Materials / Korea 24 February 2012

Initiation: buoyed by China's Korea Petrochemical Sector recovering demand

• Monetary easing in China and limited capacity additions should underpin the buoyant petrochemical cycle up to 2014 • EG (ethylene glycol) and BD (butadiene) spreads likely to remain

the strongest throughout 2012 • Top pick Honam; should benefit the most from robust cycle How do we justify our view?

polyester market, while BD should Valuation enjoy strong auto-tyre demand. The sector is trading at a one-year Honam Petrochemical (Honam) forward PER of 13.1x, above its past- should be the key beneficiary of EG five-year average. We believe its

and BD spread strength, in our view. current valuation is undemanding Jihye Choi given the robust petrochemical cycle (82) 2 787 9121 [email protected] PE/PP and ABS to turn round: outlook. The polyethylene/polypropylene Jun Yong Bang (PE/PP) spread has been most Outlook for petrochemical product cycle (82) 2 787 9168 PE/ vulnerable to monetary tightening and EG BD ABS TPA PVC [email protected] PP suffered from a weak cycle since 2010. More favoured Less favoured We expect it to start to pick up with

monetary easing. We also expect the Investment case Spread outlook

We initiate coverage of the Korea acrylonitrile-butadiene-styrene (ABS) Supply-demand Petrochemical Sector with a Positive spread to start recovering from its dynamics 2H11 trough later this year, led by a Capacity additions rating. We expect the petrochemical gradual IT demand pick-up. Demand outlook cycle to remain buoyant in 2012, on favourable supply-demand dynamics. Sales contribution by product Honam 20% 10% 38% PVC and TPA likely to lag: The Hanwha 44% 31% Catalysts PVC market is likely to remain LG Chem 30% 11% unattractive, due mainly to slow China’s monetary easing is a key Source: Daiwa forecasts Note: 2011 for Honam and LG demand driver: Given Daiwa’s view demand from China’s sluggish Chem, 2010 for Hanwha; LG Chem’s sales contributions are on its petrochemical business sales. that China will ease monetary policy construction market. The purified terephthalic acids (TPA) outlook does this year, we believe all the demand- Risks related negatives are already reflected not look bright either, as we expect major capacity additions this year to We see an unexpected drop in oil in current petrochemical spreads. We prices, and a slow recovery in expect further monetary easing in exceed growth in demand. demand (even amid monetary China to underpin the buoyant cycle. loosening in China), as the key risks. Honam is our top pick: We believe Honam is poised to benefit Limited capacity additions Key stock calls fully from the robust cycle with its scheduled: Capacity expansion at New Prev. naptha cracking centres (NCC) and petrochemical-oriented business portfolio and initiate coverage with a Honam Petrochemical (011170 KS) downstream facilities should be Rating Buy limited at least until 2014. Given a 2-3 Buy (1) rating. We also like LG Chem Target price W470,000 year construction period, unexpected (Buy [1]), which should be the key Up/downside S 31.3% capacity expansion is unlikely to beneficiary of an IT industry LG Chem (051910 KS) disrupt supply-demand dynamics. recovery and whose new businesses Rating Buy offer appealing growth potential. Target price W490,000 Up/downside S 20.7% EG and BD should perform best: Hanwha Chemical (Hanwha) seems We expect ethylene glycol (EG) and to lack business momentum but this Hanwha Chemical (009830 KS) looks priced in. We expect a gradual Rating Outperform butadiene (BD) spreads to remain Target price W32,000 strong throughout 2012. EG should earnings recovery from 2H12 and Up/downside S 11.9% initiate with an Outperform (2) benefit from China’s growing Source: Daiwa forecasts rating. Note: Please refer to page 3 for details.

Important disclosures, including any required research certifications, are provided on the last three pages of this report. Korea Petrochemical Sector 24 February 2012

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Global NCCs: capacity additions

We expect the petrochemical cycle to remain solid out to ('000 tonne) 2014 on the back of limited capacity additions scheduled 12,000 for NCCs and downstream products until 2014. 10,000 Among the petrochemical products, we believe EG and 8,000 BD will continue their strong cycle, on the back of strong growth in demand from the polyester and auto- 6,000 tyre industries. We also expect the PE/PP spread to pick 4,000 up this year, thanks to China’s monetary policy easing, which should help drive demand for PE and PP. 2,000

0 2010 2011 2012E 2013E 2014E Source: Various sources including ICIS

Valuation Korea Petrochemical Sector: 1-year forward sector PER bands

The Korea Petrochemical Sector is trading currently at a ( one-year forward PER of 13.1x and a PBR of 1.9x (based (Wbn) (Wbn) on our forecasts). We believe the sector deserves to 60,000 5,000 trade at its peak-cycle valuations reached in 2011 (a PER 50,000 4,000 40,000 of 16.5x and PBR of 2.9x on a one-year forward basis) as 3,000 we expect: 1) the negative impact on demand from 30,000 2,000 China’s monetary tightening to reverse from this year, 20,000 and 2) sector earnings to be maintained at current all- 10,000 1,000 time high levels over 2012-14E. 0 0 2005 2006 2007 2008 2009 2010 2011 2012 Operating profit (RHS) PER 3.0x 8.0x 12.0x 16.0x Source: Data guide, companies, Daiwa forecasts Note: Operating profit is sum of that of Honam, LG Chem, and Hanwha

Earnings revisions Companies: operating profit, Daiwa vs. consensus (2012E) Notwithstanding our positive view on Honam, our (Wbn) consolidated 2012 operating profit forecast for the 3,500 company is 11% lower than that of the Bloomberg 3,000 consensus, due largely to our weak earnings outlook for one of its subsidiaries, KP Chemical, owing to excessive 2,500 TPA capacity additions planned in 2012. Our 2012 2,000 operating profit forecast for LG Chem is 13% lower than 1,500 the consensus forecast, which we attribute to our less 1,000 favourable outlook for the PVC spread (due to a sluggish 500 construction market in China). Our 2012 operating profit 0 forecast for Hanwha is 36% lower than that of the Honam Petrochemical LG Chem Hanwha Chemical consensus, reflecting mainly our negative view on the near- Daiwa forecast Bloomberg Consensus term earnings outlook for its solar cell/module subsidiary, Source: Bloomberg, Daiwa forecasts Hanwha Solar One (HSO) (Not rated).

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Executive summary

Buoyed by China's recovering demand We initiate coverage of the Korea Petrochemical Sector with a Positive view, premised mainly on an improving demand outlook from China’s monetary easing and limited capacity additions scheduled to 2014. Our top pick is Honam.

Investment thesis We initiate coverage of the Korea Petrochemical Sector with a Positive We see a robust cycle rating. We expect monetary easing in China to help drive an improvement in petrochemical demand throughout this year. We also expect to see ahead, on: 1) China’s limited capacity additions of NCCs and downstream capacity in the next monetary policy easing, three years, which should keep overall supply tight over this period. and 2) limited capacity We expect EG and BD spreads to remain robust, and those of PE/PP and expansions ABS to recover throughout this year.

Valuation The sector trades currently at a one-year forward PER of 13.1x and PBR of The sector’s current 1.9x (based on our forecasts). We believe it deserves to trade at its peak- cycle valuations reached in 2011 (a one-year forward PER of 16.5x and PBR valuation looks of 2.9x), given our expectations of: 1) a reversal of the negatives from undemanding as we believe China’s past monetary tightening this year, and 2) sustained earnings at a robust cycle is current all-time high levels over 2012-14E. We set SOTP-based six-month sustainable target prices of W470,000 for Honam, W490,000 for LG Chem and W32,000 for Hanwha.

Profit outlook For Honam, we forecast a similar parent-based operating profit for 2012 to Honam is our top pick; 2011, which we consider commendable given that: 1) the 2011 operating profit represented an all-time high, and 2) we expect it to maintain this operating should benefit fully from a profit level to at least 2013, driven by solid supply-demand dynamics from robust cycle; we also limited capacity additions and a recovery in demand from China’s monetary favour LG Chem, offering policy easing. For LG Chem, we also forecast a similar consolidated IFRS- sound growth prospects based operating profit for 2012 to 2011’s level, on the back of a gradual recovery in the IT industry and even amid a weak PVC cycle. We forecast Hanwha’s IFRS-based operating profit to fall by 18.3% YoY this year, on a decline in petrochemical earnings and weak earnings likely for HSO (both the petrochemical business and HSO enjoyed very strong earnings in 1H11).

Key stock calls

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 % Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. chg Honam Petrochemical 011170 KS 358,000 Buy 470,000 n.a. 34,433 n.a. 34,990 n.a. LG Chem 051910 KS 406,000 Buy 490,000 n.a. 29,384 n.a. 26,568 n.a. Hanwha Chemical 009830 KS 28,600 Outperform 32,000 n.a. 1,902 n.a. 1,018 n.a. Source: Daiwa forecasts

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Table of contents

Buoyed by China’s recovering demand ...... 5 Investment summary ...... 5 Demand: recovery likely with China’s monetary easing ...... 7 Supply: capacity expansion should be limited until 2014 ...... 9 Ethylene glycol and butadiene set to be the best performers in 2012 ...... 10 PE/PP and ABS should show a meaningful turnaround in 2012 ...... 13 PVC and TPA should remain the laggards ...... 15 Recommendations and valuations ...... 16 Potential risks ...... 20 Appendix ...... 20 Initiation: fully exposed to the upcycle ...... 26 Valuation ...... 26 Valuation gap should narrow with Formosa ...... 27 Parent’s 2012 earnings should remain at the 2011 all-time high level ...... 28 Exposed to strong upcycles in EG and BD spreads ...... 29 Key subsidiaries ...... 30 Risks ...... 30 Growth story continues ...... 35 Valuation ...... 35 I&E business: we expect solid earnings growth ...... 36 LCD glass substrate should be the key growth engine ...... 37 Mid-large size batteries for HEVs/ EVs: bright long-term outlook ...... 38 Petrochemical: partial beneficiary of solid cycle ...... 39 Hybrid chemical companies’ peer analysis: LG Chem vs. Japanese companies ...... 40 Risks ...... 41 Initiation: earnings likely to recover from 2H12 ...... 46 Valuation ...... 46 Petrochemical business: cycle not so favourable ...... 47 YNCC: solid earnings expected ...... 47 Meaningful earnings from HSO will take time ...... 48 Aggressive expansion in solar business may be burdensome ...... 48 Risks ...... 49

Company Section Honam Petrochemical ...... 22 LG Chem ...... 31 Hanwha Chemical ...... 42

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Assuming a ramp-up period for new capacities of 3-6 months, we expect the overall petrochemical supply to remain tight at least until 2014, even with the substantial capacity build-up likely in 2014.

We expect a solid petrochemical cycle in Buoyed by China’s 2012 recovering demand We present our outlook for the key petrochemical products in 2012 and beyond below:

We expect a healthy petrochemical cycle Best performers: EG and BD – We are most to continue in 2012 on the back of: 1) a positive about ethylene glycol (EG) and butadiene (BD), recovery in demand driven primarily by given limited capacity additions of both products (which follow the NCC expansion schedule) planned China’s monetary easing, and 2) limited until 2014. The demand outlook for both products is capacity additions to 2014E. also bright, as we expect healthy growth in demand from China’s polyester and auto-tyre markets in the coming years. We believe Honam should be the main Investment summary beneficiary of a strong EG and BD cycle given its high exposure to these products. Demand: China’s monetary policy easing should help boost petrochemical demand Turnaround story: PE/PP and ABS – The Daiwa’s China economist, Minchung Sun, expects the polyethylene (PE)/polypropylene (PP) cycle has been PRC Government to ease monetary policy throughout weak since 2010 and we expect it to turn round from 2012. 2012. PE/PP demand is highly correlated with overall consumption and GDP growth, and as such we expect We see a further contraction in petrochemical demand an easing of China’s monetary policy to pave the way as unlikely in 2012, following its contraction in 2011. for a recovery in the PE/PP cycle. Instead, we expect monetary easing in China to help drive an improvement in global petrochemical demand We also expect the acrylonitrile-butadiene-styrene throughout this year. China’s economy is one of the (ABS) cycle, which was weak in 2011, to bottom out this most important factors to consider when forecasting year and start recovering later in the year, on the back petrochemical demand, given that 25-35% of global of a revival in the IT industry. We expect Honam petrochemical demand comes from China. We believe (PE/PP) and LG Chem (ABS) to benefit the most from monetary easing in China should revive the country’s a recovery. industrial activity and consumption (following their slowdowns in 2011), which in turn should eventually Laggards: PVC and TPA –The outlook for the poly stimulate petrochemical demand. vinyl chloride (PVC) cycle appears less attractive to us, as we do not envisage a meaningful pick-up in demand Supply: limited capacity additions should from China’s sluggish construction market. We expect purified terephthalic acids (TPA) to suffer this year keep supply tight from an oversupply resulting from continuous capacity We believe the key focus for investors over recent expansion, despite growth in demand from China’s months has been for how long the currently robust textile market. Hanwha is exposed to PVC and petrochemical cycle can be sustained. We note that Honam’s subsidiary, KP Chemical, is exposed to TPA. limited capacity additions are scheduled for NCC and downstream products over the next three years.

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Daiwa’s outlook for petrochemical product cycle Product outlook EG BD PE/PP ABS TPA PVC Note More favoured Less favoured

Spread outlook

Supply-demand dynamics

Capacity additions

Demand outlook

Sales contribution by product NCC/BTX: 16% Honam Petrochemical 20% 10% 38% SM: 10% Hanwha Chemical 44% 31% CA: 23%

LG Chem 30% 11% BR/SBR: 19%

Source: Daiwa forecasts Note: Honam and LG Chem’s sales contributions are for 2011, Hanwha’s are for 2010; LG Chem’s sales contributions are based on its petrochemical business sales. BTX refers to benzene, Toluen, and Xylene; BR refers to butadiene rubber and SBR refers to styrene-butadiene rubber.

Summary of our view Honam Petrochemical LG Chem Hanwha Chemical Daiwa’s preference* 1 2 3 More favoured Less favoured

Valuation attractiveness

Key product outlook

Key products EG, BD, PE/PP ABS, NCC, PO PVC, LDPE

New business opportunity

New businesses Pure chemical business in South East HEV/EV battery Solar energy Asia LDC glass plate

Companies’ capacity expansion

Capacity expansion in 2012E Ethylene (250) Ethylene (100) EVA (40) (‘000 tonne/year, ‘000 cell/month for LiB) Propylene (175) SAP (72) HDPE (250) Acrylic acid (160) PP (200) Polymer (4,000) BD (20)

Balance sheet

Net debt-to-equity ratio (2012E) 6.6% 10.9% 86.6% Source: Companies, Daiwa forecasts Note: *The lower the number, the more we like the stock

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EG-ethylene spread ABS spread (US$/t) (US$/t) 1,600 2,500 1,400 2,000 1,200 1,000 1,500 800 1,000 600 400 500 200 0 0 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E

Spread EG Ethylene Spread ABS SM

Source: Cischem, Daiwa forecasts Source: Cischem, Daiwa forecasts

BD-naphtha spread PVC-ethylene spread

(US$/t) (US$/t) 4,000 2,000 3,500 3,000 1,500 2,500 2,000 1,000 1,500 1,000 500 500 0 0 (500) 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E Spread Butadiene Naphtha Spread PVC Ethylene

Source: Cischem, Daiwa forecasts Source: Cischem, Daiwa forecasts

HDPE-ethylene spread TPA-PX spread (US$/t) (US$/t) 1,800 1,800 1,600 1,600 1,400 1,400 1,200 1,200 1,000 1,000 800 800 600 600 400 400 200 200 0 0 (200) 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E Spread HDPE Ethylene Spread TPA PX

Source: Cischem, Daiwa forecasts Source: Cischem, Daiwa forecasts

Demand: recovery likely with China’s monetary easing

China is likely to ease monetary policy As noted earlier in this report, Daiwa’s China economist, Minchung Sun, expects the PRC Government to ease monetary policy throughout 2012.

