Kolon Industries (120110)

KOREA November 25, 2011 Company Analysis Kolon Industries (120110) BUY (maintain) Undervalued Even in Worst-case Scenario Dongkun Kim Analyst / Hybrid Chemicals 82-2-2003-2907 dongkun.kim@hdsrc.com Daeyong Park Analyst / Hybrid Chemicals 82-2-2003-2904 dy.park@hdsrc.com Current price (Nov 24) KRW60,800 Fair value KRW90,000 (prev. KRW119,000) Reuters code Bloomberg code Industry/Sector Rating 120110.KS 120110 KS Chemicals Overweight Market cap USD1.3bn Ordinary shares issued 24,717,241shrs Free float 53.9% KOSPI 1795.06 KOSDAQ 489.48 Avg T/O Vol (60d) shrs Avg T/O Val (60d) USD34.6mn Foreign ownership 15.1% 3yr CAGR of adj EPS (11~13) 10.0% Market s 3yr CAGR of adj. EPS 10.3% 52wk high/low KRW129,000 / KRW55,200 Beta (12M, daily return) 1.0 Major shareholders KOLON CORPORATION etc. 30.8% Price performance 1M 3M 6M Absolute -16.5% -44.0% -33.2% Relative -11.7% -45.2% -23.3% Relative performance (LHS) % Stock price (RHS) KRW 120 100 80 60 40 20 0-20 11/10 1/11 3/11 5/11 7/11 9/11 150,000 130,000 110,000 90,000 70,000 50,000 3Q11 OP (KRW93.6bn) fell slightly short of estimates primarily due to earnings removal following sale of stake in Kolon B&S and earnings slowdown at consolidated subsidiaries 4Q11 profits to grow QoQ led by continuously robust flagship businesses, including fashion (a peak demand season), industrial materials and chemicals Profit uptrend to continue through 2012 fueled by brisk sales of flagship products with solid global market shares and benefits from capacity expansion Kolon Industries s shares are undervalued even under worst-case scenario, as in paying full compensation (KRW1tr) to US-based DuPont for loss of intellectual property case BUY maintained, but fair value trimmed to KRW90,000 reflecting risks stemming from the result of first trial against DuPont 3Q11 OP of KRW93.6bn fell just short of estimates 3Q11 consolidated OP came in at KRW93.6bn, down 21.4%QoQ and 13.5%YoY. Although stand-alone OP of KRW74.7bn was in line with our estimates, consolidated OP was weaker than expected. This can be attributed to earnings removal after Kolon Industries sold its stake in its sub-subsidiary Kolon B&S in Sep and unexpectedly large earnings declines at consolidated subsidiaries (e.g., weaker margins at KIN, the company s film manufacturing subsidiary in Indonesia). FY-end 12/09A 12/10A 12/11F 12/12F 12/13F OR (KRWbn) NA 3,241.2 5,535.1 6,389.7 7,285.4 OP (KRWbn) NA 251.3 441.7 535.8 612.0 NP (KRWbn) NA 211.1 373.6 350.1 415.3 Parent NP (KRWbn) NA 211.1 364.0 330.1 392.3 EPS (KRW) NA 10,136 13,686 12,303 14,621 Adj. EPS (KRW) NA 10,136 10,800 11,360 13,500 PER* (x) NA 7.4-3.8 5.6 5.4 4.5 PBR (x) NA 1.5 1.0 0.8 0.7 EV/EBITDA (x) NA 6.9 5.1 4.5 4.2 Div. Yield (%) NA 1.6 2.4 2.8 3.3 ROE (%) NA 15.9 22.0 18.3 18.5 ROIC (%) NA 19.8 11.3 15.1 15.2 For explanations of equity research ratings and disclosures, please refer to the compliance section at the end of this report.

