Korea Construction
Quantifying inventory and PF
loan risks
Sungmee Park, CFA
Research Analyst
(82) 2 316 8900
sungmee.park@db.com
Nicole Jang
Research Associate
(82) 2 316 8912
nicole.jang@db.com
Fundamental, Industry, Thematic and Thought Leading
In this report, we analyse key risk issues for the Korea property market, including
housing prices, unsold inventory, PF loan guarantee and bankruptcies. We also
apply scorecard-based distress tests for companies under our coverage to gauge
downside risks and to evaluate longer-term demand for housing construction in
Korea.
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LOCATED IN APPENDIX 1.
FITT Research
Top picks
Hyundai E&C (000720.KS),KRW50,000.00 Buy
Companies featured
Hyundai E&C (000720.KS),KRW50,000.00 Buy
2007A 2008E 2009E
P/E (x) 29.8 14.9 12.2
EV/EBITDA (x) 17.4 7.1 6.0
Price/book (x) 4.27 2.05 1.78
GS E&C (006360.KS),KRW51,400.00 Hold
2007A 2008E 2009E
P/E (x) 15.8 5.3 6.9
EV/EBITDA (x) 11.7 3.3 3.1
Price/book (x) 3.73 1.03 0.93
Hyundai Dev. Co. (012630.KS),KRW29,400.00 Hold
2007A 2008E 2009E
P/E (x) 20.0 10.4 10.3
EV/EBITDA (x) 14.5 7.3 6.9
Price/book (x) 3.07 0.93 0.86
Daewoo E&C (047040.KS),KRW8,070.00 Sell
2007A 2008E 2009E
P/E (x) 16.6 12.3 10.3
EV/EBITDA (x) 11.2 5.2 5.4
Price/book (x) 2.62 0.82 0.80
Fundamental: Korea is no exception to global property market downturn
The property market downturn is a global phenomenon, and Korea is no exception
to the rule. Based on housing affordability index analysis, we expect housing
prices to decline by a magnitude similar to that seen during the 1998 balance
sheet crisis. Record unsold inventory will likely remain unresolved on a weak
housing price outlook. PF loan guarantees pose another serious off-balance sheet
risk. Risks are clearly reflected in the 41% YoY rise in the number of bankruptcies
YTD in the sector. The government is sponsoring a debt restructuring program that
targets viable companies facing liquidity shortfalls. In return, we expect the sector
to undergo a painful restructuring.
Industry: Earnings, cash flow and balance sheet face material downside
risks
Earnings and cash flows from housing construction will decline sharply on lower
construction starts, falling ASPs and write-offs of unsold inventory and PF loan
guarantees. We expect balance sheet deterioration, as unsold inventory will lead
to negative cash flows and some PF loan guarantees will turn into real liabilities.
Thematic: Structural demand remains solid, survivors will reap the benefit
Despite near-term turmoil, we believe structural demand for housing remains solid,
given that Korea’s housing supply ratio has fallen significantly below the levels of
other industrialized countries and the order backlog of reconstruction and
redevelopment amounts to W120tr. Survivors of the industry turmoil will reap the
benefits of structural demand for housing and industry consolidation.
Thought Leading: Quantifying value erosion
We performed distress tests to gauge downside risks on unsold inventory and PF
loan guarantees. We conclude that estimated write-off loss should represent 7%-
25% of our coverage construction companies’ respective BVs. Based on our
analyses, we conclude downside risks should be most significant for Daewoo
E&C and GS E&C. However, we do not foresee bankruptcy risks, as projected
EBITDA fully covers interest costs (even under a scenario of no cash recovery
from unsold units and PF loan-related land).We do, however, see refinancing risks
from negative cash flows and ABCP exposure. We cut TPs by 9-55%, reflecting
the estimated write-off loss, our earnings downgrade, and the deterioration of
working capital. We downgrade GS E&C to Hold. We maintain Sell on Daewoo
E&C and Hold on Hyundai Dev. Our top Buy is Hyundai E&C, based on its limited
exposure to property risks and its significant overseas order backlog.
Valuations are based on SOTP; risks include GDP growth and regulation
TPs are based on SOTP, with core operational value derived from a DCF model.
Risks include a further deterioration of property market, a more significant decline
in overseas projects, GDP growth and regulatory uncertainty.

