Duty-free Time to shop! Duty-free market expands rapidly - Having expanded at a CAGR of 20% in the past decade, South Korea’s travel-retail industry is now a $12.8bn market (as of 2017). - Last year, 74% of revenue came from foreign shoppers, especially package tourists from China, whose numbers started to balloon in 2012. - Foreign tourists also tend to spend more than local shoppers. As of 1H18, foreign shoppers spent six times more than local customers (based on a per-customer basis), mainly driven by Chinese free-spending middlemen so-called daigou, who have emerged as a top customer for Korea’s duty-free operators. More players join the growing market - Local retail giant Hyundai Department Store is set to open a duty-free store this November in Gangnam, the southern part of Seoul where another travel retailer Shinsegae rolled out a new outlet in July. (There are two Lotte duty-free stores also Cindy Yu operating in the region.) [email protected] - The cluster of duty-free shops will help attract daigou, helping the new locations break even more easily. But given the limited range of products and promotion expenses spent at the time of the launch, it will take a while before they start generating stable Rating profits. OVERWEIGHT Impacts of China-US trade tension - Shares of Korea’s duty-free operators are under heavy pressure as China faces an escalating trade fight with the US that is depressing its currency and hurting consumer upgrade confidence. - With the China risk largely priced in, the share prices might rebound strongly once the tension between the world’s two largest economies unwinds. In addition, earnings will Company Rating TP (W) likely prove immune to the government’s proposed regulation on Chinese grey-market Hotel Shilla (008770 KS) BUY 140,000 resellers, an issue the sector has faced every year. Shinsegae (004170 KS) BUY 480,000 - Therefore, investors would be well-advised to increase exposure to the sector Hyundai Dept. Store (069960 KS) BUY 125,000 incrementally, while monitoring how China’s economic situation unfolds. F&F (007700 KS) BUY 115,000 Shinsegae Int’l (031430 KS) BUY 235,000 Company TP (W) CP (W) Investment highlights - Enjoys scale advantage in both downtown and airport duty-free businesses Hotel Shilla 140,000 107,000 - Free of start-up cost burden being a well-established player - Share price to likely rebound most strongly among peers once the industry regains health - Uncertain outlook for new stores - Offers deep value Shinsegae 480,000 305,500 - Share price to likely rise gradually after the third-quarter earnings season - Successfully shifted its business portfolio from low-margin clothes Shinsegae to lucrative cosmetics 235,000 205,500 International - Stronger brand-extension potential - Undervalued relative to cosmetics peers This report has been prepared by Daishin Securities Co., Ltd. SEE APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION. Industry Analysis 2018.08.29 www.daishin.com Contents Duty-free business expands rapidly 3 More players join the growing travel-retail market 5 Outlook: Shinsegae’s new air-port duty-free outlets 7 Impacts of China-US trade war 10 Company Analysis 12 Hotel Shilla (008770 KS) 15 Shinsegae (004170 KS) 23 Hyundai Department Store (069960 KS) 28 F&F (007700 KS) 32 Shinsegae International (031430 KS) 38 DAISHIN SECURITIES Duty-free business expands rapidly A decade of 20% After a decade of solid growth (20% a year on average), travel retailing in South Korea CAGR is now a $12.8bn market (as of 2017). The industry used to generate an equal amount of revenue from domestic and foreign shoppers, but that changed in 2012 when a large number of Chinese group tourists started flowing into Korea. The share of foreign shoppers in the country’s duty-free sales surged to 74% in 2017 as Chinese middlemen so-called daigou started to snap up Korea’s duty-free goods for resale in their home country a couple of years ago. Thanks to daigou, Korea’s downtown duty-free business is also thriving. Last year, the downtown operation constituted 78% of total domestic duty-free sales, up from 50% in 2012. Foreign travelers shell Amid diplomatic friction between Seoul and Beijing last year, the number of foreign out more on duty-free arrivals to Korea shrank (down 23% yoy), which led to a decline in traffic to duty-free goods than local customers stores (down 27% yoy for foreign customers). Yet, foreign tourists’ spending on duty- free goods increased thanks to free-spending daigou. On a per-customer basis, foreign travelers spent six times more on duty-free goods than local customers in 1H18. Fig 