Initiating Coverage. Investment Thesis and Recommendation. Target Price: CLP 485 Recommendation: Hold Risk: High

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1 Hites Target Price: CLP 485 Recommendation: Hold Risk: High Sector: Retail Analyst: M. Josefina Güell T: Company Information Bloomberg Ticker: HITES CI Equity Closing Price (CLP per share): M Price Range: 287, Daily Volume (CLP mn): 471,4 Shares (mn): 377,124 Market Cap (USD mn): 336,7 Shares / ADR: - Share Price Prices Hites & IPSA Base IPSA Hites Initiating Coverage Investment Thesis and Recommendation Our target price for Hites SA is CLP 485 per share for year-end 2013, with a Hold recommendation and High risk. Relative to current closing price, our target price implies a potential increase of 14.7%. In addition, we forecast a dividend yield of 3.1% for December 2013, therefore obtaining an expected 17.8% total return of investment. Our target price update includes a US$200 million investment plan for , which aims mainly at doubling the points of sale compared to December We expect 90% completion of this plan and we consider a 5% delay a year on the opening of the POS. This investment is aimed at increasing the department stores presence nationwide, opening 60% of the overall stores in regions other than Metropolitana Region, where most of Hites stores are located. Our thesis is supported by the vast leadership of the company in segments C3-D. We expect favorable growth in Chile, with expansion rates of 4.5% to 5.0% of GDP during Because of the difficulties in some economies in Asia and Europe, the economy is expected to slow down. Good economic health is expected although consumption growth should slow down. In our expected economic unemployment remains low in Chile, remaining around 6.5% throughout Stabilization of loan book write-off levels. The company customers have presented high nonpayment rates throughout 2012, with loans percentage acknowledged as unrecoverable increased 1920 basis points over the 2011 rate. The average period of debt is 254 days, which is significantly higher than Falabella s, for example, which averages 141 days. This is due mostly to the fact that the other retailers are focused in segments ABC1 and C2, while Hites focuses in segments C3 and D. Risks Investment plan: The plan execution could either affect the company s value favorably or unfavorably, depending on whether our expectations are exceeded or not. Interest rate risk: The financial business depends on the spread that Hites can obtain among the finance rate and the placement rate. The company results are sensitive to this rate differential. 75 Commission risk: Recent interpretation from authorities, regarding readjustment systems of commission contract prices has increased the degree of uncertainty to investments. Source: Bloomberg, CorpResearch Hites - M Josefina Güell May, 14th 2013

2 Company Description Hites is the fifth largest retailer in Chile, holding a 5% market share. It is aimed at fulfilling the consumption and financial needs of the ample C3-D segment of the population. To accomplish this, the company has a product mix focused on clothing and electronics and offers credit through the Hites card in 14 department stores throughout the country. Its aggressive USD 200 million investment plan for aims primarily at doubling the number of stores. Profit&Loss Statement (CLP Th) E 2014E 2015E 2016E Non-Financial Business Sales Gross Margin Gross Margin % 37,5% 37,4% 37,2% 37,2% 37,1% 37,2% Operating Income Operating Income % 8,1% 8,0% 8,0% 7,9% 7,8% 8,0% EBITDA EBITDA Margin % 10,9% 10,5% 10,4% 9,9% 10,9% 11,3% Net Financial Expenses ( ) ( ) ( ) ( ) ( ) ( ) Non-Operating Result ( ) ( ) ( ) ( ) ( ) ( ) Net Income, Controller s Net Margin (Controller)% 5,4% 5,3% 5,8% 5,9% 6,0% 6,2% EPS (USD/acc) Ownership Balance Sheet (CLP Th) E 2014E 2015E 2016E Float 40% Hites Family 60% Cash & Equivalents Other Current Assets PP&E Other Non-Current Assets Total Assets Financial Debt Total Liabilities Total Equity Minority Interest Revenue Distribution Cash Flow (CLP Th) E 2014E 2015E 2016E Financial Business 35% Retail Business 65% Operating Result Adjusted Taxes ( ) ( ) ( ) ( ) ( ) Depreciation & Amortization Capex ( ) ( ) ( ) ( ) ( ) ( ) Δ Working Capital Free Cash Flow Equity Raised Dividends Debt Issuance Peers P/E EV/EBITDA Ratios E 2014E 2015E 2016E Cencosud 27,1 20,8 Stock Price (CLP) Falabella 34,7 12,9 P/E (x) 9,9 11,5 9,8 8,8 8,0 7,4 Ripley 26,7 15,4 Liabilities/Equity (x) 1,1 1,3 1,2 1,0 0,9 0,8 Hites 11,0 7,3 EV/EBITDA (x) 6,8 7,2 7,6 7,8 6,5 5,8 EBITDA/Interest Expenses 7,4 4,7 9,7 9,3 11,7 13,7 Net Financial Debt/EBITDA 1,9 1,4 2,2 2,6 2,1 1,8 ROA (%) 5,9% 5,6% 6,0% 6,4% 6,5% 6,5% β (vs IPSA): 1,3 ROE (%) 12,6% 12,6% 13,1% 12,6% 12,1% 11,5% WACC: 9,5% Dividend Yield (%) 3,0% 2,6% 3,1% 3,4% 3,7% 4,0%

