[Korea] January 25, 2021

Cosmetics (Overweight/Initiate) Chinese market to transition to quantitative growth

Mirae Asset Daewoo Co., Ltd. Junghan Yoon [email protected]

Initiate coverage with Focus on cosmetics names with high exposure to China Overweight recommendation ó In 2021, we expect China’s aggregate demand for cosmetics to recover. ó We advise investors to focus on Korean OEMs/OD Ms, which previously faced uncertainties over growth. ó Our top pick is Cosmax, which holds the largest share in China’s cosmetics OEM/ODM market at 4.9%.

Cosmetics consumption to see Focus on quantitative growth of China ’s cosmetics consumption amid improving economic growth reminiscent of 2017 conditions ó Since 2H20, China has recorded the highest disposable income growth (excluding transfer income) among major countries. ó Financial conditions supportive of the Chinese yuan suggest the Chinese government will pursue an urbanization policy that is supportive of rational consumption. ó Rapid urbanization and growing income should support the quantitative growth of China’s cosmetics consumption. ó We believe China’s cosmetics consumption environment is reminiscent of 2017, when retail cosmetics sales rapidly increased.

OEMs/ODMs in China have Overall environment positive to OEMs/ODMs, whose valuations are driven by top -line plenty of room for growth; growth valuation gap with global brands ó While China’s retail cosmetics market is around five times bigger than that of Korea, its appears excessive cosmetics OEM/ODM market is only 1.5 times larger than Korea’s. ó Chinese authorities have begun regulating installment purchases facilitated by online small loan platforms (which have played an important role in shaping young consumers’ cosmetics consumption). ó We believe demand for cosmetics will extend to value-for-money s egments, which rely on OEM/ODM manufacturing. ó OEMs/ODMs in China are trading at a more than 50% discount to global brands on a 12-month forward P/E basis. ó We view such a valuation gap as excessive, considering China’s improving economic conditions and rebounding PPI in the household & personal care (HPC) category.

Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he US. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES AND DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. January 25, 2021 Cosmetics

C O N T E N T S

Executive summary 3

I. Chinese demand holds the key 4 Korean cosmetics industry is largely driven by Chinese consumer behavior 4 China’s 2021 domestic consumption growth to match the 2017 level 13 Millennials and Gen Z drive the luxury cosmetics market in China 22

II. Potential changes in consumption patterns 25 Post-pandemic changes in Gen Z’s cosmetics consumption behavior 25 Korean cosmetics OEM/ODM players stand to benefit from the rise of C-beauty 34

AmorePacific 36 LG H&H 41 Cosmax 46

Mirae Asset Daewoo Research 2 January 25, 2021 Cosmetics

Executive summary

We initiate our coverage of the cosmetics sector with an Overweight rating. In our view, investors should focus on companies with high revenue exposure to China, given that the country’s aggregate demand for cosmetics is likely to pick up this year. We highlight Korean OEMs/ODMs, which appear well-positioned to shake off the uncertainties surrounding their growth outlook. (During 2018-20, the concentration of demand in the luxury category raised concerns over their prospects.) Our top pick is Cosmax, which holds the largest share in China’s cosmetics OEM/ODM market at 4.9%.

When economic growth slowed after 2018, China’s cosmetics consumption became bifurcated. Korean companies failed to respond effectively to this shift, as their value-for- money/volume-oriented strategies were at odds with the direction of the Chinese market. Incremental demand was largely confined to the luxury segment, and brands realized growth by raising their pricing. In the masstige space, where competition intensified amid slowing growth, Korean firms lost ground to local brands, whose localized marketing campaigns appealed to young consumers.

Currently, there are doubts over whether Korean brands still have an advantage over local Chinese brands in the value-for-money category. Chinese consumers no longer choose cosmetics brands based on their country of origin; confidence in product quality and brand stories are more important considerations. In light of this, we do not believe that a potential rebound in Chinese inbound tourism would have a significant impact on the fundamentals of the Korean cosmetics industry.

In 2021, we look for quantitative growth in China’s cosmetics consumption on the back of improving economic conditions. China’s industrial production data and manufacturing sector have already rebounded sharply from the impact of COVID-19. While consumer spending has been slower to recover, we note that China has seen the highest disposable income growth (excluding transfer income) among major countries since 2H20. Financial conditions supportive of the Chinese yuan also suggest the Chinese government will pursue an urbanization policy that is supportive of rational consumption. Rapid urbanization and growing income should support quantitative growth in cosmetics consumption. We believe China’s cosmetics consumption environment is reminiscent of 2017, when retail cosmetics sales rapidly increased.

We believe China’s shift to quantitative consumption will provide positive momentum to companies operating at the lower end of the value chain (OEMs/ODMs, packaging, materials, etc.), as the valuations of such companies are largely driven by top-line growth rather than profit margins. In particular, the OEM/ODM sector is where Korean firms enjoy a competitive edge over local suppliers. While China’s retail cosmetics market is around five times the size of Korea’s, its cosmetics OEM/ODM market is only 1.5 times larger than Korea’s. Thus, we see plenty of room for growth.

Furthermore, young Chinese consumers’ habits are expected to change in ways that are favorable to the business environment of OEMs/ODMs. Chinese authorities have begun regulating installment purchases facilitated by online microlending platforms (which have played an important role in shaping young consumers’ cosmetics consumption). This should help extend demand beyond the luxury segment to the value-for-money segment, which relies on OEM/ODM manufacturing. Notably, we think recent trends such as cosmeceuticals (cross between cosmetics and pharmaceuticals) and guochao (preference for homegrown brands) are all part of the broader transition toward value-for-money.

To be sure, the long-term structural growth of China’s cosmetics sector will come largely from the luxury segment as Chinese consumers’ tastes become more sophisticated. However, the valuation gap between OEMs/ODMs operating in China and global brands—which began to widen in 2H18—now stands at more than 50% on a 12-month forward P/E basis. We view such a gap as excessive, given China’s improving economic conditions and rebounding PPI for HPC goods (daily-use articles). From a trading perspective, we thus see greater upside to OEMs/ODMs than brand names in 2021.

Mirae Asset Daewoo Research 3 January 25, 2021 Cosmetics

I. Chinese demand holds the key

Korean cosmetics industry is largely driven by Chinese consumer behavior

Following a period of growth through 2016, Korea’s cosmetics market (not including duty- free purchases by foreigners) expanded at 2.9% CAGR between 2017 and 2019, which indicates essentially zero growth after adjusting for inflation. The country’s annual cosmetics spending per capita is around US$210, similar to the levels of developed markets. Against this backdrop, it appears that the domestic market has reached maturity.

In addition, aggregate demand was curtailed by a drop in Chinese group tourists (one of the industry’s biggest customers) in the wake of the THAAD dispute in late 2016. This coincided with fears of chemicals in beauty products highlighted on social media, which caused many consumers to simplify their beauty routines.

As the cosmetics market has matured, domestic consumers’ tastes have become more diversified, with a greater emphasis on individuality. The widespread adoption of OEM/ODM manufacturing has also significantly lowered market barriers for new entrants. AmorePacific, Korea’s leading cosmetics company, saw its share in the stagnant domestic market decline rapidly from 32.9% in 2015 to 19.4% in 3Q20.

Figure 1. Estimated size of domestic cosmetics market Figure 2. AmorePacific: Domestic M/S trend (excl. duty-free purchases by foreigners)

(Wbn) (%) 35% 32.9% 6,000 Domestic cosmetics market (L) YoY (R) 20 31.9% 30% 29.0% 27.2% 5,000 10 25% 22.8% 4,000 0 19.4% 20% 3,000 -10 15%

2,000 -20 10%

1,000 -30 5%

- -40 0% 1Q16 4Q16 3Q17 2Q18 1Q19 4Q19 3Q20 2015 2016 2017 2018 2019 3Q20

Source: KDFA, Statistics Korea, Mirae Asset Daewoo Research Source: Kantar, Mirae Asset Daewoo Research

In a sign of how fragmented the market has become, the number of registered cosmetics sellers increased by a record 3,034 YoY to 15,707 in 2019. The diversification of consumer preferences has also led to changes in cosmetics distribution channels, with demand gradually shifting away from mono-brand shops (so-called road shops) and door-to-door channels, which focus on single brands, to health & beauty (H&B) stores and online channels, which offer access to a more diverse range of products and categories.

During the market’s previous growth period, domestic cosmetics firms sold their products through mono-brand shops (key examples being Missha, Etude House, and Aritaum) to capture retail margins. Able C&C, the company behind the brand Missha, earned an OP margin of around 20% in 2003-04. This underscores the strong operating leverage cosmetics firms enjoyed, as costs were generally 30% of selling prices due to the outsourcing of manufacturing.

Mirae Asset Daewoo Research 4 January 25, 2021 Cosmetics

After 2016, however, Chinese inbound tourism—a key growth driver of mono-brand shops— dropped dramatically, forcing out many companies that struggled to adapt to changes in distribution channels. In the case of mono-brand shops, the number of stores did not decline sharply in 2017, even as the share of online cosmetics sales soared. Because of their heavy reliance on demand from Chinese tourists, which had begun to increase exponentially in 2014, they were slow to respond to the shift in domestic demand toward H&B and online channels.

Figure 3. No. and growth of registered domestic cosmetics Figure 4. Quarterly online cosmetics penetration rate sellers

(No.) Registered domestic cosmetics sellers (L) (No.) (%) 18000 3,500 50 YoY chg. (R) Demand has shifted to online channels since 2017 16000 45 3,000 40 14000 2,500 35 12000 30 10000 2,000 25 8000 1,500 20 6000 1,000 15 4000 10 500 2000 5 0 0 - 2012 2013 2014 2015 2016 2017 2018 2019 1Q15 4Q15 3Q16 2Q17 1Q18 4Q18 4Q19 3Q20

Source: MFDS, Mirae Asset Daewoo Research Source: Statistics Korea, Mirae Asset Daewoo Research

Figure 5. OP margins of mono-brand shop operators Figure 6. No. of mono-brand and H&B stores

(%) (No.) 30 Able C&C Skinfood Tony Moly 6,000 Mono-brand stores H&B stores

20 5,000

10 4,000 - 3,000 -10 2,000 -20

-30 1,000

-40 - 2002 2005 2008 2011 2014 2017 2015 2016 2017 2018 2019

Source: WISEfn, Mirae Asset Daewoo Research Notes: Mono-brand shops include Missha, The Face Shop, Nature Republic, Innisfree, Tony Moly, and Skinfood; H&B stores include Olive Young, Lalavla, and Lohb’s. Source: Industry data, Mirae Asset Daewoo Resea rch

Mirae Asset Daewoo Research 5 January 25, 2021 Cosmetics

Unlike the domestic market, China’s cosmetics market is continuing to grow strongly. According to Euromonitor data, China’s cosmetics market has grown 9.9% CAGR since 2014 and accounts for 20% of the global market as of 2019, an 8%p increase from 2009. When excluding personal care, China is the world’s largest cosmetics market.

China’s annual per-capita spending on cosmetics is just US$44—around 20% of the levels in not only the US and Europe, but also neighboring countries like Japan and Korea. Per-capita spending is low because of the large number of low-tier, underpenetrated cities in the country. As of 2019, China’s urbanization rate was 60.3%, far below Korea’s 81.4%. This suggests that China’s cosmetics market still has plenty of room for growth.

Figure 7. China’s cosmetics market size and growth Figure 8. Global cosmetics market breakdown (2019)

(CNYbn) China cosmetic market (L) 600 YoY (R) 16% 13.8% 14% 500 12.6% 12.6% 12% China: 20% 10.3% 400 9.8% 11.2% 9.1% 10% 7.6% 300 8% 6.7% 6.4% US: 18% 6% 200 4% 100 Japan: 12% 2%

- 0% Korea: 4% 2010 2012 2014 2016 2018

Source: Euromonitor, Mirae Asset Daewoo Research Source: Euromonitor, Mirae Asset Daewoo Research

Figure 9. China’s annual per-capita makeup spending by city Figure 10. Urbanization rate by country (2019) tier (2019)

(CNY) 100% 450 90% 400 80% 350 70%

300 60%

250 50%

200 40%

150 30%

100 20%

50 10%

0 0% 1st tier 2nd tier 3rd tier China Japan Korea US Avg. China Japan Korea US France

Source: Euromonitor, Mirae Asset Daewoo Research Source: Statistics Korea, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 6 January 25, 2021 Cosmetics

In 2019, China was responsible for 58% of the global cosmetics market’s growth. In 2020, while global cosmetics spending contracted as a result of COVID-19, retail sales of cosmetics in China resumed YoY growth in April and increased more than 13.6% YoY from January to November. The country’s cosmetics sales have rebounded more rapidly than other consumer goods categories. In November, during which Tmall held its Singles’ Day event (70% of sales come from the beauty category), cosmetics retail sales surged 32.3% YoY.

Figure 11. China’s monthly retail sales growth: Cosmetics vs. other categories

(%) Overall Household goods Cosmetics Sports/recreation 35 30 25 20 15 10 5 0 -5 -10 -15 -20 10/19 12/19 4/20 6/20 8/20 10/20 12/20

Source: CEIC, Mirae Asset Daewoo Research

In sum, while Korea’s cosmetics market has come to a standstill, China’s cosmetics market is growing at a rapid rate. As a result, the gap in growth between domestic cosmetics firms that are favored by Chinese consumers and those that are not has been widening, a trend that became evident in late 2017.

One notable development in recent years has been the Chinese market’s rapid premiumization. In 2017, consumer patterns began to change, with demand for skin care products shifting to the luxury space and demand for makeup products, which are more tied to individuality and less sensitive to quality concerns, migrating to local brands.

Figure 12 . Revenue comparison of domestic firms with and Figure 13 . Annual growth rate of China’s cosmetics market by without China exposure category

(Wbn) (Wbn) Gap (R) 35% 4,000 1,600 Luxury LG H&H/AmorePacific/Cosmax (L) 30% Masstige 3,500 23 other companies (L) 1,400

3,000 1,200 25%

2,500 1,000 20%

2,000 800 15% 1,500 600 10% 1,000 400 5% 500 200 Increased polarization after 2018 - - 0% 1Q14 2Q15 3Q16 4Q17 1Q19 2Q20 2014 2015 2016 2017 2018 2019

Source: WISEfn, Mirae Asset Daewoo Research Source: Euromonitor, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 7 January 25, 2021 Cosmetics

As Chinese consumers shifted increasingly toward premium cosmetics after 2017, K-beauty gradually lost its appeal in the country. While the potential to tie marketing to Korean cultural content (e.g., dramas and idol groups) is often considered one of K-beauty’s biggest strengths, we believe that its long-term underlying competitiveness lies in its: 1) value for money; and 2) rapid trend turnover.

Aside from Europe, Japan and Korea are probably the only two countries where homegrown cosmetics brands have a strong presence in their respective markets. What makes these local brands so successful, in our view, is their ability to quickly launch on-trend products and offer good value for money, using OEMs and ODMs with superior technology.

Figure 14. Key factors behind K-beauty’s popularity Figure 15. M/S of local brands in the Chinese, Korean,

(based on Twitter and news keywords from 2015 to 2018) and Japanese cosmetics markets

Local brands Global brands Unknown 7,000 100%

6,000 90% 80% 5,000 70% 4,000 60% 50% 3,000 40% 2,000 30% 50.1% 54.4% 20% 1,000 28.6% 10% - 0% Product Price Model Brand Image Technology China Korea Japan

Source: Daumsoft, Mirae Asset Daewoo Research Source: Euromonitor, Mirae Asset Daewoo Research

In 2019, we estimate that approximately 54% of cosmetics products in Korea were produced on an outsourced (OEM/ODM) basis, well above the global average of 30%. Given the wide use of outsourced production, the domestic market has a high density of sellers relative to its size. The number of businesses registered as cosmetics sellers (including customer-facing sellers and manufacturers) totals 18,618 in Korea, vs. 5,398 in China and 3,000 in the US.

Prior to China’s THAAD-related restrictions, Chinese visitors to Korea were, by and large, female shoppers with an average monthly income below CNY8,000. Back then, the top search terms on Baidu related to travel in Korea were “reasonable prices” and “best value for money.”

At that time (mid-2010s), we believe Korean beauty products were appealing from a value- for-money standpoint because: 1) China’s per-capita GNI was only US$8,000 (Korea’s level in 1992); and 2) Chinese consumers lacked trust in local brands. Low/mid-end Korean cosmetics are still widely used by college students in China, who view them as entry-level products.

However, we believe that the value-for-money appeal of K-beauty has been overshadowed by the rapidly improving technology and quality of China-oriented OEM/ODM manufacturing. In particular, local Chinese brands have gradually expanded their market shares in the color cosmetics segment.

