Kolon Industries (120110 KS)

KOREA Chemical

Kolon Industries (120110 KS)

BUY (M) / TP: W110,000

Share price (won, Jun 28 ) 70,900

Paid-in capital (Wbn) 139

Market cap (Wbn) 1,776

BPS (won) 54,395

Net debt to equity (%) 80.7

Shares outstanding 27,823,698

Avg daily T/O (2M, Wbn) 7

Avg daily vol (2M, shrs) 99,033

52-week high (won) 126,000

52-week low (won) 55,200

Foreign ownership (%) 16.30

Major shareholders (%)

Kolon Corp & others 31.6

Stock performance (%)

1M 3M 12M

Absolute 7.6 (4.3) (29.8)

Relative 7.9 6.9 (20.4)

Abs (US$) 9.5 (6.3) (36.7)

0

50

100

150

200

250

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Jun 2010 Jun 2011 Jun 2012

KOLON IND(LHS)

Rel. to KOSPI(RHS)

(won) (%)

Source: Datastream

Jul 3, 2012

www.tys.co.kr/english TONGYANG Research

Company Report

Looks tempting 2Q operating profit likely jumped 16% q-q to W108.2bn

We estimate 2Q sales at W1.4tn, operating profit at W108.2bn, and net profit from controlling interest at W67.2bn. Operating profit likely rose 16% q-q from W96.1bn in 1Q. By division, we believe chemical operating profit stagnated due to regular maintenance, while industrial material operating profit rose. For fashion, outdoor product sales continued to grow at 10% y-y. Film operating profit was soft on weak packaging PET film margins.

OP by division: chemical W26.7bn (vs W25.5bn in 1Q), industrial materials W22.8bn (vs W19.4bn), film W16.6bn (vs W15.9bn), fashion W23.1bn (vs W16.8bn).

2H mtm: auto mat’l demand in Asia to rise, stable EG/TPA prices

Despite jitters over other chem firms’ performance, we estimate Kolon’s 2H operating profit at W206.1bn, slightly above the W204.2bn estimated for 1H.

As global carmakers are slated to complete plants in China in 2H (boosting capacity by 2mn units), this should be a boon to Kolon’s auto material sales

With China’s cotton inventory hitting record highs, prices of Kolon’s key materials, EG/TPA, should continue to retreat in 2H.

Maintain BUY, target price of W110,000

In 2012, we expect robust earnings from petroleum resin, auto materials, and outdoor products.

For the aramid lawsuit, Kolon continues to contact Dupont to reach an accord through an attorney.

Forecasts and valuations (Wbn)

FY ends Dec 2010 2011 2012E 2013E 2014E

Sales 5,110.0 5,420.1 5,751.3 6,233.2 6,627.4

Chg (% y-y) 6.1 6.1 8.4 6.3

Reported OP 371.2 397.0 410.5 439.5 510.7

Adjusted OP* 371.2 402.2 400.2 439.5 510.7

NP, CI 224.7 323.1 271.2 285.9 341.4

EPS, CI (won) 12,010.1 13,192.5 10,826.1 11,409.3 13,626.2

Chg (% y-y) 9.8 -17.9 5.4 19.4

P/E (x) 4.7 6.3 6.5 6.2 5.2

P/B (x) 1.1 1.3 0.9 0.8 0.7

EV/EBITDA (x) 5.5 5.8 6.0 5.3 4.5

ROA (%) 6.1 7.7 5.6 5.5 6.1

ROE (%) 17 21.2 14.5 13.3 14.1

Note: * Adjusted OP = reported OP (K-IFRS) – other operating profit/loss. CI = controlling interest Source: TONGYANG Securities

Kyu-won Hwang kyuwon.hwang@ tongyang.co.kr +822-3770-3564

2 TONGYANG Securities Inc.


I. 2Q operating profit to jump 16% q-q to W108.2bn We believe Kolon Ind diverged from commodity petrochem plays in terms of 2Q results. We estimate 2Q sales at W1.4tn, operating profit W108.2bn, and net profit from controlling interest at W67.2bn. Operating profit likely rose 16% q-q from W96.1bn in 1Q. As commodity petrochem plays’ 2Q results likely suffered badly, Kolon Ind should stand out in terms of stable earnings.

By division, we believe chemical operating profit stagnated on regular maintenance, while industrial material operating profit rose. For fashion, outdoor product sales continued to grow at 10% y-y. Fashion operating profit likely remained soft due to weak packaging PET film margins.

Operating profit forecasts, by division are as follows: chemical W26.7bn (vs W25.5bn in 1Q), industrial materials W22.8bn (vs W19.4bn), film W16.6bn (vs W15.9bn), fashion W23.1bn (vs W16.8bn), and other core subsidiaries W21.3bn (vs W17.7bn). Core subsidiaries include Kolon Nanjing (airbag, tire cord production in China), Kolon Fashion Material (polyester, nylon thread), Kolon Glotech (car seats), and Kolon Plastics (POM).

