokado.

Kazunori Tsuda  Valuation (81) 3 5555 7133 Our target price is based on an FY12E PER of 14.7x, [email protected] which is above the current sector average of around 12x. We expect the stock to regain the premium for current Likely to start pricing in earnings sector average (15-20%) it had been afforded previously, as the firm’s earnings-growth potential increases. We growth potential have also factored in the firm’s leading position in the industry, as well as the high liquidity of its stock.  What we recommend Following our job swap, we are upgrading our rating Share price performance from Hold (3) to Outperform (2) and raising our six- (Y) Relative to TOPIX 2,600 140 month target price to ¥2,850 from ¥2,450 (target PERs of 14.7x and 13.5x on our FY12 and FY13 EPS forecasts 2,300 120 before amortising for goodwill). 2,000 100

1,700 80 The stock has traded at roughly between ¥2,000 and 1,400 60 ¥2,500 over the past two years. The discount we afford 5/09 12/09 8/10 3/11 10/11 5/12 or the market has assigned to the stock for being a conglomerate is narrowing, and we think the market Market data (consolidated) will start pricing in the firm’s earnings growth potential, 12-month range (Y) 1,973-2,485 mainly for its convenience store operations. Market cap (¥m) 2,064,755 Shares outstanding (’000; 23/5) 883,506 Foreign ownership (%; 9/11) 33.4  Key share-price catalysts We applaud the firm’s increasingly clear stance on Investment indicators (consolidated) boosting investment in its convenience store 2/12 2/13E 2/14E operations, a revenue-growth area. In Japan, it is PER (x) 15.9 13.2 12.0 adding to its Seven-Eleven Japan network. In North EV/EBITDA (x) 4.5 4.1 3.8 PBR (x) 1.17 1.11 1.05 America, it is improving the quality of its 7-Eleven Inc Dividend yield (%) 2.65 2.78 2.91 stores through renovations and infrastructure ROE (%) 7.5 8.7 9.0 improvements, while also expanding the chain through store openings and M&As. Income summary (consolidated) (¥m) 2/12 2/13E 2/14E We are raising our operating-profit forecasts by ¥10bn Sales 4,786,344 5,065,000 5,270,000 for FY12 and ¥12bn for FY13, mainly on solid Op profit 292,060 316,000 338,000 Rec profit 293,171 316,000 338,000 convenience store operations. Domestic general Net income 129,837 157,000 172,000 merchandiser Ito-Yokado could miss its targets, but not EPS (¥) 147.0 177.7 194.7 enough to hurt group earnings FY12. DPS (¥) 62 65 68 Source: Company, Bloomberg, Daiwa forecasts Further earnings growth enhancement for the overall group is essential for a further stock rally, in our view. We also believe the firm needs to improve its capital efficiency with the help of financial strategies. We forecast an annual increase in retained earnings of more than ¥100bn from FY12, reflecting a boost in - 85 - Trading Places 24 May 2012

 Seven & i Holdings: income summary (¥m; YoY %) Year to Sales Op profit Rec profit Net income EPS (¥) CFPS (¥) DPS (¥) Consol 2/10 5,111,297 -10 226,666 -20 226,950 -19 44,875 -51 49.7 196.0 56.00 2/11 5,119,739 0 243,346 7 242,907 7 111,961 149 126.2 275.5 57.00 2/12 4,786,344 -7 292,060 20 293,171 21 129,837 16 147.0 305.4 62.00 2/13E 5,065,000 6 316,000 8 316,000 8 157,000 21 177.7 357.7 65.00 2/14E 5,270,000 4 338,000 7 338,000 7 172,000 10 194.7 393.9 68.00 2/13CP 5,060,000 6 315,000 8 312,000 6 155,000 19 175.4 - 62.00 Source: Company, Daiwa forecasts Note1: E: Daiwa forecasts, CP: company pojections Note2: Our EPS estimates before goodwill amortization are Y193.6 for FY12, and Y210.5 for FY13. Note3: We estimate goodwill amortization of Y14 billion in FY12-13.

 Seven & i Holdings: cash flow (¥bn) FY07 FY08 FY09 FY10 FY11 Cash flows from operating activities

Pre-tax income 227,441 215,115 143,104 223,291 230,817

Depreciation 143,642 140,529 132,232 132,421 139,994

Impairment losses 20,030 39,372 28,052 21,454 14,460

Goodwill amortization - - 58,000 16,606 12,915

Interest and dividends income -6,431 -7,048 -6,189 -6,049 -5,802

Interest expenses 11,665 10,313 8,505 7,753 6,974

Impact of revised accounting for asset retirement obligations - - - - 22,500

Increase/decrease in accounts receivable, trade -333 9,241 -3,153 -4,523 -12,530

Increase/decrease in inventories 1,463 -8,565 8,450 -4,298 -10,110

Increase/decrease in accounts payable 5,191 -14,455 -5,436 -3,311 32,861

Other 173,723 34,531 72,975 7,087 139,403

Sub total 576,391 419,033 436,540 390,431 571,482

Interest and dividends received 4,474 4,780 4,568 3,205 3,017

Interest paid -11,576 -10,076 -8,612 -7,859 -7,092

Income taxes paid -103,909 -103,730 -110,294 -75,248 -104,765

Net cash provided by/used in operating activities 465,380 310,007 322,202 310,527 462,642

Cash flows from investing activities

Payments for tangible fixed assets -177,357 -147,431 -154,574 -232,270 -209,604

Proceeds from sales of tangible fixed assets 20,213 27,286 45,450 5,335 12,543

Payments for investment securities -454,543 -260,770 -256,054 -280,601 -11,193

Proceeds from sales of investment securities 449,104 260,488 226,742 249,696 224,549

