(Bloomberg) -- The sterling credit rating of South Korea’s biggest drinks maker may be in trouble, and one reason can be seen in the beer aisle at the Seoul train station branch of Lotte Mart hypermarket.
Shoppers there can now buy a four-pack of foreign beers such as Guinness for 9,480 won ($9), not much more than the 7,520 won it would cost to buy four cans of Fitz Super Clear sold by Lotte Chilsung Beverage Co. Beer imports in Korea surged 45 percent to a record $263 million in 2017, and the price of overseas brews will likely head even lower as trade agreements get rid of duties.
The outlook for Lotte Chilsung’s AA+ grade was cut to negative by local credit rating firms, which cited rising leverage as the firm boosts investments in its beer operations, as well as its money-losing alcoholic beverage business. The implementation of free trade agreements has led to U.S. beer being charged no duties starting this month in South Korea and that will also be the case for European brews from July 1.
“Increasing foreign beer sales will result in higher competition and less profitability for Korean brewers,” said Park Jin-young, a credit analyst at HMC Investment Securities Co. in Seoul. “It’s not easy to improve the situation as it’s hard to change the perception of flavorless Korean brews.”
Despite the possibility of a downgrade, Lotte Chilsung saw strong demand for a sale of three-year and five-year bonds at 2.611 percent and 2.924 percent respectively on Thursday.
That was because the coupons were higher than traded yields on its previously issued notes, at a time when demand for domestic corporate bonds is strong, said HMC Investment’s Park. She said investors were willing to buy the bonds though they’re concerned about possible rating downgrades.
Lotte Chilsung got 520 billion won of orders for the 250 billion won offering, according to a filing. The yield premium on the five-year debt was 47 basis points over sovereign bonds, lower than the 53 basis-point spread on similar notes sold in April.
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The company, which is the nation’s No. 2 maker of the popular soju liquor, entered the beer business in 2014. It’s grabbed an estimated 5 percent share in the Korean beer market, according to local ratings company Nice Investors Service.
Lotte expects beer sales to rise after it invested to increase output capacity by threefold and bolstered marketing efforts, according to a spokesman. Restaurants, bars and other entertainment venues still largely sell domestic beer.
Korean brands including Cass, made in the nation by Anheuser-Busch InBev NV, and Hite Jinro Co.’s Hite dominate the top eight spots in terms of total volume market share, according to data from market research provider Euromonitor International. Budweiser comes in at No. 9.
Still, foreign beers are becoming a growing presence. At E-Mart Inc., Korea’s largest discount store operator, sales of overseas brews topped 50 percent of the total for the first time in 2017, according to a spokesman. China’s Tsingtao was the best-selling foreign brand at its hypermarkets.
As Lotte Chilsung builds up its beer facilities, net debt increased to 976 billion won at the end of September from 460 billion won at the end of 2013, according to Korea Investors Service, a local affiliate of Moody’s Investors Service. Lotte Chilsung’s balance sheet has also been hurt by its group reorganization as some assets were transferred to Lotte Corp.
The company posted a 248 billion won net loss in the first nine months of 2017, according to its financial report. Even as its beverage business earned 110 billion won in operating profit, beer operations had a 22 billion won operating loss.
While Lotte Chilsung’s large-scale investments are mostly completed, leverage will likely remain high, according to Nice Investors Service. That’s because there’s only a limited possibility its earnings will improve, given increasing competition and rising fixed costs due to a new beer factory, it said.
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