Table 1. 2Q consolidated OP estimated at W108.2bn vs W96.1bn in 4Q (Wbn) 2011 (consolidated) 2012 (consolidated) Full-year

1Q 2Q 3Q 4Q 1Q 2QE 3QE 4QE 2010 2011 2012E 2013E

Sales 1,480.9 1,557.1 1,278.1 1,447.0 1,330.9 1,435.1 1,387.2 1,598.2 3,241.2 5,763.1 5,751.3 6,223.2

Chemical 257.9 257.4 268.4 276.0 283.6 270.0 295.5 300.5 808.6 1,059.7 1,149.6 1,309.7 Industrial materials 159.1 171.2 176.9 180.2 180.0 201.9 213.3 202.4 560.4 687.4 797.6 787.0 Film 197.2 196.8 174.3 166.6 167.4 175.0 181.9 183.4 672.2 734.9 707.7 712.5 Fashion 153.6 263.9 221.0 390.4 284.3 335.1 240.7 448.0 701.6 1,028.9 1,308.1 1,460.8

Kolon Nanjing (100%) 29.4 35.5 44.3 42.4 46.8 47.7 48.2 62.5 - 149.6 205.2 262.8

Kol Fash Mat (100%) 163.6 169.4 158.4 149.8 151.7 162.1 158.1 152.0 - 641.2 623.9 659.8

Kolon Glotech (75.2%) 275.7 299.6 113.9 119.3 106.4 121.1 122.5 117.4 - 808.5 467.4 501.7 Kolon Plastic (70%) 49.4 53.1 52.7 54.0 60.1 70.2 71.6 76.9 - 209.2 278.9 313.6 Other 195.0 112.2 68.2 68.3 50.6 52.0 55.4 55.1 498.4 443.7 212.9 215.3 Operating profit 116.6 124.9 93.6 76.5 96.1 108.2 94.4 111.7 251.3 411.6 410.5 439.5

Chemical 20.4 20.8 24.0 25.0 25.5 26.7 29.3 28.1 60.9 90.2 109.5 128.4 Industrial materials 16.6 17.6 19.4 21.2 19.4 22.8 24.0 21.6 62.3 74.8 87.7 91.7 Film 28.8 28.0 24.8 15.6 15.9 16.6 18.8 17.7 82.3 97.2 69.0 72.4 Fashion 12.2 21.2 8.9 28.1 16.8 23.1 7.1 28.4 51.7 70.4 75.4 76.1 Kolon Nanjing (100%) 2.1 1.7 2.6 5.6 4.7 5.4 5.4 7.0 - 12.0 22.6 31.0 Kol Fash Mat (100%) 9.2 9.4 4.5 1.2 6.8 7.8 7.6 8.4 - 24.3 30.6 33.9 Kolon Glotech (75.2%) 12.6 14.3 7.4 5.6 3.6 4.1 6.0 4.0 - 39.9 17.8 19.0 Kolon Plastic (70%) 3.7 3.4 2.7 3.0 2.6 4.0 4.2 4.6 - 12.8 15.4 18.8 Other (incl legal exp) 11.0 8.5 -7 -288 0.9 -23 -80 -81 - -100 -175 -318

Eq-meth gain (Wbn) 7.9 8.9 4.8 5.2 6.8 7.2 7.4 5.6 72.8 26.8 27.0 36.1

Net prof, CI (Wbn) 86.0 98.4 87.3 42.9 71.8 67.2 60.5 71.7 224.7 311.0 271.2 285.9

EPS (won/share) 9,434 12,832 10,688 11,271

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Source: TONGYANG Securities

Unlike commodity petrochem firms, Kolon likely sustained stable

earnings in 2Q

OP to rise 16% q-q fromW96.1bn in 1Q

TONGYANG Securities Inc. 3

Company Report

Earnings by division (see table 1)

Chemical operating profit likely came to W26.7bn in 2Q, up slightly from W25.5bn in 1Q. The chemical division produces petroleum resin (capacity of 100,000 tpa) for industrial adhesives and phenol resins (capacity 60,000 tpa) for PCB. Production facilities are in Ulsan and Yeosu. In April, the Yeosu plant did regular maintenance for a petroleum resin line (capacity of 50,000 tpa), decreasing operating profit by W2.0bn~3.0bn. However, thanks to petroleum resin/phenol resin product price hikes and petroleum resin capacity addition of 10,000 tpa, chemical operating profit likely rose q-q. The petroleum resin export price inched up from US$2,827/tonne in 1Q to US$2,897 in 2Q, while phenol resin export price rose from US$3,141 to US$3,351.

Industrial material operating profit is estimated at W22.8bn for 2Q, up from W19.4bn in 1Q. We attribute this to robust domestic sales of airbag fabric amid seasonal strength for auto production, coupled with soft prices of raw materials EG and TPA. As shown in chart 4, airbag fabric export prices climbed about 4% from US$12,245/tonne in 1Q to US$12,745 in 2Q. By contrast, TPA and EG prices, accounting for 20~25% of airbag fabric selling prices, fell 9% (US$1,184/tonne in 1Q to US$1,075 in 2Q) and 12% (US$1,065 in 1Q to US$938 in 2Q), respectively.