Extension of loans -637 -539 -6,245 -101 -

Collection of loans 2,087 1,070 821 991 -

Payment of guarantee deposits -29,757 -25,622 -30,916 -26,513 -22,365

Return of guarantee deposits paid 30,924 33,290 28,106 40,282 29,849

Receipt of guarantee deposits 5,535 2,813 3,144 5,830 5,333

Return of guarantee deposits received -3,449 -3,757 -5,012 -4,747 -5,276

Other -79,304 -26,396 33,380 -69,983 -366,641

Net cash provided by/used in investing activities -237,184 -139,568 -115,158 -312,081 -342,805

Cash flows from financing activities

Increase/decrease in short-term borrowings -39,231 38,239 -48,600 -38,370 38,324

Proceeds from long-term borrowings 65,869 27,600 101,000 60,040 113,480

Repayments of long-term borrowings -67,354 -116,570 -94,700 -67,638 -134,666

Proceeds from issuance of bonds - 99,616 - 109,624 -

Redemption of bonds -30,390 -1,217 -50,592 -20,385 -100

Purchases of treasury stock - -158,122 -18 -47,290 -10

Redemption of treasury stock 8 36 - - -

Dividends paid -50,498 -51,046 -51,476 -50,022 -51,258

Net cash provided by/used in financing activities -130,136 -169,755 -156,708 -56,258 -40,561

Effect of exchange rates on cash and cash equivalents -422 -4,969 4,061 -2,760 -2,314 Net Increase/decrease in cash and cash equivalents 97,636 -4,286 54,397 -60,573 76,960 Cash and cash equivalents at beginning of year 570,133 667,770 663,483 717,320 656,747 Cash and cash equivalents at end of year 667,770 663,483 717,320 656,747 733,707 Source: Company

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 Seven & i Holdings: balance sheet (¥m) FY07 FY08 FY09 FY10 FY11 Assets Current assets 1,354,417 1,397,102 1,460,186 1,406,594 1,516,584 Cash and cash equivalents 649,167 650,949 691,633 654,833 711,629 Accounts receivable 128,852 116,902 119,627 122,411 270,953 Operating loans 75,741 78,042 68,243 60,269 68,691 Marketable securities 94,524 94,824 55,025 26,534 43,025 Inventories 169,026 169,534 161,394 161,110 152,204 Prepaid expenses 33,298 28,584 31,606 31,109 29,870 Deferred tax assets 35,730 28,656 28,360 30,875 38,905 Other 171,066 233,932 308,719 323,103 206,065 Allowances for doubtful accounts -2,987 -4,321 -4,421 -3,650 -4,758 Fixed assets 2,531,954 2,329,776 2,213,359 2,325,459 2,372,364 Tangible fixed assets 1,337,142 1,222,427 1,195,709 1,247,823 1,320,174 Buildings and other 722,704 657,258 618,409 644,244 699,159 Land 561,204 525,022 520,320 581,185 590,524 Lease assets - - 4,485 12,754 13,925 Construction in progress 53,234 40,147 52,495 9,640 16,566 Intangible fixed assets 465,847 421,647 297,531 324,655 333,156 Investments and other 728,964 685,701 720,118 752,979 719,034 Investment securities 160,094 140,149 168,850 227,371 181,863 Long-term loans 15,177 14,270 19,657 18,675 18,279 Long-term leasehold deposits 460,951 442,416 438,028 418,585 412,098 Deferred tax assets 28,114 22,966 26,134 20,717 40,147 Other 73,203 76,191 74,352 74,081 72,807 Allowances for doubtful accounts -8,575 -10,291 -6,903 -6,450 -6,160 Deferred assets 308 182 58 58 408 Total assets 3,886,680 3,727,060 3,673,605 3,732,111 3,889,358 Liabilities Current liabilities 1,177,493 1,254,927 1,263,370 1,348,728 1,385,728 Accounts payable 321,402 297,783 292,628 284,795 316,072 Short-term borrowings 270,280 294,452 230,355 235,517 228,476 Straight and convertible bonds 16,217 50,592 20,385 36,100 10,000 Unpaid taxes and other 44,773 53,311 42,255 51,007 58,295 Accrued expenses 84,605 78,622 76,692 75,300 71,700 Deposits 87,205 120,038 173,937 138,527 116,569 Bonus reserve 16,435 15,997 14,646 13,986 15,096 Deposits (banking businesses) 142,205 165,712 185,745 275,696 288,228 Other 194,371 178,420 226,727 237,800 281,292 Long-term liabilities 651,147 611,459 616,293 606,871 642,675 Straight and convertible bonds 131,077 180,448 190,068 263,973 253,978 Long-term borrowings 321,336 249,685 244,470 177,225 198,167 Commercial paper 11,777 18,688 16,208 8,177 - Deferred tax liabilities 62,017 44,094 38,343 35,955 34,550 Retirement benefit reserves 4,347 3,510 3,493 3,356 5,987 Deposits 61,534 60,276 55,827 56,048 55,380 Asset retirement liabilities - - - - 43,740 Other 59,059 54,758 67,884 62,137 50,873 Total liabilities 1,828,641 1,866,387 1,879,664 1,955,599 2,028,403 Net assets Shareholders' equity 1,979,848 1,862,962 1,789,065 1,803,783 1,882,287 Common stock 50,000 50,000 50,000 50,000 50,000 Capital surplus 731,621 576,074 576,072 526,899 526,886 Retained earnings 1,205,042 1,246,165 1,172,263 1,234,204 1,312,613 Treasury stock -6,815 -9,277 -9,270 -7,320 -7,212 Valuation and translation adjustments 5,170 -77,773 -67,097 -101,268 -116,303 Net unrealized gains on available-for-sale securities 3,885 247 3,227 3,226 3,360 Forex translation adjustments 1,961 -77,398 -69,776 -104,167 -119,661 Stock options - 391 721 981 1,222 Non-controlling interests 73,020 75,092 71,251 73,016 93,748 Net assets 2,058,038 1,860,672 1,793,940 1,776,512 1,860,954 Total liabilities and net assets 3,886,680 3,727,060 3,673,605 3,732,111 3,889,358 Source: Company

