Company Note SM Entertainment (041510.KQ) BUY / TP KRW50,000 July 22, 2019 Travel/Casino/Entertainment/Small-cap Peter Yoo +822-3787-2574 [email protected]

Time for a change of tune

Share price (KRW, Jul 19) 36,750 1) Investment highlights

Upside (%) 36.1 - We maintain BUY on SM Entertainment but reduce our target price to KRW50,000.

Market cap (KRW bn) 860 - We believe parent earnings were modest thanks to new albums released by a string of artists including

Shares outstanding (’000) 23,398 as well as NCT127’s world tour.

Paid-in capital (KRW bn)/Face value (KRW) 12/500 - Unprofitable subsidiaries have continued to remain in the red.

52-week high/low (KRW) 56,100/35,900 - SM is expected to respond to the request of activist funds to enhance shareholder value. 60-day avg. daily T/O (KRW bn) 13 Foreign ownership (%) 15.97 2) Major issues and earnings outlook Major shareholders (%) Lee Su Man and - SM’s 2Q19 results will likely miss consensus expectations, with sales coming in at KRW145.4bn (+17% 7 others 19.26 YoY) and operating profit at KRW9.5bn (-5.6% YoY). Price performance 1M 3M 6M - The parent unit SME likely sold more than 1.1mn albums as Red Velvet, SNSD’s , and ’s Chen Absolute (%) -16.9 -10.4 -22.7 released new albums. In addition, the full recognition of NCT127’s US/European tour and digital album Relative (%p) -11.5 1.4 -20.2 sales in China helped keep parent earnings modest. K-IFRS, consolidated - In , about 300,000 concertgoers went to SM artists’ performances. Meanwhile, SM C&C’s earnings (KRW) 18F EPS 19F EPS TP likely reached BEP. Keyeast’s earnings, although still in the red, probably improved QoQ as 2Q recognized Previous 1,621 1,986 56,000 the earnings from a drama. Revised 1,593 2,128 50,000 - Among unprofitable subsidiaries, the loss at the F&B arm likely widened QoQ due to the suspension of Consensus 1,621 1,897 55,000 operations at its site. Subsidiary Everything also remained in loss, although the number of paying Difference (%) -1.7 12.2 -9.1 fan club members increased. SM Beijing’s earnings are expected to increase from 2H19 as WayV is scheduled to pick up its promotion activities. 12-month price performance 140 3) Share price outlook and valuation 120 - SM shares have severely corrected due to concerns over subsidiaries in the red, the activist fund issue, 100 and the possibility of limited promotions in Japan amid souring relationships between the two 80 countries. We believe the company’s shareholder return policy will be the to the future direction of 60

40 SM Entertainment shares, the details of which will be announced at the end of this month. 20 KOSDAQ - For our target price, we applied a target P/E of 31.1x to 2019F EPS of KRW1,593. We applied a 10% 0 18.07 18.10 19.01 19.04 19.07 discount to our previous target multiple in light of the prospect of lower earnings this year and Source: WiseFn, Hyundai Motor Securities deteriorating sentiment over the entertainment sector amid soured Korea-Japan relations. However, we keep our rating intact at BUY as NCT127 is slated to become a global act and the company is expected to announce its shareholder return policy.

Earnings forecasts and valuations Sales OP NP EBITDA EPS Growth P/E P/B EV/EBITDA ROE Div. yield (KRW bn) (KRW bn) (KRW bn) (KRW bn) (KRW) (%YoY) (x) (x) (x) (%) (%) 2017 350 21 4 44 169 -83.9 153.0 1.7 11.0 1.2 0.0 2018 365 11 4 33 199 17.6 174.4 2.2 21.5 1.3 0.0 2019F 614 46 37 147 1,593 17.1 23.1 1.8 4.6 8.2 0.0 2020F 732 57 50 136 2,128 33.5 17.3 1.6 4.2 9.9 0.0 2021F 773 62 58 119 2,467 15.9 14.9 1.5 4.0 10.4 0.0 Note: K-IFRS, consolidated

COMPANY NOTE

Fig 1. 2Q19 earnings preview Earnings Growth Consensus (KRW bn) 2Q19F 2Q18 1Q19F (%YoY) (%QoQ) 4Q18F %difference

