Construction. Refiner-affiliated builders look attractive. Overweight (Maintain)

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1 Sector Report / Construction October 18, 2011 Overweight (Maintain) Company Rating TP (KRW) Hyundai E&C (000720) BUY 91,000 GS E&C (006360) BUY 158,000 Contents I. Investment summary... 1 II. Refinery cycle USD49bn of refinery capacity additions per annum 2. Reasons why ME oil refiners are investing 3. Vertical integration 4. Risk check ME has different price mechanism III. Korea s forte in refineries Korea commands 29% of ME refinery market share 2. European refineries use light sweet crude oil 3. Korea is home to mega-scale upgrading plants IV. Reference Déjà vu to Kuwait: Korean firms will take advantage of already large presence in the region 3. Global competitors V. Let earnings do the talking Appendix: UAE and Oman site visits Ruwais refinery visit: GS E&C holds 28% of Korean backlog in UAE 2. Oman visit: Planned investment in Duqm economic zone Refiner-affiliated builders look attractive Refinery market where Korean builders have a strong presence is expanding ME adding upgrading facilities Growth for Korean builders primarily depends on whether the market where they excel will expand. As such, 2012 looks bright as the Middle East (ME) oil refinery market, one of Korea s core markets, is forecast to grow to USD54bn, four-times bigger than in The ME countries will make massive investments to 1) reduce dependence on imported gasoline and diesel, 2) maximize profits with value-added products and 3) respond to stricter environmental regulations (i.e., desulfurization) in To achieve these goals, increasing the capacity of upgrading facilities is not an option but a must. We expect refinery investments to remain solid despite unstable oil prices and financial market jitters as ME governments continue to provide subsidies to boost domestic demand and supply. Korea s ME refinery market share at 29% Since 2004, Korea has commanded an average 29% of the ME refinery market, the biggest among all construction segments. Unlike European refineries that use high-quality light crude, Korean refineries that use heavy crude boast high upgrade ratios. We believe Korean EPC builders competitiveness comes from building upgrade facilities for local refiners. Thus, more ME refinery investments in 2012 could offer big opportunities for Korean EPC firms. Assuming their average share of 29% in the ME market, total orders would amount to USD15.7bn in If evenly divided among Korea s five major builders, each would achieve 22-52% of their 2012 overseas order targets from the ME refinery market alone. Refiner-tied firms merit attention: GS E&C and Hyundai E&C We expect GS E&C and Hyundai E&C to become primary beneficiaries on the back of strong experience built on refinery orders from affiliates such as GS Caltex and Hyundai Oil Bank, and high exposure to the Kuwaiti market that will become the biggest refinery market in We also expect strong EPC players Samsung Eng. and Daelim Ind. to win several refinery orders as well. Given current valuations and growth potential, we recommend Hyundai E&C and Samsung C&T as top picks, and GS E&C as second top pick will be the first year for major builders to break away from the burden of heavy provisioning against unsold housing units over the past three years. Against the backdrop, strong overseas orders growth should contribute to greater earnings visibility. Korea s upgrading facilities built by affiliate builders Company Hyundai Oil Bank 120,000 b/d EPC: Hyundai E&C, Daelim S-OIL 148,000 b/d (formerly Ssangyong Oil Refining) EPC: Ssangyong E&C Kyungja Lee kyungja.lee@truefriend.com Yongsok Song songyongsok@truefriend.com GS Caltex 215,000 b/d EPC: GS E&C SK Energy 172,000 b/d EPC: SK E&C, Hyundai E&C, Daelim Ind. Source: Company data, Korea Investment & Securities

2 Sector report focus What is the report about? To offer an outlook for the ME refinery investment cycle expected to pick up in 2012 Picking construction stocks that will benefit from refinery investment and comparing them with global competitors Approximating Korean builders potential market share in the 2012 ME refinery market by examining their track records and regional footing Based on this, presenting promising builders that will show strong orders momentum and earnings visibility: Hyundai E&C and GS E&C Key assumptions and valuation GCC budget for refineries and Korean builders market share (USD bn) F Major builders order receipt Budget Market share (%) Note: 2011 YTD numbers / Source: Korea Investment Assuming Korean builders keep the average share of 29% in the 2012 ME refinery market, total refinery order receipt would reach USD15.7bn If evenly divided among the five major builders, each would achieve 22-52% of their 2012 overseas order targets from the ME refinery market alone In 2012F, Korean builders total overseas order receipt is forecast to grow to USD80bn, up 14.3% from USD70bn in 2011F Sensitivity & scenario analysis (W bn, %) GS E&C Hyundai E&C Samsung Eng. Total Base 12F overseas orders (1) 8,500 11,000 13,200 32,700 case 12F OP (1 ) ,233 13F OP (1 ) ,015 2,565 Bull 12F overseas orders (2) 9,775 12,650 15,180 37,605 case 12F OP (2 ) ,337 13F OP (2 ) ,067 2,800 12F sensitivity (2 )-(1 ) F sensitivity (2 )-(1 ) Bear 12F overseas orders (3) 7,225 9,350 11,220 27,795 case 12F OP (3 ) ,129 13F OP (3 ) ,544 12F sensitivity (3 )-(1 ) (2.1) (2.5) (8.4) (4.7) 13F sensitivity (3 )-(1 ) (4.5) (4.6) (5.1) (4.8) Source: Company data, Korea Investment & Securities GS E&C, Hyundai E&C, and Samsung Eng s cumulated OP will rise by 4.7% in 2012 and 4.8% in 2013 if each company s overseas orders rise by 15% (the three companies have high overseas portions). Risks If oil prices fall much below the ME countries break-even price of USD60/bbl, hydrocarbon plant investments may fall If investment contraction by international oil companies (IOC) lengthens in the offshore market, European EPC providers may cut their margins and seek new orders in the ME onshore market on fears that a sharp decline in new orders would deplete their backlogs Sector highlights 1) Refining facilities positioned for massive investment expansion in 2012F About a quarter of 2012F ME plant budget is for refineries As refinery projects are usually tendered in complexes, their execution rate is higher than other plants Korean builders total overseas order receipts and major builders refinery order receipts (USD bn) 2008: Including the cancelled Kuwait NRP project, major builders's overseas refinery order receipts jump to USD7.9bn Korean builders' overseas order receipts (LHS) Major builders' overseas refinery order receipts (RHS) (USD bn) Source: Company data, ICAK, Korea Investment & Securities 2) Why ME refiners are increasing their investments To reduce dependence on gasoline and diesel imports To secure feedstock for domestic downstream facilities To respond to increasing environmental regulations Peer comparison Korean refining facilities that refine heavy oil boast higher upgrading efficiency compared to European refining facilities that mainly refine high-quality light oil Therefore, Korean builders are more competitive at building upgrading facilities compared to European players Refinery capacity additions: Korea vs. Europe 3,000 2,500 2,000 1,500 1, ('000 b/d) Korea (LHS) Europe (RHS) Source: BP, Korea Investment & Securities ('000 b/d) 5, ,000 20,000 15,000 10,000

3 I. Investment summary 1. Expanding Middle East refinery market bodes well for Korean builders Despite sustainability issue, ME plant market is on track to grow 20% in 2012 The key issue is whether Korean builders core markets are growing Reason behind our upbeat 2012 outlook: Refinery projects to account for a quarter of ME plant market Main competitor Europe lags behind in terms of upgrading capability Market participants are busy tapping the possibility that the ME plant market, a major target for Korean builders, will continue growing. The annual market size has been maintained at around USD100bn since Admittedly, it is hard to expect such a huge market to grow more than 30% every year as in the past. But at least for 2012, it certainly appears on track to achieve robust 20% growth. Given the average execution rate in the ME plant market, we estimate the region s total tenders in 2012 at USD153bn (67% of USD230bn budgets). This is a 70% YoY growth but there is both upside and downside depending on the actual execution rate in Before assessing the market s nominal growth potential, we think it is more important to confirm whether Korean builders core markets are growing as the market growth itself will be meaningless if the builders presence is not competitive enough to take a big piece of the pie. In this regard, we have a positive outlook for the ME plant market in 2012 as refinery projects will account for a quarter of total ME plant market. After the Saudiled downstream investment took center stage in 1H11, the ME countries should tender more upstream projects such as refineries from 2012 in an effort to produce value-added products and diversify their industrial structures. We expect Korean builders to benefit from this change for the following reasons. 1) European builders, Korean builders main rivals, have little experience with refineries, especially upgrading facilities. Most European refiners refine highquality light oil and thus their upgrading capability lags behind. Furthermore, Europe has not built many new refineries since the 70s. 2) On the other hand, Korean refiners refine heavy ME oil and thus boast significant upgrading capability. Since Korea has been building many new refineries since the 90s, Korean builders have plenty of experience building refineries and should be able to grasp a big market share on the back of this track record. As such, we recommend Overweight on the construction sector and highlight its solid momentum and earnings that deserve attention, particularly in this jittery stock market. 1

