● Solid earnings trends to continue in 2H17

For 2Q17, BGF Retail reported consolidated revenue of W1.41tr (+12.1% YoY) and operating profit of W74.1bn (+22.5% YoY), which were broadly in line with the market consensus. The company delivered solid operating profit growth despite investor worries over earnings due to the sharp increase in store count across the industry, rising cost pressures, and slowing top-line growth.

Even as top-line growth has slowed, BGF Retail has maintained strong profit growth since 2Q16 by controlling costs more efficiently and increasing the adoption of a new type of franchise contract (where stores are run more independently). We expect such earnings growth trends to continue in 2H17.

While this addresses immediate investor concerns, some uncertainties remain. Recently, there has been growing discussion about providing support for franchisees. Even though the franchise fee rate has already fallen to 36% due to the proliferation of the new contract type, spending related to support for franchisees struggling with falling margins looks inevitable. We expect this to become a major source of earnings volatility and uncertainty from 2018. We also think there needs to be a clear strategic vision for the post-split holding company for investors to buy into the company pre-split.

● More disciplined store rollout is warranted

In 2Q17, the company added a record 526 stores QoQ, raising its total store count by 17% YoY. Same-store sales (SSS), however, remained largely unchanged YoY, affected by soft cigarette sales and the deceleration of fresh food sales. The overall convenience store industry has experienced a continued revenue slowdown, even as store count has rapidly increased since 2016. Nevertheless, the company once again recorded strong profit growth through cost management, soothing worries over earnings.

In 2H17, we expect the pace of store count growth to slow across the industry compared to in 1H17. BGF Retail has introduced tighter profitability rules for store openings and closings and, as a result, now expects net store additions to be around 1,400-1,500 for the full year (942 in 1H17). In our view, the current industry cycle warrants more disciplined store rollouts and a greater focus on profitability.

● Maintain Buy, but Lower TP to W110,000

We remain Buy on BGF Retail, but cut our target price to W110,000. We see risks and uncertainties to earnings from 2018. The company`s earnings have often served as a catalyst for a rebound in its share price. While this pattern is likely to repeat itself, we believe uncertainties first need to be addressed.

By Aiden Lee, Analyst at Mirae Asset Daewoo Securities

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