For instance, in 2019, the gross merchandise value (GMV) of Chinese makeup brands on Tmall expanded 82% YoY to CNY22.14bn, accounting for 61% of Tmall’s total GMV in the segment. In addition, the combined market share of China’s top 20 beauty brands hit 15.8% in 2019, up 8.2%p compared to 2012 (7.6%).

Mirae Asset Daewoo Research 8 January 25, 2021 Cosmetics

Figure 16 . Outsourced production as % of domestic cosmetics Figure 17. In the mid-2010s, China’s per-capita GNI hit the level production seen in Korea in 1992

(Wbn) Domestic cosmetics production (L) (US$) Outsourced production (L) 40,000 Korea 18,000 Outsourced ratio (R) 56% China 16,000 35,000

14,000 30,000 12,000 55% 25,000 10,000 20,000 8,000 15,000 6,000 54% 10,000 4,000

2,000 5,000

- 53% - 2012 2013 2014 2015 2016 2017 2018 2019 90 93 96 99 02 05 08 11 14 17

Source: MFDS, Mirae Asset Daewoo Research Source: Macrotrends, Mirae Asset Daewoo Research

Figure 18 . Avg. monthly income of Chinese tourists visiting Figure 19. Cosmetics market and no. of registered businesses

Korea in 2015 in Korea, China, and the US

30% (US$mn) Cosmetics market (L) 100,000 No. of registered businesses (R) 20,000 25% 90,000 18,000 80,000 16,000 20% 70,000 14,000 60,000 12,000 15% 50,000 10,000 10% 40,000 8,000 30,000 6,000 5% 20,000 4,000 10,000 2,000 0% <5,000 5,000- 8,000- 10,000- ≥15,000 - - 7,999 9,999 14,999 Korea China U.S

Source: LG Economic Research Institute, Mirae Asset Daewoo Research Source: Statistics Korea, Euromonitor, Mirae Asset Daewoo Research

Figure 20. Combined M/S of top 20 Chinese local brands

18%

15.8% 16% 14.2% 14.1% 14% 12.3% 12.4% 12%

9.8% 10% 9.1%

7.6% 8%

6% 2012 2013 2014 2015 2016 2017 2018 2019

Source: QuestMobile, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 9 January 25, 2021 Cosmetics

At the same time, the local brand market is becoming more fragmented: from 2010 to 2019, the market share (local brands only) of the top five brands fell from 22.1% to 16.5%, while that of the top 100 brands expanded from 25% to 33.4%. The advance of local cosmetics companies and diversification of demand across brands (regardless of size) suggest that consumers increasingly trust the quality and technology of Chinese brands.

Homegrown brands are no longer perceived as cheap/inferior in China. In a recent survey of Chinese consumers with experience purchasing foreign cosmetics brands, 46% said they would be willing to choose local brands, other factors being equal. Respondents younger than 30 (a key consumer group) showed low sensitivity to a brand’s country of origin.

Figure 21. Country of origin is not a major consideration for consumers under 30

Doesn't matter Preference for global brands Preference for local brands 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% <20 20-25 25-30 30-35 35-40 40-45 >45

Source: Useit, Mirae Asset Daewoo Research

Figure 22 . Key factors affecting purchasing decisions of Figure 23. Chinese consumer survey: Intent to purchase local -

Chinese cosmetics consumers brand products (2019)

Quality Highly likely Likely Unlikely Reputation Price Effectiveness Brand Brand experience Ingredients Discount 27.3% Country of origin 62.3% Shopping experience Design Celebrity endorsement Limited edition

0% 20% 40% 60% 80%

Source: Chyxx, Mirae Asset Daewoo Research Source: Chyxx, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 10 January 25, 2021 Cosmetics

The Korean cosmetics sector is seeing a rise in share price volatility amid speculation over a potential visit by Xi Jinping and growing expectations on the lifting of THAAD-related restrictions. However, we believe this speculation ignores a more fundamental question regarding the industry’s competitiveness. Even if Chinese group tours resume, cosmetics purchases by Chinese tourists are unlikely to match historical levels. Indeed, the correlation between inbound Chinese tourism and the cosmetics sector has weakened meaningfully since 2018.

Notably, Korea’s exports of cosmetics products have been growing sharply, which some attribute to their growing popularity in the global market. Korea’s total cosmetics exports grew 14.8% YoY during Jan.-Nov. 2020 (+26.6% YoY in November), with China-bound exports expanding 25.3% YoY over the same period. Robust exports have raised expectations for growth across the sector, given that: 1) China accounts for 50% of Korea’s total cosmetics exports; and 2) SMEs contribute more than 75% of cosmetics exports.

Figure 24 . Inbound Chinese tourists to Korea and Korea’s Figure 25. Korea’s cosmetics exports to China (HS code: 3304) cosmetics sector index

('000) Inbound Chinese tourists (L) (US$mn) China-bound cosmetics exports (L) (%) 1,000 Cosmetics sector index (R) 500 400 YoY (R) 140 900 450 350 120 800 400 100 300 700 350 80 250 600 300 60 500 250 200 40 400 200 150 20 300 150 100 - 200 100 50 100 50 -20 - - - -40 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19 1/20 1/16 11/16 9/17 7/18 5/19 3/20

Source: Statistics Korea, Mirae Asset Daewoo Research Source: TRASS, Mirae Asset Daewoo Research

However, dividing export value by volume shows that price increases are mainly responsible for the growth in cosmetics exports. In fact, the pace of export growth has slowed in volume terms. We see several possible explanations for this: 1) exports have been concentrated around certain premium brands; 2) exports of pricey skin care devices (which are registered under the same HS code as cosmetics products) have increased on the back of the at-home treatment trend; and 3) daigou have been forced to change their logistics strategies (from hand carrying to express delivery/forwarding services) due to COVID-19.

Figure 26. Korea’s cosmetics exports to China: Export volume and value trends (growth, six-month moving avg.)

(%) (%) 45 Volume (L) Export recovery remains weak in terms of volume 20 40 Price (R) 15 35

30 10

25 5 20

15 -

10 -5 5

- -10 1/19 5/19 9/19 1/20 5/20 9/20

Source: KITA, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 11 January 25, 2021 Cosmetics

According to export data alone, low/mid-end Korean brands should have displayed quarterly earnings improvements in 3Q20. However, based on our earnings check, 47 out of 84 domestic cosmetics businesses fared worse both YoY and QoQ in 3Q20. China Customs data also confirm that Korea’s share of China’s cosmetics imports sharply declined during the Jan.- Jul. 2020 period, to 19% (vs. 27% in 2016). Against this backdrop, we believe it is unreasonable to assume that Korean cosmetics are regaining their former popularity with Chinese consumers.

Accordingly, we believe that investors should focus on Korean cosmetics companies that: 1) operate competitive brands able to meet local demand in China; and/or 2) are poised to grow alongside Chinese brands.

Rather than export data or Chinese inbound tourist trends, we advise investors to monitor market share data within the domestic duty-free channel and performances during major Chinese online shopping events (e.g., 618 and Singles’ Day), as these are more relevant metrics for identifying brand power. We also recommend closely monitoring whether the pace of China's monthly cosmetics retail sales growth falls below that of the total retail market.

Figure 27. Cosmetics sector earnings in 3Q20 (YoY chg.) Figure 28 . China’s cosmetics imports: Breakdown by country

(No.) 100% France Korea Japan US UK 60 Companies reporting YoY growth Companies reporting YoY declines 90%

50 80% 70% 40 60%

30 50% 10% 40% 23% 27% 26% 20 27% 23% 30% 19%

10 20% 10% 0 Revenue OP NP 0% 2014 2015 2016 2017 2018 2019 1-7/20

Source: Cosmorning, Mirae Asset Daewoo Research Source: KITA, Mirae Asset Daewoo Research

Figure 29. M/S within the domestic duty-free channel: LG H&H vs. AmorePacific

LG H&H AmorePacific 30%

25%

20%

15%

10%

5%

0% 1Q15 4Q15 3Q16 2Q17 1Q18 4Q18 3Q19 2Q20

Source: Company data, Korea Duty Free Association, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 12 January 25, 2021 Cosmetics

China’s 2021 domestic consumption growth to match the 2017 level

At the Central Economic Work Conference held last December, China unveiled a “dual circulation” strategy that seeks to balance the country’s continued export push with an increasing focus on domestic consumption. This is not the first time China has put domestic demand at the forefront of its economic growth plans. Indeed, for export-oriented economies such as China and Korea, which are highly sensitive to external market conditions, boosting domestic consumption is the ultimate policy goal. In particular, China launched the Chinese Dream campaign in 2014 to spur domestic demand and expand its middle-class population.

However, at the time, external factors (yen/euro depreciation and talks of tapering/rate hikes in the US) accelerated capital outflows from China, making it increasingly difficult for the country to hold its foreign reserves. In response, China decided to devalue its currency in Aug. 2015, dealing a heavy blow to the property market and domestic consumption. This move, coupled with far-reaching anti-corruption initiatives, also contributed to a contraction in the global luxury goods market.

Figure 30. USD/CNY rate and cosmetics retail sales growth Figure 31. Global luxury goods market size

(%) China cosmetics retail sales growth (L) (EURbn) 35 USD/CNY (inveted, R) 5.4 300 281 254 260 30 5.6 245 244 250 25 219 5.8 207 212 20 Chinese maket shock 6 200 186 167 15 159 6.2 147 10 150 6.4 5 6.6 100 0 -5 6.8 50 -10 7 -15 7.2 0 3/12 8/13 3/15 8/16 3/18 8/19 08 09 10 11 12 13 14 15 16 17 18 19 20

Source: Bloomberg, Mirae Asset Daewoo Research Source: Bain & Company, Mirae Asset Daewoo Research

In 2016, the consumption recovery in the US and the Fed’s dovishness led to a surge in the capital goods trade globally. Against this backdrop, China’s exports grew, and the resulting trade balance recovery helped stabilize the yuan. Furthermore, fiscal expansion (e.g., infrastructure spending, etc.), as part of government efforts to thwart an economic downturn, facilitated urbanization in China’s lower-tier cities. In 2017, the manufacturing rebound and rapid urbanization helped narrow the urban-rural income gap.

In 2016, properties in China’s lower-tier cities began appreciating sharply amid permissive bank reserve requirements, a low loan prime rate (LPR), and a broad-based real estate boom. Moreover, wages climbed while unemployment fell amid a recovery in manufacturing. As a result, consumer spending in the lower-tier cities increased rapidly. (Rural/lower-tier city residents have a higher marginal propensity to consume compared to urban residents.)

In 2017, asset income in China’s rural areas rebounded to 8.6%, ending the growth slowdown since 2012. Of note, rural residents saw their asset income and wages rise in tandem, while for urban residents, property assets accounted for the lion’s share of overall income growth.

Mirae Asset Daewoo Research 13 January 25, 2021 Cosmetics

Figure 32. China: YoY increase in urbanization Figure 33. China: Urban-rural income gap

(%p) (Urban/rural) 1.35 3.0

1.3 2.0 1.0 1.25 - 1.2 -1.0 1.15 -2.0 1.1 -3.0 1.05 -4.0 Relatively solid wage growth in lower-tier cities 1 -5.0

0.95 -6.0 2015 2016 2017 2018 2019 2020 3/14 11/14 7/15 3/16 11/16 7/17 3/18 11/18 7/19 3/20

Source: Statistics Korea, Mirae Asset Daewoo Research Source: CEIC, Mirae Asset Daewoo Research

Figure 35 . China: Consumption as % of disposable income Figure 34. China: Middle class as % of population (lower-tier city residents have higher propensity to consume)

70% 1st/2nd-tier cities 3rd/4th-tier cities (%) 85 Lower 3rd-tier cities 1st/2nd-tier cities 60% 83 81 50% 79 40% 77 75 30% 73 20% 71

Middle class as % of poulation in 69 10% 3rd/4th-tier cities displayed sharp 67 growth in 2017 0% 65 7/05 7/05 7/05 7/05 7/05 7/05 7/05 7/05 7/05 2013 2014 2015 2016 2017 2018 2019

Source: McKinsey Global Institute, Mirae Asset Daewoo Research Source: KOTRA, Mirae Asset Daewoo Research

Figure 36. China: Property prices in lower-tier cities and CSI Figure 37. China: Income growth in rural areas (2017)

(%) (%) (%) (%) 15 Property prices in lower-tier cities YoY (9M lagging, L) 20 18 Asset income (L) 16 Consumer CSI YoY (R) 15 Wages (R) 15 10 16 14 10 14 13 5 Unlike cities, rural areas saw 5 wage growth in 2017 12 12 0 11 0 10 10 -5 -5 9 -10 8 8

-10 -15 6 7 1/12 4/13 7/14 10/15 1/17 4/18 7/19 10/20 3/14 11/14 7/15 3/16 11/16 7/17 3/18

Source: Bloomberg, Mirae Asset Daewoo Research Source: CEIC, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 14 January 25, 2021 Cosmetics

Against this backdrop, retail sales of cosmetics in China jumped 13.1% YoY in 2017, picking up from years of slowing growth. This improvement was largely attributable to: 1) the urbanization of lower-tier cities with underpenetrated cosmetics markets; 2) disposable income growth; and 3) rural residents’ high propensity to consume.

Notably, despite the rapid market expansion, we note that the per-tonne price of cosmetics (retail sales value divided by production volume) declined in 2017, indicating that market growth was driven by increased volume rather than price increases.

Figure 38. Cosmetics retail sales and growth in China: Rapid growth in 2017 and 2019

(CNYbn) (%) 400 China cosmetics retail sales (L) 16 Growth (R) 350 14 338 300 12 299 250 10 262 251 200 222 8 205 150 183 6

100 4

50 2

0 0 2014 2015 2016 2017 2018 2019 2020F

Source: National Bureau of Statistics of China, Mirae Asset Daewoo Research

Figure 39. Cosmetics production volume and price per tonne in China: Increased volume drove market growth in 2017, while price increases drove market growth in 2019

(CNYbn) (CNY) 14 Cosmetics production volume (L) 27 12.4 12.8 Price per tonne (R) 11.7 26 12 10.8 25 10 9.2 9.3 8.9 24

8 23

6 22 21 4 20 2 19

0 18 2014 2015 2016 2017 2018 2019 2020(F)

Source: National Bureau of Statistics of China, Mirae Asset Daewoo Research

Indeed, for cosmetics imports from Europe (which are generally luxury brands), volume growth outpaced price growth in 2017. At the same time, the cosmetics CPI climbed in rural areas (unlike in cities) despite a strengthening yuan, which makes imports cheaper. This suggests that rural residents with a relatively high propensity to spend drove cosmetics demand amid the recovery of the real economy and disposable income growth.

Sales of small luxury items (shoes, cosmetics, etc.) tend to grow rapidly when consumers start to trade up. We believe that trading-up behavior in lower-tier cities has driven the sharp growth of China’s luxury cosmetics sales since 2017.

Mirae Asset Daewoo Research 15 January 25, 2021 Cosmetics

Figure 40. Cosmetics CPI climbed in rural areas of China in 2017 Figure 41. European cosmetics exports to China (growth, despite a strengthening yuan six-month moving avg.)

(P) (%) (%) Cosmetics CPI in rural areas (L) Volume (L) Price (R) 102.5 7.2 70 In 2017, the contribution of European 40 Cosmetics CPI in urban areas (L) products was high USD/CNY (R) 7.0 60 102.0 30 6.8 50 101.5 6.6 20 40 101.0 6.4 30 10 100.5 6.2 20 6.0 0 100.0 In 2017, the price of cosmetics in rural 10 5.8 areas rose rapidly despite the strong -10 99.5 yuan 5.6 0

99.0 5.4 -10 -20 1/14 4/15 7/16 10/17 1/19 4/20 6/16 2/17 10/17 6/18 2/19 10/19 6/20

Source: Bloomberg, CEIC, Mirae Asset Daewoo Research Source: KITA, Mirae Asset Daewoo Research

Figure 42. Demand for small luxury items is higher in lower - Figure 43. Lower-tier cities contributed more than big cities to tier cities than in big cities the growth of China’s online luxury item sales in 2017-18

3% 35% Contribution (L) Growth (R) 35% 2%

1% 30% 30%

0% 25% 25% -1% 20% 20% -2%

-3% 15% 15%

-4% 10% 10% -5% 5% 5%

0% 0% nr 2nd tier 3rd tier 4th tier 5th tier

Source: SECOO, Mirae Asset Daewoo Research Source: Deloitte, Mirae Asset Daewoo Research

Of note, “consumer patriotism” is more pronounced in China’s lower-tier cities than in big cities. That is, given a choice of similar-quality products, lower-tier city residents tend to favor local brands. Generally, quality differences are negligible for makeup products, which have low barriers to entry in terms of production/technology. This is why most cosmetics brands entrust manufacturing of makeup products to OEM/ODM vendors, which have strengths in producing a wide range of items in small quantities.