4 ME market: Refinery orders received by major Korean builders & petrochemical plant and refinery market outlook (USD bn) 2008: Including the cancelled Kuwait NRP project, major builders's ov erseas ref inery order receipts jump to USD7.9bn Korean builders' ov erseas order receipts (LHS) Major builders' ov erseas ref inery order receipts (USD bn) (USD bn) (USD bn) Petrochemical plants (LHS) Ref ineries (RHS) F 2012F Source: Company data, ICAK, MEED, Korea Investment & Securities Korea s average share in the ME refinery market is 29% Major builders to achieve 22-52% of 2012F overseas order targets from the ME refinery market Unprecedented, largescale refinery spending to guarantee solid overseas momentum for Korean builders Since 2004, the average market share of Korean builders in the ME refinery market has been 29%. If we apply this market share to 2012F ME refinery market size estimated at USD54bn, Korean builders potential order receipts would amount to USD15.7bn. If the amount is evenly divided among the five major builders, each builder will receive USD3.1bn of orders from the ME refinery market alone in Major Korean builders 2012F overseas order targets lie in the range of USD6bn- 12bn. If they can generate 22-52% of the target from the ME refinery market, their full-year overseas targets will be more easily achievable. Korean builders have seen refinery order receipts drive their overall overseas momentum in the past. In 2009 during the global financial crisis, overseas order receipts jumped 19.1% YoY thanks to refinery orders worth as much as USD9bn. The ME countries are expected to make unprecedented, large-scale refinery investment from 2012 and this hints at solid overseas momentum for Korean builders. We believe GS E&C and Hyundai E&C will be greatest beneficiaries of this refinery investment cycle due to their strong experience built on refinery orders from affiliates such as GS Caltex and Hyundai Oil Bank, and high exposure to the Kuwaiti market that will become the biggest refinery market in We also expect Samsung Eng. and Daelim Ind. to enjoy a piece of the pie as well. 2

5 2. Time to see orders growth push earnings upside Housing-related provisioning in the final phase; Strong overseas order growth to drive up earnings If provisions were not recognized in 2011, each builders EPS would rise by 14~18% Shrinking provisions suggest greater earnings upside Oil refineries are typically large industrial complexes and thus the projects boast a higher execution rate than other plants. Therefore, we expect Korean builders to win a significant amount of refinery orders in Opportunely, Korean builders are in a position to improve earnings visibility from 2012 as housing-related provisioning that ran on for the past three years has entered the final phase. As such, more overseas orders can directly lead to earnings growth. Since 2008, GS E&C, Daelim Ind. and Daewoo E&C have each set aside about W1trn in provisions (W100bn-300bn per annum). Though we cannot entirely rule out the possibility of more provisioning, the builders are unlikely to recognize substantial provisions from 3Q11 as they did during the past three years. Assuming the builders did not recognize provisions in 2011, EPS would rise 14% for GS E&C and 18% for Daelim Ind. We reflected W70bn in provisions for GS E&C and Daelim Ind. each in our 2012F forecasts. Barring the provisions, their EPS would have the respective upside of 12% for GS and 11.7% for Daelim in Although it is hard to completely discard the possibility of provisions in 2012, the amount should surely contract over the short to mid-term and raise the earnings upside. This suggests potential upside for not only share prices but also the sector s valuation multiples on the back of greater earnings visibility. Major builders cumulative overseas order receipts Major builders cumulative 2012F OP (W trn) 60 Cumulative overseas order receipts (W trn) 4 Cumulative construction OP CAGR 27.7% 3 Provisions in CAGR 66.3% F 2012F F 2012F Note: Major builders include Samsung C&T, GS E&C, Samsung Eng., Hyundai E&C, Daelim Ind., and Daewoo E&C Source: Company data, Korea Investment & Securities Note: Major builders include Samsung C&T, GS E&C, Samsung Eng., Hyundai E&C, Daelim Ind., Hyundai Development, and Daewoo E&C Source: Company data, Korea Investment & Securities 3

6 3. Picks: GS E&C and Hyundai E&C GS E&C and Hyundai E&C will be greatest beneficiaries of the refinery investment cycle Samsung Eng. to see larger refinery market share; Daelim Ind. with a solid footing in Saudi Arabia Major builders cumulative overseas order receipts to grow 21.2% YoY in 2012 We expect GS E&C and Hyundai E&C to benefit the most from the upcoming, unprecedented refinery investment in the ME. GS E&C has established a significant refinery track record such as building GS Caltex s nos. 1~4 heavy oil upgrade (HOU) facilities and the UAE s Ruwais Complex (world s largest refinery complex). Hyundai E&C also has experience of building refineries for Hyundai Oil Bank and SK Energy. Furthermore, the two companies have many on-going projects in Kuwait, which is set to become the largest refinery market in With growing refinery experience since 2007, Samsung Eng. is now positioned to expand its refinery market share. The company has won the Jubail complex project in Saudi Arabia and was also selected as the EPC provider for S-Oil s no. 2 aromatics plant in 2008 with the help of Saudi Aramco s recommendation. Daelim Ind, which has a solid footing in Saudi Arabia s refinery market and won multiple projects including Yanbu and Jubail complexes, should be able to win more refinery orders in Saudi Arabia. Given the ME refinery market conditions, major Korean builders combined overseas order receipts are projected to grow 21.2% YoY. If the actual overseas order receipts of three major builders change by 15% from our estimates, their operating profits will be adjusted by 4.7% in 2012F and 5.1% in 2013F. For reference, we estimate 2011F overseas orders at W7trn for GS E&C, W7trn for Hyundai E&C, and W11.2trn for Samsung Eng. Changes to major builders F OP depending on overseas order assumptions (W bn) Samsung GS E&C Hyundai E&C Total Eng. Base 2012F overseas order assumption 8,500 11,000 13,200 32,700 case 2012F OP , F OP ,015 2,672 Bull 2012F overseas order assumption 9,775 12,650 15,180 37,605 case Change to base-case OP (2012F) Change to base-case OP (2013F) Bear 2012F overseas order assumption 7,225 9,350 11,220 27,795 case Change to base-case OP (2012F) (2.1) (2.5) (8.4) (4.7) Change to base-case OP (2013F) (4.5) (4.6) (5.1) (4.8) Note: GS E&C and Hyundai E&C are based on IFRS (separate) Source: Company data, Korea Investment & Securities 4

7 GS E&C backlog breakdown Samsung Eng. backlog breakdown Daelim Ind. backlog breakdown Civil 7% Environmental 3% Civil 3% Oil & gas 19% Oil & gas 39% Refinery 37% Oil & gas 33% Refinery 28% Power 5% Refinery 44% Petrochem ical 4% Power 6% Petrochem ical 16% Ind. 6% Power 5% Petrochem ical 45% Samsung C&T backlog breakdown Hyundai E&C backlog breakdown Daewoo E&C backlog breakdown Industrial 4% Civil 21% Oil & gas 5% Building 12% Petrochem ical 8% Civil 17% Oil & gas 16% Building 17% Petrochem Refinery ical 3% 3% Civil 2% Oil & gas 30% Power 47% Power 58% Power 42% Building 15% Source: Company data, ICAk 5

