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James SullivanThe term ‘chaebol’ is given to large conglomerates that are controlled by a family in South Korea. A backdrop of chaebols has pollinated a culture of poor corporate governance and often complex corporate environment; corporations are often multi-faceted businesses with material cross holdings.

Historically the relationship between the chaebols and the government has been an accommodating one. It helped lead the country’s economic growth and propel the country to the forefront of technological innovation. However, it also harboured a darker side, concentrated power into the hands of a few, stifled creativity and stifled the growth of mid and smaller companies.

Shareholders have also been seen as second class citizens, carrying little or no influence.

Pay-out ratios have been notoriously low and cash reserves have hindered earnings per share and return on equity ratios, making other growth markets more appealing to external investors.

It is very similar to the reasons that have curtailed Japan for many years, and why Japanese equities trade on a discount to the wider market. The Korean stock market (the KOSPI index) has traditionally displayed a positive correlation to the broader MSCI Emerging Markets index of 0.88 (over 10 years), and in turn represents about 14% of the EM index.

However, these lingering concerns and observations, and subsequent negativity towards corporate Korea, have given us, what we believe to be, an attractive medium term entry point back into the KOSPI.

The catalyst for our investment is two-fold:

The valuation of the KOSPI has drifted to the extent it is once again out of line with its natural EM peer group, and we believe this dislocation presents an opportunity to enhance our Asian equity exposure at levels we haven’t witnessed for many years.

Trading on a little over 9x Price Earnings and a Price to Book of 0.87, it represents a historically cheap entry point both relative to itself and the wider EM sector. The Price to Sales ratio of just 0.55x is also a notable observation.

One potential catalyst for a re-rating in the Korean market, is the same catalyst we see when investing in Japan. With government support, there are green shoots beginning to emerge. Improving shareholder friendly initiatives inclusive of escalating pay-out ratios are slowly materialising from the ashes. We will be the first to acknowledge it is a slow and modest improvement, which will take time to evolve into something credible, but it is progress.

Dividend pay-outs of companies listed on the KOSPI reached 30 trillion won (circa $27bn) in 2018, up from 13.2 trillion in 2013. Overall, the KOSPI index pay-out ratio is now 22.5%, which is up from 13% in 2013, and yet still represents a very conservative number. To put this in to context, many developed markets operate around the 40-50% level, although that number can vary greatly.

Korea’s bellwether

Samsung has always been an extraordinary case study.

A dominant constituent in the index, the company increased its dividend in 2017 by 20% and further 100% in 2018. This equates to 9.6 trillion per annum being returned via dividends, providing shareholders with ‘greater transparency and predictability’. Inclusive of buybacks, the minimum amount that Samsung pledge to return to shareholders is 50% of free cash flow, resulting in the company now yielding north of 3% – a material improvement from their longer term average of closer to 1%.

A company with many affiliates and which represents almost 20% of South Korea’s GDP, it really is the bellwether for the market. This statement of intent, we believe, is very meaningful in the continued evolution of corporate South Korea.

The speed at which corporations continue to embrace change remains questionable, and critics are right to be sceptical, but we feel at worst, we can acknowledge we are past the nadir, and that change is being considered, if not always implemented. If Samsung, leading by example, spearheads a reappraisal of their valuation, then others no doubt will follow suit, buoying the index towards a re-rating.

Download: Weekly comment, James Sullivan – 150419


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