Sales 145.4 124.4 130.8 16.9 11.2 160.3 -9.3

Operating profit 9.5 10.0 2.8 -5.6 236.2 10.8 -12.5

OPM (%) 6.5 8.0 2.1 6.7

Pretax profit 10.2 11.1 2.7 -8.2 274.9 11.2 -8.9

Net prof t (CI) 8.3 5.1 -1.0 63.9 TB 8.9 -6.9

Note: K-IFRS, consolidated Source: Hyundai Motor Securities

Fig 2. Quarterly earnings trends

(KRW bn) 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19F 3Q19F 4Q19F 2018 2019F 2020F

Sales 110.6 124.4 168.7 208.5 130.8 145.4 162.1 175.9 612.2 614.2 731.8

SME 59.4 60.4 65.7 95.9 57.0 66.0 77.3 86.2 281.5 286.5 353.4

SM Japan 26.3 16.3 20.4 31.9 14.9 16.4 18.0 19.8 94.9 69.2 81.3

Dream Maker 6.7 12.4 17.9 21.3 16.3 17.9 19.7 21.7 58.3 75.6 89.0

SM C&C 37.5 52.5 44.5 62.5 35.2 37.0 38.8 40.7 197.0 151.7 167.1

KEYEAST 37.8 21.4 23.4 25.7 27.0 28.4 59.2 104.5 119.3 Interco transaction -19.3 -17.2 -17.6 -24.5 -16.0 -17.6 -18.8 -21.0 -78.7 -73.3 -78.3 adjustment Operating profit 10.4 10.0 12.1 15.2 2.8 9.5 16.2 17.6 47.7 46.1 57.3

OPM (%) 9.4 8.0 7.2 7.3 2.1 6.5 10.0 10.0 7.8 7.5 7.8

Net profit 11.4 4.0 7.3 0.7 3.7 9.3 15.0 16.4 23.4 37.1 49.8

Net margin (%) 10.3 3.3 4.3 0.3 -2.8 6.4 9.3 9.3 3.8 6.0 6.9

Note: K-IFRS, consolidated Source: Hyundai Motor Securities

Fig 3. Earnings revisions Revised Previous %change (KRW bn) 2019F 2020F 2019F 2020F 2019F 2020F Sales 614.2 731.8 679.1 848.7 -9.6 -13.8 Operating profit 46.1 57.3 56.0 67.0 -17.8 -14.5 Pretax profit 49.7 62.9 56.8 68.9 -12.6 -8.8 Net profit 37.1 49.8 43.6 55.1 -14.9 -9.6 Note: K-IFRS, consolidated Source: Hyundai Motor Securities

2 Travel/Casino/Entertainment/Small-cap Peter Yoo +822-3787-2574 / [email protected]

Fig 4. Sales trend Fig 5. Operating profit and margin trends

(KRW bn) (KRW bn) Sales (L) YoY (R) OP (L) OPM (R) 250 120% 35 40% 100% 30 35% 200 80% 25 30% 25% 150 60% 20 20% 40% 15 15% 100 20% 10 10% 0% 5 50 5% -20% 0 0% 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 0 -40% -5 -5% 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19

Source: Company data, Hyundai Motor Securities Source: Company data, Hyundai Motor Securities

Fig 6. NCT127 going global Fig 7. Redvelvet, ‘’

Source: Company data, Hyundai Motor Securities Source: Company data, Hyundai Motor Securities

Fig 8. P/E bands Fig 9. P/B bands

(KRW) Share price 45x (KRW) Share price 9x 100,000 40x 35x 7x 5x 100,000 30x 25x 3x 1x

80,000 80,000

60,000 60,000

40,000 40,000

20,000 20,000

0 0 11.12 12.12 13.12 14.12 15.12 16.12 17.12 18.12 19.12 11.12 12.12 13.12 14.12 15.12 16.12 17.12 18.12 19.12

Source: Dataguide, Hyundai Motor Securities Source: Dataguide, Hyundai Motor Securities