Since 2010, China has strived to tame the country’s inflation via an aggressive policy of monetary

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tightening. Between 2010 and November 2011, the China: PMI and exports PRG Government raised the required reserve ratio (%) (RRR) 11 times, resulting in the RRR rising from 15.5% 70 to 21.5% over the period. (There was no hike in 2009.) 65 60 China: RRR vs. CPI 55 50 (%) (%) 45 22 8 40 35 6 20 30 4 18 Oct-11 Oct-10 Oct-09 Oct-08 Oct-07 Oct-06 Oct-05 Jun-11 Jun-10 Jun-09 Jun-08 Jun-07 Jun-06 Jun-05 Feb-11 Feb-10 Feb-09 Feb-08 Feb-07 Feb-06 2 Feb-05 16 PMI PMI: New Export Orders Expansion-contraction line 0 14 (2) Source: CEIC Note: PMI = Purchasing Manufacturers Index 12 (4) -09 -10 -11 -09 -10 -11 p p p y y y Jul-09 Jul-10 Jul-11 Jan-10 Jan-11 Jan-09 Mar-10 Mar-11 Mar-09 Negatives seem reflected; petrochemical Nov-09 Nov-10 Nov-11 Se Se Se Ma Ma Ma RRR CPI (% change, RHS) demand to pick up with China’s monetary

Source: CEIC easing We believe Asia’s overall petrochemical demand was As a result of these measures, recent economic data affected negatively by China’s tightening in 2010 and indicates that domestic consumption and exports 2011. The decline in retail sales growth resulted in appear to be slowing, while China’s industrial activity is sluggish PE/PP demand, while weak real-estate moderating and corporate and household lending is investment activity led to a weak PVC cycle over 2010- retreating. 11. Also, we have found that sluggish growth in China’s IT industry has been negative for ABS. Daiwa believes the first 50bps RRR cut on 30 November 2011 officially opened the gate for more China: retail sales growth (YoY) policy loosening and expects further easing to follow. (%) Daiwa expects four more RRR cuts, of 50bps each, and M2 growth of 14% YoY over the course of this year. 24 22 China: M2 vs. loan growth (YoY) 20

(%) 18 40 16 35 14 30 12 25 10 20 15 8 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 10 5 Source: CEIC 0 -09 -10 -11 China: fixed asset investment (YoY) p y y Jul-10 Jul-11 Jul-09 Jan-10 Jan-09 Jan-11 Mar-10 Mar-11 Mar-09 Nov-09 Sep-10 Nov-10 Sep-11 Nov-11 Se Ma Ma May-09 (%) M2 (YoY, %) Loan growth (YoY, %) 60 Source: Bloomberg 50 40 30 20 10 0 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Total (YoY) Manufacturing (YoY) Real Estate (YoY)

Source: CEIC

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China: plastic-product demand (YoY)

(%) Supply: capacity expansion 100 should be limited until 2014 80

60 Investors’ key focus recently has been whether the current robust petrochemical cycle is sustainable. 40

20 We expect to see limited capacity additions of NCCs 0 and downstream capacity in the next three years. (20) Assuming a 3-6 month ramp-up period, we expect (40) supply to remain tight at least until 2014, even with the large capacity build-up likely by 2014. Also, we believe Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 there will be no unexpected supply increase until 2014, Source: CEIC given it generally takes 2-3 years to complete a new NCC. China building space: area under construction and completed (%) As the supply schedule is likely to remain tight, we see demand as the price-determining factor going forward. 90

70 Global NCC capacity additions 50 (’000 tonnes/year) 2010 2011 2012E 2013E 2014E 2015E 30 Total 9,650 2,390 4,050 4,670 7,400 3,030 10 China 2,640 750 1,650 800 800 1,000 (10) Middle East 3,200 1,350 1,280 1,300 4,950 1,080 Others 3,810 290 1,120 2,570 1,650 950 (30) Source: Various sources including ICIS (50) Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Global EG capacity additions Under construction (YoY) Completed (YoY) ('000 tonne) Source: CEIC 4,500 4,000 We do not expect a further contraction in Asia’s 3,500 petrochemical demand for at least the next two years, 3,000 in view of China’s policy easing. Instead, we expect 2,500 monetary easing in China to help drive an 2,000 improvement in petrochemical demand in Asia in 2012. 1,500

China: final demand 1,000 500 (% YoY) Further Forecast 0 15 destocking unlikely Inventory accumulation 2010 2011 2012E 2013E 2014E Source: Various sources including ICIS 12 Global BD capacity additions

('000 tonnes) 9 900 Destocking 800 6 700 600 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 500 Final demand Aggregate demand (GDP) 400 Source: CEIC, Daiwa forecasts 300 200 100 0 2010 2011 2012E 2013E 2014E Source: Various sources including ICIS

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Global PE (sum of HDPE/LDPE/LLDPE) capacity additions Global TPA capacity additions

('000 tonnes) ('000 tonnes) 9,000 8,000 8,000 7,000 7,000 6,000 6,000 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 0 2010 2011 2012E 2013E 2014E 2010 2011 2012E 2013E 2014E Source: Various sources including ICIS Source: Various sources including ICIS

Global ABS capacity additions

('000 tonnes) Ethylene glycol and butadiene set 1,400 to be the best performers in 2012 1,200

1,000 We are the most positive about EG and BD spreads,

800 given limited capacity additions scheduled for these chemicals over the next few years. The demand outlook 600 is also bright, as we expect healthy growth for both the 400 polyester and automobile tyre markets. The EG cycle 200 should be sustainable at least until 2014.

0 We expect the EG spread to remain strong up to 2014, 2010 2011E 2012E 2013E 2014E Source: Various sources including ICIS driven by favourable supply-demand dynamics. Restrained by limited NCC capacity additions, we Global PVC capacity addition plan expect EG supply to also be constrained until 2014.

('000 tonnes) 4,000 On the other hand, we also expect growth in EG 3,500 demand to remain strong, exceeding supply growth. In our view, the current growth of the textile industry in 3,000 China, where major polyester capacity additions are 2,500 under way, bodes well for EG, the raw material for 2,000 polyester. 1,500 1,000 Polyester vs. EG capacity additions 500 ('000 tonnes) 7,000 0 2010 2011 2012E 2013E 2014E 6,000 Source: Various sources including ICIS 5,000 4,000 3,000 2,000 1,000 0 2011 2012E 2013E 2014E EG Polyester

Source: Companies, various industry sources including ICIS

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EG value chain EG-ethylene spread trend

Polyester (PET) (US$/t) 800

0.87 0.34

TPA MEG 600 KP Chemical Honam Petrochem Taekwang

0.67 400

P-X S-Oil 200 GS SK Innovation Source: Companies 0 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E China s fibre sales trend ’ Source: Cischem, Daiwa forecasts

(Rmb tn) Fibre industry sales (%) 6 Fibre industry sales growth (YoY, RHS) 60 Given that Honam is the only EG producer with Chemical fibre industry sales growth (YoY, RHS) meaningful production volume among its Korean peers, Synthetic fibre industry sales growth (YoY, RHS) 40 we expect this company to benefit the most from strong 4 EG spreads.

20 EG makers in Korea (2011) 2 0 LG Chem Unit: '000 tonne 180

0 (20) 2003 2004 2005 2006 2007 2008 2009 2010 Source: CEIC Samsung Total We believe favourable EG supply-demand dynamics 117 will continue out to 2014, and result in a strong EG Honam Petrochem spread until 2014. (Our supply-demand dynamics 595 study indicates excess demand until 2014.)

EG: demand greater than supply Source: Korea Petrochemical Industry Association ('000 tonnes) 2,500 Strong BD spread expected, driven by 2,000 1,500 robust automobile tyre demand 1,000 In our view, limited NCC capacity expansion will 500 restrain BD supply growth. (BD is made from mixed C4, 0 which can only be produced from naphtha-based NCC.) (500) (1,000) (1,500) Demand > Supply Global BD capacity additions (2,000) ('000 tonnes) 2011 2012E 2013E 2014E 900 EG Capacity addition EG demand increment EG net supply 800

Source: Companies, various industry sources including ICIS, Daiwa forecasts 700 600 500 400 300 200 100 0 2010 2011 2012E 2013E 2014E Source: Companies, various industry sources including ICIS

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We believe the BD spread will be driven by demand for China: new auto sales trend the next three years, due to the meagre capacity additions planned. We expect BD demand to remain ('000 unit) robust in the next few years, on healthy growth in new 16,500 auto-tyre sales globally. 16,000 15,500 BD value chain 15,000 14,500 BR SBR 14,000 13,500 KKP KKP 13,000 LG Chem LG Chem 12,500 2010 2011 2012E 1.02 0.73 Source: KAMA, Daiwa forecasts

China: tyre sales trend

BD (m) 400 Honam YNCC 350 KKP 300 LG Chem 250 Source: Companies 200 Note: KKP = Korea Kumho Petrochemical (Not rated), YNCC: 50% stake owned by Hanwha Chemical and 50% by Daelim Industrial; BD-BR conversion factor is the average 150 of 0.94 and 1.10 100 Daiwa forecasts global auto sales to rise by 4.2% YoY 50 for 2012 (versus estimated growth of 4.3% YoY for 0 2011). In particular, Daiwa forecasts China’s auto 2008 2009 2010 2011 2012E 2013E 2014E demand to increase by 9.3% YoY this year (compared Source: Companies with 7.2% YoY last year). With BD prices reaching an historical peak of

Global new auto sales trend US$4,350/tonne in 3Q11, the BD spread showed a robust trend in 2011, averaging US$1,999/tonne for the ('000 unit) year. (The BD spread averaged US$1,180/tonne in 80,000 2010 and US$468/tonne in 2009.) We believe this 78,000 surge was due mainly to the limited supply additions and healthy demand from the automobile tyre industry. 76,000 74,000 We expect BD prices to remain strong, ranging from US$3,000-3,400/tonne in 2012. Following Daiwa’s 72,000 positive auto demand outlook versus limited BD 70,000 incremental capacity growth, we forecast the supply- demand dynamics for BD to be well balanced until 68,000 2010 2011 2012E 2014.

Source: KAMA, Daiwa forecasts

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BD demand-supply outlook

('000 tonnes) PE/PP and ABS should show a 1,200 meaningful turnaround in 2012 1,000 800 600 PE/PP: turnaround likely, driven by 400 China’s monetary policy 200 0 After suffering from a lacklustre cycle in 2010-11, we (200) expect the PE/PP spread to turn round from 2012, led (400) by a recovery in demand following China’s monetary (600) policy easing. (800) 2011 2012E 2013E 2014E Monetary policy tightening in China hit PE/PP the BD Capacity addition BD demand increment BD demand -supply hardest among the petrochemical products. Due to the Source: Daiwa forecasts, Company, various industry sources including ICIS Note: Conversion factor for BD-SBR was 0.73 and 1.02 for BD-BR wide variety of end usage of PE/PP, we believe PE/PP demand is directly related to overall economic BD-naphtha spread trend conditions and GDP growth, whereas demand for many (US$/t) other petrochemical products depends on several 4,000 specific industries. For this reason, as much as PE/PP 3,500 was hurt by China’s contraction efforts, we expect 3,000 PE/PP to be a direct beneficiary of China’s monetary 2,500 loosening going forward. 2,000 Relationship between HDPE spread and China M2 growth 1,500 1,000 (US$/ton) 500 35% 400 350 0 30% 300 (500) 25% 250 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E 200 20% 150 Source: Cischem, Daiwa forecasts 15% 100 50 Among its Korean peers, we believe Honam, Korea 10% 0 5% (50) Kumho Petrochemical (KKP) (Not rated), LG Chem (100) and Hanwha have meaningful exposure to BD. KKP 0% (150)

and LG Chem use BD internally to make BR/SBR. 1Q01 3Q01 1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 Hanwha owns 50% of Yeochon NCC (YNCC) (Not M2 (YoY) HDPE Spread (US$/ton) listed) and recognises it under the equity method. Source: Bloomberg, Cischem

BD makers in Korea HDPE demand breakdown Samsung Total SK Global 105 Chemical Others 130 14.2% Film & Sheet 27.0% Honam Korea Kumho Petrochem Petrochem 280 237

Blow molding 26.1%

Injection YNCC LG Chem molding 265 240 Pipe & extrusion 20.0% Unit: '000 tonne 12.8% Source: Korea Petrochemical Industry Association Source: Company, various industry sources including ICIS

Also, relatively limited new capacity additions in 2012- 14, compared to 2010, should be positive for the PE/PP spread, in our view.

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PE/PP makers in Korea HDPE capacity additions (’000 tonnes) LDPE LLDPE HDPE PP Honam Petrochemical 110 290 380 900 ('000 tonnes) LG Chem 290 590 380 4,000 Hanwha Chemical 413 355 3,500 Samsung Total 140 125 175 670 SK Global Chemical 180 210 390 3,000 KPIC 530 470 2,500 Daelim Industrial 460 2,000 Hyosung 268 GS Caltex 180 1,500 Poly Mirae 700 1,000 Source: Korea Petrochemical Industry Association 500 Note: As of June 11

0 2010 2011 2012 2013 2014 ABS: turnaround expected, driven by IT Source: Company, various industry sources including ICIS economy recovery The ABS cycle tends to move with the IT industry, Among PE/PP producers in Korea, we expect high- given that about 45% of ABS demand comes from that density polyethylene (HDPE) players to enjoy the industry. Although supply additions are set to increase turnaround more than low-density polyethylene in 2012 and 2013, we believe an upturn in demand (LDPE) makers. from the IT industry would offset any such supply additions and lead to a recovery in the ABS spread later We would expect HDPE, which was more severely hit this year from its trough reached in 2H11. from the recent downcycle led by monetary policy tightening in China, to outpace LDPE in a turnaround. Global ABS capacity additions LDPE, largely used for film & sheet, showed relatively ('000 tonnes) stronger demand than HDPE during the previous 1,400 downcycle. 1,200 HDPE spread trend 1,000

(US$/t) 800 600 600

400 400 200

200 0 2010 2011E 2012E 2013E 2014E Source: Various sources including ICIS 0 ABS demand breakdown (200) Others 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E 7.5%

Source: Cischem, Daiwa forecasts Construction & housing We expect Honam and Korea Petrochemical (KPIC) 18.5% Electronics (Not rated), which has the most HDPE exposure, to 44.0% benefit the most from a turnaround, while Hanwha, a LDPE producer, should benefit less than the other two.

Autos 30.0%

Source: Various sources including Korea Petrochemical Industry Association

- 14 - Korea Petrochemical Sector 24 February 2012

ABS spread China building space: under construction and completed

(US$/t) (%) 800 90 700 70 600 50 500 30 400 10 300 (10) 200 (30) 100 (50) 0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E Under construction (YoY) Completed (YoY)

Source: Cischem, Daiwa forecasts Source: CEIC

Based on the production volumes of ABS, we would Global PVC capacity additions expect LG Chem to be the key beneficiary of a recovery ('000 tonnes) in the ABS spread. 4,000 3,500 ABS makers in Korea 3,000 Korea Kumho 2,500 Petrochemical Cheil Industries 250 2,000 420 1,500 1,000 Korea Styrolution 500 276 0 2010 2011 2012E 2013E 2014E Source: Various sources including ICIS

Unit: '000 tonne PVC-ethylene spread trend LG Chem 650 (US$/t) Source: Various sources including Korea Petrochemical Industry Association 600

PVC and TPA should remain the 500 laggards 400

PVC: demand outlook still gloomy 300 Although the PVC cycle may start to improve from 2H12, its magnitude will not be significant, in our view. 200 Despite the limited PVC capacity expansion schedule, 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12E 1Q13E we expect no meaningful PVC demand recovery, even Source: Cischem, Daiwa forecasts amid China’s monetary easing.

PVC demand hinges on the housing and construction market, since PVC is largely used as a finishing material for buildings. We do not expect China’s sluggish housing market to recover soon. Since the building space under construction is in decline and PVC is required at the later phase of construction, we believe a recovery in PVC demand may take a while, even with China’s monetary easing.

- 15 - Korea Petrochemical Sector 24 February 2012

PVC makers in Korea, capacity (‘000 tonnes) weak TPA cycle. (Samsung Petrochemical, the largest TPA producer, is not listed.)

