November 12, 2014 KOREA Company News & Analysis Major Indices Close Chg Chg (%) KEPCO (015760/Buy/TP: W55,000) KOSPI 1,967.27 4.27 0.22 Cash flow to continue to improve KOSPI 200 251.26 0.81 0.32 KOSDAQ 546.46 1.33 0.24 Sector News & Analysis Turnover ('000 shares, Wbn) Construction (Overweight) Volume Value KOSPI 344,719 4,401 Jeonse system in crisis as Korea shifts to monthly rents KOSPI 200 72,683 3,413 KOSDAQ 384,314 2,208 Economy & Strategy Update Market Cap (Wbn) Economic Note Value A shift in F/X policy KOSPI 1,177,450 KOSDAQ 141,150 KOSPI Turnover (Wbn) Buy Sell Net Foreign 1,164 1,191 -27 Institutional 964 987 -22 Retail 2,159 2,191 -32 KOSDAQ Turnover (Wbn) Buy Sell Net Foreign 143 151 -7 Institutional 118 126 -8 Retail 1,946 1,928 19 Program Buy / Sell (Wbn) Buy Sell Net KOSPI 953 927 26 KOSDAQ 29 31 -1 Advances & Declines Advances Declines Unchanged KOSPI 442 380 57 KOSDAQ 550 386 79 KOSPI Top 5 Most Active Stocks by Value (Wbn) Price (W) Chg (W) Value Samsung Electronics 1,230,000 -1,000 223 KODEX LEVERAGE 10,750 80 217 KEPCO 44,600 -2,300 185 Hyundai Motor 176,000 0 164 Hyundai Heavy Industries 118,000 11,500 136 KOSDAQ Top 5 Most Active Stocks by Value (Wbn) Price (W) Chg (W) Value Com2us 143,000 -6,800 278 Daum Communications 142,500 2,500 87 Gamevil 114,400 4,400 58 Binex 10,600 810 58 Bosung Power Tec 4,400 -80 45 Note: As of November 12, 2014 KEPCO (015760 KS) Cash flow to continue to improve Energy 3Q14 review: OP of W2.86tr beats consensus For 3Q, KEPCO announced revenue of W14.91tr and operating profit of W2.86tr, the Results Comment latter beating both our estimate (W2.68tr) and the consensus (W2.75tr). ASP rose 3.9% November 12, 2014 YoY, lower than our expectation (+4.8% YoY), but overall costs eased on weaker sales volume (-0.3% YoY). More specifically, the company’s LNG and coal consumption declined 33.7% and 7.8% YoY, respectively. Other positive contributors in 3Q were 1) (Maintain) Buy lower fuel costs (-19.7% YoY) due to falling raw material prices, 2) solid nuclear reactor utilization (85.7% vs. our forecast of 83%), and 3) weaker electricity purchasing prices Target Price (12M, W) 55,000 on the Korea Power Exchange. Net profit attributable to controlling interests jumped 63.7% YoY to W1.55tr, above our Share Price (11/11/14, W) 46,900 projection (W1.4tr), helped by tamed interest expenses (up only 2.8% YoY to W548.5bn). Expected Return 17% Solid earnings growth vs. increasing uncertainty on dividends OP (14F, Wbn) 6,084 1) Earnings growth to continue: Fuel costs should continue to fall on lower oil and coal Consensus OP (14F, Wbn) 5,859 prices, and ASP should remain on the uptrend at least until the end of the year on tariff hikes in 4Q14. Sales volume should remain weak for some time, keeping system marginal EPS Growth (14F, %) 3,892.9 prices (SMP) low. Furthermore, nuclear reactor utilization is likely to rise to the upper Market EPS Growth (14F, %) 2.6 80% level, thanks to the resumed operations of the Hanwool 2 and Hanbit 3 reactors (in P/E (14F, x) 12.6 November 2014 and January 2015, respectively). Market P/E (14F, x) 12.6 KOSPI 1,963.00 2) Increasing uncertainty on dividends: On a less positive note, the dividend outlook has become uncertain due to the divergence between KEPCO’s consolidated and non- Market Cap (Wbn) 30,108 consolidated earnings. Cumulative non-consolidated net profit for the first three Shares Outstanding (mn) 642 quarters stands at W647.3bn, only 29% of the consolidated figure. The situation is Free Float (%) 48.9 unlikely to reverse in 4Q, and we therefore conservatively estimate 2014F and 20 15F Foreign Ownership (%) 28.6 DPS at W300 and W1,000, respectively. That said, we do see potential of a special Beta (12M) 0.15 52-Week Low 29,150 dividend next year. There is also a slight chance the company will change its dividend 52-Week High 49,450 policy, suggesting potential upside to our forecasts. (%)(%)(%) 1M1M1M 6M6M6M 12M12M12M Maintain Buy and TP of W55,000 Absolute -3.7 13.4 60.9 We remain Buy on KEPCO with a target price of W55,000. Key investment points are 1) Relative -4.8 13.0 62.1 falling raw material prices, 2) continued cash flow improvement as a result of lower SMP and limited cost pressures, and 3) a healthier balance sheet following the sale of the 180 KEPCO KOSPI 160 headquarters site. The stock has gained 35.7% YTD, but still trades at a 