Samsung Engineering (028050)

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1 Samsung Engineering (285) BUY (Maintain), TP W17, (Up) Stock price (Feb 27, KRW) 12,15 Market cap (USD mn) 2,381 Shares outstanding (mn) W High/Low (KRW) 12,85/9,15 6M avg. daily turnover (USD mn) 16.1 Free float (%) 64.7 Foreign ownership (%) 11.9 Major shareholders (%) Samsung SDI Co. and 8 others 2.5 NPS 6. Yr to Sales OP NP EPS % chg EBITDA PE EV/EBITDA PB ROE DY Dec (W bn) (W bn) (W bn) (KRW) (YoY) (W bn) (x) (x) (x) (%) (%) 214A 8, ,487 NM A 6,441 (1,454) (1,35) (35,31) NM (1,37) NM NM NM (49.) - 216F 7, NM F 5, F 6, , Note: NP in equity-method accounting The ugly duckling fights back Performance 1M 6M 12M Absolute (%) Rel. to Kospi (%p) MF PE trend (X) Mar-14 Mar-15 Mar-16 (KRW) 2, 12MF PER (L) price (R) 15, 1, 5, Lift TP to W17,: We raise our TP for Samsung Engineering by 13% to W17,. Global peers including major engineering, procurement and construction (EPC) players such as JGC and Technip trade at 19-2x 217F PE and 18-2x 218F PE. Meanwhile, Samsung Engineering features a low valuation at 1x 218F PE although orders should return to normal in 217 and result in profit getting back on track in 218. Pure plays differ from comprehensive builders in that not many variables exist for profit and share price, and therefore feature the tightest correlation with orders backlog. As such, the share price reflects two-three years forward-looking profit. Among EPC players, there are cases where the financial structure improves instantly despite a small orders backlog when problematic works are removed and followed by a flow of new orders, which results in a stream of final payments for existing projects and advanced payments for new orders. This is typically when EPC firms shares gain most swiftly. For Samsung Engineering, this phase of recovery should unfold in 217. Accordingly, we revise up our TP to W17,, applying 15x 218F PE, up from the previous 12x 218F PE. Samsung Engineering s market cap equals.4x market cap/orders backlog. Assuming the company wins orders worth W6tn in 217, the backlog is estimated at W8.3tn at end-217. When applying a multiple of.4x, fair value per share would also touch W17,. Then, we should examine achievable orders in 217. Orders should exceed W6tn in 217: There were no significant orders in 216 with the exception of an affiliate s construction project worth W3.7tn and an overseas change order worth W1tn. In the meantime, the backlog plunged from W12tn in 215 to the current W7.8tn as Kazakhstan s Balkhash power plant (W1.3tn) and Saudi Arabia s Yanbu power plant (W2tn) were cancelled and work on the Salamanca refinery in Mexico (W584bn) was suspended. Kyungja Lee kyungja.lee@truefriend.com Narae Heo @truefriend.com Samsung Engineering should begin to replenish its backlog from 217. Aside from the UAE process offshore crude (POC) equipment contract waiting to be signed (USD2.5bn), it has been identified to be the lowest bidder (lowest) for one or two of PTTGC s propylene oxide (PO), olefin and polyols packages in Thailand, which should create orders worth USD6mn-1bn. It is also currently bidding for Bahrain s Bapco Sitra oil refinery (USD1bn-1.5bn) and Lotte Chemical s domestic ethylene output expansion. We forecast Samsung Engineering will win orders worth at least USD2.5bn and in an optimistic scenario up to USD5bn in 1H17. 35

