Korean Air (003490) Company Note. Timely relisting. Hold (Maintain)

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1 Company Note September 16, M rating Hold (Maintain) Timely relisting Stock Data KOSPI (Sep 13, pt) 1,994 Stock price (Sep 13, KRW) 28,200 Market cap (USD mn) 1,890 Shares outstanding (mn) Week high/low (KRW) 51,000/28,200 6M avg. daily turnover (USD mn) 9.2 Free float / Foreign ownership (%) 67.2/12.2 Major shareholders (%) HanJin Trading Co.,Ltd and 17 others 25.9 National Pension Service (NPS) 7.2 Performance 1M 6M 12M Absolute (%) 0.0 (33.3) (43.6) Relative to KOSPI (%p) (4.2) (33.0) (45.8) 12MF PER trend 1.6 (X) 12MF PBR (LHS) (KRW) 90, price (RHS) 80, ,000 60, , , , , , Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Source: WISEfn consensus Shares relist today After trading was suspended on July 29 (W28,200) due to the spinoff, Korean Air shares will relist today. The opening price will be determined by bids and offers within a -50% to +200% range of the post-spinoff value, which has been estimated at W27,650. Shares will trade within a 15% band of the opening price. Applying the 0.9x PB multiple from the final day of trading, shares would have a fair value of W31,106 based on the newly calculated net asset worth per share. As such, shares are likely to trade above post-spinoff value today. As other cyclical plays have rebounded substantially on growing hopes for a global economic recovery, Korean Air may trade well above fair value over the near term. Holding company, Hanjin KAL, to list Following the demerger with Korean Air, Hanjin KAL will list, and the post-spinoff value is estimated at W15,350 per share. Applying the typical 40% discount for holding companies, fair value would be W11,506. Over the near term, Hanjin KAL may rally above fair value as peer companies with low-cost carrier subsidiaries, such as AK Holdings (Jeju Air) and T-way Holdings (T way Air), have performed well. Of note, Hanjin KAL wholly owns Jin Air. Hanjin KAL is a holding company that was established after the spinoff of Korean Air s investment division, and Hanjin KAL holds stakes in Korean Air, Jungseok Enterprise, Jin Air, Topas Travel Information, KAL Hotel Network, Hanjin Travel, Jaedong Leisure and Homeo Therapy. 3Q13 earnings to be weak YoY; sharp share rally unlikely Earnings growth should continue to be slow YoY at Korean Air in 3Q13. And, profits should erode further in 4Q13 on weak seasonality. We estimate 3Q13 OP at W bn, down sharply from W313bn in 3Q12. With the persistent concerns over radiation fallout from Fukushima, Japanese routes have been poor over the past year, and the soft demand has pushed down fares YoY. Moreover, fuel prices remain high. Meanwhile, cargo demand should grow gradually given the favorable seasonal factors from September to November. In fact, cargo demand may pick up YoY in 4Q13 for the first time in two years due to low base effect, but we do not believe it will be meaningful. While there are some hopes management will work to bolster shares given a likely stock swap (exchange of Korean Air shares held by Hanjin Group Chairman Yang Ho Cho and Hanjin for new Hanjin KAL shares), given the current conditions at Korean Air and the lack of details, we believe these efforts are unlikely. Yr to Sales OP EBT NP EPS % chg EBITDA PE EV/EBITDA PB ROE Heedo Yun heedo@truefriend.com Changwon Lee cw.lee@truefriend.com Dec (W bn) (W bn) (W bn) (W bn) (won) (YoY) (W bn) (x) (x) (x) (%) 2011A 12, (269) (219) (3,197) NM 1,786 NM (8.4) 2012A 12, ,673 NM 1, F 12, (589) (466) (6,729) NM 1,643 NM (18.1) 2014F 12, ,650 NM 1, F 13, ,935 (27.0) 1, Note: NP and EPS of controlling interest; Based on pre-spinoff financial statement

2 Table 1. Post-spinoff fair value calculation Korean Air Hanjin KAL Note Market cap on the date of trading suspension (July 29) (W bn) 2, Post-spinoff NAV (W bn) 2, Spinoff ratio Pre-spinoff outstanding shares Post-spinoff outstanding shares Post-spinoff value (estimated) PB used for fair value calculation - Fair value after share listing on September 16 (no. of shrs) (no. of shrs) (KRW) (KRW) 72,852,253 58,675,438 28,353,631 27,650 15, ,106 11,506 Fair market cap (W bn) 7 1, Note: 1 Based on the statement of financial position opened on September 10; Hanjin KAL s NAV includes shareholders equity (W12.73bn) Note: 2 The sum of the ratio is greater than 1 because Hanjin KAL s par value is set at W2,500 per share Note: 3 The spinoff ratio is changed but the post-spinoff outstanding shares remains unchanged since the initial announcement in March Note: 4 Market cap on the date of trading suspension * spinoff ratio post-spinoff outstanding = W27,610; Korean Air s postspinoff value of W27,650 (estimate); Hanjin KAL s value of W15,350 (estimate) based on the same calculation method Note ::5 For Korean Air, 2013F PB as of the date of trading suspension; For Hanjin KAL, a holding company discount (40%) is applied Note: 6 Korean Air: Post-spinoff NAV post-spinoff outstanding shares * 0.9x = W31,106; For Hanjin KAL: Post-spinoff NAV post-spinoff outstanding shares * 0.6x = W11,506 Note: 7 The sum is W2.15tn, 4.7% greater than Korean Air s market cap on the date of trading suspension (W2.05tn) Source: Korea Investment & Securities Figure 1. Hanjin Group s shareholding structure after Korean Air s spinoff Chairman Yang-Ho Cho 6.87 Hanjin Transportation Hanjin KAL Holdings 6.1 Korean Air Jungseok Enterprise Source: Korea Investment & Securities Company overview KAL is a well-known Korean airline that accounts for 30% of the passenger market and 33% of the cargo market. As of 1Q13, 59% of sales came from international passengers, 23% from cargo and 4% from domestic routes. 38% of operating costs is fuel. Due to a considerable amount of foreign-denominated debt related to aircraft leases, non-operating profit tends to fluctuate widely along with KRW/USD changes Revenue passenger kilometers (RPK): RPK is the typical means used in air transportation industry to measure volume of passengers, calculated by multiplying number of paid passengers and distance flied. Low cost carriers (LCC): LCCs are air carriers with lower cost structures than large carriers, such as reduced in-flight services. Typically, fares are lower for LCCs. There is no clear definition for LCCs, and as time passes, the distinction between LCCs are large carriers is blurring. 2

