Hugel (145020) Earnings Review. Record earnings but concerns over botulinum toxin strain origins

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1 Earnings Review October 27, M rating BUY (Maintain) 12M TP W615, from W615, Up/downside +84% Stock Data KOSPI (Oct 26, pt) 2,14 Stock price (Oct 26, KRW) 334,1 Market cap (USD mn) 968 Shares outstanding (mn) 3 52-Week high/low (KRW) 483,3/168,3 6M avg. daily turnover (USD mn) 12.4 Free float / Foreign ownership (%) 73.9/32.3 Major shareholders (%) Dongyang HC and 13 others 25.2 Byeong-Goen Kim and 1 others 8.4 Valuation 215A 216F 217F PE (x) PB (x) ROE (%) DY (%) EV/EBITDA (x) EPS (KRW) 13,361 14,195 17,772 BPS (KRW) 63,29 77,248 94,784 Performance 1M 6M 12M Absolute (%) (28.) Relative to KOSPI (%p) (26.4) MF PE trend (X) 12MF PER (LHS) (W' ) price (RHS) Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Source: WISEfn consensus Hugel (1452) Above In line Below Record earnings but concerns over botulinum toxin strain origins What s new: Record earnings again in 3Q16 Hugel posted 3Q16 sales of W33bn (+8.7% YoY) and OP of W18bn (+317.1% YoY). Botulinum toxin sales more than doubled to W19.9bn (+154% YoY) and filler sales surged to W9.8bn (+58% YoY), while domestic sales improved to W14.8bn (+22% YoY) and exports to W18bn (+195% YoY). Despite unfavorable seasonal factors, Hugel posted record earnings again on surging botulinum toxin sales. Fillers are sold in five countries, including Korea, but sales fell 25% QoQ on seasonality. Botulinum toxin is sold in 23 countries, and sales jumped 154% YoY or 4% QoQ, while OPM firmed 1.5%p to 54.6% on lower COGS and SG&A-to-sales ratios. Pros: High export growth to continue in 4Q16 Overseas demand for domestic botulinum toxin should continue to grow. Specifically, demand is growing on expanding salesforces in emerging markets, an increased interest in beauty and aging demographics. As such, export growth at Hugel, which started operating a new plant in April, should continue through 4Q16. Margins may climb higher on the rising export weighting as the ASP of botulinum toxin exports is 2% higher than the domestic ASP. Cons: Issues over botulinum toxin strain to persist Despite record earnings, Hugel shares have corrected 14% as the concerns over the origin of the botulinum toxin strain raised by competitors are intensifying. Of the seven global botulinum toxin products, three are from Korea and 4-5 more products are currently in development. The issues over origins of the botulinum toxin strain that began with Medytox are under parliamentary review over concerns of negligent supervision of high-risk pathogens and uncertainty if these products will win sales approval by the US FDA. If the origins of the strain are uncertain, there are concerns that not only would Korean approval be revoked but US approval would also be denied. The counterpoint is that the strain was developed on its own and drug safety and efficacy are not determined by the strain but by the development process, so the origins of the strain should not affect the licenses. Conclusion: Issue will not be resolved easily, but pullback excessive While the strain debate will not be resolved easily, shares have corrected 3% since 2Q16 earnings release. And, shares appear excessively cheap at 19x 217 PE. As such, we maintain BUY with a TP of W615,. (W bn, %, %p) Bora Chung bora.chung@truefriend.com Eunyoung Jung eunice.jung@truefriend.com 3Q16P Change 216F KIS est. Actual Diff. Consensus QoQ YoY KIS Consensus Sales OP OP margin EBT (67.) NP (73.9) 42 4 Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS AT THE END OF THIS REPORT.

2 Hugel (1452) Figure 1. Hugel annual sales and OP Figure 2. Product breakdown (Wbn) Sales OP (Wbn) Botulinum toxin Medical device Filler Other F 217F Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16F Source: Hugel, Korea Investment & Securities Source: Hugel, Korea Investment & Securities Figure 3. Hugel quarterly sales Figure 4. Hugel quarterly OP (Wbn) (Wbn) Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16F 1Q17F 2Q17F.1 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16F 1Q17F 2Q17F Source: Hugel, Korea Investment & Securities Source: Hugel, Korea Investment & Securities Figure 5. Hugel PE band Figure 6. Medytox PE band 6, (KRW) Price 12x 15x 19x 22x 28x (KRW) 8, Price 17x 25x 32x 41x 6x 5, 7, 4, 6, 5, 3, 4, 2, 3, 2, 1, 1, Dec-15 Mar-16 Jun-16 Sep-16 Source: Quantiwise, Korea Investment & Securities Source: Quantiwise, Korea Investment & Securities 2

