The author is an analyst of Shinhan Investment Corp. He can be reached at email@example.com. -- Ed.
Initiate coverage with BUY and target price of KRW34,000
We initiate coverage of Kolon Industries with a BUY rating for a target price of KRW34,000. Our target price is based on sum-of-the-parts valuation with 2020F operating value by division assessed at KRW1.3tr for industrial materials, KRW464.1bn for chemicals, KRW403.6bn for films, KRW195.5bn for apparel, and KRW78.2bn for other textile materials. The target price translates to a 2020F PBR of 0.43x vs. lows of 0.76x recorded in 2016-2018 while shares traded at a valuation premium as the company neared the end of legal battles with DuPont and completion of investment into a new tire cord plant in Vietnam amid rising expectations for further growth from CPI films. Kolon Industries shares appear excessively undervalued at current share price levels, considering visible improvement in CPI film profit and substantial growth potential added from aramid fibers. We believe now is the time to focus on earnings momentum expected from aramid and CPI films.
Key investment points: 1) Aramid capacity addition; 2) CPI film shipment growth; and 3) tire cord profit improvement in Vietnam
First, the industrial materials division is expected to see operating profit jump 40% YoY in 2020 thanks to the expansion of aramid production capacity (5,000 tons to 7,500 tons). The division should deliver operating profit margin of 30%, backed by tight supply of aramid and ASP hikes (USD24,700/ton in 4Q19 vs. USD16,400/ton in 1Q17). Second, earnings momentum from CPI films should strengthen alongside steep growth in foldable smartphone sales from 7mn units in 2020 to 126mn in 2022. Operating profit from the CPI film business is likely to come in at KRW36.8bn this year on shipment growth from the addition of new clients. Third, tire cord operating profit margin is projected to increase on improving cost competitiveness of the Vietnamese plant (wages are just one-seventh of the levels in Korea) and approval by clients as a first-tier vendor.
2020 OP forecast at KRW192.5bn (+11.4% YoY)
For 2020, we forecast sales at KRW4.6tr (+4.6% YoY) and operating profit at KRW192.5bn (+11.4%YoY). By division, operating profit from industrial materials should reachKRW114.2bn (+41.4% YoY), chemicals KRW40.7bn (-45.5% YoY), films/electronic materials KRW31.5bn (+36.3% YoY), and apparel KRW9.9bn (-26.8% YoY). Earnings from chemicals will likely decline due to market entry of a new competitor. Rising marketing expenses and outdoor apparel market downturn should weigh on earnings from the apparel business. However, we expect rapid profit growth from aramid and CPI films and normalization of earnings from tire cord to offset the impact on overall earnings. The uptrend in earnings should continue with YoY operating profit growth to reach 20% levels in 2021.