2 Chemical firms that have made profits: While EPC firms order receipts seem positive, we also pay attention to another positive change in industry conditions that clients are resuming order placement for projects they cancelled or delayed for three to four years. Global chemical firms have been in a long phase of investment contraction since 212 amid rising threats from more ethane cracking centers (ECC) in North America and cheap oil. As a result, since two years ago, the oil refining/chemical industry has turned upward as during After a long break, chemical firms that have made considerable profits are poised to add capacity to their plants. If placement for large-scale refinery projects winds down in the Middle East in 217, downstream facilities based on naphtha cracking centers (NCC) will likely expand from 218 over the mid to long-term. Of note, it was the ethylene cycle in the Middle East that drove Samsung Engineering s top-line growth by 1-fold in 1 years in the early 2s. Table 15. Project progress for 217 (USD bn) Status Projects Value Note Secured Vietnam Long Son refinery.5 Selected as the lowest in 216 Oman Salalah ammonia.4 Selected as the lowest in 216 UAE process offshore crude 2.5 Selected as the lowest in 217 PTTGC PO/Polyols/Olefin.9 Appears to be the lowest for some packages in 217 Bidding Lotte Chemical ethylene addition 1. Bahrain Sitra refinery 1. Consortium with Technip and Técnicas Reunidas; Shortlist to be selected in March Oman Duqm refinery 2.2 Consortium with Petrofac and Chiyoda; Bidding for two packages UAE Bab integrated oil 2. Commercial bid to close in May Source: Korea Investment & Securities Figure 46. Orders backlog and market cap Figure 47. Net debt 25, (W bn) (W bn) Backlog (L) Market cap (R) 9, (Wbn) 2, Net debt 8, 1,8 2, 7, 1,6 15, 1, 5, 6, 5, 4, 3, 2, 1,4 1,2 1, , Q16 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Source: Company data Source: Company data Growth different from the past; Focused approach to LNG: LNG is one of the promising energy sources for the future. In 216, the US emerged as a major LNG exporter with its first shipment from the Sabine Pass LNG terminal. For Korean players, it seems obvious that the US is the most appealing market to export LNG plants. There were no Korean EPC firms that entered the US LNG liquefaction plants market until SK E&C won an EPC order for the Magnolia LNG project for the first time in

3 After going through pre-feed and finishing FEED in 216, the company ratcheted up off-taker attraction to reach a final investment decision (FID). Recently, in its first round of marketing, Samsung Engineering attracted off-takers from Southeast Asia and China and entered a second round to secure additional off-takers. Brownsville is considered to have good project feasibility due to its proximity to the Eagle Ford region that is very profitable. Given the brisk attraction of off-takers to this small/midsize LNG project (2mtpa), luring financial investors will likely gain traction as well. If the project goes smoothly, Samsung Engineering will be able to start EPC work after acquiring FID in 218. The recent promotion of LNG exports by the Trump administration boosts this outlook. Table 16. Texas LNG project overview Project Client FEED firm Timeline EPC consortium Size EPC value Texas LNG Texas LNG Samsung Engineering FEED contract signed in 4Q14; FEED finished in 216; Investor attraction ongoing Investment development-type; Samsung Engineering and Black & Veatch (licensor) 2mn tonnes (p.a.), 4mn tonnes (final) EPC USD1bn (Samsung Engineering alone) Source: Texas LNG, Korea Investment & Securities Figure 48. Texas LNG project progress Current Engineering Pre-FEED FEED Pre-FID Detailed engineering/ EPC contract Current Permitting FERC Prefiling DOE FTA Complete draft resource reports file FERC application Draf t EIS Final EIS DOE non-fta FERC approval FID 218 Ready f or startup Current Commercial Offtake Discussions Sing MOU w ith customers & develop financial structure Binding tolling agreements & finance Conceptual Study Pre-FEED FEED Pre-FID detailed engineering EPC Construction Completed May 214 June-Oct , man-hours Nov.214-End , man-hours To commerce Early Phase 1 production starts Source: Texas Brownsville LNG 37