Profits to resume growth in 4Q11 OP uptrend to continue in 2012 Current share price excessively low even with DuPont s compensation at KRW1tr Fair value cut to KRW90,000 in view of full payment of compensation OP is forecast to climb to KRW121.2bn in 4Q11, renewing the quarterly high record for OP from 2Q11. The fashion division, which is currently enjoying peak seasonal demand, will likely lead the company s overall earnings growth. The industrial materials and chemicals divisions also should see 4Q11 OP pick up QoQ fueled by robust sales and solid spreads for flagship products (e.g., tire cord/airbag, petroleum resins). The film division s 4Q11 OP is projected to inch down QoQ due to the still sluggish LCD and PV industries. In 2012, Kolon Industries is expected to sustain its top- and bottom-line expansion on brisk sales of flagship products based on its firm grip over the global market and capacity additions for airbags, PET films, and tire cords in 2011-12. With the outdoor wear market set to keep growing robustly in 2012, the fashion division s 2012 OP is projected to rise more than 15%YoY. Kolon Industries announced the first trial outcome of its ongoing litigation with DuPont over the alleged infringement of aramid-related trade secrets. The size of total compensation is to reach KRW1.05tr (jury verdict of USD920mn, plus punitive damages of USD350,000). A final ruling will be sentenced after appeal, which will likely take at least one year. Details relating to the provisions for the lost trial and deposits for Kolon Industries s appeal are not yet released. However, even under the worst-case scenario, in which the company pays the full compensation decided at the first trial, the company s fair enterprise value is estimated at KRW2.3tr. The company valuation was calculated by taking the sum (KRW4.7tr) of the operating value and investment asset value less net debt of KRW2.4tr. The current share price, which has a market cap of just KRW1.5tr, hints at undervaluation. In view of the compensation amount from the first trial, we lower our adjusted 2012 EPS estimate to KRW11,360 from KRW13,288 and reduce our fair value to KRW90,000 from KRW119,000. The fair value was derived conservatively, assuming that the first ruling s compensation amount will be fully paid, but still holds 48% upside potential from the current share price. Thus, we keep a BUY rating on the company. HYUNDAI Research 2

Fig 1: Earnings growth to resume in 4Q11 (KRWbn) 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11P 4Q11F 2010 2011F 2012F OR 1,047.5 1,165.4 1,094.1 1,324.9 1,316.2 1,378.8 1,278.1 1,562.1 4,632.0 5,535.1 6,389.7 Industrial materials 261.9 293.5 290.7 329.9 326.8 364.7 369.6 408.1 1,176.0 1,469.2 1,836.6 Films/electronic materials 154.2 178.0 195.2 197.1 212.8 201.4 185.3 189.3 724.5 788.8 944.1 Chemicals 197.3 207.9 210.2 214.8 264.4 264.9 274.0 291.6 830.2 1,094.9 1,163.0 Fashion 250.2 287.7 201.1 383.5 270.5 302.5 223.7 422.6 1,122.5 1,219.3 1,453.8 Fashion materials/others 184.0 198.3 196.9 199.5 241.7 245.3 225.4 250.4 778.7 962.8 992.1 OP 74.5 111.4 108.2 103.1 107.8 119.1 93.6 121.2 397.3 441.7 535.8 Industrial materials 28.4 32.6 37.1 27.9 26.2 34.0 33.7 37.0 126.0 130.9 177.0 Films/electronic materials 13.5 23.9 34.1 33.4 37.6 30.9 23.5 22.8 104.9 114.8 128.2 Chemicals 12.9 18.6 20.9 14.6 20.6 20.9 24.0 25.8 67.0 91.3 99.7 Fashion 13.5 24.3 5.4 24.9 16.4 24.2 8.5 28.5 68.1 77.6 92.2 Fashion materials/others 6.1 11.9 10.8 2.3 7.0 9.2 3.8 7.1 31.1 27.1 38.7 Non-operating profits (15.4) (19.6) (17.4) (24.9) (7.4) (8.2) (19.3) (9.8) (77.6) (44.7) (98.2) Interest income (24.8) (26.6) (24.6) (23.8) (15.3) (17.1) (24.1) (16.3) (99.9) (72.8) (129.3) Equity-method income 9.3 7.0 7.1 (1.1) 7.9 8.9 4.8 6.7 22.3 28.3 31.1 Others 0.1 0.0 0.1 0.0 0.0 (0.0) 0.0 (0.1) 0.0 (0.2) 0.0 EBT 59.1 91.8 90.8 78.2 100.4 110.9 74.3 111.5 319.8 394.1 437.6 NP 52.8 78.5 90.4 76.0 90.5 103.4 99.5 93.3 297.7 386.7 350.1 Parent NP 86.0 94.8 94.5 88.6 364.0 330.1 EPS (KRW) 10,136 13,686 12,303 Adj. EPS (KRW) 10,136 10,800 11,360 Note: Actual results for 1Q10 through 3Q11 exclude figures related to Kolon B&S Fig 2: Adjusted EPS estimate revised down assuming compensation payment Additional interest Previous adj. EPS Revised adj. EPS after %Change expense (funding cost (KRW) compensation payment (KRW) (KRWbn) assumed at 6%) 11F 12F 13F 11F 12F 13F 11F 12F 13F Assumed total compensation 200.0 12.0 11,968 12,881 14,886 (3.4) (3.1) (2.0) 500.0 30.0 12,385 13,288 15,195 11,344 12,271 14,422 (8.4) (7.7) (5.1) 1,048.7 62.9 10,800 11,360 13,500 (12.8) (14.5) (11.2) HYUNDAI Research 3

Fig 3: Fair value cut to KRW90,000 (KRWbn) 2012F EBITDA 681.0 Industrial materials 230.3 Films 173.5 Chemicals 128.9 Fashion 113.8 Fashion materials 46.6 EV/EBITDA (x) 6.4 Industrial materials 6.3 Films 6.3 Chemicals 6.3 Fashion 6.3 Fashion materials 6.3 Operating value (A) 4,365.9 Industrial materials 1,450.7 Films 1,092.8 Chemicals 812.3 Fashion 716.6 Fashion materials 293.4 Equity-method subsidiaries (B) Stake (%) 175.8 SKC Kolon PI 50.0 97.1 Book value as of end-2q11 Hana Capital, etc. 78.7 Book value as of end-2q11 Available-for-sale securities (C) 210.6 CAPRO 19.9 193.3 Market value Korea Express 2.3 Market value Debt securities 15.0 Book value as of end-2q11 Investment assets (D=B+C) 386.4 Enterprise value (E=A+D) 4,752.3 Net debt (F) Cash flow upon the exercise of BWs reflected When KRW200bn is set aside as provision 1,548.5 When KRW500bn is set aside as provision 1,848.5 When KRW1.05tr is set aside as provision 2,397.2 Fair market cap (G=E-F) When KRW200bn is paid in compensation 3,203.8 When KRW500bn is paid in compensation 2,903.8 When KRW1.05tr is paid in compensation 2,355.1 Market cap of preferred shares (H) 46.1 Market cap of common shares (I=G-H) When KRW200bn is paid in compensation 3,157.7 When KRW500bn is paid in compensation 2,857.7 When KRW1.05tr is paid in compensation 2,309.0 No. of common shares issued based on BW exercises (J=a+b+c-d) 25,744,205 No. of common shares issued (a) 24,717,241 No. of shares upon the exercise of BWs issued in 1999 (b) 1,282,500 No. of shares upon the exercise of BWs issued in 2009 (c) 338,675 No. of treasury shares (d) 594,211 Fair value (KRW, I/J) When KRW200bn is paid in compensation 122,657 When KRW500bn is paid in compensation 111,003 When KRW1.05tr is paid in compensation 89,690 HYUNDAI Research 4

Profit & Loss Operating revenue NA 3,241.2 5,535.1 6,389.7 7,285.4 Cost of sales NA 2,410.7 4,101.5 4,703.7 5,457.8 Gross profit NA 830.5 1,433.6 1,686.0 1,827.6 SG&A expenses NA 579.2 992.8 1,150.8 1,215.6 Other operating income NA 0.0 0.9 0.5 0.0 Operating profit NA 251.3 441.7 535.8 612.0 EBITDA NA 383.3 581.6 689.1 750.6 Non-operating accounts NA (22.5) (47.7) (98.2) (92.9) Net financing income NA (81.1) (75.9) (129.3) (118.1) Profit on equity method NA 72.8 28.3 31.1 34.2 Net other non-operating income NA (14.2) (0.1) 0.0 (9.1) Profit before tax NA 228.8 394.1 437.6 519.1 Income tax expense NA 17.8 64.1 87.5 103.8 Net profit NA 211.1 373.6 350.1 415.3 Profit attributable to owners of parent NA 