December 13, 2012 Industry Report Logistics (Overweight) Daewoo Securities Co., Ltd. Winner takes all Jay JH Ryu +822-768-4175 Oversupply to end; Top-tier firms to gain market share [email protected] Almost two decades of oversupply has taken its toll on the logistics industry, cutting freight rates in half. In the next five to ten years, however, we expect the oversupply situation to ease as the market becomes increasingly consolidated. Among the various segments of the logistics industry, warehousing and parcel delivery are anticipated to post the strongest recoveries. Warehousing margins are already improving on the back of recent supply shortages and geographic barriers to entry. Parcel delivery rates have plunged since the early 2000s, but we expect the segment to experience the logistics industryÊs fastest market consolidation on the back of M&A efforts (which have been underway for the past five years), shutdowns of underperformers, and the strengthening cost competitiveness of top-tiers. In 2013, CJ Korea Express (Korex) will merge with CJ GLS, and the merged entityÊs Seoul metropolitan area parcel terminal will be completed in 2014, accelerating consolidation. Meanwhile, trucking remains in a state of oversupply due to an increase in the number of trucks since the 1998 Asian financial crisis. Over the long term, however, the trucking business is also likely to see a steady recovery on the expansion of the logistics market and limited supply. The third-party logistics (3PL) segment, which accounts for about 60% of the logistics industry, is anticipated to continue to grow, aided by: 1) policy support and 2) the consolidation of the logistics market. The merger between Korex (an asset-based business utilizing its own transportation and shipping equipment) and CJ GLS (a non- asset-based business) should give rise to a company well-equipped to adapt to the changing market environment. Hyundai Glovis is expected to shift its business focus from second-party logistics (2PL) to 3PL. The growing presence of large logistics firms will likely expand the overall size of the market, and top-tier firms are anticipated to see their top-line growth accelerate amid industry restructuring. In our view, Korex will benefit the most from the aforementioned market changes; thus, we maintain our Buy call with a target price of W150,000. In addition, we initiate our coverage of Hyundai Glovis with a Buy rating and a target price of W300,000. Logistics industry outlook by business type 2nd-tier firms Falling rates Oversupply forced out of the market Stevedoring Stevedoring LandLand transporttransport IncreasesIncreases inin ratesrates && profitabilityprofitability Top-tier companies: Gaining M/S Warehousing ParcelParcel deliverydelivery Source: KDB Daewoo Securities Research Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. I. Investment summary ...................................................................................................................3 1. Riding out a period of oversupply .............................................................................................3 2. Logistics companies with dominant market positions to prevail eventually..............................4 II. The history and structure of the logistics industry.................................................................5 1. A history of the logistics industry...............................................................................................5 2. Oversupply has led to stagnant freight rates ............................................................................6 3. Truck subcontracting and brokers.............................................................................................8 III. Winner-take-all market to emerge ..........................................................................................10 1. Economic slowdown to weigh on logistics industry ................................................................10 2. Size matters.............................................................................................................................12 3. Large logistics firms to prevail.................................................................................................13 IV. Will 3PL rise? ...........................................................................................................................14 1. What is 3PL? ...........................................................................................................................14 2. Conditions for 3PL development and support measures........................................................15 V. Overseas expansion is a must, not an option.......................................................................17 1. Overseas expansion to drive strong growth ...........................................................................17 2. Current status of domestic companies’ overseas expansion .................................................19 VI. Restructuring underway in parcel delivery market..............................................................20 1. Parcel delivery market restructuring in Japan.........................................................................20 2. Take a long-term perspective on the opening of the postal service market...........................21 3. Parcel delivery market: 2012~2014 ........................................................................................24 VII. Look out for the larger players..............................................................................................27 1. Korex and Glovis: Strengths and weaknesses .......................................................................27 2. Bound to cross paths...............................................................................................................28 VIII. Taking stock of the five forces and risks............................................................................29 1. Five forces analysis.................................................................................................................29 2. Policy risk: Restrictions on parent-subsidiary deals ...............................................................30 3. Selective overseas market entry.............................................................................................31 Hyundai Glovis (086280 KS)........................................................................................................ 32 CJ Korea Express (000120 KS)................................................................................................... 35 2 December 13, 2012 Logistics I. Investment summary 1. Riding out a period of oversupply The logistics sector has The logistics sector has been overlooked by investors due to its supply glut and low been overlooked by profitability. Indeed, a large number of independent contractors have entered the market investors since the Asian financial crisis, and most of them remain small in size and suffer from low margins. However, an increasing number of small and less profitable companies are being forced out of the market. This trend is most prominent in the parcel delivery segment. As restructuring, Profit deterioration is which began in earnest in 2007, has been accelerating recently, competition is expected to driving small and less ease going forward, leading to an improvement in profitability. In our view, competition is profitable companies out unlikely to intensify further as large conglomerates (e.g., Samsung Group, Shinsegae) have of the market already withdrawn from the market and entry barriers (e.g., costs) are high. While rates are unlikely to rise sharply in light of the B2C segmentÊs high price sensitivity (owing to an increase in small- to mid-sized internet-based operators), we believe that they will stabilize. And we believe that top-tier players will lead an ASP uptrend starting in 2014. Some segmentsÊ Certain segments are already displaying improvement in profits. In particular, some profitability is improving warehousing companies based in Seoul and the neighboring areas are seeing sharp improvement in margins on the back of their favorable locations. The supply of well-located warehouses and terminals is not meeting demand currently due to: 1) a lack of investment in the past three~four years, 2) high land prices, and 3) the governmentÊs land development regulations (greenbelt). Thanks to the supply shortage, Korea Integrated Freight Terminal, KorexÊs warehousing/terminal subsidiary, is reporting OP margins near 50%. Trucking and Meanwhile, competition remains intense in the trucking and stevedoring segments with stevedoring segments to restructuring proceeding slowly and rates stagnating or even falling by over 50% in the past improve as well decade. Surging oil prices have depressed operatorsÊ profitability rapidly. The Korea Trucking AssociationÊs recurrent strikes are primarily attributable to this margin deterioration. However, we expect these segments to experience full-scale restructuring over the next three~five years, which should lead top-tier companies to cement their dominance. Figure 1. Logistics industry trends by business type 01 02 03 04 05 06 07 08 09 10 11 12 Warehousing/ Rising land price/slowdown in capital Recovery of Continuous oversupply, stagnating market growth terminal expenditure profitability nd Parcel delivery Growing competition Fall in profitability