Table of Contents
Executive summary ........................................................................... 3
Unsold inventory and PF loan guarantees cause liquidity shortfall............................................3
Sector valuation ........................................................................................................................3
Risks ........................................................................................................................................3
TPs lowered on heightened property market risks ........................ 4
Daewoo E&C is most exposed to property market risks, followed by GS E&C........................4
Downgrade GS E&C to Hold; our top Buy is Hyundai E&C.......................................................5
Valuations are not demanding, but still stand above trough levels ...........................................5
Four key downcycle issues............................................................... 7
1. Housing prices remain under pressure .................................................................................7
2. Record high unsold inventory ...............................................................................................8
3. PF loan guarantees and associated real liability risks..........................................................10
4. Bankruptcy risks..................................................................................................................11
Implications for the sector.............................................................. 13
Lower housing revenue and margins expected ......................................................................13
Balance sheets are deteriorating.............................................................................................16
Exposure by company..................................................................... 18
1. Weaker housing prices and volume: Hyundai Dev has the greatest earnings exposure.....18
2. Unsold inventory: GS E&C and Daewoo E&C are highly exposed ......................................18
3. PF loan guarantees: GS E&C and Daewoo E&C are highly exposed ..................................19
4. Bankruptcy risks: No material concerns for our coverage companies ................................19
Value impact of downcycle distress.............................................. 20
Introduction............................................................................................................................20
Base assumption model for our analysis ................................................................................20
Distress tests: calculation of write-off losses .........................................................................22
Debt service capability does not seem to be a big concern ...................................................24
Greater refinancing risks for Daewoo E&C and GS E&C.........................................................25
Opportunities................................................................................... 27
Industry consolidation .............................................................................................................27
Long-term demand for housing remains firm .........................................................................27
Reconstruction and redevelopment demand..........................................................................28
Earnings revisions ........................................................................... 29
Earnings forecasts lowered ....................................................................................................29
Share price recovery will take time ............................................... 32
Stabilization of the property market is a prerequisite..............................................................32
Property deregulation will not provide an immediate boost ...................................................33
Hyundai E&C.................................................................................... 34
GS E&C............................................................................................. 37
Hyundai Dev. Co. ............................................................................. 40
Daewoo E&C.................................................................................... 43

Executive summary
Unsold inventory and PF loan guarantees cause liquidity shortfall
The Korea construction industry is experiencing serious liquidity shortfalls resulting from
unsold inventory and PF loan guarantees provided to property developers. The difficulties in
the property market are clearly reflected in the 41% YoY rise in the number of construction
companies declaring bankruptcy (to 348) YTD. We do not expect the unsold inventory issues
to be resolved in the near term, due to the negative housing price outlook, while presale
prices of inventories are quoted at a 20-30% premium over the market prices of comparable
houses. We expect housing prices to decline by a magnitude similar to that seen during the
balance sheet crisis in 1998 (12% nationwide and 18% in Seoul, based on our affordability
index analysis). To minimize the spillover impact on the overall economy, the government is
sponsoring a debt restructuring program for construction companies in order to support
viable companies that are experiencing liquidity shortfalls. In return, we expect the sector will
undergo a painful restructuring.
We expect earnings from housing construction will be reduced sharply on lower construction
starts, falling ASPs and write-offs of unsold apartment inventory and PF loan guarantees. We
also expect deterioration of balance sheets as unsold inventory should lead to continuing
negative cash flows, and some portion of PF loan guarantees may turn into real liabilities.
We performed scorecard-based distress tests to gauge downside risks on unsold inventory
and PF loan guarantees at a company level. We conclude that estimated write-off loss should
represent 7-25% of our coverage construction companies’ respective book values. Based on
our analyses, we conclude downside risks should be most significant for Daewoo E&C and
GS E&C given these companies’ high exposure to unsold inventory and PF loan guarantees.
We do not foresee bankruptcy risks, however, as projected EBITDA fully covers interest
costs -- even under the scenario of no cash recovery from unsold units and PF loan-related
land. However, we do see refinancing risks from negative cash flow and the ABCP (Assetbacked
commercial paper) exposure. Thus we believe joining the debt-restructuring program
looks inevitable for many construction companies. We conclude the negative impact of
unsold inventory and PF loan guarantees is not substantial for Hyundai Development, but we
remain cautious on the company due to its high earnings exposure to housing projects. We
believe Hyundai E&C is insulated from property market concerns due to its lowest earnings
exposure to housing construction (only 27% of GP in1Q-3Q08) and low unsold inventory and
PF loan holding.
Sector valuation
We applied SOTP valuation in setting our TPs, with core operational value derived from a DCF
model. Key assumptions used in our DCF are a risk-free rate of 6.4%, a risk premium of 4.5, a
beta of 1.2, and terminal growth of 2%. We directly incorporated the estimated write-off
losses on unsold inventory and PF loan guarantees into our TPs.
Risks
Key upside risks include a full recovery of the property market resulting from falling interest
rates and unsold inventory, as well as a stronger economy. Downside risks include a more
serious decline in overseas new orders, further significant deterioration of the property
market, and value deterioration of non-core asset holdings.

