Deep-dive 2022-4: LG Household & Healthcare preference share

Turnaround king "Suk Cha" well placed to deal with short-term COVID problems

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LG Household & Healthcare (common: 051900 KS, preference share: 051905 KS) is South Korea’s second-largest cosmetics company.

It owns brands such as “The Face Shop”, “The mystery of Whoo”, and “su:m37°”. It’s also one of Korea’s largest fast-moving consumer goods companies with 30%+ market shares in toothpaste, shampoos, detergents, fabric softeners, etc. And finally, the company also runs the Coca-Cola bottling operation for South Korea.

What’s unique about LG Household & Healthcare (“LG H&H”) is that it’s run by capable former Procter & Gamble executive Suk Cha. He’s a genius at brand-building. And he’s done several intelligent acquisitions for the company.

For example, in 2007, Suk Cha acquired 90% of Coca-Cola’s bottling operations in Korea for KRW 287 billion. In 2010, he acquired Haitai beverage for a token amount. Today, the beverage segment makes almost KRW 200 billion in profits each year, mostly from these two acquired companies.

Since Suk Cha took in 2005, LG H&H’s revenues have grown eight-fold and earnings per share ten-fold. Despite being an acquisitive company, return on equity has consistently been above 20%. Such a high return on equity is unusual in a Korean context.

While the Korean cosmetics market is mature, the Chinese cosmetics market has tremendous potential. According to Euromonitor, the per consumption of cosmetics is only €35 in China compared with €208 in South Korea. It’s plausible that China’s cosmetics market could eventually grow somewhere around 5x to 7x in real terms.

LG H&H’s Chinese business recently experienced weakness. Cross-border travel between China and South Korea came to a halt after COVID-19 related border restrictions were imposed. Korean duty-free stores have been suffering. Omicron outbreaks in China have hurt the demand for cosmetics too. But judging from Tmall statistics, LG H&H’s brand “Whoo” is doing exceptionally well. The brand is stronger than ever. So there’s every reason to believe that LG H&H will do well in China after the current headwinds subside.

Assuming top-line growth of around 8% and flat operating margins, the common shares will likely reach a P/E ratio of 15.9x by 2025 vs a historical median of 30x and an industry average of 21x.

The preference shares trade at even lower multiples thanks to their 43% discount to the common - despite identical cash flow rights. The P/E ratio for the preference shares against 2025e earnings is currently 9.1x P/E. And it looks like Suk Cha himself has been buying the preference shares rather than the common.

The key risks include possible flare-ups of anti-Korean sentiment in China and restrictions on “daigou” purchases. A recurring expense item of “donations” also raises a few eyebrows.

But Suk Cha is clearly a genius, and LG Household & Healthcare is likely to continue doing well under his control.

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