TPA makers in Korea, capacity (‘000 tonnes)

Hanwha Hyosung Chemical 420 560 Taekwang 1,000

LG Chem 820 Samsung Petrochemical KP Chemical 3,500 950

Source: Korea Petrochemical Industry Association SK Petrochemical TPA: new capacity addition would surpass 520 the expected strong demand growth Source: Korea Petrochemical Industry Association Although TPA demand is likely to pick up on the back of rising polyester demand, we expect capacity Recommendations and valuations additions to outweigh demand, and hamper the cycle’s recovery. Lacking a near-term catalyst, we cautiously We initiate coverage of the Korea Petrochemical Sector expect the TPA spread to remain weak until 2014. with a Positive rating given: 1) limited NCC and downstream capacity additions scheduled over 2012-14, Global TPA capacity additions and 2) our expectation of gradual growth in demand ('000 tonnes) driven by China’s credit policy loosening. 8,000

7,000 We believe the Korean Petrochemical Sector deserves 6,000 to trade at its peak-cycle valuation reached in 2011 (a 5,000 16.5x PER and 2.9x PBR on a one-year forward basis), 4,000 as we expect: 1) the negatives from China’s monetary 3,000 tightening to ease from this year, and 2) earnings to be sustained at current l-time high levels over 2012-14E. 2,000 The Korea Petrochemical Sector is trading currently at 1,000 a one-year forward PER of 13.1x and a PBR of 1.9x 0 (based on our forecasts). 2010 2011 2012E 2013E 2014E

Source: Various sources including ICIS We expect the EG and BD spreads to remain robust, led TPA: demand less than supply by strong growth of the textile and automobile tyre markets. We see Honam as the key beneficiary of this ('000 tonnes) Supply > Demand petrochemical cycle, given that around 30% of 8,000 Honam’s parent-based revenue comes from EG (about 7,000 6,000 20%) and BD (about 10%). Honam is our top pick in 5,000 the sector and we initiate coverage with a Buy (1) rating. 4,000 3,000 We initiate coverage of LG Chem with a Buy (1) rating, 2,000 as we expect: 1) earnings growth from a recovery of the 1,000 0 IT industry, and 2) new businesses to gain momentum (1,000) (glass substrates and mid-large size batteries for 2011 2012E 2013E 2014E HEV/EV). We initiate coverage of Hanwha with an TPA Capacity addition TPA demand increment TPA net supply Outperform (2) rating. Despite the sluggish outlook we Source: Daiwa forecasts, Company, various industry sources including ICIS see for PVC, we believe Hanwha’s current valuation is attractive (now trading at a PER of just 28.1x and a In our opinion, KP Chemical (52%-owned by Honam) PBR of 0.9x for 2012E), especially as we expect HSO’s is the most vulnerable among its Korean peers to a earnings to bottom out from 2H12.

- 16 - Korea Petrochemical Sector 24 February 2012

Korea Petrochemical Sector: one-year forward PER vs. KOSPI

(x) 20

15

10

5

0 2004 2005 2006 2007 2008 2009 2010 2011 2012

Korea refinery sector Korea refinery sector average KOSPI

Source: FnGuide, Bloomberg, Daiwa

Korea Petrochemical Sector: one-year forward PBR vs. KOSPI

(x) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 2004 2005 2006 2007 2008 2009 2010 2011 2012

Korea refinery sector KOSPI Korea refinery sector average

Source: FnGuide, Bloomberg, Daiwa

- 17 - Korea Petrochemical Sector 24 February 2012

Global petrochemical companies: valuation comparison Mkt cap Mkt cap Price (LCY) PER (x) PBR (x) EV/EBITDA (x) EPS growth (%) OP margin (%) ROE (%)

BB ticker Rating (US$m) (loc curr) (m) (23/Feb/2012) 2012E 2013E 2012E 2013E 2012E 2013E 2012-13E 2012E 2013E 2012E 2012E Korea

Honam Petrochemical* 011170 KS Buy 10,378 11,437,740 358,000 10.2 8.4 1.8 1.5 6.4 5.1 22.0 8.6 10.7 19.7 19.7 LG Chemical* 051910 KS Buy 23,606 26,872,932 406,000 15.3 13.2 2.7 2.3 8.4 7.3 16.0 11.6 13.3 19.1 18.9 Hanwha Chemical* 009830 KS Outperform 3,641 4,166,420 28,600 28.1 11.7 0.9 0.8 11.0 7.6 140.2 4.4 7.9 3.2 7.2 Kumho Petrochemicals* 011780 KS NR 3,804 4,144,185 163,000 8.0 6.4 2.5 1.8 6.0 5.0 25.0 12.8 14.2 36.3 32.6 Taiwan

Formosa Petrochemical 6505 TT NR 29,608 882,104 92.6 24.5 20.0 3.5 3.4 15.0 13.3 12.4 4.6 5.3 15.2 17.2 Formosa Plastics 1301 TT NR 18,115 558,839 91.3 14.6 12.4 1.9 1.8 13.3 13.2 18.4 24.2 23.8 19.6 19.5 Formosa Chemical & Fibre 1326 TT NR 16,956 520,678 91.5 13.7 12.2 1.7 1.6 17.1 16.9 12.4 19.6 20.2 16.9 16.7 Nan Ya Plastics 1303 TT NR 17,933 563,795 71.8 16.9 14.0 1.8 1.7 19.1 18.2 20.5 27.0 27.4 14.6 15.6 Japan

Sumitomo Chemical 4005 JT Hold 6,904 564,507 341 143.5 10.5 1.1 1.0 8.2 7.6 N/M 3.7 4.4 7.0 9.9 Mitsui Chemicals 4183 JT NR 3,355 285,144 279 14.6 10.5 0.7 0.7 7.1 6.4 N/M 2.5 3.1 4.1 6.0 Shin-etsu Chemical 4063 JT Hold 23,388 1,892,627 4,380 16.3 14.5 1.2 1.2 6.4 6.0 11.9 15.0 15.9 7.6 8.1 Toray Industries 3402 JT Underperform 11,767 956,048 586 13.2 12.1 1.4 1.3 7.3 6.7 9.5 7.1 7.3 11.2 11.4 Kuraray 3405 JT Hold 5,319 445,270 1,163 11.2 10.3 1.1 1.0 3.6 3.3 8.3 15.6 15.9 9.7 9.9 JSR 4185 JT Outperform 5,251 424,769 1,660 13.3 11.8 1.4 1.3 5.3 4.8 12.7 11.8 12.4 10.9 11.3 Nitto Denko 6988 JT Hold 7,070 585,566 3,370 13.9 12.5 1.2 1.2 4.3 4.2 10.5 10.1 10.4 9.1 9.5 Others

Dow Chemical DOW US NR 39,900 40,136.7 33.9 12.4 9.9 1.7 1.5 7.3 6.5 25.8 8.7 9.9 14.1 15.6 Dupont DD US NR 46,109 47,945.8 51.4 12.0 10.7 4.3 3.4 7.9 7.1 12.6 13.9 14.5 37.1 34.3 Lyondell-Basell LYB US NR 25,153 24,939.7 43.2 8.9 7.6 2.0 1.7 5.4 4.9 17.3 8.3 9.2 22.3 23.6 BASF BAS GR NR 73,385 60,252.2 65.6 11.9 10.8 2.3 2.2 6.6 6.1 10.3 11.0 11.7 19.8 19.8 Bayer BAYN GR NR 59,312 46,325.6 56.0 11.2 10.1 2.1 1.9 6.9 6.3 11.7 12.9 14.4 17.7 19.2 Average

Chemical average 20.7 11.5 1.9 1.7 8.6 7.8 22.1 11.7 12.6 15.8 16.3

Pure chemical average 16.4 12.3 2.1 1.9 12.0 10.8 33.4 14.1 15.3 18.1 18.4

Hybrid chemical average 30.2 11.9 1.3 1.2 6.3 5.8 499.2 9.3 10.0 8.3 10.3

Source: Bloomberg, *Daiwa forecasts

- 18 - Korea Petrochemical Sector 24 February 2012

Honam Petrochemical: Buy (1) Hanwha Chemical: Outperform (2) We initiate coverage of Honam with a Buy (1) rating We initiate coverage of Hanwha with an Outperform and six-month target price of W470,000, derived from (2) rating and six-month target price of W32,000, our SOTP valuation. based on our SOTP valuation. We apply a target EV/EBITDA multiple of 6.9x (a 20% discount to Within our SOTP valuation, we apply the current Honam’s parent business and the KOSPI average) to KOSPI market average EV/EBITDA multiple of 8.6x as value Hanwha’s petrochemical business. We assign a our target multiple for Honam’s parent petrochemical 10% discount to Hanwha’s equity holdings to reflect business. Historically, petrochemical stocks have subsidiary risk including the losses from HSO. (We tended to trade below the KOSPI’s average PER, due value YNCC at 2x of its 3Q11 book value and HSO at its mainly to their cyclical nature and the difficulty in current market value). predicting the timing of a downcycle. However, we believe that limited capacity expansion scheduled until Daiwa sales and earnings forecasts (Wbn) 2014, and a demand recovery from China’s monetary Sales Operating profit Net profit policy easing should keep Honam’s supply-demand Honam Petrochemical 2012E 16,340 1,413 1,115 dynamics favourable and lower the downcycle risk. For 2013E 16,256 1,738 1,360 this reason, we believe Honam’s parent business LG Chem deserves a market valuation. 2012E 23,928 2,790 1,942 2013E 24,065 3,199 2,252 Hanwha Chemical For Titan Chemicals (Not listed), we apply a 2012E 2012E 7,831 346 143 EV/EBITDA multiple 6.9x as our target multiple. For 2013E 8,145 646 343 Titan, we assign a 20% discount to Honam’s parent Source: Daiwa forecasts business, given that Titan does not produce EG or BD, Note: All IRFS based which we expect to show the strongest spreads among the petrochemical products this year. For KP Chemical Korea petrochemical companies’ capacity breakdown (1H11) (Not rated), in which Honam owns a 51.9% stake, we Honam Hanwha KP Korea apply a market value. Petro. Chemical LG Chem KKP Chemical total NCC 1,750 1,930 7,770 LDPE 110 413 290 953 LG Chem: Buy (1) LLDPE 290 355 1,020 HDPE 380 590 2,345 We initiate coverage of LG Chem with a Buy (1) rating PP 900 380 3,958 and six-month target price of W490,000, based on a EG 1,055 180 1,352 SOTP valuation. We apply a target EV/EBITDA PVC 560 820 1,380 multiple of 7.7x to value the petrochemical business, BR/SBR 365 873 1,238 representing a 10% discount to our target multiple of ABS 650 250 1,596 TPA (PTA) 950 6,390 8.6x used to value Honam’s parent petrochemical Source: Korea Petrochemical Industry Association business, given our expectation that Honam’s petrochemical products will enjoy a better cycle (as the company has EG and BD) than LG Chem’s. We also apply a 7.7x EV/EBITDA target multiple to value LG Chem’s IT and electronic materials business. We value LG Chem’s new businesses together at W8.6tn (W2.7tn for the mid-large size battery and W5.9tn for the LCD glass businesses), derived using a DCF methodology.

Valuation summary EPS EBITDA Rating TP (W) PER (x) Growth (%) PBR (x) ROE (%) EV/EBITDA (x) Growth (%) Div yield (%) 2012E 2013E FY12-13 2012E 2013E 2012E 2013E 2012E 2013E FY12-13 2012E 2013E Honam Petrochemcal 1 470,000 10.2 8.4 22.0 1.8 1.5 19.7 19.7 6.4 5.1 17.5 0.6 0.8 LG Chem 1 490,000 15.3 13.2 16.0 2.7 2.3 19.1 18.9 8.4 7.3 12.6 1.2 1.2 Hanwha Chemical 2 32,000 28.1 11.7 140.2 0.9 0.8 3.2 7.2 11.0 7.6 46.6 0.7 1.0 Source: Daiwa forecasts Note: multiples and yields are based on closing share prices of 23 February 2012

- 19 - Korea Petrochemical Sector 24 February 2012

Potential risks Appendix

Key product glossary and conversion factor No improvement on China consumption Product Full name Conversion factor We estimate the Korea petrochemical companies’ sales HDPE High density Polyethylene 1.03*Ethylene exposure to China at around 30-40% of their total sales. LDPE Low density Polyethylene 1.03*Ethylene Hence, their earnings are influenced heavily by China’s EG Ethylene glycol 0.65*Ethylene economic conditions. Although Daiwa forecasts PVC Polyvinyl chloride 0.864*EDC + 0.235*Ethylene PP Poly-propylene 1.075*Propylene monetary easing in China throughout 2012, unexpected SM Styrene-monomer 0.288*Ethylene + 0.795*Benzene inflation in the country and a resulting slowdown in ABS Acrylonitrile butadiene styrene 0.54*SM + 0.19*Butadiene + 0.27*AN monetary policy easing would pose downside risk for PX Para-xylene 0.67*MX the Korean petrochemical players’ earnings, in our view. SBR Styrene-butadiene rubber 0.73*Butadiene + 0.23*SM BR Butadiene rubber 0.94~1.1*Butadiene TPA Purified terephthalic acid 0.67*PX A sharp decline in crude-oil prices Polyester Polyester 0.35*MEG + 0.65TPA A significant drop in crude-oil prices could result in Source: Korea Petrochemical Industry Association traders and end-users delaying their purchases of petrochemical products, on the expectation that prices Korea’s NCC capacity might fall further. Company Capacity ('000 ton/year) LG Chem 1,930 YNCC 1,910 Honam Petrochemical 1,750 SK Innovation 860 Samsung Total 850 KPIC 470 Source: Korea Petrochemical Industry Association Note: As of June 11

- 20 - Korea Petrochemical Sector 24 February 2012

Petrochemical derivatives chain

Refining Petrochemical Applications Companies

Hanwha , LG Chem, Samsung Total, Naphtha Ethylene LDPE Film & sheet Honam

HDPE Film & sheet, molding Honam, LG Chem, KPIC, Daelim Ind

Construction PVC Hanwha, LG Chem Gasoline finishing materials

EG Polyester Honam Kerosene

Propylene PP Film, molding Honam, Samsung Total, KPIC Diesel Acrylic fiber, KPX Chemical, SKC PO PPG urethane resin Heavy Oil Butadiene SBR Tires, sho es KKP, LG Chem

BR Tires, sho es KKP, LG Chem

Electronics, Benzene SM PS/EPS KKP, Cheil Industries, LG Chem Construction Electronics, Autos, LG Chem, Cheil Industries, KKP ABS Construction Toluene

KP Chemial, Samsung Petrochemical, Xylene P-X TPA Polyester Taekwang

Source: Various sources including Korea Petrochemical Industry Association

- 21 -

Materials / Korea 24 February 2012

Honam Petrochemical Target price: W470,000 Up/downside: +31.3% 011170 KS Share price (23 Feb): W358,000

Initiation: fully exposed to the upcycle

• Likely to be the key beneficiary of the upcycle for EG and BD. Honam is our top pick in the sector • Recovery of PE/PP, backed by China’s monetary easing, should also be positive for the company • Stock’s valuation appears undemanding, given the limited capacity additions planned and the outlook for a demand recovery How do we justify our view?

are close to all-time highs. However, How we differ we believe the upcycles in EG and Our 2012-13 operating-profit BD spreads are solid and sustainable, forecasts are on average 9% lower and will offer additional upside to than those of the Bloomberg

Honam’s current valuations. consensus, due to our expectation of Jihye Choi weak earnings for KP Chemical (Not (82) 2 787 9121 [email protected] The petrochemical stocks have rated), a key subsidiary of Honam. traded below the average valuations Jun Yong Bang of the KOSPI, due mainly to the Share price performance (82) 2 787 9168 [email protected] unpredictability of a downcycle. In (W) (%) the past few years, the market had 490,000 150 been concerned about the huge 420,000 130 What's new capacity expansion plans in the 350,000 110 We believe Honam’s product Middle East. However, these plans 280,000 90 have been either cancelled or 210,000 70 portfolio means that the company Feb-11 May-11 Aug-11 Nov-11 Feb-12 delayed. Honam Petrochemical (LHS) will benefit the most among its peers Relative to KOSPI (RHS) in the current upcycle in the petrochemical industry. In our opinion, the current 12-month range 229,500-458,000 petrochemical upcycle is different Market cap (US$bn) 10.10 What's the impact from previous ones, given the Average daily turnover (US$m) 57.27 We forecast Honam’s EG and BD limited NCC and downstream Shares outstanding (m) 32 sales to account for 20% and 10%, capacity expansion plans until 2014. Major shareholder Lotte Moolsan (33.6%) respectively, of the company’s revenue for 2012, and to perform What we recommend Financial summary (W) Year to 31 Dec 11E 12E 13E the best among its peers. We initiate coverage of Honam with a Buy (1) rating and six-month Revenue (bn) 15,773 16,340 16,256 Operating profit (bn) 1,544 1,413 1,738 While the PE/PP spread was weak in target price of W470,000. Our target price is based on our SOTP Net profit (bn) 1,097 1,115 1,360 2011, we expect it to recover Core EPS 34,433 34,990 42,694 valuation, in which we apply the somewhat in 2012 from monetary EPS change (%) 39.9 1.6 22.0 easing in China, and this should KOSPI’s current average Daiwa vs Cons. EPS (%) 0 (5) (2) benefit Honam. About 40% of the EV/EBITDA multiple of 8.6x for the PER (x) 10.4 10.2 8.4 company’s revenue comes from petrochemical business of Honam’s Dividend yield (%) 0.7 0.6 0.8 PE/PP. parent. DPS 2,400 2,300 2,800 PBR (x) 2.2 1.8 1.5 Based on our 2012 forecasts, the Honam is our top pick in the Korea EV/EBITDA (x) 6.1 6.4 5.1 stock is trading currently at a PER of Petrochemical Sector. ROE (%) 22.9 19.7 19.7 10.2x and a PBR of 1.8x, levels that Source: Bloomberg, Daiwa forecasts

