Buy Call: Eugene Corp. (023410: KQ)

Eugene Corp. “The end of bloody hell of competition”

Update TDG VRSN 04192017 Kwon

Historical Data. Trading at discount due to competition. But, does it last forever? 

Business: Eugene Corporation manufactures and sells construction materials in South Korea. The company offers ready-mixed concrete, asphalt concrete, and basic construction materials under the Remicon/Ascon names. In addition, the company is involved in the aggregates, and construction management and development businesses.The company was founded in 1984 and is based in Seoul, South Korea. Eugene Corporation is a subsidiary of Eugene Group.

Investment Thesis
Stable Growth on Construction Spending
Korea domestic construction spending (civil / residential / non- residential) in 2016 totaled 164 trillion Won, renewing the domestic history in 2015. In 2015, 158 trillion Won of domestic construction, which had risen sharply to 110 trillion Won in 2014, The market size was 164 trillion won with many orders in the fourth quarter and the housing sector is leading the growth in recent years. I believe the construction spending that directly affects Eugene’s sales volume in terms of cement manufacturing and Remicon (Ready Mix Concrete) business is expected to remain steady for at least a couple of years as it has been at its lowest level for the past five years and they will continue to receive construction orders at least 2 years.


Historical Construction Spending. Concern of the peak? 

Direct Synergies are expected as a No.1 Remicon player: Acquired No.3 Remicon player in Korea: It is anticipated that the size of the business will expand in the main business area which is a Remicon business. Eugene has currently 29 Remicom manufacturing plants while Dongyang has 24 plants but there is no overwrapping area with those plants except only 1 plant. Unlike cement business is targeting nationwide basis, Remicon business can only be achieved through small regional, local sales within the constraints of time for the product life less than 90 minutes since mixing cement with water. Cement is the main raw material that accounts for more than 70% of the raw materials in Remicon, so acquiring Dongyang, which is No.3 Remicon maker makes it possible to be a big buyer from cement makers so that they might increase their bargaining power whatsoever. Remicon industry consolidation is expected to strengthen the bargaining power of annual price negotiations with construction companies and cement manufacturers. Going back to five years ago, the cement-Remicon industry was hit hard as a whole with the price competition of many players. In recent years, structural reforms have been taking place in the industry, and as a result, the level of competition has weakened and it has been transformed into an oligopolistic system. As a result, the annual price with the construction company and the unit price of Remicon have been raised by more than 5%, and stable price hikes are expected in the future as the competitive structure is relaxed.

Capital Structure Improvement: At the end of 2016, Eugene Corp’s assets is 1.5 trillion Won, 871.6 billion Won of liabilities, 647.9 billion Won of equity. In a meantime, Dongyang is a company with 983.5 billion Won of assets, 125.1 billion Won of liabilities, 855.5 billion Won of equity. If it is consolidated, it will be 2.5 trillion Won assets, 977.9 billion Won of liabilities and 1.5 trillion Won of capital (0.9 billion Won of controlling interest). Especially, cash and cash equivalent of Eugene are 71.7 billion Won, while Dongyang owns approximately 400 billion Won including 101 billion Won and short-term financial instruments of 301.2 billion Won, I expected the acquisition would contribute to the improvement of Eugene’s financial structure and the decrease in interest payments.

Valuation: Average of DCF and Multiples, Target Price is 8,540 KRW

– Advanced DCF analysis due to changes of capital structure over time –> Fair Value per share ended up with 9,300 KRW. (See Valuation Tap)

– P/E, P/B multiples
–> Currently, Eugene is trading at discount as a 5.55x of P/E, 0.55x of P/B apiece. Industry Average of P/E, P/B in 2018 is 7.88x, 0.6x respectively. I believe my target price based on P/E multiples is 7,840 KRW.

Picture4Risk & Mitigants

– Growth of Domestic Construction Spending might become slow due to residential’s peak out
–> Eugene covers Seoul and surburban area of Seoul, which is relatively less volatile market due to stable demand for housing

– P&L might be volatile depending on industry growth
–> Acquiring No.3 player made it possible to have economy of scale

– 30% of Debt, 0.9x of interest coverage ratio
–> capital structure will be relaxed due to the M&A with Dongyang