We believe film operating profit remained soft at W16.6bn in 2Q vs W15.9bn in 1Q. Film operating margin fell from 14.2% in 3Q11 to 9.5% in 1Q12, and probably stayed weak in 2Q. As shown in chart 5, the average export price for packaging, industrial, optical, and solar-cell PET film recovered from US$4,441 in 1Q to US$4,773 in 2Q. However, demand for packaging PET film, representing 40% of Kolon Ind’s PET film sales, remains lackluster. Consequently, Kolon Ind’s film operating profit growth should be weaker than rival SKC’s. (Of SKC’s PET film production capacity of 160,000 tpa, 70~80% goes to high-margin optical and solar cell PET films.)

Fashion operating profit likely soared from W16.8bn in 1Q to W23.1bn in 2Q. Amid the economic downturn, we think sales of menswear brand “Cambridge Kolon” fell 5~10%, while sales of outdoor product brand “Kolon Sports” likely continued to grow more than 10% y-y. As a result, we believe fashion operating margin was stable at a mid-7% level. According to department store sales data for May (Ministry of Knowledge Economy), womenswear sales grew 6.4% y-y, menswear 5.6%, sportswear 6.4%, and women’s casualwear 0.1%, showing that outdoor product sales were relatively strong.

We believe Kolon incurred about W4.0bn in legal fees related to the Dupont lawsuit in 2Q, similar to the level in 1Q. Of the four actions (damages, punitive fines, suspension of production/sales of aramid, legal fee payment) filed by Dupont with the Virginia Court of first instance, the rulings have yet to be made on suspension of production/sales of aramid, and legal fee payment. In addition, Dupont has not yet seized accrued accounts receivable on Kolon’s exports to the US. We estimate that Kolon did not do provisioning for 2Q for losing the first instance.

Industrial material OP rises from W19.4bn in

1Q to W22.8bn in 2Q

Film OP stays soft at W16.6bn in 2Q vs

W15.9bn in 1Q

Fashion OP soars from W16.8bn in 1Q to

W23.1bn in 2Q

Dupont lawsuit legal fees estimated at

W4.0bn for 2Q

Chem OP likely up from W25.5bn in 1Q to

W26.7bn in 2Q



Chart 1. Kolon Ind: petroleum resin product price Chart 2. Kolon Ind: phenolic resin product price

10001200140016001800200022002400260028003000

07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan

(US$/tonne)

Petroleum resin export price

2Q12: US$2,897

1Q12: US$ 2,827

1,500

2,000

2,500

3,000

3,500

200701 200801 200901 201001 201101 201201

(US$/tonne)

Phenolic resin export price

2Q12:US$3,351

1Q12:US$3,141

Note: Used as material for industrial adhesive Source: Korea International Trade Assoc (HS code: 3911-10-1000)

Note: Used for IT and commodity plastic Source: Korea International Trade Assoc (HS code: 3909-40-0000)

Chart 3. Kolon Ind: tire cord price Chart 4. Kolon Ind: airbag price

3000

3500

4000

4500

5000

200701 200801 200901 201001 201101 201201

(US$/tonne)

PET tire cord export price

2Q12: US$4,140

1Q12:US$4,255

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

200701 200801 200901 201001 201101 201201

(US$/tonne)

Airbag export price

2Q12: US$12,745

1Q12:US$12,245

Note: Used as tire reinforcement Source: Korea International Trade Assoc (HS code: 5902-20-1000)

Note: Used in automobiles Source: Korea International Trade Assoc (HS code: 8708-95-9000)

Chart 5. Kolon Ind: PET film price Chart 6. Dom dept store sporting good sales growth

0

1,000

2,000

3,000

4,000

5,000

6,000

200701 200801 200901 201001 201101 201201

(US$/tonne)

PET film export price

2Q12: US$4,773

1Q12: US$4,441

-5

0

5

10

15

20

25

30

Jan 2009 Jan 2010 Jan 2011 Jan 2012

(% y-y)

Sports goods sales growth at department

Jan 2012: +2.3% y-yFeb: +5.1% y-yMar: +8.6% y-yApr: +7.1% y-yMay: +6.4% y-y

Note: Used as optical, packaging, and industrial PET film Source: Korea International Trade Assoc (HS code: 3902-62-0000)

Source: Ministry of Knowledge Economy


Company Report

Table 2. Kolon Ind: international price trend by product (FOB Korea) Petroleum resin Phenolic rosins PET tire cord Airbag PET film Aramid

HS code: 3911-10-1000 (export)






Monthly avg

Qtrly avg

Monthly avg

Qtrly avg

Monthly avg

Qtrly avg

Monthly avg

Qtrly avg

Monthly avg

Qtrly avg

Monthly avg

Qtrly avg

(US$/tonne) (US$/tonne) (US$/tonne) (US$/tonne) (US$/tonne) (US$/tonne) Jan 2007 1,675 2,373 3,621 8,540 2,764 24,633

