Mark Williams

Seoul searching – why we have increased our Korea exposure

Mark Williams

Mark Williams: Seoul searching – why we have increased our Korea exposure

Last week I returned from spending four days in Seoul. There I had met the management teams of 19 companies, all of whom paid out dividends, with yields averaging almost 3%.

Finding companies that return money to shareholders is increasingly easy in Korea, which was one of the key reasons for the visit. The rise in dividends is most evident amongst those with the largest market capitalisation - Korea’s ten biggest companies have increased the absolute amount they are paying to shareholders by 136% in the past five years, or 40% in the past two. Moon Jae-in’s recent election as President may accelerate this process.

My main purpose was to try to get a sense of how sustainable this is, especially for the family-run behemoths called chaebols, who have historically tended to hoard their cash. As recent improvements are being forced upon them [of which more detail can be found in my last blog on Korea] rather than initiated by the companies themselves, they could easily slide if allowed to. So how confident are we that the increase in dividend payments will continue? Equally, do they meet two further conditions: can these companies continue to grow their earnings, and, after this year’s 20% rise, can we still find value?

For dividends, it is clear that the government will continue to pressure the chaebols to adopt better practices. I met with the authors of the Korean stewardship code, who were surprised by a sudden move to embrace their code. They have spent many years fighting for its adoption, but until recently it had been pushed aside due to government opposition. After Moon Jae-in’s appointment there was a sudden change of direction, with the new government immediately saying it would sign it off. This in turn encouraged a significant number of larger fund managers to sign up, and a similar number of private equity funds and two major pension funds all hired employees to study the process. Although there will not be any legal backing for the code, change is being driven as much by public demand as by government, which means the chaebols want to be seen to embrace it.

While an improvement, this desire to be seen to do good is not always translating to actual corporate activity. Shareholders and government have long desired some restructuring of complicated company cross-holdings, for the webs of interconnected companies that make up the chaebols allow control of entities with few checks and balances. Hyundai Motors said it sees little need to reform, however. For it, corporate change is expected to be determined by succession issues, of which it currently believes there are few, as at 70 years old their chairman is in good health. Equally, while government intervention may be good for the overall economy longer-term, it is potentially an immediate detriment for individual companies. Kepco seemed almost uninvestible as it awaits clarity in the government’s requirements to move electricity production from nuclear and coal to gas-powered, with significant investment costs yet to be determined, and Samsung Card fears increased regulation further curbing its merchant fees. Conversely, Grand Korea Leisure is delighted to suddenly have a more government-connected regulator that might make things happen faster.

Overall, however, it seems clear that under the current administration there will be ongoing efforts to improve corporate governance. But while this is likely to help in our quest to invest in companies that pay dividends, finding growth in Korea remains a challenge. A number of companies mentioned rising concerns that high levels of debt would possibly quell future demand (although domestic demand is holding up at the moment, with high single digit earnings growth expected from a number of companies). More immediately, the impact of China punishing South Korea for its acceptance of the US military defence system, THAAD, is significant. From cars to casinos and cosmetics there was a sense that the slowdown in sales to Chinese, both at home and abroad (which was particularly apparent in May’s exports) was nearing its bottom. At the same time none were expecting a significant recovery soon.

So, where did this leave us? More positive of the political environment than I had been ahead of my visit, but less so on the growth front. South Korea, largely through its heavy skew to cyclicals, has already benefited from a synchronised global growth recovery this year. The market has risen more than 22% in US dollar terms, or 17% in sterling, and our value bias tends to eschew chasing momentum. The market as a whole still trades at 9.3x forward earnings, however, which is cheaper than its historic average of 10.5x and provides us with some support, while domestic growth seems relatively resilient. We have already increased our Korean exposure to almost 7% over the last three months, and are looking for further opportunities. One of the companies from the trip which stood out was DGB Financial. It is a holding company which largely comprises of a bank, based out in the South East of Korea. It avoids many of the risks of household exposure by having 70% exposure to corporate loans. It is relatively conservative, with a high (and rising) core deposit rate of 38% (bigger than the national banks) which gives it a lower cost of funding. Loan growth at the moment is hitting a normalised 8% for the year, and it is both increasing its payout ratio and growing its earnings.


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Thursday, July 13, 2017, 10:47 AM