In 2017, local brands began to rapidly penetrate China’s makeup product market through OEM/ODM production. It was also around this time that Perfect Diary and Florasis (respectively no. 1 and no. 2 in GMV rankings during Singles’ Day 2020) were founded. Notably, the combined revenue of listed Chinese firms selling cosmetics and HPC goods expanded most sharply in 2017-18, the period during which local makeup brands rapidly gained market share.

On the other hand, imported luxury brands remain dominant in the skin care segment, where consumers place a higher premium on product quality and safety.

Mirae Asset Daewoo Research 16 January 25, 2021 Cosmetics

Figure 44. Chinese makeup product sellers : Market entry Figure 45 . Breakdown of local product consumption by city tier timeline

35%

30%

25%

20%

15%

10%

5%

0% 1st tier 2nd tier 3rd tier 4th tier 5th tier Other

Source: EqualOcean Intelligence, Mirae Asset Daewoo Research Source: CBNData, Mirae Asset Daewoo Research

Figure 46. Combined quarterly revenue of Chinese Figure 47. Combined GMV of Chinese makeup product sellers cosmetics/household goods makers at Tmall

(CNYbn) (CNYbn) 700 250 GMV (R) 100% 221.43 YoY (L) 650 200 80% 600

550 150 60% 121.52 500 100 40% 450 74.97 Local cosmetics/household goods 400 companies displyed rapid growth in 2017 50 20% 350

300 0 0% 3/15 11/15 7/16 3/17 11/17 7/18 3/19 11/19 7/20 2017 2018 2019

Note: Based on revenue for companies listed before 2015 (five companies including Source: EqualOcean Intelligence, Mirae Asset Daewoo Research Shanghai Jahwa) Source: Bloomberg, Mirae Asset Daewoo Research

Since 2H18, the stagnation of the real economy (amid intensifying trade tensions with the US) has weighed on the Chinese cosmetics market. As a result, Korea’s China-bound cosmetics exports (especially low/mid-priced products) have seen a slowdown in growth.

Meanwhile, the low-interest environment has triggered asset inflation. The resultant wealth effect has led to a higher concentration of cosmetics consumption in the luxury segment. According to Euromonitor, in 2019, the combined revenue of luxury brands in China climbed 30.7% YoY (vs. 1.1% for masstige brands). In addition, after years of sharp increases, the combined market share of local brands fell slightly in 2019.

Mirae Asset Daewoo Research 17 January 25, 2021 Cosmetics

Figure 48. Korean cosmetics firms’ export prices and volume (growth, six-month moving avg.)

(%) (%) Korea's cosmetics export volume growth 90 Volume (L) Price (R) 20 has been slowing since end-2018 80 15 70 10 60 5 50 - 40 -5 30 -10 20

10 -15

- -20 6/16 12/16 6/17 12/17 6/18 12/18 6/19 12/19 6/20

Source: KITA, Mirae Asset Daewoo Research

Figure 49. China: Combined M/S of local cosmetics brands Figure 50. China: Luxury brands’ M/S increased in 2018-19

M/S of local brands in the top 50 brands in China Luxury Masstige 40% M/S of global brands in the top 50 brands in China 100% 35% 90% 80% 30% 70% 25% 60% 20% 50%

15% 40% 30% 10% 20% 5% 10% 0% 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2016 2017 2018 2019

Source: Euromonitor, Mirae Asset Daewoo Research Source: Euromonitor, Mirae Asset Daewoo Research

While local Chinese brands and low/mid-priced brands have been hit hard by demand shocks, global brands have solidified their positions in the luxury segment. Despite the slowdown in the real economy, they have delivered top-line growth by leveraging product relaunches/renewals to hike prices. For Estee Lauder, relaunches of leading products across its brand portfolio led to a 10% gain in ASP in 2019.

In response to robust luxury cosmetics demand in China, The History of Whoo, LG H&H’s luxury brand, launched Royal Privilege Cream (priced at over W800,000). In addition, AmorePacific’s luxury brand Sulwhasoo released Jinseol, its highest-end line, while shifting its flagship product from Yoon Jo serum to the Jaumseng set, which is US$50 more expensive.

Mirae Asset Daewoo Research 18 January 25, 2021 Cosmetics

In China, the daily-use articles PPI and cosmetics CPI began to markedly diverge in 2019, due mainly to the concentration of demand in imported products. Indeed, in 2018, Korea’s total revenue from the duty-free channel (a primary sales channel for China-bound exports of luxury cosmetics products; 70% exposure to cosmetics) expanded 40.8% YoY, while China’s overall retail cosmetics sales grew a mere 4.2% YoY (+13.1 in 2017). This implies that the primary driver behind China’s cosmetics market growth since end-2018 has been price increases rather than volume growth.

Indeed, after years of double-digit growth in the low/mid-end skin care segment, Chando and Pechoin, major Chinese local brands, did not disclose their revenue figures for 2019 (on account of poor results). Considering that Cosmax’s Shanghai subsidiary, an important production partner of the two local brands, posted a 9.5% YoY decline in revenue for 2019, we estimate that their revenues contracted over 10% YoY in 2019.

Against this backdrop, global cosmetics brands began to outperform OEM/ODM players in terms of valuation, thanks to their ability to raise prices backed by strong brand equity.

Figure 52 . Cosmetics: Valuation gap between global brands Figure 51. China: Daily-use articles PPI vs. cosmetics CPI and OEMs/ODMs

(P) (x) 102.5 Cosmetics CPI Daily-use articles PPI 50 L'Oreal/Estee Lauder Cosmax/Kolmar Fujian Green Pine 102.0 45 101.5 40 Widening valuation gap vs. luxury brands (deflationary pressure, market polarization) 101.0 35 100.5 30 100.0 25 99.5 20 99.0 15 Gap is widening 98.5 10 98.0 5 97.5 0 1/17 7/17 1/18 7/18 1/19 7/19 1/20 7/20 1/17 7/17 1/18 7/18 1/19 7/19 1/20 7/20

Source: Bloomberg, Mirae Asset Daewoo Research Note: Fujian Green Pine (FGP; 300312 SZ) acquired a 51% stake in Nox Bellcow in Oct. 2018. Source: Bloomberg, Mirae Asset Daewoo Research

Figure 53 . Growth comparison: China’s cosmetics market vs. Figure 54. Pechoin’s annual revenue trend (2019 data are

Korea’s duty-free market unavailable)

(%, YoY) (CNYbn) China cosmetics market Double-digit decrease (est.) 45 Sales to foreign customers in Korean duty-free channels 25 40

35 20

30 15 25

20 10 15

10 5 5

- 0 2017 2018 2019 2016 2017 2018 2019

Source: National Bureau of Statistics of China, Korea Duty Free Association, Mirae Asset Source: Press materials, Mirae Asset Daewoo Research Daewoo Research

Mirae Asset Daewoo Research 19 January 25, 2021 Cosmetics

In 2020, the COVID-19 pandemic dealt a heavier blow to the masstige segment within the cosmetics sector, accelerating the polarization in consumer patterns. Meanwhile, luxury brands’ Chinese onshore revenue grew markedly amid restrictions on overseas travel (which dampened duty-free cosmetics demand). Indeed, the flagship brands of Estee Lauder, L’Oreal, LG H&H, and AmorePacific delivered Chinese onshore revenue growth of more than 20% YoY in 3Q20 (vs. broader Chinese cosmetics market growth of 18%).

Figure 55. Luxury brands: 3Q20 Chinese onshore revenue growth

35%

30%

25%

20%

15%

10%

5%

0% LG H&H Estee Lauder L'Oreal AmorePacific Procter & Gamble The History of Whoo All brands All brands Sulwhasoo SK-II

Source: Company data, Mirae Asset Daewoo Research

In 2021, however, we expect Chinese cosmetics demand to pick up across all segments amid a favorable real economic environment, as in 2017.

The Chinese manufacturing sector is picking up rapidly, as China is emerging from the pandemic faster than any other emerging economy. Global trade volume and China’s exports, leading indicators of global demand, are also recovering. That said, the manufacturing recovery could lose steam, given that other emerging economies are gradually resuming industrial production.

However, we see more room for Chinese real economic growth this year, as US consumption should expand in light of the US’s high savings rate of 13% (vs. the pre-pandemic rate of 7%). Since 2H20, China has recorded the highest disposable income growth (excluding transfer income) among major global countries.

Figure 57 . 2020 disposable income growth (excluding transfer Figure 56. China manufacturing PMI and global trade volume income) by country

(%, YoY, 3MA) (%, YoY) China US Germany Korea 8 Global trade volume 6 China manufacturing PMI (official) 6 4

4 2

2 0

0 -2

-2 -4

-4 -6

-6 -8

-8 -10

-10 -12 3/17 8/17 1/18 6/18 11/18 4/19 9/19 2/20 7/20 12/20 1Q20 2Q20 3Q20 4Q20

Source: Bloomberg, CPB, Mirae Asset Daewoo Research Source: Bloomberg, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 20 January 25, 2021 Cosmetics

We believe the Chinese government will execute aggressive fiscal spending, as: 1) the trade surplus is expanding; 2) the yield gap between the 10-year UST and Chinese government bond has widened to 2.1%p, leaving the yuan strong against the US dollar; and 3) the low US interest rate environment should persist for an extended period of time due to the Fed’s average inflation targeting (AIT) strategy. Of note, the Chinese government’s 2021 fiscal deficit target stands at 3% of GDP, the highest level excluding 2020. We expect China’s fiscal spending to focus on qualitative domestic consumption growth (via urbanization of rural areas) in line with its dual circulation economic strategy. Of note, growth in the tertiary industry and a rise in population density arising from urbanization typically boost overall cosmetics demand.

The 2021 environment is reminiscent of the year 2017. China’s disposable income will likely grow thanks to urbanization and a real economic recovery, leading to overall cosmetics demand and volume growth. This should drive up PPI, benefiting the entire value chain. Indeed, since 2H20, Chinese local ODMs appear to have been operating at their full capacity, with Cosmax East delivering double-digit production growth.

Figure 58. Yield gap between 10Y UST and 10Y Chinese Figure 59. China’s fiscal deficit/GDP trend and 2021 target government bonds

USD/CNY (L) (%) 2009 2012 2015 2018 2021F 7.4 10Y yield gap (inverted, R) - - 7.2 0.5 -1 7.0

6.8 1.0 -2 6.6 1.5 -3 6.4

6.2 2.0 Fiscal deficit/GDP ratio target of 3% exceeds -4 historical levels (excluding 2020) 6.0 2.5 5.8 -5

5.6 3.0 -6

1/15 5/15 9/15 1/16 5/16 9/16 1/17 5/17 9/17 1/18 5/18 9/18 1/19 5/19 9/19 1/20 5/20 9/20 1/21 (%)

Source: Bloomberg, Mirae Asset Daewoo Research Source: Bloomberg, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 21 January 25, 2021 Cosmetics

Millennials and Gen Z drive the luxury cosmetics market in China

Millennials and Gen Zers are powering the growth of China’s luxury goods market (CAGR of 25.1% since 2015), representing 80% of consumption—far higher than their 36% share globally (as of 2018).

By item, cosmetics/perfumes hold the largest share of China’s luxury goods market (30% vs. 5% globally), with sales growth also outpacing other product categories. This is probably because cosmetics/perfumes are more affordable and accessible for younger consumers than other luxury items.

Young consumers also represent a relatively high share of China’s luxury cosmetics consumption, with those under the age of 30 accounting for approximately 50%.

Figure 60. Luxury goods market size and growth in China

(CNYbn) Luxury goods market (L) Growth (R) 400 60%

350 50%

300 40% 250 30% 200 20% 150 10% 100

50 0%

- -10% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source: Bain & Company, Mirae Asset Daewoo Research

Figure 61. Breakdown of China’s luxury goods market by age: Figure 62 . Breakdown of global luxury goods market by age:

Younger consumers hold a higher share Younger consumers hold a smaller share

40% 40%

35% 35%

30% 30%

25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% Baby boomers Gen X Millenials Gen Z <18 18-24 25-30 31-35 36-40 41+ (1946-64) (1965-80) (198-95) (1995-2005)

Source: Boston Consulting Group, Mirae Asset Daewoo Research Source: Bain & Company, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 22 January 25, 2021 Cosmetics

Figure 63. Breakdown of China’s luxury goods market by Figure 64. Breakdown of women’s cosmetics market in China category (2017) by age (2020)

35% Accessories, 5 Footwear, 5 29.5% 30% Women's apparel, 7 25.2% 25% Cosmetics/ 20.1% perfume, 30 20% Jewelry, 8 15.3% 15% Men's apparel, 10 10% Watches, 20 6.5% Leather goods, 15 5% 3.5%

0% 18-24 25-29 30-34 35-39 40-44 45-50

Source: Industry reports, Mirae Asset Daewoo Research Source: iResearch, Mirae Asset Daewoo Research

Kiehl's, a dermatological cosmetics brand under L'Oreal, has strongly appealed to young Chinese consumers with its advertising campaigns focused on ingredients, function, and chemical stability; 60% of the brand’s customers are under the age of 30. Dior, famous for its high-end makeup products, also has a high share of young customers (mid-50% level), as do the luxury skin care brands Estee Lauder and Lancome (high-40% level each).

The under-30 age group also represents a high share of consumption (over 40%) at the Korean luxury cosmetics brands The History of Whoo and Sulwhasoo. Interestingly, these brands’ online sales are characterized by a high mix of skin care gift sets; based on 2020 Singles’ Day pre-orders, the Cheongidan set represented 95% of The History of Whoo’s total transaction value, and the Jaeumsaeng anti-aging set around 50% of Sulwhasoo’s. The disproportionately high sales mix of gift sets indicates a possible discrepancy in who pays for and who actually uses the items. For global peers, the share of best-selling items in preorder sales was around 10%.

Figure 65 . Share of young consumers (under 30) in luxury Figure 66. Top four product categories by Gen Z consumptio n cosmetics share

60% 70%

55% 60%

50% 50% 40% 45% 30% 40% 20%

35% 10%

30% 0% Kiehl's Dior Avg. Estee Sulwhasoo Lancome The History Apparel Food/misc. Electronics Cosmetics Lauder of Woo

Source: Industry reports, Mirae Asset Daewoo Research Source: Accenture, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 23 January 25, 2021 Cosmetics

Young Chinese consumers, especially Gen Zers, are continuing to trade up despite the pandemic; luxury goods accounted for approximately 35% of Gen Z’s monthly consumer goods expenditure in 2020 (vs. a mid-20% share among other demographics).

Sales on Tmall also illustrate the strong preference of young Chinese spenders for luxury goods, with those under 30 accounting for 79% of luxury goods GMV during the first 10 months of 2020. Although Gen Z’s GMV share was just 4%, it surged 189% YoY. Indeed, Gen Z is the fastest-growing generation in terms of spending on luxury goods (with annual growth of 33%), despite still lagging behind millennials in this category (representing 40% of millennials’ annual budget).

Figure 67. Contribution to Tmall’s luxury goods GMV b y Figure 68 . Comparison of annual average spending on luxury generation (Jan.-Oct. 2020) goods by generation (Jan.-Oct. 2020; Tmall)

Luxury goods GMV contribution (L) Growth (YoY, R) (Gen Z=100) Annual avg. consumption expenditure (L) 80% 200% 400 Growth (YoY, R) 35%

70% 180% 350 30% 160% 60% 300 140% 25% 50% 120% 250 20% 40% 100% 200 80% 15% 30% 150 60% 10% 20% 100 40% 5% 10% 20% 50 0% 0% 0 0% Gen Z Millenials Other Gen Z Millenials Other

Source: Tmall, Bain & Company, Mirae Asset Daewoo Research Source: Tmall, Bain & Company, Mirae Asset Daewoo Research

Notably, strengthening spending power appears to be supporting the rapid growth in Gen Z consumption. Even though most Gen Zers (who are in their late teens to early 20s) have yet to start working for a living, 39% of 1,050 Gen Z respondents reported having a financially comfortable life and strong confidence in their future economic situation in a 2019 survey, up from just 15% in the same survey conducted in 2018.

Figure 69. Survey of Gen Zers on personal financial situation Figure 70. Gen Z’s YoY spending growth by product category

(2018 and 2019) (2019)

2018 2019 52% 70% 50% 60% 58% 48% 50% 39% 46% 40%

44% 30%

20% 42%

10% 40% 3% 0% 38% Lack of financial comfort Uncertainty Financial comfort Internet shopping Travel Online education

Source: iResearch, Mirae Asset Daewoo Research Source: iResearch, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 24 January 25, 2021 Cosmetics

II. Potential changes in consumption patterns

Post-pandemic changes in Gen Z’s cosmetics consumption behavior

In China, the middle class is expanding more rapidly than the global average. However, we note that the National Bureau of Statistics of China defines the middle-income group based on assets (households with properties in big cities and annual income between CNY30,000 and CNY450,000), not on disposable income or purchasing power. The per-capita annual disposable income of Chinese urban residents is CNY43,834 (W7.46mn), equivalent to only 23% of that of their Korean counterparts. Based on purchasing power, the percentage of people in the middle class is much lower in China than in developed economies.

