Lotte Foods (002270 KS) Negatives priced in 4Q15 preview: Processed meat sales will be key Food & Beverage We forecast Lotte Foods’ 4Q revenue and operating profit to grow 2.2% and 356.1% YoY to W390.5bn and W3.6bn, respectively. We believe the recent negative news about processed meat will have an impact on profits. Despite the tailwinds from lower pork Company Report prices, processed meat profits will likely be weighed down by higher marketing spending December 2, 2015 and discounts to boost sales following the WHO’s report linking processed meat to cancer. The processed meat unit’s annual revenue is estimated at W550bn (33% of overall revenue), of which W350bn is from ham/sausage/frozen products and W200bn is from meat products. (Maintain) Buy Food services has strong room for growth Target Price (12M, W) 1,200,000 We believe Lotte Foods’ future growth lies in its food services business, which consists of food supplies, home meal replacements (HMR), and catering. For food supplies (key Share Price (12/1/15, W) 902,000 customers include Lotteria, 7-Eleven, and catering companies), we see ample room for growth, as the market is underdeveloped and underpenetrated. The company will likely Expected Return 33% invest in improving its sourcing abilities and building logistics centers. HMR is a growing industry. Lotte Foods currently operates three HMR plants . The company mainly supplies samgak kimbap, lunch boxes, and sandwiches to convenience OP (15F, Wbn) 71 stores, but is expected to broaden its reach to Lotte Mart and Lotte Super . We estimate Consensus OP (15F, Wbn) 76 HMR revenue to rise to W160bn in 2015 from W140bn in 2014. We expect the company to launch around 25-30 HMR products in collaboration with Lotte Mart by the EPS Growth (15F, %) -16.5 end of the year and another 50-60 products in 2016. (The timing of the releases was Market EPS Growth (15F, %) 22.6 pushed back due to coordination issues with Lotte Mart and consumer reception.) We P/E (15F, x) 24.7 forecast revenue from HMR products for Lotte Mart to reach W20bn in 2016. If Lotte Market P/E (15F, x) 11.4 Mart decides to expand its HMR product lineup, this would present an attractive growth KOSPI 2,023.93 opportunity for Lotte Foods. And because Lotte Foods has ties to different retail channels (convenience stores, hypermarkets, and super supermarkets) within the Lotte Market Cap (Wbn) 1,235 Group, we think it is well positioned to develop products that are suited to each Shares Outstanding (mn) 1 channel’s needs. Free Float (%) 49.8 For catering, we estimate revenue to expand to W33bn in 2015 from W22bn in 2014. Foreign Ownership (%) 5.2 While it may take time, the catering business is almost certain to grow, with potential Beta (12M) 1.23 captive (group) demand estimated at W130bn. 52-Week Low 559,000 52-Week High 1,189,000 Infant formula exports to China to grow We forecast infant formula exports (the majority of which are bound for China) to (%)(%)(%) 1M1M1M 6M6M6M 12M12M12M increase from W27bn in 2014 to W34bn in 2015 and W40bn in 2016. Up until 2013, Absolute 0.3 2.2 33.8 most of the company’s infant formula exports to China were private label (PL) products , Relative 0.6 6.1 29.9 but the percentage of national brands (Grand Noble, etc.), which are more profitable, has been increasing since 2014. 