[This Week's Industry Insight] GS Construction's Poor Workmanship Stigma... Breakthrough to Deficit After 9 Years?

Stock Price Falls to 20-Year Low Due to Substandard Construction in Geomdan New Town Apartments
36 Trillion Won Urban Maintenance Order Backlog... Brand Image Management Is Key

Editor's NoteDear individual investors dreaming of successful investments. How well do you know the stocks you invest in with your own money? In the unrefined and chaotic online environment filled with all kinds of information, Asia Economy aims to be your hands and feet, eyes and ears, delivering accurate information about companies. Each week, we focus on companies that rank high in stock inquiries by the financial information provider FnGuide, providing basic information as well as analysis of related companies such as partners, clients, and investors. We will explain the companies' financial status, performance, and future value in an easy-to-understand manner. We come to you every week under the name "This Week's Watchlist," highlighting stocks of interest. This week, we analyzed GS Construction, which recently faced a crisis due to a poor construction scandal.

GS Construction, one of South Korea's leading construction companies, has encountered its greatest crisis due to a poor construction scandal. Since the collapse of an underground parking lot at an apartment construction site in Geomdan New Town, Incheon, at the end of April, approximately KRW 700 billion in market capitalization has evaporated in about two and a half months. Above all, GS Construction's flagship brand 'Xi' has always competed for the top ranks in domestic apartment brand rankings, but this incident has dealt a fatal blow to its image. GS Construction is expected to record a loss for the first time in about nine years due to losses from the unexpected collapse incident.

According to the Korea Exchange on the 12th, GS Construction decided to completely reconstruct the apartments in Geomdan New Town, Incheon, where the parking lot collapse occurred, causing its stock price to plummet 35% in just the past month. On the 10th, the stock closed at KRW 14,120, but during the day it fell as low as KRW 13,370, hitting a 52-week low. This is the first time since April 1, 2003 (closing price KRW 13,963) that GS Construction's stock price has been in the KRW 13,000 range. The stock price had already been declining due to concerns about a housing market slump, and this adverse event pushed it back to levels seen 20 years ago.

As stock price volatility increased, institutional investors including the National Pension Service quickly sold off their holdings. The pension fund sold KRW 29.843 billion worth of GS Construction shares this month alone. Institutions as a whole net sold KRW 64.234 billion. This was the second-largest net selling volume among all KOSPI stocks this month, following Samsung Electronics. Consequently, GS Construction's market capitalization, which was about KRW 1.85 trillion just a month ago, has shrunk to around KRW 1.2 trillion recently.

GS Construction is expected to turn to a loss in the second quarter of this year. On the 6th, GS Construction announced regarding this incident, "Considering demolition costs, new construction costs, and costs related to prospective residents, we plan to reflect approximately KRW 550 billion as a loss in the first half financial statements this year," adding, "The funds will be injected in installments over about five years from demolition to the completion of the new apartments." The market consensus for GS Construction's operating profit in the second quarter was initially in the KRW 170 billion range, but securities firms now expect a loss of KRW 350 billion to 400 billion after reflecting this loss. This will be the first quarterly operating loss for GS Construction since the first quarter of 2014, about nine years ago.

The problem is that uncertainties related to the collapse incident have not yet been fully resolved. The Ministry of Land, Infrastructure and Transport, the competent authority, views this accident as a result of comprehensive poor workmanship throughout the entire process including design, supervision, and construction, and has launched a full inspection of the 83 sites where GS Construction is currently working. The results are scheduled to be announced next month. It was confirmed that only 15 of the 32 columns at the problematic Geomdan New Town apartments had the required rebar (shear reinforcement), and the concrete strength was insufficient, raising the possibility that similar issues may be found at other construction sites. If additional poor construction cases are confirmed, additional costs will inevitably arise.

Concerns have also been raised that administrative sanctions against GS Construction may follow depending on the full inspection results. HDC Hyundai Development Company, which caused the collapse accident at Gwangju Hwajeong I-Park last year, was suspended from business for eight months. However, the company continued operations after the court accepted its injunction request. According to the Framework Act on the Construction Industry, poor construction companies are subject to cancellation of construction business registration or suspension of business for up to one year. The severity of sanctions will likely depend heavily on the degree of regulation violations and intentionality.

