Margins Improving at Domestic Division
The author is an analyst of NH Investment & Securities. She can be reached at mj27@nhqv.com. -- Ed.
Overseas subsidiaries’ 2Q20 earnings are likely to come in sluggish due to the Covid-19 pandemic. However, we believe that the firm’s fundamentals remain intact. Margins have been improving at the domestic division, backed by new product rollouts, SKU streamlining, and offline store downsizing.
Domestic and overseas earnings to improve and uncertainties to ease over mid/long term
While reiterating a Buy rating, we lower our TP on Lotte Confectionery from W200,000 to W135,000. The transfer of its core overseas subsidiaries (in Kazakhstan, Europe, and Pakistan) from Lotte Corp to Lotte Confectionery last year was expected to lead to a sharp rise in enterprise value. However, due to unfavorable forex rates, the incorporation effects have been smaller than expected.
More recently, the Covid-19 pandemic has greatly disrupted production and distribution at overseas subsidiaries. That said, while earnings at overseas subsidiaries have been affected by external variables since last year, their fundamentals remain intact. And, once the Covid-19 pandemic subsides, food demand will likely increase in their respective markets. We note that with its takeover of overseas subsidiaries having been completed, additional capital increase or cash outflow events are unlikely.
2Q20 preview
Lotte Confectionery should book 2Q20 consolidated sales of W535.2bn (-1.9% y-y) and OP of W27.7bn (+1.2% y-y). Despite sound growth at its nonconsolidated domestic business, Covid-19-related damage at overseas subsidiaries is likely to limit overall earnings improvement.
Despite sluggish snack sales at large discount stores, the domestic business is to post y-y sales and OP growth, backed by: 1) new ice-cream products rollouts; 2) narrowing losses at Natuur Ice cream brand; and 3) greater demand for health products. But, negative events have unfolded at overseas subsidiaries due to the Covid-19 crisis, including a factory shutdown in Kazakhstan in June, a temporary operation discontinuation in India’s snack plant in June, and a double-digit y-y drop in sales at Belgium (with the subsidiary turning to the red from 2Q20). We note that the Pakistan subsidiary is likely to show y-y earnings improvement thanks to a favorable forex rate.