35_doosan heavy industries & construction - things can only get better

Rating Starts at BuyTarget price Starts at KRW 49,000

Closing price 24 March 2014 KRW 33,250

Potential upside +47.4%

Anchor themesA positive outlook for long-term earnings growth is emerging from higher backlog growth. We expect further backlog growth from the growing power-plant market due to rising global power demand.

Nomura vs consensusOur TP is 14% higher than consensus.

Research analysts

Korea Engineering & Construction

Michael Na - NFIK [email protected] +82 2 3783 2334

Hans Park - NFIK [email protected] +82 2 3783 2342

Key company data: See page 2 for company data and detailed price/index chart

Doosan Heavy Industries & Construction 034020.KS 034020 KS

EQUITY: ENGINEERING & CONSTRUCTION

Things can only get better

Thirst for electricity cannot be quenched without nuclear power Action: initiate with Buy We initiate coverage of Doosan Heavy Industries & Construction (DH) at Buy with a TP of KRW49,000. The stock has been on a downward path for more than three years, falling 65% from its peak in early 2010. We attribute the fall to slower new power plant equipment and EPC new orders, deteriorating fundamentals of subsidiaries, and increased uncertainty about the long-term growth prospects of nuclear power due to the catastrophic failure at the Fukushima Nuclear Power Plant. However, we think the negatives are already priced into the shares and see greater upside risk.

Catalysts: new order growth, revival of nuclear power energy, recovery in housing market We expect DH’s new orders to rebound to KRW9trn from the low base of KRW5.8trn in 2013. Given that we expect the long awaited orders from Shin Gori #5&6 (KRW2.1trn) and Nghi Son coal power plants (EPC, KRW1.6trn) to be realized in 2014F, we think our new orders assumption is rather conservative. It would appear that investors have written off nuclear power energy as a major source of electricity due to safety issues and proliferation of unconventional natural gas. However, experience has shown utilities that they should diversify. In our opinion, plans to restart nuclear power plants in Japan confirms our belief that nuclear energy is likely to remain a key source of electricity. Lastly, we think that DH’s subsidiaries no longer impose a significant risk to it.

Valuation: TP of KRW49,000 We derive our TP of KRW49,000 by using SOTP valuation methodology. We apply peer group EV/EBITDA of 10x to DH’s derived core operation value and then add the value of its subsidiaries at a 30% holding company discount (see Fig. 1 for details). 31 Dec FY12 FY13F FY14F FY15F

Currency (KRW) Actual Old New Old New Old New

Revenue (bn) 9,627 19,208 19,295 20,135

Reported net profit (bn) 38 69 196 332

Normalised net profit (bn) 38 69 196 332

FD normalised EPS 306.39 468.47 1,730.88 2,922.75

FD norm. EPS growth (%) -88.0 52.9 269.5 68.9

FD normalised P/E (x) 108.5 N/A 71.0 N/A 19.2 N/A 11.4

EV/EBITDA (x) 12.7 N/A 14.2 N/A 11.6 N/A 10.2

Price/book (x) 0.8 N/A 0.8 N/A 0.7 N/A 0.7

Dividend yield (%) 2.3 N/A 2.3 N/A 2.1 N/A 2.1

ROE (%) 0.8 1.5 4.2 6.8

Net debt/equity (%) 63.2 205.9 189.2 171.2

Source: Company data, Nomura estimates

Global Markets Research 26 March 2014

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Doosan Heavy Industries & Construction 26 March 2014

2

Key data on Doosan Heavy Industries & Construction Income statement (KRWbn) Year-end 31 Dec FY11 FY12 FY13F FY14F FY15F

Revenue 8,496 9,627 19,208 19,295 20,135Cost of goods sold -7,250 -8,241 -16,076 -16,152 -16,858

Gross profit 1,245 1,386 3,132 3,143 3,277SG&A -719 -792 -2,174 -2,128 -2,082

Employee share expense

Operating profit 526 595 958 1,015 1,195

EBITDA 705 802 1,155 1,368 1,537

Depreciation -143 -160 -107 -263 -252Amortisation -37 -47 -91 -91 -91

EBIT 526 595 958 1,015 1,195Net interest expense -164 -184 -574 -575 -551

Associates & JCEs 505 -301 -8 -8 -8

Other income -486 -123 -306 -62 -20Earnings before tax 381 -12 70 370 616

Income tax -119 27 -51 -108 -168

Net profit after tax 262 15 19 262 448Minority interests 13 23 50 -66 -116

Other items

Preferred dividends

Normalised NPAT 275 38 69 196 332

Extraordinary items

Reported NPAT 275 38 69 196 332

Dividends -67 -67 -80 -74 -74

Transfer to reserves 207 -29 -10 122 257

Valuation and ratio analysis

Reported P/E (x) 11.0 93.8 67.5 18.0 10.6

Normalised P/E (x) 11.0 93.8 67.5 18.0 10.6

FD normalised P/E (x) 13.0 108.5 71.0 19.2 11.4FD normalised P/E at price target (x) 18.0 150.1 98.2 26.6 15.7

Dividend yield (%) 2.3 2.3 2.3 2.1 2.1

Price/cashflow (x) 264.3 11.2 9.6 4.3 4.6Price/book (x) 0.7 0.8 0.8 0.7 0.7

EV/EBITDA (x) 5.2 12.7 14.2 11.6 10.2EV/EBIT (x) 6.2 21.7 17.2 15.7 13.1

Gross margin (%) 14.7 14.4 16.3 16.3 16.3

EBITDA margin (%) 8.3 8.3 6.0 7.1 7.6EBIT margin (%) 6.2 6.2 5.0 5.3 5.9

Net margin (%) 3.2 0.4 0.4 1.0 1.6

Effective tax rate (%) 31.3 na 73.2 29.1 27.3Dividend payout (%) 24.5 175.8 115.1 37.8 22.4

Capex to sales (%) 4.0 3.4 1.8 1.8 1.7Capex to depreciation (x) 2.4 2.1 3.2 1.3 1.3

ROE (%) 6.5 0.8 1.5 4.2 6.8

ROA (pretax %) 11.5 2.3 5.0 3.9 4.6

Growth (%)

Revenue -58.4 13.3 99.5 0.5 4.4EBITDA -67.6 13.7 44.0 18.4 12.4

EBIT -61.1 13.1 61.1 5.9 17.7Normalised EPS 99.1 -88.3 39.1 275.4 68.9

Normalised FDEPS -88.0 52.9 269.5 68.9

Per share

Reported EPS (KRW) 3,027.99 354.40 492.88 1,850.07 3,124.00

Norm EPS (KRW) 3,027.99 354.40 492.88 1,850.07 3,124.00Fully diluted norm EPS (KRW) 2,554.70 306.39 468.47 1,730.88 2,922.75