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Korea Petrochemical Sector 24 February 2012

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Honam: parent-only operating profit We expect Honam’s parent-based operating profit in 1,600 2012 to be similar to that for 2011, which we do not regard as disappointing, given that: 1) the 2011 1,400 operating profit was an all-time high, and 2) we expect 1,200 this level of operating profit to continue until at least 1,000 2013, driven by solid supply-demand dynamics from 800 limited capacity additions and a demand recovery as a result of monetary easing in China. 600 400 On a consolidated basis, we forecast Honam’s 2012 200 operating profit to fall by around 9% YoY, mainly due to 0 drop in KP Chemical’s earnings. 2009 2010 2011E 2012E 2013E Source: Company, Daiwa forecasts

Valuation Honam: 12-month forward PER bands vs. operating profit

Based on our 2012 forecasts, the stock is currently (( trading at a PER of 10.2x and a PBR of 1.8x, levels that (W) (Wbn) are close to all-time highs. Although the current 500,000 1,200 valuation may seem demanding, we believe the stock 400,000 1,000 deserves to trade at a level higher than its peak PER 300,000 800 valuation in 1H11 (a PER of 12.9x) and near its peak 200,000 600 1H11 PBR of 2.5x, given that we believe: 1) the current 100,000 400 strong upcycles in EG and BD spreads is sustainable, 0 200 and 2) the negatives from China’s monetary tightening (100,000) 0 are priced in, and 3) the current level of earnings – an 2004 2005 2006 2007 2008 2009 2010 2011 2012 all-time high –will continue for the next few years. Operating profit (Parent, RHS) Price 3.0x 6.5x 9.8x 13.0x Source: Company, DataGuide, Daiwa forecasts

Honam: consensus and Daiwa FY12-13 operating profit Earnings revisions forecasts

Although we are positive on the prospects for Honam, (Wbn) our consolidated 2012 and 2013 operating-profit 2,000 forecasts are respectively 11% and 7% lower than those of the Bloomberg consensus. This is largely due to our 1,500 expectation of weak earnings for KP Chemical, as we expect excessive TPA capacity additions to drive down 1,000 the company’s earnings over the next few years.

500

0 FY12 FY13 Daiwa Bloomberg consensus

Source: Bloomberg, Daiwa forecasts Note: Bloomberg consensus is for the past 28 days

- 23 - Korea Petrochemical Sector 24 February 2012

Financial summary

Key assumptions Year to 31 Dec 2006 2007 2008 2009 2010 2011 2012E 2013E Ethylene-Naphtha (US$/tonne) 588 490 331 314 354 245 216 300 HDPE-Ethylene (US$/tonne) 38 110 242 215 95 141 205 300 LDPE-Ethylene (US$/tonne) 49 228 394 267 340 386 218 300 PP-Propylene (US$/tonne) 66 129 78 98 74 42 65 100 EG-Ethylene (US$/tonne) 100 339 152 71 180 416 435 490 PVC spread (US$/tonne) 264 335 449 351 423 474 418 470 ABS spread (US$/tonne) 306 340 292 335 370 222 270 359

Profit and loss (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Basic petrochemical 581 540 897 1,012 1,438 2,524 2,451 2,438 Synthetic resin 1,058 1,077 1,451 2,831 2,732 5,994 6,373 6,340 Others 542 638 750 2,127 3,019 7,255 7,516 7,478 Total revenue 2,181 2,255 3,098 5,970 7,189 15,773 16,340 16,256 Other income 95 88 74 234 204 648 450 450 COGS (1,822) (1,873) (2,889) (5,060) (6,082) (13,664) (14,032) (13,669) SG&A (104) (109) (119) (192) (203) (571) (895) (849) Other op. expenses (95) (88) (74) (234) (204) (642) (450) (450) Operating profit 255 273 90 718 904 1,544 1,413 1,738 Net-interest inc./(exp.) 13 24 21 (25) (15) (35) (34) (34) Assoc/forex/extraord./others 263 299 (183) 161 129 137 140 139 Pre-tax profit 532 596 (71) 853 1,018 1,645 1,518 1,844 Tax (150) (133) 26 (57) (234) (377) (334) (406) Min. int./pref. div./others 0 0 0 0 0 (171) (69) (78) Net profit (reported) 382 463 (45) 797 784 1,097 1,115 1,360 Net profit (adjusted) 382 463 (45) 797 784 1,097 1,115 1,360 EPS (reported) (W) 11,977 14,544 (1,421) 25,006 24,616 34,433 34,990 42,694 EPS (adjusted) (W) 11,977 14,544 (1,421) 25,006 24,616 34,433 34,990 42,694 EPS (adjusted fully-diluted) (W) 11,977 14,544 (1,421) 25,006 24,616 34,433 34,990 42,694 DPS (W) 750 1,000 250 1,500 1,750 2,400 2,300 2,800 EBIT 255 273 90 718 904 1,544 1,413 1,738 EBITDA 350 361 164 952 1,107 1,994 1,863 2,188

Cash flow (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Profit before tax 532 596 (71) 853 1,018 1,645 1,518 1,844 Depreciation and amortisation 95 88 74 234 204 450 450 450 Tax paid (150) (133) 26 (57) (234) (377) (334) (406) Change in working capital 24 (19) (101) (39) (333) (473) (492) (433) Other operational CF items (197) (181) 27 112 151 (73) 16 54 Cash flow from operations 304 351 (46) 1,104 805 1,172 1,159 1,509 Capex (51) (277) (201) (141) (332) (2,475) (600) (600) Net (acquisitions)/disposals (6) (50) (41) (79) (1,549) 1,722 (110) (109) Other investing CF items 15 (45) 150 (496) 339 0 0 0 Cash flow from investing (41) (372) (92) (717) (1,542) (753) (710) (709) Change in debt (200) 0 293 519 565 673 (30) (70) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (32) (24) (32) (8) (48) (56) (76) (73) Other financing CF items 0 0 (78) (741) (30) (451) 0 0 Cash flow from financing (232) (24) 183 (230) 487 167 (106) (143) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 30 (46) 45 157 (250) 585 342 656 Free cash flow 253 73 (247) 962 474 (1,304) 559 909

Source: Company, Daiwa forecasts

- 24 - Korea Petrochemical Sector 24 February 2012

Financial summary continued …

Balance sheet (Wbn) As at 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Cash & short-term investment 474 464 355 1,133 542 1,265 1,607 2,264 Inventory 165 211 249 361 477 1,503 1,684 1,777 Accounts receivable 294 309 266 716 734 1,735 1,961 2,113 Other current assets 11 20 16 96 122 300 400 500 Total current assets 943 1,004 886 2,307 1,875 4,803 5,652 6,654 Fixed assets 507 697 819 1,998 2,112 4,137 4,287 4,437 Goodwill & intangibles 4 2 1 (18) (14) 53 53 53 Other non-current assets 1,543 1,885 1,845 1,390 3,014 1,540 1,651 1,761 Total assets 2,998 3,587 3,551 5,677 6,987 10,534 11,642 12,904 Short-term debt 0 0 0 225 426 480 520 520 Accounts payable 236 279 172 695 496 2,050 1,964 1,777 Other current liabilities 95 139 92 196 398 300 250 200 Total current liabilities 331 417 264 1,116 1,320 2,830 2,734 2,497 Long-term debt 0 0 293 587 950 1,570 1,500 1,430 Other non-current liabilities 227 293 190 250 261 250 250 250 Total liabilities 558 711 747 1,952 2,531 4,649 4,484 4,177 Share capital 159 159 159 159 159 159 159 159 Reserves/R.E./others 2,280 2,717 2,644 3,566 4,296 4,957 6,065 7,430 Shareholders' equity 2,440 2,877 2,804 3,725 4,455 5,117 6,225 7,589 Minority interests 0 0 0 0 0 768 934 1,138 Total equity & liabilities 2,998 3,587 3,551 5,677 6,987 10,534 11,642 12,904 EV 9,436 9,118 9,672 9,801 9,305 12,185 11,869 11,237 Net debt/(cash) (474) (464) (62) (321) 834 785 412 (314) BVPS (W) 76,572 90,290 88,004 116,924 139,842 160,601 195,372 238,209

Key ratios (%) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Sales (YoY) 3.2 3.4 37.4 92.7 20.4 119.4 3.6 (0.5) EBITDA (YoY) (22.8) 3.1 (54.6) 481.0 16.4 80.0 (6.6) 17.5 Operating profit (YoY) (24.9) 7.0 (67.0) 694.7 26.0 70.8 (8.5) 23.1 Net profit (YoY) (25.4) 21.4 n.a. n.a. (1.6) 39.9 1.6 22.0 EPS (YoY) (25.4) 21.4 n.a. n.a. (1.6) 39.9 1.6 22.0 Gross-profit margin 16.5 16.9 6.8 15.2 15.4 13.4 14.1 15.9 EBITDA margin 16.0 16.0 5.3 15.9 15.4 12.6 11.4 13.5 Operating-profit margin 11.7 12.1 2.9 12.0 12.6 9.8 8.6 10.7 ROAE 16.8 17.4 n.a. 24.4 19.2 22.9 19.7 19.7 ROAA 13.2 14.1 n.a. 17.3 12.4 12.5 10.1 11.1 ROCE 10.8 10.3 3.0 18.8 17.4 22.4 16.5 17.5 ROIC 9.7 9.7 3.5 21.8 16.0 19.9 15.5 17.0 Net debt to equity net cash net cash net cash net cash 18.7 15.3 6.6 net cash Effective tax rate 28.3 22.3 n.a. 6.6 22.9 22.9 22.0 22.0 Accounts receivable (days) 48.8 48.8 33.9 30.0 36.8 28.6 41.3 45.7 Payables (days) 38.4 41.7 26.6 26.5 30.2 29.5 44.8 42.0 Net interest cover (x) n.a. n.a. n.a. 28.7 61.3 43.6 41.5 51.3 Net dividend payout 6.3 6.9 n.a. 6.0 7.1 7.0 6.6 6.6 Source: Company, Daiwa forecasts

Company profile Established in 1976, Honam Petrochemical is a pure petrochemical player in Korea, producing olefin, polyolefin, EG and other intermediate-petrochemical products. The company’s production facilities are located in Yeosu and Daesan, Korea, allowing for the vertical integration of petrochemical production. Honam Petrochemical, a member of the Lotte Group, is owned by Lotte Moolsan and other Lotte affiliates, which have a combined 57.3% stake.

- 25 - Korea Petrochemical Sector 24 February 2012

sustainable, and 2) the negatives from China’s monetary tightening are priced in, and 3) the current level of earnings – an all-time high –will continue for the next few years.

Honam: SOTP valuation Initiation: fully Honam (parent) operating value (Wbn) 11,172 EBITDA (Wbn) 1,299 exposed to the upcycle EV/EBITDA multiple (x) 8.6 KOSPI average

Value of equity holdings (Wbn) 4,253 Lotte E&C (Wbn) 768.6 3Q11 BV We expect Honam to be the key KP Chemical (Wbn) 866.2 Market value beneficiary of the strong upcycles in EG Titan Chemicals (Wbn) 2,232.1 6.9x of FY12 EBITDA Others (Wbn) 386.5 3Q11 BV and BD spreads and the recovery in the PE/PP spread. Honam is our top pick in Enterprise value (Wbn) 15,426 Less net debt (Wbn) 412.4 the sector. Fair market cap (Wbn) 15,014

Valuation Target price (W) 470,000 Source: Company, Daiwa forecasts

We initiate coverage of Honam with a Buy (1) rating Honam: 12-month forward PER bands and six-month target price of W470,000. Our target (( price is based on our SOTP valuation. (W) 500,000

We apply the current KOSPI market average 400,000 EV/EBITDA multiple of 8.6x as the target multiple for 300,000 Honam’s parent’s petrochemical business. The 200,000 petrochemical stocks have traded below the average valuations of the KOSPI, mainly due to the 100,000 unpredictability of a downcycle. However, we expect 0 the limited NCC and downstream capacity expansion (100,000) until 2014, and a demand recovery resulting from 2004 2005 2006 2007 2008 2009 2010 2011 2012 monetary easing in China, to ensure that Honam’s Price 3.0x 6.5x 9.8x 13.0x supply-demand dynamics remain favourable and reduce the downcycle risk. For these reasons, we Source: DataGuide, Daiwa forecasts believe Honam’s parent’s business deserves to be valued at the average level of the KOSPI. Honam: 12-month forward PBR bands (W) For Titan Chemicals (Titan) (Not listed), we apply an 500,000 EV/EBITDA of 6.9x on our 2012 forecasts as the target 400,000 multiple. This is at a 20% discount to Honam’s parent’s business, given that Titan does not produce EG or BD, 300,000 which we expect to have the strongest spreads among 200,000 petrochemical products this year. 100,000

For KP Chemical, in which Honam owns a 51.9% stake, 0 we apply the current market value of the stake. 2004 2005 2006 2007 2008 2009 2010 2011 2012 Price .3x .9x 1.4x 2.0x 2.5x Based on our 2012 forecasts, the stock is currently trading at a PER of 10.2x and a PBR of 1.8x, levels that Source: DataGuide, Daiwa forecasts are close to all-time highs. Although the current valuation may seem demanding, we believe that Honam deserves to trade at a PER valuation higher than the peak level in 1H11 (a PER of 12.9x) and near its peak 1H11 PBR of 2.5x, given that we believe: 1) the current strong upcycle in EG and BD spreads is

- 26 - Korea Petrochemical Sector 24 February 2012

Honam: 12-month forward EV/EBITDA bands Formosa Group: production capacity (Wbn) Company Product Capacity FPCC CDU_ 540 15,000 (Formosa Petrochemical) RFCC 168 13,000 (RCC No.1) 84 11,000 (RCC No.2) 84

9,000 VDU_ 80

7,000 Coker(DCU) 37

5,000 Ethylene 2,935

3,000 (NCC No.1) 700

1,000 (NCC No.2) 1,035

(1,000) (NCC No.3) 1,200

Propylene 2,367 (3,000) 2004 2005 2006 2007 2008 2009 2010 2011 2012 Butadiene 447 FPC HDPE/LLDPE 830 EV 1.0x 3.0x 5.0x 7.0x (Formosa Plastics) LDPE/EVA 240 Source: DataGuide, Daiwa forecasts PP 400 Caustic Soda 1,600 Honam: group structure VCM 1,580 PVC Resin 1,301 Lotte Holdings Nan Ya Plastics MEG 1,320 (Japan) BPA 420

2EH 200 100% 68.9% FCFC PTA 2,200 Hotel Lotte 31.1% Lotte Moolsan (Formosa Chemical & Fibre) PX 1,720 Benzene 1,280 10% SM 1,200 13.6%Honam 33.6% Petrochemical PP 510 ABS 410

31.2% 51.9% 50% 100% 50% Phenol 400 Titan PC 200 Lotte E&C KP Chemical Seetec DMMA Chemicals Source: Companies, Daiwa

100% 75% Note: in ‘000 tonne/year Lotte LPPTA Chemical UK Over the past five years, Honam has traded at an Source: Company, Daiwa average discount of 37% to Formosa Plastics, in terms of PER. However, the valuation gap between the two Valuation gap should narrow companies has narrowed in recent years as: 1) Honam’s plants have operated without any issues, while with Formosa Formosa’s have had to be stopped seven times since 2010 for unexpected repairs to its plants, and 2) As one of the largest pure-chemical companies in Korea, Honam produces EG and BD, which have had the Honam is often compared with Formosa Plastics (Not strongest spreads. We believe the gap in the PERs of rated), which is part of the Formosa Group, the the two companies will narrow further, given that the petrochemical conglomerate in Taiwan. medium- to long-term earnings-growth momentum we expect from Southeast Asia as a result of the Honam’s Formosa Group: structure Titan acquisition should outpace that for Formosa Formosa Formosa Nan Ya Formosa Chemicals & Plastics in the area. Plastics Plastics Taffeta Fibre 29.3% 23.8% 24.9% 3.7%