8 II. Refinery cycle 1. USD49bn of refinery capacity additions per annum Global refinery capacity to swell in 2015 backed by ME investment in 2012 Data from the IEA indicate that refinery capacity would increase substantially in 2012 and The increase in 2012 is driven by massive refinery investment in the UAE and Saudi Arabia in The expected capacity increase in 2015 suggests there will be large-scale refinery investments in ME countries account for 31% of global oil production, whereas their refining capacity stands at only 9%, suggesting sustainable refinery investment over the long-term. Global refinery capacity growth (mn b/d) Capacity additions f rom ref inery inv estments in 2009 Crude distillation Upgrade Desulf urisation Increased ref inery inv estments in 2012F F 2012F 2013F 2014F 2015F 2016F Source: IEA, Korea Investment & Securities Annual average refinery market estimated at USD49bn based on global capacity requirements It is estimated that the global refinery capacity requirements amount to 20mn b/d for crude distillation 1, 11mn b/d for upgrading 2 and 25mn b/d for desulfurization during It is known that a refinery complex with 400,000 b/d capacity costs USD10bn. Specifically, CDU projects require USD100mn to build 10,000 b/d capacity and upgrading facilities cost two to three times more. If we conservatively apply the lower cost band of USD200mn to upgrading facilities, the global refinery project market up to 2030 would be worth USD1.1trn in total, or an annual average of USD49bn. 1 Crude distillation or Atmospheric distillation separates crude oil into petrochemicals by heating crude oil, which is a mixture of hydrocarbons with different boiling temperatures, to over 340 C. When crude is heated in a tank, various crude components turn to vapor, which is piped into the distilling column. As the vapor rises through column, it is cooled at different points. This results in the formation of petrochemicals such as propane, butane, naphtha, kerosene, diesel, asphalt and Bunker C oil, depending on the boiling point and the molecular weight of each crude component. When crude is put through a basic refining process, although it varies according to type of crude, it normally results in 40% of high-sulfur Bunker C, a heavy fuel oil. But given its high sulfur content and low efficiency, Bunker C is not considered economically feasible. 2 After crude is put through a basic refining process, high-sulfur Bunker C is processed as a raw material once again. Upgrade facilities involve the production of gasoline, kerosene, diesel and low-sulfur Bunker C by breaking down high-sulfur Bunker C and removing the sulfur. 6

9 Global refinery capacity requirements (USD bn, mn b/d) Type capacity Annual average capacity Project cost Crude distillation Upgrade Coking/visbreaking Catalytic cracking Hydro-cracking Desulfurization Vacuum gasoil/fuel oil Distillate Gasoline Octane units Catalytic reforming Alkylation Isomerization Lubricants Annual average market size 49.0 Source: OPEC 2. Reasons why ME oil refiners are investing Increasing investments for CDUs and upgrading facilities on greater demand for lighter oil For oil producing countries, it is increasingly important to invest in refineries, particularly upgrading facilities. Reasons behind the ME refinery investment expected in 2012 can be summed up as follows. 1) To reduce dependence on imported gasoline and diesel (although ME countries are crude oil exporters, lack of refining facilities make them importers of gasoline and diesel). 2) To secure feedstock for downstream and manufacturing industries in their territory. 3) To meet a growing need for desulfurization facilities that can satisfy stricter environmental regulations around the world. 1) To reduce dependence on imported gasoline and diesel: The more sophisticated the industrial structure becomes, the greater demand arises for light oil than for heavy. While heavy oil consumption is certainly shrinking worldwide, consumption is growing for both light and heavy oil in the ME. As the dependence on imported gasoline and diesel is still high, the ME is increasing investment in CDU as well as upgrading facilities. Global heavy/light oil consumption ME heavy/light oil consumption 35,000 ('000 b/d) Light distillates Fuel oil Middle distillates Others 3,000 ('000 b/d) Light distillates Middle distillates 30,000 25,000 20,000 Globally, fuel oil (heavy oil) consumption is decreasing 2,500 2,000 1,500 Fuel oil Others In the Middle East, consumption of both middle distillates and heavy oil is rising 15,000 10,000 1,000 5, Source: BP Source: BP 7

10 ME 2012 refinery tenders will include many upgrading facilities 2) To maximize profits through upgrading: In the ME, old refineries built during s account for more than half of total capacity. As the facilities do not include upgrading facilities like the recent complexes, the refined output is simple. Accordingly, hydrocracking, catalytic cracking and residue fluidized catalytic cracking (RFCC) investments are making up a greater portion of newly added facilities in the region. As seen in the table below, ME refinery projects to be tendered in 2012 include a multitude of upgrading facilities along with CDU. Pipeline projects in the ME refinery market including upgrade projects (USD bn, b/d) Project Country Amount Facility Capacity Clean Fuel Project (CFP) Kuwait 18.5 CDU 264,000 Two hydrocracker units 120,000 Coker 37,000 Nassiriyah Refinery Iraq 8.0 CDU 300,000 FCC 50,000 Karbala Refinery Iraq 5.0 CDU 140,000 FCC 25,000 Maissan Refinery Iraq 5.0 CDU 150,000 FCC 48,000 Jizan Refinery Saudi Arabia 5.0 CDU 300,000 Hydrocracker unit 77,000 Visbreaker 85,000 Sohar Refinery expansion Oman 1.5 CDU 71,500 Once-through hydrocracker unit 66,400 Sulfur recovery unit Source: MEED, Purvin & Gertz, Korea Investment & Securities Building more refinerypetrochemical complexes to increase production efficiency Stricter environmental regulations call for more desulfurization facilities The highly refined output from the facilities can mostly be used as feedstock for downstream facilities or exported to other countries as high-margin products. One of the reasons behind the production of these value-added products is to create jobs that are crucial to the region s political stability. It is also a growing trend that refineries are built in an integrated package with petrochemical complexes for efficient production (see page 10). 3) Stricter environmental laws in 2012 and 2015 are behind the refinery investments in 2009 and 2012: Desulfurization projects 3 to make low-sulfur petroleum products are becoming more marketable due to stricter environmental regulations around the world. In 2008, the International Maritime Organization (IMO, a specialized agency of the UN) decided to considerably strengthen environmental regulations 4 on sulfur content of fuels used by ships sailing international waters. In 2012, more desulfurization facilities will come on-stream as the stringent standards will be applied in international waters from The emission control area (ECA) standards will be further beefed up in 2015, which should lead to a global rise in demand for desulfurization facilities. Thus, most refinery complexes to be tendered in 2012 will need to include such desulfurization facilities. 3 VRDS produces low-sulfur Bunker C and naphtha, the main feedstock for the petrochemical industry, by removing many of the contaminants from high-sulfur Bunker C. 4 The highest sulfur content allowed in ship fuel will drop globally on Jan 1, 2012 from 4.5% to 3.5% (on a mass basis, m/m); The Sulfur Emission Control Areas that include the Baltic Sea, the North Sea and the English Channel have stricter regulations from 1.5% to 1.0% as of Jul 1, 2010 and to 0.1% as of Jan 1,

11 Refining process at upgrading facilities Source: Korea Investment & Securities IMO s regulations on sulfur content (% m/m) Emission control area (ECA) Non-ECA Source: IMO, Korea Investment & Securities 9

12 3. Vertical integration ME countries are shifting industrial structure on fears of oil depletion Three reasons for refinery investments 1) to diversify industrial structure 2) to secure downstream feedstock 3) to respond to Europe s environmental regulation Vertical integration guarantees competitive prices 1) Saudi Arabia s Petro- Rabigh and Jubail complex-2 are examples of vertical integration Oil exports fetched enormous petrodollars to the ME countries in the past but rich public coffers did not translate into private wealth. As a result, the income gap has widened and the jobless rate has surged. The brewing public anger threatened political stability in the region as seen by civil uprisings that swept the MENA region in early Unlike the past, many current high-ranking government officials in the ME countries studied overseas, especially in the US and other advanced nations. They are shifting the national industrial structure away from a dependence on oil exports. The ultimate goal of the refinery investment in the ME is to diversify industrial structure by producing value-added refined output, which will help create jobs and maintain political stability in the region. ME countries are increasing the upgrade ratio at refineries to secure value-added feedstock for their downstream industries. In the process, they are shifting to invest in integrated refinery and petrochemicals complexes. For the production of competitive chemicals, Korea is locating its plants in neighboring Asian countries, a major market, whereas the ME is strengthening competitiveness by securing feedstock in the vicinity. The production of chemicals with feedstock coming from nearby refineries reduces transportation costs and thereby can sharpen the pricing edge. Indeed, the CEO of Kuwait Petroleum Corp. said that if refining and petrochemicals are integrated at the stage of project design, synergies would increase the project s economic feasibility by 4%. The vertical integration efforts are being confirmed in the recent projects pursued by ME countries. 1) Saudi Arabia: For the production of competitive chemicals, the country is proceeding ahead with the USD5bn Petro-Rabigh plant near the existing Rabigh refinery complex and the bid result will be revealed at year-end. The Jubail complex-2 won by Daelim Ind. at USD2bn in Sep was also a petrochemicals complex integrated with the Jubail refinery complex. ME feedstock supply to petrochemical plants Saudi annual naphtha imports ('000 bbl) 35,000 Saudi naphtha imports 30,000 25,000 20,000 15,000 10,000 5, Source: MEED, Korea Investment & Securities Source: BP, Korea Investment & Securities 10

