Korea Consumer Staples 26 July 2018

Amorepacific (090430 KS)

Target price: KRW410,000 (from KRW440,000) Share price (26 Jul): KRW268,000 | Up/downside: +53.0%

2Q18 review: earnings likely to have bottomed

 We expect earnings growth to accelerate for DFS and from 3Q18 Iris Park (82) 2787 9165  Enhanced focus on luxury cosmetics should meet demand in China [email protected]  Reiterating our Buy (1) rating; lowering 12-month TP to KRW410,000

What's new: Amorepacific recorded weaker-than-expected 2Q18 earnings, Forecast revisions (%) mainly due to one-off expenses. We remain positive on the stock as we believe Year to 31 Dec 18E 19E 20E 2Q18 to be the bottom in terms of earnings. Revenue change (4.9) (3.9) (4.5) Net profit change (13.1) (2.4) (3.1) Core EPS (FD) change (13.1) (2.4) (3.1) What's the impact: 2Q18 review. Amorepacific’s 2Q18 revenue came in at Source: Daiwa forecasts KRW1.3tn (+11.5% YoY), in line with expectations. In Korea, revenue resumed growth in 2Q18 (KRW878bn, +9.0% YoY). Even without DFS (KRW305bn, Share price performance +29.3% YoY), pure domestic revenue recorded positive growth on new product (KRW) (%) launches for major brands. We note that it is continuously gaining market share 355,000 125 in both door-to-door and online channels. In China, 2Q18 revenue growth was 321,250 115 in the mid-teens YoY in local currency terms. High-end brands, like Sulwhasoo 287,500 105 and Hera, increased its revenue by 30-50% YoY, offsetting the slowdown in 253,750 95 220,000 85 Laniege and Mamonde. China’s online revenue growth was >40% YoY in Jul-17 Oct-17 Jan-18 Apr-18 Jul-18

2Q18, accounting for c.25% of Mainland China’s revenue. Ex-China Asia sales Amore (LHS) Relative to KOSPI (RHS) were up by >20% YoY, largely led by strong growth in , and

Indonesia. Its 2Q18 operating profit was below estimates due to unexpected 12-month range 239,500-351,500 changes in the wage structure. Amorepacific increased its portion of fixed Market cap (USDbn) 13.91 salary to lower volatility in employees’ income. It booked the provisioning for 3m avg daily turnover (USDm) 43.10 this change related to 1Q18 in 2Q18, causing a one-off expense of KRW10bn. Shares outstanding (m) 58 Amorepacific Group (35.4%) Major shareholder Earnings growth to accelerate from 3Q18E. We believe Amorepacific’s Financial summary (KRW) earnings growth is bottoming out as the company becomes more flexible. From Year to 31 Dec 18E 19E 20E the last week of June, the company lowered its DFS purchase limits: from 5 Revenue (bn) 5,780 6,769 7,622 products per brand to 5 products per item. We believe this could increase Operating profit (bn) 798 1,138 1,309 Amorepacific’s ticket price by at least 50% to nearly double. Another reason for Net profit (bn) 604 873 1,003 Core EPS (fully-diluted) 10,346 14,945 17,165 our bullish view is its higher online penetration in China. Previously, Sulwhasoo EPS change (%) 51.9 44.5 14.9 was only carried in T-mall, but in 2Q18, the brand was also launched in Daiwa vs Cons. EPS (%) 3.4 23.9 21.7 VIP.com. In addition, it plans to release new products in China to accelerate PER (x) 25.9 17.9 15.6 top-line growth. Most new product launches will be made in 2H18, especially Dividend yield (%) 0.7 0.7 0.8 DPS 1,850 2,000 2,120 the high-end products, which would meet the demand for luxury cosmetics, in PBR (x) 3.3 2.8 2.4 our view. EV/EBITDA (x) 14.6 10.6 8.8 ROE (%) 13.6 16.9 16.4 What we recommend: We reiterate our Buy (1) rating, but lower our 12-month Source: FactSet, Daiwa forecasts TP to KRW410,000 (from KRW440,000), based on an unchanged target PER of 32.5x on our 2018E-19E average EPS, as we cut our 2018-19E EPS by 2- 13% to factor in: 1) weaker-than-expected 2Q18 earnings, 2) higher 2018E wages, and 3) slower growth in 2018E Chinese tourist arrivals (from 75% to 38%). As we expect growth acceleration for DFS and China from 3Q18, we remain positive on the stock. Risk: weak CNY hurting demand from Chinese tourists.