Figure 72. China’s population distribution by annual per capita Figure 71. Size of the middle class based on assets (2015) income

60% China 109 US 50% Japan Italy 40% Germany England France 30% India Spain 20% Korea Canada 10% Mexico Brazil

0% >CNY100mn CNY10mn- CNY1mn- CNY300,000- CNY300,000- CNY150,000- CNY80,000- CNY30,000- CNY10,000-

Australia 100mn 10mn 150,000 (mn) 500,000 300,000 80,000 30,000 Taiwan 1mn 0 20 40 60 80 100 120

Note: Assets worth between US$50,000 and US$500,000 Source: National Bureau of Statistics of China, Mirae Asset Daewoo Research Source: Credit Suisse, Mirae Asset Daewoo Research

In essence, consumption is a function of income and leverage. In China, it is difficult to obtain additional cash through mortgage refinancing, even if assets appreciate in value. Accordingly, consumers are likely to rely increasingly on credit to finance their consumption.

Notably, since China’s economic recovery began in 2017, the country has seen a sharp increase in small-value credit card/mobile installment payments in e-commerce transactions. Indeed, credit card debt has expanded at a CAGR of 27% since 2014, reaching CNY7.76tr as of 3Q20, and the share of consumer credit in consumer expenditure has grown steadily following a sharp increase from 20.5% in 2016 to 30% in 2017. The growth in consumer credit has coincided with the rapid expansion phase of the Chinese luxury cosmetics market.

Mirae Asset Daewoo Research 25 January 25, 2021 Cosmetics

Figure 73. Household debt as % of GDP in China (excl. Figure 74. China’s luxury cosmetics market growth and mortgages) consumer loans/consumption grown

14% 40% Consumer loans/consumption China luxury cosmetics market growth 12% 35%

30% 10% 25% 8% China household debt growth has been accelerating since 2017 20% 6% 15% 4% 10%

2% 5%

0% 0% 3/06 9/08 3/11 9/13 3/16 9/18 2014 2015 2016 2017 2018 2019

Source: Bloomberg, CEIC, Mirae Asset Daewoo Research Source: Euromonitor, Bloomberg, Mirae Asset Daewoo Research

Millennials and Gen Z, who drive the growth of the luxury cosmetics market, have short or no credit histories and are familiar with mobile payments. Thus, most of them make installment payments on mobile platforms rather than through credit cards. Mobile payment platforms also lift credit limits for users who pay bills on time (usually within 40 days), even those with no credit history, which is an important convenience. According to a Nielsen report, the penetration rate of mobile credit is 86.6% among those under 30 in China (as of 2019). In addition, a financial research center operating in China reported that around 60% of purchases made during JD.com's 618 Grand Promotion event in 2020 were paid in installments. Moreover, over 50% of Singles’ Day purchases (mostly mobile devices and beauty items) were made using one particular installment payment platform.

China’s luxury goods consumers are young relative to the global average, and they prefer small luxury items such as shoes and cosmetics to more expensive items. We think such demographic characteristics, together with the prevalence of small-value installment payments, make China’s luxury goods consumption unique.

Figure 76. Breakdown of online small loan service users by Figure 75. Small loan market size in China generation

(CNYtr) Gen Z Born between 1980-85 Other 9 8 8

7 6 15.5% 6 5 5 4 4 53.1% 3 31.5% 2

1

0 2017 2018 2019 2020F

Source: Oliver Wyman, Mirae Asset Daewoo Research Source: Rong360, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 26 January 25, 2021 Cosmetics

One of the most popular installment payment platforms among young Chinese consumers is Huabei (“just spend” in Chinese), a microlending service operated by Ant Financial. It holds a 30% online market share and a consumer loan balance of CNY1.73tr, according to Ant Financial’s IPO prospectus. Notably, interest on consumer/small business loans represents around 75% of Ant Financial’s income.

Users under the age of 30, which account for over 72% of Huabei’s 500mn customers (estimate), hold an average outstanding balance of around CNY4,811 (W810,000)— significantly higher than the average monthly Gen Z income of CNY2,210. Furthermore, given that over half of the platform’s under-30 users live in lower-tier cities (which are characterized by lower wages), this level of debt appears relatively burdensome.

Figure 77 . Ant Financial: Outstanding loan balance Figure 78. Tmall: Installment payment options (consumer/small business loans)

(CNYbn) 2,500 2,154 2,014 2,000

1,500

1,046 1,000 647

500

- 2017 2018 2019 1H20

Source: Ant Financial, Mirae Asset Daewoo Research Source: Tmall, Mirae Asset Daewoo Research

However, we note that after a period of rapid growth, the credit card balances of young consumers have been showing sharp contraction. Indeed, amid the pandemic, many young Chinese appear to be increasingly seeking buffers against economic shocks, such as insurance plans and savings. Notably, in a survey conducted at end-2020, the percentage of respondents with a positive attitude toward luxury cosmetics consumption fell compared to previous results.

Figure 79. Survey of Gen Zers’ confidence in their economic Figure 80. % of urban Chinese respondents favoring savings prospects (2019)

50% Online microcredit platform users Other (%) 55 45%

40% 50

35% 45 30% 40 25% 20% 35

15% 30 10% 25 5%

0% 20 Confidence in future earnings Confidence in job prospects 9/02 3/05 9/07 3/10 12/12 6/15 12/17 6/20

Source: Danke, Mirae Asset Daewoo Research Source: CEIC, National Bureau of Statistics of China, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 27 January 25, 2021 Cosmetics

Figure 81. Survey on luxury cosmetics spending plans (end-2019 vs. end-2020)

(%) Reduction in spending No change Increase in spending 100

80

60

40

20

- 2019 2020

Source: Industry data, Mirae Asset Daewoo Research

Nevertheless, increasing household debt is also worrisome. China’s household debt as a percentage of GDP jumped 6.5%p amid the pandemic (61.7% as of 3Q20). While mortgages account for the bulk of this debt, we note that consumer loans are growing more rapidly

Another cause for concern is that NPL ratios are on the rise. Indeed, since the start of the economic slowdown at end-2018, the charge-off rate of credit card asset-backed securities has been steadily rising. In 1Q20 (in the wake of the COVID-19 outbreak), Ping An Bank saw a 40% QoQ rise in credit card delinquencies. With Chinese households exhibiting higher sensitivity to changes in economic conditions, there are growing concerns over their financial health.

In 1H20, China’s per-capita consumer spending fell more sharply than disposable income, as consumer spending was excessively leveraged. In particular, we believe the debt burden of younger consumers (which official statistics do not reflect) has reached unsustainable levels. Although national data are not available, HSBC’s 2018 report estimated that the per-capita debt of the post-90s generation amounted to CNY120,000, implying a debt-to-income ratio as high as 1,850%.

At the company level, we note that Qudian (a major fintech company operating in the microloan sector) had seen steadily rising delinquency rates even before the COVID-19 outbreak, and the rate currently stands at 20%. Credit cost ratios at Nasdaq-listed microlending fintech firms have been increasing since end-2018.

Mirae Asset Daewoo Research 28 January 25, 2021 Cosmetics

Figure 83. Consumer patterns have changed since the COVID - Figure 82. Growth of mortgages and personal loans in China 19 outbreak

(1Q05=100) Use high-quality products in small 3500 Mortgages quantity Personal loans Exercise greater caution in purchasing 3000 decisions Worry about credit card limit 2500 Prefer timeless goods to trendy ones 2000 Wait for sales promotions 1500 Take environmental factors into account 1000 Purchase secondhand goods 500 Focus on price rather than quality 0 3/05 9/07 3/10 9/12 3/15 9/17 3/20 0% 10% 20% 30% 40% 50%

Source: CEIC, Mirae Asset Daewoo Research Source: CCTV, Mirae Asset Daewoo Research

Figure 84. Charge-off rate of consumer credit card asset - Figure 85. Delinquency rate of Qudian, a fintech firm targeting backed securities (30-60 days) younger consumers

0.8%

0.7%

0.6%

0.5%

0.4%

0.3%

0.2%

0.1%

0.0% 1/18 5/18 9/18 1/19 5/19

Source: Fitch, Mirae Asset Daewoo Research Source: Qudian, Mirae Asset Daewoo Research

The household debt problem has prompted the Chinese government to tighten regulations on online microlending platforms. In the past, the government has pursued deleveraging during periods of economic recovery or yuan appreciation, as high inflation (driven by currency appreciation) poses a risk to lenders. When the economy picked up in 2017, China’s deleveraging policy targeted the highly leveraged corporate sector.

While excessive corporate debt growth was reined in, household debt, including consumer credit, began to expand rapidly. Generally speaking, the “stock effect” (households reduce spending to pay down debt) begins to prevail over the “flow effect” (households spend more through debt) when the household debt-to-GDP ratio reaches 60%. Above that level, the impact of household debt growth on spending declines meaningfully.

Currently, China’s household debt stands at CNY55.3tr, or 61.7% of GDP. A 1% rise in the interest rate on household loans would lead to a 2.5% fall in per-capita disposable income. Given that the household debt-to-GDP ratio is above 60% (the level at which household debt growth does not translate into spending, according to the IMF), we expect the Chinese government to expand its deleveraging campaign to households in 2021. Regulations on microlending platforms, whose major customers are those under 30, could dampen younger consumers’ installment purchases.

Mirae Asset Daewoo Research 29 January 25, 2021 Cosmetics

Figure 86 . Weak economic recovery outlook and likely slowdown in household debt growth

(%) 8 Household debt/GDP HPC PPI

6 Economic recovery: Household deleveraging 4

2

0

-2

-4 Chinese Dream campaign: Economic recovery: Household Overheated domestic economy -6 deleveraging

-8 3/08 6/09 9/10 12/11 3/13 6/14 9/15 12/16 3/18 6/19 9/20

Source: CEIC, Mirae Asset Daewoo Research

Figure 87. China’s corporate debt and short-term personal loans relative to GDP (YoY chg.)

(% of GDP chg., YoY) (% of GDP chg., YoY) Corporate debt Short-term consumer loans

12 9

10 8

8 7 6 6 4 2017-18: Deleveraging efforts focusing on coporate 5 2 debt 4 - 3 -2 -4 2 -6 1 -8 - 3/13 11/13 7/14 3/15 11/15 7/16 3/17 11/17 7/18 3/19 11/19

Source: CEIC, Mirae Asset Daewoo Research

Since 2H20, China has been taking concrete steps to tighten regulations on mortgage and consumer lending. For example, in Aug. 2020, rates on consumer loans extended by non- banking financial institutions were capped at four times the benchmark LPR, bringing the maximum allowable interest rate down from 24% to 15.4%. Going forward, we expect lenders to make loans less accessible to high-risk borrowers and reduce total loans.

In Nov. 2020, a draft law took aim at Jack Ma’s Ant Financial and other online microlenders, capping total lending at four times their net assets. To guard against excessive leveraging by younger consumers, personal lending was capped at the lower of CNY300,000 or one-third of the borrower’s three-year average annual income.

The Chinese government is also working to introduce a legal framework for personal bankruptcy. The Bankruptcy Law as revised in 1994 has no notion of personal bankruptcy, meaning individuals have unlimited responsibility when it comes to paying back loans in China. In Apr. 2020, the first such legal framework—a bill titled the Personal Bankruptcy Regulation of Shenzhen Special Economic Zone—was submitted to the Standing Committee of the Sixth Shenzhen Municipal People's Congress. We think the effort to introduce such a law reflects the sharp deterioration in consumer loan quality resulting from increased unemployment amid the pandemic.

Mirae Asset Daewoo Research 30 January 25, 2021 Cosmetics

In our view, the debt burden on younger consumers and regulations targeting online microlending could weigh on luxury cosmetics consumption in China, which has seen fast growth relative to income growth. In the past, leverage has typically been used to purchase high-priced durable goods rather than nondurable goods. Indeed, when the Chinese government began to regulate peer-to-peer (P2P) lending in early 2018, the under-30 age group and high-end cars were the most-affected segments.

That said, as mentioned earlier, we expect per-capita disposable income to expand in 2021, especially in lower-tier cities. We believe that young consumers will become more rational in their purchase decisions, taking their current and future income into consideration.

A somewhat analogous episode from Korea’s history is the bursting of the credit card bubble in the early 2000s, caused by unscrupulous credit card issuance to college students. At end- 2003, Korea’s credit card delinquency rate rose to 15%, while the total credit card balance stood at 7% of GDP. To address this, the Korean government implemented credit card regulations at end-2003 limiting the use of installment payment plans and the issuance of multiple credit cards to a single person. After this, outstanding credit card balances declined nearly 40% from peak levels, indicating a marked chill in consumption.

Notably, the limits on installment payments took a heavy toll on beauty stores (which sold expensive cosmetics products), and multi-level marketing channels were also hit hard. As key distribution channels for luxury cosmetics products fell apart and spending on cosmetics declined, the Korean cosmetics market witnessed a down-trading trend to lower-priced products.

Later, the mono-brand shop channel expanded rapidly, offering value for money with minimal distribution margins. Mono-brand shops source more than 90% of their products on an OEM/ODM basis. As a result, the brand and production sides began to diverge across the value chain, catapulting Korean OEM/ODM companies—which have strengths in producing various items in small quantities—into the global top-tier from 2003 onward.

Figure 88. Outstanding P2P loan balance and China’s HPC sales Figure 89. Cosmax’s sales growth in the early 2000s (non - volume consolidated)

(CNYbn) ('000) (Wbn) (%) Cosmax (L) Growth (R) HPC sales (R) P2P loan balance (L) 900 60 1,200 2,200 800 50 1,000 2,100 700 2,000 40 800 600 1,900 500 30 600 400 1,800 20 400 300 1,700 10 200 200 0 1,600 100

- 1,500 - -10 1/14 4/15 7/16 10/17 1/19 2002 2006 2010 2014 2018

Source: CEIC, Mirae Asset Daewoo Research Source: WISEfn, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 31 January 25, 2021 Cosmetics

However, China’s situation is different from that of Korea. Even assuming an excessive deleveraging of household debt, we believe down-trading is unlikely to surface in the cosmetics market. While Korea’s outstanding credit loans exceeded 7% of GDP in the early 2000s, China’s online microlending market accounts for a meager 2.5% of China’s GDP.

When China began to regulate P2P lending at end-2017, P2P loans totaled CNY1.2tr, or approximately 1.2% of GDP. The regulation did not have a meaningful impact on the consumption of luxury cosmetics products at that time. Notably, while the delinquency rate at Huabei has increased since the COVID-19 outbreak, it nevertheless remains steady at around 3%. In contrast, during Korea’s credit card crisis at end-2003, delinquency rates at credit card companies were as high at 13%. Against this backdrop, we expect the impact of China’s regulations to play out at a moderate pace.

Figure 90 . Household loans as % of GDP: Korea’s credit card Figure 91. Huabei’s delinquency rate in 2020 crisis, China’s regulations on P2P lending/online microlending

9% 30 day+ delinquency rate 90 day+ delinquency rate 3.5% 8%

7% 3.0% 6% 2.5% 5% 4% 2.0%

3% 1.5% 2% 1.0% 1% 0% 0.5% China’s credit card Korea’s credit card China P2P Loans China’s online (Current) (2003) (2018) microlending 0.0% (Current) 1/20 2/20 3/20 4/20 5/20 6/20 7/20 8/20 9/20

Source: CEIC, Caixin, Mirae Asset Daewoo Research Source: Ant Financial, Mirae Asset Daewoo Research

All in all, the premiumization in China’s cosmetics sector looks unlikely to reverse anytime soon. Despite tighter regulations on online microlending, we expect China’s luxury cosmetics market to continue robust growth in 2021 on the back of an economic recovery. That said, we believe growth expectations are already reflected in luxury cosmetics brands: Estee Lauder and L’Oreal are trading at 12-month-forward P/Es of 37x and 42x, respectively, 20% premiums to their pre-pandemic valuation levels. Korean cosmetics brands such as AmorePacific and LG H&H are also trading at historically high valuations.

Amid high expectations on growth, online marketing is intensifying in the Chinese luxury cosmetics market. LG H&H and AmorePacific dedicate more than 50% of their marketing spending to expanding their online market shares. With live commerce emerging as a major channel for younger Chinese consumers, cosmetics companies are investing more in wang hong marketing.

Live commerce is a high-cost yet highly efficient marketing channel. For Singles’ Day 2020, global luxury brands concentrated their resources on recruiting top-tier influencers. With e- commerce now the main shopping channel for most consumers, we expect online marketing to shift into higher gear in 2021. Global brands are already gearing up for major shopping events such as 618 and Singles’ Day 2021, which suggests that competition will further escalate. In 1H20, L’Oreal’s marketing expense-to-sales ratio rose 30bps YoY to 30.5%, and it likely rose further in 4Q20 (when Singles’ Day occurred).