Book value per share (KRW) 45,072.42 42,566.51 43,907.84 45,057.91 47,481.92DPS (KRW) 750.00 750.00 750.00 700.00 700.00


Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (KRW) -8.9 -4.9 -20.8

Absolute (USD) -9.2 -6.5 -17.8

Relative to MSCI Korea -7.9 -0.2 -20.9

Market cap (USDmn) 3,275.3

Estimated free float (%)

52-week range (KRW) 48000/31700

3-mth avg daily turnover (USDmn)

15.66

Major shareholders (%)

Doosan 44.8

NPS 5.5

Source: Thomson Reuters, Nomura research

Notes


3

Cashflow (KRWbn) Year-end 31 Dec FY11 FY12 FY13F FY14F FY15FEBITDA 705 802 1,155 1,368 1,537

Change in working capital -563 -263 -1,123 220 -20

Other operating cashflow -129 -171 477 -716 -700Cashflow from operations 14 368 509 872 817

Capital expenditure -339 -331 -340 -340 -340Free cashflow -325 37 169 532 477

Reduction in investments 671 0 0 0

Net acquisitions

Reduction in other LT assets -68 -20 88 21

Addition in other LT liabilities -73 -217 37 47

Adjustments -901 -579 162 -37 -47Cashflow after investing acts -1,226 -12 94 620 498

Cash dividends -67 -67 -80 -74 -74Equity issue -49 1 700 0 0

Debt issue 628 437 2,844 -305 -289

Convertible debt issue

Others -20 -7 0 0 0

Cashflow from financial acts 492 363 3,464 -379 -363

Net cashflow -734 351 3,558 241 134Beginning cash 1,518 783 1,134 1,809 2,049

Ending cash 784 1,134 4,693 2,049 2,184Ending net debt 2,789 2,847 9,597 9,051 8,627


Balance sheet (KRWbn) As at 31 Dec FY11 FY12 FY13F FY14F FY15F

Cash & equivalents 783 1,134 1,809 2,049 2,184

Marketable securities 72 27 27 27 27Accounts receivable 2,863 2,903 5,752 5,778 6,030

Inventories 457 556 2,424 2,213 2,309Other current assets 1,088 1,098 1,098 1,098 1,098

Total current assets 5,264 5,719 11,109 11,165 11,647

LT investments 4,355 3,729 3,729 3,729 3,729Fixed assets 2,690 2,674 6,075 5,946 5,823

Goodwill 0 0 0 0 0

Other intangible assets 1,158 1,211 4,826 4,942 5,062Other LT assets 123 191 1,921 1,833 1,812

Total assets 13,589 13,524 27,660 27,615 28,074Short-term debt 2,085 1,407 5,864 5,654 5,461

Accounts payable 3,500 3,320 6,652 6,683 6,975

Other current liabilities 491 557 818 822 857Total current liabilities 6,076 5,284 13,334 13,159 13,294

Long-term debt 1,487 2,574 5,541 5,446 5,350

Convertible debt

Other LT liabilities 1,229 1,156 939 976 1,023

Total liabilities 8,792 9,015 19,814 19,581 19,667Minority interest 26 4 3,185 3,251 3,367

Preferred stock 0 0 0 0 0

Common stock 529 529 529 529 529Retained earnings 3,553 3,514 3,311 3,433 3,691

Proposed dividends

Other equity and reserves 688 462 821 821 821Total shareholders' equity 4,771 4,506 4,661 4,783 5,041

Total equity & liabilities 13,589 13,524 27,660 27,615 28,074

Liquidity (x)

Current ratio 0.87 1.08 0.83 0.85 0.88Interest cover 3.2 3.2 1.7 1.8 2.2

Leverage

Net debt/EBITDA (x) 3.95 3.55 8.31 6.61 5.61

Net debt/equity (%) 58.5 63.2 205.9 189.2 171.2

Activity (days)

Days receivable 109.6 82.2 109.1 107.0Days inventory 22.5 33.8 52.4 49.0

Days payable 151.4 113.2 150.7 147.9

Cash cycle 0.0 -19.3 2.9 10.8 8.1Source: Company data, Nomura estimates

Notes

Notes


4

Contents

5 Things can only get better

8 Earnings outlook for 2014-15F

11 Electricity demand can only grow and so will Doosan’s power business

20 Housing market turning; Doosan’s major risk factor to diminish

26 Company overview

27 Appendix A-1


5

Things can only get better

Initiate with Buy

Negatives already priced into the shares We initiate coverage of Doosan Heavy Industries & Construction (DH) at Buy with a TP of KRW49,000. The stock has been on a downward path for more than three years falling 65% from its peak in early 2010. We contribute the fall to slower new power plant equipment and EPC new orders, deteriorating fundamentals of subsidiaries (Doosan E&C, Doosan Infracore, and Doosan Engine), and increased uncertainty about the long-term growth prospects of nuclear power due to the catastrophic failure at the Fukushima Nuclear Power Plant. However, we think the negatives are already priced into the shares and see greater upside risk.

New order growth We expect DH’s new orders to rebound to KRW9trn from its low base of KRW5.8trn in 2013. Given that we expect the long awaited orders from Shin Gori #5&6 (KRW2.1trn) and Nghi Son coal power plants (EPC, KRW1.6trn) to be realized in 2014F, we think our new order assumption is rather conservative.

Revival of nuclear power energy It seems as if investors have written off nuclear power energy as a major source of electricity due to the safety issues and proliferation of unconventional natural gas. However, past experience has shown utilities that they should always try to diversify. In our view, the Japanese government’s plan to restart nuclear power plants in Japan confirms our belief that nuclear energy will likely remain as a key source of electricity. We should note that fossil fuel fired power plants are vulnerable to fuel cost fluctuation, emit more carbon dioxide, and are often less reliable than nuclear power. We do not think that energy importing countries would give up nuclear power and jeopardise their energy security given the increasing reliance on imported fuel.

Affiliate risk declining After a series of capital injections, merger with Doosan Mecatec, and HRSG business transfer from Doosan Heavy to Doosan E&C, we think that the risk of insolvency has declined significantly. More important, we think Doosan E&C will turn around as we expect a recovery in the domestic housing market. As well, we believe that Doosan Heavy’s own housing project “Trimage” should be completed without much loss.

We are buying into financial and operational leverage We are not overly excited about DH’s operating profit growth. However, given that the company is highly leveraged financially and operational, the mere normalization of its core operation and a reduction in debt servicing burden should deliver DH’s performance going forward, assuming that we are not headed into a global recession, which would derail the normalization of its core operation.

2Q14F would be a good time for investors to add to their positions We estimate the bulk of new orders for 2014F should be realized in 2H14 considering the pipeline such as Shin Gori #5 & #6, which will likely catalyze the stock. That said, we think that the best time for investors to add to their positions would be 2Q14. In our view, 1Q14F results may disappoint because of the potential loss on a derivative contract it entered into with Doosan E&C’s preferred shareholders. However, if the shares correct in 1H14, we would advise investors to accumulate further.


