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Construction materials-New valuation for new home improvement sector

April 21, 2014 13:23|April 21, 2014 13:24
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1Q14 preview: Slow season no more
We expect construction materials companies to post solid 1Q14 earnings,
especially in terms of YoY growth. KCC should post OP of W55bn (up 21.5% YoY)
and LG Hausys W32bn (up 31.9% YoY), which should be in line or above
consensus levels. As for companies outside of our coverage, Byuksan and Hansol
Homedeco should post OP of W3.8bn (up 27.2% YoY) and W1bn (versus W100mn
in 1Q13), respectively. Overall, it appears there were no negative seasonal effects
this year. Furthermore, some companies are considering increasing capacity given
the improving volume.

Improving B2B momentum, structural B2C growth
Construction materials began to turn around in 2Q13 led by B2C players and the
growing number of aged apartments and increasing housing transactions due to
revised government policies. In fact, higher B2C demand offset a downturn in the
B2B market. House supplies surged in 1998-1999 after the construction of new
urban centers, Bundang and Ilsan, were completed. 15 years have passed and the
number of aged houses should increase by 300,000 units p.a. over the next
decade. As such, home improvement demand should continue to grow over the
long term.

After slowing over the past three years, move-in volume should surge 36% YoY in
2014, signaling a turnaround in the B2B market. Average selling prices have
picked up since the market restructured in 2011-2012 and building regulations
tightened. Considering pre-sale volume in 2013-2014, move-in volume should
climb another 7% YoY in 2015 and 11% YoY in 2016. Meanwhile, Hanssem’s 1Q14
earnings surprise last week is meaningful as it was fueled by a 118.3% YoY growth
in B2B sales and solid B2C earnings growth. We believe most construction
materials players will post similar results.

New valuation paradigm for new sector
Construction materials shares have historically traded at a discount compared to
the construction sector as builders were the dominant housing players. However,
home improvement for aged houses has emerged as a growth market as the new
homes market has matured. And, we believe the new sector merits a new
valuation paradigm. Changes have already begun in the furniture sector, backed
by a rapid replacement cycle, with Hanssem trading at 22x PE and Hyundai Livart
at 14x PE. In overseas markets, Home Depot (US) trades at a 12% premium to the
market, while Lixil (Japan) has a 36% premium and Saint-Gobain (France) a 28%
premium. Of note, environmental and energy efficiency regulations for construction
materials have tightened since 2013. And, the Japanese construction materials
sector outperformed in 2003, when similar regulations were introduced.

14x, and LG Hausys’ TP at W190,000, based on a target PE multiple of 14x. We
also maintain KCC as our top pick. Construction materials demand typically peaks
in 2Q, and KCC’s earnings momentum should be significant in 2014 as ship paint
sales to Hyundai Mipo Dockyard and Hyundai Heavy Industries should surge
23.9% YoY. Small caps, such as Byuksan and Hansol Homedeco, are also
attractive. Market size is growing as both companies continue to increase market
share (refer to our New home-buying demand from today’s 30-somethings report
on April 8). While share prices have surged since 2013, we recommend buying on
any pullbacks based on a long-term investment horizon.

Case analysis) Environmental regulations on construction materials in Japan
In 2013, Korea limited formaldehyde emissions from floor materials to less than
1.5mg/l. Materials meeting these guidelines will be issued a KC mark, and sales of
materials without a KC mark have been banned. Similarly, Japan began tightening
regulations on construction materials by regulating formaldehyde emissions in
January 2003. During this process, 1) companies prepared for the regulatory
changes gained 1%p of market share, 2) importers exited the market as emissions
had to be measured for every product, and 3) margins picked up at larger
companies after announcing a 3-5% price hike several months after the new
regulations. Overall, the change was a new opportunity for large domestic players,
and we believe it will be similar in Korea.

Demand for products that resolved sick house syndrome grew as the revised
policies took effect on July 1, 2003. Representative companies were Matsushita
Electric Industrial, Daiken Industrial and INAX, which produced high-performance
ceiling and wall materials. Sales grew 30-40% p.a. from 2003, and shares also
surged. In fact, the PE premium reached as high as 30-100% since the regulations
were enacted.
*Source: Korea Investment & Securities Co.