Mirae Asset Daewoo Research 32 January 25, 2021 Cosmetics

From an investment perspective, the likely pickup in Chinese cosmetics demand is the overriding theme for 2021. We advise investors to pay attention to value-conscious consumption behavior and growth in overall cosmetics spending. Looking at the value chain, we prefer OEMs/ODMs, which stand to benefit from diversifying consumption, over luxury brand operators, which have demanding valuations and face a rising cost burden from competition.

Cosmax is enjoying double-digit top-line growth in China, supported by its competitiveness and aggressive marketing. And its customer base, which had been a cause for concern, has been reoriented toward online firms. For 2021, we expect Cosmax to see an increase in repeat order volumes, leading to reduced production losses and better margins.

Moreover, unlike in the past, the rise of homegrown Chinese brands and the cosmeceutical trend among young consumers are creating new needs for high-quality yet affordable products. We expect these trends to help OEM/ODM firms expand their customer bases.

Figure 93. Online ad penetration indices for cosmetics Figure 92. Marketing expense-to-sales ratio by company companies in China

(Index) 35% 2019 2020 2021F 70,000 Global brands Local brands 30.7% 31.0%

30% 60,000

25% 50,000

20% 40,000

15% 30,000

10% 8.5% 7.4% 20,000 5.7% 6.5% 5% 10,000

0% - AmorePacific LG H&H L'Oreal 1Q17 4Q17 3Q18 2Q19 1Q20

Note: AmorePacific data are on a non-consolidated basis. Source: iResearch, AdTracker, Mirae Asset Daewoo Research Source: Eikon , company data, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 33 January 25, 2021 Cosmetics

Korean cosmetics OEM/ODM players stand to benefit from the rise of C- beauty

According to Euromonitor, the Chinese cosmetics market was worth CNY477.7bn in 2019, with global brands accounting for approximately 70%. Notably, the share of products produced on an OEM/ODM basis is approximately 30% for global cosmetics brands and 50% for Chinese brands. Based on our calculation, applying a cost ratio of 30%, OEM/ODM production amounts to CNY50bn for the Chinese domestic market alone. Considering the percentages of turnkey contracts (where ingredient/material sourcing costs are recognized as sales; 60%) and exports (approximately 30%), we estimate China’s cosmetics OEM/ODM production totaled CNY57.2bn (W9.7tr) in 2019.

Among cosmetics OEMs/ODMs operating in China, only Cosmax East and Nox Bellcow recorded revenue of over CNY2bn in 2019. Cosmax East reported revenue of CNY2.8bn and had the largest market share, at 5%. The market is highly fragmented, with the other OEMs/ODMs estimated to hold a collective share of 90%.

We estimate Korea’s cosmetics OEM/ODM market at W6.3tr. According to Euromonitor, while China’s retail cosmetics market is around 5.2 times bigger than that of Korea (as of 2019), its cosmetics OEM/ODM market is only 1.5 times larger than Korea’s. The Chinese OEM/ODM market is relatively small due to the low market share (30%) of local Chinese brands (which rely heavily on contract manufacturing). However, Chinese demand for locally produced cosmeceutical and color makeup products has been rapidly increasing. We expect the OEM/ODM industry to share in the growth of homegrown Chinese brands and expand more rapidly than the overall Chinese cosmetics market.

Figure 94 . Chinese cosmetics market and OEM/ODM segment Figure 95. Chinese OEM/ODM market breakdown (2019)

(CNYbn) China retail cosmetics market 100% 600 88.7% China cosmetics OEM/ODM market 90% 80% 500 477.7 70%

400 60% 50% 300 40% 30% 200 20% 10% 4.9% 3.8% 1.7% 0.8% 100 57.2 0% Cosmax Nox Bellcow Intercos Kolmar (China) Other 0 (China) 2012 2013 2014 2015 2016 2017 2018 2019

Source: Euromonitor, Mirae Asset Daewoo Research Source: Euromonitor, Mirae Asset Daewoo Research

We also note that China is tightening regulations to protect its own cosmetics industry, which should prove favorable to Korean OEMs/ODMs operating in China. Effective Jan. 1, China’s National Medical Products Administration (NMPA) has introduced the Cosmetics Supervision and Administration Regulation (CSAR). Replacing the Regulations Concerning the Hygiene Supervision of Cosmetics, the 80-article CSAR takes a step further to enhance safety requirements for cosmetics and imposes stricter penalties for violations. Under the new regulation, a cosmetics company making claims about the efficacy or benefits of a product has to publish sufficient scientific evidence and research data on its website. This reflects the government’s efforts to bring the fast-growing cosmeceuticals market into a legal sphere.

Foreign imports are subject to stricter regulations than locally produced products. Regulatory filing or registration of imported cosmetics products requires the submission of quality control documents (e.g., ISO and CGMP) from overseas manufacturers or domestically conducted research data. Moreover, the import of specialty products, such as cosmeceuticals, requires preregistration with the NMPA.

Mirae Asset Daewoo Research 34 January 25, 2021 Cosmetics

The CSAR is reminiscent of the hygiene license requirement of the China Food and Drug Administration (CFDA), which presented a non-tariff barrier to Korean exporters during 2016 and 2017, when the Chinese functional cosmetics market began to flourish. In the long term, lower-quality products are likely to be forced out of the specialty cosmetics market, channeling more business to ODM firms with a proven record in China.

Compared to rivals, Cosmax makes aggressive R&D investments in quality control. In addition, Cosmax has experience supplying to global companies such as L’Oreal and Johnson & Johnson and thus has had to pass strict audits. As such, we believe the stricter regulations will affect Cosmax less than its rivals and are unlikely to cause any serious changes to its production system.

The Chinese government is continuing policies intended to foster homegrown brands. In 2017, the government declared May 10 “China Brand Day.” For China Brand Day 2020, the state-run broadcasting network China Central Television (CCTV) livestreamed an online sales event in collaboration with internet celebrities to promote homegrown brands. The event recorded 120mn cumulative viewers, with the GMV of Chinese brands totaling CNY40.14mn.

Tmall, Alibaba's online marketplace, is also investing in nurturing local brands. On May 8, 2019, Tmall announced a plan to support the development of 200 Chinese brands capable of generating annual revenue of more than CNY1bn. Based on major e-commerce platforms (e.g., Tmall and Taobao), the market share of Chinese brands was 60% or lower in the cosmetics category in 2019, which is low compared to other categories.

Thus, Alibaba is focused on cultivating homegrown brands in the cosmetics sector, where Chinese players have a marginal presence and entry barriers (for manufacturing) are relatively low. On Jul. 16, 2020, in partnership with the local cosmetics brand Proya, Tmall established its first brand incubation base in Hangzhou, with a goal of cultivating more than 50 new Chinese cosmetics brands over the next two to three years. Korea’s AmorePacific has also established an office in Hangzhou to facilitate product collaboration with Alibaba.

We believe Korean OEMs/ODMs still have a competitive edge over local players. In 2019, Cosmax’s R&D spending amounted to W32.2bn, accounting for 4.4% of its total revenue. In comparison, Chinese companies invested an average of W10bn, or 3% of their total revenue. Moreover, Cosmax’s track record as a supplier for L’Oréal should help the company in China, where consumers increasingly value quality. Cosmax is well-positioned to secure a steady inflow of orders in the fast-growing Chinese cosmetics OEM/ODM market.

Table 1. Chinese brands’ M/S in 16 categories on Alibaba e-commerce platforms (2019) Category M/S of Chinese brands Presence of Chinese brands Furniture Large appliances (e.g., air conditioners/laundry machines/refrigerators/TVs) More than 80% Strong Construction & interior materials Furniture/household items Food Small appliances (e.g., electric rice cookers/microwaves/vacuum cleaners) Apparel Culture & entertainment Infant/toddler goods More than 60% Middle Medicine/healthcare supplies Car supplies Bags Handsets Digital devices (e.g., computers/gaming devices/set - top boxes/audio equipment) Sports and outdoor equipment (e.g., sporting Below 60% Weak goods/tents) Cosmetics Source: AliResearch, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 35 [Korea] Cosmetics January 25, 2021

AmorePacific Hold (090430 KS ) (Downgrade)

Turnaround fully priced in TP: W230,000 Downside: -6.5%

Mirae Asset Daewoo Co., Ltd. Junghan Yoon [email protected]

4Q20 preview Despite overseas recovery, operating loss likely due to early retirement expenses ó For 4Q20, we forecast AmorePacific to post revenue of W1.13tr (-15.5% YoY; all growth figures hereafter are YoY) and an operating loss of W12.1bn (swinging to red). ó For the domestic business, we look for an operating loss of W46.6bn (swinging to red). - We believe the duty-free channel (-31.6%) slightly outperformed the market, helped by new contracts with corporate-type daigou . - The resurgence of COVID-19 in 4Q20 likely led to a delay in the recovery of the offline channel (-40.4%), while supporting continued growth in the online channel (+34.9%). ó For the overseas business, we look for operating profit of W33.8bn. - We estimate the Chinese subsidiary grew 3%, ending the negative growth seen throughout most of 2020. - We estimate revenue in China grew 27% for Sulwhasoo on the back of Singles’ Day events, but contracted 15.4% for Innisfree due to a reduced store count.

Fixed costs to start declining Domestic and overseas fixed costs to start declining ó We estimate that one-off expenses totaling around W60bn were incurred in 4Q20. We expect this to result in fixed-cost savings of more than W50bn in 2021 for the domestic parent business. ó Overseas, store closures likely continued in 4Q20, which should lead to lower fixed costs and margin improvements. ó We believe the company recognized W30bn in non-operating expenses, including penalties related to store closures.

Valuation and recommendation Maintain TP of W230,000, but downgrade to Hold given near -term valuation pressures ó AmorePacific is trading at a 2021F P/E of 42.4x, a 10% premium to global peers (L'Oreal and Estee Lauder). ó While Sulwhasoo’s sales during the Singles’ Day period were impressive, the brand failed to make Tmall’s list of the top 20 skin care brands (in terms of GMV) in December, pointing to a lack of strong demand outside of major events. ó In 2021, the company should benefit from strong operating leverage effects as a result of fixed- cost savings. In China, however, the company is likely to lag behind rivals in terms of growth, given its lower mix of premium cosmetics compared to peers and ongoing store shutdowns. ó We believe a premium over peers is unwarranted and thus downgrade the stock to Hold.

Key data Current price (1/25/21, W) 246,000 Market cap (Wbn) 14,381 150 AmorePacific KOSPI 130 OP (20F, Wbn) 140 Shares outstanding (mn) 69

110 Consensus OP (20F, Wbn) 153 Free float (%) 49.8 EPS growth (20F, %) -71.1 Foreign ownership (%) 32.9 90 P/E (20F, x) 205.7 Beta (12M) 0.58 70 Market P/E (20F, x) 22.3 52-week low (W) 147,500 50 1.20 5.20 9.20 1.21 KOSPI 3,208.99 52-week high (W) 246,000

Share performance Earnings and valuation metrics (%) 1M 6M 12M (Dec.) 2017 2018 2019 2020F 2021F 2022F Absolute 21.5 50.5 15.8 Revenue (Wbn) 5,124 5,278 5,580 4,403 4,936 6,294 Relative 6.3 3.2 -19.0 OP (Wbn) 596 482 428 140 466 631

OP margin (%) 11.6 9.1 7.7 3.2 9.4 10.0 NP (Wbn) 394 332 239 69 334 430 EPS (W) 5,709 4,813 3,460 1,001 4,835 6,235 ROE (%) 9.8 7.7 5.3 1.5 7.2 8.7 P/E (x) 53.3 43.5 57.8 205.7 50.9 39.5 P/B (x) 5.1 3.3 3.1 3.2 3.6 3.3 Div. yield (%) 0.4 0.6 0.5 0.1 0.5 0.7 Notes: Under consolidated K-IFRS; NP is attributable to owners of the parent Source: Company data, Mirae Asset Daewoo Research estimat es Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he US. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES AND DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. January 25, 2021 Cosmetics

Table 2. AmorePacific: 4Q20 preview (Wbn, %) 4Q20F Growth 4Q19 3Q20 Mirae Asset Daewoo Consensus Diff. YoY Revenue 1,333.7 1,088.6 1,127.3 1,153.2 -2.3 -15.5 OP 45.9 56.0 -12.1 5.5 - TTR OP margin (%) 3.4 5.1 -1.1 0.5 -1.6 TTR Pretax profit -33.8 19.3 -44.0 -9.1 - RR NP (owners of the -49.4 9.6 -23.2 -23.7 - RR parent) Source: Company data, WISEfn, Mirae Asset Daewoo Research

Table 3. AmorePacific: Quarterly and annual earnings (Wbn, %) 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20F 2019 2020F 2021F Revenue 1,451.3 1,393.1 1,402.0 1,333.7 1,130.9 1,055.8 1,088.6 1,127.3 5,580.1 4,402.6 4,935.8 Domestic 940.7 891.9 930.6 754.8 760.8 656.7 672.7 609.3 3,518.0 2,699.5 3,114.5 Cosmetics 789.4 771.7 779.9 656.2 618.6 531.4 534.3 504.4 2,997.2 2,188.7 2,602.2 Traditional channel 327.0 308.8 230.4 159.3 187.9 159.3 155.1 95.0 1,025.4 597.3 521.7 Duty-free 366.9 356.8 437.4 392.5 258.7 197.0 222.2 268.6 1,553.5 946.5 1,209.7 Digital (incl. direct cross - 95.6 106.1 112.1 104.4 172.0 175.1 157.0 140.8 418.3 644.9 870.9 bord er) Household goods 151.5 120.4 150.8 98.5 142.1 125.3 138.6 104.9 521.1 510.9 512.3 Overseas 521.8 512.0 486.6 557.9 374.0 405.4 423.2 528.6 2,078.3 1,731.2 1,858.5 Asia 497.8 485.5 452.1 528.1 345.6 388.5 394.3 501.8 1,963.5 1,630.2 1,757.4 Europe 5.8 4.8 5.9 5.3 5.4 3.0 5.0 4.8 21.8 18.2 18.0 North America 18.2 21.7 28.6 24.5 23.0 13.9 23.9 22.1 93.0 82.9 83.1 YoY revenue growth 1.4 3.7 9.7 8.9 -22.1 -24.2 -22.4 -15.5 5.7 -21.1 12.1 Domestic -0.0 1.6 10.8 9.6 -19.1 -26.4 -27.7 -19.3 5.1 -23.3 15.4 Cosmetics 1.1 1.4 11.9 10.1 -21.6 -31.1 -31.5 -23.1 5.7 -27.0 18.9 Traditional channel -9.2 -13.2 -19.1 -23.4 -42.5 -48.4 -32.7 -40.4 -15.1 -41.7 -12.7 Duty-free 14.6 17.0 31.7 25.2 -29.5 -44.8 -49.2 -31.6 22.3 -39.1 27.8 Digital (incl. direct cross - -5.0 6.0 39.3 40.0 80.0 65.0 40.0 34.9 17.6 54.2 35.0 border ) Household goods -5.9 3.1 6.2 5.1 -6.2 4.1 -8.1 6.5 1.5 -2.0 0.3 Overseas 4.2 7.4 8.8 2.3 -28.3 -20.8 -13.0 -5.3 5.5 -16.7 7.4 Asia 4.1 6.4 7.1 2.1 -30.6 -20.0 -12.8 -5.0 4.8 -17.0 7.8 Europe -23.7 -23.8 -7.8 -39.1 -6.9 -37.5 -15.3 -10.0 -24.8 -16.7 -1.1 North America 19.0 52.8 53.8 25.6 26.4 -35.9 -16.4 -10.0 37.6 -10.9 0.3 OP 186.6 87.8 107.5 45.9 60.9 35.2 56.0 -12.1 427.8 140.1 466.1 YoY OP growth -20.9 -39.8 40.6 93.1 -67.3 -59.9 -47.9 TTR -11.2 -67.3 232.7 OP margin (%) 12.9 6.3 7.7 3.4 5.4 3.3 5.1 -1.1 7.7 3.2 9.4 Source: Company data , Mirae Asset Daewoo Research

Table 4. AmorePacific: TP calculation (W, Wbn, x) 2015 2016 2017 2018 2019 2020F 2021F EPS 10,044 11,117 6,852 5,777 4,153 1,149 5,804 BPS 48,475 56,202 60,185 64,073 65,050 64,668 69,231 Peak market cap 26,014 25,780 21,104 20,548 13,767 13,825 EPS 5,889 2021F EPS Target P/E 39.5 Avg. P/E of L’Oreal and Estee Lauder Target price 230,000 Current price 246,000 Upside -6.5% Note: EPS figures are based on common shares. Source: Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 37 January 25, 2021 Cosmetics

We estimate AmorePacific’s China revenue exposure at 52.6% in 2020, higher than the levels of global brands. We believe Sulwhasoo’s China revenue grew 20% in 3Q20 and 27% in 4Q20. AmorePacific’s strategic focus on high-growth markets and categories support its high valuation (2021F P/E of 42.4x).