TPs lowered on heightened
property market risks
Daewoo E&C is most exposed to property market risks, followed
by GS E&C
We performed scorecard-based distress tests on construction companies under coverage to
gauge downside risks from weak property market. We quantified write-off loss from unsold
inventory and PF loan guarantees, and we performed analyses on debt service capability
under various scenarios and compared refinancing risks by company. Overall, Daewoo E&C
received the lowest scorecard (4 pts) -- meaning its downside risks are likely the most
significant -- followed by GS E&C (5pts) and Hyundai Dev (9pts). Hyundai E&C received the
highest score (12 pts), implying the company is the least exposed to property market woes.
􀂄 Calculation of write-off losses
Under our base-case scenario that the current unsold inventory will remain unchanged, we
project write-off losses will amount to 25% of 09E book value for GS E&C, 16% for Daewoo
E&C, 13% for Hyundai Dev and 7% for Hyundai E&C.
􀂄 Debt service capability
We foresee no serious concerns on debt-service capability. Even under our worst-case
scenario, in which construction companies are unable to dispose of the unsold inventory
even at a discount to recover cash, EBITDA covers interest costs. However, Daewoo E&C
shows the lowest interest coverage ratio.
􀂄 Refinancing risks
Refinancing risks are greater for Daewoo E&C and GS E&C, as refinancing requirements are
high under our worst-case scenario of no cash recovery. And their ABCP exposure poses
disadvantageous refinancing costs.

Downgrade GS E&C to Hold; our top Buy is Hyundai E&C
We have cut our SOTP-based target prices by 9-55% to reflect earnings revisions, the
deterioration of working capital, and our base-case estimated write-off losses on unsold
inventory and PF loan guarantees. Our earnings revision reflects our assumption of no
recovery in housing construction starts in 2010, our lower assumption on GP margins for
housing projects, and lower new order flows from overseas projects. But we have not
incorporated estimated write-off loss (or provision) on unsold inventory and PF loan
guarantees. We directly incorporated the estimated write-off losses into our target prices.
Our target prices are based on SOTP valuations, with core operational value derived from a
DCF model. Key assumptions used in our DCF are a risk free rate of 6.4%, a risk premium of
4.5% and a beta of 1.2, as well as perpetual growth of 2%.
We have downgraded GS E&C to Hold from Buy, given significant downside risks from its
high exposure to unsold inventory and PF loan guarantees. We maintain Sell on Daewoo E&C
and Hold on Hyundai Dev. Our top Buy is Hyundai E&C, as we believe the company is
insulated from property market concerns given its limited exposure to property marketrelated
risks, significant order backlog of overseas projects, and its competitive position in
civil projects.

Valuations are not demanding, but still stand above trough levels
The stocks have underperformed sharply on concerns of a weak property market and the
resulting negative impact on earnings and balance sheets. Valuations do not now look
demanding, trading at 09E PER of 9x, adjusted for non-core assets and estimated write-offs.
However, we do not see positive catalysts in the near-term, as we expect to see massive
write-offs and provisions and deterioration of GP margins. If our estimated write-off losses
(of our base case) are fully realized in 2009-2010, then this will wipe out most of the earnings
for Daewoo E&C and GS E&C. Property stocks generally move in line with housing prices and
GDP growth, for which we believe a recovery will take some time.
Current valuations still stand significantly above the historical trough levels in 2000-2001,
when balance sheet risks emerged on weak property market, implying potential further

downside risks to the share prices. Hyundai E&C, our top Buy, has a 09E PER (adjusted basis)
of 7x vs. sector average of 9x. We believe the stock deserves a premium due to its limited
exposure to property market woes. Hyundai E&C’s current valuations also stand at a
significant premium over its trough valuations. The trough valuations, however, are not a
good benchmark for Hyundai E&C, in our opinion, as they reflect the company’s balance
sheet risks and equity dilutions during 2001-2003. The company was put into a corporate
restructuring program called “Workout” in 2001 due to liquidity problems from the US$10bn
accrued receivables on an Iraq project and financial support provided to affiliated companies.
The company also underwent an equity base reduction and debt-to-equity swap in 2003.