Daewoo Securities Co.

, LTD

Cigarette and Ginseng

Equity Research for International Investors (ERII)

Company Update

KT&G

Korea
27 January 2004

Effective defensive strategy against threats from imports

Oon M. Bak
+82-2-768-4158
ombak@bestez.com

We maintain our Overweight rating on KT&G while raising our 6-month price
target to W30,500 from W27,000, applying a 20% premium to the 2004E sector
P/E. The premium valuation is due to (1) high ROE and operating margins above
the sector average, (2) dividend yield of 7%, and (3) its shareholder friendly policy
with the retirement of treasury stocks stemming from continued commitment to
management innovation.

Helped by a 23.9% yoy growth in sales in 4Q03, sales for all of 2003 rose by
20.6%. Operating profit grew by 35.1% in 2003E in particular on the back of a
55.4% rise in 4Q03, much greater than consensus estimates. New high-end product
launch and the resulting higher ASP (+15% yoy) raised domestic shipment by 2%
in unit terms. In addition, rising exports and cheaper costs thanks to procurement
of imported raw materials expanded margins.

We have revised up our revenue estimates for 2004E and 2005E by 1.6% and 2.8%,
respectively. Along with new product launch, steady demand in the absence of tax
increases in 2004 and a gradual W500 tax increase per pack in 2005 are the main
reasons for the upward revision. Margin expansion will continue, thanks to
procurement of cheaper imports versus expensive local materials, higher ASP, and
equity income from subs. We expect pretax profit to rise by 17.4% and 4.9% in
2004E and 2005E.

Overweight
Maintained

Ticker: 033780.KS
Share price (26/01/04): W24,000
Target price (6mos): W30,500
52-Wk Hi/Lo: W24,000/16,100
Market cap: US$3,603.1mn
W4,282.6bn
Shares issued: 178.4mn shr
Foreign ownership: 39.94%
Major shareholders:

Forecasts/Valuation

IBK (10.75%)

FY
Price performance (%)
1M

6M

NP

EPS

P/E

P/BV

EV/ EBITDA

ROE

(W bn)

(W bn)

(W)

(x)

(x)

(x)

(%)

12M

12/01

1,701.4

333.8

1,748

11.1

1.4

7.2

12.4

12/02

1,806.9

347.4

1,846

8.9

1.5

6.6

15.1

12/03E

2,178.9

466.0

2,568

8.1

1.8

5.5

22.0

12/04E

2,383.2

546.8

3,014

8.0

1.8

6.0

22.5

12/05E

2,366.0

573.8

3,162

7.6

1.5

5.5

20.5

Absolute

9.1

19.4

44.6

Relative

-1.0

-3.1

1.4

KOSPI
Share price

(2/1/2003=100)
200

Sales

Source: Company data, Daewoo Securities estimates

150
100

Impressive results in 2003

50
0
1/03

4/03

7/03

10/03 1/04

Despite the overall slowdown in the South Korean economy, KT&Gs business results
in 2003 were impressive. Helped by a 23.9% yoy growth in sales in 4Q03, sales in 2003
rose by 20.6% yoy. More encouraging was operating profit growth of 35.1% in 2003E,
in particular a 55.4% rise in 4Q03, which was much greater than consensus estimates.
Effective defensive strategy in the domestic market against imports combined with new
high-end product launches and resulting higher ASP (+15% yoy) raised domestic
shipment by 2% in unit terms. In addition, rising exports and cheaper costs thanks to
procurement of imported raw materials expanded margins.

Please carefully read important notices in the last pages of this report.

KT&G

27 January 2004

Figure 1. Earnings Results

% yoy

(W bn)

3Q02

4Q02

2002

3Q03

4Q03

2003

3Q

4Q

2003E

Sales

461.3

465.0

1,806.9

576.8

576.3

2,178.9

25.0

23.9

20.6

Operating profit

136.2

115.9

527.1

173.5

180.2

712.0

27.4

55.4

35.1

Pretax profit

121.0

104.1

493.6

154.1

108.2

640.6

27.4

3.9

29.8

Net profit

84.1

75.9

347.4

108.4

92.9

466.0

28.9

22.4

34.1

EPS (W)

1,854

1,673

1915

2,390

2,047

2,568

28.9

22.4

34.1

Source: Company data, Daewoo Securities estimates

Loss from debt conversion

Nonetheless, pretax profit growth was slower at 39.8% primarily due to a marginal
3.9% yoy growth in 4Q03 pretax profit which was a result of incurred losses of W70bn
from the exercise of exchange-able bonds.