AmorePacific’s aggressive positioning in a rising channel also looks promising. For Singles’ Day in 2020, AmorePacific held marketing campaigns comparable to those of rivals, including eight live commerce sessions with Chinese internet celebrity Li Jiaqi.

We estimate that online sales accounted for 50% of AmorePacific’s China revenue at end- 2020; this puts the company’s online exposure behind only that of local rival Proya. We expect the online share of AmorePacific’s China revenue to further increase in 2021, considering the planned reduction in Innisfree stores to 300 (from 470).

Domestically, AmorePacific has changed its duty-free channel strategy by entering contracts with large-scale daigou in Oct. 2020. We estimate the firm’s duty-free revenue contracted only 32% YoY in 4Q20 (overall market: -35% YoY). For domestic online channels, AmorePacific collaborates with NAVER and 11 th Street to drive live commerce on its own online shopping mall. The company’s online channel strategy focuses on promoting Sulwhasoo’s Bloomstay line, which is popular among younger consumers, to prevent cannibalization with offline channels.

For 2021, we forecast AmorePacific to display rapid earnings improvement and high operating leverage, supported by fixed-cost reduction efforts (early retirement program and scaling back of directly run stores). We estimate fixed costs will decline W58.5bn YoY in 2021 on a non-consolidated basis, causing OP margin to expand to 9.4% (vs. 3% in 2020). Margin expansion is encouraging, given that operating profit improvement serves as a share price catalyst in the cosmetics sector.

However, we note that AmorePacific’s valuation has expanded to demanding levels amid elevated expectations. The stock is currently trading at a 2021F P/E of 42.4x, on par with Estee Lauder (42x) and higher than L’Oréal (37x). Meanwhile, the stock is trading at 30.9x our 12- month forward operating profit estimate. Thus, shares are trading on par with global brands, which have seen their shares pull back. Although Sulwhasoo (luxury segment) has been faring well since 2H20, it failed to make it into Tmall’s top 20 brands list (in terms of GMV) in December. We believe it is necessary to confirm AmorePacific’s ability to generate steady demand in China, aside from major online shopping events. We maintain our target price of W230,000 on AmorePacific but downgrade our rating to Hold (from Trading Buy).

Figure 96 . Online exposure of China revenue: AmorePacific vs. Figure 97. AmorePacific’s OP margin and adj. share price rivals

70% (%) (W) OP margin (L) 18 500,000 60% Adj. share price (R)

15 400,000 50%

40% 12 300,000

30% 9 200,000 20%

10% 6 100,000

0% 3 0 Proya L'Oreal Estee Lauder AmorePacific LG H&H 1Q11 1Q13 1Q15 1Q17 1Q19 1Q21F

Source: Company data, Mirae Asset Daewoo Research Source: WISEfn, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 38 January 25, 2021 Cosmetics

Figure 98. AmorePacific: Revenue trends Figure 99. AmorePacific: Duty-free business growth (YoY)

(Wbn) (%) (%) Domestic (L) AmorePacific Duty-free market 1600 Overseas (L) 15 60

1400 Growth (R) 10 40 5 1200 0 20 1000 -5 800 0 -10 600 -15 -20 400 -20 -40 200 -25

0 -30 -60 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: Company data, Mirae Asset Daewoo Research Source Company data, KDFA, Mirae Asset Daewoo Research

Figure 100 . Domestic cosmetics market: Revenue share of Figure 101. AmorePacific: E-commerce as % of domestic duty-free channels cosmetics revenue

60% 35%

50% 30% 30% 44% 25% 40% 20% 30%

15% 20% 10%

10% 5%

0% 0% 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 102 . AmorePacific: China revenue breakdown by brand Figure 103. Growth comparison: AmorePacific’s China revenue

(4Q20F) vs China cosmetics market

(%) AmorePacific China cosmetics market 40

30

20

10

0

-10

-20

-30

-40 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 39 January 25, 2021 Cosmetics

AmorePacific (090430 KS)

Income statement (summarized) Balance sheet (summarized) (Wbn) 2019 2020F 2021F 2022F (Wbn) 2019 2020F 2021F 2022F Revenue 5,580 4,403 4,936 6,294 Current assets 1,803 1,673 1,752 2,129 Cost of revenue 5,580 1,260 1,373 1,719 Cash & equivalents 882 716 757 890 GP 0 3,143 3,563 4,575 AR & other receivables 387 416 423 537 SG&A expenses 3,652 3,002 3,097 3,943 Inventory 453 427 450 560 OP (adj.) 428 140 466 631 Other current assets 81 114 122 142 OP 428 140 466 631 Non-current assets 4,186 4,060 4,275 4,674 Non-operating profit -57 -80 -21 -33 Investments in associates 0 0 0 0 Net financial income -7 5 6 7 PP&E 2,662 2,426 2,286 2,180 Net income from associates 0 0 0 0 Intangible assets 227 227 377 627 Pretax profit 371 60 445 598 Total assets 5,989 5,733 6,027 6,804 Income tax 147 15 118 162 Current liabilities 1,067 903 852 1,046 Profit from continuing operations 224 44 327 437 AP & other payables 173 268 203 196 Profit from discontinued operations 0 0 0 0 Short-term financial liabilities 298 122 103 154 NP 224 44 327 437 Other current liabilities 596 513 546 696 Attributable to owners 239 69 334 430 Non-current liabilities 424 356 386 615 Attributable to minority interests -15 -25 -7 7 Long-term financial liabilities 0 0 0 150 Total comprehensive income 224 44 327 437 Other non-current liabilities 424 356 386 465 Attributable to owners 239 69 334 430 Total liabilities 1,490 1,259 1,239 1,661 Attributable to minority interests -15 -25 -7 7 Equity attributable to owners 4,490 4,465 4,778 5,132 EBITDA 913 626 906 1,037 Capital stock 35 35 35 35 FCF 472 172 425 517 Capital surplus 724 724 724 724 EBITDA margin (%) 16.4 14.2 18.4 16.5 Retained earnings 3,874 3,849 4,163 4,518 OP margin (%) 7.7 3.2 9.4 10.0 Minority interests 9 9 10 11 Net margin (%) 4.3 1.6 6.8 6.8 Shareholders' equity 4,499 4,474 4,788 5,143

Cash flow statement (summarized) Key valuation metrics/ratios (Wbn) 2019 2020F 2021F 2022F 2019 2020F 2021F 2022F Operating cash flow 718 422 725 817 P/E (x) 57.8 205.7 50.9 39.5 NP 224 44 327 437 P/CF (x) 13.5 25.9 19.1 16.8 Non-cash income/expenses 796 504 562 572 P/B (x) 3.1 3.2 3.6 3.3 Depreciation 485 486 440 405 EV/EBITDA (x) 13.2 20.4 17.1 14.9 Amortization 0 0 0 0 EPS (W) 3,460 1,001 4,835 6,235 Other 311 18 122 167 CFPS (W) 14,778 7,948 12,885 14,616 Chg. in working capital -154 -109 -43 -26 BPS (W) 65,050 64,696 69,231 74,363 Chg. in AR & other receivables -83 -22 15 -89 DPS (W) 1,000 198 1,201 1,604 Chg. in inventory -94 26 -23 -110 Dividend payout ratio (%) 30.6 30.6 25.0 25.0 Chg. in AP & other payables 62 96 -66 -7 Dividend yield (%) 0.5 0.1 0.5 0.7 Income tax -147 -15 -118 -162 Revenue growth (%) 5.7 -21.1 12.1 27.5 Cash flow from investing activities -200 -341 -651 -801 EBITDA growth (%) 22.1 -31.4 44.7 14.5 Chg. in PP&E -247 -250 -300 -300 OP growth (%) -11.2 -67.3 232.9 35.4 Chg. in intangible assets 0 0 0 0 EPS growth (%) -28.1 -71.1 383.0 29.0 Chg. in financial assets 0 0 0 0 AR turnover (x) 17.1 11.7 12.9 15.1 Other 47 -91 -351 -501 Inventory turnover (x) 13.0 10.0 11.3 12.5 Cash flow from financing activities -387 -246 -33 118 AP turnover (x) 39.3 5.7 5.8 8.6 Chg. in financial liabilities -21 -177 -20 200 ROA (%) 3.9 0.8 5.6 6.8 Chg. in equity 0 0 0 0 ROE (%) 5.3 1.5 7.2 8.7 Dividends -81 -69 -13 -82 ROIC (%) 6.8 2.0 8.2 10.5 Other -285 0 0 0 Debt-to-equity ratio (%) 33.1 28.1 25.9 32.3 Chg. in cash 131 -165 40 133 Current ratio (%) 169.1 185.2 205.6 203.5 Beginning balance 751 882 716 757 Net debt-to-equity ratio (%) -13.0 2.0 1.6 1.1 Ending balance 882 716 757 890 Interest coverage ratio (x) 21.4 33.6 423.7 263.1 Source: Company data, Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research 40 [Korea] Cosmetics January 25, 2021

LG H&H Buy (051900 KS ) (Maintain)

A quality stock that looks excessively undervalued TP: W2,000,000 ▲ Upside: 19.3%

Mirae Asset Daewoo Co., Ltd. Junghan Yoon [email protected]

4Q20 preview Both revenue and operating profit likely grew ó For 4Q20, we expect LG H&H to deliver revenue of W2.11tr (+4.4% YoY; all growth figures hereafter are YoY) and operating profit of W256.1bn (+6.3%). ó By division, we look for operating profit of W211.2bn (-1%) for cosmetics, W21bn (+127.4%) for HPC, and W23.4bn (+32.2%) for beverages.

Cosmetics Robust demand for The History of Whoo in China, but continued weakness in domestic market ó We estimate duty-free revenue grew 2% on the back of continued demand from corporate-type daigou . ó The domestic cosmetics market remained depressed in 4Q20. In the masstige segment, margin contraction likely continued. ó Demand for The History of Whoo in China (onshore) was concentrated in November due to Singles’ Day. In December, the brand’s GMV on Tmall declined 56%. For 4Q20, we expect revenue growth of 38% in China. ó We estimate cosmetics OP margin slipped 1.1%p QoQ to 16.2%, affected by increased online marketing spend.

HPC and beverages Despite weaker hygiene product sales, margins to remain high ó We estimate revenue from hygiene products (which have higher margi ns) shrank to less than W20bn. Still, we believe the share of premium products increased to over 40%, supporting margins. ó The brand New Avon likely turned a profit earlier than guidance, thanks to digitalization. Revenue from the highly lucrative Physiogel line also likely contributed to earnings. ó In beverages, the share of high-margin soft drinks likely remained high, backed by the continued expansion of the online food delivery market.

Valuation and recommendation Valuation looks cheap, with discount to global peers at nearly 40% ó LG H&H is trading at a 2021F P/E of 26.1x, a 34% discount to global peers. ó We believe the stock is excessively undervalued at current levels. The stock’s average discount pre-pandemic was around 20%. ó We raise our target price to W2,000,000, applying a P/E of 31.5x to our 2021F EPS of W64,100.

Key data Current price (1/25/21, W) 1,676,000 Market cap (Wbn) 26,176 150 LG H&H KOSPI 130 OP (20F, Wbn) 1,221 Shares outstanding (mn) 18

110 Consensus OP (20F, Wbn) 1,225 Free float (%) 59.8 EPS growth (20F, %) 4.6 Foreign ownership (%) 45.9 90 P/E (20F, x) 35.3 Beta (12M) 0.50 70 Market P/E (20F, x) 22.3 52-week low (W) 1,066,000 50 1.20 5.20 9.20 1.21 KOSPI 3,208.99 52-week high (W) 1,676,000

Share performance Earnings and valuation metrics (%) 1M 6M 12M (Dec.) 2017 2018 2019 2020F 2021F 2022F Absolute 3.1 26.7 24.2 Revenue (Wbn) 6,105 6,748 7,685 7,852 8,687 9,610 Relative -9.8 -13.1 -13.0 OP (Wbn) 930 1,039 1,176 1,221 1,400 1,603

OP margin (%) 15.2 15.4 15.3 15.6 16.1 16.7 NP (Wbn) 606 683 778 814 940 1,081 EPS (W) 34,226 38,534 43,916 45,954 53,036 61,012 ROE (%) 21.9 20.5 19.9 17.9 17.9 17.9 P/E (x) 34.7 28.6 28.7 35.3 31.6 27.5 P/B (x) 6.9 5.6 5.4 6.0 5.4 4.7 Div. yield (%) 0.8 0.8 0.9 0.7 0.9 1.2 Notes: Under consolidated K-IFRS; NP is attributable to owners of the parent Source: Company data, Mirae Asset Daewoo Research estimat es Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he US. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES AND DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. January 25, 2021 Cosmetics

Table 5. LG H&H: 4Q20 preview (Wbn, %) 4Q20F Growth 4Q19 3Q20 Mirae Asset Daewoo Consensus Diff. YoY Revenue 2,013.3 2,070.6 2,101.7 2,092.7 0.4 4.4 OP 241.0 327.6 256.1 261.8 -2.2 6.3 OP margin (%) 12.0 15.8 12.2 12.5 -0.3 1.8 Pretax profit 194.4 318.3 223.9 228.4 -2.0 15.2 NP (owners of the 133.1 227.2 154.5 162.1 -5.0 16.0 parent) Source: Company data, WISEfn, Mirae Asset Daewoo Research

Table 6. LG H&H: Quarterly and annual earnings (Wbn ) 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20F 2019 2020F 2021F Revenue 1,874.8 1,832.5 1,964.9 2,013.3 1,896.4 1,783.2 2,070.6 2,101.7 7,685.4 7,851.8 8,687.4 YoY 13.0% 10.9% 13.1% 18.5% 1.2% -2.7% 5.4% 4.4% 13.9% 2.2% 10.6% Cosmetics 1,139.6 1,108.9 1,160.8 1,336.5 1,066.5 923.3 1,143.8 1,310.0 4,745.8 4,443.6 5,275.9 YoY 20.3% 16.3% 21.7% 27.3% -6.4% -16.7% -1.5% -2.0% 21.5% -6.4% 18.7% HPC 401.4 343.4 401.1 342.2 479.3 462.2 508.8 447.1 1,488.1 1,897.4 1,871.8 YoY 1.7% 1.8% 3.0% 0.7% 19.4% 34.6% 26.9% 30.7% 1.8% 27.5% -1.3% Beverages 333.7 380.3 402.9 334.6 350.5 397.7 418.0 344.6 1,451.5 1,510.8 1,539.7 YoY 5.3% 5.1% 2.4% 8.4% 5.0% 4.6% 3.7% 3.0% 5.1% 4.1% 1.9%

OP 322.1 301.5 311.9 241.0 333.7 303.3 327.6 256.1 1,176.4 1,220.7 1,399.9 YoY 13.5% 12.8% 12.4% 14.3% 3.6% 0.6% 5.1% 6.3% 13.2% 3.8% 14.7% Cosmetics 246.2 226.2 212.4 213.8 221.8 178.2 197.9 211.6 898.6 809.6 998.0 YoY 16.1% 16.3% 15.3% 11.3% -9.9% -21.2% -6.8% -1.0% 14.8% -9.9% 23.3% HPC 43.4 28.2 45.3 9.2 65.2 63.3 66.7 21.0 126.1 216.2 216.1 YoY 3.6% 3.1% 5.8% 8.8% 50.4% 124.9% 47.1% 127.4% 4.6% 71.5% 0.0% Beverages 32.4 47.5 54.8 17.7 47.0 62.0 63.1 23.4 152.4 195.6 185.8 YoY 8.7% 4.2% 7.9% 79.6% 45.1% 30.5% 15.2% 32.2% 12.1% 28.3% -5.0%

OP margin 17.2% 16.5% 15.9% 12.0% 17.6% 17.0% 15.8% 12.2% 15.3% 15.5% 16.1% YoY 0.1% 0.3% -0.1% -0.4% 0.4% 0.6% 0.0% 0.2% -0.1% 0.2% 0.6% Cosmetics 21.6% 20.4% 18.3% 16.0% 20.8% 19.3% 17.3% 16.2% 18.9% 18.2% 18.9% YoY -0.8% 0.0% -1.0% -2.3% -0.8% -1.1% -1.0% 0.2% -1.1% -0.7% 0.7% HPC 10.8% 8.2% 11.3% 2.7% 13.6% 13.7% 13.1% 4.7% 8.5% 11.4% 11.5% YoY 0.2% 0.1% 0.3% 0.2% 2.8% 5.5% 1.8% 2.0% 0.2% 2.9% 0.2% Beverages 9.7% 12.5% 13.6% 5.3% 13.4% 15.6% 15.1% 6.8% 10.5% 12.9% 12.1% YoY 0.3% -0.1% 0.7% 2.1% 3.7% 3.1% 1.5% 1.5% 0.7% 2.4% -0.9% Source: Company data, Mirae Asset Daewoo Research

Table 7. LG H&H: TP calculation (W, Wbn, x) 2015 2016 2017 2018 2019 2020F 2021F EPS 31,402 38,760 41,366 46,572 53,077 55,539 64,100 BPS 114,985 142,927 169,108 198,222 234,042 269,411 311,326 Peak market cap 16,508 18,445 19,523 23,115 22,693 25,754 EPS 64,100 2021F EPS Target P/E 31.5 20% discount to the global peer avg. (L’Oreal and Estee Lauder) before COVID-19 Target price 2,000,000 Current price 1,676,000 Upside 19.3% Source: Company data, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 42 January 25, 2021 Cosmetics

LG H&H’s The History of Whoo recorded CNY1.55bn (+181% YoY) in Singles' Day revenue in 2020, taking fourth place in the skin care category. Despite the pandemic, revenue from the brand’s domestic duty-free and China sales collectively expanded 4.2% YoY to W692.7bn in 3Q20. We forecast the brand’s China revenue (inclusive of duty-free sales) to jump 17.6% YoY in 4Q20 thanks to solid demand from loyal customers.

