SK Innovation (096770)

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1 SK Innovation (096770) Hold (Initiate) Stock price (Oct 8, KRW) 146,000 Market cap (USD mn) 12,573 Shares outstanding (mn) 92 52W High/Low (KRW) 182,000/128,500 6M avg. daily turnover (USD mn) 44.3 Free float (%) 66.0 Yr to Sales OP EBT NP EPS % chg EBITDA PE EV/EBITDA PB ROE Dec (W bn) (W bn) (W bn) (W bn) (KRW) (YoY) (W bn) (x) (x) (x) (%) 2011A 68,371 2,959 4,309 3,169 34, , A 73,330 1,699 1,689 1,185 12,720 (62.6) 2, F 69,273 1,860 1, ,596 (16.7) 2, F 69,350 1,490 1, ,964 (6.0) 2, Foreign ownership (%) F 70,314 1,464 1, ,682 (2.8) 2, Note: NP and EPS attributable to controlling interest Innovation underway, but pace is still slow Performance 1M 6M 12M Absolute (%) 2.5 (3.9) (8.5) Rel. to Kospi (%p) 0.0 (8.3) (9.5) 12MF PB trend (X) (W' 000) MF PBR (LHS) 50 price (RHS) 0 Nov-08 Nov-10 Nov-12 Recommend Hold: We initiate coverage on SK Innovation with a Hold rating. We believe the company is heading towards innovation given diversified growth drivers, such as information/electronic (I&E) materials and exploration/production (E&P), compared to other oil refiners. But in the short term, we see downside risk, given: 1) a falling complex margin in percentage terms compared with Dubai crude, 2) weak prices of key refined products, such as gasoline, and 3) a narrowing BTXnaphtha spread while its BTX facility will be on stream in earnest in Our sum of the parts-based fair value is W135,000, offering a limited upside. Our analysis shows a close correlation between the SotP-based fair value and actual share performance. Our fair price equates to 13.6x 2014F PE and 0.7x 2014F PB, the lower end of the historical range. We recommend a conservative approach. 3Q13 to be slightly better QoQ: 3Q13 results should improve slightly from 2Q13 with sales of W17.1tn (+1.6% QoQ, -7.2% YoY) and OP of W437.4bn (+10.8% QoQ, -50.5% YoY). But our estimates are still less than the consensus as we reflected a 47% decline in the one-month lagging Singapore complex margin (key OP variable) in September and the cracking margin drop. The petrochemical division should post the biggest sales growth of 5.0% QoQ while the refining and lubricant sales should edge up 0.9% QoQ and 2.0% QoQ, respectively. 2014, a preparatory year for competitiveness rebuilding: We attribute the 3Q13 earnings growth to a low base, and forecast a short-term earnings slowdown from 4Q13. Our downbeat forecast is due to the following: 1) refining OPM is not likely to recover in 2014 given decline in the complex margin-to-dubai crude price ratio. 2) The gasoline price should stay weak through 1Q14 with the end of the summer driving season. 3) Petrochemical OPM should not improve significantly either given the narrowing spread of BTX, its main petrochemical product. Total OP should fall 19% YoY to W1.55tn in Matthew Yang matthew.yang@truefriend.com Bohwa Hong bohwa.hong@truefriend.com Rechargeable battery and I&E materials to deliver visible results: SK Innovation is scaling up the non-petroleum business, which should serve as a growth driver over the long term. The rechargeable battery and I&E material businesses are particularly noteworthy as they deliver visible outcome. For automobile-use rechargeable batteries, the company plans to expand capacity by 33% to 300MWh at the Seosan plant. Cumulative sales of rechargeable battery separators totaled W600bn since 2005, and global market share reaches 19%. For the I&E material division, the company began full-fledged sales of two-layer flexible copper clad laminate (FCCL), a material for flexible printed circuit board (FPCB). SK Innovation s FCCL production capacity will top the domestic industry, supplanting Doosan Electronics, when the no. 2 facility goes online in

