Negatives priced in; 2Q upturn hopes intact

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The author is an analyst of Shinhan Securities. She can be reached at hpark@shinhan.com — Ed.

1Q23 results to disappoint due to weak duty-free earnings

We now expect LG H&H to post consolidated operating profit of KRW156.1bn (-11% YoY) on sales of KRW1.61tr (-2% YoY) for 1Q23, missing market consensus of KRW167.1bn. Amid the growing need for downward-adjustment of expectations on duty-free and China earnings, shares have been stuck in correction territory for over a month. We believe cosmetics sales dropped 12% YoY in 1Q23, while steady growth similar to 4Q22 levels continued for household goods at 4% YoY and beverages at 7% YoY.

Duty-free sales, one of main causes of weak cosmetics sales in 1Q23, likely tumbled by KRW148bn QoQ to KRW86.6bn as the cutback on daigou (small-scale individual Chinese merchant) commissions sparked a boycott of the company’s products and decline in traffic. Downward revision of expected sales from the duty-free channel, the main profit contributor, inevitably leads to a decline in operating profit estimates for the cosmetics business. Reflecting recent changes in sales share by channel, we now expect cosmetics operating margins to come in lower by 2.4%pt on a YoY basis.

China demand to recover from 2Q23

While raw material prices have stabilized at lower levels across the board in the industry, we find that the cost burden for the household goods division’s ingredients business (sales share of 10%) has actually increased. Effects of ASP hikes carried out on beverages and household goods will be felt with a lag, while room for further margin improvement will continue to narrow with the reshuffle of product/channel mix nearly completed. However, the upbeat outlook for an upturn from 2Q23 remains intact with in/outbound traffic set to increase along with the reopening of Korea and China. Certain brands in China have reportedly seen double-digit growth in retail sales from March. Although not the main beneficiary of China’s reopening, Korean cosmetics brands still stand to see trickle-down benefits from the upturn in consumption. Large-scale cost issues that emerged at the end of 2022 will also dissipate on stabilizing management of overseas subsidiaries Avon and Boinca.

Most of the negatives already priced in

Our target price for LG H&H is adjusted slightly downward, with full-year earnings forecasts for 2023 revised down by 10% in reflection of an expected 21% YoY decline in duty-free sales. However, we retain our BUY rating with most of the negatives priced in and expectations to improve for a recovery in China consumption and duty-free demand.

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