New merchandise to prop up results

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1 Korea/Pharmaceuticals Daewoong Pharmaceutical Earnings preview BUY 12 July 2010 BUY BUY BUY 4 May Apr Mar 2010 Ji-Won Shin, Korea Pharmaceuticals Analyst, jwshin@miraeasset.com New merchandise to prop up results For 1Q FY10 (March-end fiscal year), Daewoong Pharmaceutical is expected to post sales of W176.4bn and operating profit of W21.6bn, in line with market consensus (sales of W169.2bn and operating profit of W21.2bn). It is, however, expected to turn in a net loss, due to a corporate tax bill of approximately W28.4bn, imposed after a tax investigation. FY10 earnings will be driven by the sales contribution of OTC drugs licensed from Boehringer Ingelheim Korea, and strong control of SG&A costs. Concerns exist over Olmetec, the company s main drug, as the US FDA is undertaking a safety review of Olmesartan (the active ingredient in Olmetec), but its impact is unknown thus far, pending the results of the review. Given that the 1Q FY10 net loss was a one-off due to the tax investigation, we maintain our Buy rating and target price of W70,000. Target price W70,000 Current price (9 July 2010) W41,950 Upside/downside 66.9% Consensus target price W70,500 Difference from consensus -0.7% Forecast earnings & valuation Fiscal year ending Mar-09A Mar-10A Mar-11E Mar-12E Revenue (KRWm) 547, , , ,147 Op EBIT (KRWm) 43,198 74,701 92, ,346 Net income (KRWm) 32,877 49,467 44,171 77,285 Norm profit (KRWm) 32,877 49,467 44,171 77,285 EPS (KRW) 3,074 4,622 4,125 7,217 EPS growth (44.5%) 50.3% (10.8%) 75.0% Norm P/E (x) EV/EBITDA (x) Dividend yield 1.79% 0.00% 1.74% 1.48% P/B (x) ROE 11.1% 15.0% 11.8% 17.8% Net debt/equity 24.6% (9.9%) (10.4%) (21.8%) Cons EPS (KRW) 3,074 4,622 5,807 6,686 Prev EPS (KRW) 3,155 5,055 5,646 6,465 Earnings quality score Sector Average: 55» 1Q FY10 results expected to satisfy Street expectations» Sales contribution of newly introduced items» Fall of Olmetec to be offset by the rise of Sevika Earnings Quality Score Historical Earnings Stability Consensus Forecast Certainty Consensus Forecast Accuracy » Buy rating and target price of W70,000 maintained Performance 1Q FY10 results expected to satisfy Street expectations For 1Q FY10 (March-ending fiscal year), Daewoong is expected to post sales of W176.4bn and an operating profit of W21.6bn, in line with market consensus (sales of W169.2bn and an operating profit of W21.2bn). Operating margin is estimated at 12.2%, helped by the sales contribution of seven OTC drugs (including Mucopect and Dulcolax) licensed from Boehringer Ingelheim Korea, and strong control of SG&A costs, despite a rise in the cost-to-sales ratio, following a merchandise sales increase. Meanwhile, the company is expected to turn in a net loss, due to corporate tax amounting to approximately W28.4bn, imposed after a tax investigation. Hedge fund investors Investors should keep an eye on the results from Olmesartan s US FDA review Long-only investors Not only does the company release new drugs of its own each year, but it also licenses overseas drugs for sale in the Korean market. By doing so, Daewoong Pharmaceutical now boasts a well-diversified product line-up See the last page of this report for important disclosures Price Close Relative to.ks11 (RHS) 72,000 67, , , , , , , Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Trading data Market cap (Wbn/US$mn) 395.8/324.0 Shares outstanding 10.71mn Free float 41% 52-week price high/low W40,300 66,800 Daily average turnover (3M) US$0.80mn Performance 1M 3M 12M Absolute -15.1% -16.8% -23.7% Relative to KOSPI -18.2% -15.3% -42.4% Absolute (US$) -14.3% -23.8% -20.6% Major shareholders Daewoong Corp. 40.3% Source for data: Company, Thomson Reuters, Mirae Research estimates 1

