Halla Holdings (060980 KS ) Undervalued stock with limited risks Auto Limited exposure to China risks In 4Q16, major Korean auto parts suppliers suffered sharp margin erosion in Initiation Report China, and this is an issue that warrants continued attention. Given that China’s March 7, 2017 auto and auto parts industries are facing structural margin downtrends, we think that investors should focus on identifying market players that are relatively free from risks to downside. Based on 4Q16 results alone, it appears as though Mando fits the bill, as the company was able to overcome headwinds by pursuing revenue (Initiate) Buy growth via customer and product diversification. However, in our view, Halla Holdings is more attractive than its subsidiary. Indeed, despite its relatively solid Target Price (12M, W) 83,000 performance in 4Q16, Mando is highly exposed to China-related risks , as over 70% of its consolidated operating profit is generated in that country. Meanwhile, only Share Price (03/03/17, W) 61,500 34% of Halla Holdings’ enterprise value (EV) stems from Mando’s net profit and share price. This profile allows Halla Holdings to benefit from Mando’s strong top- Expected Return 35% line growth (in the form of brand royalties), while limiting exposure to margin risk in China. OP (16F, Wbn) 112 Growth potential for MHE, margin improvement for distribution/logistics Consensus OP (16F, Wbn) 107 Mando-Hella Electronics (MHE), which is 50% owned by Halla Holdings, saw its EPS Growth (16F, %) -9.4 revenue grow by a CAGR of 19% from 2013 through 2016. A nd we believe the Market EPS Growth (16F, %) 14.0 company still has plenty of room to run, as: 1) demand for electronic control units P/E (16F, x) 9.6 (ECUs) for braking /steering systems is rapidly expanding, driven by the increasing Market P/E (16F, x) 11.6 adoption of electronic chassis systems in emerging markets; and 2) dema nd for KOSPI 2,078.75 advanced driver assistance system (ADAS) sensors is on the rise, as stricter safety regulations and technological competition among global automakers are Market Cap (Wbn) 664 accelerating ADAS adoption in developed markets. We project that MHE’s revenue Shares Outstanding (mn) 11 will increase at a CAGR of 11.5% from 2016 through 2020, on the back of global Free Float (%) 69.7 technology trends. Foreign Ownership (%) 10.5 Beta (12M) 0.31 Since 2013, the in-house distribution/logistics unit has been pursuing 52-Week Low 51,400 restructuring, which has translated into higher profitability (OP margin : 2.2% in 52-Week High 78,500 2015 3.7% in 2016F). We expect OP margin to rise further to the high-4% level by 2020, driven by production cost savings for auto parts and improved efficiency in (%) 1M 6M 12M the logistics segment. Absolute 2.5 -21.0 3.2 Relative 2.2 -22.5 -2.8 Initiate coverage with Buy call and TP of W83,000 We initiate our coverage on Halla Holdings with a Buy rating and recommend 150 Halla Holdings KOSPI focusing more on Halla Holdings than on Mando. Our target price of W83,000 was 130 derived using net asset value (NAV) analysis, with 40-60% discount rates applied to 110 equity stakes in affiliates and subsidiaries. In our view, Halla Holdings is undervalued, with the company’s current market cap (W664bn) falling below the 90 value of its holdings in Mando (W695bn). While Halla Holdings’ share momentum 70 has been largely driven by Mando’s growth potential since 2016, we believe 3.16 7.16 11.16 3.17 earnings stability will take center stage going forward. Mirae Asset Daewoo Co., Ltd. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) 929 919 892 959 999 1,047 [Autonomous Driving/Auto Parts ] OP (Wbn) 31 50 96 112 121 132 Inwoo Park OP margin (%) 3.3 5.4 10.8 11.7 12.1 12.6 +822 -3774 -3763 NP (Wbn) 178 1,079 75 68 71 82 [email protected] EPS (W) 9,852 72,030 6,959 6,304 6,530 7,559 ROE (%) 11.3 84.0 8.2 7.3 7.1 7.7 P/E (x) 11.8 1.0 9.3 9.6 9.4 8.1 P/B (x) 1.2 0.8 0.8 0.7 0.6 0.6 Dividend yield (%) 1.0 0.7 1.9 2.1 2.1 2.3 Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. March 7, 2017 Halla Holdings I. Investment recommendation and valuation Initiate coverage with Buy call and TP of W83,000 We initiate our coverage on Halla Holdings with a Buy rating and target price of W83,000. We derived our target price using NAV analysis, with key assumptions outlined in Table 1. Of Halla Holdings’ EV, we estimate that: 1) 17% comes from the operating value of the in- house