Feb 1,677 2,314 3,653 10,894 3,230 23,510 Mar 1,670 1,674 2,037 2,241 3,627 3634 10,137 9,857 2,865 2,953 25,194 24,446 Apr 1,680 2,248 3,720 6,184 2,957 26,065 May 1,689 2,293 3,629 11,190 2,882 24,552 Jun 1,691 1,687 2,058 2,200 3,647 3665 8,417 8,597 2,958 2,932 25,242 25,286 Jul 1,754 2,221 3,672 9,327 2,822 20,963

Aug 1,763 2,150 3,679 6,897 2,795 24,212 Sep 1,754 1,757 2,306 2,226 3,739 3697 12,970 9,731 2,910 2,842 25,244 23,473 Oct 1,785 2,114 3,709 12,232 2,971 23,399 Nov 1,783 2,248 3,847 9,948 2,795 23,730 Dec 1,808 1,792 2,293 2,218 3853 3803 12,217 11,466 2,804 2,857 25,165 24,098

Jan 2008 1,887 2,420 3,844 10,169 2,937 24,881 Feb 1,902 2,377 3,922 10,957 2,943 29,611 Mar 1,971 1,920 2,349 2,382 4,035 3934 11,568 10,898 3,012 2,964 29,209 27,900 Apr 1,993 2,546 4,110 11,940 3,087 27,710 May 2,018 2,505 4,129 12,023 3,149 24,893 Jun 1,995 2,002 2,405 2,485 4,063 4101 10,895 11,619 3,161 3,132 28,153 26,919 Jul 2,120 2,448 4,128 9,378 3,252 28,,516

Aug 2,172 2,529 4,036 10,841 3,258 28,095 Sep 2,169 2,154 2,597 2,525 4,038 4067 11,656 10,625 3,390 3,300 27,828 28,416 Oct 2,162 2,499 3,972 11,005 3,341 28,153 Nov 2,226 2,532 3,922 11,225 3,276 24,952 Dec 2,133 2,174 2,754 2,595 3840 3911 10,749 10,993 2,930 3,182 25,627 26,244

Jan 2009 1,950 2,373 3,881 7,995 3,102 25,898 Feb 1,884 2,488 3,689 11,245 3,008 23,051 Mar 1,782 1,872 2,366 2,409 3,650 3740 11,251 10,164 3,067 3,059 24,335 24,428 Apr 1,751 2,262 3,644 10,329 2,791 22,,749 May 1,789 2,162 3,706 11,203 2,962 23,983 Jun 1,800 1,780 2,302 2,242 3,744 3698 10,767 10,766 3,179 2,977 23,345 23,359 Jul 1,790 2,295 3,697 11,532 3,253 22,742

Aug 1,817 2,128 3,673 10,407 3,166 22,503 Sep 1,840 1,816 2,132 2,185 3,728 3699 11,140 11,026 3,361 3,260 30,424 25,223 Oct 1,887 2,194 3,747 11,883 3,527 30,140 Nov 1,907 2,184 3,737 11,164 3,486 18,,170 Dec 1,872 1,889 2,271 2,216 3,772 3752 10,598 11,215 3,541 3,518 19,327 22,546

Jan 2010 1,867 2,287 3,833 10,760 3,618 21,745 Feb 1,885 2,489 3,824 10,202 3,578 21,325 Mar 1,901 1,884 2,376 2,384 3,801 3819 11,814 10,925 3,630 3,609 20,412 21,161 Apr 1,980 2,580 3,814 12,189 3,844 22,359 May 2,075 2,512 3,765 15,710 3,876 20,883 Jun 2,105 2,053 2,588 2,560 3,785 3788 14,251 14,050 4,097 3,939 21,469 21,570 Jul 2,191 2,506 3,931 12,381 4,290 21,060

Aug 2,238 2,614 4,048 12,260 4,339 21,186 Sep 2,251 2,227 2,611 2,577 3,995 3991 12,234 12,292 4,609 4,413 21,465 21,237 Oct 2,345 2,635 4,059 12,102 5,034 22,343 Nov 2,351 2,953 4,066 11,264 4,933 21,802 Dec 2,410 2,369 2,833 2,807 3,987 4037 10,686 11,351 4,864 4,944 21,653 21,933

Jan 2011 2,551 3,025 4,112 11,835 5,025 21,574 Feb 2,623 2957 4,169 9,981 5,071 22,585 Mar 2,694 2,623 3,000 2,994 4,130 4137 11,044 10,953 4,951 5,016 23,004 22,391 Apr 2,850 3,355 4,310 10,838 4,862 22,544 May 2,912 3,370 4,395 12,462 4,783 22,717 Jun 2,933 2,898 3,328 3,351 4,425 4377 12,522 11,941 5,041 4,895 23,375 22,879 Jul 2,931 3,350 4,527 10,189 5,409 23,657