211.1 364.0 330.1 392.3 Total comprehensive income NA 473.7 373.6 350.1 415.3 TCI, attributable to owners of parent NA 473.7 364.0 330.1 392.3 Net exceptionals NA 0.0 52.7 0.0 0.0 Adj. net profit NA 211.1 311.3 330.1 392.3 Cash Flow Net profit NA 211.1 373.6 350.1 415.3 Depreciation & amortization NA 131.9 140.8 153.8 138.6 Other non-cash adjustments NA (26.9) 110.8 135.1 152.3 Investments in working capital NA (167.5) (360.9) (239.2) (193.0) Other operating cash flow NA 0.0 (134.5) (87.5) (103.8) Cash flow from operating activities NA 148.5 129.8 312.3 409.3 Capital expenditure NA (155.0) (250.0) (200.0) (200.0) Investments in intangibles NA (16.7) 0.0 0.0 0.0 Changes in current financial assets NA (129.3) 0.0 0.0 0.0 Changes in investment assets NA (21.0) 0.0 0.0 0.0 Other investment cash flow NA 0.4 (2.8) (100.0) (200.0) Cash flow from investing activities NA (321.6) (252.8) (300.0) (400.0) Proceeds from (repayments of) debt NA (125.7) 0.0 0.0 0.0 Changes in equity NA 314.6 0.0 0.0 0.0 Dividends paid NA 0.0 (32.0) (39.1) (45.9) Other financing cash flow NA 1.5 1,268.2 (72.6) 5.5 Cash flow from financing activities NA 190.3 1,236.2 (111.7) (40.4) Other cash flow NA 0.0 0.0 0.0 0.0 Increase/decrease in cash NA 17.2 1,113.2 (99.4) (31.1) Cash and cash equivalents at FYB NA 37.5 160.2 1,273.4 1,174.0 Cash and cash equivalents at FYE NA 54.7 1,273.4 1,174.0 1,142.9 Gross operating cash flow NA 430.5 436.5 578.3 624.3 Free cash flow NA 21.8 77.3 (10.9) 31.3 Net cash flow NA (909.3) (638.9) (85.6) (31.1) Net cash (net debt) NA (871.8) (1,405.2) (1,490.8) (1,522.0) Statement of financial position Cash and cash equivalents NA 54.7 1,273.4 1,174.0 1,142.9 Current financial assets NA 130.5 78.8 78.8 78.8 Trade receivables NA 417.0 858.2 950.4 1,045.4 Inventories NA 382.6 740.5 804.3 884.8 Other current assets NA 54.0 128.1 140.9 143.7 Current assets NA 1,038.7 3,078.9 3,148.4 3,295.5 Investment assets NA 831.0 523.5 531.4 539.3 Property, plant and equipment NA 1,107.5 2,025.5 2,025.5 2,025.5 Intangible assets NA 23.1 96.6 96.1 95.6 Deferred tax assets NA 0.0 0.0 0.0 0.0 Other non-current assets NA 55.8 58.7 158.7 358.7 Non-current assets NA 2,017.5 2,704.2 2,811.6 3,019.1 Total assets NA 3,056.2 5,783.1 5,960.0 6,314.6 Trade payables NA 352.7 659.8 649.9 640.1 Short-term financial liabilities NA 458.6 1,006.3 1,001.2 1,001.2 Current provisions NA 0.0 1.4 1.4 1.5 Other current liabilities NA 191.8 395.6 335.2 330.2 Current liabilities NA 1,003.1 2,063.0 1,987.7 1,973.0 Non-current financial liabilities NA 598.4 1,751.2 1,742.4 1,742.4 Non-current provisions NA 0.0 4.7 4.7 4.7 Provisions for employee benefits NA 73.8 61.9 61.9 61.9 Deferred tax liabilities NA 70.4 0.0 0.0 0.0 Other non-current liabilities NA (13.5) 236.4 186.4 186.4 Non-current liabilities NA 729.1 2,054.1 1,995.3 1,995.3 Total liabilities NA 1,732.2 4,117.2 3,983.1 3,968.3 Issued capital NA 131.1 131.1 131.1 131.1 Share premium NA 719.4 719.4 719.4 719.4 Other equity interest NA (0.2) (0.2) (0.2) (0.2) Accumulated other comprehensive income NA 262.6 262.6 262.6 262.6 Retained earnings NA 211.1 543.4 834.4 1,180.8 Equity attributable to owners of parent NA 1,324.0 1,656.3 1,947.3 2,293.7 Non-controlling Interests NA 0.0 9.6 29.6 52.6 Total equity NA 1,324.0 1,666.0 1,976.9 2,346.3 Total Liab. and equity NA 3,056.2 5,783.1 5,960.0 6,314.6 Per-share Performance (KRW) 12/09A 12/10A 12/11F 12/12F 12/13F EPS NA 10,136 13,686 12,303 14,621 Adj. EPS NA 10,136 10,800 11,360 13,500 BPS NA 50,505 61,586 72,403 85,283 SPS NA 151,731 207,430 237,580 