Formosa Petrochemical

100% 88% Formosa Formosa Oil Petrochemical (Asia Pafific) Transportation Source: Company

- 27 - Korea Petrochemical Sector 24 February 2012

Honam vs. Formosa Plastics: operating profit (YoY) Honam vs. Formosa Plastics: 12-month forward EV/EBITDA

180% (x) 160% 15 140% 13 120% 11 100% 80% 9 60% 7 40% 5 20% 3 0% 1 (20%) (1) 2010 2011E 2012E 2013E 2005 2006 2007 2008 2009 2010 2011 2012

Honam OP (% YoY, Parent) Formosa Plastics OP (% YoY, Parent) Honam Petrochemical Formosa Plastics

Source: Companies, Bloomberg (for Formosa), Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Honam vs. Formosa Plastics: 12-month forward PER (x) Parent’s 2012 earnings should 30

25 remain at the 2011 all-time high

20 level

15 We expect Honam’s parent-based operating profit in 10 2012 to be similar to that for 2011, which we do not 5 regard as disappointing, given that: 1) the 2011 0 operating profit was an all-time high, and 2) we expect 2005 2006 2007 2008 2009 2010 2011 2012 this level of operating profit to continue until at least Honam Petrochemical Formosa Plastics 2013, driven by solid supply-demand dynamics from

Source: Bloomberg, Daiwa forecasts limited capacity additions and a demand recovery as a result of monetary easing in China. Honam vs. Formosa Plastics: 12-month forward PBR

(x) On consolidated basis, we forecast the company’s 2012 operating profit to decline by around 9% YoY, mainly 4.0 due to a drop in KP Chemical’s earnings. 3.5 3.0 2.5 In 1H11, KP Chemical’s earnings rose strongly YoY, due 2.0 to the strong TPA spread. However, we forecast the 1.5 TPA spread to fall from US$233/tonne for 2011 to 1.0 US$125/tonne this year, affected by large TPA capacity 0.5 additions. 0.0 2005 2006 2007 2008 2009 2010 2011 2012 We expect the operating-profit contribution from Titan Honam Petrochemical Formosa Plastics to improve this year, on the back of a turnaround in the Source: Bloomberg, Daiwa forecasts PE/PP spread. We forecast revenue from PE/PP to account for more than 60% of Titan’s total 2012 revenue.

- 28 - Korea Petrochemical Sector 24 February 2012

Honam: operating profit and operating-profit margin (parent) Honam: capacity (Yeosu plant)

(Wbn) HDPE (380) (+250) 1,600 16% MEG (400) PET (70) 1,400 14% Ethylene (750) EO 1,200 12% (+250) EOA (130) 1,000 10%

800 8% PC (80) 600 6% Propylene PP (380) (380) 400 4% (+200) (+125) 200 2% BD (130) (+20) 0 0% Mixed C4 2009 2010 2011E 2012E 2013E MMA (50) PMMA (40) OP OPM (%) DMMA Source: Company, Daiwa forecasts BZ (165)

Pyrolysis TL (78) Honam: operating-profit breakdown (consolidated) Gasoline

(Wbn) XL (47) 2,000 Source: Company Notes: Figures in brackets show annual capacity in ’000 tonnes. Figures outside of boxes 1,500 denote the expansion capacity planned in 2012.

1,000 Honam: capacity (Daesan plant)

500 LDPE (130)

0 Ethylene LLDPE (290) 2011E 2012E 2013E (1000) Honam (parent) KP Chemical Titan (+100) EO MEG (640) Source: Company, Daiwa forecasts Note: KP Chemical includes KP Chemical subsidiaries including LCUK and LPPTA Propylene PP (500) (500) Exposed to strong upcycles in EG (+50) and BD spreads BD (150) Mixed C4

Honam is one of the largest pure-chemical makers in PMMA (90) Korea. The company’s product portfolio includes DMMA PE/PP, EG, and BD. Pyrolysis BZ (320) SM (500) Gasoline Honam: sales breakdown by product (2011E) Others Source: Company BD 6.0% PE Notes: Figures in brackets show annual capacity in ’000 tonnes. Figures outside of boxes denote the expansion capacity planned in 2012. 10.0% 19.0%

We expect EG and BD, which account for about 30% of Honam’s petrochemical-business sales, to have the NC/BTX 16.0% strongest spreads among petrochemical products this PP year. In addition, the spread for PE/PP, which accounts 19.0% for about 40% of the company’s revenue, should recover this year. SM 10.0% EO&EG Operating profit and key petrochemical-product spreads 20.0% (Wbn, US$/tonne) 2009 2010 2011 2012E 2013E Source: Daiwa forecasts Operating profit (parent) 718 904 1,031 1,096 1,360 EG-ethylene spread 61 183 410 435 490 BD-naphtha spread 468 1,180 1,999 2,240 2,561 HDPE-ethylene spread 231 98 131 205 300 Source: Cischem, Daiwa forecasts

- 29 - Korea Petrochemical Sector 24 February 2012

Key subsidiaries Unlike KP Chemical, we expect Titan’s 2012 operating profit to be higher than that for 2011, due to a better Honam’s key subsidiaries, which are included in its PE/PP spread. We forecast revenue from PE/PP to consolidated earnings, are Korea’s KP Chemical and account for more than 60% of Titan’s total 2012 Malaysia’s Titan Chemicals. KP Chemical’s main revenue. products are TPA and PET, while Titan manufactures mostly PE/PP. (Titan also produces some other NCC Titan: capacity downstream products.) Malaysia capacity LDPE (230) Despite the strong demand for polyester, we do not believe the outlook for TPA is bright, given that there is Ethylene HDPE(115) a significant TPA capacity expansion under way. We (720) expect weak earnings from KP Chemical, due to an oversupply of TPA, to be the main cause of a decline in HD/LLD (220) Honam’s consolidated operating profit in 2012. Propylene PP (480) (480) KP Chemical: capacity 115KTA of Metathesis plant

P-Xyl (720) PTA (950) MEG (434) Mixed C4 BD (100)

Meta Xyl(160) PIA (200) Pyrolysis BTX (220) O-Xyl (255) Gasoline

Benzene (102) Ulsan Complex Capacity (Korea) HD/LLD (450)

PTA (500) PET (150) Indonesia capacity LCUK Capacity (UK)

PTA (500) Source: Company Note: Figures in brackets show annual capacity in ’000 tonnes LPPTA Capacity (Pakistan)

Source: Company Note: Figures in brackets show annual capacity in ’000 tonnes Risks

KP Chemical: sales breakdown by product (2010) No improvement likely in China consumption Others 10.0% We estimate that about 30-40% of the Korea PTA petrochemical companies’ sales are to China. Hence, 27.0% the companies’ earnings are affected by the economic conditions in the country. Although Daiwa forecasts BTX monetary easing in China throughout 2012, unexpected 27.0% inflation in the country and a resultant slowdown in monetary easing could affect the earnings of the Korea PIA 9.0% petrochemical players. In particular, as Honam is a pure petrochemical player with significant exposure to demand from China, we believe Honam is the most PET 27.0% vulnerable company in our coverage universe to an Source: Company unexpected slowdown in or reversal of monetary easing in China.

A sharp decline in the crude-oil price A significant drop in the crude-oil price could lead traders and end-users to delay purchases of petrochemical products, on expectations that the price might fall further.

- 30 -

Materials / Korea 24 February 2012

LG Chem Target price: W490,000 Up/downside: +20.7% 051910 KS Share price (23 Feb): W406,000

Initiation: growth story continues

• New LCD glass business should generate solid earnings growth with a healthy operating-profit margin going forward • Despite the pause in 2011, the long-term EV battery business growth story remains intact

• Petrochemical business should benefit partially from the current robust cycle

How do we justify our view?

high operating-profit margin of over respectively, lower than the 30% on the back of high entry Bloomberg consensus forecasts, due barriers, and 2) LG Chem has LG to our less favourable outlook for Display (LGD) (034220 KS, PVC spreads (on the back of the

W28,600, Hold [3]) as its captive sluggish construction market in Jihye Choi client. China). (82) 2 787 9121 [email protected] We also believe the mid-large size Share price performance Jun Yong Bang battery business for HEVs/EVs is (W) (%) (82) 2 787 9168 620,000 150 [email protected] another growth engine for LG Chem. According to the company’s 530,000 130 guidance, its mid-large size battery 440,000 110 What's new sales will increase to W800bn for 350,000 90 2012 (from W300bn last year), 260,000 70 We believe LG Chem’s share price Feb-11 May-11 Aug-11 Nov-11 Feb-12 thanks to contracts with various will be driven by its new LCD glass LG Chem (LHS) Relative to KOSPI (RHS) substrate business and existing IT & automakers including General electronic materials (I&E) business. Motors (GM US, US$26.79, Hold 12-month range 285,000-567,000 [3]) and Renault (Not rated). Market cap (US$bn) 26.28 What's the impact Although global sales of HEV/EVs Average daily turnover (US$m) 129.29 Being a leading hybrid-chemical were slower than expected in 2011, Shares outstanding (m) 73 company in Korea, LG Chem’s share we believe the mid-long term Major shareholder LG Corp (30.1%) price depends on the growth outlook outlook for the mid-large size for its new businesses, including battery business is still promising. Financial summary (W) glass substrates and HEV/EV Year to 31 Dec 11E 12E 13E Revenue (bn) 22,682 23,928 24,065 batteries. We expect What we recommend We initiate coverage of LG Chem Operating profit (bn) 2,802 2,790 3,199 commercialisation of the LCD glass Net profit (bn) 2,148 1,942 2,252 business and a rise in HEV/EV with a Buy (1) rating and six-month target price of W490,000, based on Core EPS 29,384 26,568 30,817 battery sales to give investors EPS change (%) (0.5) (9.6) 16.0 greater conviction in LG Chem’s our SOTP valuation. We value the Daiwa vs Cons. EPS (%) 0 (22) (23) long-term growth story. new businesses using a DCF PER (x) 13.8 15.3 13.2 methodology and apply an Dividend yield (%) 1.0 1.2 1.2 We are upbeat about LG Chem’s EV/EBITDA multiple of 7.7x (a 10% DPS 4,000 5,000 5,000 new LCD glass substrate business, discount to the KOSPI average) to PBR (x) 3.2 2.7 2.3 which will be commercialised in the petrochemical business. EV/EBITDA (x) 8.6 8.4 7.3 2H12. We expect the glass business ROE (%) 25.3 19.1 18.9 to be a new growth driver for LG How we differ Source: Bloomberg, Daiwa forecasts

Chem as: 1) this business enjoys a Our 2012 and 2013 operating profit forecasts are 8% and 14%,

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Korea Petrochemical Sector 24 February 2012

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook LG Chem: operating profit trend (IFRS)

We expect LG Chem’s consolidated operating profit this (Wbn) year to be almost similar to that for last year, as we 3,500 expect healthy earnings from the I&E business to offset 3,000 slower earnings at the petrochemical business. 2,500 We forecast the new glass business to contribute W30bn 2,000 to the company’s operating profit for 2012 (through 1,500 prudence, we have not included the operating profit for the glass business in our earnings assumptions). 1,000 Another new business, mid-large size batteries, should 500 be a mid-long term earnings growth driver for LG 0 2009 2010 2011 2012E 2013E Chem, irrespective of the current slow sales of GM’s Volt (plug-in type electric car). Source: Company, Daiwa forecasts Note: 2009 data is based on K-GAAP (parent), whereas 2010 and onward figures are based on IFRS (consolidated)

LG Chem: 12-month forward PER bands vs. operating profit Valuation trend

The stock is trading currently at a 2012E PER of 15.3x (W) (( (Wbn) and a 2012E PBR of 2.7x, slightly below its past-five- 600,000 3,500 year peak PER of 17.0x and PBR of 3.7x. We believe its 500,000 current valuation is attractive given: 1) earnings 2,500 400,000 expansion that we see for the I&E business, 2) new business momentum that we expect from 2012E, and 3) 300,000 1,500 200,000 resilient earnings at the petrochemical business. 500 100,000 0 (500) 2004 2005 2006 2007 2008 2009 2010 2011 2012 Operating profit (parent, RHS) Price 3.0x 8.0x 12.0x 16.0x Source: Company, DataGuide, Daiwa forecasts

LG Chem: 2012-13 operating profit forecasts (Daiwa vs. Earnings revisions consensus)

Our operating profit forecasts for LG Chem for 2012 and (Wbn) 2013 are 13% and 14%, respectively, lower than those of 4,000 the Bloomberg consensus, which we attribute to our less 3,500 favourable outlook for PVC spreads (due to the sluggish 3,000 construction market in China). 2,500 2,000 1,500 1,000 500 0 2012E 2013E Daiwa forecast Bloomberg consensus

Source: Bloomberg, Daiwa forecasts Note: Bloomberg consensus is for the past 28 days

- 32 - Korea Petrochemical Sector 24 February 2012

Financial summary

Key assumptions Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Ethylene-Naphtha (US$/tonne) 588 490 331 314 354 245 216 300 HDPE-Ethylene (US$/tonne) 38 110 242 215 95 141 205 300 LDPE-Ethylene (US$/tonne) 49 228 394 267 340 386 218 300 PP-Propylene (US$/tonne) 66 129 78 98 74 42 65 100 EG-Ethylene (US$/tonne) 100 339 152 71 180 416 435 490 PVC spread (US$/tonne) 264 335 449 351 423 474 418 470 ABS spread (US$/tonne) 306 340 292 335 370 222 270 359

Profit and loss (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Petrochem 5,612 6,510 9,934 9,477 14,525 17,336 17,441 16,930 I&E 1,597 2,133 2,696 4,181 4,903 5,187 6,486 7,135 Others 2,094 2,152 15 37 43 159 0 0 Total revenue 9,302 10,795 12,645 13,695 19,471 22,682 23,928 24,065 Other income 532 464 423 434 1,118 757 857 907 COGS (7,965) (8,982) (10,506) (10,876) (15,473) (18,586) (19,715) (19,300) SG&A (1,003) (1,050) (795) (874) (1,159) (1,294) (1,423) (1,566) Other op. expenses (532) (464) (423) (434) (1,136) (757) (857) (907) Operating profit 334 764 1,344 1,945 2,821 2,802 2,790 3,199 Net-interest inc./(exp.) (80) (62) (35) (8) (35) (32) (39) (45) Assoc/forex/extraord./others 141 121 (64) 48 32 (155) (188) (182) Pre-tax profit 395 822 1,245 1,984 2,818 2,615 2,563 2,973 Tax (77) (121) (300) (445) (619) (624) (615) (713) Min. int./pref. div./others 0 (15) 57 (33) (42) 156 (6) (7) Net profit (reported) 319 686 1,003 1,507 2,158 2,148 1,942 2,252 Net profit (adjusted) 319 686 1,003 1,507 2,158 2,148 1,942 2,252 EPS (reported) (W) 4,362 9,389 13,718 20,621 29,530 29,384 26,568 30,817 EPS (adjusted) (W) 4,362 9,389 13,718 20,621 29,530 29,384 26,568 30,817 EPS (adjusted fully-diluted) (W) 4,362 9,389 13,718 20,621 29,530 29,384 26,568 30,817 DPS (W) 1,000 2,000 2,500 3,500 4,000 4,000 5,000 5,000 EBIT 334 764 1,344 1,945 2,821 2,802 2,790 3,199 EBITDA 866 1,227 1,768 2,379 3,493 3,559 3,647 4,107