Aug 2,970 3,320 4,623 12,193 4,950 22,983 Sep 2,988 2,963 3,245 3,305 4,554 4568 11,522 11,301 5,055 5,138 22,394 23,011 Oct 2,894 3,077 4,498 13,146 4,876 22,837 Nov 2,929 3,040 4,445 14,558 4,720 21464 Dec 2,847 2,890 3,213 3,110 4,450 4464 12,222 13,309 4,840 4,812 22,887 22,396

Jan 2012 2,884 3,236 4,288 12,233 4,365 22,959 Feb 2,826 3,049 4,280 12,643 4,495 22,535 Mar 2,771 2,827 3,137 3,141 4,196 4255 11,860 12,245 4,464 4,441 21,762 22,419 Apr 2,895 3,471 4,114 11,475 4,603 21,692 May 2,898 3,230 4,165 14,032 4,943 22,295 Jun

Annual capacity

110K tpa 60K tpa 43K tpa 16K tpa 114K tpa 5K tpa

Source: Company data, KITA



II. 2H positive: better auto mat, stable raw mat price Solid earnings growth should continue in 2H12. Even with Dupont-related costs of W10bn per quarter, we expect 2H12 operating profit of W206.1bn, slightly above W204.2bn in 1H, given an upcycle in the Asian auto materials market and continued stability in prices for key raw materials (EG and TPA).

(1) Asian auto materials market to change

Asia’s auto materials market should see a favorable turn in Jul 2012, as a string of global auto makers are due to finish plant construction in 2H, starting with Hyundai Motor ending Beijing plant construction in July. The world’s top-10 automakers had combined auto production capacity in China of 8.8mn units as of end-2011. As shown in table 3, in 2H12, the top-10 automakers are set to ramp up production capacity in China by a total of 1.97mn units (GM 800k, VW 300k, Hyundai 300k, Ford 170k, Toyota 150k, Fiat-Chrysler 140k, and Honda 100k), up 22% vs their previous combined capacity. Plant construction in China is not confined only to 2012. Auto production capacity in China should expand by 1.6mn in 2013, 1.2mn in 2014, and 1.9mn in 2015, meaning demand for auto materials, especially in Asia, should rise.

Chart 7 shows chemical products used for auto production. Chemical plastics account for 14% of car materials. PP (polypropylene) is used for bumpers; butadiene rubber and tire cord for tires; polyurethane for interior materials such as dashboards; silicon for airbags; optical PET films for IR films designed to block UV rays and heat. With capacity additions in China, auto material makers are set to benefit.

Auto materials represent 50% of Kolon Ind’s total sales. Kolon Ind also makes auto chemical materials such as airbags, tire cords, PET films, plastics for interior materials (Kolon Plastics), and auto sheets (Kolon Glotech). Encouragingly, it has plants both in Korea and China.

Table 3. Global automakers’ capacity in China Chart 7. Chem plastics make up 14% of auto materials

(‘000 units) 2011 2012 2013 2014 2015 Chg

GM 2,365 3,175 810 3,195 3,745 4,070 Ford 467 637 170 637 1,027 1,227 VW 2,080 2,380 300 2,930 3,230 3,350 Toyota 820 970 150 970 970 1,280

Honda 770 870 100 890 890 1,010 Hyundai/ Kia

1,030 1,330 300 1,630 1,630 1,730

Nissan 1,030 1,030 - 1,515 1,515 1,815 Fiat 240 380 140 650 650 1,050 Total 8,802 10,772 1,970 12,417 13,657 15,532

Source: Marklines Source: TONGYANG Securities

2H OP estimated at W206.1bn

Bright outlook for Asian auto material makers

on large-scale plant built in China in 2H12

Auto materials include PP, BR, PU, PET films,

and nylon

Auto materials yield50% of Kolon’s sales

Window- heat resistance PET film

Airbag - nylon 6,6

Interior material - urethane /ABS

Bumper - PP

Tire- synthetic rubber/reinforcement material


Company Report

(2) Stabilization of raw material prices

As chart 8 shows, key raw materials Kolon uses are EG, TPA, and caprolactam, which it uses to make PET film, PET tire cord, textiles, nylon tire cord, and airbag apparatus. With key raw material prices likely fall in 2H12, Kolon should generate stable profits.

Prices of these key raw materials started to fall in Feb 2012. International EG prices fell 22.3% from US$1,086 in February to US$844/tonne in June. International TPA prices fell 23.3% from US$1,204 to US$923/tonne, respectively, and international caprolactam price also dropped 23.2% from US$2,961 to US$2,275/tonne. Behind the price drops lie excess polyester inventory in China. While general polyester fabric inventory stood at 7~10 days, inventory in China exceeded 30 days in 2Q12. Utilization at polyester makers using EG and TPA as raw materials fell to 60~70%. As a result, EG and TPA prices declined. The situation is similar for caprolactam price.

