February 28, 2011 Korea-Equity Research (004990 KS)

Food & Beverage Woon-mok Baek +822-768-4158 [email protected] Amy Lee +822-768-3066 [email protected]

Chinese business to take off in 2011 Buy (Maintain)

Bloomberg: 004990 KS Target Price (12M, W): 1,850,000  Raise TP to W1,850,000; Maintain Buy rating Share Price (02/25/11, W): 1,370,000 Despite stable domestic operations, Lotte Confectionery’s share price has moved in line Expected Return (%): 35.0 with the KOSPI due to the sluggish performance of its overseas operations (especially Sector: Food Products in ). However, things will likely change, as the company’s Chinese subsidiary is Sector Rating: Neutral expected to show sales growth and swing to positive in 2011 following the completion of EPS Growth (11F, %): 13.2 restructuring. In light of this bright outlook for its Chinese operations, we maintain our Buy rating. Furthermore, we raise our target price to W1,850,000 (from W1,700,000) Market EPS Growth (11F, %): 24.2 because we revised up our 2011 earnings forecasts for the company. P/E (X): 12.7 Market P/E (02/25/11F, x): 9.6  Chinese operations to get back on track in 2011 Market Cap (Wbn): 1,947 Shares Outstanding (mn): 1 Until the end of 2010, Lotte Confectionery invested W500bn in its overseas business, but to no avail. The company’s overseas business only showed stagnant sales and Avg Trading Volume (60D, '000): 1 suffered an operating loss. Avg Trading Value (60D, Wbn): 2 Margin Balance ('000 sh): 0 However, the company’s sales in China are likely to turn upward in 2011, driven by: 1) the liquidation of its non-performing bonds and ailing customers in 2010, 2) localization, Dividend Yield (11F, %): .3 3) the expansion of direct operations, and 4) product portfolio diversification. Free Float (%): 49.0 52-Week Low/High: 1,170,000/1,570,000 In 2011, Lotte Confectionery’s Chinese subsidiary aims to post sales of W140bn (up from W80bn in 2010) and reach a break-even point (from an operating loss of W15bn in Beta (12M, Daily Rate of Return): 0.6 2010). Price Return Volatility (12M Daily,%,SD): 1.6 Foreign Ownership (%): 42.5  Domestic operations to stay robust despite negative external factors Major Shareholder(s):

In spite of the deteriorating external factors facing food and beverage companies, Lotte Lotte Aluminum et al. (49.97%) Confectionery is projected to deliver sales growth of 8.2% and operating profit growth of Silchester International Investors LLP (9.7%) 10.4% in 2011. The domestic confectionery market is anticipated to expand in 2011, Arnhold and S. Bleichroeder Advisers, LLC and won appreciation should be favorable for the company, which relies on imports for (6.5%) 60% of its raw materials. And cost burdens should remain minimal if commodity food Price Performance prices are not raised. Even if commodity food prices increase, the company should be (%) 1M 6M 12M able to offset the subsequent cost increase by releasing new products and revamping Absolute -4.3 9.3 16.4 its existing products. Relative 1.6 -3.9 -7.3

FY Sales OP OP Margin NP EPS EBITDAFCF ROE P/E P/B EV/EBITDA Share price (Wbn) (Wbn) (%) (Wbn) (W) (Wbn)(Wbn) (%) (x) (x) (x) 140 KOSPI 12/08 1,245 90 7.2 178 125,285 145 59 10.3 10.4 1.0 12.3 120

12/09 1,317 112 8.5 96 67,233 165 17 4.5 19.2 0.8 12.1 100

12/10P 1,416 151 10.7 136 95,367 214 59 5.5 15.8 0.8 11.2 80 12/11F 1,532 167 10.9 153 107,954 242 73 5.8 12.7 0.7 8.8 60 12/12F 1,643 181 11.0 175 123,050 252 78 6.3 11.1 0.7 8.1 40 Source: Company data, Daewoo Securities Research estimates 2/10 6/10 10/10 2/11

