Room for Further Growth Substantial
The author is an analyst of Shinhan Investment Corp. She can be reached at hpark@shinhan.com. -- Ed.
Initiate coverage with BUY for a target price of KRW107,000
We initiate our coverage of KT&G with a BUY rating and a target price of KRW107,000. Investment points are: 1) earnings improvement on non-tobacco market share gains, despite the limited growth in domestic tobacco demand; and 2) attractive valuations. Our target price is based on 2020F EPS and a target PER of 13.3x, which is the past five-year average and about 7% higher vs. end-2019 PER of 12.4x. For 2020, the company is forecast to report sales growth of 3.1% YoY, marking a 7.9%p drop vs. 2019, and operating profit growth of 6% YoY, down 4.1%p vs. 2019. However, there is substantial room for further growth given the partnership with Philip Morris International (PMI) established in January, as well as the sales contract signed with a UAE partner in February. We find current valuations undemanding, considering potential upside to earnings.
2020 growth outlook: Sales+3.1% YoY, OP+6.0% YoY
For the full year, we forecast sales at KRW5.11tr (+3.1% YoY) and operating profit at KRW1.46tr (+6.0% YoY). Cigarette sales will likely climb 2.9% YoY. The subsidiary KGC should also record a 5.1% YoY growth in sales.
We see upside to cigarette sales growth estimates for 2Q and onwards. KT&G established a partnership with PMI in January for global distribution of e-cigarettes, and signed a seven-year contract with Alokozay in February that grants the UAE-based company the right to sell its cigarettes in the Middle East. The contract with Alokozay will likely generate at least KRW2.3tr in sales through 2027. This translates into annual average of about KRW300bn or 10% of annual cigarette sales estimate. Sales forecasts may be revised up depending on actual export values. We expect earnings improvement for 2H20 and onwards with the PMI contract set to be reflected in earnings.
Undemanding valuations at 2020F PER of 10x
KT&G shares are currently trading at an undemanding 2020F PER of 10x, the lowest level since 2015. The PER exceeded 11x even in 2016 when the company saw similar growth in sales and operating profit. There is substantial room for further earnings improvement given the contracts signed with PMI and Alokozay. We believe the shares have been excessively corrected considering stable domestic market share and growth potential in overseas markets. We recommend a buy-and-hold strategy for the stock.