CFA Institute Research Challenge Hosted in CFA Society Korea Korea University Korea University Consumer Products - Student Research This report is published for educational purposes only by students competing in the CFA Institute Research Challenge Amorepacific Close Price: KRW 2,220,000 Recommendation: BUY Date: Dec. 30, 2014 Target Price: KRW 3,000,000 Upside Potential: 35.1% Ticker: 090430 KS Equity Analysts LEE, Dongjin [email protected] Amorepacific: Beautifying China PARK, Jeongu [email protected] We initiate our coverage on Amorepacific (AP) with a buy recommendation suggesting one-year JANG, Dongbin [email protected] target price of KRW 3,000,000, which gives 35.1% upside from the closing price of KRW 2,220,000 on SHIN, Eugene [email protected] December 30th, 2014. AP is expected to show a solid business performance with strongly recurring JANG, Jihye [email protected] cash flows, attributable to the growing demand from Chinese customers. Investment Summary Target Price Breakdown 1. China: the Unique Positioning By 2020, AP is expected to gain market share (M/S) of 4.3% within China, the world’s second DCF (50%) KRW 3,300,000 largest and fastest growing market. AP is expected to experience 26.3% annual sales growth to Multiple (50%) KRW 2,700,000 generate KRW 1.8 trillion from China segment in 2020 due to its unique competitive positioning: 1) Asian origin, preferred by consumers due to the suitability for Chinese skin type Target Price KRW 3,000,000 2) Trendy manufacturer that captures the growing consumer demand for herb-medicinal and naturalistic cosmetics 3) Reliable brand distinguished from the Chinese local producers As a result, AP generates strong forward purchasing intent from customers in China. Market Profile 2. Korea: Dynamics of Distribution Close Price KRW 2,200,000 AP’s duty-free and ecommerce sales are projected to grow due to: (1) the increase in both number and expenditure of inbound Chinese tourists in duty-free channel and (2) the promising prospects KRW 2,520,000 / 52Wk High / Low KRW 857,000 of mobile shopping market along with the rising foreign direct purchases via online channel. Furthermore, the increasing contribution of the two highly lucrative channels will enhance the Market Cap. KRW 12,978 bil overall operating profit margin of AP’s domestic segment, from 14.7% in 2013 to 18.3% in 2020. Trade Volume 15,348 3. Strong Cash Position AP will remain attractive for the expected cash stock of KRW 703 billion in 2020. Increased As % of shares 0.26% operating cash flows will exceed investment needs while AP’s debt-free structure minimizes Shares Outstanding 5,842,556 financial cash outflows. The abundant cash stacked on the balance sheet will grant the firm a great financial flexibility to either increase investment or dividend payouts in near future. Valuation Share Price & Relative Performance We applied the Discounted Cash Flow Model (DCF) and the P/E multiples method, each with the (KRW) equal weighting, to compute the one-year target price of KRW 3,000,000. 3,000,000 For the DCF valuation, we applied the sum-of-the-parts method by separately estimating two 2,500,000 components segmented by Korea and Overseas, with different discount periods and rates. 2,000,000 For the Multiples valuation, we computed the benchmark P/E multiple of 36.1x by the historical mean of the peers during their periods of rapid growth similar to AP between 2014 and 2016. 1,500,000 By combining two different valuation models, we tried to capture the absolute stock value and to 1,000,000 reflect the market sentiment. 500,000 AP’s Performance and Key Ratios (KRW bil) 0 Jan-11 Nov-11 Sep-12 Jul-13 May-14 2011 2012 2013 2014F 2015F 2016F 2018F 2020F AP KOSPI 200 Sales 2,555 2,849 3,100 3,675 4,122 4,677 5,905 7,426 Korea 2,227 2,427 2,561 2,921 3,169 3,497 4,113 4,761 Source: Fn Dataguide Duty-free 213 265 348 596 806 1,033 1,449 1,896 Online 177 222 294 354 408 472 616 782 Door-to-door 643 649 562 514 513 502 476 451 Earnings Per Share Movement Other cosmetics 1,194 1,291 1,357 1,457 1,441 1,489 1,572 1,631 (KRW) MC & Sulloc 403 438 468 468 472 484 502 511 180,000 Overseas 327 443 540 754 954 1,181 1,792 2,665 160,000 China 191 262 339 444 572 729 1,155 1,802 140,000 HK/Taiwan/SEA 47 30 79 260 306 365 530 746 120,000 Others 89 150 122 50 76 87 107 117 100,000 OPM 14.6% 12.8% 11.9% 13.7% 14.4% 15.0% 15.7% 16.4% 80,000 NIM 12.8% 9.4% 8.6% 10.1% 10.6% 11.0% 11.5% 12.0% 60,000 EPS (KRW) 56,015 46,086 45,761 63,448 74,684 87,832 116,440 152,534 40,000 EPS YoY 13.8% -17.7% -0.7% 38.7% 17.7% 17.6% 14.4% 14.8% 20,000 ROE 15.3% 11.5% 10.4% 12.8% 13.3% 13.7% 13.9% 13.8% 0 2011 2012 2013 2014E 2015E 2020E Fwd P/E 35.0 29.7 25.3 19.1 14.6 Source: Company data Source: Company data, team estimates 1 Korea University Figure 1. 