3 Balance sheet FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F Current assets 3,350 3,365 3,211 3,381 3,553 Cash & cash equivalent 1,466 1,465 1,398 1,472 1,547 Accounts & other receivables 1, Inventory Non-current assets 19,038 19,608 19,468 19,663 19,833 Investment assets 2,771 2,733 2,607 2,745 2,885 Tangible assets 14,189 14,880 14,956 14,913 14,841 Intangible assets Total assets 22,388 22,973 22,678 23,044 23,386 Current liabilities 6,626 6,207 6,073 6,089 6,281 Accounts & other payables 1,047 1,080 1,030 1,085 1,140 ST debt & bond 1,011 1,266 1,271 1,170 1,251 Current portion of LT debt 3,629 2,848 2,834 2,866 2,910 Non-current liabilities 12,994 13,862 13,788 13,943 13,947 Debentures 2,442 3,702 3,877 4,356 4,670 LT debt & financial liabilities 8,108 7,415 7,292 6,829 6,379 Total liabilities 19,619 20,069 19,861 20,032 20,228 Controlling interest 2,460 2,622 2,510 2,693 2,827 Capital stock Capital surplus Capital adjustments (64) (66) (66) (66) (66) Retained earnings 1,939 2,096 1,630 1,814 1,947 Minority interest Shareholders' equity 2,769 2,904 2,817 3,012 3,158 Income statement FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F Sales 12,246 12,720 12,136 12,779 13,431 COGS 10,525 11,243 10,910 11,281 11,658 Gross profit 1,721 1,476 1,225 1,498 1,773 SG&A expense 1,268 1,158 1,139 1,158 1,343 Operating profit Financial income Interest income Financial expense Interest expense Other non-operating profit (320) 516 (475) 102 (44) Gains (Losses) in associates, subsidiaries and JV Earnings before tax (269) 432 (589) Income taxes (61) 180 (130) Net profit (200) 256 (455) Net profit of controlling interest (219) 246 (466) Other comprehensive profit (75) (87) Total comprehensive profit (275) 170 (87) Total comprehensive profit of controlling interest (279) 163 (84) EBITDA 1,786 1,835 1,643 1,905 1,997 Cash flow FY-ending Dec. (W bn) 2011A 2012A 2013F 2014F 2015F C/F from operating 2,009 2, ,492 1,431 Net profit (200) 256 (455) Depreciation 1,312 1,493 1,536 1,544 1,544 Amortization Net incr. in W/C (76) 112 (34) (26) (51) Others (280) (243) (231) C/F from investing (572) (657) (902) (1,371) (1,356) CAPEX (664) (906) (1,756) (1,668) (1,585) Decr. in fixed assets Incr. in investment Net incr. in intangible assets (2) (1) (7) (38) (39) Others (8) (10) (13) C/F from financing (830) (1,591) 47 (47) 0 Incr. in equity Incr. in debts (1,153) (983) 47 (47) 0 Dividends (47) (11) Others 370 (597) C/F from others 8 (59) Increase in cash 614 (0) (67) Key financial data FY-ending Dec. 2011A 2012A 2013F 2014F 2015F per share data (KRW) EPS (3,197) 3,673 (6,729) 2,650 1,935 BPS 34,426 36,626 34,684 37,152 38,954 DPS Growth (%) Sales growth (4.6) OP growth (63.4) (29.6) (72.9) NP growth NM NM NM NM (27.0) EPS growth NM NM NM NM (27.0) EBITDA growth (24.3) 2.7 (10.5) Profitability (%) OP margin NP margin (1.8) 1.9 (3.8) EBITDA margin ROA (0.9) 1.1 (2.0) ROE (8.4) 9.7 (18.1) Dividend yield Stability Net debt (W bn) 13,545 13,629 13,751 13,622 13,538 Debt/equity ratio (%) Valuation (X) PE NM 12.3 NM PB PS EV/EBITDA Note: Based on K-IFRS (consolidated) 3

4 Changes to recommendation and price target Company (Code) Date Recommendation Price target Korean Air Lines (003490) BUY W77, BUY W67, BUY W60, BUY W50, Hold - 120, ,000 80,000 60,000 40,000 20,000 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep

5 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 Korean Air Lines. 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 Korean Air Lines in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates has not received compensation for investment banking services from Korean Air Lines 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 Korean Air Lines in the next 3 months. Korea Investment & Securities Co., Ltd., or its affiliates was not making a market in Korean Air Lines s securities at the time that the research report was published. Korea Investment & Securities Co., Ltd. does not own over 1% of Korean Air Lines shares as of September 16, Korea Investment & Securities Co., Ltd. has provided this report to various third parties. Neither the analysts covering these companies nor their associates own any shares of as of September 16, Prepared by: Heedo Yun, Changwon Lee 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. 5