Company Comment March 29, 2013 Samsung C&T (000830) BUY TP W97,000 Stock(Mar 28) W68,500 Wins Australia s Roy Hill project; previous bidding system no longer valid News: Samsung C&T wins W6.5trn mine project Samsung C&T announced it had won the iron ore infrastructure development project tendered by Roy Hill Holdings in Australia. Construction should break ground Apr 2, and should be completed by Nov 2015 (32 months). The project will develop a mine in Pilbara (west Australia) that has 2.4bn tonnes of reserves, and will be completed over six phases (AUD5.6bn, W6.5trn). Implication 1): Rapid backlog growth, should meet 2013 overseas order target Samsung C&T has secured YTD overseas orders of W7.5trn, already meeting 65% of its fullyear target of W11.6trn. Considering the projects to be awarded in 2Q13, including Saudi Arabia s Rabigh #2 (USD1.9bn), Turkey s Kirikkale power plant (USD0.6bn) and Turkey s Gaziantep healthcare complex (USD0.18bn), Samsung C&T should easily meet its full-year target in 1H13. Accordingly, the overseas backlog should grow to 3.5x sales (average 3.1x). In addition to the growing volume, order quality is also improving. Overseas orders should consist of 24% power, 10% LNG terminals, 57% mining and 19% civil and construction. This would be a significant diversification compared to 2012, when most overseas projects were civil and construction orders. Implication 2): Success on technique-based pre-construction marketing; can penetrate new markets now We attribute the record new orders to new strategies, including pre-construction marketing. Pre-con focuses on offering the best construction methods and ways to reduce costs to clients. As projects become more complicated and larger, pre-con has become increasingly important to minimize EPC-related risks and bolster efficiency. Global top tiers have won mega projects via private contracts based on this type of marketing. Pre-con is attractive as builders can emphasize technological skill, avoid price competition and secure solid margins (refer to Competition paradigm shifts from price to skill, Mar 18). Meanwhile, given the size of the Roy Hill mega project there are some concerns over margins and deadlines. But, Samsung C&T should employ the following strategies to fade these risks. Kyung ja Lee 822-3276-6155 kyungja.lee@truefriend.com Hyungjun Ahn 822-3276-4460 hyungjoon@truefriend.com 1) COGS are mostly comprised of labor costs (estimated W3trn) as wages in Australia are 3x higher than that of Korea. The company plans to minimize its local workforce to enhance margins, and the target GPM for the project should be 10%, in line with the overall GPM. 2) As important details about the project were already disclosed during the pre-con process, Samsung C&T and Roy Hill have already agreed to escalation clauses regarding unexpected matters. Risks related to subcontractors have also been minimized by passing these responsibilities fully onto these companies. 3) The project is expected to be fast-tracked as design and construction should proceed concurrently, with the second phase scheduled to begin only three months after the third phase of the EPC breaks ground. Given the concerns over meeting the 32-month deadline, we analyzed Bechtel s pre-con of the Jamnagar refinery (page 2). Samsung C&T has confirmed it has diversified from aggressive price-based bids in the Middle East. In fact, the company has opened up new markets via pre-con, the strategy employed by top global players. Samsung C&T also scouted top mining experts from Bechtel in 2011, as the company focused on bolstering technological competitiveness. While Korean
companies have competed on price over the past 10 years, the early investments in technology should differentiate Samsung C&T. The company has expanded its presence by abandoning the old bidding style of focusing solely on price. We maintain Samsung C&T as our top sector pick. Case study) Bechtel s pre-construction on Jamnagar refinery Formed in 1898, Bechtel has held a competitive edge in building infrastructure across all areas, including offshore design and mining. We believe a differentiating factor for the company from rivals is its construction management department, which manages bidding for projects and deals with order negotiations. This is where pre-construction services emerged. Backed by these services, Bechtel made an early entry to regions with potential demand, rather than waiting for bidding notices to come out, and provided marketing and consulting services to win mega projects. A major example was Bechtel s Jamnagar refinery in India. At the time, shortening the construction period was crucial to save on project costs and Bechtel s strength in pre-construction and project management played a key role. 1) The project employed a large number of engineers over a short period of time (up to 70,000 at peak construction). Using the regional time differences, engineers at Bechtel s worldwide offices, such as in Houston and London, were assigned to the project for detailed design for 24 hours. 