How we differ: Our 2019-20E EPS are 22-24% above the consensus, as we are more bullish on Chinese demand.

See important disclosures, including any required research certifications, beginning on page 6

Amorepacific (090430 KS): 26 July 2018

Amorepacific: revenue breakdown (KRWbn) 2017 2018E 2019E 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18P 3Q18E 4Q18E Revenue 5,123.8 5,780.0 6,769.5 1,569.0 1,205.0 1,209.9 1,140.0 1,431.6 1,343.7 1,494.5 1,510.2 Korea 3,297.3 3,688.9 4,218.3 1,054.3 805.5 790.2 647.3 940.8 877.7 967.3 903.1 Cosmetics 2,830.2 3,157.4 3,672.4 941.3 694.7 638.9 555.3 780.7 760.8 809.1 806.9 Travel Retail 1,102.2 1,398.9 1,783.0 419.0 235.8 235.8 211.6 320.2 304.8 363.8 410.2 Digital 372.2 391.3 450.2 112.2 99.8 83.7 76.5 100.6 100.1 95.3 95.3 Mass Beauty & Sulloc 517.2 531.6 545.9 163.1 110.9 151.3 91.9 160.2 116.9 158.2 96.3 Overseas 1,815.2 2,168.2 2,635.5 477.0 408.6 427.3 502.3 500.8 498.0 543.5 625.9 Operating Profit 596.4 797.8 1,138.0 316.8 101.6 101.1 76.9 235.9 145.8 201.3 214.8 YoY growth (%) 2017 2018E 2019E 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18P 3Q18E 4Q18E Revenue -5.7% 11.9% 15.4% 5.7% -16.5% -13.6% -13.4% -8.8% 11.5% 23.5% 32.5% Korea -14.2% 9.3% 12.5% -2.9% -22.5% -21.5% -25.5% -10.8% 9.0% 22.4% 39.5% Cosmetics -16.0% 10.4% 14.2% 1.6% -23.5% -24.5% -27.7% -17.1% 9.5% 26.6% 45.3% Travel Retail -24.8% 22.2% 27.5% 11.1% -39.6% -35.2% -42.6% -23.6% 29.3% 54.3% 93.8% Digital -8.1% 5.0% 15.1% 1.3% -2.3% -20.1% -13.7% -10.3% 0.3% 13.8% 24.6% Mass Beauty & Sulloc -2.7% 3.4% 2.5% 2.8% -14.9% -6.1% -9.6% -1.8% 5.4% 4.6% 4.8% Overseas 7.0% 19.4% 21.6% 16.9% -2.1% 5.0% 8.1% 5.0% 21.9% 31.6% 31.2% Profitability (%) 2017 2018E 2019E 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18P 3Q18E 4Q18E Operating Margin 11.6% 13.8% 16.8% 20.2% 8.4% 8.4% 6.7% 16.5% 10.9% 13.5% 14.2%

Source: Company, Daiwa forecasts

Amorepacific: OPM by region (2Q17 vs. 2Q18) Amorepacific: domestic revenue of major brands (KRW bn) 17% 12.4% 450 402.0 12.2% 11.7% 400 379.9 356.3 12% 336.3 324.2 328.3 8.2% 350 318.6 271.5 7% 300 256.0 223.3 250 2% 200 150.6 155.1 133.9 152.4 150 122.7 123.2 114.1 95.0 100.4 96.4 (3%) 100 -1.6% 137.9 136.1 -1.8% 50 98.7 100.0 118.2 99.1 82.2 77.7 108.2 90.4 (8%) 0 Korea-cosmetics Korea-mass beauty & Asia 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 sulloc 2Q17 2Q18 Sulwhasoo Hera

Source: Company Source: Company Note: Asia excludes Korea

Amorepacific: new product ASP Amorepacific: online sales in China (KRW) 50% Singles’ Day effect 40% 160,000 140,000 ↓ 140,000 40% 30% 120,000 98,000 90,000 90,000 25% 100,000 30% 20% 20% 80,000 63,000 30% 55,000 20% 60,000 25% 40,000 20% 10% 18% 18% 20,000 0 0% Concentrated Ginseng Sulwhasoo Bloomstay Hera rosy-satin cream Renewing Emulsion Vitalizing Essence 2Q17 3Q17 4Q17 1Q18 2Q18