Please read carefully important notices at the end of this report. February 28, 2011 Lotte Confectionery

Ready to reap the benefits of overseas investments

As of end-2010, Lotte As of end-2010, Lotte Confectionery invested W500bn in its overseas business, but to no avail. Confectionery invested The company has yet to record equity-method gains from due to goodwill amortization, W500bn in its overseas while its Chinese subsidiary has shown stagnant sales and suffered an operating loss. However, we expect business to turn around in 2011. First, the consolidated financial statement will begin to business, but to no avail show operating profit from Guylian, as the company will no longer be required to amortize goodwill under the new IFRS system. Second, we expect the Chinese operation to show sales growth and swing to positive territory in 2011 after restructuring. In light of this bright outlook, Lotte targets overseas sales of W500bn (up 67% YoY) in 2011 and plans to achieve overseas sales of W4.4tr in 2018 through additional M&As.

Figure 1. Lotte ConfectioneryÊs overseas business profile

** **China - Acquired Guylian, premium chocolate brand in **Russia - Entered Chinese market in 1994 2008 - Lotte Europe Holdings - Subsidiaries: Lotte China Investment (Holding company) - Established Asia headquarters in , China - Expected to generate Lotte China Foods, Lotte Qingdao Foods - Subsidiary: Lotte Confectionery Holdings profit from 2014 Lotte PengCheng, Lotte Packaging (Beijing) Lotte Shanghai Foods LH Foods (Joint venture with Hershey’s) - Operating branches: Beijing, Shanghai, Tianjin, Nanjing, Shenyang, Hangzhou, Qingdao, ** Guangzhou, Wuhan, Chengdu - Acquired Kolson in 2010 -MS 2nd in snack, MS 1st in pasta, MS 4th in biscuit markets **Vietnam ** - Acquired BIBICA, - Acquired Parrys in 2004 Vietnam’s 2nd largest confectionery company in 2007 -MS 3rd in Indian candy market - Manufacturing base for Southeast Asia - Subsidiaries: Lotte Foods India, - Subsidiaries: BIBICA Corporation, Lotte India Lotte Vietnam

Source: Company data, Daewoo Securities Research

Figure 2. 2011 Overseas sales and OPM targets for Lotte Confectionery Figure 3. Lotte ConfectioneryÊs long-term sales target

(Wbn) (%) (Wtr) 150 12 8 Sales (L) Russia OP margin (R) Vietnam Pakistan 120 8 India 6 Guylian

90 4 China 4 60 0

2 30 -4 Domestic

0 -8 0 China Guylian India Pakistan Vietnam Russia 2010 2011F 2018F

Source: Company data, Daewoo Securities Research Source: Company data, Daewoo Securities Research

Daewoo Securities Research 2 February 28, 2011 Lotte Confectionery

Chinese operations to get back on track in 2011

2011F: Chinese In 2011, the Chinese subsidiary aims to post sales of W140bn (up from W80bn in 2010) and subsidiary to post sales reach break-even point (versus operating loss of W15bn in 2010). Although these targets are growth of 75% and reach aggressive, they appear to be somewhat achievable considering that Chinese sales grew 29% YoY in January. break-even point We expect the Chinese subsidiary to improve, in light of: 1) the leadership shift from Lotte Japan to Lotte Korea; 2) the liquidation of non-performing bonds and termination of relationships with ailing customers in 2010; 3) localization; 4) expansion of direct operations; 5) synergies with China-based Lotte Shopping; and 6) product portfolio diversification. Domestic operations to remain robust despite external factors

