KEPCO KPS (051600.KS) BUY / TP KRW44,000 Refining/Chemical/Utility Kang Dong-jin

Jung Hea-jin +822-3787-2228 +822-3787-2370

dongjin.kang@hmsec.com heajin.jung@hmse.com

Earnings surprise on structural improvement

Share price (KRW, Nov 14)

Upside (%)

33,700

30.6

Market cap (KRW bn)

Shares outstanding (’000)

Paid-in capital (KRW bn)/ Face value (KRW )

1,517

45,000

9/200

52-week high/low (KRW) 38,250/26,650

60-day avg. daily T/O (KRW bn) 3

Foreign ownership (%)

Major shareholders (%)

12.41

KEPCO 37.05

Price performance

Absolute (%)

Relative (%p)

1M

1.5

-1.9

3M

9.2

-1.0

6M

-1.0

-3.7 K-IFRS, consolidated

(KRW) 19F EPS 20F EPS TP

Previous 3,357 3,588 44,000

Revised 3,248 3,902 44,000

Consensus 3,116 3,047 40,500

Difference (%) 4.3 28.1 8.6

12-month price performance

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20

40

60

80

100

120

140

160

18.11 19.2 19.5 19.8 19.11

KEPCO KPSKOSPI

Source: WiseFn, Hyundai Motor Securities

Earnings forecasts and valuations

Sales OP NP EBITDA EPS Growth P/E P/B EV/EBITDA ROE Div. yield

(KRW bn) (KRW bn) (KRW bn) (KRW bn) (KRW) (%YoY) (x) (x) (x) (%) (%)

2017 1,237 164 136.0 201.2 3,021 54.0 13.4 2.0 8.0 16.0 3.6

2018 1,242 192 161.3 231.0 3,585 18.7 9.3 1.5 5.8 17.1 5.4

2019F 1,274 179 146.2 219.4 3,248 -9.4 10.4 1.5 5.7 14.5 4.8

2020F 1,340 204 175.6 240.8 3,902 20.1 8.6 1.3 4.8 16.2 5.8

2021F 1,365 212 182.0 250.0 4,045 3.7 8.3 1.2 4.3 15.4 6.0 Note: K-IFRS, consolidated

1) Investment highlights - KEPCO KPS’s 3Q19 results were an earnings surprise. - The higher-than-expected earnings mainly have to do with a deferred sales recognition but other

factors also contributed, including: 1) higher market labor prices, which helped to boost sales; 2) cost stabilization despite the conversion of non-regular to regular employees; and 3) market share growth in thermal plant maintenance.

- The contract to provide maintenance services to POSCO’s Gwangyang steel mill has also contributed to sales growth. This is a factor that could drive 2020’s top-line higher.

- Regular maintenance for UAE plants will be recognized into sales from 2021. We recommend a buy-and-hold strategy.

2) Major issues and earnings outlook - For 3Q19, KPS reported KRW297.4bn in sales (-9.4% QoQ, +12% YoY) and KRW53bn in operating profit

(-4.1% QoQ, +228% YoY), which crushed consensus estimates. - Deferred sales were mostly recognized in 3Q19, which was the main reason behind the earnings

surprise. That said, cumulative operating profit in 2019 was up 22% YoY vs. the sales period last year. - The major catalyst for margins is cost stabilization, which has mainly to do with a decrease in bonuses.

The company is believed to have turned some of its non-regular employees to regular employees, which has lowered its labor cost.

- After an accident last year, KPS strengthened its security standards and its market share in thermal plant maintenance crept up YoY in 2018 and we believe its market share expansion is ongoing. The hiring of non-regular employees as regular employees has made it especially hard for private maintenance service providers to expand market share aggressively due to a lack of human resources.

- The price of labor has surged amid an increase in the minimum wage and introduction of the 52-hour workweek. This is favorable for KPS as the labor market rate is taken into account when the price of plant maintenance is set.

- We adjust up our 2020 earnings forecasts. KPS recently won a KRW36.9bn deal to improve the performance of POSCO’s Gwangyang plant turbines (#1 and #2), which is huge considering non-KEPCO domestic sales are typically less than KRW100bn per year. Since there are 10 turbines in total, there could be more contracts on the way.

3) Share price outlook and valuation - Dividends are likely to grow continuously on the back of steady top-line growth and stable costs. KPS is

a great dividend play considering its 50% dividend propensity.