2013 Revenue Breakdown Business Description Sulloc Amorepacific (AP) is the largest cosmetics supplier in Korea with a concrete market share (M/S) of 32.1% as of 1.9% 2014. Founded in 1945, AP has served a wide range of beauty products including cosmetics, personal care, health care and Green Tea products. A bulk of its sales, however, are earned through the Cosmetics Division, Mass Cosmetics accounting for 84.7%, followed by Mass Cosmetics (13.3%) and Sulloc (1.9%) (Figure 1). 13.3% Business Structure There are three major business divisions under AP: Cosmetics, Mass Cosmetics, and Sulloc. AP serves a Cosmetics variety of cosmetics products with 14 brands and personal care products with 7 brands. In addition, there are 84.7% 3 brands for health care business along with Sulloc for Green Tea products. (Appendix 16) Cosmetics AP has shown a robust sales growth of its cosmetics products with an annual average of 14.3% over the last 5 years. Source: Company data 1. Diversified Brand Portfolio Figure 2. AP Brand Portfolio Listed from high-end to low-end, AP’s cosmetics brands consists of prestige, masstige and mass. Main brands of AP includes Sulwhasoo, Hera, IOPE, Laneige, and Mamonde. (Figure 2) Prestige 2. Wide Utilization of Domestic Distribution Channels The major domestic distribution channels for AP’s cosmetics products can be largely classified as: online sales(15%), department stores(13%), door-to-door(21%), specialty stores(18%), duty-free shops(25%), and others(9%). All the channels have different operating profit margins; duty-free channel has the highest profit Masstige margin of around 25%, followed by door-to-door and online channels that have margins of around 20%. 3. Heavy Concentration on Skin Care Products Cosmetics market can be segmented by Skin Care, Hair Care, Color, Fragrance, Hygiene and Oral Care market. AP’s production is focused on Skin Care and Color cosmetics; Skin Care products generate 93% of the divisional sales revenue. Mass Mass Cosmetics (Personal Care & Health Care) Source: Company data Mass Cosmetics (MC) refers to the product category served at relatively lower prices than ordinary cosmetics, and therefore, practicality is more valued than brand image. They are usually sold at Figure 3. AP Domestic Distribution supermarkets and discount stores. MC division, highly concentrated on domestic market, consists of 100% personal & health care brands such as Ryoe, Mise-en-scene, Happy Bath, Median, etc. Though AP has Door to Door 90% significant market share of 22.5%, its further growth is expected to be limited with forecasted growth rate of 80% Specialty store less than 2% due to the low growth potential of the market itself. (Appendix 10) 70% Travel Retail 60% Sulloc (Green Tea) Online/Homes Sulloc is a representative Green Tea maker in Korea with a dominant market share of over 50% in domestic 50% hopping tea market. Its business consists of operation of the Green Café and production of Green Tea products. For 40% Department store the past 5 years it has grown rapidly thanks to new product launches, broadening channels and line 30% Discount store expansion. However, its growth is slowing down as forecasted to be less than 5%. Also, with a very small 20% Direct Sale sales contribution(1.9%), it will not meaningfully affect the overall performance of AP. (Appendix 10) 10% 0% Others Corporate Strategies 2007200820092010201120122013 The company mainly focuses on the following three core strategies: Source: Company data Concentration Figure 4. Sales Breakdown by Region AP is heavily focusing its operations on the cosmetics business. Kyung-Bae Suh, the President and CEO of AP, has his management philosophy of ‘Snowballing Theory’. He views beauty and healthcare business as (KRW bil) the core of the entire company. He believes incessantly reinforcing the core is the only way to grow the firm. 8,000 During the Asian Financial Crisis in 1997, Suh executed a series of daring structural reforms by getting rid 7,000 of secondary businesses that had no relevance to beauty enterprise such as security, fashion and sports 6,000 38.5% (Appendix 15). 5,000 4,000 Responsiveness 3,000 Although the domestic demand for cosmetics stays static, the increasing consumption of the inbound 2,000 20.5% 61.5% Chinese tourists is nurturing the Korean cosmetics market.