Robust domestic Despite the deteriorating external factors facing food and beverage companies, we expect sales operations in 2011 on the and operating profit to improve by 8.2% and 10.4% in 2011. The domestic confectionery market back of: 1) confectionery should expand in 2011; we have noted consistent improvement since 2008 when the market suffered from multiple crises, including melamine contamination of dairy products in China. We market growth, 2) won anticipate production efficiency to improve thanks to the acquisition of Kirin, leading to higher appreciation and 3) new market share. products Table 1. Lotte ConfectioneryÊs quarterly earnings forecasts (Wbn, %) 2010P 2011F 1Q 2Q 3Q 4Q Annual 1Q 2Q 3Q 4Q Annual Sales 317 370 398 332 1,416 346 404 428 3541,532 Operating profit 27 52 56 16 151 31 59 59 17 167 Pretax profit 42 47 68 19 176 43 66 70 22 201 Net profit 34 36 53 13 136 33 50 54 17 153 Sales growth 6.1 5.0 9.0 10.4 7.6 9.3 9.2 7.5 6.8 8.2 OP growth 56.5 21.1 27.6 99.3 34.7 16.4 13.2 6.5 4.7 10.4 Pretax profit growth 10.5 -3.7 17.5 TTB 24.9 1.0 39.9 2.9 15.3 13.7 Net profit growth 12.7 -4.5 20.2 TTB 41.8 -3.8 41.6 1.5 27.5 13.2 OP margin 8.5 14.2 14.0 4.9 10.7 9.0 14.7 13.9 4.8 10.9 Net margin 10.7 9.6 13.3 3.9 9.6 9.4 12.4 12.6 4.7 10.0 Source: Company data, Daewoo Securities Research

Table 2. Revisions to Lotte ConfectioneryÊs 2011~12 earnings forecasts (Wbn, %) Previous Revised % Change % YoY 11F 12F 11F 12F 11F 12F 11F 12F Sales 1,462 1,536 1,532 1,643 4.8 6.9 8.2 7.2 Operating profit 150 161 167 181 11.3 12.6 10.4 8.3 Pretax profit 176 199 201 229 13.7 14.8 13.7 14.0 Net profit 138 155 153 175 11.5 12.6 13.2 14.0 OP margin 10.3 10.4 10.9 11.0 - - - - Net margin 9.4 10.1 10.0 10.6 - - - - Source: Daewoo Securities Research

Daewoo Securities Research 3 February 28, 2011 Lotte Confectionery

Figure 4. Confectionery shipments and growth Figure 5. Ice cream shipments and growth

('000 tonnes) (%) ('000 tonnes) (%) 70 40 30 Confectionery shipments (L) 40 Ice cream shipments (L) % YoY (R) % YoY (R) 60 30

25 20 50 20

40 10 20 0 30 0

20 -10 15 -20

10 -20

10 -40 0 -30 00 02 04 06 08 10 00 02 04 06 08 10

Source: Statistics Korea, Daewoo Securities Research Source: Statistics Korea, Daewoo Securities Research

Figure 6. W/US$ and Lotte Confectionery share price Figure 7. Prices of domestic raw materials

(W'000) (W/US$) (Jan/00=100) 1,800 Lotte Confectionery share price (L) 1,500 250 Flour W/US$ (R) Sugar 1,500 1,400 Edible oil 200 1,200 1,300

900 1,200 150

600 1,100 100 300 1,000

0 900 50 00 02 04 06 08 10 00 02 04 06 08 10

Source: Daewoo Securities Research Source: Statistics Korea, Daewoo Securities Research

Daewoo Securities Research 4 February 28, 2011 Lotte Confectionery

Lotte Confectionery (004990 KS/Buy/TP: W1,850,000)