13 Saudi Aramco announced a plan to invest USD125bn in refineries over the next five years Along with the investment in integrated petrochemical plant projects, refinery investment to secure feedstock is also underway. During his visit to Korea in April, the president of Saudi Aramco announced a plan to invest USD125bn over the next five years to increase crude refining capacity from 4mn b/d to 6mn b/d. The capacity expansion includes the construction of two additional refineries and four basic facilities in Saudi Arabia. After his comment, the project plan for the USD7bn Jizan refinery was announced eight months earlier than initially planned and is scheduled to open for bids in 1Q12. Aramco s existing five refineries in the country are not enough to meet domestic refining demand given the nation s annual naphtha imports of more than 30mn barrels. Although competition is intense, the Saudi refinery market remains a promising target for Korean builders given its steady stream of large tenders. Among Korean builders, only Daelim Ind. and Samsung Eng. provided EPC works for refinery complexes in Saudi Arabia. But given a long track record of refinery building in Kuwait and the UAE, we expect Korean builders to take a large share of Saudi Arabia s refinery market. Saudi refinery EPC providers (USD bn) Complex Sponsor Amount EPC provider Note Yanbu Aramco 0.5 SK E&C Crude unit package 1.1 Daelim Ind. Gasoline package 0.6 Daelim Ind. Hydrocracking package Jubail SATORP 0.4 SK E&C Utility package (Aramco+Total) 0.8 Daelim Ind. Acid gas removal package 0.7 Samsung Eng. Aromatic compounds package 0.4 Samsung Eng. Coker unit package Ras Tanura Aramco 0.4 Samsung Eng. Hydrotreating package Riyadh Aramco 0.1 Daewoo E&C Firefighting facilities Source: ICAK, Korea Investment & Securities Saudi refinery capacity Yanbu - 230,000b/d (Aramco) - 400,000b/d (Aramco/Sinopec) Ras Al-Zour - 350,000b/d (Aramco) Jubail - 305,000b/d (Aramco) - 400,000b/d (Aramco/Total) Rabigh - 400,000b/d (Aramco) Ras Tanura - 550,000b/d (Aramco) Petrochemical complex Jizan - 400,000b/d (Aramco) Riyadh - 120,000b/d (Aramco) Note: Projects under construction or set to be tendered marked in blue. Source: MEED, Korea Investment & Securities 11

14 2) UAE to invest USD20bn in 2012 as part of the ChemaWEyaat project 2) UAE: The state-owned oil company, the Abu Dhabi National Oil Co. (ADNOC), is currently promoting the ChemaWEyaat project, a naphtha-based petrochemicals complex, in a JV with the Abu Dhabi Investment Council and the International Petroleum Investment Corp. (IPIC). The USD20bn project will be tendered in end- 2012~2013. Naphtha and propane from the Ruwais refinery complex (tendered by ADNOC in 2009) would be used as feedstock for the complex. Abu Dhabi s ChemaWEyaat project outline Source: ChemaWEyaat Refineries and downstream complexes in the UAE Chemaweyaat Complex Jebel Ali Refinery Capacity: 120,000 bpsd Status: In operation (ENOC) Ruwais Refinery Capacity: 415,000 bpsd Status: In operation (ADNOC) Ruwais Complex Umm Al-Nar Refinery Capacity: 85,000 bpsd Status: In operation (ADNOC) Fujairah Refinery Capacity: 82,000 bpsd Status: Shut down due to financial difficulties (FRC) Source: Arabianoilandgas, Korea Investment & Securities 12

15 3) After Sohar, Oman plans to establish an integrated refinery and petrochemical complex at Duqm 3) Oman: As the country is not rich in natural resources compared to neighbors, the urgent task is to diversify its industrial structure and focus on high value-added segments. After building refinery and petrochemicals complexes in the Sohar special economic zone, Oman plans to establish the USD7bn Duqm integrated refinery and petrochemicals complex in the special economic zone at Duqm. In particular, Oman is expected to tender refining expansion projects at the Sohar economic zone in 2012, which would increase capacity by 72,000 b/d. Oman is not only making new investments but expanding refineries to satisfy robust demand. Oman s refineries, petrochemicals complexes and scheduled projects Sohar Complex Ref inery : 116,000 bpd - expansion 72,000 bpd Petrochemicals: - PP 0.4 mn t/y - Aromatics 1 mn t/y Mina Al Fahal Refinery Ref inery : 106,000 bpd Duqm Complex Ref inery : 300,000 bpd Petrochemicals: - Mixed cracker 2 mn t/y - PP 1.2 mn t/y - Aromatics 2.8 mn t/y - Sty rene 0.8 mn t/y Note: Scheduled expansion projects marked in blue. Source: ORPIC, Korea Investment & Securities Southeast Asia is steadily investing in refineries as well Vietnam is the most promising market with four large-scale refinery complexes under way With a solid footing in Vietnam, GS E&C to benefit from the nation s refinery investment 4) Southeast Asia: Recently, GS E&C inked a USD700mn RFCC deal with Indonesia and is waiting for a USD1.1bn refinery order from Vietnam. Such a continuous flow of refinery order receipts from Southeast Asia shows the facilities are seriously lacking. Even though most countries in Southeast Asia are oil producers, they still import chemicals and this is one of the major reasons behind their fiscal deficits. The main culprit behind the chemical imports is a lack of refineries. In terms of hydrocarbon plants, the most promising market over the long-term is Vietnam. The country is proceeding with four large-scale refinery complexes. The project sponsor is Vietnam Oil and Gas Group (PetroVietnam, PVN) that invested USD3bn in 2005 to build the Dung Quat refinery, Vietnam s first facility of its type, which started operation in As the refinery s utilization rate reached 100% in Jan 2010 due to robust demand, PVN is planning to expand the refinery s annual capacity from 6.5mn to 10mn tonnes. The sponsor also invested USD8bn to build a second refinery and petrochemicals complex in 2008 and has broken ground. GS E&C s awaited refinery deal with Vietnam is also a part of this project. Vietnam also plans to invest in its third and fourth refinery complexes. The nation s oil refining demand has increased sharply since 2005 but domestic refineries can satisfy less than half the need, suggesting the country will continue to invest in refineries over the long-term. Among Korean builders, GS E&C has been the most aggressive in penetrating the Vietnamese plant market and is expected to win additional orders. Moreover, sustainable refinery investment by Vietnam and other Southeast Asian countries is favorable for Korean builders that can expand their target markets to non-me regions. Indeed, the builders have posted an annual increase in hydrocarbon plant orders from Southeast Asia since

16 Korean builders hydrocarbon plant orders from Southeast Asia since 2006 (USD bn) Year Country Builder Project Project sponsor Amount 2006 Philippines Daelim Ind. PetroFCC capex Petron Corp. 0.2 Thailand Samsung Eng. MOC naphtha cracker Map ta Phut Olefins Philippines Daelim Ind. Petron BTX Petron Corp. 0.1 Thailand Samsung Eng. Ethane separation palnt PTT Public Co. 0.5 Thailand GS E&C HMC polypropylene plant HMC Polymers Philippines Daelim Ind. JG Summit naphtha cracker plant JG Summit Petrochem Thailand GS E&C IRPC polypropylene plant IRPC Public Co Indonesia GS E&C RFCC PT. Pertamina 0.7 Note: Limited to projects worth more than USD100mn. Source: ICAK, Korea Investment & Securities Total 2.7 Vietnam both an oil producer and chemicals importer Vietnam s major refinery investment plans (mn b/d) Oil production Oil consumption Exports Refinery complex Amount (USD bn) Capacity (b/d) Status 1) Dung Quat ,500 Completed in Dung Quat expansion ,300 Investment negotiation in progress 2) Nghi Son ,000 Should break ground in 3Q11 (USD1.1bn for GS E&C) 3) Long Son ,000 Investment negotiation in progress 4) Nam Van Phong ,000 Feasibility study in progress Source: IEA, Korea Investment & Securities Source: PVN, Petrolimex, Korea Investment & Securities 4. Risk check ME has different price mechanism ME has different price mechanism for petroleum products ME countries encourage demand and supply of petroleum products by giving subsidies Construction shares recently plummeted on falling oil prices and concern about tender delays or cancellations in the ME as oil price drops tend to make petroleum products less profitable. But given the ME s different pricing mechanism for petroleum products, the possibility of margin erosion appears remote. ME countries are increasing the portion of value-added products to create jobs and diversify the industrial structure. Based on this, their plan is to nurture auto, steel and electronics industries that use the value-added products as feedstock. To encourage domestic demand and sale of the products, ME countries are granting subsidies. For example, government subsidies provide a better price footing for refined output from the region that can be sold at prices on par with Singapore s, which are slightly more than the global level. Also, consumers can buy the products at lower prices, which should stimulate both demand and supply. While emerging countries in Asia started slashing their subsidies, the ME is unlikely to follow suit in the foreseeable future given the civil uprisings in early