1. Korea’s duty-free industry: Global market Fig 2. Korea’s duty-free industry: Market size share (USDbn) (%) (W조원tn) ) Global글로벌duty면세점-free market시장 규모(좌) 시내Downtown면세점 70 21 16 Korea’s한국 면세점market share점유율(우) Incheon인천공항Airport 기타Other 60 18 14 12 2010~2017년 CAGR 50 15 전체 18.1%, 인천공항 6.3%, 10 시내면세점 24.1% 40 12 8 30 9 6 20 6 4 10 3 2 0 0 0 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 2017 Source: Korea Duty Free Shops Association, The Generation research, Daishin Source: Korea Duty Free Shops Association, Daishin Securities Research Center Securities Research Center 3 Duty-free Fig 3. Duty-free purchase: Domestic customers Fig 4. Duty-free purchase: Foreign travelers (달러($) ) (%) ((달러$) ) (%) 150 P내국인urchase인당value구매액(좌) 20 1,000 P외국인urchase인당value구매액(좌) 120 YoYyoy((RHS)우) YoYyoy((RHS)우) 120 10 800 90 90 0 600 60 60 -10 400 30 30 -20 200 0 0 -30 0 -30 15.1 15.7 16.1 16.7 17.1 17.7 18.1 18.7 15.1 15.7 16.1 16.7 17.1 17.7 18.1 18.7 Source: Korea Duty Free Shops Association, Daishin Securities Research Center Source: Korea Duty Free Shops Association, Daishin Securities Research Center Fig 5. Foot traffic: Domestic customers Fig 6. Foot traffic: Foreign travelers (mn(백만person명s)) (%) (mn(백만person명s)) (%) Foot내국인traffic인원수(좌) Foot외국인traffic인원수(좌) 3.5 Yyoy(oY (RHS)우) 50 2.5 Yyoy(oY (RH우)S) 200 3.0 40 150 2.0 2.5 30 100 1.5 2.0 20 50 1.5 10 1.0 0 1.0 0 0.5 0.5 -10 -50 0.0 -20 0.0 -100 15.1 15.7 16.1 16.7 17.1 17.7 18.1 18.7 15.1 15.7 16.1 16.7 17.1 17.7 18.1 18.7 Source: Korea Duty Free Shops Association, Daishin Securities Research Center Source: Korea Duty Free Shops Association, Daishin Securities Research Center Fig 7. Duty-free sales mix: Koreans vs. Foreigners Fig 8. Number of Chinese tourists visiting Korea (%) 내국인Koreans Foreigner외국인 s (1K(per천s명on)s) Chine방한s중국인e visitor(s좌) (%) 100 1,200 %비중(RHS)(우) 60 80 50 900 60 40 600 40 30 300 20 20 0 0 10 09 10 11 12 13 14 15 16 17 18 11 12 13 14 15 16 17 18 19 Note: From Jan.-July, 2018 Source: Korea Tourism Organization, Daishin Securities Research Center Source: Korea Duty Free Shops Association, Daishin Securities Research Center 4 DAISHIN SECURITIES More players join the growing travel-retail market More companies Lotte and Hotel Shilla were the two dominant forces leading the Korea’s duty-free keen for a slice of the industry. In May 2016, retail titan Shinsegae entered the travel retail market by opening growing duty-free pie a duty-free shop in Myeongdong, a shopping mecca in northern Seoul. In July this year, the company launched another duty-free outlet in Gangnam, the southern part of Seoul. This November, Hyundai Department Store will open its tax-free store in the same neighborhood, which by that time will be a home to four duty-free stores (including two Lotte duty-free stores already operating in the region). Time needed for new Clustered in the same neighborhood, the new stores will be able to attract more stores to generate tourists, most importantly daigou, helping them break even earlier. But with the limited stable profits number of brands they carry and early investments they made to draw traffic, it will take a while before they can get on stable footing. Fig 9. Duty-free stores in downtown Seoul (143) (322) (444) (1,351) (3,162) (2,124) (833) (331) (572) (216) Note: Numbers in blue indicate 2017 duty-free sales (Wbn). Source: Korea Duty Free Shops Association, the companies, Daishin Securities Research Center 5 Duty-free Region # Operator Store Launch Retail space Seoul 1 Hotel Lotte Lotte Duty-Free (flagship) 1980 13,236 ㎡ 2 Hotel Lotte Lotte Duty-Free 2000 5,828 ㎡ 3 Hotel Shilla Shilla Duty-Free 1986 7,270 ㎡ 4 Dongwha Duty-Free Dongwha Duty-Free 1973 6,460 ㎡ 5 HDCShilla Duty-Free Shilla IPark Duty-Free 2015 27,400 ㎡ 6 Hanwha Galleria TimeWorld Galleria Duty-Free 2015 10,072 7 SM Duty-Free SM Duty-Free 2016 9,977 ㎡ 8 ShinsegaeDF Shinsegae Duty-Free 2016 13,884 ㎡ 9 Doosan Doota Duty-Free 2016 05 16,825 ㎡ 10 Hotel Lotte Lotte Duty-Free(World Tower) 1989/2017 17,334 ㎡ 11 ShinsegaeDF Central City 2018 13,350 ㎡ 12 Hyundai Dept. Duty-Free (Trade Center) Set for end-2018 14,005 ㎡ 13 Top-city Duty-Free (City Plus) Top-city Duty-Free Set for end-2018 - Busan 1 Hotel Lotte Lotte Duty-Free 1995 5,600 ㎡ 2 Shinsegae ChosunHotel Shinsegae Duty-Free 2009 8,600 ㎡ 3 Busan Duty-Free Busan Duty-Free 2018 1,500 ㎡ Jeju 1 Lotte Duty-FreeJeju Lotte Duty-Free 2000 6,612 ㎡ 2 Hotel Shilla Shilla Duty-Free 1989/2017 6,765 ㎡ 3 JTO JTO Duty-Free 2016 2,634 ㎡ Incheon 1 Entas Duty Free IncheonEntas downtown Duty-Free 2015 4,300 ㎡ Ulsan 1 Jinsan Sunmoo Jinsan Duty-Free 2013 1,296 ㎡ Changwon 1 Daedong Dept.