6

Valuation

TP of KRW49,000 We value Doosan Heavy on SOTP methodology. Although all its subsidiaries are consolidated given its firm control, we think it is more appropriate to treat the subsidiaries as investment assets rather than part of its core business given that DH owns less than 50% of Doosan Infracore (the key subsidiary) and Doosan Engine.

Fig. 1: SOTP valuation

Note: * Global peer group EV/EBITA multiple is used

Source: Nomura estimates

Risks

First-quarter results likely to impose short-term risk We see downside risk to 1Q14F earnings due to the derivative contract the company entered into with investors who hold redeemable convertible preferred shares of Doosan E&C. If Doosan E&C’s share price falls below KRW17,600, then DH would incur an unrealized loss on this derivative contract. Every KRW1,000 decline in the share price would result in a loss of KRW23bn for DH. Doosan E&C’s current share price (as of March 24) is KRW16,800, which translates into a KRW25bn loss for DH.

Delay in domestic housing market recovery Although we expect a recovery in the domestic housing market, the delay in the housing market and subsequent failure of major housing projects such as “Trimage” could present a risk to our bullish call.

Fig. 2: Doosan Heavy – P/E chart

Source: QuantiWise, Nomura estimates

Fig. 3: Doosan Heavy – P/B chart

Source: QuantiWise, Nomura estimates

(KRWbn) 2014F

2014 EBITDA 700

Target EV/EBITDA multiple (peer goup multiple) 10*

Value of core operation 7,000

Doosan Infracore (042670KS) 914

Doosan E&C (011160KS) 524

Doosan Engine (082740KS) 177

Value of subsidiaries at 30% holding company discount 1,615

Enterprise value 8,615

-Net debt 3,350

Equity value 5,265

Shares outstanding 106

Per share value 49,000

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Fig. 4: Doosan Heavy – Peer valuation

Source: Bloomberg, Nomura estimates

Note: All numbers are based on Bloomberg consensus estimates except for Doosan Heavy, which are Nomura’s estimates; share prices are as of 24 March 2014 close. Fig. 5: Doosan Heavy: share price and key events

Source: QuantiWise, Nomura research

Company Bloomberg Ticker Rating Market cap Share pxUS$mn Loc curr 14F 15F 14F 15F 14F 15F 14F 15F 14F 15F

Doosan Heavy 034020 KS Equity Buy 3,350 33,250 19.2 11.4 0.7 0.7 11.6 10.2 4.2 6.8 2.1 2.1Hyundai Heavy Industries 009540 KS Equity Buy 14,744 206,000 23.5 13.2 0.8 0.8 14.6 11.3 3.4 6.0 1.1 1.1Samsung C&T 000830 KS Equity Buy 8,527 57,900 19.2 16.4 0.8 0.8 15.8 14.0 4.1 4.6 0.9 0.9Hyundai E&C 000720 KS Equity Not Rated 5,561 53,800 9.6 8.1 1.1 1.0 6.4 5.6 12.3 13.1 1.0 1.1Daewoo E&C 047040 KS Equity Not Rated 2,971 7,540 12.7 10.4 1.0 0.9 11.9 10.6 8.1 9.1 1.2 1.2Daelim Industrial 000210 KS Equity Neutral 2,746 82,200 9.8 7.4 0.6 0.6 7.4 5.8 6.5 8.1 0.6 0.6Samsung Engineering 028050 KS Equity Reduce 2,562 68,200 na 11.3 2.5 2.2 14.8 10.2 12.4 19.0 2.0 2.5GS E&C 006360 KS Equity Buy 1,664 34,750 18.3 8.9 0.6 0.6 16.2 10.2 3.4 6.4 1.0 1.4

Domestic peer average 15.5 10.8 1.1 1.0 12.4 9.7 7.2 9.5 1.1 1.2

Siemens SIE GY Equity Buy 116,214 95 14.0 12.4 2.6 2.4 9.1 8.3 19.0 19.7 3.4 3.6Mitsubishi Heavy Indus. 7011 JP Equity Neutral 18,150 550 13.6 14.7 1.2 1.2 8.6 7.6 8.8 8.3 1.4 1.6AREVA AREVA FP Equity Notrated 9,292 18 31.3 19.1 1.4 1.3 10.9 9.1 2.4 5.4 1.1 1.1Alstom ALO FP Equity Reduce 8,604 20 7.9 8.2 1.1 1.0 5.7 5.8 14.2 13.0 2.8 3.4Bharat Heavy Electricals BHEL IN Equity Reduce 7,593 188 12.6 13.9 1.4 1.3 8.6 9.4 13.8 10.5 2.5 2.3IHI Corp 7013 JP Equity Buy 6,352 429 19.3 17.5 2.0 1.9 10.1 9.0 10.9 11.7 1.2 1.3Dongfang Electric 1072 HK Equity Not Rated 4,029 12 9.1 8.7 1.0 0.9 5.9 5.7 11.3 10.9 1.6 1.7Foster Wheeler FWLT US Equity Not Rated 3,120 32 16.4 13.5 3.0 2.4 8.6 7.3 23.0 22.1 0.0 naToshiba Plant 1983 JP Equity Neutral 1,461 1,529 14.1 13.0 1.4 1.3 5.0 4.5 10.1 10.2 1.0 1.0

Overseas peer average 15.4 13.4 1.7 1.5 8.0 7.4 12.6 12.4 1.7 2.0Global peer average 15.4 12.3 1.4 1.3 10.0* 8.4 10.2 11.1 1.4 1.6

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Acquire Doosan Infracore

Acquire Bobcat

Credit risk from Doosan Engine

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plant order intake

Nuclear accident in Fukushima

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Treasury stock sale


8

Earnings outlook for 2014-15F

Parent company

Power division We expect sales in the Power business to decline by 7.3% y-y to KRW6.1tr on an operating profit margin of 8.0% in FY14F, 1) as we expect revenue recognition from large-scale projects such as UAE NPP to reach the final stage, and 2) disappointing order intake during 2012-13 will likely put a damper on near-term top-line prospects. However, despite the sales decline, operating margin should hold up in FY14F, as current order backlog mix contains relatively high margin projects. We believe the earnings of the power business is likely to recover from 2015F on the back of increasing order intakes; DH won an EPC project regarding a coal plant in Vietnam (Vinh Tan4) which amounts to KRW1.6tr in size in December 2013 and expects to win a similar scale project during 1H14.

Water division We forecast a slight increase in sales (KRW782bn,+0.5% y-y) and operating profits (KRW35bn, +1.0% y-y) in 2014F for water business. According to Global Water Intelligence and the company forecast, the desalination plant market is expected to grow by 59.7% to 1,754 million imperial gallons per day( MIGD), (equivalent to 4,500m²) during 2013-17F (vs 1,098MIGD during 2008-12). We expect the water business to be able to enjoy a solid growth in the growing market.