2 Table 30. SotP valuation (W bn) Current NAV Note EBITDA EV/EBITDA Operating value (A) 16,199 SK Innovation 4, mn bbl in reserves, USD3/bbl, 40% discount SK Energy 4, F global refiners avg SK Global Chemical 5, F global chemical firms avg SK Lubricants 1, F global lubricant frms avg Investment asset value (B) % discounted to BV Net debt (C) 4,264 Based on 2013 half-year Enterprise value (A+B-C) 12,411 No. of shares outstanding (mn) 92.5 Market cap 13,500 Based on October 8 close Discount to EV (%) 9% Fair price (KRW) 135,000 Source: Korea Investment & Securities Table 31. Quarterly earnings by business (W bn) 1Q13 2Q13 3Q13F 4Q13F 1Q14F 2Q14F 3Q14F 4Q14F F 2014F Sales 18,214 16,853 17,130 17,182 17,513 17,023 17,070 17,744 73,330 69,273 69,350 SK Innovation (E&P) ,269 1,257 1,304 SK Energy (refining) 13,884 12,720 12,837 12,965 13,082 12,634 12,706 13,416 56,589 52,407 51,838 SK Global Chemical (petrochemical) 3,285 3,137 3,294 3,203 3,409 3,339 3,337 3,219 12,571 12,918 13,304 SK Lubricants (lubricant) ,901 2,796 2,904 % of total sales SK Innovation (E&P) 1.7% 1.9% 1.8% 1.9% 1.8% 1.9% 1.8% 2.0% 1.7% 1.8% 1.9% SK Energy (refining) 76.2% 75.5% 74.9% 75.5% 74.7% 74.2% 74.4% 75.6% 77.2% 75.7% 74.7% SK Global Chemical (petrochemical) 18.0% 18.6% 19.2% 18.6% 19.5% 19.6% 19.5% 18.1% 17.1% 18.6% 19.2% SK Lubricants (lubricant) 4.0% 4.0% 4.1% 4.0% 4.1% 4.2% 4.2% 4.2% 4.0% 4.0% 4.2% OP ,699 1,860 1,490 OPM (%) 3.8% 2.3% 2.4% 2.1% 1.9% 1.7% 2.5% 2.5% 2.3% 2.7% 2.1% EBT ,689 1,380 1,250 EBT margin (%) 2.2% 2.0% 2.0% 1.7% 1.5% 1.4% 2.1% 2.2% 2.3% 2.0% 1.8% NP of controlling interest , NPM (%) 1.4% 1.5% 1.5% 1.3% 1.1% 1.0% 1.6% 1.6% 1.6% 1.4% 1.3% 61

3 Figure 103. Sales by business (2014) Figure 104. OP by business (2014) Petrochem 19% Lubricants 4% Innovation 2% Lubricants 18% Innovation 12% Energy 25% Energy 75% Petrochem 45% Figure 105. SotP fair value vs. actual share price Figure 106. PB band 300,000 (KRW) Upside (R) TP Share price 100% (X) ,000 80% % 200, ,000 40% 20% Avg +1std 100,000 0% 1.0 Avg 50,000-20% -40% 0.5 Avg -1std %

4 Table 32. Overview of automobile-use rechargeable battery business Date January 2009 April 2010 July 2010 February 2011 July 2011 May 2012 September 2012 January 2013 July 2013 End-2013 Details Signed a contract with Mitsubishi Fuso & CT&T Signed an MOU to supply EV batteries to China as a JV with CT&T, SK China and Beijing Automotive Group Tested batteries jointly with the US Advanced Battery Consortium (USABC) for one year Selected as an exclusive lithium battery provider to Hyundai Motor Company in the government s electric vehicle project Signed a contract with Daimler (Mercedes-Benz s SLS AMG E-Cell) Selected as a supplier for the Hyundai BlueOn electric vehicle Selected as a supplier for the Kia s Ray electric vehicle Sales started for Canter Eco-hybrid, a hybrid diesel electric commercial truck jointly developed with Mitsubishi Fuso, Construction completed for the rechargeable battery plant in Seosan (200MWh) Established SK Continental E-motion Set up a JV with Beijing Automotive Group and Beijing Electric Works Scheduled to complete 100MWh capacity addition to the Seosan battery plant Source: Company data, press release, Korea Investment & Securities Table 33. I&E material business overview Product Details Rechargeable battery separators Lithium-ion battery separator (LiBS) A separator between cathode and anode in lithium ion rechargeable batteries; a key material to ensure stable electricity storage and production Progress Cumulative sales of over W600bn since it entered into commercial production in 2005; global market share of 19% Production capacity IT purpose: Cheongju plant (58mn m 2 /year), Jeungpyong plant (72mn m 2 /year) Electric vehicle purpose: Completed construction of the No. 67 production line with capacity of 57.7mn m 2 /year, which is sufficient to supply for 190,000 units of pure electric vehicles, in 2012 Sales should reach USD3.7bn (or W4.10tn) led by mid/large-sized battery separators in 2020, five times greater than Market outlook and goals USD660mn in 2010 Plans to establish position as a global major producer with setting up the No. 8 and No. 9 lines by 2014 Tri-acetyl cellulose (TAC) film LCD polarizer protective films Progress Product certification process is underway after test-run of production line Production capacity 54mn m 2 /year (sufficient to supply for 100mn units of 42-inch TV) Market outlook and goals Currently, Korea imports most of demand from Japan; Likely to grow fast by serving domestic demand Production based on advanced technology; Japan s Fujifilm and Konica Minolta together command more than 90% shares of the global market Aims to lower dependence on imported films by emerging to the world s top three position in the TAC film market FCCL A raw material for FPCB used in small-sized electronic devices Progress No. 1 FCCL line went on stream in August 2011 Supplied to Nippon Mektron, the world s no. 1 circuit board maker, in 1H12 In April, the company decided to augment No. 2 FCCL line with W90bn in capex for start of commercial production in 2014 Production capacity 3.5mn m 2 /year FCCL capacity should total 9mn m 2 /year when the No. 2 FCCL line goes online in 2014 Market outlook and goals Aims to emerge as the world s biggest FCCL maker by 2020 via continued capacity additions Green polymer CO2 based polymer Environmentally-friendly catalyzing technology that converts CO2 to polymer Progress Completed to build a pilot plant in 2009 Aims to start production in 2014 after entering into R&D for commercial production in 2013 Market outlook and goals An alternative to PVC with projected market size of W26tn in 2025 Aims to expand capacity to more than 2mn tonnes in 2020 and run W5tn environmentally-friendly new material business Green coal Clean coal energy Production of synthetic natural gas from low-priced coal Progress Entered into technology development in earnest in 2008 Singed an MOU with the Ministry of Knowledge Economy, POSCO, Korea Institute of Energy Research Institute and Institute for Advanced Engineering in July 2009 and related projects are underway since 2012 Bio-ethanol Bio-ethanol A bio-fuel made by fermentation of renewable feedstocks, mainly crops such as sugar beat, wheat, corn, potato and barley, and used as a fuel additive Progress After starting R&D for bio-butanol in 2008, the company switched its R&D focus to bio-ethanol due to low feasibility Source: Company data, press release, Korea Investment & Securities In joint R&D with KIST; Plans to continue R&D investment 63