17 Refining margins: Singapore vs. global ($/bbl) 9 Global crack spread Singapore crack spread Jan-11 Mar-11 May-11 Jul-11 Sep-11 Subsidies by country Iran Saudi Arabia India Egypt Venezuela China Indonesia Iraq Algeria Mexico Malaysia Thailand Kazakhstan Kuwait Libya UAE Qatar Argentina Turkmenistan Total value of subsidies in 2009 (USD bn) Source: Wood Mckenzie, Thomson Reuters Source: IEA, Korea Investment & Securities Fewer project costs during oil price downs to ease the financing burden of sponsors Japanese banks took over the bulk of PF loans from struggling European counterparts If falling oil prices are long-lasting, a cutback in ME projects seems likely due to reduced public coffers. But project sponsors appear to have ample room to issue tenders thanks to high oil prices over the past two years. In addition, fewer project costs accompanied by falling oil prices are favorable for sponsors who can achieve economic feasibility over the long-term. In fact, the UAE s Ruwais oil/gas refinery complex was tendered in 2009 when oil prices fell to as low as USD40/bbl. Finally, the unstable global financial market can create a risky environment. But we note that most of the ME hydrocarbon plant projects are tendered by national oil companies that can cover a significant portion of funding with their own capital. For instance, non-me capital represented 18.8% of the financing requirement for the Jubail refinery complex jointly tendered by Saudi Aramco and French oil group Total in In addition, there are growing cases of Japanese banks purchasing the PF loans from faltering European investment banks at a discount. As such, it would be far-fetched if we said the global funding sources are drying up due to the recent European debt crisis. Purchase of European PF loans by Japanese banks In Nov 2010, Bank of Tokyo-Mitsubishi decided to buy RBS PF portfolio for USD6.1bn - RBS was a major player in the PF market but stumbled after the global financial crisis (The UK government provided a GBP45bn bailout for the crisis-stricken RBS) Source: Infrastructureinvestor.com 15

18 III. Korea s forte in refineries 1. Korea commands 29% of ME refinery market share Korean builders will benefit from unprecedented refining plant boom in the ME Korean firms average share of ME refinery market 29%; More than USD10bn in orders expected in 2012 We believe Korean builders will benefit from the ME s large-scale investment in refineries in 2012 based on the following. 1) Competitive pricing and project management. 2) Reputation as a top-notch refinery builder. 3) Accumulated experience in upgrading projects in Korea, which boasts one of the greatest upgrading levels in the world. Unlike petrochemicals, the refinery projects are unlikely to be sharply reduced in scale as they necessarily involve orders for CDU, upgrading facilities and utilities. In the six member states of the Gulf Cooperation Council (GCC), Korean builders share of the refinery market is estimated at 29% on average (23% if excluding the 2008 Kuwait New Refinery Project orders cancelled in 2008). If the ME starts the refinery projects worth USD54bn as anticipated and Korean builders command the historical average share of 29%, at least USD15.7bn could be awarded to them. The track record in the UAE and Kuwait supports our forecast. Korean major builders share of the refinery/petrochemical plant/gas plant market in six GCC member states (USD bn) Received USD14.9bn refinery orders in with avg. M/S of 23% (%) but M/S jumps to 29% if including the cancelled Kuwait NRP project in 2008 Ref inery market (LHS) Korean builders' M/S (RHS) F (USD bn) (%) Petrochemical plant market (LHS) Korean builders' M/S (RHS) Received USD14bn petrochem plant orders in with avg. M/S of 23% F (USD bn) (%) Gas plant market (LHS) Korean builders' M/S (RHS) Received USD11.5bn gas plant orders in with avg. M/S of 15% F Source: ICAK, MEED, Korea Investment & Securities 16

19 2. European refineries use light sweet crude oil Korean construction firms lead the refinery market Most European refineries refine light crude; European EPC players are less competitive in upgrading projects Korean refiners use heavy crude and local builders built the domestic upgrade projects As the market is expected to grow, our next interest is how intense the competition will be. Given the huge project tenders in the pipeline, we expect the ME will become a battlefield for builders in But we see no global companies to compete with the Koreans in terms of both technology and experience. European EPC players have little experience with upgrading plant projects. European refineries use Libyan light sweet crude oil as a feedstock. The Libyan light crude has high quality with a low sulfur content and weighs less than other types of light oil. That is, European refineries already enjoy high productivity and see little need to add upgrading facilities. Besides, a majority of the European refineries were built in the 1970s, suggesting it has been quite long since European EPC players built such facilities. By contrast, Korean refiners mostly use ME heavy crude oil and most Korean refineries were built starting in the 1990s. Korean builders armed with the most recent experience in sophisticated refinery projects should appeal to ME refiners. Meanwhile, most European refineries lack the ability to process heavy oil from the ME, according to The Economist. Refinery capacity additions: Korea vs. Europe 3,000 ('000 b/d) Korea (LHS) Europe (RHS) ('000 b/d) 25,000 2,500 20,000 2,000 15,000 1,500 1,000 10, , Source: BP, Korea Investment & Securities Oil quality comparison Productivity at France s refineries vs. France s dependence on Libya s light sweet crude (Sulfur content, %) Saudi Arabia (Arab light) Heavy oil High-sulfur Low-sulfur Light oil (x) (%) France refining productivity (LHS) France's portion of Libyan oil imports (RHS) Libya (Es Sider) UK (Brent blend) Kazakhstan (CPC Blend) Libya (El Sharara) Algeria (SaharanBlend) Nigeria (Qua Iboe) (API Gravity) Note: The lower Y value and higher the X value, the better the oil quality is. Source: IEA, Korea Investment & Securities Source: IEA, Korea Investment & Securities 17

20 3. Korea is home to mega-scale upgrading plants Korean refiners boast high upgrade ratios Korean construction firms have built largescale upgrade plants for affiliated refiners Korea is the base for mega-scale upgrade plants. Hyundai Oilbank established its no. 2 upgrade plant in Daesan, South Chungcheong province, in Jul. The new unit has lifted the company s upgrade ratio to 30.8%, the most among Korean refiners. GS Caltex trails Hyundai with 28.7% as it added the no. 3 upgrade plant in Yeosu, South Jeolla province, earlier in Jun Korean refiners upgrade ratio is at the upper-end of the world s scale, which in turn proves Korean builders competitiveness in building the plants. The upgrade plants of refiners were mostly built by affiliated construction companies: Hyundai Oilbank s by Hyundai E&C and Daelim Ind., GS Caltex s by GS E&C and SK Energy s by SK E&C, Hyundai E&C and Daelim Ind. We believe the experience will serve the Korean construction companies (especially GS E&C and Hyundai E&C) well as they pursue opportunities in the overseas refinery market going forward. Korean refiners upgrade ratio and respective builder ( 000 b/d, %) SK Energy GS Caltex S-Oil Hyundai Oilbank Refining capacity 1, Upgrade capacity Upgrade ratio Hyundai Oil Bank 120,000 b/d EPC: Hyundai E&C, Daelim S-OIL 148,000 b/d (formerly Ssangyong Oil Refining) EPC: Ssangyong E&C GS Caltex 215,000 b/d EPC: GS E&C SK Energy 172,000 b/d EPC: SK E&C, Hyundai E&C, Daelim Ind. Source: Company data, Korea Investment & Securities Korean refiners upgrade ratio and respective builder ( 000 b/d) Refiner Upgrade plant Upgrade capacity Builder Hyundai Oilbank No. 1 (Daesan, South Chungcheong) 68 No. 2 (Daesan, South Chungcheong) 52 Hyundai E&C, Daelim Ind. Total 120 S-Oil Bunker C cracking center phase 1 (Ulsan, South Gyeongsang) 75 Bunker C cracking center phase 2 (Ulsan, South Gyeongsang) 73 Ssangyong E&C Total 148 GS Caltex No. 1 (Yeosu, South Jeolla) 94 No. 2 (Yeosu, South Jeolla) 61 No. 3 (Yeosu, South Jeolla) 60 No. 4 (Yeosu, South Jeolla) 53 Total 215 SK Energy No. 1 (Ulsan, South Gyeongsang) 57 No. 2 (Ulsan, South Gyeongsang) 45 No. 3 (Ulsan, South Gyeongsang) 70 Total 172 Source: Company data, Korea Investment & Securities GS E&C SK E&C, Hyundai E&C, Daelim Ind. 18

