Evolving Online Commerce And Overseas Risks Will Pressure Margins And Weigh On Future Earnings

Catalysts

About Lotte Shopping

Lotte Shopping operates a diversified retail portfolio spanning department stores, grocery, e-commerce, home electronics, home shopping, cinemas and overseas malls and hypermarkets.

What are the underlying business or industry changes driving this perspective?

• The rapid shift of Korean consumers toward online and mobile commerce risks structurally eroding foot traffic and pricing power in Lotte Shopping's core domestic grocery and hypermarket formats. This could cap revenue growth and compress net margins as legacy store costs remain fixed.
• Reliance on foreign inbound tourists and premium fashion categories to drive department store growth leaves earnings exposed to external shocks such as travel policy changes, geopolitical tensions or macro slowdowns in key source markets. These factors could potentially reverse recent operating profit gains.
• Large scale automation and fulfillment investments such as the Ocado CFC introduce significant upfront depreciation and operating complexity. If order volumes or productivity ramp more slowly than planned, this could deepen losses in e-commerce and delay any improvement in consolidated earnings.
• Ongoing international expansion in Vietnam and recovery efforts in Indonesia tie the company to volatile regulatory, political and currency environments. Disruption or policy reversals in these markets could quickly undermine currently strong overseas revenue trends and dilute group level margins.
• High leverage, reflected in an elevated net debt to EBITDA ratio, limits financial flexibility at a time when the company is undertaking capital intensive digital and overseas projects. This heightens the risk that weaker than expected cash generation forces cutbacks that weigh on future revenue growth and earnings quality.

Assumptions

This narrative explores a more pessimistic perspective on Lotte Shopping compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Lotte Shopping's revenue will remain fairly flat over the next 3 years.
• The bearish analysts assume that profit margins will increase from -7.6% today to 3.7% in 3 years time.
• The bearish analysts expect earnings to reach ₩512.2 billion (and earnings per share of ₩18167.68) by about December 2028, up from ₩-1041.1 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₩772.5 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 5.1x on those 2028 earnings, up from -1.9x today. This future PE is lower than the current PE for the KR Multiline Retail industry at 8.6x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.85%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• High margin domestic department stores are showing resilient growth supported by strong foreign tourist demand, with foreigner contribution already above pre COVID levels and double digit revenue increases in October and November. This could drive sustained revenue growth and support a structural improvement in group operating profit.
• Vietnam operations across malls, hypermarkets, hotel and offices are delivering record high revenue growth and rising occupancy, underpinned by an extended land usage period that lowers depreciation. This could provide a long term earnings growth engine that offsets domestic weaknesses and lifts consolidated margins.
• Cost optimization and efficiency gains in e commerce, including lower logistics and marketing costs and the planned Ocado CFC automation, are already narrowing losses and may accelerate profit improvement. This would improve group earnings and potentially re rate the business on higher expected net margins.
• Ongoing refurbishment of hypermarkets into Grand grocery focused formats, combined with potential customer inflows from competitor disruptions such as the Home Plus incident and recovering participation in government support programs, could restore same store sales growth and elevate grocery unit profitability. This would support a rebound in consolidated operating profit and earnings.
• Balance sheet indicators such as declining total debt, improving interest expense trends and management’s guidance that net debt to EBITDA and net income will improve by year end suggest financial risk may ease over time. This could support higher valuation multiples and a more stable earnings profile.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Lotte Shopping is ₩63816.52, which represents up to two standard deviations below the consensus price target of ₩88642.86. This valuation is based on what can be assumed as the expectations of Lotte Shopping's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₩110000.0, and the most bearish reporting a price target of just ₩57000.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ₩13706.6 billion, earnings will come to ₩512.2 billion, and it would be trading on a PE ratio of 5.1x, assuming you use a discount rate of 12.8%.
  
• Given the current share price of ₩71500.0, the analyst price target of ₩63816.52 is 12.0% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.