Upward earnings revision for 2004E and 2005E

We have revised up our revenue estimates for 2004E and 2005E by 1.6% and 2.8%,
respectively. Along with new product launches, steady demand in the absence of a tax
increase in 2004 and an acceptable W500 tax increase per pack in 2005 will be the main
reason for the upward revision. Margin expansion will continue thanks to procurement
of cheaper imports versus expensive local materials, higher ASP, and equity income
from subs. We expect pretax profit to rise by 17.4% and 4.9% in 2004E and 2005E.
Figure 2. Earnings Revision
(W bn)
Sales

Previous

Revised

Change (%)

Change yoy (%)

2004E

2005E

2004E

2005E

2004E

2005E

2004E

2005E

2,346.7

2,300.4

2,383.2

2,366.0

1.6

2.8

9.4

-0.7

Operating profit

724.4

696.5

755.4

762.4

4.3

9.5

6.1

0.9

Pretax profit

720.7

692.9

751.8

788.8

4.3

13.8

17.4

4.9

Net profit

507.3

487.7

546.8

573.8

7.8

17.6

17.4

4.9

EPS (W)

2,796

2,688

3,014

3,162

7.8

17.6

17.4

4.9

Source: Daewoo Securities estimates

A critical factor that will materially affect the share price is increases in tax and sale
price. Although a tax hike has a high level of uncertainty, it is most probable sometime
in early 2005. Currently, a health tax of W150 per pack is levied but there could be an
additional W1,000 tax which will inevitably raise the retail price of a cigarette pack by
W1,000. This is the worst scenario and we expect a 10% pa decrease in unit demand if
this takes place. However, there are wide differences of opinions among interest parties
and thus, we do not expect an immediate tax increase.
A W300-W500 rise in tax and sale price will not have lasting impact on demand. After
a year decline as a result of the price increase, demand tends to recover to a normal level.
Under this scenario, we think the impact on share price is negligible.

Daewoo Securities Co., LTD.

KT&G

27 January 2004

Figure 3. Historical Tax Rate

January 1989

Tobacco consumption tax of W360

January 1994

Tobacco consumption tax increased to W460

July 1996

Education tax of W184 (40% of the consumption tax)

December 1996

Waste management fee of W4

May 1997

National healthcare contribution of W2

January 1999

VAT of 10%

January 2001

Tobacco consumption tax increased to W510, Education tax increased to W225

(50% of the tobacco consumption tax)

July 2001

Import duty 40% until July 2004

February 2002

National healthcare contribution increased to W150, agriculture aid of W10

Source: Daewoo Securities

Figure 4. Tax Rate Impact on Retail Price of Cigarette (W/Pack)
Net sale price
Supply
(W)
Tax
(ex-factory price)
price

VAT

Selling
price

Retailers
margin

Retail price

Net
Increase

Current price (W2,000)

708

929

1,637

164

1,800

200

2,000

W200 rise

708

1,129

1,837

184

2,020

224

2,244

244

W300 rise

708

1,229

1,937

194

2,130

237

2,367

367

W500 rise

708

1,429

2,137

214

2,350

261

2,611

611

W1,000 rise

708

1,929

2,637

264

2,900

322

3,222

1,222

Note: 1) Net sale price is sum of manufacturing costs, SGAE, and profit margins
2) Assume no other factor change other than tax factor
Source: Company data, Daewoo Securities

One of the challenges facing KT&G is its declining domestic market share. KT&Gs
market share skidded to 77% in 2003 from 81% in mid-2002. The Korean consumers
have become more accommodative about imported cigarettes as the price gap has
narrowed. However, more aggressive product launches and marketing by KT&G will
likely help the firm maintain its share at 76% in 2004E and 2005E.
Figure 5. Sales Volume of Total Domestic Tobacco Market & KT&G
(%)
15
Total domestic sales volume

10
5
0
-5
-10

Sales volume of KT&G

-15
92

93

94

95

96

97

98

99

00

01

02

03

04E 05E

Source: Daewoo Securities

Daewoo Securities Co., LTD.