5 Balance sheet FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F Current assets 19,887 17,885 16,166 15,835 15,660 Cash & cash equivalent 4,380 2,829 1, Accounts & other receivables 6,755 6,502 6,143 6,149 6,235 Inventory 7,482 6,759 7,662 7,670 7,777 Non-current assets 15,140 15,946 18,284 18,910 20,436 Investment assets 2,353 2,221 2,221 1,620 1,602 Tangible assets 11,377 12,204 13,808 14,609 15,812 Intangible assets 1,206 1,364 1,364 1,364 1,364 Total assets 35,027 33,831 34,450 34,745 36,096 Current liabilities 14,305 12,025 12,357 12,206 12,365 Accounts & other payables 9,934 8,472 8,749 8,789 8,918 ST debt & bond 2,782 1,538 1,528 1,326 1,326 Current portion of LT debt 1,101 1,767 1,824 1,833 1,860 Non-current liabilities 5,890 5,458 5,446 5,207 5,749 Debentures 3,669 3,368 3,360 3,213 3,547 LT debt & financial liabilities 1,315 1,240 1,238 1,183 1,307 Total liabilities 20,195 17,483 17,803 17,413 18,114 Controlling interest 14,577 15,371 16,362 17,029 17,660 Capital stock Capital surplus 5,886 5,885 5,885 5,885 5,885 Capital adjustments (144) (128) (128) (128) (128) Retained earnings 8,203 9,115 9,845 10,511 11,142 Minority interest Shareholders' equity 14,832 16,348 16,647 17,332 17,982 Income statement FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F Sales 68,371 73,330 69,273 69,350 70,314 COGS 63,551 69,744 65,477 65,779 66,740 Gross profit 4,820 3,586 65,477 65,779 66,740 SG&A expense 1,860 1,887 1,936 2,080 2,109 Operating profit 2,959 1,699 1,860 1,490 1,464 Financial income 2,705 2,165 1,659 1,652 1,675 Interest income Financial expense 2,737 2,324 2,551 2,426 2,459 Interest expense Other non-operating profit 1, Gains (Losses) in associates, subsidiaries and JV Earnings before tax 4,309 1,689 1,380 1,250 1,215 Income taxes 1, Net profit 3,176 1,182 1, Net profit of controlling interest 3,169 1, Other comprehensive profit 166 (226) Total comprehensive profit 3, , Total comprehensive profit of controlling interest 3,323 1, EBITDA 5,197 2,540 2,333 2,203 2,106 Cash flow FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F C/F from operating 2,722 1,162 1,407 1,691 1,483 Net profit 3,176 1,182 1, Depreciation Amortization Net incr. in W/C (13) (520) (266) 25 (64) Others (1,047) (125) (166) (97) (108) C/F from investing 814 (2,462) (2,708) (1,354) (2,031) CAPEX (1,192) (1,458) (1,603) (802) (1,203) Decr. in fixed assets Incr. in investment (187) (877) (1,198) (599) (899) Net incr. in intangible assets (182) (223) (3) (2) (2) Others 2, C/F from financing (2,085) (242) (319) (684) 168 Incr. in equity Incr. in debts (1,880) (805) (21) (403) 458 Dividends (199) (264) (298) (281) (290) Others (6) 20 0 (0) 0 C/F from others (4) (25) Increase in cash 1,447 (1,567) (1,621) (347) (380) Key financial data FY-ending Dec. 2011A 2012A 2013F 2014F 2015F per share data (KRW) EPS 34,004 12,720 10,596 9,964 9,682 BPS 157, , , , ,805 DPS 2,800 3,200 3,200 3,200 3,200 Growth (%) Sales growth (5.5) OP growth 30.5 (42.6) 9.5 (19.9) (1.8) NP growth (62.6) (16.7) (6.0) (2.8) EPS growth (62.6) (16.7) (6.0) (2.8) EBITDA growth 78.6 (51.1) (8.1) (5.6) (4.4) Profitability (%) OP margin NP margin EBITDA margin ROA ROE Dividend yield Stability Net debt (W bn) 4,226 4,126 6,532 6,485 7,350 Debt/equity ratio (%) Valuation (X) PER PBR PSR EV/EBITDA Note: Based on K-IFRS (consolidated) 64