Cash flow (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Profit before tax 395 822 1,245 1,984 2,818 2,615 2,563 2,973 Depreciation and amortisation 532 464 423 434 672 757 857 907 Tax paid (77) (121) (300) (445) (619) (624) (615) (713) Change in working capital (424) (462) (694) 438 (1,849) 370 (160) (180) Other operational CF items 291 296 294 (302) 1,485 (507) (175) (179) Cash flow from operations 718 999 969 2,109 2,507 2,612 2,469 2,807 Capex (527) (451) (773) (943) (1,617) (2,236) (2,465) (1,725) Net (acquisitions)/disposals (58) (7) 6 (63) (295) (15) (14) (13) Other investing CF items (18) (79) (19) 76 290 0 0 0 Cash flow from investing (603) (536) (786) (930) (1,622) (2,251) (2,480) (1,739) Change in debt (248) (221) 36 (537) 1,235 7 (235) (139) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (91) (73) (167) (209) (280) (292) (292) (365) Other financing CF items (30) (13) (145) 271 (1,579) 0 0 0 Cash flow from financing (369) (307) (276) (476) (624) (285) (527) (505) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (255) 156 (93) 703 261 75 (538) 564 Free cash flow 190 549 196 1,166 890 376 4 1,082

Source: Company, Daiwa forecasts

- 33 - Korea Petrochemical Sector 24 February 2012

Financial summary continued …

Balance sheet (Wbn) As at 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Cash & short-term investment 122 573 522 963 1,376 1,206 669 1,232 Inventory 869 1,168 1,509 1,341 2,182 2,622 2,760 2,895 Accounts receivable 864 1,026 1,157 1,228 2,602 2,041 2,154 2,166 Other current assets 94 95 130 126 131 174 209 247 Total current assets 1,949 2,862 3,317 3,657 6,292 6,043 5,791 6,540 Fixed assets 3,099 3,622 3,868 3,860 5,872 7,435 9,128 10,031 Goodwill & intangibles (213) (183) (113) (97) 180 0 0 0 Other non-current assets 971 749 965 939 330 292 363 433 Total assets 5,807 7,050 8,036 8,359 12,673 13,771 15,282 17,004 Short-term debt 465 366 575 455 1,621 1,466 1,373 1,374 Accounts payable 751 749 527 868 1,235 1,484 1,574 1,541 Other current liabilities 657 915 1,060 942 1,422 630 630 630 Total current liabilities 1,873 2,030 2,162 2,265 4,277 3,579 3,577 3,545 Long-term debt 1,116 994 821 404 473 635 493 353 Other non-current liabilities 200 148 163 205 79 14 14 14 Total liabilities 3,189 3,172 3,147 2,874 4,830 4,229 4,084 3,912 Share capital 365 420 420 370 370 370 370 370 Reserves/R.E./others 2,252 3,459 4,470 5,115 7,334 9,002 10,628 12,488 Shareholders' equity 2,617 3,878 4,890 5,484 7,703 9,372 10,998 12,858 Minority interests 0 0 0 0 140 171 200 234 Total equity & liabilities 5,807 7,050 8,036 8,359 12,673 13,771 15,282 17,004 EV 30,255 29,826 29,747 28,728 30,318 30,454 30,716 29,977 Net debt/(cash) 1,459 787 875 (104) 718 894 1,197 494 BVPS (W) 35,218 52,471 66,311 74,518 104,881 127,709 149,954 175,404

Key ratios (%) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Sales (YoY) 25.3 16.0 17.1 8.3 42.2 16.5 5.5 0.6 EBITDA (YoY) 9.1 41.7 44.0 34.6 46.9 1.9 2.5 12.6 Operating profit (YoY) (20.8) 128.7 76.0 44.7 45.1 (0.7) (0.4) 14.7 Net profit (YoY) (20.4) 115.3 46.1 50.3 43.2 (0.5) (9.6) 16.0 EPS (YoY) (20.4) 115.3 46.1 50.3 43.2 (0.5) (9.6) 16.0 Gross-profit margin 14.4 16.8 16.9 20.6 20.5 18.1 17.6 19.8 EBITDA margin 9.3 11.4 14.0 17.4 17.9 15.7 15.2 17.1 Operating-profit margin 3.6 7.1 10.6 14.2 14.5 12.4 11.7 13.3 ROAE 12.8 21.4 23.1 29.3 32.9 25.3 19.1 18.9 ROAA 5.6 10.7 13.3 18.4 20.5 16.2 13.4 14.0 ROCE 7.9 16.2 23.3 30.8 34.7 26.0 22.6 22.9 ROIC 6.6 14.9 19.6 27.1 31.6 22.5 18.6 18.7 Net debt to equity 55.8 20.3 17.9 net cash 9.3 9.5 10.9 3.8 Effective tax rate 19.4 14.7 24.1 22.4 22.0 23.9 24.0 24.0 Accounts receivable (days) 27.7 32.0 31.5 31.8 35.9 37.4 32.0 32.8 Payables (days) 26.4 25.4 18.4 18.6 19.7 21.9 23.3 23.6 Net interest cover (x) 4.2 12.3 38.0 241.3 81.6 88.5 72.2 71.6 Net dividend payout 22.9 21.3 18.2 17.0 13.5 13.6 18.8 16.2 Source: Company, Daiwa forecasts

Company profile LG Chem is the largest petrochemical company in Korea by revenue. It operates two main divisions: chemicals and IT and electronic materials (I&E). The company’s earnings structure is shifting from petrochemical products to advanced chemical materials for the IT and electronic material segments. We expect its I&E division to record substantial sales growth in the future, as the automobile LiB and TFT-LCD glass-substrate businesses are rolled out by LG Chem.

- 34 - Korea Petrochemical Sector 24 February 2012

petrochemical cycle. We also apply a 7.7x EV/EBITDA target multiple to value the I&E business. We value LG Chem’s new businesses together at W8.6tn (W2.7tn for mid-large size batteries and W5.9tn for LCD glass), derived using a DCF methodology.

Growth story continues LG Chem: SOTP valuation (Wbn) Total operating value 36,871 Petrochemical business value 20,286 We are positive about LG Chem’s new EBITDA 2,621 LCD glass and HEV/EV battery Multiple (x) 7.74 10% discount to KOSPI businesses, as well as its existing I&E I&E material business value 7,940 EBITDA 1,026 business, and initiate coverage with a Multiple (x) 7.74 10% discount to KOSPI Buy (1) rating. New businesses 8,645 EV battery 2,685 DCF Glass 5,960 DCF Valuation Value of equity holdings 265 3Q11 book value We initiate coverage of LG Chem with a Buy (1) rating Enterprise value 37,137 and six-month target price of W490,000, based on our Less net debt 1,197 SOTP valuation. We apply an EV/EBITDA target multiple of 7.7x to value the petrochemical business, Fair value 35,940 representing a 10% discount to our multiple of 8.6x Target price (W) 490,000 applied to Honam’s petrochemical business, as we Source: Company, Daiwa forecasts expect Honam’s petrochemical products to benefit more than LG Chem’s from a an upswing in the

LG Chem: valuation of EV-battery business (W bn) 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E Sales 800 1,600 2,400 3,200 3,360 3,528 3,704 3,890 4,084 4,288 4,503 Operating profit 40 80 144 192 202 212 222 233 245 257 270 Operating-profit margin (%) 5.0 5.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

FCF -289 195 221 239 231 225 223 222 224 227 231 Present value of FCF -289 176 181 177 155 137 122 111 101 92 85

Terminal value 4,433 Terminal growth rate 5% Present value of terminal value 1,637

Car battery business value 2,685 Source: Company, Daiwa forecasts

LG Chem: valuation of glass business (W bn) 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E Sales 125 594 1,063 1,531 2,000 2,060 2,122 2,185 2,251 2,319 2,388 Operating profit 31 178 319 536 700 721 743 765 788 811 836 Operating-profit margin (%) 25.0 30.0 30.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0 35.0

FCF - 421 - 235 - 66 150 843 807 780 761 749 742 739 Present value of FCF - 421 - 213 - 54 111 566 490 429 379 337 302 273

Terminal value 10,183 Terminal growth rate 3% Present value of terminal value 3,760

Glass business value 5,960 Source: Company, Daiwa forecasts

- 35 - Korea Petrochemical Sector 24 February 2012

LG Chem: 12-month forward PER bands Correlation between LGD’s operating profit vs. LG Chem’s I&E (( business operating profit (QoQ) (W) (Wbn) (Wbn) 550,000 1,500 250 450,000 350,000 1,000 200

250,000 500 150 150,000 0 100 50,000 (50,000) (500) 50

2004 2005 2006 2007 2008 2009 2010 2011 2012 (1,000) 0 Price 3.0x 8.0x 2010 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 12.0x 16.0x LGD LG Chem (I&E, RHS)

Source: DataGuide, Daiwa forecasts Source: Companies, Daiwa forecasts

LG Chem: 12-month forward PBR bands However, as we expect global IT demand to bottom out (W) from this year, we expect LG Chem’s I&E business 550,000 earnings to improve in 2012. 450,000 350,000 LG Chem’s I&E business: operating-profit and operating-profit 250,000 margin

150,000 (Wbn) 50,000 800 14% (50,000) 700 12% 2004 2005 2006 2007 2008 2009 2010 2011 2012 600 10% 500 Price .3x 1.0x 8% 400 1.8x 2.5x 3.2x 6% 300 Source: DataGuide, Daiwa forecasts 200 4% 2% LG Chem: 12-month forward EV/EBITDA bands 100 0 0% (Wbn) 2009 2010 2011 2012E 2013E 40,000 35,000 OP OPM (%) 30,000 Source: Company, Daiwa forecasts 25,000 20,000 Global handset/smartphone sales trend 15,000 (m) 10,000 5,000 2,500 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2,000

EV 2.0x 4.0x 1,500 6.0x 8.0x 10.0x 1,000 Source: DataGuide, Daiwa forecasts 500 I&E business: we expect solid 0 2009 2010 2011E 2012E 2013E earnings growth Handset Smartphone

Source: Industry and company sources, Daiwa forecasts Small-size batteries (for consumer electronics) and LCD polarising plates, key products for the company’s I&E division, were affected adversely by slowing demand in 2011.

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LG Display: global shipment trend and forecasts

('000 substrates) LCD glass substrate should be the 90,000 key growth engine 80,000 70,000 Unlike the market’s sceptical outlook for the company’s 60,000 50,000 LCD-glass-substrate business, we believe its glass 40,000 business will generate strong sales growth, led by the 30,000 business’s high profitability and captive demand. 20,000 10,000 We believe the high entry barriers, as a result of 0 technological challenges, will allow the business to 2006 2007 2008 2009 2010 2011E 2012E 2013E yield an elevated operating-profit margin of 25-35% Smartbook Notebook LCD monitor LCD TV Others once it becomes fully commercial, which we expect Source: Company, Daiwa forecasts from 2H12. We consider it positive that other glass makers recorded operating-profit margins of around LG Chem: small-size LiB capacity 20-65% for 2011, when the display makers (the end ('000 cells/month) 2009 2010 2011 2012E Cylindrical 34,500 34,500 34,500 34,500 users) suffered operating losses. Prismatic 23,500 29,500 32,500 32,500 Polymer 7,000 10,000 14,000 18,000 LCD glass makers: comparison (unit: LCY bn) Samsung Corning Corning Asahi Glass NEG Source: Company, Daiwa forecasts Note: as of year-end Country Korea US Japan Japan Type Fusion Fusion Floating Fusion Global small-size LiB market shares (1H11) Sales 5,167.8 7.9 386.5 289.3 Op. profit 3,503.5 1.7 133.5 73.3 OP margin 67.8% 21.4% 34.5% 25.3% Others Samsugn SDI Fiscal year 2010 2011 2011 2011 26.5% 25.3% Business LCD business Total business Electronics & Electronic and (Display contributes Display information 45% of sales) devices Source: Bloomberg, Company, Daiwa Note: Samsung Corning has not released its FY11 earnings yet.

Panasonic 4.6% LCD glass production type comparison LG Chem Type Floating Fusion Sony 17.3% 7.9% Company Schott, Asahi Glass, LG Chem Corning, NEG Strength Easy to make large-size glass Additional process not necessary Sanyo Weakness One more additional process necessary Not easy to make large-size glass 18.4% Technology Forms glass in a large furnace by Involves vertical stretching in a small Source: Hankyung, Daiwa continuously supplying molten glass on furnace to form glass. Allows more flat molten tin, and stretching it horizontally and clear glass Global polarising-plate market shares (TFT-LCD, 1H11) Source: Companies, Daiwa

Cheil Industry Others 4.8% 3.2% Another key advantage of LG Chem’s glass business is CCMT Nitto Denko that it has a captive end-user (LGD). We believe LG 7.1% 26.2% Chem is able to sell most of its glass substrate to LGD, BQM (Daxon) which purchased W2.6tn of the product in 9M11. 8.6%

With plans to expand to seven production lines in the next few years, LG Chem targets to supply 50% of LGD’s demand in 2016. Assuming a 30% operating- profit margin for the business, we forecast that it will LG Chem Sumitomo 27.2% 22.9% take five years to pay back the investment in one production line, which generally requires W350bn.

Source: Various news sources including KBench

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LG Chem: plan for glass business LiB market forecasts 2009 2011 2012 E 2016E (US$bn) Capacity plan (no. of production lines) 1 line 7 lines 70 Capacity (m) 5.0m2/year 50m2/year

Investment (Wbn) 500 2,600 60 13% CAGR

Sales (Wbn) 125 2,000 50 Operating-profit margin 25% 35% 24% CAGR 40 LGD’s market share 10% 40-50% Global market (Wtn) 11 17 30

Source: Company, Daiwa forecasts 20 10 According to the company’s guidance, the No.1 glass 0 production line will be operational for the 2010 2011E 2012E 2013E 2014E 2015E 2020E commercialisation of the glass business from 2H12 (the Auto Grid Reserve power Consumer electronics line is currently being tested by LGD). We forecast LG Source: Daiwa forecasts Chem’s glass sales to reach W125bn for 2012. Pranab now forecasts the global LiB market to record a LG Chem’s glass business: sales and operating profit 19% revenue CAGR and 28% volume CAGR between forecasts 2010 and 2020, to reach US$60bn/236GWh by 2020, driven mainly by stationary batteries and eco cars. (Wbn) 1,800 40% Our forecasts represent a 4-fold increase over 1,600 35% estimated 2011 levels by value, and an 8.8-fold increase 1,400 30% 1,200 in terms of capacity. 25% 1,000 20% 800 EV/HEV demand trend 15% 600 (000 units) 400 10% 12,000 200 5% 0 0% 10,000 2012E 2013E 2014E 2015E 8,000

Sales OP OPM (%) 6,000

Source: Company, Daiwa forecasts 4,000

2,000 Mid-large size batteries for HEVs/ 0 06 07 08 09 10 11E 12E 13E 14E 15E 20E EVs: bright long-term outlook HEV PHEV EV Long-term growth story looks intact Source: Various sources compiled by Daiwa, Daiwa forecasts

Following on the analysis by Daiwa’s regional Li-ion battery market outlook chemicals/materials analyst, Hidemitsu Umebayashi, 2011E 2020E Shift to automotive Li-ion batteries necessary for Li-ion battery demand (US$bn) 14.2 60.8 firms to survive and grow, Daiwa’s head of solar, Consumer-electronics batteries 11.5 15.1 Pranab Kumar Sarmah, recently augmented the Automotive batteries 1.5 25.2 ESS 1.1 20.2 forecasts for the lithium-ion battery (LiB) market to Total battery capacity (GWh) 26.7 236.6 include the energy storage sector (ESS). Consumer-electronics batteries 22.9 44.5 Automotive batteries 1.5 82.9 ESS 2.2 109.2 Green car demand (‘000 units) 1,190 10,400 HEV 1,100 6,100 PHEV 5 1,800 EV 85 2,500 Source: Various sources compiled by Daiwa, Daiwa forecasts Note: Original forecast was based on ¥. US$-¥ conversion currency was US$1.28=¥100

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We expect automotive applications to drive battery LG Chem: HEV/EV battery supply contracts demand. We forecast the size of the automotive battery Signing Date Customers Country market to reach US$25bn or 83GWh by 2020, far 7-Dec Hyundai Motor-Avante Hybrid Korea Kia Motors's Forte Hybrid Korea outstripping the market for consumer electronics 9-Jan GM's Volt US applications. For 2020, we project global shipments of 9-Oct CT&T's urban Evs Korea 2.5m EVs, which require high-capacity batteries. We 10-Jan Eaton's commercial vehicles US see significant room for cost reductions in battery 10-Feb Changan Auto China 10-Apr Volvo's EVs Sweden production and other areas, making EVs a cost- 10-Jul Ford's Focus US effective alternative (even without subsidies) to 10-Sep Renault's EVs France gasoline-powered vehicles from 2015 to 2020, which 11-Apr FAW China should accelerate their popularity. Source: Company, various news sources including MBN

In his 23 February report on Pan-Asia energy storage, The company also gave guidance for an improvement LiBs: the missing link, Pranab highlights that LG Chem in sales of mid-large size batteries based on the has the most advanced auto LiB technology and could contracts it has won for this year (W800bn in 2012, up potentially become the leading motive battery player in from W330bn in 2011). We estimate the mid-large size Asia. We see a long-term structural growth story for battery operating profit was just over the breakeven LG Chem’s battery business, and forecast the point in 2011; we forecast a 5% operating-profit margin company’s revenue from this business to rise at a 76% for this business in 2012. CAGR for 2011-15. LG Chem: HEV/EV battery sales forecast Weak GM Volt sales in 2011 not a concern (Wbn) LG Chem is one of the global leaders in the mid-large 900 size battery market for HEVs/EVs. While our mid-long 800 term outlook for this business is positive, we note that 700 sales of GM’s Volt (plug-in vehicle) were disappointing 600 500 in 2011. (Our initial expectations for GM’s Volt sales +142% YoY were for 15,000 units, but only 7,671 units were sold in 400 2011.) We believe the disappointing sales were due 300 mainly to a still immature HEV/EV market and the 200 product’s initial stage noise, including the safety issue. 100 0

2011 2012E Daiwa forecast However, we believe HEV/EV sales should eventually Source: Company, Daiwa forecast achieve sizeable growth on the back of: 1) structural industry growth, 2) technology developments, and 3) sales price competiveness along with cost reductions. Petrochemical: partial As the HEV/EV market expands, we see LG Chem beneficiary of solid cycle benefiting the most among its domestic peers, given its diversified customer base. (LG Chem has battery Although we envisage a solid overall petrochemical supply contracts with 10 global auto companies, cycle in 2012, we expect LG Chem to benefit only including GM and Renault.) partially from this.