KT&G

27 January 2004

Figure 6. Market Share of KT&G vs. Imported Brands

(%)

(%)
30

100
Imported brands (R)
95

25

90

20

85

15

80

KT&G (L)

10
5

75

70
92

93

94

95

96

97

98

99

00

01

02

03

04E 05E

Source: Daewoo Securities

Valuation
We maintain our Overweight rating on KT&G while raising our 6-month price target to
W30,500 from W27,000. The newly set price target is at a 20% premium to the sector
P/E for 2004E given (1) its high ROE and operating margin above the sector average,
(2) dividend yield of 7% and (3) its shareholder friendly policy with the retirement of
treasury stocks stemming from continued commitment to management innovation.
We do not think the overhang from the potential exercise of exchange-able bonds is
serious. Of the 27.7mn shares or 15.3% of shares outstanding (exchange price of
W17,820 vs average share price of W22,000 in 4Q03) for the domestically issued
exchange bond, 74.1% were changed into equity. Majority of these shares are taken care
of through stock repurchase by KT&G and foreign institutional buying. There is another
15.2mn shares or 8.5% of outstanding shares to be exchanged from overseas issued
exchange bonds at around W25,000 per share. We have not seen any exercise of the
overseas EB yet.
Figure 7. KT&Gs EB
Issuance
Issuance size
Bond exercised
Issuer
Investor
Conversion price (W)

Oversea

Domestic

Oct 2001

June 2002

8.5% (15.2mn share)

15.3% (27.7mn share)

0%

74.1% (20.5mn share)

KT&G

KT&G

Foreign investors

Domestic institutions

20,886

17,820

Premium

18%

10%

Maturity

Oct 2006

June 2005.

4.57%

5.70%

Yield to maturity
Source: Daewoo Securities

Daewoo Securities Co., LTD.

KT&G

27 January 2004

Figure 8. KT&G - Financial Statement

BALANCE SHEET PROJECTION
(W bn)
Current Assets
Cash & Bank Deposits
ST Financial Instruments

Receivables

PRO FORMA INCOME STATEMENT

2002

2003E

2004E

2005E

1,853.7

2,014.0

2,112.5

2,343.5

54.9

297.3

160.1

591.4

6.7

36.7

56.7

76.7

117.6

143.6

143.2

141.9

(W bn)

2002

2003E

2004E

2005E

1,806.9

2,178.9

2,383.2

2,366.0

Gross Profit

902.0

1,188.8

1,254.3

1,272.3

OP. Profit

Sales

527.1

712.0

755.4

762.4

Net Non-Oper. Exp

33.5

71.4

3.7

-26.4

24.4

27.5

27.2

27.1

0.7

27.0

21.5

21.5

493.6

640.6

751.8

788.8

0.0

0.0

0.0

0.0

Inventories

1,435.5

1,277.1

1,443.2

1,224.2

Net Forex Exp.

Fixed Assets

2,062.4

2,208.9

2,355.1

2,511.3

Net Financial Exp.

922.8

992.8

1,112.8

1,242.8

Rec. Profit

1,137.7

1,214.9

1,241.1

1,267.3

Net Extraordinaries

Investment Asset
Tangible Assets
Total Assets

3,916.2

4,222.9

4,467.7

4,854.8

Current Liabilities

1,060.1

1,037.6

853.3

784.6

46.8

47.6

63.3

44.6

Payables
ST Bor. & Curr. Port. of LTD

Long-term Liabilities
Bonds & LT Borrowings
Total Liabilities
Paid-in Capital
Surplus
Total Shareholders' Equity

290.0

290.0

290.0

290.0

871.4

938.4

1,006.1

1,073.8

819.9

819.9

819.9

819.9

1,931.5

1,976.0

1,859.4

1,858.4

Pretax Profit

493.6

640.6

751.8

788.8

Net Profit

347.4

466.0

546.8

573.8

Free Cash Flow

212.4

432.3

99.5

668.0

EBITDA

606.8

812.0

855.4

862.4

33.6

37.3

35.9

36.4

EBITDA Margin(%)
Gross Profit to Sales(%)

49.9

54.6

52.6

53.8

OP. Profit to Sales(%)

29.2

32.7

31.7

32.2

955.0

955.0

955.0

955.0

Rec. Profit to Sales(%)

27.3

29.4

31.5

33.3

2,126.0

2,388.2

2,749.6

3,137.8

Net Profit to Sales(%)

19.2

21.4

22.9

24.3

1,984.7

2,246.9

2,608.3

2,996.5

Note: Free Cash Flow = Cash flow from Oper. - CAPEX

CASH FLOW PROJECTION

VALUATION

(W bn)

2002

2003E

2004E

2005E

(W, %, x)

2002

2003E

2004E

2005E

Cash Flow from Oper.