190 Lotte Foods KOSPI 170 Maintain TP of W1,200,000; Negatives priced in 150 130 Lotte Foods shares have pulled back sharply due to the aforementioned WHO report on 110 processed meat as well as delays to HMR product launches. However, we believe 90 negatives have been mostly priced in. We expect ham and sausage demand to pick up early next year (February-March) and HMR products to be launched by the end of this 70 11.14 3.15 7.15 11.15 year. In our view, the headwinds are only temporary and do not affect the company’s long -term fundamentals. We maintain our Buy call and target price of W1,200,000 . Daewoo Securities CCo.,o., Ltd. FY (Dec.) 12/12 12/13 12/14 12/15F 12/16F 12/17F Revenue (Wbn) 1,007 1,568 1,633 1,708 1,793 1,897 [F&B/Tobacco] OP (Wbn) 59 74 66 71 76 82 Woon-mok Baek OP margin (%) 5.9 4.7 4.0 4.2 4.2 4.3 +822-768-4158 NP (Wbn) 61 114 60 50 61 69 [email protected] EPS (W) 48,326 83,227 43,721 36,494 44,558 50,409 ROE (%) 10.8 16.5 7.5 5.8 6.7 7.1 P/E (x) 13.6 9.0 13.3 24.7 20.2 17.9 P/B (x) 1.4 1.3 1.0 1.4 1.3 1.2 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. December 2, 2015 Lotte Foods Table 111.1. 4Q15 preview (Wbn, %) 4Q15F Growth 4Q144Q144Q14 3Q153Q153Q15 KDB Daewoo Consensus YoYYoYYoY QoQQoQQoQ Revenue 382.1 469.6 390.5 399.7 2.2 -16.8 Operating profit 0.8 30.1 3.6 9.8 356.1 -87.9 Pretax profit -5.0 22.0 2.3 10.5 TTB -89.4 Net profit -3.6 18.9 2.0 8.2 TTB -89.4 OP margin 0.2 6.4 0.9 2.5 - - Net margin -1.0 4.0 0.5 2.1 - - Source: Company data, KDB Daewoo Securities Research Table 222.2. Quarterly and annual earnings (Wbn, %) 2020201520 151515 20202016F20 16F16F16F 202020 141414 202020 15F15F15F 20202016F20 16F16F16F 1Q1Q1Q 2Q2Q2Q 3Q3Q3Q 4QF4QF4QF 1Q1Q1QF1Q FFF 2Q2Q2QF2Q FFF 3Q3Q3QF3Q FFF 4Q4Q4QF4Q FFF Annual Annual Annual Revenue 405 443 470 391 419 464 494 416 1,633 1,708 1,793 Operating profit 13 25 30 4 10 26 31 8 66 71 76 Pretax profit 13 21 22 2 13 25 28 7 73 59 72 Net profit 11 18 19 2 11 21 24 6 60 50 61 OP margin 3.2 5.6 6.4 0.9 2.5 5.7 6.2 2.0 4.0 4.2 4.2 Net margin 2.7 4.1 4.0 0.5 2.6 4.5 4.8 1.4 3.7 2.9 3.4 Revenue growth 5.6 4.1 6.3 2.2 3.6 4.7 5.1 6.5 4.1 4.6 5.0 OP growth -11.1 1.7 14.2 356.1 -20.0 7.0 1.8 126.6 -10.6 8.2 6.0 Pretax growth -19.1 -42.3 -12.8 TTB -5.8 17.9 27.5 193.0 -40.5 -19.8 23.0 Net growth -18.8 -40.7 -3.1 TTB -2.4 15.5 25.1 187.4 -47.5 -16.5 22.1 Source: Company data, KDB Daewoo Securities Research Table 333.3. Earnings forecast revisions (Wbn, %) Previous Revised % chg. NoteNoteNotesNote sss 20202015F20 15F15F15F 20202016F20 16F16F16F 20202015F20 15F15F15F 20202016F20 16F16F16F 20202015F20 15F15F15F 20202016F20 16F16F16F Revenue 1,709 1,791 1,708 1,793 -0.1 0.1 - Reflects lower pork prices - Reflects ham/sausage Operating profit 70 74 71 76 1.9 2.2 promotion al expense s Pretax profit 57 72 59 72 3.0 0.3 Net profit 49 60 50 61 2.0 1.7 OP margin 4.1 4.1 4.2 4.2 - - Net margin 2.9 3.4 2.9 3.4 - - Source: Company data, KDB Daewoo Securities Research Figure 111.1. 201520152015-2015 ---16F16F P/E peer comparison Figure 222.2. 201520152015-2015 ---16F16F P/B peer comparison (x) (x) 60 2015F 10 2015F 2016F 2016F 50 8 40 6 30 4 20 2 10 0 0 Lotte Foods Samlip CJ Freshway Ottogi Shinsegae Dongwon Lotte Foods Samlip CJ Freshway Ottogi Dongwon Shinsegae Food F&B F&B Food Source: QuantiWise consensus, KDB Daewoo Securities Research Source: QuantiWise consensus, KDB Daewoo Securities Research KDB Daewoo Securities Research 2 December 2, 2015 Lotte Foods Figure 333.3. Processed meat (ham/sausage) shipment growth has Figure 444.4. Pork price has been weakening since August been declining since October (tonnes) Processed meat shipments (L) (%) (W/kg) Korea pork price (L) (%) 20,000 YoY (R) 45 8,000 YoY (R) 80 60 6,500 17,000 30 40 20 14,000 15 5,000 0 -20 11,000 0 3,500 -40 8,000 -15 2,000 -60 10 11 12 13 14 15 10 11 12 13 14 15 Source: KOSTAT, KDB Daewoo Securities Research Source: eKAPEPIA, Bloomberg, KDB Daewoo Securities Research Figure 555.5. Infant formula exports to China rising steadily Figure 666.6. Infant formula national brand exports expanding (US$mn) (%) (Wbn) 160 Infant formula exports to China (L) 160 45 National brand YoY (R) 40 PL 35 120 120 30 25 80 80 20 15 40 40 10 5 0 0 0 05 07 09 11 13 15F 10 11 12 13 14 15F 16F Source: Korea Customs Service, KDB Daewoo Securities Research Source: Company data, KDB Daewoo Securities Research Figure 777.7. Domestic HMR market size Figure 888.8.