April 19, 2011 Company Report Hyundai E&C (000720 KS) Construction Focus on long-term growth potential, not on short-term earnings Daniel Song +822-768-2122 [email protected] Maintain Buy call with TP of W130,000 (vs. current share price of W84,000) Ryan Nho We reiterate our Buy call on Hyundai E&C with a target price of W130,000. +822-768-4147 Hyundai-Kia Automotive Group (HKAG) began managing Hyundai E&C on April 1st [email protected] with the aim of nurturing the company into one of its three growth engines (alongside its automobile and steel businesses). HKAG announced its plan to invest W10tr in Hyundai E&C in order to make it a global top-tier builder capable of generating total new orders of W120tr and sales of W55tr by 2020. Given that HKAG gained full control of Hyundai E&C, investors should pay attention to the companyÊs long-term growth potential, rather than its short-term earnings. Buy (Maintain) 1Q11 Preview: Sales of W2.6tr (up 26.2% YoY); OP of W121bn (down 2.3% YoY) Target Price (12M, W) 130,000 We forecast Hyundai E&CÊs 1Q11 sales and operating profit at W2.621tr (up 26.2% Share Price (04/18/11, W) 84,000 YoY) and W121bn (down 2.3% YoY), respectively. This operating profit result would Expected Return (%) 54.8 fall shy of the market estimate by 20.3% due to the recognition of an increase in EPS Growth (11F, %) 30.8 costs related to overseas construction projects. Market EPS Growth (11F, %) 25.2 P/E (11F, x) 13.5 However, it has been widely expected that the companyÊs 1Q earnings may fall shy Market P/E (11F, x) 10.8 of market estimates due to cost increases. Now is the time to focus more on the KOSPI 2,137.72 companyÊs potential for becoming HKAGÊs long-term growth engine, not on Market Cap (Wbn) 9,354 weaker-than-expected short-term earnings. Shares Outstanding (mn) 111 Avg Trading Volume (60D, '000) 1,263 Became part of HKAG in April Avg Trading Value (60D, Wbn) 102 HKAG reorganized Hyundai E&C into a 15-division/1-office body (from a 10- Dividend Yield (11F, %) 0.8 Free Float (%) 65.1 division/11-office body) in order to improve the efficiency of the companyÊs 52-Week Low 46,050 operation divisions. To accelerate Hyundai E&CÊs integration into HKAGÊs corporate 52-Week High 91,800 culture, HKAG named its employees heads of Hyundai E&CÊs key operating Beta (12M, Daily Rate of Return) 1.0 divisions (e.g., management support, financial management, procurement, and Price Return Volatility (12M Daily,%,SD) 2.6 planning), while retaining the heads of Hyundai E&CÊs civil works, plant Foreign Ownership (%) 18.8 construction, power plant construction, nuclear power plant construction, overseas Major Shareholder(s): sales, domestic sales, E&P, and marketing divisions. Hyundai Motor et al. (34.91%) NPS (6.95%) In short, Hyundai E&C (with HKAG) is currently making efforts to stabilize its structure after a massive reorganization process. Since many key divisions Price Performance remained little changed, HKAG should be able to move forward with its mid-to (%) 1M 6M 12M long-term growth strategy for Hyundai E&C as early as June. Absolute 5.4 12.6 43.1 Relative -2.5 -1.4 19.9 § Earnings & Valuation Metrics Share price 160 KOSPI OP EV/ Sales OP NP EPS EBITDA FCF ROE P/E P/B FY Margin EBITDA 140 (Wbn) (Wbn) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) (%) (x) 120 12/09 9,279 419 4.5 457 4,107 490 724 15.4 17.3 2.6 15.7 100 12/10 10,005 584 5.8 530 4,759 624 578 16.1 15.2 2.3 11.9 80 12/11F 12,448 752 6.0 694 6,226 769 648 17.8 13.5 2.2 11.1 60 12/12F 13,974 975 7.0 938 8,417 991 778 20.1 10.0 1.8 8.2 40 12/13F 15,495 1,153 7.4 1,117 10,018 1,167 970 19.9 8.4 1.5 6.6 4/10 8/10 12/10 4/11 Source: Company data, Daewoo Securities Research estimates Please read carefully important disclosures at the end of this report. April 19, 2011 Hyundai E&C Long-term growth to stay robust on greater margins and order growth HKAGÊs strategy is to enable Hyundai E&C to sustain growth by improving construction margins (on the back of enhanced efficiency at the firmÊs operating divisions) and strengthening order performance. The key to the overseas construction business is to complete construction (for plants, civil works, or architecture) earlier than scheduled. Since builders for