21 IV. Reference 1. Déjà vu to 2009 GS E&C and SK E&C had won mega-scale projects in the UAE in 2009 The biggest refining complex investment of late was made in the UAE in Takreer, an affiliate of ADNOC, invested a whopping USD21bn in building oil refining and gas complexes at Ruwais during Korean companies swept most of the package deals at both complexes. In particular, GS E&C and SK E&C won the CDU and RFCC projects, respectively, which are the main refining units. Ruwais refining/gas complex projects in the UAE (USD bn) Refineries Amount Capacity Winning bidders CDU ,000 b/d SK E&C RFCC ,000 b/d GS E&C SOC and power system Samsung Eng. Storage tanks Daewoo E&C Site development/facilities - - Local builders Offshore facilities GS E&C Gas plants Amount Winning bidders Gas plants JGC+Tecnimont (consortium) SOC and power system Hyundai E&C No. 4 NGL train Petrofac+GS E&C (consortium) Storage tanks CB&I Gas treatment and power facilities Hyundai Heavy Ind. Source: ICAK, Korea Investment & Securities The CDU and RFCC plants at the Ruwais complex are so far the biggest in the world. By taking on the projects, GS E&C and SK E&C built meaningful track records for both technology and scale, which has put them in an advantageous position for future refinery upgrade projects. 2. Kuwait: Korean firms will take advantage of already large presence in the region Kuwait s USD15bn New Refinery project is the biggest of all refinery projects scheduled in the ME in 2012 GS E&C and Hyundai E&C have a large presence in Kuwait The biggest refinery market will be formed in Kuwait in In Apr 2011, the Kuwait Oil Co. (KOC) approved the Clean Fuel Project (CFP) and New Refinery Project (NRP) worth USD18.5bn and USD15bn, respectively. The order placements for the NRP and CFP complexes will likely be completed in 2012 and 2013, respectively. There will be intense competition among builders as the NRP is the biggest of all refinery projects scheduled in the ME in Extensive experience is a core competency to win the bids. We view GS E&C and Hyundai E&C as the most promising bidders considering their presence in Kuwait as well as past track records in refinery construction. Kuwait is a familiar market for both GS E&C and Hyundai E&C, as well SK E&C (unlisted). As the large-scale complex project is scheduled in 2012, GS E&C made a pre-emptive move by winning three projects and started construction in Kuwait in Hyundai E&C is currently lowest bidder for the USD2.1bn Jaber bridge project. Thus, both companies expanded their presence in Kuwait in preparation for Kuwaiti refinery market expansion in

22 Serving multiple projects in the same region is very effective to reduce indirect costs GS E&C and SK E&C were named lowest bidders in 2008 s NRP bidding Having many construction sites around the target market is obviously an advantage to win multiple projects in the same region. Such is true as demonstrated by Daelim Ind. s success at the Jubail 2 complex project in Saudi Arabia in 1H11. Daeilm Ind. appealed to the proposer citing its ongoing projects in Jubail, the biggest in number among bid participants, as well as with its competitiveness in petrochemical plants. Serving multiple projects in the same region helps enhance competitiveness in winning orders as it reduces indirect costs. Earlier in 2008, the NRP had been scrapped due to a cost issue even after naming the lowest bidder. Looking back on how the project proceeded can provide a good guide to see the future of the project. In 2008, GS E&C and SK E&C were selected as the lowest bidders for the no. 1 hydrocracker and no. 2 hydrogen & SRU facilities, respectively. Hyundai E&C and Daelim Ind. were also named lowest bidder for the offshore and tankage packages. If this project is re-tendered in a similar fashion, Korean builders have high chances at taking a lion s share of the project again. Kuwait s scrapped NRP in 2008 (USD bn) Package Amount Lowest bidders #1 Hydrocracker & ARDS 3.9 GS E&C / JGC #2 Hydrogen &SRU 2.7 SK E&C #3 O&U 2.0 Fluor Canada #4 Tankage 1.2 Daelim Ind. #5 Offshore 1.1 Hyundai E&C Source: MEED, ICAK Ongoing projects in Kuwait by company (USD bn) Company Project Sponsor Amount Construction Construction start complete (scheduled) GS E&C KNPC new liquefied gas storage tank KNPC GS E&C WARA pressure maintenance project KOC GS E&C Al-Zour water treatment facility Daelim Ind. MAA No. 4 LPG treatment facility KNPC Hyundai E&C Oil & gas (LSFO) pipelines KOC Hyundai E&C Bubian Island port phase 1, stage 2 Ministry of public Works Hyundai E&C Al Zour North 400kV electricity transmission line Water & Electricity Ministry Hyundai E&C 300/132/33kV electricity transmission line Water & Electricity Ministry Hyundai E&C *Jaber Causeway Bridge Ministry of Public Works 2.1 Expected in 2012 Expected in 2016 SK E&C Gas pumping station construction and upgrades KOC Note: *Hyundai E&C is currently the lowest bidder for the Jaber Causeway Bridge project but order award is delayed due to the client s issues Source: ICAK, Korea Investment & Securities Kuwait s Clean Fuel project overview and product mix changes upon completion (%) LPG/ Propy lene Breakdown of Kuwait's current oil production Breakdown of Kuwait's oil production af ter CFP Naphtha/ Gasoline Kerosene Diesel Fuel oil Others Project: Clean Fuel Project Value: USD18.5bn Outline: - Upgrade/expand MAA and MAB ref ineries - Add 264,000 b/d of CDU capacity, as well as upgrade and desulf urization f acilities including two hy drocracker units and one coker unit Source: KPC, Korea Investment & Securities 20

23 3. Global competitors Korean firms are the most competitive among global peers; Bright prospects for 2012 ME orders Korean construction companies will fare well in the ME in 2012 given 1) a solid track record building the world s largest refineries and Korea s advanced upgrade plants and 2) competitiveness over global players. Financial summary of global peers F Saipem Sales 7,517 9,530 10,094 10,292 11,160 12,210 (EUR mn) OP ,084 1,163 1,319 1,462 EBT 544 1,123 1,217 1,063 1,239 1,338 New order 10,962 11,845 13,860 9,917 12,935 - Order backlog 13,090 15,390 19,105 18,730 20,505 - Technip Sales 6,927 7,887 7,481 6,456 6,082 6,677 (EUR mn) OP EBT New order 6,143 7,198 5,755 7,176 6,957 - Order backlog 10,273 9,390 7,208 8,018 9,228 - TR Sales 1,235 2,005 2,479 2,634 2,771 2,851 (EUR mn) OP EBT New order 2,621 3,582 2,207 2,661 3,619 - Order backlog 3,040 4,713 4,711 4,820 5,730 - Tecnimont Sales 1,047 1,928 2,401 2,138 2,489 2,693 (EUR mn) OP (134) EBT (151) New order 2,834 2,573 2,653 2,578 2,659 - Order backlog 3,768 4,196 4,534 4,728 5,359 - Petrofac Sales 1,864 2,440 3,330 3,655 4,354 5,633 (USD mn) OP EBT New order 2,657 2,237 2,717 7,300 7,800 - Order backlog 4,173 4,441 3,997 8,071 11,699 - JGC Sales (JPY bn) OP EBT New order Order backlog ,028 1,190 - Chiyoda Sales (JPY bn) OP EBT New order Order backlog 1, Note: Bloomberg consensus for Source: Company data, Thomson Reuters Global peer valuation (x, %) 2011F 2012F PE PB ROE PE PB ROE Saipem Technip TR Tecnimont (2.0) 0.9 (44.0) Petrofac JGC Chiyoda Note: Based on closing prices of Oct 14 Source: Company data, Thomson Reuters Global peers orders backlog breakdown by region Saipem Technip TR Petrofac Tecnimont JGC Chiyoda ME 32% 24% 33% 31% 44% 44% 9% Africa 23% 17% - 25% - 8% - Europe/CIS 22% 17% 39% 38% 34% - - Asia 8% 13% % 51% America 15% 29% % - Others % 6% 12% 17% 40% Note: Backlog as of 2Q11. Source: Company data, Korea Investment & Securities 21