Fig. 6: Power business OP and OPM trends & forecasts


Fig. 7: Water business OP and OPM trends & forecasts


C/F, Cons, etc division We expect earnings from C/F, Cons, etc business would trend lower for the next 3-5 years as the company has decided against undertaking any PF (project financing) involved construction projects. We find the move affirmative as it would allow the company to avoid taking on an excessive financial risk. Construction accounts for more than 50% of divisional sales volumes, and general construction (vs. contract-based construction), which usually requires project financing comprise about 60% of total construction revenues. As the company aims to exit from the general construction business within the next 3-5 years, more than 30% (50% x 60%) of the top line would be eliminated over time. The company noted that it will continue to maintain its contract-based construction business. The company generates about 35% of divisional earnings from casting & forging (C&F) business (as of 2013). The C&F business provides casted and foraged parts mainly to Doosan Engine, and therefore has a similar earnings trend with Doosan Engine. We believe earnings from the C&F business will recover next year (2015F) after bottoming in 2014F along with earnings of Doosan Engine (explained further below).

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9

Subsidiaries

Doosan Infracore In 2014F, we expect sales and operating profits of Doosan Infracore to rise by 2.9% and 29.3%, respectively to KRW7.96tr and KRW478bn on the back of 1) increasing excavator sales in China; 2) solid earnings from Bobcat, its 100% owned subsidiary and 3) a turnaround of engine business. Doosan Infracore plans to solidify its medium- and small-size excavator line-up in the China market, and that would help the company to recover market share, in our view.

Fig. 8: C/F, Cons, etc OP and OPM trends & forecasts


Fig. 9: Doosan Infracore OP and OPM trends & forecasts


Doosan Construction We expect sales of Doosan Construction to increase by 1.2% in 2014F to KRW2.38tr on operating profit of 2% (vs. 0.0% in 2013). We believe domestic construction market has bottomed, and expect the market to recover in the next 3-5 years on the back of: 1) enhanced affordability, 2) rising natural demand, and 3) housing inventory that has fallen, 4) Jeonse property becoming scarce and 5) mortgage rates at historically low levels. (Our view on the Korean construction market is explained in further detail on pages 21-26)

Doosan Engine We estimate that Doosan Engine will post an operating loss of KRW12bn in 2014F (turned to red y-y) due to order intake during 1Q-2Q13 with negative margin, in our view However, we expect Doosan Engine to post profits from 2015F (operating profit of KRW25bn in 2015F) on the back of 1) increasing order intake on container and tanker from Deawoo Shipbuilding and Samsung Heavy Industries; 2) rise in engine ASP (up 5-8% starting from 4Q13) and 3) newly added sales from nitrogen oxide reduction equipment (a sample has been provided to Samsung Heavy Industries – sales to be gradually increase up to 5% of total sales).

Fig. 10: Doosan Construction OP and OPM trends & forecasts


Fig. 11: Doosan Engine OP and OPM trends & forecasts


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10

Fig. 12: Doosan Heavy – Earnings trends and forecasts


Note: 2011 and 2012 earnings are restated based on the changed consolidation policy implemented as of 2013, and therefore, the above numbers are different from the ones in the financial tables on pages 1-2.

Derivative contract regarding RCPS issued by Doosan E&C - swing in net income Doosan E&C issued KRW400bn redeemable convertible preferred shares (RCPS) in December 2013. In order to back up Doosan E&C, DH entered into a derivative contract with investors who purchased the RCPS that the company will pay the difference between Daewoo E&C’s share price and strike price (KRW17,600) per share for 22.7mn RCPS issued by Doosan E&C to investors on the settlement date (16 December 2016), if Daewoo E&C shares are trading higher than the strike price. If Daewoo E&C’s share price trades lower than the strike price on settlement date, investors would pay the different between the strike price and the share price to DH for the total RCPS.

Regarding the derivative contract, DH marks to market on a quarterly basis. For 1Q14 YTD, Doosan E&C’s price fell by 11.3% to KRW16,800 (as of March 24) from KRW17,800 on 31 December 2013. We estimate Doosan Heavy to record unrealised losses of KRW25.0bn {(KRW17,800 – KRW16,800) x 22.7mn RCPS} for the quarter. As we anticipate a recovery of the domestic housing market going forward, we expect Doosan E&C’s price to trend higher. If that is the case, DH will likely unwind the unrealised losses, in our view.

(Wbn) 2011 2012 2013 2014F 2015FTotal Sales 21,412 21,274 19,208 19,295 20,135% y-y na -1% -10% 0% 4%Power 5,612 7,180 6,566 6,087 6,134Water 807 927 782 785 807C/F, Cons, etc 1,741 1,341 1,194 1,117 1,090Doosan Heavy 8,159 9,448 8,541 7,989 8,274

Doosan Infra 8,463 8,158 7,737 7,963 8,267Doosan Construction 2,783 2,377 2,355 2,384 2,467Doosan Engine 2,007 1,379 744 1,092 1,231

Gross profit 3,138 3,064 3,132 3,143 3,277GPM 14.7% 14.4% 16.3% 16.3% 16.3%

Operating profit 1,178 586 958 1,015 1,195% y-y na -50% 63% 6% 18%Power 299 534 524 481 509Water 26 28 35 35 36C/F, Cons, etc 77 -46 -44 -34 -14Doosan Heavy 403 516 515 482 531

Doosan Infra 680 362 370 478 546Doosan Construction 299 70 1 48 74Doosan Engine -309 -449 57 -12 25

OPM 5.5% 2.8% 5.0% 5.3% 5.9%Power 5.3% 7.4% 8.0% 7.9% 8.3%Water 3.3% 3.0% 4.4% 4.5% 4.5%C/F, Cons, etc 4.4% -3.4% -3.7% -3.0% -1.3%Doosan Heavy 4.9% 5.5% 6.0% 6.0% 6.4%

Doosan Infra 8.0% 4.4% 4.8% 6.0% 6.6%Doosan Construction 10.8% 2.9% 0.0% 2.0% 3.0%Doosan Engine -15.4% -32.6% 7.7% -1.1% 2.0%

Net income 262 15 19 262 448Net profit margin 1.2% 0.1% 0.1% 1.4% 2.2%


11

Electricity demand can only grow and so will Doosan’s power business

Non-OECD countries to drive growth

World electricity demand to double by 2040 World electricity demand is projected to double between 2010 and 2040, growing at an annual rate of 2.4%, according to the US Energy Information Administration (EIA). This is faster than any other final energy source. Electricity’s share of total final energy demand is expected to continue to rise. Much of this growth should come from growth in electricity demand in the non-OECD counties, which is expected to grow at an average annual rate of 3.6% from 2010 to 2040 based on a study conducted by the EIA.