451.4

608.3

224.5

793.0

EPS (W)

1,846

2,568

3,014

3,162

Net Profit

347.4

466.0

546.8

573.8

SPS (W)

9,599

12,009

13,135

13,040

Depreciation

79.2

100.0

100.0

100.0

BVPS (W)

10,927

11,758

13,649

15,682

Amortization

0.5

0.0

0.0

0.0

8.9

8.1

8.0

7.6

Change in Net W/C

-83.4

133.1

-150.0

201.5

P/S (x)

1.7

1.7

1.8

1.8

Others

107.7

-90.8

-272.3

-82.3

P/BV (x)

1.5

1.8

1.8

1.5

Cash Flow from Inv.

CAPEX
Asset Disposal
Chg. in Investment Assets
Others
Cash Flow from Financing

P/E (x)

-203.0

-162.2

-176.2

-176.2

Dividend Ratio(%)

28(C)

32(C)

32(C)

32(C)

-239.0

-176.0

-125.0

-125.0

Dividend Yield(%)

8.5

7.7

6.7

6.7

13.8

13.8

13.8

13.8

EV/EBITDA (x)

6.6

5.5

6.0

5.5

-153.8

-20.0

-70.0

-70.0

Interest Coverage Ratio(x)

16.5

14.2

15.1

15.2

D/E Ratio (%)

97.3

87.9

71.3

62.0

Borrowings to Sales (%)

39.3

50.9

46.6

46.9

176.0

20.0

5.0

5.0

-229.3

-203.7

-185.5

-185.5

Borrowings

783.0

0.0

0.0

0.0

ROE(%)

15.1

22.0

22.5

20.5

Right Issues

16.2

0.0

0.0

0.0

ROIC(%)

18.5

24.0

23.8

23.1

Dividend

-212.0

-203.7

-185.5

-185.5

Others

-816.3

0.0

0.0

0.0

19.2

242.4

-137.2

431.3

Chg. in Cash

Interest Coverage Ratio: OP. Profit / Interest Expenses

Stock Price: W24,000 (26/01/2004)

Source: Company data, Daewoo Securities estimates

Daewoo Securities Co., LTD.

IMPORTANT
27 January 2004 NOTICES

Equity Research for International InvestorsKT&G

(ERII)

Record of Ratings and Target Prices of the Subject Company

(W)

26 Jan. 2004, Overw eight

Target price (6M): W30,500

KT&G

30,000
24 Jul. 2003, Overw eight
Target price (6M): W25,100

25,000
20,000
15,000

29 Oct. 2003, Overw eight

Target price (6M): W27,000

6 May. 2003, Overw eight

Target price (6M): W22,700

10,000
5,000
0
1/03

3/03

5/03

7/03

9/03

11/03

1/04

Rating Allocation
% of companies under coverage

% for which IB services have been provided

Overweight

47.76%

4.36%

Equal-weight

52.24%

12.76%

Underweight

0.00%

0.00%

As of 20 January 2004
Source: Equity Research for International Investors, Daewoo Securities
Important notices to continue to next page

DAEWOO SECURITIES INTERNATIONAL NETWORK

DAEWOO SECURITIES CO., LTD
150-716, 34-3, Youido-dong, Yongdungpo-ku, Seoul, Korea
Tel : (822) 768-3568 Fax : (822) 768-2126
Contact: Joseph Park josephpark@bestez.com
Daewoo Securities (Europe) Ltd.
41st floor, Tower 42, 25 Old Broad Street,
London EC2N 1HQ, U.K.
Tel : 4420-7982-8000 Fax : 4420-7982-8040
Contact: Kevin Jee kevinjee@dwse.com

Daewoo Securities (America) Inc.

101 East 52nd Street, Manhattan Tower,
28th Fl., New York, NY10022 U.S.A.
Tel : 1212-407-1000 Fax : 1212-407-1010
Contact: David Kim davidkim@dwsusa.com

Daewoo Securities (Hong Kong) Ltd.