GM’s Volt: sales trend (monthly) Based on the supply-demand outlook, we expect ABS (Unit) spreads to enjoy some recovery but PVC spreads to 1,800 remain sluggish. (ABS and PVC are two of the key 1,600 products for LG Chem.) 1,400 1,200 1,000 Given that LG Chem enjoyed a very favourable 800 petrochemical cycle in 1H11 as a result of the rise in oil 600 prices, the company’s average petrochemical spread 400 200 this year is likely to be a little weaker than last year, 0 regardless of the ABS spread improvement that we expect this year from the bottom reached in 2H11.

Jul-2011 Apr-2011 Oct-2011 Jan-2011 Jun-2011 Jan-2012 Mar-2011 Feb-2011 Dec-2010 Aug-2011 Sep-2011 Nov-2011 Dec-2011 May-2011 Source: Hybridcars

- 39 - Korea Petrochemical Sector 24 February 2012

Our outlook for PVC is relatively less attractive in 2012. LG Chem: petrochemical capacity Despite limited capacity additions planned, we expect (’000 tonne/year) 2011 2012E weak construction demand in China to hamper a Ethylene 1930 2030 Propylene 960 960 recovery in PVC spreads this year. PVC contributed Butadiene 265 265 around 11% of LG Chem’s total petrochemical revenue Benzene 506 506 for 2011. SM 670 670 HDPE 470 470 LG Chem: petrochemical operating profit trend LDPE 276 276 PP 300 300 (Wbn) PS 150 150 EG 150 150 3,000 13% PVC 780 780 2,500 12% PVC China 450 450 11% 2,000 ABS 650 650 10% ABS China 650 650 1,500 SBR 125 125 9% 1,000 BR 180 180 8% SAP 108 180 500 7% Acrylic acid 193 353 0 6% Caustic soda 490 490 2009 2010 2011 2012E 2013E Source: Company, Daiwa forecasts OP OPM (%)

Source: Company, Daiwa forecasts Hybrid chemical companies’ peer LG Chem: petrochemical business sales breakdown (2011) analysis: LG Chem vs. Japanese Synthetic rubber/ companies Speicialty resin NCC/PO 19.1% 27.8% As a leading hybrid-chemical company in Korea, LG Chem is often compared with its Japanese peers. We note that LG Chem’s current valuation in terms of PER Acrylate/ Plasticizer for FY12E is slightly higher than most of its Japanese 12.0% peers, as illustrated in the next table. We believe LG PVC Chem deserves premium valuation to its peers, given 11.3% its growth momentum from new businesses this year. ABS/EP 29.7%

Source: Company

LG Chem and peers: business, financial and valuation comparison LG Chem Sumitomo Chemical Mitsui Chemicals Shin-etsu Chemical Toray Industries Kuraray JSR Nitto Denko Market cap (US$) 23,606 6,904 3,355 23,388 11,767 5,319 5,251 7,070 PER (FY12E) 15.3 143.5 14.6 16.3 13.2 11.2 13.3 13.9 EPS growth (FY12-13E, %) 16.0 N/M N/M 11.9 9.5 8.3 12.7 10.5 PBR (FY12E, x) 2.7 1.1 0.7 1.2 1.4 1.1 1.4 1.2 ROE (FY12E, %) 19.1 7.0 4.1 7.6 11.2 9.7 10.9 9.1 EV/EBITDA (FY12E, x) 8.4 8.2 7.1 6.4 7.3 3.6 5.3 4.3 Feedstock and prime Prime polymers, Basic chemical/ polymers, PVC/Chlor-Alkali , ABS, Polyester Synthetic ABS, PVC, NCC/PO synthetic rubber, (No PVA resin, MMA Petrochemical Polyurethane, Silicones film, nylon rubber, ABS Suggestions), MMA phenols, TPA Silicon wafers Optical fibre, Optical films, flexible Optical & display (Semiconductor), LCD colour Semiconductor, printed circuits, thin- polarisers for TFT- LCD polarising films, IT-related Synthetic quartz glass filters, PDP rear LCD and optical film metal circuit LCD, printed circuit LiB materials substrates (TFT-LCD), panel, electronic materials boards and more for materials / LiB Epoxy molding circuit materials electronics Carbon fibre and Agrochemical and Automotive and Performance Automobile, housing Others HEV/EV battery Cellulose derivatives composite Medical products pharmaceuticals packaging materials chemicals products materials Source: Companies, Bloomberg, Daiwa forecasts

- 40 - Korea Petrochemical Sector 24 February 2012

A sharp decline in crude-oil prices Risks A significant drop in crude-oil prices could result in traders and end-users delaying their purchases of No improvement in China consumption petrochemical products, on the expectation that prices We estimate the Korea petrochemical companies’ sales might fall further. exposure to China at around 30-40% of their total sales. Hence, their earnings are influenced heavily by China’s Weak growth at new businesses economic conditions. Although Daiwa forecasts Slower-than-expected growth in the EV/HEV market monetary easing in China throughout 2012, unexpected and a delay in LG Chem’s commercialisation of its inflation in the country and a resultant slowdown in LCD-glass business could pose a threat to the monetary policy easing would pose a downside risk for company’s earnings growth, in our view. the Korean petrochemical players’ earnings, in our view.

Please also see:

Energy Storage Sector: Changing Competitive Landscape for Green-car Batteries: LiBs: the missing link Shift to automotive Li-ion batteries necessary for firms to survive and grow 23 February 2012 19 January 2012 Pranab Kumar Sarmah, CFA (852) 2848 4441 ([email protected]) Hidemitsu Umebayashi / Mitsuharu Watanabe / Hideaki Ayabe Christeen So (852) 2773 8769 ([email protected])

- 41 -

Materials / Korea 24 February 2012

Hanwha Chemical Target price: W32,000 Up/downside: +11.9% 009830 KS Share price (23 Feb): W28,600

Initiation: earnings likely to recover from 2H12

• Hanwha’s share price seems to have factored in the negatives • PVC cycle unlikely to fall from its current level and little risk of solar-product prices contracting • However, aggressive investment in its solar business over the next few years could be a burden for the company

How do we justify our view?

company’s overall 2012 earnings How we differ growth, in our view. Our 2012-13 operating-profit forecasts are on average about 20% lower than While maintaining operations at its those of the Bloomberg consensus, as

petrochemical business, Hanwha we are much more negative on the Jihye Choi has also been expanding its solar 2012 earnings outlook for the solar (82) 2 787 9121 [email protected] business. Although we have a subsidiary, HSO. positive long-term view on the Jun Yong Bang global solar market, we think Share price performance (82) 2 787 9168 [email protected] Hanwha will suffer from the current (W) (%) tough conditions that we are seeing 59,000 150 in the solar industry this year. 49,000 130 What's new 39,000 110 We expect to see a gradual recovery Furthermore, we think Hanwha may 29,000 90 have to use most of its 2012 19,000 70 in Hanwha’s earnings from 2H12, Feb-11 May-11 Aug-11 Nov-11 Feb-12 petrochemical earnings to invest in its Hanwha Chemical (LHS) even though we do not expect much Relative to KOSPI (RHS) in the short term. We believe the solar business, including building a current share price factors in the new poly-silicon plant this year, which 12-month range 22,000-54,300 negatives. will be completed in late 2013. Market cap (US$bn) 3.55 Average daily turnover (US$m) 61.39 What's the impact Despite all this, however, we believe Shares outstanding (m) 140 Hanwha’s petrochemical business the current share price has factored Major shareholder Hanwha (37.9%) appears to lack near-term positive in all the negatives. In particular, we catalysts. In our view, the PVC do not expect the prices of solar Financial summary (W) Year to 31 Dec 11E 12E 13E (Hanwha’s key product) cycle is likely products to fall further, as they are already priced below their Revenue (bn) 8,043 7,831 8,145 to remain weak due to China’s Operating profit (bn) 424 346 646 sluggish construction market. breakeven points. Net profit (bn) 267 143 343 However, we do not expect the PVC Core EPS 1,902 1,018 2,445 What we recommend cycle to fall from its current level in EPS change (%) (33.1) (46.5) 140.2 view of the monetary easing in China. We initiate coverage of Hanwha with Daiwa vs Cons. EPS (%) (32) (66) (35) an Outperform (2) rating and SOTP- PER (x) 15.0 28.1 11.7 Although we expect to see a recovery based six-month target price of Dividend yield (%) 0.7 0.7 1.0 in the PE/PP spread cycle this year, W32,000. We apply a target DPS 200 200 300 we expect the magnitude of recovery EV/EBITDA multiple of 6.9x (a 20% PBR (x) 0.9 0.9 0.8 to be greater for HDPE than LDPE, discount to our target multiple for EV/EBITDA (x) 10.1 11.0 7.6 which Hanwha produces. This is Honam’ parent business and the ROE (%) 7.1 3.2 7.2 likely to have an impact on the current KOSPI average) to Source: Bloomberg, Daiwa forecasts Hanwha’s petrochemical business.

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Korea Petrochemical Sector 24 February 2012

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Hanwha: operating profit (IFRS)

We expect Hanwha’s IFRS-based operating profit to (Wbn) decline this year, given lower earnings from its 700 petrochemical business and sluggish earnings from its solar subsidiary, HSO (both the petrochemical business 600 and HSO posted very strong earnings in 1H11). Although 500 the solar business, which Hanwha is keen to expand as a 400 new revenue-growth engine, should be attractive in the mid-to-long term, it is unlikely to contribute much to 300 Hanwha’s earnings in 2012. We have a positive view on 200 YNCC, its 50%-owned subsidiary, which should help 100

Hanwha’s 2012 bottom line. (YNCC’s earnings are 0 reflected through the equity method.) 2009 2010 2011E 2012E 2013E Source: Company, Daiwa forecasts Note: 2009 and 2010 data are based on K-GAAP (parent), whereas 2011E and onward figures are based on IFRS (consolidated)

Valuation Hanwha: 12-month forward PBR bands vs. operating profit

The stock is trading currently at a 2012E PER of 28.1x (W) (Wbn) and 2012E PBR of 0.9x. We attribute this high PER 60,000 600 valuation to HSO’s poor earnings. As we expect HSO’s 50,000 500 earnings to recover from 2H12, we expect the stock’s 40,000 400 valuation to normalise in 2012. 30,000 300 Also, despite the poor earnings-growth momentum 20,000 200 currently, we see limited downside from Hanwha’s 10,000 100 current share price, as: 1) solar product prices are 0 0 unlikely to fall further from current levels as prices are 2004 2005 2006 2007 2008 2009 2010 2011 2012 already below their breakeven points, and 2) Hanwha Operating profit (parent, RHS) Price .3x .8x should see a gradual recovery in the LDPE spread on the 1.2x 1.6x back of China’s monetary easing. Source: Company, DataGuide, Daiwa forecasts

Hanwha: 2012-13 operating-profit forecasts (Daiwa vs. Earnings revisions consensus)

Our 2012 operating-profit forecast is 36% lower than (Wbn) that of the Bloomberg consensus, due mainly to our 800 negative view on HSO’s near-term earnings growth. 700 600 500 400 300 200 100 0 FY12 FY13 Daiwa Bloomberg consensus

Source: Bloomberg, Daiwa forecasts Note: Bloomberg consensus is the past 28 days consensus

- 43 - Korea Petrochemical Sector 24 February 2012

Financial summary

Key assumptions Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Ethylene-Naphtha (US$/tonne) 588 490 331 314 354 245 216 300 HDPE-Ethylene (US$/tonne) 38 110 242 215 95 141 205 300 LDPE-Ethylene (US$/tonne) 49 228 394 267 340 386 218 300 PP-Propylene (US$/tonne) 66 129 78 98 74 42 65 100 EG-Ethylene (US$/tonne) 100 339 152 71 180 416 435 490 PVC spread (US$/tonne) 264 335 449 351 423 474 418 470 ABS spread (US$/tonne) 306 340 292 335 370 222 270 359

Profit and loss (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E PE 1,007 1,122 1,338 1,330 1,590 1,717 1,710 1,679 PVC & plasticizer 743 812 994 966 1,142 1,259 1,250 1,227 Others 469 551 706 738 896 5,067 4,871 5,238 Total revenue 2,219 2,485 3,037 3,034 3,628 8,043 7,831 8,145 Other income 108 105 107 108 121 273 348 372 COGS (1,925) (2,111) (2,537) (2,369) (2,858) (6,690) (6,524) (6,499) SG&A (179) (207) (242) (254) (285) (930) (961) (999) Other op. expenses (108) (105) (107) (108) (121) (273) (348) (372) Operating profit 114 167 258 411 486 424 346 646 Net-interest inc./(exp.) (44) (43) (50) (62) (62) (182) (187) (187) Assoc/forex/extraord./others 212 153 (155) 69 86 107 62 72 Pre-tax profit 282 276 53 418 510 348 221 532 Tax (77) (63) (12) (74) (110) (96) (58) (139) Min. int./pref. div./others 0 0 0 0 0 15 (21) (50) Net profit (reported) 205 213 41 343 399 267 143 343 Net profit (adjusted) 205 213 41 343 399 267 143 343 EPS (reported) (W) 2,052 2,132 319 2,448 2,845 1,902 1,018 2,445 EPS (adjusted) (W) 2,052 2,132 319 2,448 2,845 1,902 1,018 2,445 EPS (adjusted fully-diluted) (W) 2,052 2,132 319 2,448 2,845 1,902 1,018 2,445 DPS (W) 350 400 350 450 450 200 200 300 EBIT 114 167 258 411 486 424 346 646 EBITDA 222 272 365 519 607 697 695 1,018

Cash flow (Wbn) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Profit before tax 282 276 53 418 510 348 221 532 Depreciation and amortisation 108 105 107 108 121 273 348 372 Tax paid 0 0 0 0 0 0 0 0 Change in working capital (113) 29 (170) 249 (79) (318) (344) (48) Other operational CF items (73) 26 236 (78) (85) (96) (61) (148) Cash flow from operations 204 436 226 697 466 207 164 707 Capex (100) (646) (230) (287) (178) (450) (700) (700) Net (acquisitions)/disposals 16 (102) (151) (481) (627) 0 0 0 Other investing CF items 9 (7) (324) 34 228 0 0 0 Cash flow from investing (75) (754) (706) (735) (577) (450) (700) (700) Change in debt (92) 266 516 (47) 157 1,000 (10) 695 Net share issues/(repurchases) 0 0 202 0 0 0 0 0 Dividends paid (35) (35) (40) (50) (64) (64) (28) (28) Other financing CF items 7 79 69 (125) 13 (30) 0 0 Cash flow from financing (121) 310 747 (222) 106 906 (38) 667 Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 8 (9) 268 (260) (6) 663 (574) 674 Free cash flow 105 (210) (4) 410 288 (243) (536) 7