2 Sales contribution of newly introduced items Daewoong Pharmaceuticals is in charge of distribution and sales of seven OTC drugs of Boehringer Ingelheim Korea, which were previously overseen by Zuellig Pharma. Combined sales of the seven drugs came in at roughly W20.0bn in Together with Korea Vaccine, the firm also took over domestic distribution of Prevenar 13, an infantile pneumococcus vaccine, released by Pfizer Korea in June. We expect the company to log over W30.0bn in sales from the vaccine this year. Following the expansion of its new drug line-up, we forecast a greater sales contribution from new drugs, compared with that of existing major products. Fall of Olmetec to be neutralized by Olmetec compound Sevika Olmetec, the company s main drug, has recently come into the spotlight following the US FDA s announcement of a safety review of Olmesartan due to an unexpected finding of a higher rate of cardiovascular deaths in patients taking the drug. It is premature to predict the result of the safety examination and its impact on the domestic market. Prescription amounts of Olmetec have been down since 3Q09, as it has lost market share to competing new drugs. However, the losses are expected to be neutralized, to some degree, by increased prescriptions of Sevika, a newly released Olmetec compound. Prescriptions of Olmetec are projected to fall 5% YoY in FY10, to W79.7bn, but we should focus more on the contribution a varied drug line-up will have on sales. Buy rating and target price of W70,000 maintained As the company expressed its strong intention to cut marketing costs in 3Q09, we expect its FY10 operating profit to rise slightly on lower SG&A costs. In the company s R&D pipeline, a neuropathic pain reliever (DWP 05195) is scheduled to complete phase I clinical trials this month, and an accelerator of bond formation (BMP-2) is expected to enter phase III clinical trials this year. All other pipeline drugs are still in their seminal stages, requiring a mid- to longterm view. We believe the 1Q FY10 net loss is a one-off, stemming from a corporate tax imposed after a tax investigation. We maintain our Buy rating and target price of W70,000. 2

3 Summary financial statements Profit & Loss (KRWm) Mar-08A Mar-09A Mar-10A Mar-11E Mar-12E Revenue 484, , , , ,147 Cost of goods sold (223,960) (294,325) (322,038) (385,241) (408,855) Gross profit 260, , , , ,292 SG and A (186,036) (210,142) (217,011) (239,634) (244,946) Op profit 74,246 43,198 74,701 92, ,346 Op EBITDA 85,531 54,916 88, , ,083 Depreciation (8,985) (9,898) (11,256) (11,509) (12,722) Amortisation (2,301) (1,820) (2,334) (2,628) (3,014) Op EBIT 74,246 43,198 74,701 92, ,346 Net interest 1,866 (587) (1,494) 1,480 2,542 Associates and JCEs 558 (923) (1,114) (1,479) (1,567) Other income 3,062 2,846 (814) 519 (6,233) Net exceptional income Profit before tax 79,732 44,534 71,279 93,044 99,088 Tax (20,749) (11,657) (21,812) (48,874) (21,803) Post-tax profit 58,983 32,877 49,467 44,171 77,285 Minorities Preferred dividends Net income 58,983 32,877 49,467 44,171 77,285 Norm profit 58,983 32,877 49,467 44,171 77,285 Dividends (7,298) (6,871) - (268) (535) Retained earnings 51,685 26,007 49,467 43,903 76,749 Cashflow (KRWm) Mar-08A Mar-09A Mar-10A Mar-11E Mar-12E Op EBITDA 85,531 54,916 88, , ,083 Decrease in working capital (39,670) (18,129) 18,159 (21,600) (6,733) Other operating cashflow 2,969 8,335 7,138 1,181 (6,524) Operating cashflow 48,831 45, ,588 86, ,825 Tax paid (20,749) (11,657) (21,812) (48,874) (21,803) Net interest 1,866 (587) (1,494) 1,480 2,542 Dividends received (3,762) (1,481) 3,626 (1,485) (1,573) Cashflow 26,185 31,397 93,908 37,364 85,991 Capital expenditure (36,595) (40,872) (18,724) (30,373) (28,605) Net acquisitions Net investments (5,303) 1,296 69,309 (644) 310 Other investing cashflow (1,787) (30,392) (48,727) - - Investing cashflow (43,685) (69,967) 1,858 (31,017) (28,295) Dividends paid (7,298) (7,298) (6,871) - (268) Increase in equity Increase in debt 28,162 67,501 (15,000) - - Other financing cashflow (20,000) (13,061) (2,994) - - Financing cash flow ,142 (24,865) - (268) Beginning cash 54,479 37,843 46, , ,663 Total cash generated (16,636) 8,572 70,901 6,347 57,428 Forex effects Ending cash 37,843 46, , , ,090 3