Company Note November 15, 2019

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COMPANY NOTE

Fig 1. 3Q19 earnings review (KRW bn)

Quarterly results Change HMS estimates Consensus

3Q19P 3Q18 2Q19 %YoY %QoQ 3Q19 %diff 3Q19 %diff Revenue 297.4 265.8 328.3 11.9 -9.4 288.2 3.2 282.9 5.1

Operating profit 53.0 16.2 55.3 227.6 -4.1 28.2 88.0 25.6 107.1 Operating margin (%)

17.8 6.1 16.8 11.7 1.0 9.8 8.0 9.0 8.8

Pretax profit 52.7 18.0 52.7 192.6 0.0 33.4 57.9 28.7 83.4

Net profit (CI) 40.9 14.3 40.9 187.2 0.0 26.0 57.3 23.0 78.0 Note: K-IFRS, consolidated; TB=turn to black, RR=remain in red, TR=turn to red Source: Company data , FnGuide, Hyundai Motor Securities

Fig 2. Earnings revisions (KRW bn)

2019F 2020F

Revised Previous %change Consensus %difference Revised Previous %change Consensus %difference

Revenue 1,274.3 1,271.7 0.2 1,234.6 3.2 1,339.8 1,310.2 2.3 1,295.3 3.4

Operating profit 179.2 166.0 8.0 172.4 4.0 203.5 179.5 13.4 173.7 17.2

OPM (%) 14.1 13.1 1.0%p 14.0 0.1%p 15.2 13.7 1.5%p 13.4 1.8%p

Net profit (CI) 146.2 140.1 4.3 140.2 4.3 175.6 157.3 11.6 137.1 28.1

Source: Company data, FnGuide, Hyundai Motor Securities

Fig 3. P/B bands Fig 4. Market labor prices

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

08 09 10 11 12 13 14 15 16 17 18 19

Price 3x 4x5x 6x 7x

(KRW)

Source: FnGuide, Hyundai Motor Securities Source: CAK, Hyundai Motor Securities

Fig 5. Thermal plant maintenance M/S holding up well Fig 6. Stabilizing labor costs

79.2%

68.0%64.5% 64.3%

61.5% 61.3% 61.3%

53.9%

46.3% 46.4%

94.9% 94.9%92.1%

89.2%

81.8%78.7%

75.5% 76.3% 75.8% 75.3%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Thermal M/S Nuclear M/S

349 355

396 406 429 407

494 548 541 518

546

30%

35%

40%

45%

50%

55%

0

100

200

300

400

500

600

2009 2011 2013 2015 2017 2019F

Labor costs

As % of costs(KRW bn)

Source: Company data, Hyundai Motor Securities Source: Company data, Hyundai Motor Securities

100

120

140

160

180

200

220

240

260

280

1H12 1H13 1H14 1H15 1H16 1H17 1H18 1H19

Engineer electric work Engineer electric industrial work

All

(KRW ‘000)

3

Fig 7. Earnings forecasts (KRW bn)

1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19P 4Q19F 2017 2018 2019F 2020F KEPCO gencos’ capacity (MW) 81,677 81,122 81,331 81,362 81,466 82,266 83,762 85,678 82,132 81,362 85,544 89,058

Sales 251 339 266 386 243 328 297 405 1,237 1,243 1,274 1,340

%YoY -7.9 -0.7 -5.0 12.8 -3.1 -3.2 11.9 4.9 1.1 0.5 2.5 5.1

Thermal 79 129 87 132 93 137 94 129 477 426 453 457

Nuclear/hydro 104 123 106 158 77 109 120 188 472 490 494 522

T/T 20 24 18 21 21 21 20 23 81 83 85 86

Overseas 33 29 34 48 38 32 38 39 129 144 147 154

Non-KEPCO, domestic

15 35 21 27 15 30 25 26 78 98 96 119

Operating profit 23 64 16 88 18 55 53 53 164 192 179 204

(OPM) 9.2 18.9 6.1 22.9 7.4 16.8 17.8 13.0 13.3 15.4 14.1 15.2

%YoY -36.3 8.2 -49.6 141.5 -21.4 -13.7 227.2 -40.2 55.1 16.7 -6.4 13.5

Pretax profit 27 66 18 99 21 56 53 58 175 211 188 225

%YoY -27.0 6.0 -49.7 150.6 -21.9 -14.8 192.5 -41.3 55.2 20.2 -10.5 19.5

Net profit 22 51 14 74 16 44 41 45 136 161 146 176

%YoY -26.8 5.2 -48.3 144.4 -25.6 -14.0 187.2 -39.2 54.0 18.7 -9.4 20.1

Note: TB=turn to black; TR=turn to red; RR=remain in red Source: Company data, Hyundai Motor Securities