overseas projects are responsible for engineering, procurement, and construction, they must be good at all three processes in order to improve margins. Although Hyundai E&C has a competitive edge in construction, its competitiveness in engineering and procurement is weak relative to that of global top-tier engineering firms. However, now that HKAG is improving efficiency at key operating divisions, Hyundai E&C should be able to improve its competitiveness in engineering and procurement as well. Furthermore, investors should note that: 1) Hyundai E&CÊs commission rate paid to financial institutions for overseas project guarantees is expected to decrease by 0.1~0.2%p on the back of HKAGÊs guarantee, and 2) the companyÊs credit rating is likely to be raised from AA- to AA. Table 1. Hyundai E&C’s quarterly earnings outlook (Wbn) 2011F 2012F YoY (%) 1QF 2QF 3QF 4QF Annual 1QF 2QF 3QF 4QF Annual Annual Sales 2,621 3,104 3,128 3,595 12,448 2,881 3,566 3,415 4,112 13,974 12.3 Operating profit 121 192 193 246 752 188 249 237 300 975 29.6 Pretax profit 139 224 234 282 878 241 301 291 354 1,187 35.2 Net profit 110 177 185 222 694 191 238 230 280 938 35.2 OP margin (%) 4.6 6.2 6.2 6.8 6.0 6.5 7.0 6.9 7.3 7.0 Net margin (%) 4.2 5.7 5.9 6.2 5.6 6.6 6.7 6.7 6.8 6.7 Note: 2011~2012F Earnings based on IFRS, Source: Company data, Daewoo Securities Research estimates Table 2. Revisions to Hyundai E&C’s annual earnings forecasts (Wbn) Previous Revised % Chg. 10 11F 12F 10 11F 12F 10 11F 12F Sales 10,005 12,744 14,171 10,005 12,448 13,974 0.0 -2.3 -1.4 Operating profit 584 852 987 584 752 975 0.0 -11.7 -1.2 Net profit 530 831 962 530 694 938 0.0 -16.5 -2.5 OP margin (%) 5.8 6.7 7.0 5.8 6.0 7.0 - - - Net margin (%) 5.3 6.5 6.8 5.3 5.6 6.7 - - - EPS (W) 4,759 7,452 8,627 4,759 6,226 8,417 0.0 -16.5 -2.5 Note: 2011~2012F Earnings based on IFRS, Source: Company data, Daewoo Securities Research estimates Figure 1. Hyundai E&CÊs sales and operating profit outlook (Wtr) (Wbn) 16 Sales (L) 1,200 Operating profit (R) 12 900 8 600 4 300 0 0 03 04 05 06 07 08 09 10 11F 12F 13F Source: Company data, Daewoo Securities Research estimates Daewoo Securities Research 2 April 19, 2011 Hyundai E&C Figure 2. Governance structure of Hyundai-Automotive Group Hyundai Hysco 10.0% Hyundai Hysco 72.6% 33.8% Kia Motors (010520(010520 KS)KS) Kia Motors Chung, Mong Koo (000270(000270 KS)KS) HyundaiHyundai현대건설현대건설 E&CE&C & Affiliates Hyundai현대엔지니어링 Engineering (000720(000720(000720)(000720) KS)KS) 5.2% BNGBNG Steel Steel 5.0% 26.1% Hyundai Hysco (004560(004560 KS)KS) 8.7% 20.9% Hyundai Hysco 13.9% (010520 KS) 41.1% (010520 KS) 53.5% 1.7% 12.6% 7.0% 5.2% 26.3% HMCHMC SecuritiesSecurities (001500 KS) 21.3% 5.7% 20.8% (001500 KS) GlovisGlovis KiaKia MotorsMotors HyundaiHyundai12.6% SteelSteel HyundaiHyundai Mobis Mobis HyundaiHyundai Motor Motor (086280(086280 KS)KS) (000270(000270 KS)KS) (004020(004020 KS)KS) (012330(012330 KS)KS) (005380(005380 KS)KS) 37.6% Hyundai Powertek 35.1% 25.0% 56.5% 20.0% Hyundai Capital Hyundai Amco 51.0% 90.0% 20.0% HL Green Power IHL 3.7% 57.6% 25.0% 3.7% Hyundai Rotem Seoul Metro Line Nine HMCHMC Securities Securities 51.0% (001500(001500 KS)KS) 2.7% Green Air 15.8% GlovisGlovis (086280 KS) 80.0% 39.3% (086280 KS) 20.0% Maintrance Hyundai Wia 20.0% Auto EverSystems 5.4% 31.5% HyundaiHyundai SteelSteel 29.9% Hyundai Card 16.9% (004020(004020 KS)KS) HyundaiHyundai Mobis Mobis (012330 KS) Hyundai Commercial 99.8% (012330 KS) 11.5% 5.5% 53.7% 50.0% NGVTEK M Seat 0.7% Hyundai Card 13.0% PARTECS 45.4% 50.0% 48.5% Dymos Inc. 31.0% 56.0% Kefico 25.7% Metal Industrial Ace MN Soft 24.4% 47.3% 50.9% 38.6% 31.8% Dymos Inc. NGVTEK Wistco Hyundai KANES 5.1% 100% 24.8% 37.6% 39.5% Hyundai Powertek Wia Magna Train Hyundai Wia AIA 50.0% 100% Source: Daewoo Securities Research Figure 3. Hyundai E&CÊs new orders by division outlook Figure 4. Hyundai E&CÊs order backlog by division outlook (Wtr) (Wtr) 28 Overseas 80 Civil engineering Architecture Plant Plant Overseas Architecture 21 Civil engineering 60 14 40 7 20 0 0 03 04 05 06 07 08 09 10 11F 12F 13F 03 04 05 06 07 08 09 10 11F 12F 13F Source: Company data, Daewoo Securities Research estimates Source: Company data, Daewoo Securities Research estimates Figure 5.