3 Hugel (1452) Botox strain issue will not be resolved easily Botulinum toxin was discovered in Germany in the late-18 th century following several deaths due to rotten sausages. Therapeutic usage was first identified by a German doctor Kerner who began researching botulism. Dr. Schantz succeeded in refining and producing botulinum toxin. An ophthalmologist, Alan Scott, established the Oculinum (rights passed to Allergan) by using botulinum toxin to treat strabismus. And, the Carruthers family from Canada succeeded in clinical trials to treat forehead wrinkles, which is the foundation for current Botox treatments. Allergan s Botox was developed based on Oculinum, using the Hall strain from Wisconsin. This strain was found by Professor Hall in the US and donated to Wisconsin. Professor Kyu Hwan Yang brought this strain to Korea after studying abroad. It is known that products from Ipsen, Lanzhou institute and Medytox are developed from the Hall strain. In contrast, Daewoong Pharma (Daewoong) and Hugel received domestic sales approval with a strain found in a Yongin stable and rotten food, respectively. This issue started as three of seven botulinum toxin products are from domestic companies and currently 3~4 companies developing new products. The botulinum toxin business is protected by high entry barriers due to the difficulties finding a botulinum toxin strain that can be commercialized. However, for some reason multiple products are being developed in Korea. Due to doubts over the origins of botulinum toxin strain, Medytox has suggested an open debate with Hugel and Daewoong regarding the origins. Hugel and Daewoong are maintaining their position that the strain was found internally and that there are no problems in terms of safety or efficacy. Table 1. History of botulinum toxin strain and development status Strain Origin Product History Company Released year Progress type A Hall Wisconsin Professor Hall donated to University of Wisconsin type A Wisconsin Ophthalmologist Dr. Scott developed with Oculinum -> Acquired by BOTOX 1989 Hall(Allergan) type A Hall received from Wisconsin Allergan Sales worldwide type A Wisconsin British research group researching in Dysport Hall(NCTC2916) Wisconsin transferred rights to Ipsen Ipsen 1991 Sales worldwide type A Hall Wisconsin Chinese researcher in Wisconsin Sold in China and BTX-A Lanzhou 1996 developed after returning to China certain countries type A Hall Wisconsin 5 countries Professor Yang in KAIST developed after Meditoxin Medytox 26 excluding China and returning from University of Wisconsin US Hall ATCC352 ATCC Developed by a strain donated by Dr. Hall Xeomin Merz to ATCC in mid-19s 28 Sales worldwide Developed by Developed by Dr. Moon with strain found type A CBFC26 Botulax Hugel own in rotten food 29 Sold in 23 countries type A Hall Developed by own Nabota Source: Filler&Toxin, NCBI, Korea Investment & Securities Researcher in Daewoong pharm developed with strain found in Gyeonggido Pogok, a part of nucleotide sequence is identical to type A Hall Daewoong Pharm 214 There are two key issues. First is if the DNA of Hugel and Daewoong s botulinum toxin strain is equal to Medytox s. Second is if there will be obstacles securing FDA approval or administrative action, such as revocation of approval. Most botulinum toxin genetic information is open in the gene bank, a website that compiles genetic information. Nucleotide sequences of more than 12, genes and six key genes have been mostly published. Compared to the Hall strain, Allergan (1), Dysport (2) and Daewoong (2) show differences in nucleotide sequences while Medytox and Merz s nucleotide sequence was 1% identical. 3

4 Hugel (1452) Compared to Medytox s genetic information, Merz and Daewoong showed an 1% identical ratio on the six publically-opened genes. Despite claims that the strains of Medytox and Daewoong are identical, Merz s Xeomin developed based on ATCC352 showed an identical sequence as the Hall strain in terms of the key six genes. If the range is extended, 99 nucleotide sequences were not equal. To determine the equivalence of the genetic information, Daewoong would have sequence the entire genome. Medytox continues to require the disclosure of genetic information while Daewoong and Hugel are keeping their position that they do not have to respond to their competitor s requests as both have already submitted all genetic information to regulators. Table 2. Required information on the origin of strain when applying for sales approval List - Information of the origin and development details (Detailed description of the origin strain, report and approve the Korea Centers for Disease Control and Prevention - The origin of the strains for the production and characteristic (how it was obtained, test data confirmed for the strain) Example: Botulinum neurotoxin serotype analysis, sequence analysis, analysis of protein complexes Example: Amino acid sequence analysis, SDS-PAGE - Data on storage and seed strains for the production strain - Methods for producing, separating and purifying the botulinum toxin from cultured strains Note: Extracted information related to strains Source: Korea Investment & Securities The strain controversy will not directly impact the approval on current products. Hugel and Daewoong received sales approval based on the botulinum toxin sales approval guideline. As genetic information is not required by the Ministry of Food and Drug Safety to disclose the origin of botulinum toxin strain, it is unlikely that sales approval for Daewoong and Hugel will be revoked for not disclosing the information. However, for the US FDA, no domestic companies have received sales approval for botulinum toxin, so uncertainty remains if the submitted genetic information will affect sales approval and it will require thorough research. However, there is a claim that approval is determined based on the botulinum toxin s safety and efficacy based on the process rather than the origin of the strain. With the strain controversy, it seems that the risk on approval cancellation will not be resolved over the near term. Despite the controversy, Hugel posted record earnings in 3Q16, and as it is expected to post record results again in 4Q16 on seasonality and export growth. As such, the recent share plunge seems excessive. Company overview & Glossary Founded in November 21, Hugel develops, manufactures and sells plastic surgery related and biomedicalrelated products. Hugel holds a permit for 2unit botulinum toxin and has more than 7 years experience in clinical trials. Wellague, a cosmetic brand of Hugel, excludes 9 types of harmful ingredients. 4