24 European players mainly focus on the high-margin offshore market Offshore market is in good shape Major IOCs capex Europe: At this point, the most likely competitors are European firms such as Petrofac, Saipem, Technip and Tecnicas Reunidas. The companies put more focus on offshore projects that are very profitable and have a relatively weaker presence in the onshore market that is dominated by Korean firms. Burdened with high wage and equipment sourcing costs, European companies cannot beat Korean rivals on costs. That is, unless there is a drying up of the backlog or a strategic move to siphon off the available orders, European companies are unlikely to speed up their access to the onshore market. The offshore market is in good shape. Major companies in Europe have seen the onshore portion decreasing in their orders backlog whereas the offshore projects from Europe and Central Asia are on the rise. That is, the portion of onshore projects proposed by the ME NOCs continue to fall. European companies should continue to exit the regional onshore market as long as competition remains fierce. European builders onshore backlog portion (USD bn) Major IOCs' capex (%) Saipem Technip Portion of onshore backlog F 40 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 Source: IEA, Korea Investment & Securities Source: PVN, Petrolimex, Korea Investment & Securities Focusing on cost-plusfee contracts, US Fluor has limited exposure to the ME s LSTK projects US: The US Fluor has a different target market. Instead of participating in competitive bids to win EPC deals, Fluor works on joint projects with US-based IOCs or investment/development projects with partner companies. In particular, Fluor does not place bids in the auction of lump-sum turn-key (LSTK) contracts, which are proposed mainly by NOCs in the ME. Instead, Fluor focuses on the costplus-fee contracts 5, suggesting it will not aggressively tap opportunities in the ME refinery projects in Fluor s orders backlog by contract type Fluor s orders backlog by region Fixed price, 9.7, 24% Asia, 12.9, 32% US, 7.7, 19% Reimbursable, 30.6, 76% Europe, Africa, ME 9.7, 24% Americas, 10.1, 25% (USD bn) (USD bn) Source: Fluor, Korea Investment & Securities Source: Fluor, Korea Investment & Securities 5 Compensation is based on a fixed sum independent of the final project cost. The customer agrees to reimburse the builder's actual costs, regardless of amount, and in addition pay a negotiated fee independent of the amount of the actual costs. 22

25 Japan s three EPC firms have struggled with a lack of engineers and strong JPY Japan: All three Japanese EPC companies JGC, Chiyoda and Toyo will have difficulty raising market share due to a lack of skilled engineers and high labor costs. JGC is the only company that has managed to grow among the three. JGC has centered its business in Qatar recently. Basically, the Japanese companies weakness lies in the limited pool of skilled engineers. Besides, a persistently strong JPY has undermined their price competitiveness. Global companies labor increase (from 2009 to end-2010) (5) (%) workf orce growth (2) Samsung C&T(Korea) Samsung Eng(Korea) Petrofac(UK) Daewoo E&C(Korea) Hyundai E&C(Korea) GS E&C(Korea) Tecnimont (Italy) Chiyoda(Japan) TR(Spain) Fluor(USD) Daelim Ind(Korea) Saipem (Italy) Technip(France) JGC(Japan) Toyo(Japan) (W bn) new orders per builder Hyundai E&C Daewoo E&C Samsung C&T GS E&C (Korea) Samsung Eng. Daelim Ind. JGC (Japan) TR (Spain) Fluor (US) Tecnimont (Italy) Chiyoda (Japan) Toyo (Japan) Petrofac (UK) Saipem (Italy) Technip (France) Source: Company data, Korea Investment & Securities China is less favored in terms of equipment safety and labor issue India is strong in engineering but that s it; Punji Lloyd faces multiple lawsuits China & India: Chinese and Indian companies may be considered a threat. But Chinese companies cause worry among their potential customers due to the questionable safety of equipment they use and labor illegally staying in the ME. As hydrocarbon plants are not without risks, reliable quality of machinery and equipment is very crucial. But many in the ME believe Chinese equipment is not of appropriate quality. In addition, a lot of Chinese workers reportedly stay in the ME after projects are completed, which is affecting the nation s order-taking competitiveness directly or indirectly. India has strength in engineering but is weak in procurement. For example, India s Punji Lloyd is facing multiple lawsuits as it ran over its construction periods and project costs. All in all, armed with competitive price and advanced technology, Korean companies will continue to rule the market for the time being. Lawsuits faced by Punji Lloyd Conflicts with sponsors of three major projects; Cost overrun erodes profits 1)Feb 2006 Sabic s Tesside LDPE plant: Costs rose from GBP135mn to GBP156mn lost the case 2) Jan 2007 ONGC Heera Redev s USD290mn project (India): Incurred losses due to excess costs lawsuit underway 3) Mar 2007 Ensus s Teeside Bioethanol plant worth GBP160mn: Construction period extended six months; Cost overruns; Compensation paid for damages Source: Punj Lloyd, Korea Investment & Securities 23

26 V. Let earnings do the talking After housing-related expenses are reflected, strong overseas order receipts should result in earnings Housing-related writeoffs ongoing for the past three years largely completed as of 2Q11 Builders PF loans as a percentage of capital at an avg. 43% Samsung C&T, Hyundai E&C, Samsung Eng, and Hyundai Dev should see solid 3Q11 results Foreseeable profit trend should lead to valuation upgrade Why does Samsung Eng. receive a greater PE valuation? In addition to strong order receipts growth, stable overseas COGS ratio and mid to long-term growth potential through ample pre-emptive investment in human resources, the biggest premium for the stock is the builder faces no housing-related risks. During the past three years, major builders were trapped in a cycle of housing-related write-offs, which made it difficult to present a reliable earnings forecast and was a discount factor for builders. However, they should no longer experience heightened profit volatility from 3Q11. This means strong growth in overseas order receipts could lead to an increase in enterprise value. We believe housing-related write-offs ongoing since 2008 have largely been completed as of 2Q11. For builders, potential write-offs will remain a lingering issue. However, the size of the write-offs should subside considerably. The biggest reason behind the previous write-offs was the buildup of unsold pre-sale units due to oversupply triggered by a flood of pre-sales during 2007 and 2008 when builders unloaded a slew of homes to avoid the price cap on pre-sales imposed by the government. But as three years have passed, these housing projects are at the end of construction and all gains and losses will be recognized. Thus, we believe housing-related write-offs for the unsold pre-sale homes from 2008 and 2009 are near completion. We also believe PF-related risks have been fully reflected. During the past three years, the most notable builders with pre-sale homes such as GS E&C, Daelim Ind. and Daewoo E&C each reflected about W1trn as PF expenses. At present, the outstanding PF balance stands at W1trn-2trn each for major builders and should dip to around W1trn at end At present, major builders PF loans as a percentage of capital stands at 43.1% on average, a comfortable level given the percentage was over 100% at end We expect major builders to post solid 3Q11 earnings. In 2Q11, most firms conservatively recognized costs as they booked gains after selling Seoul Beltway stakes. As such, their 2H11 bad-debt provisioning could be less than expected. We believe Samsung C&T, Hyundai E&C, Samsung Eng, and Hyundai Dev may deliver 3Q11 results above consensus. From 2012, it will become possible to evaluate the enterprise value of major builders based on earnings. Given that the recognition of housing-related expenses, more than W100bn-200bn annually, has entered the final phase, operating profit would have an average 14%-18% upside on the base effect alone. Good profit visibility will help drive up the valuation multiples as well. Bad-debt provisions set aside since 2008 by builder (W bn) F Total Daewoo E&C ,181 GS E&C ,059 Daelim Ind Hyundai Dev Hyundai E&C Samsung C&T Source: Company data, Korea Investment & Securities PF balance and current PF/capital by builder (W bn, %) Q11 PF/capital Daewoo E&C 3,863 4,368 3,851 3, GS E&C 4,272 3,091 2,514 2, Daelim Ind. 3,106 2,524 1,986 1, Hyundai Dev Hyundai E&C 1,522 1,952 1,756 1, Samsung C&T 468 1,426 1,294 1, Source: Company data, Korea Investment & Securities 24