Given raw cotton inventories in China, we expect prices of EG, TPA, and caprolactam (raw materials for chemical textiles) to stay low in 2H12. Chart 10 shows raw cotton inventory levels in China, the largest consumer of raw cotton. As of end-Jun 2012, China’s raw cotton inventory hit a record-high of 27.33mn bales. Moreover, cotton planted in April is set for harvest in October. Inventory growth should drive down raw cotton prices, meaning prices of polyester and its raw materials EG and TPA are unlikely to recover. The situation is bad for chemical plays that produce EG and TPA, like Honam Petrochem, but good for companies that use EG and TPA as raw materials.

Chart 8. Production process of key products [Key raw materials] [Products for sales]

PET film wrapper, optical film

EG

PET chip PET tire cord Tire material

TPA

Polyester yarn Polyester yarn, fabric

Kolon Material

Airbag nylon 6,6 with silicon coating

Caprolactam Nylon chip

Nylon tire cord Tire material

Cotton

Source: TONGYANG Securities

Chart 9. Raw material prices (EG, TPA, caprolactam) Chart 10. Raw cotton inventory in China

1500

2000

2500

3000

3500

4000

400

600

800

1000

1200

1400

1600

Jan 2011 May 2011 Sep 2011 Jan 2012 May 2012

(US$/tonne) (US$/tonne)

EG Jun 2012: US$844

TPA Jun 2012: US$923

Caprolactam Jun 2012: US$2275

0

5000

10000

15000

20000

25000

30000

35000

Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012

(1000 bales)

2013 estimate(USDA)

Chinese cotton inventory hit record high in Jun 2012 at 27.33mn bales

Source: Chemlocus Source: USDA

Key raw materials are EG, TPA, caprolactam

Excess polyester inventory in China

drives down EG, TPA,and caprolactam prices

about 23% each over Feb~Jun

Raw cotton inventory still at record-high;

prices of raw cotton, polyester, EG, TPA likely

to remain low in 2H12



III. Conclusion: maintain BUY, target W110,000 Considering earnings improvement and risks of litigation with Dupont becoming manageable, we believe our W110,000 target is reachable in 2H12 and recommend accumulating shares.

First, despite global economic jitters, Kolon can generate W400bn per year in operating profit, as it has built a stable business portfolio thanks to restructuring in 2007~2011. Each of its four main divisions—chemical, industrial material, film, and fashion—generates 20~25% of operating profit. With all divisions competitive in the domestic and global markets, Kolon has achieved a profit structure that is insensitive to the economic cycle. We believe it will stand out at a time when economic growth worldwide is stagnating.

Second, resolution of the litigation with Dupont will likely act as a share price driver. Kolon is known to have contacted Dupont to settle out of court since Mar 2012. In fact, Kolon said it would try everything to reach an accord with Dupont within this year during its announcement of 1Q results on May 24.

We believe both Dupont and Kolon Ind could be satisfied if Kolon Ind makes aramid under Dupont’s “Kevlar” brand, with Kolon paying brand royalties to Dupont and holding a sales license in Asia. In addition, Kolon will have to pay litigation expenses accumulated since 2009, estimated at W100bn~300bn. As of June, the two companies were still at odds over the amount of cash that Kolon Ind should pay.

When the agreement is reached, Kolon’s enterprise value should rise by the difference between W1tn (damages ruled in the first trial) and the amount of cash outflow as a result of out-of-court settlement. Market cap may rise by this amount (chart 11).

Third, shares hold valuation merit, trading at a 2012 P/B of 0.9x. We believe litigation risk is fully reflected given that shares traded at a P/B of 2.0x right before the ruling of W1tn. Also, Kolon’s P/E stands at 6.6x, far lower than the chemical sector average of 12x. Given the pluses of stable earnings generation and potential out-of-court settlement with Dupont, we think shares have been overly discounted.

Chart 11. Kolon mkt cap chg on out-of-court settlement Chart 12. Kolon Ind’s P/B

0

20000

40000

60000

80000

100000

120000

140000

160000

02 03 04 05 06 07 09 10 11 12

(won)

0.1

1.9

1.3xBottom P/B seen in 2008

financial crisis: 0.5x0.8x

(bottom)

2H12H target P/B: 1.3x

Inc. in market

cap

W1t

W1t Size of the award

Kolon won't settle if the award is bigger than W1tn

0

Market cap to recover by an amount that's equal to W1tn minus the size

of the award

Source: TONGYANG Securities Source: TONGYANG Securities

Backed by 3 strengths(stable earnings, reduced

legal risk, low P/B), shares likely to hit W110,000

2) trying to settle out of court with DuPont

With conditions of manufacturing on OEM basis + cash payment

1) despite global economic unrest, Kolon can earn W400bn in OP

annually

3) undervalued at 2012 P/B of 0.9x and P/E of

6.6x


Company Report

Table 4. Target price set at W110,000, even assuming Kolon Ind pays the entire damages to DuPont

(Wbn) May 26 Details

(+) Operations 5,064 Division Stake (%) OP Deprec EBITDA Targ mult (x) Fair value (EBITDA x

target multiple x stake (%, Wbn))