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We see considerable upside to the shares if concerns about the firm exercising the call option subside. The stock is likely to garner buying interest for the firm’s earnings growth potential, backed by domestic structural reforms, market share expansion, and its foray into Asia. Aeon (8267 JP) Rating: Outperform Potential risks are: 1) a deterioration in return on Target price: ￥1,400  ￥1,150 (+19.8%) investments, and 2) inconsistency in the capital policy for group companies (reorganisation of subsidiaries, Kazunori Tsuda listing of subsidiaries). (81) 3 5555 7133 [email protected]  Valuation Our six-month target price of ¥1,150 is based on our Earnings likely to continue FY12 diluted EPS estimate and the sector average PER of 12x. The firm’s advantageous position in the expanding industry, the high stock liquidity, and its earnings growth potential suggest the stock deserves to trade at  What we recommend a premium; we have applied the sector average Following on from our job swap, we reaffirm our multiple due to dilution concerns. Outperform (2) rating. However, we are lowering our six-month target price from ¥1,400 to ¥1,150, Share price performance reflecting a slight reduction to our earnings forecasts. (Y) Relative to TOPIX In addition, concerns about dilution from callable 1,150 160 convertibles are likely to continue to weigh on the 1,020 140 shares. 890 120

Aeon’s large shopping centre development business, its 760 100 630 80 backbone, boasts a competitive edge in the Japan 5/09 12/09 8/10 3/11 10/11 5/12 market, both in terms of quality and quantity. We expect the business to generate a sufficient cash flow to Market data (consolidated) help the firm expand its operations in Japan and 12-month range (Y) 888-1,106 overseas. Its unique business model (due to its Market cap (¥m) 738,605 development business) should enable the firm to Shares outstanding (’000; 23/5) 769,381 survive the tough competition in China and ASEAN Foreign ownership (%; 9/11) 15.8 countries that we see for this year and beyond. Investment indicators (consolidated)  Key share-price catalysts 2/12 2/13E 2/14E Having just been to Korea, we see the potential for PER (x) 11.0 8.7 7.4 EV/EBITDA (x) 5.6 5.0 4.5 industry realignment in the general merchandiser and PBR (x) 0.79 0.74 0.68 supermarket sectors in future. Aeon is likely to take Dividend yield (%) 2.40 2.50 2.71 centre stage and expand its market share. While the ROE (%) 7.3 8.8 9.6 company is experiencing a slowdown in SSS growth momentum for its general merchandising segment Income summary (consolidated) currently, its sales are solid compared with its main (¥m) 2/12 2/13E 2/14E Sales 5,206,132 5,680,000 5,920,000 peers. Op profit 195,690 222,000 252,000 Rec profit 212,260 240,000 263,500 We are slightly lowering our earnings forecasts over Net income 66,750 85,000 100,000 EPS (¥) 87.2 110.5 130.0 FY12-13, but maintain our basic stance on the outlook. DPS (¥) 23 24 26 The firm’s FY12 projections appear conservative Source: Company, Bloomberg, Daiwa forecasts (especially for net income) to us and could be upgraded with each quarterly earnings release. We expect operating profit to continue expanding at a double- digit pace in both FY12 and FY13.

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 Aeon: income summary (¥m; YoY %) Year to Sales Op profit Rec profit Net income EPS (¥) CFPS (¥) DPS (¥) Consol 2/10 5,054,394 -3 130,193 5 130,198 3 31,123 黒転 40.7 226.1 20.00 2/11 5,096,569 1 172,360 32 182,080 40 59,688 92 78.0 253.2 21.00 2/12 5,206,132 2 195,690 14 212,260 17 66,750 12 87.2 264.7 23.00 2/13E 5,680,000 9 222,000 13 240,000 13 85,000 27 110.5 292.4 24.00 2/14E 5,920,000 4 252,000 14 263,500 10 100,000 18 130.0 324.9 26.00 210,000 7 220,000 4 68,000 2 88.4 2/13CP 5,650,000 9 - 24.00 -220,000 -12 -230,000 -8 -73,000 -9 -94.9 Source: Company, Daiwa forecasts Note1: E: Daiwa forecasts, CP: company pojections Note2: Before net goodwill amortization, our EPS forecasts are Y111.3 for FY12 and Y141.2 for FY13. Note3: Net goodwill amortization estimated at Y660 million in FY12, and Y8.64 billion in FY13. Note4: DPS figures for FY09-10 include Y3 commemorative dividend.