2015F P/B of just 0.5x. While d ividend momentum could weaken in the near term, we estimate 140 dividend yield to be around 2.1% in 2015, even on a conservative basis, and thus remain 120 positive on the stock over the long term. 100 80 11.13 3.14 7.14 11.14 Daewoo Securities CCo.,o., Ltd. FY (Dec.) 12/11 12/12 12/13 12/14F 12/15F 12/16F Revenue (Wbn) 43,456 49,422 54,038 56,541 58,383 59,268 [Transportation/Energy] OP (Wbn) -1,020 -818 1,519 6,084 7,318 9,255 Jay JH Ryu OP margin (%) -2.3 -1.7 2.8 10.8 12.5 15.6 +822-768-4175 NP (Wbn) -3,370 -3,167 60 2,396 8,607 4,807 [email protected] EPS (W) -5,251 -4,933 93 3,733 13,407 7,488 Choong-hyun Kim ROE (%) -6.1 -6.1 0.1 4.7 15.2 7.7 +822-768-4126 P/E (x) - - 371.7 12.6 3.5 6.3 [email protected] P/B (x) 0.3 0.4 0.4 0.6 0.5 0.5 Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. Construction Jeonse system in crisis as Korea shifts to monthly rents Korea’s housing diffusion ratio: 102.7% as of 2012 Under the updated formula, housing diffusion ratio is calculated by dividing the number of housing units (regardless of ownership) by the number of households (including single-person households). In 2012, Korea’s housing diffusion ratio stood at 102.7%, Overweight (Maintain) indicating that 2.7% of housing units were vacant (assuming no households were residing in two homes simultaneously). Against this backdrop, the unyielding uptrend in Industry Report jeonse prices (massive lump sum deposits paid in lieu of monthly rent) appears November 11, 2014 counterintuitive. In our view, this situation points to a major shift in the Korean housing market. Daewoo Securities CCCo.,Co., Ltd. Since 1986, the jeonse price index has seen only three sustained falls Since 1986, there have been only three periods in which the jeonse price has fallen for at [Construction/Construction Materials] least four straight months: 1) during the Asian financial crisis in the late 1990s; 2) after Hyung-ryul Park the credit card crisis in Korea in the early 2000s; 3) after the global financial crisis in +822-768-4165 2008. From 2000 to just before the global financial crisis, the national average jeonse [email protected] price soared by 62%. After moving sideways for four months following the crisis , the average national price has since surged by 59%. Ye-gee Kim +822-768-4155 Jeonse system in crisis [email protected] Amid skyrocketing jeonse prices, the Korean housing market has been tr ansitioning to the more globally common housing system of monthly rent agreements . Drivers of this change include: 1) the falling number of new housing units available for move-in, 2) landlords’ increased bargaining power amid both low interest rates and a shortage of jeonse housing, 3) households’ rising preference for apartments in large complexes , and 4) higher housing demand from occupants displaced by reconstruction/redevelopment projects. Outlook: Korean market is transitioning to monthly rent agreements We think the Korean housing market is currently shifting to a n environment dominated by monthly rent agreements, as jeonse contracts are not advantageous for landlords in a prolonged low interest rate environment. In the Seoul capital area (SCA), jeonse prices will likely continue to rise on a shortage of available housing units , whereas prices are likely to stagnate in other regions due to increased availability . Meanwhile, housing earnings at large builders are likely to improve, buoyed by: 1) a rise in real demand and 2) an increase in reconstruction/redevelopment projects. Rental income-based housing valuations to become the norm The paradigm shift to a monthly rent-based housing market will allow for rationalized housing price valuations, as housing prices will likely converge to: (total annual rental income) x (1/expected rate of return). Although the expected rate of return may vary by investor and region, we believe that housing valuations based on rental income will li kely become the norm. JJJeonseJeonse price index (3/13=100) Asian financial crisis: Credit card crisis: Global financial crisis: 120 Period of jeonse price decline -23.3% over 10 months -5.4% over 22 months -3.2% over four months Apartment jeonse price 100 80 60 40 20 0 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 Source: KB Kookmin Bank, KDB Daewoo Securities Research Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S.