3 National Presence Hites stores Business Line and Geographic Presence Hites goal is to fulfill the consumption and financial needs of the wide national C3-D segment of the population, which takes up 48% of the country s households. Its sales distribution channel is clothing, accessories and household goods, offered in its 14 department stores. The financial service are offered to customers through Hites card, which provides loans for store sales, associated points of sale and cash advances. Different related products complement the financial area of the business, which are mainly insurance types. By December 2012, Hites owns 14 stores, with an area of 86,994 square meters. 50% of the stores are located in the downtown or west area of the metropolitan region. This has enabled Hites to offer its target segment a wide product mix, aimed at fulfilling its needs and requirements. During 2012, Hites revenues were CLP 253,831 million. From that amount, 65% came from the retail area. The product lines are: clothing (women, men, children, shoes and sports), covering 43% of sales in 2012; electronics (electronics and household appliances), covering 42% of sales in 2012; deco (home decoration line), representing 10% of 2012 sales; other items account for the remaining 5%. Source: Hites 48% of households in the C3-D segments. Hites is the leading department store that meets the needs of these segments. Source: Hites The vast business-segment related know-how that Hites has gathered throughout the years has provided the company with a deep knowledge of their customers, which has become one of its main competitive advantages. Hites has developed brands of its own, which are gradually becoming stronger in the market. These brands have gained a significant share of total sales, reaching 21% of clothing sales.

4 Investment Plan Number of stores Hites has announced an aggressive investment scheme for the period between the years , which considers a 72% physical area increase in comparison with December This involves the opening of 14 new stores, which would double the current number. In addition, it will mean an investment of USD 200 million for the years Nevertheless, due to construction-related delays in projects throughout 2011, we foresee a 5% delay in the opening of these points of sale Hites currently owns 14 stores. During 2013, a leasing contract will be used in the first openings in a joint effort with Parque Arauco Company. The opening of the first of these POS was in April, in the new Mall Arauco Quilicura. Throughout the last quarter of 2013, an expansion of the Plaza El Roble Mall will be executed, which will become Arauco Chillán, and Hites will be the mall s anchor store. By the end of the year 2013, the opening of a stand-alone department store is planned in downtown Santiago, in Paseo Puente, a good location for an iconic project of the company, which will strengthen their leadership in one of its original neighborhoods. Also, in 4Q 2013 Hites will open a store in the city of Ovalle, a new key location for the mining and agricultural industry in Chile. This store, together with the store opened in December 2012 in the city of La Serena, will strengthen Hites s positioning in Chile s fourth region. Finally, for the year 2014 and 2015, ten new stores will open, considered with the plan to have 28 stores nationwide by the year Retail - Revenues CLP Billions 216,0 227,9 With a 17% area increase throughout this year, we estimate 11% revenue increase for The EBITDA margin is expected to decrease by 10 base points, as a consequence of the SG&A expenses increase of 10%, associated to pre-operational expenses of the department stores openings and the development of logistic projects. We expect that by mid-2016; after all new openings have taken place, the company will have greater operational efficiency, which should slowly diminish the SG&A expenses, until it reaches the historical levels of 28.3%, consequently increasing its EBITDA margin to 11.5% in ,8 Funding 147,5 165,4 186,1 This strong investment plan is backed up by a financial plan divided in several steps. The first phase started in April 2012 and considered the restructuring of liabilities, with a significant expansion in terms of maturity. In November 2012 the most significant step was taken: for the first time in the company s history, bonds were placed in a successful operation for an amount of over CLP 22 billion. For this reason we believe that the company maintains a strong financial position and is ready to execute an aggressive expansion plan throughout The expected 2013 NFD/Equity ratio of 0.5 and EBITDA/Interest Expense of 9.7x present some room when compared to current covenants (DFN/Equity 1.5x and EBITDA/Int. Exp. 3.0x), which are of similar magnitues the to rest of the industry.