Original products New products Online revenue growth Revenue portion

Source: Company Source: Company

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Amorepacific (090430 KS): 26 July 2018

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Duty-free store revenue (KRW bn) 347.8 702.9 1,069.0 1,499.3 1,102.2 1,398.9 1,783.0 2,148.5 China cosmetic revenue (KRW bn) 338.8 464.5 765.8 1,090.9 1,258.0 1,476.9 1,793.5 2,078.1 Chinese inbound YoY growth to Korea 52.5 41.6 (2.3) 34.8 (47.1) 26.8 35.0 24.0 Overseas (ex-China) cosmetic revenue 206.0 365.1 442.1 554.2 509.9 631.8 752.7 875.1 (KRW bn)

Profit and loss (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Korea cosmetics 2,556 3,041 3,559 4,001 3,638 3,698 4,218 4,673 Others 545 833 1,208 1,645 1,486 2,082 2,551 2,949 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 3,100 3,874 4,767 5,645 5,124 5,780 6,769 7,622 Other income 124 136 147 181 224 220 231 253 COGS (912) (1,028) (1,169) (1,425) (1,380) (1,499) (1,619) (1,800) SG&A (1,819) (2,282) (2,824) (3,373) (3,148) (3,483) (4,012) (4,513) Other op.expenses (124) (136) (147) (181) (224) (220) (231) (253) Operating profit 370 564 773 848 596 798 1,138 1,309 Net-interest inc./(exp.) 9 11 22 13 11 17 25 28 Assoc/forex/extraord./others (15) (45) (17) (5) (40) (17) 1 6 Pre-tax profit 364 530 778 857 567 798 1,164 1,343 Tax (96) (145) (194) (211) (169) (194) (291) (340) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 267 385 585 646 398 604 873 1,003 Net profit (adjusted) 267 385 585 646 398 604 873 1,003 EPS (reported)(KRW) 45,761 65,919 10,009 11,052 6,812 10,346 14,945 17,165 EPS (adjusted)(KRW) 45,761 65,919 10,009 11,052 6,812 10,346 14,945 17,165 EPS (adjusted fully-diluted)(KRW) 45,761 65,919 10,009 11,052 6,812 10,346 14,945 17,165 DPS (KRW) 6,500 9,000 1,350 1,580 1,280 1,850 2,000 2,120 EBIT 370 564 773 848 596 798 1,138 1,309 EBITDA 493 700 920 1,029 820 1,017 1,369 1,562

Cash flow (KRWbn) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax 364 530 778 857 567 798 1,164 1,343 Depreciation and amortisation 124 136 147 181 224 220 231 253 Tax paid (78) (123) (171) (227) (169) (194) (291) (340) Change in working capital (18) (0) (167) (163) (93) 10 (71) (149) Other operational CF items 36 43 41 29 (16) 134 158 266 Cash flow from operations 427 586 628 677 513 968 1,192 1,373 Capex (326) (321) (274) (495) (769) (500) (500) (500) Net (acquisitions)/disposals (2) (1) 2 0 0 0 0 0 Other investing CF items (20) (169) 56 (115) 368 (60) (84) (29) Cash flow from investing (349) (491) (217) (610) (401) (560) (584) (529) Change in debt 90 (3) (7) (5) (3) 0 0 0 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (45) (46) (63) (95) (109) (158) (170) (181) Other financing CF items 4 2 0 (34) 1 0 0 0 Cash flow from financing 49 (46) (69) (133) (111) (158) (170) (181) Forex effect/others (4) (1) 3 0 0 0 0 0 Change in cash 123 49 345 (66) 1 250 437 663 Free cash flow 100 266 353 182 (256) 468 692 873 Source: FactSet, Daiwa forecasts

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Amorepacific (090430 KS): 26 July 2018