 Aeon: cash flow (¥bn) FY07 FY08 FY09 FY10 FY11 Cash flows from operating activities

Pre-tax income 72,611 124,575 106,240 155,166 138,230

Depreciation 140,313 134,457 141,905 134,030 135,777

Impairment losses 55,584 46,339 26,723 33,284 28,177

Goodwill amortization 8,192 8,346 7,563 7,019 7,808

Negative goodwill amortization -11,406 -11,226 -11,571 -11,209 -11,100

Increase/decrease in allowance for doubtful accounts 37,481 40,257 32,358 30,147 22,290

Interest and dividends income -4,612 -5,461 -3,901 -4,537 -4,354

Interest expenses 11,751 12,774 12,366 10,858 10,334

Impact of revised accounting for asset retirement obligations - - - - 17,773

Increase/decrease in accounts receivable, trade 5,384 -44,140 -19,139 -118,892 -23,773

Increase/decrease in inventories -5,207 -17,314 12,378 21,750 -20,393

Increase/decrease in accounts payable 25,062 42,583 48,396 924 -16,217

Other -101,071 -131,140 66,704 65,082 7,848

Sub total 234,082 200,050 420,022 323,622 292,400

Interest and dividends received 3,969 4,942 3,412 4,158 3,934

Interest paid -11,563 -12,425 -11,576 -10,773 -10,109

Income taxes paid -68,260 -79,766 -50,761 -55,875 -69,166

Net cash provided by/used in operating activities 234,082 200,050 361,096 261,132 203,382

Cash flows from investing activities

Payments for tangible fixed assets -349,786 -270,505 -307,390 -177,006 -311,904

Proceeds from sales of tangible fixed assets 7,021 50,759 6,784 29,803 2,974

Payments for investment securities -33,590 -97,930 -47,645 -12,804 -619

Proceeds from sales of investment securities 31,301 11,028 11,497 3,309 82

Extension of loans - - - - -

Collection of loans - - - 45,058 544

Payment of guarantee deposits -17,358 -25,716 -13,820 -7,116 -14,476

Return of guarantee deposits paid 20,520 28,502 24,989 19,863 33,649

Receipt of guarantee deposits 32,021 25,184 13,486 18,199 14,275

Return of guarantee deposits received -20,870 -17,066 -22,980 -22,520 -15,369

Other 4,983 4,461 10,506 -2,303 -37,021

Net cash provided by/used in investing activities -325,758 -291,283 -324,573 -105,517 -327,865

Cash flows from financing activities

Increase/decrease in short-term borrowings 162,288 -2,464 -168,416 -38,387 -23,343

Proceeds from long-term borrowings 212,018 118,343 236,347 152,972 279,644

Repayments of long-term borrowings -175,423 -147,408 -160,523 -189,406 -270,819

Proceeds from issuance of bonds 21,140 25,134 57,550 7,343 42,883

Redemption of bonds -25,092 -45,950 -27,878 -27,585 -15,214

Purchases of treasury stock - -60,687 - - -

Redemption of treasury stock - - - - -

Dividends paid -13,008 -11,994 -13,008 -15,304 -16,069

Net cash provided by/used in financing activities 165,000 -141,266 11,179 -121,847 -13,061

Effect of exchange rates on cash and cash equivalents -8,443 9,898 1,847 -7,468 -2,997 Net Increase/decrease in cash and cash equivalents 64,881 -222,601 49,550 26,299 -140,542 Cash and cash equivalents at beginning of year 159,744 382,851 224,625 280,521 306,820 Cash and cash equivalents at end of year 224,625 159,744 280,521 306,820 166,277 Source: Company

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 Aeon: balance sheet (¥m) FY07 FY08 FY09 FY10 FY11 Assets Current assets 1,509,930 1,513,935 1,533,085 1,509,462 1,372,530 Cash and cash equivalents 175,274 240,447 294,427 320,212 184,324 Notes and accounts receivable 357,118 314,134 323,779 416,548 421,929 Marketable securities 7,282 3,215 3,372 4,509 2,198 Inventories 346,682 342,904 333,624 308,951 340,971 Deferred tax assets 37,432 33,087 41,367 40,728 47,784 Operating loans 503,814 483,527 423,324 293,427 255,704 Other 131,529 148,979 167,318 178,329 163,301 Allowance for doubtful accounts -49,201 -52,361 -54,129 -53,245 -43,681 Fixed assets 2,080,810 2,227,278 2,252,202 2,265,166 2,676,406 Tangible fixed assets 1,258,705 1,422,764 1,432,648 1,407,068 1,749,903 Buildings and other 908,884 1,072,085 1,056,698 1,021,907 1,180,398 Land 316,649 330,662 347,211 354,029 531,954 Lease assets (net) - - 3,140 6,336 16,007 Construction in progress 33,172 20,017 25,599 24,796 21,544 Intangible fixed assets 139,049 126,795 119,816 117,365 144,987 Goodwill 82,651 72,425 69,479 74,753 101,720 Investments and other 683,056 677,718 699,737 740,731 781,515 Investment securities 210,633 190,314 242,111 274,507 296,724 Deferred tax assets 52,006 70,543 61,519 63,981 73,774 Guarantee deposits 355,156 338,391 321,571 324,916 322,395 Other 83,450 96,446 91,143 92,331 104,049 Allowance for doubtful accounts -18,189 -17,976 -16,607 -15,004 -15,427 Deferred assets 665 233 - - - Total assets 3,591,406 3,741,447 3,785,288 3,774,628 4,048,937 Liabilities Current liabilities 1,333,760 1,528,089 1,388,050 1,418,913 1,539,334 Notes and accounts payable 569,889 583,033 637,470 640,114 644,059 Short-term borrowings 262,551 310,001 272,383 269,093 320,162 Corporate bonds 25,410 27,120 27,518 15,311 100,978 Commercial paper 3,000 81,000 7,000 5,410 9,921 Lease assets - - 571 1,468 2,460 Unpaid taxes 38,006 34,564 33,233 44,838 35,757 Bonus reserve 17,216 16,933 15,183 17,991 19,138 Reserve for losses from store closures 7,791 4,302 3,770 8,397 1,810 Point system reserve 5,272 7,194 7,981 12,070 16,052 Restructured debt due within one year 1,904 - - - - Bills issued to finance equipment purchases 102,251 149,389 27,890 30,861 46,045 Other 300,470 314,553 355,051 373,354 342,946 Long-term liabilities 1,090,169 1,107,646 1,252,802 1,136,478 1,227,537 Corporate bonds 202,186 192,169 223,182 215,209 204,319 Bonds with warrants - - 99,998 99,976 49,988 Long-term borrowings 548,118 584,321 616,213 547,624 631,196 Retirement benefit reserve - - 3,869 7,759 16,159 Deferred tax liabilities 6,983 8,714 13,140 8,390 8,877 Restructured debt and othe 48,217 31,607 14,475 9,160 9,951 Allowance for losses 19,914 23,961 34,329 21,671 14,690 Restructured debt and other 9,845 - - - - Restructured debt and other - - - - 41,975 Guarantee deposits received 221,468 231,250 220,266 216,844 232,254 Other 33,438 35,619 27,325 9,841 18,128 Total liabilities 2,423,929 2,635,735 2,640,853 2,555,391 2,766,871 Net assets Shareholders' equity 855,906 837,495 852,456 899,208 953,701 Common stock 199,054 199,054 199,054 199,054 199,054 Capital surplus 264,968 264,967 264,963 264,963 264,963 Retained earnings 453,399 434,991 449,950 496,648 543,771 Treasury stock -61,515 -61,517 -61,512 -61,458 -54,087 Valuation and translation adjustments 13,839 -16,417 -11,922 -11,836 -17,964 Stock options 427 787 920 1,118 1,313 Non-controlling interests 297,302 283,846 302,980 330,746 345,015 Total net assets 1,167,477 1,105,712 1,144,434 1,219,236 1,282,066 Total liabilities and net assets 3,591,406 3,741,447 3,785,288 3,774,628 4,048,937 Source: Company