5 Hugel (1452) Balance sheet FY-ending Dec. (W bn) 214A 215A 216F 217F 218F Current assets Cash & cash equivalent Accounts & other receivables Inventory Non-current assets Investment assets Tangible assets Intangible assets Total assets Current liabilities Accounts & other payables ST debt & bond Current portion of LT debt 26 Non-current liabilities Debentures LT debt & financial liabilities Total liabilities Controlling interest Capital stock Capital surplus Other Reserves Retained earnings Minority interest Shareholders' equity Income statement FY-ending Dec. (W bn) 214A 215A 216F 217F 218F Sales COGS Gross profit SG&A expense Operating profit Financial income Interest income Financial expense 1 Interest expense 1 Other non-operating profit () 19 (1) (1) Gains (Losses) in associates, subsidiaries and JV Earnings before tax Income taxes Net profit Net profit of controlling interest Other comprehensive profit 1 (1) (1) (1) (1) Total comprehensive profit Total comprehensive profit of controlling interest EBITDA Cash flow FY-ending Dec. (W bn) 214A 215A 216F 217F 218F C/F from operating Net profit Depreciation Amortization Net incr. in W/C (6) 2 1 (22) (29) Others 3 (2) C/F from investing (8) (17) (31) (36) (47) CAPEX (6) (12) (17) (12) (9) Decr. in fixed assets Incr. in investment () (2) (4) (2) (22) Net incr. in intangible assets (1) (1) (6) (3) (15) Others (1) (2) (4) (1) (1) C/F from financing (2) 5 (5) (6) (8) Incr. in equity 1 66 Incr. in debts (3) (15) Dividends Others (1) (5) (6) (8) C/F from others Increase in cash Key financial data FY-ending Dec. 214A 215A 216F 217F 218F per share data (KRW) EPS 5,91 13,361 14,195 17,772 22,581 BPS 17,95 63,29 77,248 94, ,129 DPS Growth (%) Sales growth OP growth NP growth EPS growth EBITDA growth Profitability (%) OP margin NP margin EBITDA margin ROA ROE Dividend yield Dividend payout ratio..... Stability Net debt (W bn) 19 (67) (15) (126) (136) Debt/equity ratio (%) Valuation (X) PE NM PB NM EV/EBITDA Note: Based on K-IFRS (consolidated) 5

6 Hugel (1452) Changes to recommendation and price target Company (Code) Date Recommendation Price target Hugel, Inc. (1452) BUY W37, BUY W416, BUY W465, BUY W615, 7, 6, 5, 4, 3, 2, 1, Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 6

7 Hugel (1452) Guide to Korea Investment & Securities Co., Ltd. stock ratings based on 12-month forward share price performance relative to the market index BUY: Expected to outperform the market index by 15%p or more Hold: Expected to underperform or outperform the market index by less than 15%p Underweight: Expected to underperform the market index by 15%p or more Korea Investment & Securities does not offer target prices for stocks with Hold or Underweight ratings. Guide to Korea Investment & Securities Co., Ltd. stock rating allocation (as of Sep 3, 216) BUY Hold Underweight (Sell) 81.1% 17.6% 1.3% Note: % of companies under coverage with this rating 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 compliance notice 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 1 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 Hugel, Inc.. 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 Hugel, Inc. in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates has not received compensation for investment banking services from Hugel, Inc. in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates does not expect to receive or intend to seek compensation for investment banking services from Hugel, Inc. in the next 3 months. Korea Investment & Securities Co., Ltd., or its affiliates was not making a market in Hugel, Inc. s securities at the time that the research report was published. Korea Investment & Securities Co., Ltd. does not own over 1% of shares of the companies mentioned in this report as of October 27, 216. Korea Investment & Securities Co., Ltd. has not provided this report to various third parties. Neither the analyst/analysts who prepared this report nor their associates own any shares of the company/companies mentioned in this report as of October 27, 216. Korea Investment & Securities Co., Ltd. has lead-managed an initial public offering of Hugel, Inc.. Prepared by: Bora Chung 7

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