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment 434 636 933 1,089 666 925 1,374 2,048 Inventory 283 305 324 410 375 399 457 515 Accounts receivable 223 228 317 340 369 330 366 412 Other current assets 27 258 259 278 268 318 372 419 Total current assets 968 1,427 1,833 2,116 1,677 1,971 2,570 3,394 Fixed assets 1,936 1,744 1,871 2,359 2,613 2,894 3,162 3,409 Goodwill & intangibles 133 174 212 228 240 240 240 240 Other non-current assets 366 509 528 478 845 916 1,018 1,062 Total assets 3,402 3,855 4,443 5,182 5,376 6,021 6,989 8,105 Short-term debt 82 34 118 145 87 85 85 85 Accounts payable 298 367 383 565 554 625 732 824 Other current liabilities 162 250 371 462 406 405 406 457 Total current liabilities 543 651 872 1,171 1,046 1,115 1,223 1,367 Long-term debt 80 125 57 10 62 54 56 43 Other non-current liabilities 211 200 142 104 92 83 74 66 Total liabilities 834 976 1,071 1,285 1,200 1,252 1,354 1,475 Share capital 35 35 35 35 35 35 35 35 Reserves/R.E./others 2,520 2,824 3,311 3,844 4,119 4,711 5,575 6,568 Shareholders' equity 2,554 2,859 3,346 3,879 4,154 4,745 5,610 6,603 Minority interests 14 20 27 18 22 23 25 27 Total equity & liabilities 3,402 3,855 4,443 5,182 5,376 6,021 6,989 8,105 EV 15,401 15,207 14,934 14,748 15,168 14,903 14,457 13,772 Net debt/(cash) (272) (477) (758) (934) (518) (785) (1,233) (1,920) BVPS (KRW) 436,058 488,114 57,140 66,262 70,965 81,086 95,873 112,857

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) 8.8 25.0 23.0 18.4 (9.2) 12.8 17.1 12.6 EBITDA (YoY) 5.7 41.8 31.4 11.9 (20.3) 24.1 34.6 14.1 Operating profit (YoY) 1.2 52.4 37.1 9.7 (29.7) 33.8 42.6 15.0 Net profit (YoY) (0.7) 44.1 51.8 10.4 (38.4) 51.9 44.5 14.9 Core EPS (fully-diluted) (YoY) (0.7) 44.1 (84.8) 10.4 (38.4) 51.9 44.5 14.9 Gross-profit margin 70.6 73.5 75.5 74.8 73.1 74.1 76.1 76.4 EBITDA margin 15.9 18.1 19.3 18.2 16.0 17.6 20.2 20.5 Operating-profit margin 11.9 14.6 16.2 15.0 11.6 13.8 16.8 17.2 Net profit margin 8.6 9.9 12.3 11.4 7.8 10.5 12.9 13.2 ROAE 11.0 14.3 18.9 17.9 9.9 13.6 16.9 16.4 ROAA 8.3 10.6 14.1 13.4 7.5 10.6 13.4 13.3 ROCE 14.4 19.5 23.5 22.3 14.2 17.3 21.3 20.9 ROIC 12.4 17.4 23.2 22.9 12.6 15.8 20.4 21.5 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 26.5 27.4 24.9 24.6 29.8 24.3 25.0 25.3 Accounts receivable (days) 20.1 21.3 20.9 21.2 25.2 22.1 18.8 18.6 Current ratio (x) 1.8 2.2 2.1 1.8 1.6 1.8 2.1 2.5 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 14.2 13.7 13.5 14.3 18.8 17.9 13.4 12.4 Free cash flow yield 0.6 1.7 2.3 1.2 n.a. 3.0 4.4 5.6 Source: FactSet, Daiwa forecasts

Company profile

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

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Amorepacific (090430 KS): 26 July 2018

Amorepacific: share price and Daiwa recommendation trend Date Target Price Rating Date Target price Rating Date Target price Rating 07/07/16 515,000 Buy 26/07/17 298,000 Hold 28/06/18 440,000 Buy 14/02/17 415,000 Buy 30/10/17 350,000 Outperform

24/04/17 354,000 Buy 09/05/18 430,000 Buy 550,000 515,000 500,000 500,000

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

350,000 354,000 350,000

300,000 298,000

250,000

200,000

Jul-15 Jul-16 Jul-17

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

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

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

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

May-16 May-17 May-18

Target price (KRW) Closing Price (KRW)

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

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Amorepacific (090430 KS): 26 July 2018

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Name of Analyst : Iris Park

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Amorepacific (090430 KS): 26 July 2018

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The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report.

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Amorepacific (090430 KS): 26 July 2018

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

Disclosure of investment ratings Rating Percentage of total Buy* 70.4% Hold** 21.1% Sell*** 8.5% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 30 June 2018. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

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

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

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

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