5 Financial Business Revenues Financing Business Hites value is mainly based on its financing business, which accounted for 71.3% of Hites EBITDA throughout 2012 and 87.7% in Unlike other retailers, which have a balanced mix between its different business lines, the operational margins of Hites come almost completely from its financing business. In our forecast, Hites will continue to depend on this business to make its operations profitable, since there are no growth drivers in retail results that could significantly impact the mix. The financing business is more similar to the operation of a bank than a retail company. It is necessary to understand its operations as if it were a banking entity, dedicated to providing consumer loans to the store customers. The focus is to sell loans to clients with lower incomes and high risk of non-payment level, who pay high interest rates for the loans taken with the company, close to the Conventional Maximum Rate (TMC in Spanish), a cap on interest rates enforced in Chile. Commissions are added to this interest charge, totaling approximately an extra 20% over the total loan book. These administrative commissions are agreed in an annual amount in UFs, but are charged as a sales percentage, reason for which they should suffer no impact in the case of freezing of the annual amount by the regulator. To manage the risks of this portfolio, Hites has implemented several policies. In the first place, the loan periods are brief, usually less than a year. Consequently, any debt that cannot refinanced will be written off, and its effect reflected in financial statements. Secondly, the company is evaluating historic payment to determine maximum loan size. Finally, the write-off policies for the loan book are strict and loans are rotated relatively quickly, written-off and assumed as loss. The costs of financing these loans are assumed partly with company equity and through bank loans, which are obtained at an average yearly rate of 9.5%, our WACC for Hites financing business. In order to model the company, we have analyzed this business area separately, estimating the flows for each business line, to determine the contribution each one makes to the company in terms of value. Loan Book Growth ,0% % 32% 24% Loan Book Our placement growth forecast is indexed to the growth of the sales in the retail business. Hites loan book size is only possible because of the retail business sales, since it would be rather difficult to maintain sustained loan growth over the retail business expansion level. Due to the latter, our estimated growth of SSS and expansion of the number of stores determine the evolution of the portfolio. In addition, we have assumed that this business should take a slightly longer period to reach an equilibrium level of penetration, as many new stores that will open between 2013 and 2014 should contribute to loan growth in 2015 and % 40 9,2% 11,1% 6,5% 5,5% 8% 0 0,3% 0%

6 Financial Business: Active Customers Thousands Q Q Q Q Q Q Q Q 2012 Financial Business - Gross Margin Margins The gross margin is explained mainly by the expenses in provisions and necessary write offs throughout this period. Margins are sensitive to two key variables: the interest rate of the placements and the level write offs. In the case that Hites were forced to reduce its placement interest rates, 1% less interest rate spread would mean an approximate reduction of 5%-6% in the EBITDA reported in the financial business. In our forecasts, the EBITDA growth towards 2016 is moderate, due to increasing expenses in provisions. This is because we have estimated a long-term level slightly higher than the historic average of the portfolio, a 13% instead of a 12% from the whole of the placement portfolio. This will enable Hites to get closer to a provision / write off ratio near to 0.5 times 30 Source: Company Reports, CorpResearch Financial Business - EBITDA 40 Interest margins are expected to drop in the following years as a consequence of greater regulation to retail companies with financial operations. This, in addition to the SG&A growing at moderate rates, in line with higher salaries and inflation, will mean a fairly stable EBITDA of the financial business until 2015, and a similar behavior to the retail sales from 2016 onwards. Growth of the financial business will go hand in hand with the increases in the retail business over the long term ,7 28, ,7 19,0 20,6 21, Source: Company Reports, CorpResearch

7 Provisions % of Loan Book ,7% 14,1 13,0% 13,0% 12,5% 12,5% 12,0% 16,4 17,3 20,0 22,1 23,3 Write-offs % of Loan Book ,7% 25,8 26,8% 27,6% 26,4% 26,4% 24,8% 32,7 38,5 44,1 44,9 47,4 16% 12% 8% 4% 0% 30% 25% 20% 15% 10% 5% Portfolio Risk The provision level that Hites needs to face write offs is high but historically the business model has been able to absorb its high level successfully. Throughout 2012, we noticed a significant rise in write offs as a consequence of the elimination of debtor registries, known as the Dicom Law. We expect that write off levels remain high throughout 2013 but lower than in 2012, and continue falling towards This will contribute to lifting the financial business results and will be enough to compensate higher SG&As and narrower margins. For this reason, the EBITDA does not grow at the same rates as income, recovering in Regarding refinanced loans, they account for 21.9% of the loan book by the end of This percentage increased 560 basis points since 2011, when the rate was 16.3%. This increase has been associated to the rise in write offs throughout 2012, and just like it was stated in our write off forecast; we expect that the refinancing levels remain high but with a tendency to fall. We believe that Hites portfolio is fairly risky. However, if the Chilean macroeconomic environment remains positive and growth of real salaries stays fairly strong, as our economic forecast expects, the company should be able to maintain its business model, even though the mid-term growth is limited by the physical area increase of the POS. Financial Business: Average Debt per customer CLP Thousands % 1Q Q Q Q Q Q Q Q 2012 Financial Business: Average Term Days Q Q Q Q Q Q Q Q 2012