Source: Company, Daiwa forecasts

- 44 - Korea Petrochemical Sector 24 February 2012

Financial summary continued …

Balance sheet (Wbn) As at 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Cash & short-term investment 40 38 325 62 38 800 226 900 Inventory 154 157 252 215 256 636 979 975 Accounts receivable 315 349 329 305 365 1,207 1,175 1,222 Other current assets 15 11 319 31 44 503 52 64 Total current assets 525 556 1,226 612 703 3,145 2,432 3,160 Fixed assets 1,094 1,531 1,648 1,809 1,858 5,226 5,578 5,906 Goodwill & intangibles 3 9 8 8 9 389 439 489 Other non-current assets 1,427 1,533 1,574 2,388 2,850 2,988 3,300 3,472 Total assets 3,049 3,629 4,456 4,817 5,421 11,748 11,748 13,027 Short-term debt 293 93 686 743 410 2,306 2,558 3,096 Accounts payable 254 320 226 413 436 1,338 1,305 1,300 Other current liabilities 106 125 170 96 196 125 97 154 Total current liabilities 654 539 1,083 1,252 1,042 3,769 3,960 4,550 Long-term debt 412 878 802 698 1,188 2,392 2,130 2,287 Other non-current liabilities 226 263 200 199 193 562 553 676 Total liabilities 1,293 1,680 2,084 2,149 2,423 6,723 6,643 7,513 Share capital 505 505 707 707 707 707 707 707 Reserves/R.E./others 1,251 1,445 1,664 1,962 2,290 3,792 3,856 4,220 Shareholders' equity 1,756 1,950 2,371 2,669 2,998 4,499 4,563 4,927 Minority interests 0 0 0 0 0 527 543 586 Total equity & liabilities 3,049 3,629 4,456 4,817 5,421 11,748 11,749 13,027 EV 2,263 2,423 3,516 3,324 2,942 7,210 7,790 7,855 Net debt/(cash) 665 933 1,163 1,379 1,560 3,898 4,462 4,483 BVPS (W) 17,523 19,464 18,173 18,983 21,328 32,027 32,485 35,084

Key ratios (%) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Sales (YoY) 4.8 12.0 22.2 (0.1) 19.6 121.7 (2.6) 4.0 EBITDA (YoY) (30.8) 22.3 34.4 42.2 17.0 14.9 (0.3) 46.6 Operating profit (YoY) (47.7) 46.3 54.4 59.3 18.3 (12.8) (18.3) 86.8 Net profit (YoY) (37.6) 3.9 (80.5) 727.6 16.2 (33.1) (46.5) 140.2 EPS (YoY) (37.6) 3.9 (85.0) 668.0 16.2 (33.1) (46.5) 140.2 Gross-profit margin 13.2 15.1 16.5 21.9 21.2 16.8 16.7 20.2 EBITDA margin 10.0 10.9 12.0 17.1 16.7 8.7 8.9 12.5 Operating-profit margin 5.1 6.7 8.5 13.5 13.4 5.3 4.4 7.9 ROAE 12.1 11.5 1.9 13.7 14.1 7.1 3.2 7.2 ROAA 6.8 6.4 1.0 7.4 7.8 3.1 1.2 2.8 ROCE 4.7 6.2 7.6 10.3 11.2 5.9 3.5 6.2 ROIC 3.5 4.9 6.3 8.9 8.8 4.5 2.8 4.9 Net debt to equity 37.9 47.9 49.0 51.7 52.0 86.6 97.8 91.0 Effective tax rate 27.2 22.9 21.7 17.8 21.7 27.7 26.1 26.1 Accounts receivable (days) 48.6 48.8 40.8 38.2 33.7 35.7 55.5 53.7 Payables (days) 47.4 42.2 32.8 38.4 42.7 40.2 61.6 58.4 Net interest cover (x) 2.6 3.8 5.2 6.6 7.8 2.3 1.9 3.5 Net dividend payout 17.1 18.8 109.8 18.4 15.8 10.5 19.7 12.3 Source: Company, Daiwa forecasts

Company profile Hanwha Chemical is a petrochemical-product manufacturer, focusing on the polyethylene, PVC, and chlor-alkali businesses. It procures its raw materials from Yeochon NCC, in which it owns a 50% stake. Hanwha Chemical is a member of Hanwha Group, Korea's 10th-largest conglomerate, and is 37.9% owned by Hanwha.

- 45 - Korea Petrochemical Sector 24 February 2012

Hanwha: 12-month forward PER bands (( (W) 60,000 50,000 40,000 Initiation: earnings 30,000 20,000 likely to recover from 10,000 0 2H12 2004 2005 2006 2007 2008 2009 2010 2011 2012 Price 2.0x 7.8x 13.5x 19.3x 25.0x The current share price appears to have Source: FnGuide, Daiwa forecasts factored in the negative outlook that we see for Hanwha’s solar and Hanwha: 12-month forward PBR bands petrochemical businesses (W) 60,000 50,000 Valuation 40,000 30,000 We initiate coverage of Hanwha Chemical (Hanwha) with an Outperform (2) rating and SOTP-based six- 20,000 month target price of W32,000. We apply a target 10,000 EV/EBITDA multiple of 6.9x (a 20% discount to our 0 multiple ascribed to Honam’s parent business and the 2004 2005 2006 2007 2008 2009 2010 2011 2012 current KOSPI average) to Hanwha’s petrochemical Price .0x .3x business. We assign a 10% discount to Hanwha’s equity .8x 1.2x 1.6x holdings to reflect subsidiary risk, including potential Source: FnGuide, Daiwa forecasts losses from HSO. (We apply a PBR of 2.0x for YNCC, and the current market value for HSO.) Hanwha: 12-month forward EV/EBITDA (Wbn) Hanwha: SOTP valuation (Wbn) 10,000 Operating value (parent-only) 3,922 8,000 EBITDA 570 2012 EBITDA Multiple (x) 6.9 20% discount to KOSPI 6,000 4,000 Value of equity holdings 2,715 2,000 Galleria 299 BV (as of 3Q11) Resort 241 BV (as of 3Q11) 0 L&C 369 BV (as of 3Q11) (2,000) YNCC 740 2x of BV (as of 3Q11) 2004 2005 2006 2007 2008 2009 2010 2011 2012 Daehan 231 Market value EV 2.0x 4.3x HSO 99 Market value 6.5x 8.8x 11.0x Others 736 BV (as of 3Q11) Source: FnGuide, Daiwa forecasts Discount to equity investment (%) 10% Hanwha: key subsidiaries (as at 3Q11) Discounted equity value 2,444 Hanwha Chemical Enterprise value 6,366

Less net debt 1,700 Parent only 3.7% 100% 50% 41%100% Fair value 4,666 Korea Life Hanwha Solar Hanwha Solar Hanwha L&C YNCC Target price (W) 32,000 Insurance Energy Holdings

Source: Company, Bloomberg, Daiwa forecasts 100% 100% 99.4% 100% Hanwha Hanwha Hanwha Dreampharma Chemical Galleria Nanotech (Ningbo) 100% Hanwha SolarOne

Source: Company, Daiwa

- 46 - Korea Petrochemical Sector 24 February 2012

Hanwha: petrochemical sales breakdown by product (2010) Petrochemical business: cycle not Others so favourable 2.0%

PVC Hanwha’s key petrochemical products are PVC (31% of 31.0% total sales) and PE (44%, mainly LDPE). We do not PE think the current PVC cycle is attractive, as: 1) China’s 44.0% current construction market is weak, and 2) PVC demand lags the construction cycle by 2-3 years, as PVC is used as a finishing material in buildings.

Even if construction demand were to rise, boosted by CA China’s monetary easing, we think any pick-up in PVC 23.0% demand would take more time to materialise. We Source: Company believe the recent China data on ‘areas under Hanwha: petrochemical capacity construction’ supports our view that no immediate boost in construction-market demand is likely, and Expansion hence, PVC demand is unlikely to recover in the near ('000 tonne/year) Current 2012E schedule Hanwha term. LDPE 413 413 EVA 100 140 Nov-12 As HDPE is more widely used than LDPE, we think LLDPE 355 355 HDPE sales have been more affected by China’s Chlorine 821 821 monetary easing than LDPE sales (the end demand for Caustic Soda 902 902 ECH 25 25 LDPE is for general films and sheets). However, as EDC 1,641 1,641 HDPE is more exposed to China’s overall demand, we VCM 597 597 expect the magnitude of recovery from China’s policy PVC 560 560 easing to be greater for HDPE than LDPE in 2012. OA 123 123 YNCC Ethylene 1,950 1,950 However, we do not expect the PVC and LDPE cycle to Propylene 930 930 fall from its current level in the next few years, given BTX 792 792 limited capacity addition plans and monetary easing in SM 290 290 China, going forward. BD 220 220 Hanwha Chemical (Ningbo) EDC 500 500 Hanwha: operating profit and operating-profit margin (parent) VCM 300 300 (Wbn) PVC 300 300 Source: Company 600 16%

500 14%

400 12% YNCC: solid earnings expected

300 10% YNCC, a 50%-owned subsidiary, produces olefin and 200 8% aromatics, and has limited exposure to downstream 100 6% petrochemical products. We expect YNCC’s 2012 0 4% earnings to continue to be solid, thanks to favourable 2009 2010 2011E 2012E 2013E supply-demand dynamics and the bright BD-spread Operating profit OPM (%) outlook that we see for the year. YNCC’s healthy

Source: Company, Daiwa forecasts earnings, which are reflected in Hanwha’s net equity method, should help Hanwha’s 2012 bottom line, in our view.

- 47 - Korea Petrochemical Sector 24 February 2012

YNCC: operating profit HSO: production capacity Product 2011 2012E* (Wbn) Module 1.5GW 2.5GW 600 Cell 1.3GW 2.3GW Ingot 900MW 1.9GW 550 Wafer 900MW 1.9GW 500 Source: Company Note: 2012E target capacities are subject to change 450 HSO: share-price performance vs. solar cell/module price 400 movements (US$) (US$/W) 350 15 2.0 300 13 2010 2011E 2012E 2013E 11 1.5 Source: FnGuide, Daiwa forecasts 9 7 1.0 5 Meaningful earnings from HSO 3 0.5 1 will take time (1) 0.0 Apr-10 Apr-11 Oct-10 Oct-11 Jun-10 Jun-11 Feb-11 Since it acquired a 50% stake in HSO (solar Aug-10 Dec-10 Aug-11 Dec-11 HSO price Cell (RHS) C-Si module (RHS) cell/module producer in China) in late 2010, Hanwha has been aggressively seeking to expand its solar Source: Bloomberg business.

However, as HSO has been directly hit by the overall Aggressive expansion in solar slowdown in the solar industry, it has been posting business may be burdensome losses from 2Q11. Although HSO’s weak earnings are likely to be a near-term burden for Hanwha, we expect In order to expand its solar business, Hanwha (parent these weak earnings to bottom out from 2H12, along basis) will incur heavy capex of around W700bn/year with more stable solar product prices. in 2012-13E – it plans to build its first poly-silicon plant that will produce 10,000 tonnes of poly-silicon a We believe Hanwha’s current share price reflects the year from 2014. We think such capex will be a burden current solar business-related risks after the 44% for Hanwha, given its 2012E EBITDA (parent basis) correction from the peak in April 2011, given that no should be W570bn. Hanwha’s parent-based net debt further price drops for solar products are likely, in our and net gearing ratio in 3Q11 were W1.7tn and 50%, view (solar products are selling at lower than their respectively. break-even points currently.) Hanwha (parent basis): Capex and EBITDA HSO: sales and operating-profit margin (Wbn) (US$m) 800 1.4x 1,200 20% 700 1.2x 1,000 15% 600 1.0x 500 800 10% 0.8x 400 0.6x 600 5% 300 0.4x 400 0% 200 100 0.2x 200 (5%) 0 0.0x 0 (10%) 2008 2009 2010 2011E 2012E 2013E 2009 2010 2011E 2012E 2013E CAPEX EBITDA CAPEX/EBITDA (RHS)

Sales OPM (%) Source: Company, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

- 48 - Korea Petrochemical Sector 24 February 2012

Risks

No improvement on China consumption We estimate the Korea petrochemical companies have around 30-40% sales exposure to China. Hence, their earnings are influenced heavily by China’s economic conditions. Although Daiwa forecasts monetary easing in China throughout 2012, unexpected inflation in the country and a resultant slowdown in monetary policy easing would pose a downside risk for the Korean petrochemical players’ earnings, in our view.

A sharp decline in crude-oil prices A significant drop in crude-oil prices could result in traders and end-users delaying their purchases of petrochemical products, on the expectation that prices might fall further.

Delay in solar industry’s turnaround Although we forecast HSO’s earnings to bottom out from 2H12, a slower-than-expected recovery in the solar industry may hamper HSO and therefore Hanwha’s earnings, in our view.

- 49 - Korea Petrochemical Sector 24 February 2012

ƒ Honam Petrochemical: share price and Daiwa recommendation trend Date 2/24/2012 Target price 470,000 Rating 1

500,000 450,000 470,000 400,000 350,000 300,000 250,000 200,000 150,000 ` 100,000 50,000 0 Jul-10 Jul-11 Apr-10 Apr-11 Oct-10 Oct-11 Jun-10 Jun-11 Jan-11 Jan-12 Feb-10 Mar-10 Feb-11 Mar-11 Feb-12 Nov-10 Dec-10 Nov-11 Dec-11 Aug-10 Sep-10 Aug-11 Sep-11 May-10 May-11

Target price (W) Closing price (W)

Source: Daiwa

ƒ LG Chem: share price and Daiwa recommendation trend Date 2/24/2012 Target price 490,000 Rating 1

600,000

500,000 490,000

400,000

300,000

200,000 `

100,000

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

Target price (W) Closing price (W)

Source: Daiwa

- 50 - Korea Petrochemical Sector 24 February 2012

ƒ Hanwha Chemical: share price and Daiwa recommendation trend Date 2/24/2012 Target price 32,000 Rating 2 60,000

50,000

40,000 32,000

30,000

20,000 `

10,000

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

Target price (W) Closing price (W)

Source: Daiwa

ƒ LG Display: share price and Daiwa recommendation trend Date 1/30/2012 10/20/2011 9/28/2011 7/21/2011 6/15/2011 4/13/2011 1/19/2011 Target price 27,000 21,000 19,000 36,000 38,000 44,000 47,000 Rating 3 3 3 2 2 2 2

Date 7/22/2010 4/14/2010 Target price 38,000 43,000 Rating 3 3

50,000 47,000 43,000 44,000 45,000

38,000 40,000 38,000 36,000 35,000

30,000 27,000

25,000 21,000 19,000 20,000

15,000 Jul-10 Jul-11 Apr-10 Apr-11 Oct-10 Oct-11 Jan-10 Jun-10 Jan-11 Jun-11 Jan-12 Feb-10 Mar-10 Feb-11 Mar-11 Aug-10 Sep-10 Nov-10 Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 May-10 May-11

Target price (W) Closing price (W)

Source: Daiwa

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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] 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 (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, 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] IT/Electronics - Semiconductor/IC Design (Taiwan) Ashley CHUNG (852) 2848 4431 [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] Regional Head of Clean Energy and Utilities; Utilities; Power Equipment; Dave DAI (852) 2848 4068 [email protected] Renewables (Hong Kong, China) 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 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 Banking/Diversified Financials Jerry YANG (886) 2 8758 6252 [email protected] 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; 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] All Industries Fumio YOKOMICHI (91) 22 6622 1003 [email protected] Automobiles and Components Ambrish MISHRA (91) 22 6622 1060 [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 the 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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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 Capital Markets Co. Ltd Daiwa Securities Capital Markets 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: Patel Engineering (PEC IN); International Taifeng Holdings Limited (873 HK); Sihuan Pharmaceutical Holdings Group Limited (460 HK); Strides Arcolab Limited (STR IN); China Metal Resources Holding Limited (8071 HK); China 33 Media Group Limited (8087 HK); Sabana Shari’ah Compliant Industrial Real Estate Investment Trust (SSREIT SP); SBI Holdings Inc. (6488 HK); Shunfeng Photovoltaic International Limited (1165 HK); Rexlot Holdings Limited (555 HK). *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 : Jihye Choi / Jun Yong Bang

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.

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

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual 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 Capital Markets 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 Capital Markets Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.109 Memberships: Japan Securities Dealers Association, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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