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FamilyMart are likely to struggle in FY12E, they should improve in FY13E (see the report from our Taiwan Consumer/Retail analyst, Yoshihiko Kawashima, Margins set to expand despite short-term woes).

In the short term, we think the defensive characteristics of FamilyMart (8028 JP) the convenience-store business model will affect the Rating: Outperform stock’s share price. In the medium to long term, investors Target price: ￥3,600  ￥3,800 (+9.4%) are likely to focus on the role FamilyMart plays when the domestic market undergoes further realignment and the Kazunori Tsuda firm’s earnings growth potential in Asia. (81) 3 5555 7133 [email protected] Risks include: 1) domestic competition intensifying more than expected as a result of accelerated store openings by Boasts clear earnings growth the major players, and 2) the company lagging rivals in attracting users of service offerings at domestic stores. strategy and brisk earnings  Valuation  What we recommend To arrive at our six-month target price, we assign a We maintain our Outperform (2) rating. In light of the target FY12 PER of 15.7x. We afford a premium to the convenience store operations’ profit growth potential in sector average of around 12x in view of the stock’s past the Pan-Asia region and following our job swap, we are three-year trading range of 15x to below 20x, as well as raising our six-month target price to ¥3,800 from the company’s clear earnings growth strategy, which is ¥3,600, representing target PERs of 15.7x and 13.2x on already bearing fruit. our FY12 and FY13 EPS forecasts, respectively, before goodwill amortisation. Share price performance

(Y) Relative to TOPIX FamilyMart’s clear earnings growth strategy is bearing 3,800 170 fruit both at home and elsewhere in Asia. We believe part 3,400 150 of the reason for the company’s success is its regional approach to overseas expansion, achieved by alliances 3,000 130 with local firms. 2,600 110

2,200 90 5/09 12/09 8/10 3/11 10/11 5/12 We like the firm from a medium- to long-term perspective for: 1) its enhanced competitive edge in the mainstay domestic market, and 2) its expansion in ex- Market data (consolidated) Japan Asia (revenue-growth area). We expect the 12-month range (Y) 2,719-3,660 company to meet its FY15 net income target as laid out in Market cap (¥m) 329,885 its medium-term business plan of ¥30bn (of which 20% Shares outstanding (’000; 23/5) 94,931 Foreign ownership (%; 9/11) 30.0 should be generated overseas).

Investment indicators (consolidated)  Key share-price catalysts 2/12 2/13E 2/14E SSS tend to have an influence on the share price. In our PER (x) 19.9 14.8 12.4 view, SSS growth is likely to slow from FY12 as a boost EV/EBITDA (x) 3.8 3.6 3.4 from cigarette price hikes plays out, but sales should PBR (x) 1.51 1.43 1.33 Dividend yield (%) 2.36 2.65 2.94 remain solid in FY12-13E, especially for mainstay ready- ROE (%) 7.8 9.9 11.2 made foods. Changing the acquired ‘am/pm’ stores to the ‘FamilyMart’ format should also support sales going Income summary (consolidated) forward. (¥m) 2/12 2/13E 2/14E Sales 329,218 335,000 349,000 We are leaving our FY12-13 operating-profit forecasts Op profit 42,586 45,800 49,400 unchanged, but are slightly raising our recurring profit Rec profit 44,810 48,800 52,600 Net income 16,584 22,300 26,700 figure for that period to factor in higher equity-method EPS (¥) 174.7 234.9 281.3 income. Earnings should remain solid in FY12-13E. We DPS (¥) 82 92 102 expect contributions from the company’s subsidiaries to Source: Company, Bloomberg, Daiwa forecasts increase overall in FY12. Although earnings at Taiwan