8 Valuation Retail - EBITDA 7,7 8,7 9,6 10,0 10,6 We have valued the company using the discounted cash flow (DCF) model. Given the positive economical perspectives for the country and the strong leadership of the company in the socioeconomic segments C3-D, we confirm the investment appeal for Hites. The company currently has a USD 200 million Capex from 2013 to 2015, which would double the number of stores by December 2015, in comparison to December Of the total investment, 40% will be allocated to the opening of new stores in the Metropolitan region and the remaining 60% for other regions inside Chile. A 36% increase in company revenues is expected as a result of the expansion relative to December 2012, reaching CLP 346 billion by The sales per square meter should increase from CLP 1.9 million in 2012, as a cause of the 2-year maturity period of the stores and the economy s dynamism, to CLP 2.2 million in ,1 We expect that SG&As are raised in 50 base points throughout 2015, in comparison to December 2012, as a consequence of the opening of the mentioned 12 stores in the country. In addition to the development of new logistic projects aimed at increasing product repositioning, jointly with the new storage capacity enlargement. This means doubling warehousing size in order to reach the storage room level required for such an operation. This will cause slower growth of the EBITDA margin, which will rate 10% in 2013 and at the beginning of 2014; a situation that we hope will normalize gradually until it reaches EBITDA margin of 11.3% in All previous data will lead to an increase of earnings, which will reach CLP 21,500 million in According to current rating, Hites S.A shares display an EV/EBITDA 2013E multiple of 8.4x, in alignment with the historic average of the last three years: 7,5x, and a multiple of P/U 2013E of 11,2x, positioned above the historical average 10.2x of the company.

9 Glossary Term Definition / Translation Calculation EBITDA EBITDAR Earnings Before Interests, Taxes, Depreciation and Amortization Earnings Before Interests, Taxes, Depreciation, Amortization and Rents Operational Income plus Depreciation and Amortization Operational Income plus Depreciation and Amortization plus rent of fixed assets. It is used the at transport industries to reverse the rent of airplanes or ships. EV Enterprise Value Market capitalization plus Net Financial Debt plus Minority Interest EV/EBITDA Valuation multiple. While greater it is, more expensive it is the stock EV divided by Ebitda FCF Free Cash Flow Operational Income plus Depreciation and Amortization minus tax minus capital expenditures plus (minus) working capital variation. Free-float Margin Operational Ebitda Net Percentage of stocks that can be freely traded in the market Percentage of sales Percentage of stock that does not belong to controller s shareholders. Operational Income / Revenue Ebitda / Revenue Net Income / Revenue P/E Price / Earnings Market Price divided by EPS P/B Price to Book value ratio Market price divided by the accounting value of the stock. Dividend Yield The return in terms of dividends of investing in equities Dividends distributed in a year divided by the market price. FCF yield Free Cash Flow Return. FCF / Market Price ROA Return on Assets Net Income / Total Assets ROE Return on Equity Net Income / Accounting capitalization EPS Earnings Per Share Net Income / Shares outstanding YtD Year to Date Percentage variation year to date x Times Stocks recommendations are established according to the stock yield relative to the IPSA Index. We recommend Hold when we expect the share to have a yield in line with the IPSA; Buy, when the yield expected for the share is above to that expected for the IPSA; and Sell, when the yield expected for the share is below to that expected for the IPSA. We define a yield to be In line with the IPSA when it is within a range whose scope is equivalent to a third of the variation expected for the index, with a 5% minimum. Hites - M Josefina Güell May, 14th 2013

10 CorpResearch Álvaro Donoso Director CorpResearch Economic Research Sebastián Cerda Executive Director CorpResearch & Economic Studies Nicolás Birkner Chief Economic and Financial Analyst Natalie Charles Senior Analyst Investment Strategies Karla Flores Economic Analyst Equities Research Cristobal Lyon Director of Strategies Vicente Meschi Senior Analyst. Sectors: Banking, Forestry Sergio Zapata Senior Analyst. Sector: Energy Pedro Letelier Analyst. Sectors: Transport, Telecommunications and Food & Beverages Josefina Guell Analyst. Sector: Retail Patricio Acuña Analyst. Rosario Norte th floor, Las Condes, Santiago. Phone

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