4

COMPANY NOTE

Income statement

Balance sheet (KRW bn) 2017 2018 2019F 2020F 2021F (KRW bn) 2017 2018 2019F 2020F 2021F Sales 1,237 1,242 1,274 1,340 1,365 Current assets 630 636 778 873 961

Change (%) 1.1 0.5 2.6 5.1 1.9 Cash and cash equivalents 98 38 163 257 338 Cost of goods sold 986 974 1,017 1,057 1,074 Short-term investment assets 112 111 93 94 96

% of sales 79.7 78.4 79.8 78.9 78.6 Accounts receivable 142 133 135 134 141 Gross profit 251 269 257 282 292 Inventory assets 2 1 2 2 2

Gross margin (%) 20.3 21.6 20.2 21.1 21.4 Other current assets 277 339 375 375 375 Change (%) 30.2 7.2 -4.3 9.7 3.3 Non-current assets 570 645 584 591 598

SG&A expenses 87 77 78 79 80 Tangible assets 431 442 443 449 455 % of sales 7.0 6.2 6.1 5.9 5.8 Intangible assets 10 9 9 10 10 EBITDA 201 231 219 241 250 Investment assets 47 115 48 49 49

EBITDA margin (%) 16.3 18.6 17.2 18.0 18.3 Other non-current assets 81 78 83 83 83 Change (%) 42.1 14.8 -5.0 9.7 3.8 Other financial assets 0 0 0 0 0

Operating profit 164 192 179 204 212 Total assets 1,200 1,281 1,362 1,464 1,559 Operating margin (%) 13.3 15.4 14.1 15.2 15.5 Current liabilities 279 270 254 252 253 Change (%) 55.1 16.7 -6.4 13.5 4.1 Short-term debt 0 0 0 0 0

Non-operating profit 11 19 9 22 24 Accounts payable 11 13 14 14 15 Interest income 6 7 9 10 13 Current portion of long-term debt 0 0 0 0 0 Interest expenses 1 1 7 0 0 Other current debt 268 257 240 238 238 Other non-operating income 6 12 7 12 12 Non-current liabilities 16 26 76 77 77

Subsidiaries/affiliate income 0 0 0 0 0 Bonds 0 0 0 0 0 Pretax profit from cont ops 175 211 188 225 236 Long-term debt 0 0 0 0 0

Pretax margin (%) 14.2 16.9 14.8 16.8 17.3 LT financial debt (incl. lease) 0 0 5 5 5 Change (%) 55.2 20.2 -10.5 19.5 5.0 Other non-current debt 16 26 72 72 73

Income tax 39 49 42 50 54 Other financial liabilities 0 0 0 0 0 Profit from continuing ops 136 161 146 176 182 Total liabilities 295 297 330 329 330 Profit from discontinuing ops 0 0 0 0 0 Owners of parent equity 905 984 1,032 1,135 1,229 Net profit 136 161 146 176 182 Paid-in capital 9 9 9 9 9

Net margin (%) 11.0 13.0 11.5 13.1 13.3 Capital surplus 0 0 0 0 0 Change (%) 54.0 18.7 -9.4 20.1 3.7 Capital adjustment, etc. 0 0 0 0 0

NP from controlling interest 136 161 146 176 182 Other accumul earnings and comp income -1 -1 -1 -1 -1 NP from non-controlling interest 0 0 0 0 0 Retained earnings 897 976 1,024 1,126 1,221 Other comprehensive income 10 -16 -18 0 0 Non-controlling interest 0 0 0 0 0 Total comprehensive income 146 145 128 176 182 Total equity 905 984 1,032 1,135 1,229 Cash flow Key financial data (KRW bn) 2017 2018 2019F 2020F 2021F (KRW, x, %) 2017 2018 2019F 2020F 2021F Operating cash flow 133 130 152 212 214 EPS (based on net profit) 3,021 3,585 3,248 3,902 4,045 Net profit 136 161 146 176 182 EPS (based on parent net profit) 3,021 3,585 3,248 3,902 4,045 Depreciation on tangible assets 34 37 37 34 34 BPS (based on total equity) 20,113 21,870 22,931 25,212 27,310 Amortization on intangible assets 3 3 3 3 4 BPS (based on owners of parent equity) 20,113 21,870 22,931 25,212 27,310 FX-related profit 2 0 1 0 0 DPS 1,470 1,790 1,621 1,947 2,019 Dec (inc) in working capital -177 -149 -77 -1 -6 P/E (based on net profit) 13.4 9.3 10.4 8.6 8.3 Others 135 79 42 0 0 P/E (based on parent net profit) 13.4 9.3 10.4 8.6 8.3 Investing cash flow -193 -124 58 -46 -46 P/B (based on total equity) 2.0 1.5 1.5 1.3 1.2 Dec (inc) in investment assets -3 -68 67 0 -1 P/B (based on owners of parent equity) 2.0 1.5 1.5 1.3 1.2 Decrease in tangible assets 5 1 0 0 0 EV/EBITDA (reported) 8.0 5.8 5.7 4.8 4.3 Increase in tangible assets (capex)