2) Construction started even before design was finalized. It is noteworthy that 50% of the cement was already used when only 65% of the engineering was complete. The integration of the value chain helped reduce errors in each process and accelerate the progress of processes with little time difference, which resulted in a substantial reduction in costs and errors. Samsung C&T s Roy Hill project is similar with this Bechtel case. Some may wonder: Why do pre-construction services remain exclusive to only a few firms? The reason is the necessary technological capabilities. Builders must have a good understanding of all the processes in a project to offer techniques and construction types that are suitable for each client. With the new approach, we anticipate Samsung C&T will win mega orders, not only in mining, but in power generation (alliance with S&L, US power engineering company) and LNG terminal markets (taking over FEED company, Whessoe) where investments have already been made in technology upgrades. 2
Figure 1. Bechtel s Jamnagar refinery case: Error and costs reduced through preconstruction Pre-construction 70,000 workers were put on the project including engineers Design & Engineering -Phase before construction Construction began when only 65% of Engineering was completed, total 50% of cement was used Reduce construction period Construction -Generally begins at design completion Construction -Reduce construction period and costs on strong capability of Pre-construction and Project management Process Desinged 24 hours by engineers all around the world working by turns Maximize efficiency by fully utilizing resource U.K India Jamnagar Refinery China San francisco (Headquarter) Australia Source: Bechtel 3
Table 1. Valuation (W bn) Value 1) Construction (A+B) 5,654 Op. value + SOC value Base NOPLAT 404 12MF Target multiple 14.0 Major builders target multiple (past mid-cycle avg. of 2006-2010) 2) Trading (A+B+C) 2,900 Parent op. + E&P + petrochem subsidiary values A) OP. value 822 Base NOPLAT 103 Based on 12MF Target multiple 8.0 Major trading companies target multiple B) E&P value 1,378 DCF method Mexico Ankor 263 2008-2025 Parallel Petroleum 290 2012-2032 Chile Lithium/C. Chloride 265 Ambatoni Nickel 305 Oman/Qatar 255 C) Gen. Chem & Petrochem 700 PE 10x 2012F-2013F avg. equity-method gains 3) Invested asset 8,936 A) Stakes in listed affiliates 7,133 30% discount to MV for SEC; 50% discount to BV for others B) Samsung SDS, Everland 1,183 3M avg. Tax effect accounted C) Treasury stocks 620 Based on common shares 4) Net debt 2,420 Based on 12MF, excl. W850bn in debt related to trading export discounts Shareholders value (1+2+3+4) 15,069 Value per share (KRW) 97,000 156,218 shares Source: Samsung C&T, Korea Investment & Securities Figure 2. Overseas backlog Figure 3. New overseas order (W trn) 20,000 15,000 (W bn) 30 25 20 General civil/construction Mining LNG tank Power 2013~2017 CAGR 21% 10,000 15 10 86%YoY 5,000 5-4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13F 2007 2009 2011 2013F 2015F 2017F Source: Samsung C&T, Korea Investment & Securities Source: Samsung C&T, Korea Investment & Securities 4
Samsung C&T (000830) Changes to recommendation and price target Company (Code) Date Recommendation Price target Samsung C&T (000830) 05-01-11 BUY W103,000 07-25-11 BUY W110,000 10-28-12 BUY W97,000 120,000 100,000 80,000 60,000 40,000 20,000 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 0 5
Samsung C&T (000830) 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 Samsung C&T. 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 Samsung C&T in the past 12 months; Korea Investment & Securities Co., Ltd., or its affiliates has not received compensation for investment banking services from Samsung C&T 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 Samsung C&T in the next 3 months. Korea Investment & Securities Co., Ltd., or its affiliates was not making a market in Samsung C&T s securities at the time that the research report was published. Korea Investment & Securities Co., Ltd. does not own over 1% of Samsung C&T shares as of March 29, 2013. 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 March 29, 2013. Korea Investment & Securities Co., Ltd. has issued ELW with underlying stocks of Samsung C&T and is the liquidity provider. Prepared by: Kyungja 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. 6