Fig. 13: Electricity market outlook

Source: WEO, Company data, Nomura research

Coal-fired power plant capacity to grow Despite the proliferation of unconventional natural gas, coal-fired power plant capacity is expected to grow through 2040. It should remain as the largest source of world power generation through 2040, according to EIA. However, we think that the estimate may differ if there are major changes to the greenhouse gas emission policy.

Fig. 14: Coal-fired power plant capacity forecasts

Source: WEO, company data, Nomura research

Nuclear power plant capacity to double EIA expects nuclear power plant capacity to increase from 2,620 billion kilowatt-hours in 2012 to 5,492 billion kilowatt-hours in 2040, as market concerns about energy security and greenhouse gas emissions support growth. The EIA noted that it has considered the Fukushima disaster for the purpose of forecasts.

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Fig. 15: Nuclear power plant capacity forecasts

Source: WEO, company data, Nomura research

Renewable energy to remain dismal Although we expect renewable energy to grow rapidly, we do not think it can replace any one of aforementioned major energy sources in our life time and remain as a supplementary energy source. While solar power is taking off, we do not think that the added solar energy capacity is nowhere near replacing what traditional energy source can supply.

Tesla provides upside risk

Gigafactory to change the game We believe electricity demand could grow faster if electric vehicle (EV) prices fall swiftly. Despite the skeptics, Tesla’s CEO Elon Musk believes that he can produce a mass market electric sedan, now referred to as the Model E. The price target for the Model E is below USD40,000, which is one-third less than the price of the Model S that Tesla successfully commercialized. In order to cut costs, Tesla plans to build a so called “Gigafactory.” According to Tesla, the Gigafactory is designed to reduce cell costs quickly, and produce more lithium-ion batteries per year than were produced globally last year. By the end of the first year of production, the company expects to have driven down the per KWh cost of its electric car battery pack by over 30%. Given that the battery comprises roughly 30% of the cost of an electric vehicle, a 30% decline in battery cost is a must to produce a mass-market electric vehicle, in our view.

Electric vehicle to grow exponentially If Gigafactory is successful and Elon Musk can bring down battery prices by more than 30%, then we think that EV growth could be much stronger than what the market currently expects. We believe EVs are attractive since they can reduce dependence on petroleum and tap into a source of electricity that is often domestic and relatively inexpensive, and can also decarbonise the transport sector. As Tesla speeds up the evolution of EVs we think other existing car makers have no choice but to bring electric vehicles into the market. BMW has already jumped into the game with a BMW i3 model that costs roughly US$41,000. We expect more to come.

Fig. 16: Electric vehicle growth forecasts by Solar & Energy Solar & Energy is optimistic about the future of electric vehicles

Source: Solar & Energy

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Fig. 17: Electric vehicle specifications Mass market EV is already here

Source: Company data, Nomura research

Nuclear power making a comeback

Cleaner energy than natural gas Market concerns about clean air is one of the main reasons that 70 reactors are under construction around the world including five in the US, in our view. Nuclear energy is by far the largest source of electricity that doesn’t emit any air pollution and the only one that can produce large amounts of electricity around the clock. According to Nuclear Energy Institute, greenhouse gas emissions of nuclear power plants are among the lowest of any electricity generation method and on a lifecycle basis are comparable to wind, hydro-electricity and biomass. We note that lifecycle emissions of natural gas generation are 36x greater than nuclear. In addition, nuclear power eliminates other sources of pollution such as soot, which causes lung diseases.

Fig. 18: Lifecycle CO2 emissions from electric sources Lifecycle emissions of natural gas generation are 36x greater than nuclear

Source: Nuclear Energy Institute, Nomura research

More reliable than natural gas We also note that nuclear power plants can produce electricity more reliably than natural gas. Nuclear energy facilities have the highest capacity factor among all electricity sources. The net capacity factor of a power plant is the ratio of its actual output over a period of time, to its potential output if it were possible for it to operate at full nameplate capacity indefinitely. This is a crucial measure of reliability and a plant’s online performance.

BMW i3 Leaf Focus Electric Tesla Model SManufacturer BMW Nissan Ford TeslaCountry Germany Japan US USMSRP (USD) 41,350 28,800-34,840 39,200 69,900-94,900Battery capacity (kWh) 22 24 23 60/85Range on full charge (km) 190 160 140 368Horsepower (hp) 170 107 160 302Fuel economy (city, km/L) n/a 55 47 34Fuel economy (highway, km/L) n/a 46 42 38Fuel economy (average, km/L) n/a 51 44 36Basic warranty 3years 3years/57,936km 3years/57,936km 4years/80,467kmSource: each company

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Fig. 19: Average capacity factors by energy source (2009)

Source: U.S. Energy Information Administration, Nomura research

Still more affordable than natural gas Understandably, with the proliferation of unconventional natural gas it seems that investors have written off nuclear power plants as a major source of electricity in the future. Shale gas is not just a cheap and abundant energy source, but it can also be used in combined cycle generators that are efficient and easily permitted. However, we should not forget that fossil fuels are subject to a higher fluctuation in prices that could threaten energy security of a nation especially the countries that have to import the fuel source. However, nuclear energy is not subject to unpredictable fuel cost fluctuation or over-dependence on foreign suppliers. Nuclear energy has price stability because fuel accounts for just 31% of projection costs vs. 80-90% for coal and natural gas fired power plants, according to Nuclear Energy Institute.

Fig. 20: Cost breakdown by power generation type (2012)


Fig. 21: US electricity total production costs Even with proliferation of shale gas, nuclear power is still cheaper


Fig. 22: US electricity fuel costs Even with proliferation of shale gas, nuclear power is still cheaper


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Experience has shown utilities that they should diversify Relative to a natural gas power plant, setting up a nuclear power plant seems to be a hard-sell considering the high initial capital investment (roughly USD15bn) and the difficulty in getting permission from the neighbouring communities to set it up. However, if natural gas were to win by default and utilities were to eliminate their coal and nuclear power facilities, we think utility CEOs would be likely have some sleepless nights going forward. Even in today’s low-cost natural gas environment, we think utilities should diversify to hedge against future risks such as: 1) a sharp pick-up in fossil fuel costs, 2) disruption in fuel supply due to geopolitical risk, and 3) severe weather conditions that are disruptive to fossil fuel and renewable energy power plants to name few. Nuclear energy facilities that ran at nearly 100% capacity throughout the spell of arctic weather earlier this year helped carry the record-breaking demand for electricity, according to Nuclear Energy Institute.

Safe energy source that became safer

Safe energy relatively The catastrophic failure of Fukushima’s nuclear power plant caused the world community to pause and to re-examine its nuclear energy options. However, we note that other conventional power plants also have profound safety implications for both operational risks and public health. Further, there have been more fatalities associated with other conventional power plants than nuclear power plants, as shown below.