-72 -48 -28 -40 -40 Dividend yield 3.6 5.4 4.8 5.8 6.0 Others -123 -8 18 -5 -5 Growth (%)

Financing cash flow -31 -66 -85 -73 -88 EPS (based on net profit) 54.0 18.7 -9.4 20.1 3.7 Increase (decrease) in debt 0 0 5 0 0 EPS (based on parent net profit) 54.0 18.7 -9.4 20.1 3.7 Increase (decrease) in bond 0 0 0 0 0 Profitability (%)

Increase in capital 0 0 0 0 0 ROE (based on net profit) 16.0 17.1 14.5 16.2 15.4 Dividend -31 -66 -81 -73 -88 ROE (based on parent net profit) 16.0 17.1 14.5 16.2 15.4 Others 0 0 -9 0 0 ROA 11.9 13.0 11.1 12.4 12.0 Other cash flow -2 0 0 0 0 Stability (%)

Increase (decrease) in cash -93 -60 125 94 81 Total liabilities/equity 32.6 30.2 32.0 29.0 26.9 Beginning cash 191 98 38 163 257 Net debt/equity Net cash Net cash Net cash Net cash Net cash Ending cash 98 38 163 257 338 Interest coverage 20,506.7 N/A 370.4 415.6 432.9 Note: K-IFRS, consolidated

5

Investment rating and target price history Two-year price chart

Date Rating TP Difference (%)

Average High/Low

17/12/08 BUY 53,000 -23.7 -20.3 18/02/14 BUY 53,000 -22.9 -12.6 18/03/21 BUY 53,000 -19.6 -3.4 18/05/03 BUY 59,000 -36.6 -23.9 18/08/07 BUY 53,000 -37.5 -30.2 18/11/07 BUY 38,000 -15.6 -6.4 19/02/18 BUY 44,000 -19.2 -13.1 19/05/16 BUY 44,000 -23.8 -13.1 19/08/07 BUY 44,000 -24.4 -13.1 19/11/15 BUY 44,000 - -

Compliance note • The author(s) of this report does(do) not have any interests in the company(ies) covered herein. • Hyundai Motor Securities has not disclosed the material contained in this report to any institutional investor or third party prior to its publication. • The author(s) of this report does(do) not own more than 1% of the shares of the company(ies) covered in this report. • Hyundai Motor Securities has not taken part in securities issuance (DR, CB, IPO, and market making) of the company(ies) covered in this report as lead manager for

the past six months. • This report accurately reflects the author(s)’s professional views and was written without any undue external influence or interference.

Investment rating Hyundai Motor Securities offers three sector investment ratings based on six-month forward fundamentals and share price outlook.

• OVERWEIGHT: Sector-wide fundamentals and share prices are expected to turn up. • NEUTRAL: No meaningful fundamental improvement is expected. • UNDERWEIGHT: Sector-wide fundamentals and share prices are expected to turn down.

Hyundai Motor Securities offers three company investment ratings based on the relative return expected in the following six months, based on the closing price on the date of rating declaration.

• BUY: Excess return of +15%p or more • MARKETPERFORM (M.PERFORM): Excess return of between -15%p and +15%p • SELL: Excess return of -15%p or less

Stock ratings distribution (October 1, 2018-September 30, 2019)

Rating Count % of rating category BUY

MARKETPERFORM SELL

143 20 0

87.73 12.27

0.0

• This report has been prepared for informational purposes only and thus may not be reproduced or distributed without the prior written consent of Hyundai Motor Securities. • The information and statistical data contained herein were taken from sources believed to be relia ble but in no way can be guaranteed and, therefore, final investment decisions should be

made based on each client’s own judgment. • This report cannot be used as evidence in any legal disputes related to the client’s investment de cisions.

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17.11 18.02 18.05 18.08 18.11 19.02 19.05 19.08 19.11

(KRW ‘000)

KEPCO KPSTarget price