● 2Q16 results: Earnings miss consensus

On a consolidated basis, Lotte Shopping registered 2Q16 sales of W7,504.1bn (up 1% y-y) and operating profit of W171.0bn (down 15% y-y), with operating profit falling wideof consensus (W216.1bn).

In detail, Lotte Shopping recorded low sales growth amid ongoing sluggish domestic household spending, with most of its business arms (with the exception of its department store division) registered either operating profit declines or continued operating losses. The operating loss at the firm`s domestic discount store business worsened W23.0bn y-y to W30.0bn on: 1) a y-y decline in its fresh foods sales (despite strengthened merchandise sourcing capability); and 2) drops in its sales of daily supplies and household goods due to stronger online competition and a faulty product scandal (toxic sterilizersused in humidifiers).

● Worries in play towards domestic discount store sales and suspension of home shopping business

With the impact of the humidifier sterilizer scandal now easing, and supported by improving seasonal product demand, Lotte Shopping`s sales should recover gradually. However, worries towards its margins are unlikely to dissipate soon given expectations towards an increase in the domestic minimum wage and the firm`s ongoing investment in a distribution center (both items to boost SG&A expenses). Also, the company`s competitiveness is being sapped by a recent deterioration in the business environment for its domestic discount stores due to: 1) lower sales of fresh foods; and 2) a consumer trend towards online shopping.

The Ministry of Science, ICT, and Future Planning (MSIP) has announced that Lotte Homeshopping must (starting from Sep 28) suspend its business operations (broadcasting) for six hours a day (8am~11am and 8pm~11pm) for six months. Estimating that Lotte Homeshopping`s TV gross merchandise sales (GMS) over this period will slide 35~40% y-y, we expect the firm to register an operating loss of W31.1bnduring the suspension period.

● Needs to improve profitability

Lotte Shopping`s shares are currently trading at a 2016E P/B of 0.4x, but its ROE is also quite low (2.2%). Affected by its sluggish earnings performance, the company`s shares are now trading at a 2016E P/E of 19x. It is difficult to expect Lotte Shopping`s shares to re-rate until it achieves significant margin improvement. However, we expect Lotte Group-related risk and the impact of the suspension of Lotte Shopping`s home shopping broadcasts to ease from 1H17, in turn leading to earnings improvement.

By Lee Ji-young, Analyst at NH Investment & Securities

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