Fig. 23: Accidents in energy chains for electricity 1996-2000

Source: World Nuclear Association, Nomura research

Chernobyl and Fukushima There have been only three significant accidents which occurred in the history of nuclear energy: 1) Three Mile Island in 1979, 2) Chernobyl in 1989 and 3) Fukushima in 2011. Of all these accidents and incidents, only the Chernobyl and Fukushima accidents resulted in radiation doses to the public greater than those resulting from the exposure to natural sources, according to World Nuclear Association. Chernobyl did not have a containment structure like those used in the West or in post-1980 Soviet designs. Fukushima reactors did shut down automatically and cooled as designed until the tsunami swamped them.

Improvements since Fukushima accident Assessment of the aspects of nuclear plant safety highlighted by the Fukushima accident is being applied to the 143 nuclear reactors in the EU’s 27 member states, as well as those in any neighbouring states that have decided to take part, according to the Western European Nuclear Regulators’ Association (WENRA). These comprehensive and transparent nuclear risk and safety assessments, the so-called “stress tests,” involved targeted reassessment of each power reactor’s safety margins in the light of extreme natural events, such as earthquakes and flooding, as well as on loss of safety functions and severe accident management following any initiating event. The scope of the reassessment takes into account the issues that have been directly highlighted by the events in Fukushima. In accident scenarios, regulators consider the means to protect against loss of core cooling as well as cooling of used fuel in storage, and loss of containment integrity and core melting including consequential effects such as hydrogen accumulations.

Fatalities Fatalities/Twy Fatalities Fatalities/TwyCoal 2,259 157 18,000 597 Natural Gas 1,043 85 1,000 111 Hydro 14 3 30,000 10,285 Nuclear - - 31 48

Non-OECDOECD


16

Giving up nuclear boosts pollution and fuel costs

Japan plans to restart closed nuclear reactors In the wake of the catastrophic failure at the Fukushima nuclear plant, Japan’s government decided to phase out nuclear power. Other governments, notably Germany, followed Japan’s lead. But in February this year, the Japanese government reversed course issuing a draft energy plan that includes restarting idled nuclear reactors. Since the nuclear plants were shut down, combined fuel costs for Japan’s nine regional power companies will almost double to 7.5trn yen (USD74bn) this fiscal year from the year before the Fukushima accident, the Japanese trade ministry predicted.

Fig. 24: World nuclear capacity as of January 2014


Fig. 25: Nuclear capacity forecasts by region and country

Source: International Energy Outlook, Nomura research

Fig. 26: Global nuclear power capacity

Source: International Atomic Energy Agency, Nomura research

Country Number of Nuclear Units Nuclear Capacity (MW) Nuclear Generation (BkWh) Nuclear Fuel Share (Percent)Argentina 2 935 5.9 4.7Armenia 1 375 2.1 26.6Belgium 7 5,927 38.5 51Brazil 2 1,884 16.1 3.1Bulgaria 2 1,906 14.9 31.7Canada 19 13,500 91.0 15.3China 19 14,860 98.2 2Czech RP 6 3,804 28.6 35.3Finland 4 2,752 22.1 32.6France 58 63,130 404.9 74.8Germany 9 12,068 94.1 16.1Hungary 4 1,889 14.9 45.9India 21 5,308 29.7 3.6Iran 1 915 1.3 0.6Japan 50 44,215 17.1 2.1Korea Rep. 23 20,739 143.5 30.4Mexico 2 1,330 8.4 4.7Netherlands 1 482 3.7 4.4Pakistan 3 725 5.3 5.3Romania 2 1,300 11.5 19.4Russia 33 23,643 165.6 17.8Slovakia 4 1,816 14.4 53.8Slovenia 1 688 5.2 36South Africa 2 1,860 12.4 5.1Spain 8 7,567 58.7 20.5Sweden 10 9,474 61.5 38.1Switzerland 5 3,308 24.4 35.9Taiwan, China 6 5,028 38.9 18.4U.K. 16 9,231 64.0 18.1U.S. 100 98,560 769.3 19Ukraine 15 13,107 84.8 46.2Total 436 372,326 2,351.0 12.3

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Enough nuclear power projects for all

Saudi Arabia and Jordan Saudi Arabia plans to construct 16 nuclear power reactors over the next 20 years at a cost of more than US$80bn, with the first reactor scheduled to be on line in 2022, according to The National (11 November 2013). Construction would commence in 2017 for completion in 2022. Jordan has selected Russia as the preferred bidder for its first nuclear power plant, with a view towards a 2020 operation date. Final sites have not yet been determined in either country.

Turkey Russian state company Rosatom will build the US$20bn Akkuyu nuclear plant, which will be fully operational by 2023, according to AMSAmed (13 March 2014). Turkey also plans to build a second nuclear plant in the port city of Sinop on the Black Sea coast with a Franco-Japanese consortium.

Finland Russian state company Rusatom’s affiliate, “Rusatom Overseas”, intends to finance the construction of the Fennovoima’s (a Finnish nuclear consortium) Hanhikivi-1 nuclear power plant with construction planned to start in 2015, according to ITAR-TASS (25 February 2014). According to the report, the cost of the project is EUR6.5bn, with EUR1.6bn contributed by Fennovoima and the Rusatom Overseas financing the remainder.

China Chinese state-owned utility, China Power Investment, plans to construct two new nuclear reactors in the eastern coastal province of Shandong at an estimated cost of $5.1 billion, according to OILPRICE (2 March 2014). Currently, China has 31 reactors under construction.

India France has decided to work together with India’s Jaitapur Nuclear Power Plant to build 6 European Pressurised Nuclear Reactors in five villages in the coastal Ratnagiri district of Maharashtra, according to Economic Times (15 Dec 2013). France has decided to provide a 25-year loan at 4.8% interest for Rs 6 per unit.

Japan The estimated cost to restart Japan’s nuclear power plants is greater than $12.3 billion. There are 46 reactors on the coastlines throughout Japan undergoing tougher safety standards, according to Bloomberg (11 March, 2014). Japan currently has two reactors under construction, but another three which were likely to start building by mid-2011, have been deferred.

Fig. 27: Korean consortium’s nuclear power plant project biddings

Source: Various news articles (including on Thomson Reuters and in Yonhap), Nomura research

Country Size Description

UAE 5,600MW Plans to bid on NPP projects due to positive feedback on APR 1400

Finland 3,000MW

A bid is submitted by Korean consortium by 2013.5 bidders in total / GE-Hitachi, Toshiba, Mitsubishi, Areva KHNP and TVO are accessing whether APR1400 abides Finish regulationsThe bidding phase for Olkiluoto is nearly completion bid comparisons are being prepared and then TVO and its owners will decide how the projects will move ahead

South Africa 3,000MWKorean consortium is trying to participate in South Africa's government plans to build 6 NPPS by 2030

Poland 3,000MW Plans to bid

Vietnam 2,800NWIn 2012, Korean government was selected as the preferred bidder.Currently under reviewing

Saudi Arabia 2,800MWSaudi Arabian government plans to build 16 NPPS by 2030.Korean consortium is likely to participate bidding for 2 NPPs in 2014


18

Korea electricity demand growing faster than expected

Demand growth outpacing supply growth The Korean government announced its long-term power supply plan last year. As the electricity reserve ratio continue to dwindle faster than the previous projection it seems that the government is concerned about electricity shortage. The plan calls for an increase in reserve ratio to 22%. The electricity reserve ratio fell to only 3.8% in 2012.