In the securities industry, target prices for GS Construction are being lowered one after another, and investment opinions are being downgraded to neutral (Hold). Hanwha Investment & Securities sharply lowered the target price for GS Construction from KRW 31,000 to KRW 16,000, about half, and downgraded the investment opinion to neutral in a report released yesterday. Song Yurim, a researcher at Hanwha Investment & Securities, said, "Although GS Construction voluntarily decided on full reconstruction and disclosed large-scale loss reflection, uncertainties have not completely disappeared," adding, "Concerns remain about difficulties in refinancing real estate project financing (PF), credit rating downgrades, and deterioration of financial stability due to the impact of large-scale loss reflection."

Korea Investment & Securities also downgraded its investment opinion on GS Construction from 'Buy' to 'Neutral.' Due to the high level of uncertainty, no separate target price was presented. Kang Kyungtae, a researcher at Korea Investment & Securities, said, "Additional liquidated damages due to prolonged demolition period, compensation payments such as interest costs to Korea Land & Housing Corporation (LH), which is responsible for financing existing projects, and other tangible and intangible losses will increase," adding, "The loss amount from the reconstruction decision is manageable with annual EBITDA, but it is uncertain whether the company’s dividend policy, which has maintained a payout ratio of about 30%, will continue."

Most critically, trust in GS Construction's flagship brand 'Xi,' which competed for first or second place in apartment brand rankings, has declined. This could lead to weakened competitiveness in future bidding. The public is greatly disappointed that poor construction, such as missing rebar, which was thought to be a thing of the past, has recently occurred in a major construction company. Online communities have even given it the dishonorable nickname "Boneless Xi." Kim Seryeon, a researcher at eBest Investment & Securities, said, "The GS Construction Xi brand, which competed with Samsung C&T for the number one apartment brand, has been tarnished," adding, "Since GS Construction was actively expanding its housing exposure, this incident shakes the company’s economic moat, which is regrettable." eBest Investment & Securities also downgraded its investment opinion to 'Neutral' and significantly lowered the target price from KRW 30,000 to KRW 16,000, about half.

Following last year's Gwangju Hwajeong I-Park collapse accident by HDC Hyundai Development Company, the recent poor construction scandal involving GS Construction's underground parking lot has further increased skepticism about the domestic housing business. The real estate market situation remains challenging with a decrease in supply in the second half of this year, an increase in unsold units, and reverse jeonse (lease) issues, and concerns about real estate PF risks among construction companies persist. There are warnings that the impact of this incident could spread beyond GS Construction to the overall construction industry. Lee Minjae, a researcher at NH Investment & Securities, said, "Just as large losses at overseas sites in the 2010s fundamentally adjusted the valuation of the construction industry, this issue is likely to cause construction industry valuations to form at levels lower than the current price-to-earnings ratio (PER) of around 5 times."

However, there is also regret that if not for the provisions related to this incident, GS Construction's second-quarter performance would have had several positive factors. In the second quarter, sales in the housing and construction sectors increased by about 17% year-on-year, and housing sales reached 6,980 units cumulatively in the first half, achieving 35% of the annual target. The expected operating profit for the second quarter was also estimated to exceed market consensus, and excluding the loss cost of KRW 550 billion, it was set to record the best second-quarter performance since 2019.

In light of these points, some still maintain a positive evaluation of GS Construction. Shinhan Investment Corp. maintained a 'Buy' rating and the existing target price of KRW 27,000 in a report released on the 6th despite the recent incident. Kim Sunmi, a researcher at Shinhan Investment Corp., said, "With a KRW 36 trillion urban redevelopment order backlog, solid sales performance, and Xi S&D's successful entry into small and medium-sized complex construction, which are based on the 'Xi' brand, protecting the brand image is more important than short-term costs," adding, "If August passes well, recovery is possible."