Korea Research Initiating coverage Daewoo E&C (047040 KS) Korea / Construction Little giant 13 June 2014 BUY We initiate coverage of constructor Daewoo E&C with a BUY rating and target Target price KRW9,500 price of KRW95,000 (17.9% upside from current levels). Our target price is Last price (12 June 2014) KRW8,060 based on a 2015E P/E of 12.3x, which suggests 23% premium to our target Upside/downside (%) 17.9 P/E for the construction sector. We are positive on the company, given: 1) the KOSPI 2,011.65 strong top-line growth in its domestic housing business (despite the slow Mkt. cap (KRWbn/US$bn) 3,350/3.3 growth of the market as a whole); 2) qualitative and quantitative improvement 52-week range (KRW) 5,930 - 9,040 in its overseas orders; and 3) the recent increase in its single prime contracts Avg. trading value daily (KRWbn) 5.71 Foreign ownership (%) 7.1 from the Middle East, which underscores its strengthened technological capability and improved project performance. Source: Bloomberg Forecast earnings & valuation Korean housing market leader Fiscal year ending Dec-13 Dec-14 E Dec-15 E Dec-16 E Despite sluggish growth in Korea’s overall domestic housing market, Daewoo Revenue (KRWbn) 8,782 9,599 10,534 11,423 E&C has been enjoying strong top-line growth, backed by its ability to respond EBIT (KRWbn) (244.7) 454.7 524.2 588.3 proactively to changes in Korea’s domestic housing market conditions. We Net profit (KRWbn) (718.0) 258.2 319.8 372.5 Net profit(underlying) (717.8) 257.9 319.8 372.5 expect the housing division’s 2014 full-year revenue to grow by 19.9% YoY to EPS (KRW) (1,727) 621 769 896 KRW2.4tn and its gross profit to jump by 68.4% YoY to KRW295bn. While the EPS growth (%) TN TP 24.0 16.5 division’s gross margin declined to 5.7% in 2013, due to adjusted cost ratio in P/E (x) (4.3) 13.0 10.5 9.0 EV/EBITDA (x) N/A 10.7 9.3 8.3 4Q13, it jumped to 13.8% in 1Q14. We expect its 2014 full-year gross margin Dividend yield (%) 24.4 0.0 0.0 0.0 to reach 12.3%. The housing division should post a revenue CAGR of 10.7% P/B (x) 1.2 1.2 1.0 0.9 from end-2013 to 2016, thanks to continued growth in pre-sale volume since ROE (%) (27.6) 9.0 10.0 10.4 2011, which should drive growth of the company’s domestic business going Net debt/equity (%) 96.3 80.9 71.0 61.5 forward. Performance Qualitative and quantitative improvement in overseas business (KRW) Price (LHS) Rel. to KOSPI (RHS) (%) We expect Daewoo E&C’s overseas division to post 76% YoY growth in order 9,600 115 9,100 110 intake, to KRW7.4tn, and 21% YoY growth in revenue, to KRW3.5tn, in 2014. 8,600 105 While Africa had previously served as the main growth driver of the company’s 8,100 100 95 7,600 overseas business, the Middle East has emerged as the key growth driver 90 7,100 85 since 2008. We note the recent increase in the portion of single prime 6,600 80 contracts in the company’s total order intake, in line with its growing exposure 6,100 75 5,600 70 to the Middle East. While weak technological prowess had been cited as the Jun13 Sep13 Dec13 Mar14 main obstacle to Daewoo E&C’s entry into the Middle Eastern market, the recent increase in its single prime contracts from the Middle East underscores Performance 1M 3M 12M its strengthened technological capability and improved project performance. Absolute (%) (4.4) 5.4 6.2 Absolute (US$, %) (3.8) 10.4 18.4 Relative to KOSPI (%) (6.8) 1.3 0.9 Coverage initiated with BUY and target price of KRW9,500 Our target price is based on a 2015E P/E of 12.3x, which suggests 23% Source: Bloomberg premium to our target P/E for the construction sector. The 23% premium was derived by applying a 30% discount to the average 32.8% premium (versus the sector) that its peer Hyundai E&C had received in 2005-2011, prior to its 2011 acquisition by Hyundai Motor Group. The 30% discount is due to skepticism over the likelihood of a strong bidder appearing, as in the case of Seongjin Byun, Analyst Hyundai E&C. 82 2 3774 1457 [email protected] Eunsol Shim Risk factors 82 2 3774 3824 [email protected] Potential risk factors include: 1) a decline in home prices in Korea; 2) potential margin erosion in its overseas business, due to accelerated forays into overseas projects markets by Chinese E&C players amid China’s economic slowdown; and 3) potential overhang from second-largest shareholder