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 FamilyMart’s: income summary (¥m; YoY %) Year to Sales Op profit Rec profit Net income EPS (¥) CFPS (¥) DPS (¥) Consol 2/10 278,175 -3 33,530 -8 35,760 -9 15,102 -8 158.5 266.9 70.00 2/11 319,889 15 38,223 14 39,907 12 18,023 19 189.7 322.4 72.00 2/12 329,218 3 42,586 11 44,810 12 16,584 -8 174.7 345.2 82.00 2/13E 335,000 2 45,800 8 48,800 9 22,300 34 234.9 430.8 92.00 2/14E 349,000 4 49,400 8 52,600 8 26,700 20 281.3 502.5 102.00 2/13CP 353,700 7 45,000 6 47,800 7 21,400 29 225.4 - 92.00 Source: Company, Daiwa forecasts Note1: E: Daiwa forecasts, CP: company pojections Note2: Our EPS estimates before goodwill amortization are Y242.3 for FY12, and Y288.6 for FY13. Note3: We estimate goodwill amortization of Y700 million in FY12-13.

 FamilyMart’s: cash flow (¥m) FY07 FY08 FY09 FY10 FY11 Cash flows from operating activities

Pre-tax income 28,832 29,929 28,278 34,375 31,283

Depreciation 9,856 9,668 10,338 12,582 16,190

Impairment losses 1,966 2,078 2,493 2,164 2,590

Goodwill amortization 516 726 458 - -

Increase/decrease in allowance for doubtful accounts 18 -120 - -1,117 -338

Interest and dividends income -1,870 -2,124 -1,815 -1,678 -1,567

Interest expenses 242 135 225 516 716

Increase/decrease in inventories 323 -844 837 -844 -596

Increase/decrease in accounts payable - - -39,031 -8,938 -4,453

Other 16,966 46,106 2,930 23,484 27,859

Sub total 56,849 85,554 4,713 60,544 71,684

Interest and dividends received 1,983 2,419 2,013 1,986 1,882

Interest paid -246 -133 -227 -516 -714

Income taxes paid -9,211 -12,813 -13,074 -11,676 -1,888

Net cash provided by/used in operating activities 49,375 75,027 -6,574 50,337 72,900

Cash flows from investing activities

Payments for tangible fixed assets -11,158 -14,219 -15,247 -16,942 -18,217

Proceeds from sales of tangible fixed assets -116,776 101,284 607 484 613

Payments for investment securities -123,438 -101,627 -22,394 -5,955 -16,982

Proceeds from sales of investment securities 116,776 101,284 17,606 3,588 14,439

Extension of loans 0 -1,698 -2,239 -876 -38

Collection of loans 3 - 3,630 2,104 10

Payment of guarantee deposits -15,222 -15,381 -15,543 -10,958 -13,373

Return of guarantee deposits paid 2,978 2,604 3,143 3,034 3,044

Receipt of guarantee deposits 2,978 2,604 -1,094 -1,427 -1,593

Return of guarantee deposits received -1,596 -1,109 1,190 1,447 1,509

Other 120,863 -101,958 -5,811 -297 9,842

Net cash provided by/used in investing activities -24,592 -28,216 -36,152 -25,798 -20,746

Cash flows from financing activities

Increase/decrease in short-term borrowings -370 -62 - -165 -153

Purchases of treasury stock -16 -27 -7 -1,102 -4

Redemption of treasury stock 8,968 1 1 0 0

Dividends paid -4,793 -6,290 -6,574 -6,755 -7,214

Net cash provided by/used in financing activities 3,956 -7,030 -8,341 -13,976 -14,188

Effect of exchange rates on cash and cash equivalents 555 -2,737 342 -237 -996 Net Increase/decrease in cash and cash equivalents 29,293 37,043 -50,726 -13,976 -14,188 Cash and cash equivalents at beginning of year 69,550 98,844 135,887 85,161 95,486 Cash and cash equivalents at end of year 98,844 135,887 85,161 95,486 133,157 Source: Company, Daiwa forecasts

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 E-Mart: share price and Daiwa recommendation trend Date 23/03/2012 13/12/2011 15/09/2011 11/08/2011 18/07/2011 Target price 250,000 300,000 330,000 290,000 280,000 Rating 3 3 3 3 3

350,000 330,000 300,000 290,000 300,000 280,000 250,000 250,000

200,000

150,000

100,000

50,000

0 Jul-10 Jul-11 Apr-10 Apr-11 Apr-12 Oct-10 Oct-11 Jun-10 Jan-11 Jun-11 Jan-12 Mar-11 Mar-12 Feb-11 Feb-12 Aug-10 Sep-10 Nov-10 Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 May-10 May-11 May-12 Target price (W) Closing price (W)

Source: Daiwa

 Lotte Shopping: share price and Daiwa recommendation trend Date 2012-05-24 2012-02-21 2011-12-19 2011-11-16 2011-05-27 2011-03-31 2011-01-27 Target price 440,000 480,000 480,000 560,000 590,000 540,000 450,000 Rating 1 1 1 1 1 1 3

Date 2010-07-28 2009-11-30 2009-10-23 2009-08-19 Target price 378,000 350,000 340,000 320,000 Rating 3 3 3 3 700,000 590,000 560,000 600,000 540,000 480,000 480,000 500,000 450,000 440,000 378,000 400,000 350,000

300,000

200,000

100,000

0 Jul-10 Jul-11 Apr-10 Apr-11 Apr-12 Oct-10 Oct-11 Jan-10 Jun-10 Jan-11 Jun-11 Jan-12 Feb-10 Mar-10 Feb-11 Mar-11 Feb-12 Mar-12 Nov-09 Dec-09 Aug-10 Sep-10 Nov-10 Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 May-10 May-11 May-12