Su:m37 and O Hui—which the company is promoting as secondary brands—have been displaying steady revenue growth in China. As LG H&H reopens its offline channels, it plans to focus on upselling its customers to higher-end sub-brands such as Su:m37 Losec Summa and O Hui The First—pricey functional cosmetic lines that are seeing growing demand as cosmeceuticals gain traction among Chinese consumers.

Meanwhile, we also note that the Singles' Day sales period was longer than usual last year, and that LG H&H’s Tmall GMV tanked 56% YoY in Dec. 2020. Moreover, the decline in in-store traffic and higher mix of lower-margin products in duty-free sales continued into 4Q20. Accordingly, while we expect cosmetics top line to improve slightly YoY, driven by strong Singles' Day sales and a rebound in duty-free sales, improvements in the bottom line will likely fall short. For 4Q20, we forecast LG H&H’s cosmetics division to post revenue of W1.31tr (-2% YoY), operating profit of W211.6bn (-1% YoY) and an OP margin of 16.2%.

The HPC division is displaying growth. While sales of profitable hygiene products have fallen since 3Q20, the ongoing shift to online channels and the growing sales mix of high-margin products (following SKU reductions since end-2019) have helped prop up the bottom line. The growing online sales share for New Avon and revenue growth in high-margin Physiogel products should also boost earnings. For 4Q20, we forecast the HPC business to record revenue of W447.1bn (+30.7% YoY) and operating profit of W21bn (+127.4% YoY).

Based on 2021F P/E, LG H&H is trading at a 34% discount to global peers L'Oreal and Estee Lauder, reflecting its relatively weak brand power and heavy reliance on a single brand in the Chinese market. Marketing expenses are also anticipated to increase, given the firm’s low online sales mix in China (36%) relative to peers and the high proportion of duty-free sales in overall cosmetics revenue. That said, we think the discount is excessive, considering that the company traded at a 20% discount (on average) before the pandemic (reflecting the same discount factors). We maintain our Buy call and raise our target price to W2,000,000, which is based on 31.5x (20% discount to peers) our 2021F EPS estimate of W64,100.

Figure 104. The History of Whoo: GMV growth in Oct.-Dec. 2020 (Tmall)

100% 81% 80%

60%

40% 31%

20%

0%

-20%

-40%

-60% -56% -80% 10/20 11/20 12/20

Source: Tmall, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 43 January 25, 2021 Cosmetics

Figure 105. Domestic cosmetics retail revenue (excl. duty-free Figure 106. LG H&H: China revenue sales to foreigners)

(Wbn) (%) (Wbn) (%) Domestic cosmetics retail sales (L) YoY (R) 6,000 15 1200 China-related revenue (L) YoY (R) 80 10 5,000 5 1000 60 0 4,000 -5 800 40 -10 3,000 600 20 -15 -20 2,000 400 0 -25 -30 1,000 200 -20 -35 - -40 0 -40 1Q16 4Q16 3Q17 2Q18 1Q19 4Q19 3Q20 1Q18 4Q18 3Q19 2Q20 1Q21F 4Q21F

Source: Statistics Korea, KDFA, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 107. Growth comparison: LG H&H’s duty-free revenue Figure 108. Growth comparison: LG H&H’s China revenue vs. vs. domestic duty-free market Chinese cosmetics market

(%) (%, YoY) Duty-free market LG H&H duty-free LG H&H China revenue growth 80 60 China cosmetics retail sales growth 70 40 60 50 20 40

0 30 20 -20 10 0 -40 -10 -60 -20 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: KDFA , Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 109. LG H&H: HPC revenue Figure 110. LG H&H: P/E discount rate trend

(Wbn) (x) 700 Existing domestic Existing overseas 45 Discount rate (R) 40% Physiogel New Avon L'Oreal/Estee Lauder (L) 600 35% 40 LG H&H (L) 30% 500 35 25% 400 30 20% 300 15% 25 200 10% 20 100 5%

0 15 0% 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 1/19 4/19 7/19 10/19 1/20 4/20 7/20 10/20 1/21

Source: Company data, Mirae Asset Daewoo Research Source: Bloomberg, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 44 January 25, 2021 Cosmetics

LG H&H (051900 KS)

Income statement (summarized) Balance sheet (summarized) (Wbn) 2019 2020F 2021F 2022F (Wbn) 2019 2020F 2021F 2022F Revenue 7,685 7,852 8,687 9,610 Current assets 2,163 2,249 2,544 2,874 Cost of revenue 7,685 2,984 3,302 3,612 Cash & equivalents 719 754 882 1,039 GP 0 4,868 5,385 5,998 AR & other receivables 641 654 724 801 SG&A expenses 3,592 3,647 3,986 4,395 Inventory 746 762 844 933 OP (adj.) 1,176 1,221 1,400 1,603 Other current assets 57 79 94 101 OP 1,176 1,221 1,400 1,603 Non-current assets 4,331 4,801 5,554 6,281 Non-operating profit -84 -82 -85 -91 Investments in associates 0 0 0 0 Net financial income -5 -1 0 0 PP&E 2,036 2,318 2,519 2,651 Net income from associates 7 7 7 7 Intangible assets 1,787 1,949 2,304 2,702 Pretax profit 1,092 1,139 1,315 1,512 Total assets 6,494 7,050 8,098 9,155 Income tax 304 314 363 417 Current liabilities 1,771 1,660 1,910 2,126 Profit from continuing operations 788 825 952 1,095 AP & other payables 640 654 723 800 Profit from discontinued operations 0 0 0 0 Short-term financial liabilities 392 252 353 404 NP 788 825 952 1,095 Other current liabilities 739 754 834 922 Attributable to owners 778 814 940 1,081 Non-current liabilities 485 513 552 565 Attributable to minority interests 10 11 12 14 Long-term financial liabilities 34 54 54 24 Total comprehensive income 788 825 952 1,095 Other non-current liabilities 451 459 498 541 Attributable to owners 778 814 940 1,081 Total liabilities 2,257 2,173 2,462 2,690 Attributable to minority interests 10 11 12 14 Equity attributable to owners 4,147 4,773 5,516 6,327 EBITDA 1,427 1,527 1,744 1,973 Capital stock 89 89 89 89 FCF 814 560 791 1,023 Capital surplus 97 97 97 97 EBITDA margin (%) 18.6 19.4 20.1 20.5 Retained earnings 4,175 4,815 5,574 6,402 OP margin (%) 15.3 15.6 16.1 16.7 Minority interests 90 104 120 138 Net margin (%) 10.1 10.4 10.8 11.2 Shareholders' equity 4,237 4,877 5,636 6,465

Cash flow statement (summarized) Key valuation metrics/ratios (Wbn) 2019 2020F 2021F 2022F 2019 2020F 2021F 2022F Operating cash flow 1,140 1,110 1,291 1,473 P/E (x) 28.7 35.3 31.6 27.5 NP 788 825 952 1,095 P/CF (x) 15.5 19.9 17.9 15.8 Non-cash income/expenses 653 616 703 785 P/B (x) 5.4 6.0 5.4 4.7 Depreciation 224 268 299 318 EV/EBITDA (x) 14.8 18.0 16.3 14.4 Amortization 27 38 45 52 EPS (W) 43,916 45,954 53,036 61,012 Other 402 310 359 415 CFPS (W) 81,335 81,327 93,428 106,109 Chg. in working capital 3 -14 1 15 BPS (W) 234,042 269,411 311,326 357,086 Chg. in AR & other receivables -23 -14 -67 -74 DPS (W) 11,000 11,514 15,902 19,600 Chg. in inventory -31 -16 -81 -90 Dividend payout ratio (%) 23.4 23.4 28.0 30.0 Chg. in AP & other payables 2 6 32 35 Dividend yield (%) 0.9 0.7 0.9 1.2 Income tax -304 -314 -363 -417 Revenue growth (%) 13.9 2.2 10.6 10.6 Cash flow from investing activities -404 -770 -1,070 -1,070 EBITDA growth (%) 19.2 7.0 14.2 13.1 Chg. in PP&E -326 -550 -500 -450 OP growth (%) 13.2 3.8 14.7 14.5 Chg. in intangible assets 0 0 0 0 EPS growth (%) 14.0 4.6 15.4 15.0 Chg. in financial assets 0 0 0 0 AR turnover (x) 13.2 12.7 13.2 13.2 Other -78 -220 -570 -620 Inventory turnover (x) 11.3 10.4 10.8 10.8 Cash flow from financing activities -429 -306 -93 -247 AP turnover (x) 30.4 10.2 10.6 10.4 Chg. in financial liabilities 0 -121 100 20 ROA (%) 13.4 12.2 12.6 12.7 Chg. in equity 0 0 0 0 ROE (%) 19.9 17.9 17.9 17.9 Dividends 0 -184 -193 -267 ROIC (%) 21.0 19.5 19.3 19.5 Other -429 -1 0 0 Debt-to-equity ratio (%) 53.3 44.6 43.7 41.6 Chg. in cash 306 35 128 157 Current ratio (%) 122.1 135.5 133.2 135.2 Beginning balance 414 719 754 882 Net debt-to-equity ratio (%) -6.9 11.2 9.7 8.5 Ending balance 719 754 882 1,039 Interest coverage ratio (x) 84.8 167.6 264.0 228.0 Source: Company data, Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research 45 [Korea] Cosmetics January 25, 2021

Cosmax Buy (192820 KS ) (Maintain)

More than meets the eye TP: W145,000 Upside: 29.5%

Mirae Asset Daewoo Co., Ltd. Junghan Yoon [email protected]

4Q20 preview More resilient than domestic market; Guangzhou operation to resume growth ó For 4Q20, we forecast Cosmax to record consolidated revenue of W368.4bn (+4.3% YoY; all growth figures hereafter are YoY) and operating profit of W18.5bn (-12.5%). ó For the domestic parent business, we expect revenue of W185.1bn (+0.2%), operating profit o f W12.6bn (-4.8%), and OP margin of 6.8%. - Despite a sluggish domestic market caused by the resurgence of COVID-19, we believe a higher mix of online customers (roughly 30%) helped cushion revenue. - Utilization also likely held steady at 75%. We expect a high OP margin, despite weaker revenue from high-margin hand sanitizers (W2bn in 4Q20). ó For Cosmax East, we look for revenue of W149.1bn (-1.4%; non-adjusted) and OP margin of 9.4%. - At the Shanghai operation, we estimate revenue fell 5.4%, hurt by the largest customer’s switch to non-turnkey contracts. - At the Guangzhou operation, we estimate revenue grew 13% on stronger demand for makeup products and increased orders from a major customer.

Risks to be resolved Risk factors are gradually subsiding ó The company’s slowdown in China is largely the result of changes in the contract structure and product mix. Production volume is actually up 15% YoY. ó The Southeast Asia subsidiary, which cause d a drag on margins in 3Q20, should begin to recognize hygiene product revenue for a global customer in 2Q21. ó We believe online customers account for 50% of revenue for the Shanghai operation and 75% for the Guangzhou operation.

Valuation and recommend ation Our top pick; reaffirm Buy and TP of W145,000 ó Cosmax is trading at a 2021F P/E of 16.7x, a historical low. ó In 1H21, operating profit is likely to be negatively affected by a tough comparison, as the domestic business’s revenue from high-margin hand sanitizers should decline. ó We believe the focus should be on the growth potential of the main business. The US subsidiary is set to win a long-term contract from a global company in 2H21. ó We expect a fast turnaround in loss-generating regions from 2H21.

Key data Current price (1/25/21, W) 112,000 Market cap (Wbn) 1,126 170 Cosmax KOSPI 150 OP (20F, Wbn) 75 Shares outstanding (mn) 10 130 Consensus OP (20F, Wbn) 75 Free float (%) 71.3 110 EPS growth (20F, %) 30.7 Foreign ownership (%) 24.7 90 P/E (20F, x) 24.0 Beta (12M) 0.56 70 Market P/E (20F, x) 22.3 52-week low (W) 60,700 50 1.20 5.20 9.20 1.21 KOSPI 3,208.99 52-week high (W) 126,000

Share performance Earnings and valuation metrics (%) 1M 6M 12M (Dec.) 2017 2018 2019 2020F 2021F 2022F Absolute 14.6 23.8 36.9 Revenue (Wbn) 884 1,260 1,331 1,397 1,553 1,689 Relative 0.3 -15.1 -4.2 OP (Wbn) 35 52 54 75 104 129

OP margin (%) 4.0 4.1 4.1 5.4 6.7 7.6 NP (Wbn) 19 33 32 42 67 75 EPS (W) 1,876 3,246 3,166 4,139 6,713 7,454 ROE (%) 8.8 13.5 11.4 12.9 18.9 18.0 P/E (x) 62.4 40.0 25.2 24.0 16.7 15.0 P/B (x) 5.4 4.9 2.3 2.8 2.7 2.3 Div. yield (%) 0.3 0.5 1.1 0.6 0.8 1.0 Notes: Under consolidated K-IFRS; NP is attributable to owners of the parent Source: Company data, Mirae Asset Daewoo Research estimat es Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he US. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES AND DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. January 25, 2021 Cosmetics

Table 8. Cosmax: 4Q20 preview (Wbn , %)

4Q20F Growth 4Q19 3Q20 Mirae Asset Daewoo Consensus % chg. YoY Revenue 353.1 320.7 368.4 384.7 -4.4 4.3 OP 16.9 13.9 18.5 18.4 0.8 9.8 OP margin (%) 4.8 4.3 5.0 4.8 0.2 5.2 Pretax profit 6.6 4.7 9.3 11.1 -19.1 42.1 NP attributable to 9.7 5.8 10.6 11.2 -5.8 9.0 owners Source: Company data, WISEf n, Mirae Asset Daewoo Research

