Valuation Re-rating Factors Reappearing
The author is an analyst of NH Investment & Securities. She can be reached at mj27@nhqv.com. -- Ed.
I. 2015 is here again
Valuation re-rating factors reappearing
We believe the factors that sparked sector valuation premiums in 2014~2015 are reemerging this year. Over 2014~2015, investment sentiment towards the F&B sector improved strongly, as: 1) there were a series of mega-hit products, including Honey Butter Chips and Jjawang ramen; 2) overseas sales grew briskly, led by China where therising popularity of Korean culture boosted consumption of Korean products (including snacks and food); and 3) the domestic HMR market began growing in earnest in line with an increase in the number of single-member households. Back then, the F&B sector enjoyed higher than 100% valuation premium to the Kospi. This year, such valuation premium factors are strengthening even more than in 2014~2015 thanks to: 1) the
appearance of mega-hit products (Terra, Jinro is Back, hot chicken flavor ramen, etc); 2) brisk overseas sales growth in the US and Southeast Asia in addition to China; and 3) rising household food demand in addition to greater HMR consumption. In our view, these factors should be sufficient to lift market concerns towards the F&B sector (namely, that as traditional domestic demand-oriented plays, F&B shares have only limited top-line growth potential).
Sector valuation level attractive
While these premium-warranting factors are meaningfully pushing up overall sales figures, we do not view recent sector share price hikes as reflecting such. Recently, the overall Kospi valuation level has risen, mainly in response to downward earnings forecasts revisions made to reflect the impact of the Covid-19 crisis. However, the F&B sector’s valuation level has remained below the past average, with its valuation premium against the Kospi hovering around only 10%. We see ample upside, considering: 1) valuation premium factors that have yet to be properly reflected; and 2) the F&B sector’s relatively low valuation level.
II. 2Q20E: OP likely grew 23% y-y for major F&B players
2Q20E OPM: +1.0%pt y-y
We believe that OP growth will stand out in 2Q20 sector earnings releases. Major F&B players (based on 14 companies) should post combined 2Q20 sales of W14,150.9bn (+7.4% y-y) and OP of W1,071.7bn (+23.0% y-y). With demand for food remaining on a rise in Korea, their earnings likely trended upwards on: 1) low-base effects (y-y); 2) an upsurge in overseas market demand for food amid Covid-19; and 3) profitability-focused management. Accordingly, we estimate that combined 2Q20 COGS-to-sales ratio and SG&A-to-sales ratio dropped 0.4%pt and 0.6%pt y-y, respectively, with OPM likely climbing 0.1%pt y-y. Food demand growth has been brisk paced since 2Q20, as Covid-19 has spread fast in overseas markets other than China, and as demand for home meals has stayed strong in Korea and China, where Covid-19 has subsided. We also note that in 2Q19, major food firms saw their margins fall sharply on aggressive promotion activity during the off-season, and major beverage players fared well as hot weather came earlier than normal. Thanks to low-base effects (y-y), earnings growth at food companies is likely to prove faster in 2Q20 than in 1Q20, when Covid-19 was raging in Korea. In contrast, high-base effects are in play for beverage companies.
Price movement should differ by raw material. Wheat, corn, soybean, and raw sugar prices will likely stabilize downwards, affected by oversupply, lessened demand, and decreased oil prices. That said, wheat prices temporarily rose in 1Q20, due to wild fires in Australia. Affected by three-month lagging effects, wheat input costs are expected to increase in 2Q20. Also, prices for some raw materials such as Korean cabbage, chili, and livestock have climbed on bad harvests and Covid-19. But, given that raw material volume figures and ASPs both remain sound on favorable forex rates, demand upsurge, and eased promotion activity, we do not believe that price hikes for some raw materials will place a burden on sector player earnings. While promotion and marketing activity have been resuming as of late, the extent of such has been far below that in normal years.
Offer CJCJ as sector top pick
Taking into account both likely brisk 2Q20 earnings and mid/long-term growth prospects, we present CJCJ as our sector top pick. We expect other processed food providers to report earnings improvement as well, backed by strong demand for food and an easing in competitive promotional activities. Meanwhile, we believe that overseas growth momentum is sustaining for Orion, Nongshim and Samyang Foods. And, Hite Jinro is likely enjoying operating leverage effects in line with domestic M/S expansion. Looking at KT&G, Lotte Chilsung, and Maeil Dairies, while earnings expansions were likely limited in 1H20, we foresee stronger growth momentum in 2H20. Earnings at all three players are to benefit from y-y low-base effects in 2H20, and all three offer valuation merit. KT&G’s share price should trend upwards in 2H20, backed by a recovery in overseas tobacco sales, exports of its e-cigarette product (Lil), and an improved shareholder return policy. As for Lotte Chilsung, the pace of a decline in its liquor sales has been slowing (versus times when boycotts of Japanese products were prominent). And, we expect its cost streamlining efforts to translate into earnings improvement from 2H20. Elsewhere, Maeil Diaries is set to enjoy top- and bottom-line growth, backed by both a widened product lineup and cost reduction efforts. Lastly, although we believe that Ottogi’s sales growth accelerated in 2Q20 on higher demand and brisk new product sales, its relatively low overseas sales portion makes it somewhat less attractive versus other players, in our view.