6 Guide to Korea Investment & Securities Co., Ltd. stock ratings based on absolute 12-month forward share price performance BUY: Expected to give a return of +15% or more Hold: Expected to give a return between -15% and +15% Underweight: Expected to give a return of -15% or less Korea Investment & Securities does not offer target prices for stocks with Hold or Underweight ratings. Guide to Korea Investment & Securities Co., Ltd. sector ratings for the next 12 months Overweight: Recommend increasing the sector s weighting in the portfolio compared to its respective weighting in the Kospi (Kosdaq) based on market capitalization. Neutral: Recommend maintaining the sector s weighting in the portfolio in line with its respective weighting in the Kospi (Kosdaq) based on market capitalization. Underweight: Recommend reducing the sector s weighting in the portfolio compared to its respective weighting in the Kospi (Kosdaq) based on market capitalization. Analyst Certification I/We, as the research analyst/analysts who prepared this report, do hereby certify that the views expressed in this research report accurately reflect my/our personal views about the subject securities and issuers discussed in this report. I/We do hereby also certify that no part of my/our compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report. Important Disclosures As of the end of the month immediately preceding the date of publication of the research report or the public appearance (or the end of the second most recent month if the publication date is less than 10 calendar days after the end of the most recent month), Korea Investment & Securities Co., Ltd., or its affiliates does not own 1% or more of any class of common equity securities of the companies mentioned in this report. There is no actual, material conflict of interest of the research analyst or Korea Investment & Securities Co., Ltd., or its affiliates known at the time of publication of the research report or at the time of the public appearance. Korea Investment & Securities Co., Ltd., or its affiliates has not managed or co-managed a public offering of securities for the companies mentioned in this report in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates has not received compensation for investment banking services from the companies mentioned in this report in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates does not expect to receive or intends to seek compensation for investment banking services from the companies mentioned in this report in the next 3 months. Korea Investment & Securities Co., Ltd., or its affiliates was not making a market in securities of the companies mentioned in this report at the time that the research report was published. Korea Investment & Securities Co., Ltd. does not own over 1% of Samsung Fine Chemicals,Hanwha Chemical,Lotte Chemical,Kumho Petrochemical,LG Chem,S- Oil,GS Holdings,SK Innovation shares as of October 9, Korea Investment & Securities Co., Ltd. has not provided this report to various third parties. Neither the analysts covering these companies nor their associates own any shares of as of October 9, Korea Investment & Securities Co., Ltd. has issued ELW with underlying stocks of Lotte Chemical,Kumho Petrochemical,LG Chem,S-Oil,GS Holdings,SK Innovation and is the liquidity provider. Prepared by: Matthew Yang This report was written by Korea Investment & Securities Co., Ltd. to help its clients invest in securities. This material is copyrighted and may not be copied, redistributed, forwarded or altered in any way without the consent of Korea Investment & Securities Co., Ltd. This report has been prepared by Korea Investment & Securities Co., Ltd. and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. We make no representation as to its accuracy or completeness and it should not be relied upon as such. The company accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. The final investment decision is based on the client s judgment, and this report cannot be used as evidence in any legal dispute related to investment decisions.

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