Retailing / Korea & Japan 24 May 2012 Counter cultures An aisle-by-aisle walk through the Korea and Japan retail sectors Korea leads in department store profitability. Japan’s CVS segment has room to grow. Overseas earnings are long-term drivers Our Pan-Asia pick is Hyundai Department Store. We also favour Lotte Shopping and Seven & i Holdings Kazunori Tsuda Sang Hee Park (81) 3 5555 7133 (82) 2 787 9165 [email protected] [email protected] Important disclosures, including any required research certifications, are provided on the last two pages of this report. Trading Places 24 May 2012 Table of contents Counter cultures ..................................................................................................................... 3 Executive summary ............................................................................................................... 4 About Trading Places ........................................................................................................... 7 Tsuda’s and Sang Hee’s pre-job-swap views ......................................................... 10 Korea retail industry ................................................................................................................... 10 Japan’s retail industry ................................................................................................................ 15 Korea retail companies ............................................................................................................... 18 Japan retail companies ............................................................................................................... 20 Pre-job-swap summary .............................................................................................................. 23 On the ground in Japan and Korea ............................................................................ 26 How Sang Hee spent her time in Japan ..................................................................................... 26 How Tsuda spent his time in Korea ........................................................................................... 32 Post-job-swap view .............................................................................................................. 38 Key highlights in Japan and Korea ............................................................................................ 38 Finding value among the similarities and differences ............................................................... 44 Food for thought ......................................................................................................................... 52 Reassessing our views on the companies we cover .................................................................... 55 Revisions to Daiwa forecasts ...................................................................................................... 62 Implications for the Pan-Asia Retail Sector ............................................................................... 65 Company Section Lotte Shopping (023530 KS) ..................................................................................................... 70 E-Mart (139480 KS) ................................................................................................................... 73 Hyundai Department Store (069960 KS) .................................................................................. 76 GS Retail (007070 KS) ............................................................................................................... 79 J. Front Retailing (3086 JP) ...................................................................................................... 82 Seven & i Holdings (3382 JP) .................................................................................................... 85 Aeon (8267 JP) ........................................................................................................................... 88 FamilyMart (8028 JP) ............................................................................................................... 91 - 2 - Retailing / Korea & Japan 24 May 2012 Counter cultures An aisle-by-aisle walk through the Korea and Japan retail sectors Korea leads in department store profitability. Japan’s CVS segment has room to grow. Overseas earnings are long-term drivers Our Pan-Asia pick is Hyundai Department Store. We also favour Lotte Shopping and Seven & i Holdings Korea 15-20 years from now, Korea’s Pan-Asia picks leading retailers should fare well, Our job-swap has strengthened our backed by expansion plans designed conviction in our Buy (1) call on to overcome the hurdles that Hyundai Department Store (HDS). Japan’s department stores now face As we see it, HDS’s expansion into Kazunori Tsuda as society greys and economic malls and its decision to acquire an (81) 3 5555 7133 [email protected] growth slows, 2) Korea’s CVS and apparel company leave it well- drugs-store segments are likely to be placed to overcome the issues now key growth areas in the next five to facing Japan’s department stores. 10 years, and 3) discount stores in Korea face a more challenging We are now more positive on Lotte environment, with regulations being Shopping’s aggressive expansion tightened in a maturing industry. plans (shopping malls, super Sang Hee Park supermarkets, CVS, electronic (82) 2 787 9165 [email protected] Tsuda: 1) unlike Korea, it is difficult category killer) and its overseas to expect Japan’s retail market to moves. In our view, these plans show meaningful expansion. But foreshadow changes in consumer Talking shop top-tier firms have room to gain behaviour and will deliver sales As part of Daiwa’s Trading Places market share through store growth once the domestic market project, we swapped jobs and hit the openings and M&A, 2) given macro reaches maturity. streets in the other’s market. We uncertainties, retailers need to visited department stores, general hammer out clear growth strategies Seven & i is upgraded to Outperform merchandise and discount stores, and and step up execution, 3) Japan’s (2), from Hold (3), with our target convenience stores (CVS), met with department stores must solve price rising to ¥2,850, from ¥2,450. company representatives, and spoke structural problems and become We believe the stock’s conglomerate to clients. And then we compared our more responsive to market changes, discount is narrowing, and we think findings and reassessed our own assumptions and stock calls. 4) the general merchandiser and the market will start pricing in the supermarkets segments are ripe for firm’s earnings growth potential, reorganisation, and 5) the CVS mainly for its CVS operations. Similarities and differences 1) Korea and Japan retail firms have format has room to expand its share Key stock calls much to learn from each other, 2) of Japan’s retail sector. New Prev. investors have not yet fully Hyundai Department Store (069960 KS) Overseas prospects recognised the growth potential of Rating Buy Buy the leading companies, and 3) We expect growth in both Korea and Target price W210,000 W210,000 among subsectors, discrepancies in Japan retailers’ overseas profit Up/downside 46.3% profitability are biggest for the contributions over the medium to Lotte Shopping (023530 KS) department stores — the Korea long term. We see strong potential Rating Buy Buy players are far more profitable. in: 1) suburban areas of China’s Target price W440,000 W480,000 first-tier cities, 2) China’s second- to Up/downside 40.8% Key takeaways fourth-tier cities, and 3) ASEAN. Seven & i Holdings (3382 JP) Sang Hee: 1) while Japan’s retail Competition is intense. But, if they Rating Outperform Hold industry, demographics and Target price ¥2,850 ¥2,450 succeed, we think the Japan players Up/downside 22.0% consumer behaviour are a leading could become leading Asian retailers. Source: Daiwa forecasts indicator of what we will see in Note: Please refer to page 6 for details Important disclosures, including any required research certifications, are provided on the last two pages of this report. Trading Places 24 May 2012 Executive summary Counter cultures In retail, Japan is widely seen as a leading indicator for Korea. But Korea arguably stands as a benchmark for the Japan department stores and general merchandise stores. Overseas earnings are one growth area, though competition is tough. What led us to undertake a job swap? The Japan and Korea retail industries are at different stages of growth, and have differing levels of competition and market sizes. Furthermore, the earnings of retail companies in both countries are driven domestically — they do not compete against one another. On the macroeconomic side, private-consumption growth in Japan has been stagnant for the past few years, whereas in Korea it has seen healthy growth. But comparing and contrasting the two sectors is meaningful for three reasons: 1) many investors see Japan as a leading indicator of what will happen in Korea in the future, given its similar demographic trends and business models, 2) Korea arguably serves as a benchmark for the Japan department stores and the general merchandise stores (GMS), given the high profitability and efficient management decision-making in Korea, and 3) overseas operations (including those in China and ASEAN) are one of the earnings-growth areas, although competition remains fierce. This report comprises