distribution/logistics business; 2) 22% derives from brand royalties paid by affiliates; and 3) the remaining 61% is from the value of its stakes in affiliates (discounted by 40-60%), to which Mando (34% of EV) and MHE (9%) are the two largest contributors. Given that Mando pays more than 90% of Halla Holdings’ brand royalties, the auto parts supplier essentially accounts for around 55% of the company’s EV. The reliance on Mando looms even larger, when considering the fact that it is one of the biggest clients of Halla Holdings’ distribution/logistics business and other major affiliates. Table 1. NAV analysis (Wbn, ‘000 shares, W) Components Value Details Operating value (A) 227 2017F distribution/logistics net profit × target P/E of 10x Intangible assets (B) 287 PV of future after-tax brand royalties (WACC: 8.5%; growth rate: 0%) Investments (C) 816 Mando 451 YTD avg. market cap × 30.25% stake × 60% (40% discount) 2017F net profit × target P/E of 12 x × 50% stake × 60% MHE 126 (40% discount) 2017F net profit × target P/E of 8x × 70% stake × 60% HSC 58 (40% discount) Halla Corp.’s common stock 16 YTD avg. market cap × 16.89% stake × 60% (40% discount) Halla Corp.’s preferred stock 102 Book value × 40% (60% discount) (W50bn in common equity + W80bn in participating bonds ) × 50% J.J. Halla 65 (50% discount ) Discounted EV (D=A+B+C) 1,331 Net debt (E) 436 Non-consolidated basis Discounted NAV (F=D-E); target EV 895 No. of shares outstanding (G) 10,803 Target price (H=F/G, W) 82,821 Source: Mirae Asset Daewoo Research Figure 1. EV breakdown Investment value - Other, 14% Operating value, 17% Investment value -HSC, 4% Investment value - MHE, 9% Brand royalties, 22% Investment value - Mando, 34% Source: Mirae Asset Daewoo Research Mirae Asset Daewoo Research 2 March 7, 2017 Halla Holdings While Halla Holdings’ EV and share price are significantly influenced by Mando’s operating earnings and share price, we think that the company has several unique features that distinguish it from its subsidiary. In 4Q16, many Korean auto parts suppliers suffered sharp margin erosion in China, which is an issue that warrants continued attention. In our view, Halla Holdings is relatively free from such margin risks, compared with Mando. Indeed, because Mando generates more than 70% of its consolidated operating profit from China, it is particularly vulnerable to risks of margin deterioration in the country. However, only 34% of Halla Holdings’ EV is tied to Mando’s net profit and share price; this profile allows the company to benefit from Mando’s strong top-line growth, while limiting exposure to the risk of margin deterioration in China. In addition, we see great growth potential for another subsidiary, MHE. Indeed, MHE’s revenue is projected to increase at a CAGR of 11.5% from 2016 through 2020 on the back of growing demand in emerging markets for ECUs for braking/steering systems, as well as increasing adoption of ADAS in developed countries. Furthermore, the subsidiary’s margins have been improving sharply since 2016, due to the discontinuation of unprofitable logistics businesses. In light of the aforementioned merits, we initiate our coverage on Halla Holdings with a Buy rating. We also recommend greater focus on Halla Holdings than on Mando. Figure 2. Halla Group governance 23.2% Chung Mong-won Halla Holdings 70% 30.25% 50% 16.88% 100% Halla Stackpole Mando Mando Brose Halla Corp. Halla Encom (HSC) ： 50% 100% ： Mando-Hella Electronics Mando China Holdings (MHE) ： 100% ： J.J. Halla 100% WECO 51% Halla MTIS ： ： Source: Company data, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 3 March 7, 2017 Halla Holdings II. Investment points 1. Relatively free from China risk In 4Q16, all major Korean auto parts firms reported sluggish earnings, except for Mando. Hyundai Mobis’ operating profit fell below the market consensus by 23%, and Hanon Systems’ by 9%. Both firms cited downward pricing pressure from China as the main culprit behind their dismal performances. Hyundai Wia posted a particularly disappointing result, likely for the same reason, with operating profit underperforming the consensus by a whopping 68%. Hyundai Wia’s machinery unit recorded a quarterly operating loss of W30bn, and the auto parts unit also displayed a weak performance. While Mando faced the same pressure from China, higher operating leverage (resulting from a 19% YoY surge in revenue) more than offset the negative impact from price cuts.