▶Chemical Parent 114 34 149 6.5x 966

▶Ind mat Parent 105 22 126 6.9x 871

▶Film Parent 143 19 162 8.5x 1,375

▶Fashion Parent 98 25 123 6.6x 812

▶Kolon Nanjin 100 25 5 30 6.9x 208

▶Kolon Fashion Mat 100 35 5 40 5.0x 200

▶Kolon Glotech 75.2 23 11 34 6.0x 154

▶Kolon Plastic 70.0 22 2 24 7.8x 133

▶Other 42 6 48 7.1x 345

Total 633 129 764 6.8x 5,064

(+) Asset value 362 Assets Stake (%) NAV (2011) P/B (x) Fair value

(Wbn) Note

SKC Kolon PI 50.0 99 0.7x 67 Flexible PCB film maker (unlisted)

Hana Capital 29.1 61 1.1x 67 Lender (unlisted)

Capro 19.9 182 1.1x 175 Nylon material caprolactam maker (listed) -7,955,218 shares × W31,500

Other 53 1.0x 53

Total 411 0.9x 362

(-) Net debt 1,514

Total debt 1,737 Consolidated debts of W1,668bn + preferred shares W69bn

Cash & equivalents 223

Pre-provisioning common shares (A)

3,911

Contingent debt related to DuPont lawsuit

104.9 ▶Court orders Kolon Ind to pay DuPont W1.05tn in damages for violating trade secrets in Nov 2011

Post-provisioning common shares (A’)

2,862

Shares outstanding (B) 25,790k = 24,302,211 shares out + 2,078,974 shares from conversion of BWs - 594,211 treasury shares

Per share value (A’/B) W110,000 Source: TONGYANG Securities



Kolon Industries (120110 KS) pro forma financial statements (K-IFRS, consolidated)

Statement of financial position Statement of comprehensive income

FY to Dec (Wbn) 2010 2011 2012E 2013E 2014E FY to Dec (Wbn) 2010 2011 2012E 2013E 2014E

Non-current assets 2,436 2,559 2,758 2,861 2,948 Sales 5,110 5,420 5,751 6,233 6,627

Investment in affiliate 179 192 216 252 290 Cost of sales 3,799 4,036 4,308 4,646 4,903

LT financial assets 233 244 268 268 268 Gross profit 1,311 1,384 1,443 1,588 1,724

Tangible assets 1,856 1,966 2,034 2,102 2,151 SG&A 940 982 1,043 1,148 1,214

Other non-current 121 43 56 59 64 Reported op prof 371 397 411 440 511

Current assets 1,601 2,239 2,530 2,749 3,078 Adjusted op prof 371 402 400 440 511

Cash & equivalent 147 231 193 271 394 Other op prof/loss 0 -9 11 0 0

ST financial assets 142 19 69 69 69 Non-operating prof -90 -49 -44 -47 -42

Accts rec & other 627 869 1,074 1,131 1,220 Interest income 4 6 11 13 17

Inventory 643 824 1,017 1,071 1,154 Interest expense 104 92 96 97 97

Other current 42 296 177 207 242 Forex gain/loss 5 2 4 0 0

Total assets 4,038 4,798 5,288 5,610 6,026 Equity-meth gain/loss 25 27 27 36 38

Non-current liabilities 1,144 949 1,227 1,195 1,166 Other -22 4 11 0 0

LT financial liabilities 856 733 964 904 844 Pre-tax from cont op 281 348 367 392 469

Other non-current liab 249 168 205 224 245 Income tax 36 64 84 95 113

Current liabilities 1,438 2,057 1,970 2,060 2,182 Net profit 245 339 282 297 355

Accts payable & other 727 683 845 890 959 NP for controlling int 225 323 271 286 341

ST financial liabilities 567 950 787 775 763 Total comprehensive inc 245 335 296 297 355

Other current 144 425 338 395 460 TCI for controlling int 225 317 287 286 341

Total liabilities 2,582 3,006 3,196 3,255 3,349 EBITDA 562 552 571 625 696

Equity for controlling int 1,319 1,723 2,021 2,273 2,581 Free cash flow -125 -382 -10 233 275

Paid-in capital 131 139 139 139 139 EPS 12,010 13,193 10,826 11,409 13,626

Capital surplus 719 921 965 965 965 Book value/share 50,323 66,952 77,590 86,660 97,725

Retained earnings 206 668 904 1,156 1,464 Dividend/share 1,200 1,200 1,200 1,200 1,200

Equity for non-control int 137 69 71 82 96 EBITDA/share 26,582 20,445 20,527 22,479 25,031

Total equity 1,456 1,792 2,091 2,355 2,677

Net debt 1,134 1,432 1,489 1,339 1,144

Cash flow statement Valuation

FY to Dec (Wbn) 2010 2011 2012E 2013E 2014E FY to Dec 2010 2011 2012E 2013E 2014E