Target price (W) Closing price (W)

Source: Daiwa

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 Hyundai Department Store: share price and Daiwa recommendation trend Date 26/04/12 25/07/11 28/04/11 31/03/11 20/01/11 30/11/09 Target price 210,000 220,000 190,000 170,000 110,000 92,000 Rating 1 1 1 1 4 4 250,000 220,000 210,000 190,000 200,000 170,000

150,000

100,000 110,000 92,000 50,000

0 Jul-11 Jul-10 Oct-11 Apr-12 Oct-10 Apr-11 Oct-09 Apr-10 Jun-11 Jan-12 Jun-10 Jan-11 Jan-10 Mar-12 Mar-11 Mar-10 Feb-12 Feb-11 Feb-10 Aug-11 Sep-11 Nov-11 Dec-11 Aug-10 Sep-10 Nov-10 Dec-10 Nov-09 Dec-09 May-12 May-11 May-10 Target price (W) Closing price (W) Source: Daiwa

 GS Retail: share price and Daiwa recommendation trend Date 24/05/2012 Target price 27,000 Rating 2 30,000 27,000

25,000

20,000

15,000

10,000

5,000

0 Jul-10 Jul-11 Apr-10 Apr-11 Apr-12 Oct-10 Oct-11 Jun-10 Jan-11 Jun-11 Jan-12 Feb-11 Mar-11 Feb-12 Mar-12 Aug-10 Sep-10 Nov-10 Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 May-10 May-11 May-12 Target price (W) Closing price (W) Source: Daiwa

 Shinsegae: share price and Daiwa recommendation trend Date 13/12/11 15/09/11 07/06/11 31/03/11 21/03/11 25/08/10 11/01/10 Target price 270,000 360,000 370,000 273,000 287,000 345,000 320,000 Rating 3 3 3 3 1 1 1 700,000

600,000

500,000

370,000 360,000 400,000 320,000 345,000 287,000 273,000 270,000 300,000

200,000

100,000

0 Jul-11 Jul-10 Apr-12 Apr-11 Apr-10 Oct-11 Oct-10 Jun-11 Jan-12 Jun-10 Jan-11 Jan-10 Feb-12 Mar-12 Feb-11 Mar-11 Feb-10 Mar-10 Aug-11 Sep-11 Nov-11 Dec-11 Aug-10 Sep-10 Nov-10 Dec-10 Dec-09 May-12 May-11 May-10 Target price (W) Closing price (W) Source: Daiwa - 94 - Trading Places 24 May 2012

Daiwa’s Asia Pacific Research Directory Hong Kong Regional Research Head Nagahisa MIYABE (852) 2848 4971 [email protected] Regional Research Co-head Christopher LOBELLO (852) 2848 4916 [email protected] Head of Product Management John HETHERINGTON (852) 2773 8787 [email protected] Head of Thematic Research; Product Management Tathagata Guha ROY (852) 2773 8731 [email protected] Head of China Research; Chief Economist (Regional) Mingchun SUN (852) 2773 8751 [email protected] Deputy Head of Hong Kong and China Research; Regional Head of Clean Energy and Dave DAI (852) 2848 4068 [email protected] Utilities; Utilities; Power Equipment; Renewables (Hong Kong, China) Deputy Head of Regional Economics; Macro Economics (Regional) Kevin LAI (852) 2848 4926 [email protected] Head of Hong Kong Research; Regional Property Coordinator; Jonas KAN (852) 2848 4439 [email protected] Co-head of Hong Kong and China Property; Property Developers (Hong Kong) Automobiles and Components (China) Jeff CHUNG (852) 2773 8783 [email protected] Head of Greater China FIG; Banking (Hong Kong, China) Grace WU (852) 2532 4383 [email protected] Banking/Diversified Financials (Taiwan) Jerry YANG (852) 2773 8842 [email protected] Banking (Hong Kong, China) Queenie POON (852) 2532 4381 [email protected] Capital Goods –Electronics Equipments and Machinery (Hong Kong, China) Joseph HO (852) 2848 4443 [email protected] Consumer/Retail (Hong Kong, China) Bing Zhou (852) 2773 8782 [email protected] Consumer, Pharmaceuticals and Healthcare (China) Hongxia ZHU (852) 2848 4460 [email protected] Internet (Hong Kong, China) Alicia HU (852) 2532 4180 [email protected] Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Eric CHEN (852) 2773 8702 [email protected] Regional Head of Materials; Materials/Energy (Regional) Alexander LATZER (852) 2848 4463 [email protected] Materials (China) Felix LAM (852) 2532 4341 [email protected] Regional Head of Small/Medium Cap; Small/Medium Cap (Regional) Mark CHANG (852) 2773 8729 [email protected] Small/Medium Cap (Regional) John CHOI (852) 2773 8730 [email protected] Head of Solar Pranab Kumar SARMAH (852) 2848 4441 [email protected] Transportation – Aviation, Land and Transportation Infrastructure (Regional) Kelvin LAU (852) 2848 4467 [email protected] Head of Custom Products Group; Custom Products Group Justin LAU (852) 2773 8741 [email protected] Custom Products Group Philip LO (852) 2773 8714 [email protected] Custom Products Group Jibo MA (852) 2848 4489 [email protected]