Income Statement (Summarized) Balance Sheet (Summarized) (Wbn) 12/09 12/10F 12/11F 12/12F (Wbn) 12/09 12/10F 12/11F 12/12F Sales 1,317 1,416 1,532 1,643 Current Assets 499 493 592 690 Cost of Goods Sold 810 850 927 991 Cash and Cash Equivalents 52 68 146 202 Gross Profit 507 566 605 652 Accounts Receivable 137 159 170 182 SG&A 395 415 438 471 Inventories 111 119 128 137 Operating Profit 112 151 167 181 Other Current Assets 199 147 148 169 Non-Operating Income 29 25 34 48 Non-Current Assets 2,963 3,087 3,156 3,272 Interest Income/Expense -1 -11 -10 -7 Investment Assets 2,026 2,131 2,175 2,256 F/X-Related Gain/Loss 21 -30 1 2 Property, Plant and Equipment 935 955 980 1,015 Equity Method Gain/Loss 23 35 44 57 Intangible Assets 2 1 1 0 Asset Disposal Gain/Loss 8 3 0 0 Total Assets 3,462 3,580 3,748 3,962 Other Non-Operating Profit/Loss -19 28 -1 -4 Current Liabilities 289 429 447 456 Pretax Profit 141 176 201 229 Accounts Payable 111 122 130 140 Tax 46 41 47 54 Short-Term Debt 0 20 -10 -10 Profit from Continuing Operation 96 136 153 175 Current Long-Term Debt 0 150 190 180 Profit from Discontinued Operation 0 0 0 0 Other Current Liabilities 178 137 137 147 Tax Effect 0 0 0 0 Non-Current Liabilities 749 597 598 632 Net Profit 96 136 153 175 Bonds 384 265 265 275 Residual Income 96 80 95 113 Long-Term Debt 0 0 0 0 EBITDA 165 214 242 252 Other Non-Current Liabilities 364 331 332 357 Free Cash Flow 17 59 73 78 Total Liabilities 1,038 1,026 1,045 1,089 Gross Profit Margin (%) 38.5 40.0 39.5 39.7 Paid-In Capital 7 7 7 7 EBITDA Margin (%) 12.5 15.1 15.8 15.4 Capital Surplus 270 270 270 270 Operating Margin (%) 8.5 10.7 10.9 11.0 Retained Earnings 1,346 1,477 1,625 1,795 Net Margin (%) 7.3 9.6 10.0 10.7 Stockholders' Equity 2,424 2,554 2,703 2,873

Cash Flow (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/09 12/10F 12/11F 12/12F 12/09 12/10F 12/11F 12/12F Cash Flow from Operating Activities 158 142 173 183 P/E (x) 19.2 15.8 12.7 11.1 Net Profit 96 136 153 175 P/CF (x) 12.4 9.6 8.3 7.7 Non-Cash Income and Expense 43 39 31 13 P/B (x) 0.8 0.8 0.7 0.7 Tangible Assets Depreciation 52 62 75 71 EV/EBITDA (x) 12.1 11.2 8.8 8.1 Intangible Assets Depreciation 1 0 0 0 EPS (W) 67,233 95,367 107,954 123,050 Others -10 -24 -44 -59 CFPS (W) 103,863 139,204 160,728 173,084 Chg in Working Capital 19 -32 -11 -4 BPS (W) 1,704,377 1,796,397 1,901,12 2,020,890 Chg in Accounts Receivable -5 -23 -11 -13 DPS (W) 3,500 3,500 3,500 3,500 Chg in Inventories 13 -9 -8 -9 Payout Ratio (%) 5.2 3.6 3.2 2.8 Chg in Accounts Payable 10 11 8 9 Dividend Yield (%) 0.3 0.3 0.3 0.3 Others 1 -12 0 8 Sales Growth (%) 5.8 7.6 8.2 7.2 Cash Flow from Investment Activities -381 -72 -102 -149 EBITDA Growth (%) 14.0 29.8 13.2 4.1 Chg in Tangible Assets -141 -81 -101 -106 Operating Profit Growth (%) 25.2 34.7 10.4 8.3 Chg in Intangible Assets 0 0 0 0 EPS Growth (%) -46.3 41.8 13.2 14.0 Chg in Investment Assets -268 -43 0 -24 Accounts Receivable Turnover (x) 9.8 9.6 9.3 9.3 Others 28 53 -1 -19 Inventory Turnover (x) 11.2 12.3 12.4 12.4 Cash Flow from Financing Activities 238 -54 7 22 Accounts Payable Turnover (x) 12.5 12.2 12.1 12.2 Chg in Borrowings 242 -50 11 25 ROA (%) 3.2 3.9 4.2 4.5 Chg in Equity -4 -5 -5 -5 ROE (%) 4.5 5.5 5.8 6.3 Dividends -4 -5 -5 -5 ROIC (%) 17.6 18.4 18.1 18.9 Others 0 1 1 2 Liability to Equity Ratio (%) 42.8 40.2 38.7 37.9 Chg in Cash 15 16 78 56 Current Ratio (%) 172.6 115.1 132.3 151.2 Beginning Cash Balance 38 52 68 146 Net Debt to Equity Ratio (%) 6.6 9.6 6.5 3.5 Ending Cash Balance 52 68 146 202 Interest Coverage Ratio (x) 11.4 8.1 8.3 8.9 Source: Company data, Daewoo Securities Research estimates