Fig. 28: Electricity reserve capacity in Korea

Source: Ministry of Knowledge and Economy, Nomura research

Fig. 29: Korea GDP growth and Electricity consumption growth


Further upside risk to electricity demand The government now estimates electricity demand to show a 2.2% CAGR through 2027 vs. previous estimate of 1.9%. We expect electricity demand growth could further surprise to the upside if the government does not rationalize the electricity price and continue to provide subsidy on industrial use electricity.

Fig. 30: Electricity bill comparison – Household (2011)


Fig. 31: Electricity bill comparison – Industrial (2011)


The government to add more supply In order to meet increased demand outlook and the increase in reserve ratio target, the government plans to increase new supply. New projects have been added to the existing growth plan. The new additions will cost roughly KRW16trn to build through 2022. Moreover, the government decided to keep the previously planned new additions to the nuclear capacity.

Doosan to supply equipments for most of them Given that Doosan is the only domestic company that could supply the power plant equipments we expect Doosan to supply more than 50% of all plant equipments going into these new plants. For nuclear plants, Doosan should supply 100% of the equipments.

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Doosan’s market share could rise We believe that the probability of Doosan increasing market share is fairly high within the domestic market given that the government want to localize the sourcing for gas turbines. Although, Doosan does make gas turbines, the larger capacity turbines are still sourced from foreign companies such as GS, Siemens, Alstom, and Mitsubishi. The government decided to provide support to Doosan to develop larger size gas turbines by 2018 and put into commercial usage by 2020.

Fig. 32: Power plants construction schedule (in the pipeline)


Types Project Completion date Capacity (MW)LNG Dangjin #5 Dec-15 950

Youngnam Jun-16 400Daewoo Pocheon #1 Oct-16 940Yeoju Jun-17 950ShunPyungtaek (Pending) Nov-17 900Tongyoung #1 (Pending) Dec-17 920

LNG-Total 5,060

Coal Youngheung #7 Dec-18 870Shinseicheon #1 Dec-18 870NSP IPP #1 Oct-18 1,000NSP IPP #2 Apr-19 1,000G-Project #1 Apr-19 1,000G-Project #2 Oct-19 1,000Youngheung #8 Jun-19 870Shinseicheon #2 Jun-19 500Dongyang Power #1 Dec-19 1,000Dongbu Haslla #1 Dec-19 1,000Dongbu Haslla #2 Jun-20 1,000Dongyang Power #2 Jul-21 1,000

Coal-Total 11,110

Nuclear Shin Gori #3 Dec-13 1,400Shin Gori #4 Sep-14 1,400Shin Uljin #1 Apr-17 1,400Shin Boryung #2 Jun-17 1,000Shin Uljin #2 Apr-18 1,400Shin Gori #5 Dec-19 1,400Shin Gori #6 Dec-20 1,400Shin Uljin #3 Jun-21 1,400Shin Uljin #4 Jun-22 1,400Shin Gori #7 Dec-23 1,500Shin Gori #8 Dec-24 1,500

Nuclear Total 15,200


20

Housing market turning; Doosan’s major risk factor to diminish

Housing exposure no longer imposes risk

Doosan E&C can survive on its own After a series of capital injections, merger with Doosan Mecatec, and HRSG business transfer from Doosan Heavy to Doosan E&C, we think the risk of insolvency has declined significantly. More important, Doosan E&C should turn around as we expect a recovery in the domestic housing market.

Doosan Heavy’s own housing project Trimage near Seoul Forest should breakeven The company noted that the pre-sale of Trimage near Seoul Forest should start in 1H14 and the construction should be completed by 2017. Given that we expect housing market recovery to continue and the luxury apartment called Galleria Foret near where Trimage will be built saw a sharp rebound in price in recent months after hitting the bottom in 2013 we think that the project should not make losses for Doosan Heavy.

Housing affordability improved

Disposable incomes and home prices back to 1999 levels We believe domestic housing prices were very affordable in 1999 given that housing prices fell to the 1989 level right after the Asian Financial Crisis. Korea household disposable income growth has been outpacing that of home price growth since 2010 (or falling in Seoul), and now both are back to their 1999 levels.

Jeonse-to-value ratio surpasses the level seen in 2000 Moreover, we believe the Jeonse-to-value ratio also indicates a bottoming of home prices. Of note, the Jeonse-to-value ratio surpassed the level seen in 2000 when the home price recovery started.

Fig. 33: Home price index March 2013 = 100

Source: Kookmin Bank, Nomura research

Fig. 34: Home price % change y-y Home prices were most affordable in 1999


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Fig. 35: Home prices vs. disposable income Affordability is back to the 1999 level

Source: Kookmin Bank, BOK, Nomura research

Fig. 36: Jeonse-to-value ratio trends Jeonse-to-value ratio higher than the level seen in 2000 when the home price recovery started

Source: Budongsan 114, Nomura research

Home prices haven’t kept up with inflation since 1988 If we were to set 1988 as a base year, then it seems like housing prices have not even kept up with inflation. We should note that housing prices were relatively “cheap” in the late-1990s with significant new supply coming into the market with new satellite cities being built around Seoul and also because of the Asian Financial Crisis.

Fig. 37: Home prices vs. consumer prices Jan1988=100


Fig. 38: Home Affordability Index trends Affordability improving continuously since 2008


Korea is not too expensive relative to other countries Despite half of the total domestic population living in Seoul and the metropolitan areas, it appears Korea’s housing prices are comparable with other developed countries. Although Seoul’s price-to-income ratio looks relatively expensive at 9.4x, if we were to account for the homes that have mortgages outstanding then the multiple falls to 7.8x. In addition, the metropolitan area (Gyeonggi province) price-to-income ratio is even lower at 6.6x.

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Fig. 39: Major cities’ price-to-income ratio (2013)

Note: (Mortgage) = only the homes that have mortgage with Kookmin Bank

Source: Performance Urban Planning, Kookmin Bank, Nomura research

Fig. 40: Major countries’ price-to-income ratio(2013)

Source: Performance Urban Planning, Kookmin Bank, Nomura research

Housing natural demand rising

Natural demand on the rise Based on Kookmin Bank’s research, it takes roughly 10 years for married couples to buy their first house in Korea. That said, the number of couples married for 10 years (natural demand, statistically) should continue to pick up in 1H14F, based on our analysis, and hence, we expect housing demand to increase.