SEBT Investment’s 12.28% stake in the company. See the last page of this report for important disclosures Seongjin Byun, Analyst, 82 2 3774 1457, [email protected] DWEC Eunsol Shim, 82 2 3774 3824, [email protected] 047040 KS Recommendation and valuation We initiate coverage of Daewoo E&C with a BUY rating and target price of KRW95,000 (17.9% upside from current levels). Our target price is based on a 2015E P/E of 12.3x, which suggests 23% premium to our target P/E for the construction sector. The 23% premium was derived by applying a 30% discount to the average 32.8% premium (versus the sector) that its peer Hyundai E&C had received in 2005-2011, prior to its 2011 acquisition by Hyundai Motor Group. The 30% discount is due to skepticism over the likelihood of a strong bidder appearing, as in the case of Hyundai E&C. Figure 1 Target price calculation (%, x, KRW) Remark EPS (2015E) 769 Target P/E 12.3 23% premium on target construction sector P/E of 10x Calculated price 9,463 Target price 9,500 Current price 8,060 Upside 17.9 Source: Mirae Asset Research Figure 2 Target premium calculation (x) 2005 2006 2007 2008 2009 2010 2011 Average Hyundai E&C 9.2 13.6 27.5 21.2 15.0 13.4 16.8 Daelim Industrial 6.1 9.5 9.9 33.2 6.7 7.8 8.7 GS E&C 7.0 8.4 15.8 14.5 10.9 11.3 13.4 Samsung Engineering 10.2 14.1 22.2 16.0 12.8 14.6 18.8 Hyundai Development 6.3 11.8 14.7 17.1 60.9 22.0 9.0 Sector average 7.4 10.9 15.7 20.2 22.8 13.9 12.5 Premium 24.8 23.9 75.9 4.9 (34.2) (3.7) 34.6 32.8 Discount rate (%) 30 Target premium 23.0 Source: Bloomberg, Mirae Asset Research Figure 3 Daewoo E&C P/E band chart Figure 4 Daewoo E&C P/B band chart (KRW) (KRW) 30.0x 20,000 20,000 25.0x 15,000 15,000 2.0x 20.0x 1.8x 1.5x 10,000 15.0x 10,000 1.3x 10.0x 1.0x 5,000 5,000 0 0 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 Source: Quantiwise, Mirae Asset Research Source: Quantiwise, Mirae Asset Research 2 Mirae Asset Securities 2 Seongjin Byun, Analyst, 82 2 3774 1457, [email protected] DWEC Eunsol Shim, 82 2 3774 3824, [email protected] 047040 KS Figure 5 Peer valuation Daewoo Samsung Samsung Hyundai Daelim GS Hyundai Company E&C ENG C&T E&C Industrial E&C Develop. Code 047040 028050 000830 000720 000210 006360 012630 Rating BUY HOLD BUY BUY HOLD HOLD HOLD Target price (KRW) 9,500 66,000 74,000 68,000 89,000 36,000 21,000 Share price (KRW) (6/11) 8,220 78,200 74,100 54,300 82,900 31,900 30,350 Upside (%) 15.6 (15.6) (0.1) 25.2 7.4 12.9 (30.8) Market cap (KRWbn) 3,416 3,128 11,576 6,047 2,885 2,265 2,288 Market cap (US$ m) 3,363 3,079 11,396 5,953 2,840 2,230 2,252 Foreign ownership (%) 7.1 27.9 24.6 21.3 28.6 21.5 49.9 Sales (KRW bn) 2012 8,223 11,440 25,326 13,325 10,253 9,569 3,334 2013E 8,782 9,824 28,433 13,938 9,847 9,566 4,217 2014E 9,599 9,630 31,216 15,824 10,144 9,779 4,245 2015E 10,534 9,655 34,255 17,343 10,784 10,447 4,479 Operating profit (KRW bn) 2012 346 732 490 760 486 176 104 2013E (245) (1,022) 433 793 40 (935) (148) 2014E 455 238 568 940 372 252 213 2015E 524 431 665 1,117 446 348 334 Net income (KRW bn) 2012 177 524 465 567 401 95 6 2013E (718) (677) 266 570 (12) (827) (201) 2014E 258 145 516 750 317 144 97 2015E 320 293 557 916 435 210 179 ROE (%) 2012 5.3 30.1 3.9 11.2 8.2 2.4 (0.0) 2013E (27.6) (74.0) 2.2 10.3 (0.5) (28.9) (9.8) 2014E 9.0 13.7 4.3 12.3 5.9 4.7 4.4 2015E 10.0 22.0 4.4 13.1 7.4 6.4 7.7 EPS (KRW) 2012 426 13,095 2,884 4,579 11,239 1,693 (1) 2013E (1,727) (16,915) 1,552 4,523 (714) (16,239) (2,768) 2014E 621 3,617 3,120 6,168 8,398 2,787 1,263 2015E 769 7,317 3,370 7,533 11,521 4,055 2,323 P/E (x) 2012 23.4 12.6 21.7 15.3 7.7 33.9 (16,727.0) 2013E 0.0 (4.1) 39.0 13.4 0.0 0.0 0.0 2014E 15.3 21.6 23.7 8.8 9.9 11.4 24.0 2015E 12.3 10.7 22.0 7.2 7.2 7.9 13.1 P/B (x) 2012 1.2 3.8 0.9 1.7 0.7 0.8 0.7 2013E 1.2 3.0 0.9 1.4 0.8 0.5 0.8 2014E 1.4 3.0 1.0 1.1 0.6 0.5 1.1 2015E 1.2 2.3 1.0 0.9 0.6 0.5 1.0 EV/EBITDA (x) 2012 16.3 13.7 20.4 8.6 4.9 14.1 26.2 2013E 0.0 (4.1) 20.4 7.6 28.7 0.0 0.0 2014E 10.9 13.8 19.1 5.5 7.4 11.6 16.1 2015E 9.5 8.0 16.9 4.5 6.1 9.2 11.0 Source: Mirae Asset Research 3 Mirae Asset Securities 3 Seongjin Byun, Analyst, 82 2 3774 1457, [email protected] DWEC Eunsol Shim, 82 2 3774 3824, [email protected] 047040 KS Outlook for the Korean housing market Korea’s housing market recovery, which began in 2H13, has been losing steam gradually since 1Q14.