Table 9. Cosmax: Quarterly and annual earnings (Wbn) 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20F 2019 2020F 2021F Revenue 288.7 327.5 314.6 328.8 327.8 332.3 317.5 353.1 328.5 379.2 320.7 368.4 1,330.6 1,396.8 1,553.1 Domestic (parent) 152.4 190.2 167.3 169.5 190.2 192.9 171.4 184.6 202.0 209.0 172.1 185.1 739.0 768.1 813.4 Cosmax East 99.1 121.6 120.2 136.7 103.7 118.1 108.8 151.2 88.4 129.4 107.0 149.1 481.8 473.9 565.2 Cosmax West 42.8 38.7 46.2 37.7 43.0 37.5 46.3 32.4 37.7 40.5 49.4 46.3 159.3 173.9 206.7 Indonesia 1.7 2.4 2.5 4.0 8.0 8.3 11.5 11.5 10.2 10.9 5.6 5.8 39.4 32.4 39.7 Thailand 0.7 0.7 4.9 4.8 4.1 3.7 4.6 5.6 5.3 4.6 4.2 5.1 17.9 19.2 20.0 Korean 2.6 2.9 3.6 4.1 5.3 4.4 18.3 20.9 20.8 20.5 15.4 18.0 48.9 74.7 80.6 subsidiaries Revenue YoY (%) 24.3 57.1 40.5 13.9 0.1 5.6 -3.5 7.7 -1.1 19.5 -9.2 12.1 5.6 5.0 11.2 Domestic (parent) 7.1 38.2 40.3 31.4 24.8 1.4 2.5 8.9 6.2 8.4 0.4 0.2 8.8 3.9 5.9 Cosmax East 28.7 15.2 36.7 35.7 4.6 -2.8 -9.5 10.6 -14.8 9.5 -1.6 -1.4 0.9 -1.6 19.3 Cosmax West 493.2 509.9 286.7 199.8 0.4 -3.0 0.3 -14.0 -12.3 7.9 6.7 42.8 -3.7 9.2 18.9 Indonesia -40.0 31.4 7.9 104.8 364.5 239.2 362.4 189.7 26.2 31.8 -51.6 -50.0 270.1 -17.7 22.6 Thailand - - - - 455.1 407.7 -7.7 15.0 31.3 23.8 -8.9 -8.0 59.2 7.3 4.3 Korean 122.6 125.5 62.0 75.3 99.3 50.8 409.9 408.9 296.6 364.5 -16.1 -13.9 268.6 52.8 8.0 subsidiaries OP 10.4 18.6 13.3 10.1 13.6 13.2 10.4 16.9 16.0 26.2 13.9 18.5 54.0 74.7 103.7 Domestic (parent) 5.0 7.7 4.0 5.4 7.7 10.6 8.6 13.2 16.4 20.8 11.4 12.6 40.2 61.1 58.1 Other + adj. 5.4 10.9 9.3 4.7 5.8 2.5 1.8 3.7 -0.3 5.5 2.5 6.0 13.8 13.5 45.6 OP YoY (%) 10.6 29.7 163.9 58.5 30.2 -29.2 -21.5 67.2 18.4 99.2 33.6 9.7 -54.2 -2.0 236.4 OP margin (%) 3.6 5.7 4.2 3.1 4.1 4.0 3.3 4.8 4.9 6.9 4.3 5.0 4.1 5.3 6.7 NP attri butable to 9.3 11.9 5.3 6.2 9.0 9.3 3.8 9.7 4.8 20.3 5.8 13.5 31.8 44.4 69.6 owners YoY NP growth (%) 276.4 47.8 247.1 -3.7 7.9 -76.8 -80.3 -22.0 -105.8 116.9 35.9 62.0 -2.4 39.6 56.6 Source: Company data, Mirae Asset Daewoo Research

Table 10. Cosmax: TP calculation (Wbn , x, W ) NP attributable Operations by region Target P/E Value Notes to owners Cosmax Applied a 30% discount to domestic ODMs’ average 12MF P/E (17. 2x) to 42.4 12.0 508.8 (domestic and subsidiaries) reflect financial risks Applied a 20% discount to Nox Bellcow’s 12MF P/E (30 x) to reflect low Cosmax East 40.8 24.0 979.2 profitability and ROE No. of shares 10,045,662 Target price 145,000 Current price 112,000 Upside (%) 29.5% Source: Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 47 January 25, 2021 Cosmetics

Cosmax is the largest cosmetics ODM/OEM vendor in Korea (market share of 12% based on our 2019 estimates) and China (4.9%). In 3Q20, the company’s Korea business grew 0.4% YoY, despite the fact that the domestic cosmetics market (excluding duty-free) has contracted by more than 20% YoY since 2Q20. We attribute this relatively strong performance to the company’s proactive efforts to expand its exposure to online sellers; in 3Q20, online channels accounted for 30% of parent-based domestic revenue.

For 4Q20, we expect the domestic business to post parent-based revenue of W203.4bn (+0.2% YoY), operating profit of W13.5bn (+2.2% YoY), and an OP margin of 7.3%, backed by high capacity utilization even amid unfavorable market conditions. Since 4Q19, the business has consistently delivered an OP margin of over 7%—effectively the highest level an OEM/ODM player can achieve, in our view—supported by automated production lines and a higher mix of non-turnkey contracts.

Since Cosmax released its 3Q20 earnings results, concerns have increased over the slowing growth of the China business. Indeed, the Guangzhou subsidiary posted below-market growth of 9% YoY amid intensifying competition. However, we believe this was only a temporary setback stemming from delayed order placements by a key customer and a short- term increase in the sales contribution of low-margin products.

In fact, we note that competing local ODM vendors also reported high-single-digit growth in 3Q20. And the GMV of key customer Perfect Diary (Tmall) recovered sharply YoY in the following quarter as the pandemic subsided. We forecast that Cosmax’s Guangzhou subsidiary, which focuses on makeup products, will show top-line growth of 13% YoY in 4Q20, easing concerns over a slowdown. Production at Cosmax East (Shanghai and Guangzhou) also remains healthy, increasing over 15% YoY in 2H20.

For Cosmax West, which includes Cosmax USA and NuWorld, hand sanitizer production could provide an opportunity to address impaired capital. We expect Cosmax West to record revenue of W46.3bn (+42.8% YoY) in 4Q20, inclusive of hand sanitizer revenue worth over W15bn.

We also note that sanitizer production costs are likely to fall gradually, given that Cosmax USA’s Ohio factory (which was previously designated for skin care products) has engaged in sanitizer production since end-3Q20. (The skin care and sanitizer production processes are somewhat similar.) For NuWorld, yield losses are decreasing thanks to automation and accumulated production know-how. Moreover, NuWorld is set to sign a two- to three-year supply contract with a multinational brand in 2H21.

As Cosmax West (which has posted quarterly operating losses of more than W5bn in recent years) is likely to perform better, we expect to see solid improvements in consolidated profit. We believe that Cosmax’s growth story remains valid and that its US subsidiary issues are being addressed. The stock appears significantly undervalued at a 2021F P/E of 16.7x. We retain our Buy rating and target price of W145,000.

Mirae Asset Daewoo Research 48 January 25, 2021 Cosmetics

Figure 112 . Cosmax: Proportion of online beauty firms in Figure 111. Korea: Retail cosmetics market customer mix

(Wbn) (%) Domestic cosmetics retail sales (L) YoY (R) End-2019 End-2020 6,000 15 80% 75% 10 70% 5,000 5 0 60% 4,000 50% -5 50% -10 3,000 40% -15 30% -20 30% 2,000 -25 20% 1,000 -30 10% -35 - -40 0% 1Q16 4Q16 3Q17 2Q18 1Q19 4Q19 3Q20 Domestic Shanghai Guangzhou

Source: Statistics Korea, Korea Duty Free Shops Association, Mirae Asset Daewoo Source: Company data, Mirae Asset Daewoo Research Research

Figure 114 . Cosmax’s domestic business (parent): Revenue and Figure 113. Cosmax East (China): Revenue and OP OP

(Wbn) (Wbn) Revenue (L) 180 Revenue (L) 12% 250 12% OP (L) OP (L) 160 OP margin (R) OP margin (R) 10% 10% 140 200

120 8% 8% 150 100 6% 6% 80 100 60 4% 4%

40 50 2% 2% 20

0 0% 0 0% 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 116 . GMV growth of Perfect Diary (Tmall) and makeup Figure 115. China: Quarterly cosmetics retail sales growth category

(%, YoY) (YoY) Perfect Diary Makeup 35 30.3 100% 30 80% 25 20 60%

15 40% 10 20% 5 0 0% -5 -20% -10 -40% -15 1/20 3/20 5/20 7/20 9/20 11/20 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20

Source: CEIC, Mirae Asset Daewoo Research Source: Tmall, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 49 January 25, 2021 Cosmetics

Cosmax (192820 KS)

Income statement (summarized) Balance sheet (summarized) (Wbn) 2019 2020F 2021F 2022F (Wbn) 2019 2020F 2021F 2022F Revenue 1,331 1,397 1,553 1,689 Current assets 618 617 700 753 Cost of revenue 1,147 1,184 1,308 1,415 Cash & equivalents 77 68 88 106 GP 184 213 245 274 AR & other receivables 318 334 371 383 SG&A expenses 129 138 141 146 Inventory 209 199 224 245 OP (adj.) 54 75 104 129 Other current assets 14 16 17 19 OP 54 75 104 129 Non-current assets 586 616 654 721 Non-operating profit -18 -25 -22 -24 Investments in associates 0 0 0 0 Net financial income -22 -21 -19 -20 PP&E 432 448 468 487 Net income from associates 0 0 0 0 Intangible assets 103 111 119 137 Pretax profit 36 50 82 105 Total assets 1,204 1,233 1,354 1,474 Income tax 18 28 22 31 Current liabilities 716 710 763 809 Profit from continuing operations 18 22 59 74 AP & other payables 225 236 262 285 Profit from discontinued operations 0 0 0 0 Short-term financial liabilities 403 382 399 414 NP 18 22 59 74 Other current liabilities 88 92 102 110 Attributable to owners 32 42 67 75 Non-current liabilities 171 193 208 217 Attributable to minority interests -13 -19 -8 -1 Long-term financial liabilities 132 152 162 167 Total comprehensive income 18 22 59 74 Other non-current liabilities 39 41 46 50 Attributable to owners 32 42 67 75 Total liabilities 888 903 971 1,026 Attributable to minority interests -13 -19 -8 -1 Equity attributable to owners 343 358 416 486 EBITDA 92 120 150 177 Capital stock 5 5 5 5 FCF 13 17 19 58 Capital surplus 182 182 182 182 EBITDA margin (%) 6.9 8.6 9.7 10.5 Retained earnings 162 175 228 293 OP margin (%) 4.1 5.4 6.7 7.6 Minority interests -27 -28 -33 -38 Net margin (%) 2.4 3.0 4.3 4.4 Shareholders' equity 316 330 383 448

Cash flow statement (summarized) Key valuation metrics/ratios (Wbn) 2019 2020F 2021F 2022F 2019 2020F 2021F 2022F Operating cash flow 75 77 84 123 P/E (x) 25.2 24.0 16.7 15.0 NP 18 22 59 74 P/CF (x) 6.5 10.2 8.6 7.2 Non-cash income/expenses 104 76 72 84 P/B (x) 2.3 2.8 2.7 2.3 Depreciation 36 44 45 46 EV/EBITDA (x) 13.4 13.2 11.3 9.6 Amortization 2 2 2 2 EPS (W) 3,166 4,139 6,713 7,454 Other 66 30 25 36 CFPS (W) 12,203 9,734 13,088 15,638 Chg. in working capital -29 10 -22 1 BPS (W) 34,178 35,595 41,394 48,386 Chg. in AR & other receivables 2 -15 -35 -11 DPS (W) 900 551 884 1,099 Chg. in inventory 6 10 -25 -21 Dividend payout ratio (%) 49.3 25.0 15.0 15.0 Chg. in AP & other payables -11 9 21 18 Dividend yield (%) 1.1 0.6 0.8 1.0 Income tax -18 -28 -22 -31 Revenue growth (%) 5.6 5.0 11.2 8.8 Cash flow from investing activities -106 -75 -85 -115 EBITDA growth (%) 17.9 30.4 25.0 18.0 Chg. in PP&E -61 -60 -65 -65 OP growth (%) 3.8 38.9 38.7 24.0 Chg. in intangible assets 0 0 0 0 EPS growth (%) -2.5 30.7 62.2 11.0 Chg. in financial assets 0 0 0 0 AR turnover (x) 4.4 4.5 4.7 4.8 Other -45 -15 -20 -50 Inventory turnover (x) 6.4 6.8 7.3 7.2 Cash flow from financing activities 63 -11 20 10 AP turnover (x) 6.4 6.4 6.6 6.5 Chg. in financial liabilities 0 -2 26 19 ROA (%) 1.6 1.8 4.6 5.2 Chg. in equity 0 0 0 0 ROE (%) 11.4 12.9 18.9 18.0 Dividends 0 -9 -6 -9 ROIC (%) 3.7 4.2 9.0 10.1 Other 63 0 0 0 Debt-to-equity ratio (%) 280.6 274.1 253.3 229.0 Chg. in cash 32 -9 19 18 Current ratio (%) 86.3 87.0 91.8 93.1 Beginning balance 46 77 68 88 Net debt-to-equity ratio (%) 144.8 185.4 159.6 136.6 Ending balance 77 68 88 106 Interest coverage ratio (x) 2.4 3.5 5.4 6.5 Source: Company data, Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research 50 January 25, 2021 Cosmetics

Appendix 1

Important disclosures and disclaimers Two-year rating and TP history

Company Date Rating TP (W) Company Date Rating TP (W) AmorePacific (090430) 03/19/19 Buy 1,640,000 01/25/21 Hold 230,000 08/07/18 No Coverage 12/17/20 Trading Buy 230,000 Cosmax (192820) 10/20/20 Trading Buy 185,000 11/05/20 Buy 145,000 10/16/20 No Coverage 10/16/20 No Coverage 04/29/20 One year 06/24/20 Trading Buy 97,000 04/29/19 Hold 02/27/20 Trading Buy 90,000 03/19/19 Trading Buy 210,000 08/09/19 Trading Buy 103,000 08/07/18 No Coverage 05/13/19 Trading Buy 140,000 LG H&H (051900) 03/19/19 Trading Buy 164,000 01/25/21 Buy 2,000,000 08/07/18 No Coverage 10/20/20 Buy 1,900,000 10/16/20 No Coverage 03/19/20 One year 1,640,000

(W) AmorePacific (W) LG H&H (W) Cosmax 300,000 2,500,000 200,000

250,000 2,000,000 150,000 200,000 1,500,000 150,000 100,000 1,000,000 100,000 50,000 50,000 500,000

0 0 0 Jan 19 Jan 20 Jan 21 Jan 19 Jan 20 Jan 21 Jan 19 Jan 20 Jan 21

Stock ratings Sector ratings Buy Expected 12-month performance: +20% or greater Overweight Expected to outperform the market over 12 months Trading Buy Expected 12-month performance: +10% to +20% Neutral Expected to perform in line with the market over 12 months Hold Expected 12-month performance: -10% to +10% Underweight Expected to underperform the market over 12 months Sell Expected 12-month performance: -10% or worse

Rating and TP history: Share price ( ─), TP (▬), Not Rated ( ■), Buy ( ▲), Trading Buy ( ■), Hold ( ●), Sell ( ◆) * Our investment rating is a guide to the expected return of the stock over the next 12 months. * Outside of the official ratings of Mirae Asset Daewoo Co., Ltd., analysts may call trading opportunities should technical or short-term material developments arise. * The TP was determined by the research analyst through valuation methods discussed in this report, in part based on estimates of future earnings. * TP achievement may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions.

Ratings distribution and investment banking services Buy Trading Buy Hold Sell Ratings distribution 78.43% 11.76% 8.50% 1.31% Investment banking services 66.67% 22.22% 11.11% 0.00% * Based on recommendations in the last 12 months (as of December 31, 2020)

Disclosures As of the publication date, Mirae Asset Daewoo Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of LG H&H, AmorePacific as an underlying asset; other than this, Mirae Asset Daewoo has no other special interests in the covered companies.

Analyst certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws or regulations thereof. Each Analyst responsible for the preparation of this report certifies that (i) all views expressed in this report accurately reflect the personal views of the Analyst about any and all of the issuers and securities named in this report and (ii) no part of the compensation of the Analyst was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Mirae Asset Daewoo Co., Ltd. (“Mirae Asset Daewoo”) policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director, or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. Like all employees of Mirae Asset Daewoo, the Analysts receive compensation that is determined by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading, and private client divisions. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Mirae Asset Daewoo except as otherwise stated herein.

Disclaimers Mirae Asset Daewoo Research 51 January 25, 2021 Cosmetics

This report was prepared by Mirae Asset Daewoo, a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled in good faith and from sources believed to be reliable, but such information has not been independently verified and Mirae Asset Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein or of any translation into English from the Korean language. In case of an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws, and accounting principles, and no person whose receipt or use of this report would violate any laws or regulations or subject Mirae Asset Daewoo or any of its affiliates to registration or licensing requirements in any jurisdiction shall receive or make any use hereof. This report is for general information purposes only and is not and shall not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The report does not constitute investment advice to any person, and such person shall not be treated as a client of Mirae Asset Daewoo by virtue of receiving this report. This report does not take into account the particular investment objectives, financial situations, or needs of individual clients. The report is not to be relied upon in substitution for the exercise of independent judgment. Information and opinions contained herein are as of the date hereof and are subject to change without notice. The price and value of the investments referred to in this report and the income from them may depreciate or appreciate, and investors may incur losses on investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur. Mirae Asset Daewoo, its affiliates, and their directors, officers, employees, and agents do not accept any liability for any loss arising out of the use hereof. Mirae Asset Daewoo may have issued other reports that are inconsistent with, and reach different conclusions from, the opinions presented in this report. The reports may reflect different assumptions, views, and analytical methods of the analysts who prepared them. Mirae Asset Daewoo may make investment decisions that are inconsistent with the opinions and views expressed in this research report. Mirae Asset Daewoo, its affiliates, and their directors, officers, employees, and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Mirae Asset Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making, or other financial services as are permitted under applicable laws and regulations. No part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Mirae Asset Daewoo. For further information regarding company-specific information as it pertains to the representations and disclosures in this Appendix 1, please contact [email protected] or +1 (212) 407-1000.

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Mirae Asset Daewoo Research 52 January 25, 2021 Cosmetics

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