Suite 816-819, Jardine House,
1 Connaught Place, Central, H.K., China
Tel : 852-2845-6332 Fax : 852-2845-5374
Contact: K. Y. Lee kylee@dws.com.hk

Shanghai Woosang Investment Consulting Ltd.

NO. 555, Nanjing Road(West), Shanghai, CHINA 200041
Tel : 8621-6215-5776 Fax : 8621-6255-4123

Uz-Daewoo Bank
1 Pushkin Street, Tashkent, 700000, Uzbekistan
Tel : 998-71-1320640 Fax : 998-71-1206970

Daewoo Securities Co., LTD.

IMPORTANT
27 January 2004 NOTICES

Equity Research for International Investors (ERII)

KT&G

Analyst of the subject company or member of the analyst's household does not have any financial interest in the securities of the subject company and
the nature of the financial interest (including without limitation, whether it consists of any option, right, warrant, future, long or short position)
This report is a translation of the KT&G report written by Oon M. Bak, analyst for research division of Daewoo Securities Co., Ltd publicly released on 26
January 2004.
As of 27 January 2004, Daewoo Securities Co., Ltd and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the
subject companys shares outstanding.
Daewoo Securities Co., Ltd may have managed or co-managed a public offering of securities for the subject company, or received compensation for investment
banking services from the subject company in the past 12 months.
This report has been provided by ERII (Equity Research for International Investors) of Daewoo Securities Co., Ltd. Daewoo Securities ERII separately runs its
research independent of the research division of Daewoo Securities Co., Ltd. The stock ratings, target prices, estimates, and overall viewpoints of ERII may have
been different from those of research division of Daewoo Securities. Thus, this report has to be viewed as Daewoo Securities ERII's independent opinion and should
not be interpreted by any means as an official viewpoint of research division of Daewoo Securities. Daewoo Securities ERII was established at Daewoo Securities to
service international institutional investors although the reports are being publicly released. Investors can have access to Daewoo Securities ERII's research through
Firstcall, Daewoo research direct(www.bestez.com), Multex and Bloomberg(DWIR).
Daewoo Securities Co., Ltd. is a full-service, integrated investment banking, and brokerage firm. We are a leading underwriter of securities and leading participant in
virtually all trading markets. We have investment banking and other business relationships with a substantial percentage of the companies covered by the research
division of Daewoo Securities and Daewoo Securities ERII. Our research professionals provide important input into our investment banking and other business
selection process. Investors should assume that Daewoo Securities Co., Ltd. are seeking or will seek investment banking or other business from the subject
companies covered by this report and that the research analysts who involved in preparing this report may participate in the solicitation of such business. Our
research analysts compensation is determined based upon the activities and services intended to benefit the investors of Daewoo Securities Co., Ltd. Like all
employee of Daewoo Securities Co., Ltd, analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other
business units, the intuitional equities, investment banking, proprietary trading, and private client division.
This document was prepared by Daewoo Securities Co., Ltd. (Daewoo). Information and opinions contained herein have been compiled from sources believed to
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Daewoo and/or other affiliate companies, their directors, representative, or employees may have a long or short position in any of the securities or other financial
instruments mentioned in this document or of issuers described herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or sale, of
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Daewoo has prepared this document. Daewoos U.S. affiliate, Daewoo Securities (America) Inc., is distributing this document in the U.S.. This document may be
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Summarized version of this report available in Daewoo Securities, Korea Daily Focus on 28 January 2004.
Analyst Stock Ratings of ERII (Equity Research for International Investors), Daewoo Securities Co., Ltd
Risk Rating

Target Return

Overweight

> +15%

Equal-weight

-15% - +15%

Underweight

< -15%

y Rank is a guide to the expected total return over the next 6-12 months unless separately specified otherwise.
y The target return is relative to the market index, which is assumed to be constant at current level.
y Although it is not part of the official ratings at ERII, we may call a trading opportunity in case there is a technical or short-term material development.
Analyst Industry Ratings of ERII, Daewoo Securities
Positive

Industry fundamentals are improving

Neutral

Industry fundamentals are steady without any material changes

Negative

Industry fundamentals are worsening

Daewoo Securities Co., LTD.