3 COMPANY NOTE

Income statement Balance sheet (KRW bn) 2017 2018 2019F 2020F 2021F (KRW bn) 2017 2018 2019F 2020F 2021F Sales 365 612 614 732 773 Current assets 441 537 634 774 901 Change (%) 4.4 67.6 0.3 19.2 5.6 Cash and cash equivalents 195 237 381 507 619 Cost of goods sold 249 410 412 490 518 Short-term investment assets 3 45 38 40 42 % of sales 68.1 66.9 67.0 67.0 67.0 Accounts receivable 121 124 105 111 117 Gross profit 116 203 202 241 255 Inventory assets 9 12 10 10 11 Gross margin (%) 31.9 33.1 33.0 33.0 33.0 Other current assets 113 119 101 106 112 Change (%) 13.8 74.1 -0.1 19.3 5.6 Non-current assets 357 465 397 341 307 SG&A expenses 105 155 156 184 193 Tangible assets 93 93 61 39 29 % of sales 28.9 25.3 25.5 25.2 25.0 Intangible assets 113 186 163 123 93 EBITDA 33 88 147 136 119 Investment assets 127 152 114 120 127 EBITDA margin (%) 9.0 14.3 24.0 18.5 15.3 Other non-current assets 23 34 59 59 59 Change (%) -25.4 166.3 68.0 -8.0 -12.6 Other financial assets 0 0 0 0 0 Operating profit 11 48 46 57 62 Total assets 798 1,002 1,032 1,115 1,208 Operating margin (%) 3.0 7.8 7.5 7.8 8.0 Current liabilities 330 394 351 383 417 Change (%) -47.2 336.4 -3.5 24.4 7.9 Short-term debt 11 7 7 7 7 Non-operating profit -7 5 4 4 9 Accounts payable 124 179 151 159 168 Interest income 2 8 7 8 11 Current portion of long-term debt 37 36 48 64 80 Interest expenses 7 4 4 5 5 Other current debt 159 172 145 153 162 Other non-operating income -2 0 1 0 3 Non-current liabilities 31 32 48 49 50 Subsidiaries/affiliate income 21 -6 0 2 2 Bonds 6 7 9 9 9 Pretax profit from cont ops 24 46 50 63 73 Long-term debt 5 3 3 3 3 Pretax margin (%) 6.7 7.5 8.1 8.6 9.4 LT financial debt (incl. lease) 0 0 18 18 18 Change (%) 8.0 88.4 8.0 26.6 15.9 Other non-current debt 20 22 19 20 21 Income tax 29 23 15 13 15 Other financial liabilities 0 0 0 0 0 Profit from continuing ops -5 23 35 50 58 Total liabilities 362 426 399 432 467 Profit from discontinuing ops 0.0 0.0 0 0 0 Owners of parent equity 344 424 477 527 584 Net profit -5 23 35 50 58 Paid-in capital 11 12 12 12 12 Net margin (%) -1.3 3.8 5.7 6.9 7.5 Capital surplus 170 219 234 234 234 Change (%) TR TB 48.5 44.6 15.9 Capital adjustment, etc. 32 30 30 30 30 NP from controlling interest 4 31 37 50 58 Other accumul earnings and comp income -3 -10 -10 -10 -10 NP from non-controlling interest -9 -7 -2 1 1 Retained earnings 134 174 211 261 319 Other comprehensive income -7 4 1 0 0 Non-controlling interest 91 152 156 157 157 Total comprehensive income -12 27 36 50 58 Total equity 436 576 633 683 742

