The bullish case for South Korean shares

Even a modest rerating in Seoul means attractive money making potential in South Korean banks and insurers, who are not exactly victims of the won/yen spike.

South Korea’s KOSPI stock market index has been an underperformer against China, Japan and ASEAN since November due to the spike in the yen/won rate. This is only natural since South Korea’s chaebols (conglomerates), with their auto/electronics exports, face Japanese competitors in global export markets, and a spike in the won/yen rate is a drag on EPS growth. Stock market bulls view FX rated downward earnings revisions like the financial equivalent of the Black Death. After all, the won/yen has soared by 20 per cent since September and it is only logical that momentum investors have gone long Nikkei, short KOSPI. Two thirds of the Seoul stock market free float is owned by global funds.
The Korean chaebols, like the Japanese zaibatsu in the 1980s, have built extensive offshore manufacturing hubs and supply chains to reduce the impact of won strength on their bottomline. South Korea, despite the won/yen rate, can well post 13-14 per cent earnings growth in 2013 and 2014. South Korea is one of Asia’s most cyclical stock markets and the rise in China/US growth is arguably a far more important variable in EPS growth than the won/yen rate alone. This is all the more true since the Bank of Korea opts for monetary stimulus at the same time as President Madame Park presents an expansionary budget. This can only boost sentiment on local banks and insurers, some of the most attractively priced financials in Asia.

South Korea now trades at eight times forward earnings and 1.2 times price to book, a 25 per cent discount to broader Asian indices. In perspective, Philippines trades at 18 times earnings while Malaysia and Thailand trade at 14-15 times earnings. South Korea trades almost a full standard deviation below its own historical range. There has been a relative valuation derating on South Korea which makes no sense to me. Even a modest rerating in Seoul means attractive money making potential in South Korean banks and insurers, who are not exactly victims of the won/yen spike (for obvious reasons!).

Hyundai Motor has fallen to 200,000 won, where it trades at book value. Samsung electronics is one of the world’s leading technology conglomerates, one fifth of the KOSPI index. KB, Woori and Shinhan Financials are among South Korea’s leading banks while Hyundai Fire and Marine is its leading insurer. In the index, banks and insurers have outperformed techs/exporters in 2013. Foreign flow data gives an insight into sector trends within the South Korean stock index. Foreign institutional money has been accumulating banks, retail and insurance shares, thereby aggressively exiting auto, technology and shipbuilders. This is the reason Samsung Life Insurance, Hana and Woori have risen 8-12 per cent in 2013 even while the KOSPI index has fallen. North Korean military subversion/nuclear tests are one reason why South Korea trades at such a significant discount to Asian markets.

South Korean assets will be sold in the next spasm of risk aversion on Wall Street, like global risk assets worldwide. However, I doubt if KOSPI falls much below 1,900. As long as there is no Fed tightening or a global recession, South Korea is my favourite Asian market to buy on risk sell offs. There is no shortage of bullish KOSPI catalysts in the months ahead, from central bank rate cuts to new fiscal stimuli to Samsung earnings.

China has experienced one of the most brutal valuation deratings in the history of Asian finance. In November 2007, the Shanghai index peaked at 6,000 or almost five times book value and 30 times earnings. Five years later, with the Dow and S&P 500 at new post crisis highs, Shanghai trades at a mere 1.7 times book value and 10 times earnings, 65 per cent below its November 2007 high. What went wrong? One, China’s Politburo imposed restrictions on property finance and local government borrowing in a bid to fight inflation, a politically explosive issue in the Middle Kingdom.

Two, Chinese retail investors abandoned the stock market en masse, with more than two million brokerage accounts closed in the past two years alone. The Shanghai CSI 300 had an impressive rally in November after reformist, technocrat Xi Jinping was anointed the new general secretary of the Communist Party and thus Hu Jintao’s successor as the President of China. However, China’s rally has fizzled out in 2013 after the central bank governor threatened to tighten monetary policy to combat excessive property speculation. In addition, Chinese industrial production/power generation data is below expectations, a mini growth scare.

There is a clear cleavage in the Chinese stock markets. Investors avoid property, construction, steel, cement, railway shares. However, reform prospect companies in healthcare, oil and utilities are under accumulation as long as their earnings growth is visible. Shanghai’s CSI 300 index is inexpensive relative to its 16 per cent earnings growth. Reforms and earnings could still be the ballast for a bull market in Chinese shares.

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