4 Figure 49. Eagle Ford natural gas production Figure 5. LNG liquefaction plant EPC market share 8, (mcf/day) Eagle Ford natural gas production Saipem 3% Others 6% 7, CB&I 4% 6, Technip 7% 5, Bechtel 33% 4, KBR 11% 3, 2, 1, Chiyoda 17% JGC 19% Source: EIA, Korea Investment & Securities Source: Company data, Korea Investment & Securities If the project goes smoothly and starts construction, it would mark Samsung Engineering s first entry to a cartel-dominated LNG market. The company s astonishing growth achieved in the early to mid-2s was thanks partly to the fact that it was among a handful of companies capable of ethylene cracker construction. In technological terms, cryogenic techniques for ethylene crackers are similarly applied to LNG liquefaction plants. While Samsung Engineering focused on topline expansion in the mid to late-2s, it is now pursuing a different growth path. Lessons learned: Samsung Engineering pegs its fair revenue per employee at W1bn. The revenue per employee surpassed W1.3bn in , resulting in cost overruns. The trials and errors since 21 have been a valuable experience. Since then, the company has corrected on-site errors during the initial stage via ERP systems and risk control, and this has helped it strengthen the profit structure. In the Middle East, Samsung Engineering has begun to control risks by bidding in a consortium. For the time being, the company s sales will not likely grow sharply but increase gradually with revenue per employee maintained at the W1bn level. But profitability should show an upward trend with the orders focusing on ethylene and fertilizer, its competitive product, and LNG, a next growth driver. As the first sign of normality, the OPM should reach 5.2% in 218. We assumed an 8% OPM for affiliate projects and 3.8% for hydrocarbon plants. The profit margin at the affiliates is assumed to be 8% and the margin for petrochemical plants should be 3.8%. Stable affiliate projects: Being alienated from the housing boom, Samsung Engineering s turnaround has been rather slow compared to domestic rivals. But the company has secured a stable source of revenue: the group affiliates projects worth more than W2tn annually. Samsung Group s annual capex amounts to more than W1tn and half this sum is spent on construction projects. Assuming the group affiliates projects are distributed between Samsung Engineering and Samsung C&T, Samsung Engineering will be able to sustain at least W2tn in affiliate orders. Of note, Samsung Display is reportedly considering investment for the A5 line, another plus for 218 orders. Unlike A4 that would add to an existing facility, A5 is a new investment and it could match the new A3 investment during In 216, Samsung Engineering won orders worth nearly W1.9tn from Samsung Display. 38

5 Figure Samsung affiliate orders breakdown Figure 52. Samsung Engineering affiliated orders trend (W bn) 4. (W tn) Samsung Electronics/SEMCO Samsung Display Samsung Biologics SEMCO 24 Samsung SDI 2 Samsung Biologics Samsung Electronics Samsung Display 1, F Source: Company data, Korea Investment & Securities Source: Company data, Korea Investment & Securities Table 17. Earnings summary (W bn) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F F 218F Sales 1,474 1,88 1,631 2,24 1,346 1,257 1,414 1,497 6,441 7,9 5,514 6,127 YoY -16.8% 2.% 9.3% 2.8% -8.7% -33.1% -13.3% -26.% -27.7% 8.8% -21.3% 11.1% Hydrocarbon ,283 3,291 2,75 3,213 I&I 666 1, , ,159 3,719 2,89 2,914 COGS (%) 92.2% 92.2% 9.8% 96.6% 91.9% 9.% 89.4% 88.7% 116.9% 93.1% 9.% 88.8% Hydrocarbon 96.6% 96.8% 96.9% 83.9% 94.% 92.% 92.% 9.3% 128.8% 91.% 92.% 89.5% I&I 9.1% 88.6% 86.% 17.8% 9.% 88.% 87.% 87.1% 14.5% 95.% 88.% 88.% SG&A SG&A (%) 6.% 7.6% 6.% 4.1% 6.3% 7.2% 6.7% 7.3% 5.7% 5.9% 6.9% 6.% OP (13) (1,454) YoY 23.1% -76.5% nm -16.7% -11.5% 927.1% 2.5% nm TTR -14.8% 147.9% 82.7% OPM (%) 1.8%.2% 3.3% -.7% 1.7% 2.9% 3.9% 4.% -22.6% 1.% 3.1% 5.2% EBT (1,45) NP (3) (1,34) Note: I&I is acronym for industrial and infrastructure Source: Korea Investment & Securities Company overview & Glossary Established in 197, Samsung Engineering is an industrial plant builder affiliated with Samsung Group. The business name was changed from Korea Engineering to Samsung Engineering in The business portfolio includes construction of a range of industrial plants, including refinery, gas, petrochemical, hydrocarbon upstream, power station, steel mill, water treatment, environment and infrastructure and the related engineering services. 39