Operating cash flow 292 326 246 518 539 Gross margin (%) 25.7 25.5 25.1 25.5 26.0

Net profit 245 339 282 297 355 Operating margin (%) 7.3 7.4 7.0 7.1 7.7

Depreciation & amortization 191 150 171 186 186 Net margin (%) 4.8 6.3 4.9 4.8 5.4

Forex translation gain/loss 0 -2 -4 0 0 EBITDA margin (%) 11.0 10.2 9.9 10.0 10.5

Affiliate invest gain/loss -25 0 -27 -36 -38 Sales (% y-y) 6.1 6.1 8.4 6.3

Inc (dec) in net working cap -182 -261 -238 -27 -58 Operating profit (% y-y) 8.3 -0.5 9.8 16.2

Other -61 -39 51 39 44 Net profit (% y-y) 38.2 -16.7 5.4 19.4

Investing cash flow -383 -218 -259 -237 -214 EPS (% y-y) 9.8 -17.9 5.4 19.4

Disp (acq) of tangible asst -257 -388 -278 -250 -230 EBITDA (% y-y) -1.8 3.5 9.5 11.4

Inc (dec) in intang asst -17 -6 -2 0 0 ROE (%) 17.0 21.2 14.5 13.3 14.1

Inc (dec) in ST/LT finl asst -133 151 1 0 0 ROA (%) 6.1 7.7 5.6 5.5 6.1

Other 25 26 20 13 17 Accts rec turnover (x) 8.5 7.4 6.0 5.7 5.7

Financing cash flow 167 1 -30 -203 -202 Inventory turnover (x) 8.0 7.4 6.3 6.0 6.0

Inc (dec) in ST/LT finl liab -148 98 67 -72 -72 P/E (x) 4.7 6.3 6.5 6.2 5.2

Inc (dec) in equity 315 14 0 0 0 P/B (x) 1.1 1.3 0.9 0.8 0.7

Dividend payout -1 -32 -3 -34 -34 EV/EBITDA (x) 5.5 5.8 6.0 5.3 4.5

Others 1 -79 -95 -97 -97 Div yield (com shr, %) 1.6 1.9 1.7 1.7 1.7

Inc (dec) in cash & eq 76 76 -43 78 123 Debt-to-equity (%) 177.4 167.8 152.8 138.2 125.1

Beginning cash & equiv 76 160 236 193 271 Net debt-to-equity (%) 77.9 79.9 71.2 56.9 42.7

Ending cash & equiv 152 236 193 271 394 Net fin cost/sales (%) 1.9 1.6 1.5 1.3 1.2

OP/financing cost (x) 3.6 4.4 4.2 4.5 5.3

Note: EPS, BPS, P/E and P/B are based on controlling interest For valuation metrics such as P/E, historical figures are based on annual averages, estimates on current price For ROA or ROE, assets and equity are averages of end-of-year figures for given year and year prior Data to 2010 based on K-GAAP and from 2011, K-IFRS Source: TONGYANG Securities


Company Report

Kolon Industries (120110 KS) ratings and target price history

020,00040,00060,00080,000

100,000120,000140,000160,000180,000

Jul 2010 Jan 2011 Jul 2011 Jan 2012

(won)

Current price

Target price

Date Rating TP (won)

2012/04/06 BUY 110,000

2012/01/31 BUY 110,000

2012/01/05 BUY 110,000

2011/11/23 BUY 160,000

2011/11/15 BUY 160,000

2011/10/10 BUY 160,000

2011/09/20 BUY 160,000

2011/07/05 BUY 160,000

2011/05/24 BUY 130,000

2011/02/15 BUY 100,000 Source: TONGYANG Securities

Disclosures & disclaimers

This research report has been prepared for informational purposes only; it does not constitute an offer or a solicitation of an offer to buy or sell any securities or other financial instruments. The information and data contained in this report have been obtained from sources we consider reliable; however, we make no representation that the information provided in this report is accurate or complete, and it should not be relied on as such. The recipient of this report should use his/her independent judgment regarding the sale or purchase of any securities or financial instruments mentioned herein. We disclaim any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is for our clients only. It is copyrighted material and may not be reproduced, transmitted, quoted, or distributed in any manner without the prior written consent of TONGYANG Securities Inc.

As of the publication date of this report, TONGYANG Securities Inc. does not own a stake in excess of 1%, nor does it have any interest whatsoever, in the subject company (ies). The material contained herein was not disclosed by TONGYANG Securities Inc. to any institutional investors or third parties prior to its publication. The analyst (s) of this report or the analyst (s)’ spouse does not have any financial interest in the securities of the subject company (ies) mentioned herein, nor financial interest of any nature related to the subject company (ies) (including without limitation, whether it consists of any option, right, warrant, future, long or short position), as of the publication date of this report.

Analyst certification

I/We, as the research analyst/analysts who prepared this research report, do hereby certify that the views expressed in this report accurately reflect my/our personal views about the subject securities discussed in this report.

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Kolon Industries (120110 KS)