Cash flow Key financial data (KRW bn) 2017 2018 2019F 2020F 2021F (KRW, x, %) 2017 2018 2019F 2020F 2021F Operating cash flow 77 120 124 134 121 EPS (based on net profit) -216 1,042 1,493 2,149 2,492 Net profit -5 23 35 50 58 EPS (based on parent net profit) 199 1,361 1,593 2,128 2,467 Depreciation on tangible assets 11 13 50 38 26 BPS (based on total equity) 20,024 25,019 27,054 29,203 31,695 Amortization on intangible assets 11 27 51 40 30 BPS (based on owners of parent equity) 15,824 18,424 20,384 22,511 24,978 FX-related profit 4 0 -2 0 0 DPS 0 0 0 0 0 Dec (inc) in working capital 46 52 -22 5 6 P/E (based on net profit) N/A 50.2 24.6 17.1 14.7 Others 10 4 11 0 0 P/E (based on parent net profit) 174.4 38.4 23.1 17.3 14.9 Investing cash flow -111 -127 19 -24 -25 P/B (based on total equity) 1.7 2.1 1.4 1.3 1.2 Dec (inc) in investment assets -28 -25 38 -6 -7 P/B (based on owners of parent equity) 2.2 2.8 1.8 1.6 1.5 Decrease in tangible assets 7 1 0 0 0 EV/EBITDA (reported) 21.5 12.9 4.6 4.2 4.0 Increase in tangible assets -11 -10 -16 -16 -16 Dividend yield 0.0 0.0 0.0 0.0 0.0 Others -79 -93 -3 -2 -2 Growth (%) Financing cash flow 64 46 -1 16 16 EPS (based on net profit) TR TB 43.4 43.9 15.9 Increase (decrease) in debt -5 -6 17 0 0 EPS (based on parent net profit) 17.6 583.9 17.1 33.5 15.9 Increase (decrease) in bond 6 1 2 0 0 Profitability (%) Increase in capital 6 49 15 0 0 ROE (based on net profit) -1.2 4.6 5.8 7.6 8.2 Dividend 0 0 0 0 0 ROE (based on parent net profit) 1.3 8.0 8.2 9.9 10.4 Others 57 2 -35 16 16 ROA -0.7 2.6 3.4 4.7 5.0 Other cash flow -5 3 1 0 0 Stability (%) Increase (decrease) in cash 26 42 144 126 112 Total liabilities/equity 83.1 74.0 63.0 63.2 62.9 Beginning cash 170 195 237 381 507 Net debt/equity Net cash Net cash Net cash Net cash Net cash Ending cash 195 237 381 507 619 Interest coverage 9.1 18.7 12.4 12.4 11.5 Note: K-IFRS, consolidated

4 Travel/Casino/Entertainment/Small-cap Peter Yoo +822-3787-2574 / [email protected]

Investment rating and target price history Two-year price chart Difference (%) Date Rating TP Average High/Low 17/11/15 BUY 46,000 -22.3 -15.9 KRW’000 18/01/17 BUY 46,000 -20.2 -13.2 80 18/03/12 BUY 50,000 -13.8 -10.0 70 18/03/26 BUY 50,000 -18.6 -4.4 60 18/05/16 BUY 50,000 -18.4 -4.4 50 18/07/24 BUY 50,000 -18.6 -4.4 40 18/08/16 BUY 50,000 -14.7 4.4 18/10/17 BUY 60,000 -21.9 -12.3 30 18/11/15 BUY 70,000 -26.4 -19.9 20 SM Entertainment 19/01/25 BUY 70,000 -28.8 -19.9 10 Target price 19/03/11 BUY 70,000 -32.7 -19.9 0 17.07 17.10 18.01 18.04 18.07 18.10 19.01 19.04 19.07 19/04/18 BUY 56,000 -27.4 -24.3 19/05/16 BUY 56,000 -26.5 -14.4 19/07/22 BUY 50,000 - -

Compliance note • The author(s) of this report does(do) not have any interests in the company(ies) covered herein. • Hyundai Motor Securities has not disclosed the material contained in this report to any institutional investor or third party prior to its publication. • The author(s) of this report does(do) not own more than 1% of the shares of the company(ies) covered in this report. • Hyundai Motor Securities has not taken part in securities issuance (DR, CB, IPO, and market making) of the company(ies) covered in this report as lead manager for the past six months. • This report accurately reflects the author(s)’s professional views and was written without any undue external influence or interference.

Investment rating Hyundai Motor Securities offers three sector investment ratings based on six-month forward fundamentals and share price outlook. • OVERWEIGHT: Sector-wide fundamentals and share prices are expected to turn up. • NEUTRAL: No meaningful fundamental improvement is expected. • UNDERWEIGHT: Sector-wide fundamentals and share prices are expected to turn down.

Hyundai Motor Securities offers three company investment ratings based on the relative return expected in the following six months, based on the closing price on the date of rating declaration. • BUY: Excess return of +15%p or more • MARKETPERFORM (M.PERFORM): Excess return of between -15%p and +15%p • SELL: Excess return of -15%p or less

Stock ratings distribution (July 01, 2018-June 30, 2019) Rating Count % of rating category BUY 148 89.16 MARKETPERFORM 18 10.84 SELL 0 0

• This report has been prepared for informational purposes only and thus may not be reproduced or distributed without the prior written consent of Hyundai Motor Securities. • The information and statistical data contained herein were taken from sources believed to be reliable but in no way can be guaranteed and, therefore, final investment decisions should be made based on each client’s own judgment. • This report cannot be used as evidence in any legal disputes related to the client’s investment decisions.

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