6 Balance sheet FY-ending Dec. (W bn) 214A 215A 216F 217F 218F Current assets 4,557 3,775 4,241 3,364 3,921 Cash & cash equivalents Accounts & other receivables 3,367 2,379 2,593 2,4 2,267 Inventory Non-current assets 1,595 1,856 1,977 1,682 1,683 Investment assets Tangible assets Intangible assets Total assets 6,152 5,631 6,217 5,46 5,65 Current liabilities 4,722 4,784 4,226 2,999 3,331 Accounts & other payables 3,281 2,741 1,752 1,379 1,532 ST debt & bonds 1,319 1, Current portion of LT debt 451 Non-current liabilities 476 1,16 1,94 1,31 1,28 Debentures LT debt & financial liabilities Total liabilities 5,199 5,944 5,32 4,29 4,36 Controlling interest 953 (314) 896 1,15 1,244 Capital stock Capital surplus Other reserves (285) (285) (285) (285) (285) Retained earnings 1,13 (292) (283) (164) 65 Minority interest Shareholders' equity 953 (313) 898 1,16 1,245 Income statement FY-ending Dec. (W bn) 214A 215A 216F 217F 218F Sales 8,911 6,441 7,9 5,514 6,127 COGS 8,365 7,53 6,528 4,961 5,44 Gross profit 546 (1,89) SG&A expenses Operating profit 162 (1,454) Financial income Interest income Financial expenses Interest expenses Other non-operating profit (84) Gains (Losses) in associates, subsidiaries and JV Earnings before tax 61 (1,45) Income taxes 4 (146) Net profit 56 (1,34) Net profit of controlling interest 55 (1,35) Other comprehensive profit (9) 38 Total comprehensive profit 48 (1,266) Total comprehensive profit of controlling interest 46 (1,267) EBITDA 243 (1,37) Cash flow FY-ending Dec. (W bn) 214A 215A 216F 217F 218F C/F from operations 278 (833) 462 (195) 122 Net profit 56 (1,34) Depreciation Amortization Net incr. in W/C (354) (169) Others (57) 17 (13) (18) 4 C/F from investing (222) 2 (42) 85 (24) Capex (68) (2) (54) (54) (54) Decr. in fixed assets Incr. in investment (92) 83 (53) 2 95 Net incr. in intangible assets (52) (22) (12) 6 (11) Others (25) (6) (283) 131 (54) C/F from financing 5 1,72 (2) (2) 3 Incr. in equity 1,21 Incr. in debt 5 1,72 (1,221) (2) 3 Dividends Others C/F from others Increase in cash (129) 129 Key financial data FY-ending Dec. 214A 215A 216F 217F 218F Per-share data (KRW) EPS 1,487 (35,31) ,168 BPS 3,934 (746) 6,24 6,629 7,797 DPS Growth (%) Sales growth (9.1) (27.7) 8.8 (21.3) 11.1 OP growth NM NM NM NP growth NM NM NM 1, EPS growth NM NM NM EBITDA growth NM NM NM Profitability (%) OP margin 1.8 (22.6) NP margin.6 (2.3) EBITDA margin 2.7 (21.3) ROA.9 (22.1) ROE 5.9 (49.) Dividend yield Dividend payout ratio. NM... Stability Net debt (W bn) 954 1, Debt/equity ratio (%) (918.7) Valuation (x) PE 15.9 NM PB.8 NM EV/EBITDA 9. NM Note: K-IFRS (consolidated) 4

7 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 Dec 31, 216) BUY Hold Underweight (Sell) 77.6% 21.1% 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 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 intend 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 shares of the companies mentioned in this report as of March 2, 217. 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 March 2, 217. Korea Investment & Securities Co., Ltd. has issued ELW with underlying stocks of Samsung Heavy Industries and is the liquidity provider. Prepared by: Kyungja Lee

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