27 3Q11 earnings estimates (W bn, %) 3Q10 3Q11F YoY Consensus Difference Builder Item (1) (2) (2)-(1) (3) (2)-(3) Accounting method K-GAAP consolidated IFRS consolidated IFRS consolidated Samsung Eng. Sales 1,324 2, , A OP OP margin pt pt (IFRS consolidated) EBT NP NP margin pt pt Accounting method IFRS consolidated IFRS consolidated Samsung C&T Sales 5,189 5, A OP OP margin pt (IFRS consolidated) EBT NP NP margin pt Accounting method IFRS consolidated IFRS consolidated Daelim Ind. Sales 1,945 1, A OP (4.8) OP margin pt (IFRS consolidated) EBT (9.5) NP (11.9) NP margin pt Accounting method K-GAAP separate IFRS separate IFRS separate Hyundai E&C. Sales 2,274 2, ,648 (4.2) A OP (7.1) OP margin pt pt (IFRS separate) EBT NP NP margin pt pt Accounting method K-GAAP separate IFRS separate IFRS separate GS E&C Sales 1,807 2, , A OP (1.0) 128 (2.5) OP margin pt pt (IFRS separate) EBT NP NP margin pt pt Accounting method K-GAAP separate IFRS separate IFRS separate Daewoo E&C Sales 1,483 1, , A OP (130) 94 NM 339 (72.3) OP margin (8.8) pt pt (IFRS separate) EBT (370) 90 NM 161 (44.4) NP (284) 68 NM 122 (44.4) NP margin (19.2) pt pt Accounting method K-GAAP separate IFRS separate IFRS separate Hyundai Dev. Sales A OP OP margin pt pt (IFRS separate) EBT NP NP margin pt pt Sales Note: Cannot estimate YoY growth for IFRS consolidated statements due to changes in accounting. Although IFRS separate statements are different from K-GAAP separate, the two have a good comparability and thus, we included the YoY growth; Daewoo E&C s 3Q11F estimates show a big difference with consensus as the consensus include disposal gains (Korea Express W170bn, Daewoo Entec W58bn) that have been pushed back to 4Q11. Source: FnGuide, company data, Korea Investment & Securities 25

28 Major builders cumulative overseas order receipts and overseas sales 60 (W trn) Cumulativ e ov erseas orders ~11 CAGR 27.7% ~07 CAGR 66.3% F 2012F (W trn) Cumulativ e ov erseas sales new orders to be recognized in new orders recognized in F 2012F 4 (W trn) Cumulativ e construction OP 3 Prov isions in F 2012F Source: Company data, Korea Investment & Securities 26

29 Appendix: UAE and Oman site visits Visited GS E&C s main construction sites in the ME during Sep Most Korean builders try to complete construction two months ahead of project deadline Debt crisis in advanced economies should boost relative appeal of Korean builders that have a strong presence in ME and Asia During Sep 18-21, we visited GS E&C s main construction sites in the UAE and Oman. The four-day visit was too short for us to gain full insight into the ME market and the Korean builders that are active in the region. But what we did gain were new perspectives about the ME market. The most valuable lesson we learned was that ME countries are investing in oil & gas projects with not a short-term but a long-term goal by following a well-structured plan. We also realized that in order to execute a massive project worth more than USD3bn in a region where daytime highs routinely hit 40 C, builders must build a well-organized system and have strong project management skills. Most Korean builders including GS E&C take on EPC contracts with the goal of completing construction roughly two months ahead of the project deadline and they also are maintaining a successful project completion rate. As stated on page 22~23, we were given assurances that Korean builders will remain dominant in the ME market over the long-term backed by the weakening competitiveness of advanced builders in Europe and Japan and technological gap over late entrants from China, India and other countries. But like other major builders, Korean firms have also encountered problems with human resources such as a lack of engineers. Accordingly, Korean builders are recruiting a large number of engineers from around the world to address the issue. Shipbuilding, autos and semiconductors are often mentioned as the industries in which Korean firms have the most potential to become globally recognized powerhouses. But a slowdown in the global economy constantly threatens to slow growth at these sectors. Thus, we were convinced from our visit to the ME that Korea s plant business is indeed an export industry that can represent the country on the global stage. In particular, we believe the ongoing debt crisis in advanced economies will boost the relative appeal of Korean builders that have a strong presence in ME and Asia. Timeline of the UAE and Oman visits Date Program Officials Sep 18 Visited Sohar-2 IPP site in Oman Yun Seok-yong, manager Sep 19 Visited Barka-3 IPP site in Oman Field trip to learn about Dubai s real estate market Sep 20 Visited GS E&C s office in Abu Dhabi and met with officials Park Tae-hwa, vice president of KOTRA operations in MENA Sep 21 Field trip to Saadiyat Island s development site Green diesel and NGL sites at the Ruwais refinery in Abu Dhabi Visited RRE site nos. 2 and 7 Source: Company data, Korea Investment & Securities Song Tae-bong, managing director of GS E&C Ali Abadlla Abdelrazaq Al Fahim, vice president of Takreer Senior manager, assistant manager, development service manager and foreman program and construction manager of each site 27

30 Construction UAE Ruwais refinery s access card Location of Ruwais refinery Ruwais Complex Source: Korea Investment & Securities Source: Company data 1. Ruwais refinery visit: GS E&C holds 28% of Korean backlog in UAE Ruwais complex has a 30-year history and is the biggest industrial complex in the UAE The 30-year-old Ruwais complex is the biggest industrial complex in the UAE. It was developed not only to export oil but promote industrial advancement and maximize profits as well. The Ruwais site is located 250km west of Abu Dhabi. As the refinery is the UAE government s industrial complex, even gaining access to the facility was quite difficult. All visitors were subjected to a screening process before being given an access card and no cameras were allowed inside. Visitors were only allowed to enter through a specific gate at each site. World s biggest refinery and gas packages were tendered in 2009; GS E&C won orders worth USD6.5bn The world s biggest refinery and gas packages (six refineries and five gas plants) were tendered in Takreer, a subsidiary of ADNOC, sponsored the project worth a whopping USD21bn from 2008 to GS E&C is currently executing five projects worth USD6.5bn. When the projects were tendered in Dec 2009, five Korean builders were awarded nearly all the packages. Some of the packages won by GS E&C include a USD3.1bn order to build a RFCC unit, a core processing system for refineries, and a USD520mn marine facility. Given that these facilities are the biggest in the world, their project schedules are quite long as well. Recently, GS E&C completed delivery of the world s biggest reactor equipment and parts and revenue recognition from the industrial complex should reach a record in GS E&C s ongoing projects at the Ruwais industrial complex Project name Amount Project sponsor Project description Refinery expansion package no. 2 Refinery expansion package no Inter-refinery pipelines th NGL train 1.1 Green diesel 1.1 Source: Company data, Korea Investment & Securities 28 Takreer RFCC & associated refining units 127,200 BPSD Takreer Jetty 4,400m, Berths 800m (dock and ship berthing facilities) Marine loading Arms: 39units Main export pipeline: 28units Control building/fire water pump house Takreer 10 terminals Pipeline 910km Installation of 26 new tanks and LPG bottling facilities GASCO Ethane: 4,761 TPD Propane: 7,857 TPD Butane: 9,364 TPD Paraffinic Naphtha: 5,546 TPD Condensate Return: 6,712 TPD Takreer Vacuum distillation 35,000b/d Diesel hydrotreater 44,000b/d Hydrocracker 41,000b/d (USD bn, x) Construction period Dec 2009 Feb 2014 Dec 2009 Jan 2014 Jan 2008 Jul 2011