Daewoo Securities Research 5 February 28, 2011 Lotte Confectionery

Important Notices

As of the publication date, Daewoo Securities Co., Ltd and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the subject company's shares outstanding. Analyst of the subject company or member of the analyst's household does not have any financial interest in the securities of the subject company and the nature of the financial interest (including without limitation, whether it consists of any option, right, warrant, future, long or short position). This report reflects the sole opinion of the analyst without any external influences by third parties.

Stock Ratings (W) LotteConf Buy Relative performance of +20% or greater 2,000,000 Trading Buy Relative performance of +10% or greater, but with volatility 1,500,000 Hold Relative performance of -10% and +10% Sell Relative performance of -10% 1,000,000

Industry Ratings 500,000 Overweight Fundamentals are favorable or improving 0 Neutral Fundamentals are steady without any material changes 3/09 8/09 2/10 8/10 2/11 Underweight Fundamentals are unfavorable or worsening

* Ratings and Target Price History (Share price (----), Target price (----), Not covered (▦), Buy (▲), Trading Buy (■), Hold (●), Sell (◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development. This report has been provided by the research division of Daewoo Securities Co., Ltd. The stock ratings, target prices, estimates and overall viewpoints are from the research division of Daewoo Securities. Investors can access Daewoo SecuritiesÊ research through Daewoo research direct (www.bestez.com), FirstCall Research, Reuters, FnGuide, WiseFn, FactSet and Bloomberg (DWIR). This document was prepared by Daewoo Securities Co., Ltd. („Daewoo‰). Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith. The information has not been independently verified. Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy or completeness of the information and opinions contained in this document. Daewoo accepts no responsibility or liability whatsoever for any loss arising from the use of this document or its contents or otherwise arising in connection therewith. Information and opinions contained herein are subject to change without notice. This document is for information purposes only. It is not and should not be construed as an offer or solicitation of an offer to purchase or sell any securities or other financial instruments. This document may not be reproduced, further distributed or published in whole or in part for any purpose. Daewoo and/or other affiliate companies, their directors, representatives, or employees may have long or short positions in any of the securities or other financial instruments mentioned in this document or of issuers described herein and may purchase and/or sale, or offer to purchase and/or sale, at any time, such securities or other financial instruments in the open market or otherwise, as either a principal or agent. This document is for distribution within the to persons authorized under the Financial Services Act 1986. Daewoo Securities is the sole provider of information contained in this document. DaewooÊs U.S. affiliate, Daewoo Securities (America) Inc., a member of FINRA/SIPC, is the sole distributor of this document within the U.S. This document may be distributed in the U.S. only to major U.S. institutional investors as defined in Rule 15a-6 of the U.S. Securities Exchange Act of 1934. Any U.S. recipient of this document wishing to effect any transactions in any securities discussed herein should contact and place orders with Daewoo Securities (America) Inc.

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