4 Balance Sheet (KRWm) Mar-08A Mar-09A Mar-10A Mar-11E Mar-12E Current assets 228, , , , ,787 Cash and equivalents 37,843 46, , , ,090 Receivables 91,148 99,605 95, , ,245 Inventories 72,597 77,561 83,121 97, ,676 Other current assets 26,889 33,097 15,896 13,283 13,775 Non current assets 158, , , , ,583 Net operating fixed assets 112, , , , ,513 Interest in associates 27,342 27,901 23,161 23,167 23,173 Other non-current ssets 18,533 59,445 22,941 24,589 26,896 Total assets 386, , , , ,370 Current liabilities 85, , , , ,094 Payables 39,272 42,415 47,409 55,415 58,562 ST debt - 15,000 33,870 33,870 33,870 Other current liabilities 46,192 44,549 42,192 40,175 42,661 Total non-current liabilities 37, ,229 58,812 58,812 58,812 LT debt 29,604 98,501 52,487 52,487 52,487 Other non-current liabilities 8,084 5,728 6,325 6,325 6,325 Total liabilities 123, , , , ,905 Issued capital 24,696 25,381 26,068 26,068 26,068 Share premium reserve 104, , , , ,319 Reserves/Adjustments Retained earnings 154, , , , ,505 Minorities Other equity (19,749) (35,894) (36,429) (36,429) (36,429) Shareholders' equity 263, , , , ,464 Key Ratios Mar-08A Mar-09A Mar-10A Mar-11E Mar-12E Turnover growth 20.9% 13.1% 12.1% 16.9% 5.7% Gross profit growth 17.8% (2.7%) 15.1% 13.9% 5.2% Operating profit growth 10.7% (41.8%) 72.9% 23.9% 12.8% EBITDA growth 17.4% (36.2%) 51.9% 22.4% 6.2% EPS growth 21.6% (44.5%) 50.3% (10.8%) 75.0% Norm BPS growth 22.3% 8.6% 13.4% 12.5% 19.5% Gross margin 53.8% 46.3% 47.5% 46.3% 46.1% Operating margin 15.3% 7.9% 12.2% 12.9% 13.8% EBITDA margin 18.4% 10.4% 14.1% 14.7% 14.8% EBIT margin 16.1% 8.2% 11.9% 12.8% 12.7% Net income margin 12.2% 6.0% 8.1% 6.2% 10.2% ROE 22.9% 11.1% 15.0% 11.8% 17.8% ROA 16.6% 7.6% 10.1% 8.5% 13.1% Net debt/equity (3.1%) 24.6% (9.9%) (10.4%) (21.8%) Interest cover ratio Dividend payout ratio 12.4% 20.9% 0.0% 0.6% 0.7% Inventory days Account receivable days Account payable days Reported EPS (KRW) 5,537 3,074 4,622 4,125 7,217 EPS (KRW) 5,537 3,074 4,622 4,125 7,217 Reported BPS (KRW) 26,612 28,897 32,765 36,874 44,068 Norm BPS (KRW) 26,612 28,897 32,765 36,874 44,068 DPS (KRW) Cashflow per share (KRW) 2,458 2,936 8,774 3,489 8,030 Reported P/E (x) Norm P/E (x) P/B (x) P/CF EV/EBITDA (x) EV/Operating Cashflow (x) EV/Sales (x) Dividend yield 1.91% 1.79% 0.00% 1.74% 1.48% 4

5 Recommendations By stock (12 months) Buy: A target price + 10% or more above the current price, Hold: Target price within - 10% to +10% of the current price Reduce: A target price of 10% or less below the current price By industry Overweight: over +10% of the current industry index Neutral: -10% to +10% of the current industry index Underweight: -10% or less than the current industry index Earnings quality score Earnings Quality Score = 0.70*(Historical Earnings Stability) *(Consensus Forecast Certainty) *(Consensus Forecast Accuracy) 1. Historical Earnings Stability - The variability of the net profit growth rate (YOY) over the last 20 quarters was translated into percentage terms. - Earnings growth variability was calculated based on MAD (Median Absolute Deviation), rather than SD (Standard Deviation) in order to minimize distortion from outliers. - The lower the earnings growth variability, the higher this indicator. 2. Consensus Forecast Certainty - The gap between analysts' views on 12-month forward EPS was translated into percentage terms. - The gap is calculated by dividing the SD of 12-month forward EPS with the average value. - The narrower the gap is, the higher this indicator. 3. Consensus Forecast Accuracy - The median value of absolute EPS surprise over the last 3-year was translated into percentage terms. - EPS surprise was calculated based on 'the actual figure at the end of the year / the consensus estimate at the beginning of the year - 1'. - The lower the absolute EPS surprise, the higher this indicator. * Reference 1) Consensus Forecast Certainty and Consensus Forecast Accuracy were applied only to companies with more than 5 years of EPS estimates. 2) We gave the average score of 50 to cases in which the aforementioned indicators could not be produced. 5

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