Fig. 41: Number of marriages Number of marriages started to pick up from 2H03

Source: Korea statistics, Nomura research

Fig. 42: # of couples married for 10 yrs vs. home prices Natural demand impacts home prices

Source: Korea statistics, Kookmin Bank, Nomura research

Home ownership and penetration have worsened since GFC As per Korea Statistics data, home ownership has declined since the GFC (only 39% in the 30s age group own houses). In fact, the housing penetration ratio is still below 100% for Seoul and metropolitan areas (110% is considered sufficient).

6.2 6.2 6.2 6.67.7 7.8 7.8 7.8 8.3

9.4 9.5

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ew Y

ork LA

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anF

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23

Fig. 43: Home ownership by age group For the 30s age group, home ownership is only 39%

Source: Korea statistics, Nomura research

Fig. 44: Housing penetration ratio Number of homes divided by number of households

Source: Budongsan 114, Nomura research

Number of households to grow 6% per annum on average through 2030F According to Korea statistics, the domestic number of households is expected to grow steadily until 2030F. Although population growth has slowed already and will likely start to fall, contribution of household members and average number of household members will continue to decrease. As the average number of household members decreases, housing demand will continue to increase.

Fig. 45: Number of households One and two person households is increasing rapidly

Source: Korea Statistics, Nomura estimates

Fig. 46: Household formation continues # of households to grow 6% per annum on average through 2030F

Source: Korea Statistics, Nomura estimates

Housing inventory has fallen

Supply in prime locations has declined Since the GFC, total annual home supply has not declined much. However, supply in prime locations has declined sharply, especially in Seoul. Although many redevelopment projects started in Seoul during the housing boom years (2001-08), they are either on hold or have been scrapped altogether due to falling home prices since the GFC.

Unsold units have declined sharply Moreover, based on CEIC data, we note that unsold home inventory has declined significantly since the GFC. And most existing unsold homes are located in areas that may not see much demand even if the Korea housing market recovers, because they are located in areas that are less desirable, in our view.

56%54%

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24

Fig. 47: Unsold home trends Unsold homes have declined sharply

Source: CEIC, Nomura research

Fig. 48: Completed and unsold homes Many of them are located in less desirable locations

Source: CEIC, Nomura research

Jeonse property becoming scarce

Jeonse-to-value ratio continues to rise The Jeonse-to-value ratio has been rising rapidly and we expect will likely rise continuously going forward as landlords continue to convert Jeonse property into semi-Jeonse or monthly rental property, thus decreasing the supply of Jeonse (lump-sum rent payment) property.

Renters forced to buy as Jeonse property becomes scarce Based on our market survey, it is likely becoming more difficult to find Jeonse properties. Real estate agents that we interviewed noted that more landlords are converting Jeonse property into semi-Jeonse or monthly rental property. According to Budongsan 114 (a local property market research house), the Jeonse-to-monthly rent conversion rate is 7.0% as of December 2012 (down from 7.2% in December 2011). Real estate agents noted that some renters are being forced to buy homes instead of paying monthly rents given the current high Jeonse-to-monthly rent conversion rate.

Fig. 49: Apartment Jeonse index March 2013 = 100


Fig. 50: Jeonse price % change y-y Jeonse prices rising sharply


0

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00 01 02 03 04 05 06 07 08 09 10 11 12 13

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Seoul


25

Mortgage rate at historically low levels

Attractive mortgage rate and high monthly rents Mortgage rates are currently as low as 3.7% (as of Dec 2013) vs. a monthly rent of 5-6% of house prices, based on our estimates. This makes buying a house a more attractive choice over renting, if Jeonse is not an available option, in our view. Hence, as long as mortgage rates remain low while monthly rent remains at current high levels, we believe more people are likely to buy, which would support housing prices at a sustained level.

Fig. 51: Domestic mortgage rates and CD rates Mortgage rates at historical low levels

Source: BOK, Nomura research

Fig. 52: Domestic housing prices vs. loan growth

Source: BOK, KB Budongsan

2

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(YoY,%)


26

Company overview Doosan Heavy Industries & Construction is mainly engaged in supplying industrial facilities to both domestic and international plant markets.

The parent company operates in three business divisions: Power division, which provide equipments for power generation plants including nuclear, coal, etc; Water division, which provides engineering procurement and construction (EPC) services of seawater desalination plants and water treatment systems; casting & forging and construction, etc which manufactures crankshaft, and other industrial parts, and constructs roads, apartments, etc.

There are three listed subsidiaries whose earnings are subject to be consolidated – Doosan Infracore, Doosan Engineering & Construction, and Doosan Engine. Doosan Infracore engaged in manufacture of industrial machineries such as excavator, etc; Doosan E&C constructs roads, highway, apartments, etc; Doosan Engine engaged in manufacture of marine diesel engines.

Fig. 53: Doosan Heavy – Sales breakdown (2013)


Fig. 54: Doosan Heavy – OP breakdown (2013)


Note: C/F, Cons, etc business incurred losses during 2013, therefore is not shown in the chart

Fig. 55: Doosan Group – Shareholding structure


Power 34%

Water 4%

C/F, Cons, etc 6%

Doosan Infra 40%

Doosan Construction

12%

Doosan Engine 4%

Power 53%

Water 4%

Doosan Infra 37%

Doosan Construction

0%

Doosan Engine 6%


27

Appendix A-1

Analyst Certification

I, Hans Park, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Doosan Heavy Industries & Construction 034020 KS KRW 33,250 24-Mar-2014 Buy N/A A4,A5,A6,A10

A4 The Nomura Group had an investment banking services client relationship with the issuer during the past 12 months.

A5 The Nomura Group has received compensation for investment banking services from the issuer in the past 12 months.

A6 The Nomura Group expects to receive or intends to seek compensation for investment banking services from the issuer in the next three months.

A10 The Nomura Group is a registered market maker in the securities / related derivatives of the issuer.

Doosan Heavy Industries & Construction (034020 KS)

KRW 33,250 (24-Mar-2014)

Rating and target price chart (three year history)

Buy (Sector rating: N/A)

Date Rating Target price Closing price 17-Aug-13 Not Rated 46,800.00 22-Mar-12 Neutral 63,200.00 22-Mar-12 75,000.00 63,200.00

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We derive our TP of KRW49,000 by using SOTP valuation methodology. We apply peer group EV/EBITDA of 10x to DH's derived core operation value and then add the value of its subsidiaries at a 30% holding company discount. The benchmark index for this stock is MSCI Korea. Risks that may impede the achievement of the target price Downside risks are: (1) weaker-than-expected orders, (2) lingering concerns on project-finance guarantees, and (3) poorer-than-expected equity-method results, which could have a negative impact on net profit.


28

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35_doosan heavy industries & construction - things can only get better

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