270,883 GCFPS NA 20,151 16,359 21,502 23,212 DPS NA 1,200 1,450 1,700 2,000 3yr CAGR of adj. EPS NA NA 10.0 197.8 197.6 Operating Statistics & Ratios (%) 12/09A 12/10A 12/11F 12/12F 12/13F OR growth NA NA NA 15.4 14.0 OP growth NA NA NA 21.3 14.2 EBITDA growth NA NA NA 18.5 8.9 NP growth of parent NA NA 72.4 (9.3) 18.8 Adj. NP growth NA NA 47.5 6.0 18.8 OP margin NA 7.8 8.0 8.4 8.4 EBITDA margin NA 11.8 10.5 10.8 10.3 NP margin NA 6.5 6.7 5.5 5.7 Adj. NP margin NA 6.5 5.6 5.2 5.4 Note: Adj. EPS = [(Adjusted NP - preferred share dividends) + (after-tax dilution adjustment)] / (diluted avg. number of total ordinary shares outstanding) Adjusted NP = (Parent NP) - [discontinued operation gains + (net exceptional gains) (1 - marginal tax rate)] Net exceptional gains: Pre-tax exceptional gains (exceptional gains attributable to parent including FX gains, derivatives gains, valuation gains, and one-off gains) Shareholder Value & Financial Structure (%) 12/09A 12/10A 12/11F 12/12F 12/13F ROE NA 15.9 22.0 18.3 18.5 ROA NA 9.0 7.7 7.7 8.4 ROIC NA 19.8 11.3 15.1 15.2 WACC NA 6.3 4.0 4.7 4.6 ROIC/WACC (x) NA 3.1 2.8 3.2 3.3 Economic profit (KRWbn) NA 0.0 235.5 301.9 348.4 Total liab./equity NA 130.8 247.1 201.5 169.1 Net debt/equity NA 65.8 84.4 75.4 64.9 Interest coverage (x) NA 4.6 6.3 5.0 5.8 The author has visited Kolon Industries s subsidiary in Indonesia, with the company paying the expenses. Hyundai Securities has not disclosed the material contained in this report to any institutional investor or third party prior to its publication. The author(s) confirms that the material contained herein correctly represents his/her/their opinion and that it has been prepared without any undue influences or interventions. Hyundai Securities Co., Ltd. or any of its affiliates has not taken part in public offerings of the company(ies) covered in this report for the past 12 months. The author(s) of this report does not have any interest in the company(ies) covered herein. Rating: Sector: Overweight (+10% or more), Neutral (-10 - +10%), Underweight (-10% or more) Company: Strong BUY (+30% or more), BUY (+10 - +30%), Marketperform (-10 - +10%), Underperform (-10% or more) Strong BUY = 4, BUY = 3, Marketperform = 2, Underperform = 1, Blackout/Universe Exclusion = 0 (Share price, Fair value, Rating ) All Hyundai Securities Research is available via the following electronic databases: Bloomberg, Thomson Reuters, FactSet. Contact your Hyundai Securities sales representative for access. This report has been prepared for informational purposes only, and does not constitute an offer or solicitation of a contract for trading. Opinions in this report reflect professional judgment at this date based on information and data obtained from sources we consider reliable. However, we do not guarantee that the information and data are accurate or complete, and, therefore, this report is subject to change without prior notice. Individual investment should be made based on each client s own judgment, and we expressly disclaim all liability for any investment decisions and any results thereof. This report is a copyrighted material of Hyundai Securities Co. and, thus, it may not be reproduced, distributed, or modified without the prior consent of Hyundai Securities Co. This report is not prepared for academic purposes, and any third party wishing to quote from it for academic publications should receive the prior consent of Hyundai Securities Co. KRW Kolon Industries 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 10/2 11/2 Rating 4 3 2 1 0