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Industrials
We see improving prospects for the global capex cycle
Further investments expected in infrastructure and plants on top
of strong commodity prices and resumption of suspended projects
Our highest conviction pick is Samsung Engineering; Hyundai
Motor is most likely to benefit from pricing anomalies relative to
peers, while Kia Motors should benefit from Chinese growth
2011 outlook
We expect the global capex cycle to continue to
trend up in 2011, mainly driven by 1) the
resumption of suspended projects, which have
shown an incremental recovery since last year
(after the financial crisis in 2008), 2) strong
commodity prices (eg, crude oil), which look set
to provoke further investment in infrastructure as
well as plants, and 3) sustainable demand growth
from emerging markets.
Engineering & construction
To date, the strongest demand for overseas plant
construction has come from Middle East,
including Saudi Arabia and the UAE, largely
driven by national oil companies such as ArabianAmerican Oil Co (ARAMCO), Saudi Basic
Industries Co and Abu Dhabi National Oil
Company. While we find that massive capital
investments have led to fierce competition among
the global engineering and construction players,
we believe Korean companies who successfully
diversify their new order streams both by project
type and region will eventually benefit.
Autos
We expect the momentum of HMC and Kia’s new
models to continue into 2011 in the US, China
and EM and estimate their 2011 retail volume to
increase by 12% to 6.5m. In 2010, the two Korean
automakers likely sold 5.7m vehicles globally, up
18%, helping HMC and Kia’s combined global
market share to increase to 8.2% from 7.7% in
2009. For 2011, we expect China and EM to
continue to grow at 20% and the US to recover by
10%. We believe HMC and Kia’s operating
margins will rise to 9% and 7% in 2011, driven by
the economies of scale and cost efficiency through
platform integration.
Shipbuilding
We believe the shipbuilding industry bottomed out
in 2009 following two consecutive years of order
declines. We expect a gradual recovery to continue
in 2010/11 due to a low base effect. We expect new
orders to rise around 18% to 32.9m CGT in 2011.
However, we would not view this recovery as
cyclical. Many concerns remain, such as profitability
of current new orders, overcapacity and demand
from shipowners, delays and price cuts. We believe
that more time is definitely needed to see another
strong cyclical upturn as in 2006-08.
2011 high conviction idea
Top pick: Samsung Engineering
(028050 KS, OW(V), KRW185,500,
TP KRW247,000)
We believe Samsung Engineering is the best
positioned name, especially given its first-ever order
win from the United States (Dow Chemical order),
an oligopoly market largely dominated by leading
domestic peers such as Fluor Corp. As most of the
US projects look set to be carried out through a ‘cost
+ fee base’ mechanism, we believe its entrance into
new markets will continue to provide a strong
cushion to offset margin contraction risks from
fierce competition in the Middle East.
Looking ahead, we believe 2011 new order
guidance (KRW13.5trn) looks highly achievable,
as a steady pace of diversification backed by
proven quality works should continue to improve
order visibility ahead. We believe Samsung
Engineering has reached a turning point in its
business, entering a new USD100bn market and
FEED business (front-end engineering and
design). While EV to backlog is a good way to
look at E&C valuations, a proprietary approach to
gauge how far shares are trading on their future
earnings in the upcycle. Samsung Engineering
now trades at 29% 2010e EV to backlog versus
the major overseas peers at 121%.
Valuation
Out target price of KRW247,000 is based on a
sum-of-the-parts valuation. For the core
operations, we apply target EV/EBITDA of 15.5x
reflecting the new fair EV to 2011e backlog
(30%). With non-core asset value at KRW87.4bn,
we add net cash worth of KRW1.4trn.
Risks
Key risks are higher raw material prices that erode
margins of industrial plants, further KRW
appreciation that weakens pricing power and
heightened tensions with North Korea.
Pricing anomalies
Korean auto and auto parts stocks have historically
traded at a discount to global peers, due to the
earnings volatility and high leverage. However, we
believe the discount factors are fading away given
solid global sales and strengthened balance sheets.
Hyundai Motor Company (005380 KS,
OW, KRW172,500, TP KRW240,000)
We believe HMC deserves to trade at Toyota’s
upcycle average multiple during 2004-07, as the
two companies’ global volume growth and margin
expansion stories look similar.
Valuation
We apply a target PB multiple of 1.6x to derive
our TP of W240,000. Our target multiple is based
on Toyota’s average 1-year forward PB during the
2004-07 upcycle.
Risks
Key downside risks to our view include slower-thanexpected demand recovery in global markets, any
significant quality problems with HMC vehicles and
heightened tensions with North Korea.
Stock most at risk:
Mando (060980 KS, N(V),
KRW132,500, TP KRW140,000)
With the stock trading at 1.6x 2011e PB and 10x
PE, we think Mando’s share price momentum has
abated due to the KCC overhang.
Valuation
We apply a target PB multiple of 1.8x to 2011e
BVPS, which implies a 20% discount to our 2.2x
target multiple for Mobis, given that Mando’s
2011e ROE 16% is lower than Mobis’ 23%.
Risks
Key downside risks to our view include
dependency on OEM product cycle, earnings
sensitivity to FX movement and heightened
tensions with North Korea.
Winners from Chinese growth
The combined market share of HMC and Kia in
China has grown to 10.2% in 2010 from 9.8% in
2009. We estimate that Korean automakers will
outperform the Chinese auto market in 2011, in
light of the successful launch of Sportage R, K5
and YF Sonata.
Kia Motors (000270 KS, OW,
KRW48,950, TP KRW56,000)
We estimate Kia’s Chinese retail sales will grow
25% in 2011, following 40% growth in 2010.
With the launch of Sportage R (4Q10) and K5
(1Q11), momentum in SUVs and D-segment
sedans should continue into 2011. As such, Kia’s
2011 Chinese market share is likely to rise to
3.7% from 3.4% in 2010.
Valuation
We apply a target PB multiple of 1.9x to 2011e
BVPS to derive our TP of W56,000. At our TP,
the shares would be trading at 8.7x 2011e EPS
with 12.3% growth. Our target multiple of 1.9x is
based on a 20% premium to our target PB for
HMC of 1.6x, given Kia’s higher ROE.
Risks
Key downside risks to our view include any
significant quality issues with Kia’s cars and
heightened tensions with North Korea
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