South Korea Head of Korea Research; Strategy; Banking/Finance Chang H LEE (82) 2 787 9177 [email protected] Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel Sung Yop CHUNG (82) 2 787 9157 [email protected] Banking/Finance Anderson CHA (82) 2 787 9185 [email protected] Capital Goods (Construction and Machinery) Mike OH (82) 2 787 9179 [email protected] Consumer/Retail Sang Hee PARK (82) 2 787 9165 [email protected] IT/Electronics (Tech Hardware and Memory Chips) Jae H LEE (82) 2 787 9173 [email protected] Materials (Chemicals); Oil and Gas Jihye CHOI (82) 2 787 9121 [email protected] Telecommunications; Software (Internet/Online Games) Thomas Y KWON (82) 2 787 9181 [email protected] Custom Products Group Shannen PARK (82) 2 787 9184 [email protected]

Taiwan Consumer/Retail Yoshihiko KAWASHIMA (886) 2 8758 6247 [email protected] IT/Technology Hardware (Communications Equipment); Software; Small/Medium Caps Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (Handsets and Components) Alex CHANG (886) 2 8758 6248 [email protected] IT/Technology Hardware (PC Hardware - Panels) Chris LIN (886) 2 8758 6251 [email protected]

India Head of India Research; Regional Head of Pharmaceuticals and Healthcare Kartik A. MEHTA (91) 22 6622 1012 [email protected] Deputy Head of Research; Strategy; Banking/Finance Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Capital Goods/Utilities Saurabh MEHTA (91) 22 6622 1009 [email protected] FMCG; Consumer Percy PANTHAKI (91) 22 6622 1063 [email protected]

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Singapore Head of Singapore Research Tony DARWELL (65) 6321 3050 [email protected] Quantitative Research Josh CHERIAN (65) 6499 6549 [email protected] Quantitative Research Suzanne HO (65) 6499 6545 [email protected] Banking (ASEAN) Srikanth VADLAMANI (65) 6499 6570 [email protected] Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore) Adrian LOH (65) 6499 6548 [email protected] Property and REITs David LUM (65) 6329 2102 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India) Ramakrishna MARUVADA (65) 6499 6543 [email protected] Thematic Research Amy CHEW (65) 6321 3085 [email protected]

Philippines Head of Philippines Research; Strategy; Capital Goods; Materials Rommel RODRIGO (63) 2 813 7344 ext 302 [email protected] Economy; Consumer; Power and Utilities; Transportation – Aviation Alvin AROGO (63) 2 813 7344 ext 301 [email protected] Property; Banking; Transportation – Port Danielo PICACHE (63) 2 813 7344 ext 293 [email protected]

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Daiwa’s Office 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 Securities Trust and Banking (Europe) PLC (Dublin Branch) Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

DAIWA CAPITAL MARKETS LIMITED HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, (03) 5555 3111 (03) 5555 0661 Tokyo, 100-6753 Daiwa Capital Markets America Inc 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 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Trianon Building, Mainzer Landstrasse 16, 60325 Frankfurt am Main, (49) 69 717 080 (49) 69 723 340 Federal Republic of Germany Daiwa Capital Markets Europe Limited, Paris Branch 127, Avenue des Champs-Elysées, 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, Milan Branch Via Senato 14/16, 20121 Milan, Italy (39) 02 763 271 (39) 02 763 27250 Daiwa Capital Markets Europe Limited, 25/9, build. 1, Per. Sivtsev Vrazhek, Moscow 119002, Russian Federation (7) 495 617 1960 (7) 495 244 1977 Moscow Representative Office 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 Europe Limited, Dubai Branch The Gate village Building 1, 1st floor, Unit-6, DIFC, P.O.Box-506657, (971) 47 090 401 (971) 43 230 332 Dubai, UAE. 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 6 Shenton Way #26-08, DBS Building Tower Two, Singapore 068809, (65) 6220 3666 (65) 6223 6198 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. One IFC, 10 Gukjegeumyung-Ro, Yeouido-dong, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, 150-876, Korea Daiwa Securities Capital Markets Co Ltd, Room 3503/3504, SK Tower, (86) 10 6500 6688 (86) 10 6500 3594 Beijing Representative Office No.6 Jia Jianguomen Wai Avenue, Chaoyang District, Beijing 100022, People’s Republic of China Daiwa SSC Securities Co Ltd 45/F, Hang Seng Tower, 1000 Lujiazui Ring Road, (86) 21 3858 2000 (86) 21 3858 2111 Pudong, Shanghai 200120, People’s Republic of China Daiwa Securities Capital Markets Co. Ltd, Level 8 Zuellig House, 1 Sliom Road, (66) 2 231 8381 (66) 2 231 8121 Bangkok Representative Office Bangkok 10500, 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 Capital Markets Co. Ltd, Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Hanoi Representative Office 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

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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 Capital Markets Co. Ltd., 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 derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.

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: SBI Holdings Inc. (6488 HK); Shunfeng Photovoltaic International Ltd. (1165 HK); Rexlot Holdings Limited (555 HK); China Outfitters Holdings Limited (1146 HK); Beijing Jingneng Clean Energy Co. Limited (579 HK); Infraware Inc. (041020 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 • 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 (“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. 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. 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. DHK market making DHK may from time to time make a market in securities covered by this research.

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 : Kazunori Tsuda / Sang Hee 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 six months. "2": the security is expected to outperform the KOSPI by 5-15% over the next six months. "3": the security is expected to perform within 5% of the KOSPI (better or worse) over the next six months. "4": the security is expected to underperform the KOSPI by 5-15% over the next six months. "5": the security could underperform the KOSPI by more than 15% over the next six months.

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

Additional information may be available upon request.

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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 Stockbroking Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. 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. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

India This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to, or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited.

Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. 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 Link at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively.

United Kingdom This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority (“FSA”) and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA 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-and-regulatory. Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000).

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.

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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 analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] 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.

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

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, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association