Overview
South Koreans are famously proud of their ‘miracle on the Han River’ - the rapid economic growth of the past few decades that has transformed the country into one of Asia’s wealthiest nations. But when it comes to modern stock valuations, there’s still much that Koreans covet of other markets, especially their close neighbour Japan.
Public equities in Korea look significantly cheaper by popular metrics than those in Japan, India, Taiwan, and many developed markets outside Asia. The so-called Korea discount has led the Korean government to devise a ‘value-up programme’ to boost corporate governance and shareholder returns, drawing inspiration from Japan’s market reform that has fuelled stock rallies over the last two years.
But while Fidelity International’s engagement with listed companies in South Korea has reported scepticism from some management teams around the initiative’s progress, we see the value-up programme as a free call option for a market where growth potential and equity valuations already look attractive.
Slow progress
Many Korean companies have adopted a wait-and-see attitude towards the programme, which has so far underwhelmed investors. Policy measures to encourage listed firms to boost dividends, improve disclosure, and beef up governance have turned out to be largely voluntary. And President Yoon Suk Yeol’s administration, the driving force behind the reforms, is reeling after having lost a legislative election in April.
A large technology company recently told us that it’s waiting for more direction from officials, as well as incentives such as tax breaks, before it considers increasing shareholder returns. We have engaged in sustained dialogue with the company for more than two years. Our recommendations to increase dividend payments have been met with reluctance. However, the company has shown an increasing tendency to listen to investors, and has made small yet steady improvement in its environmental, social, and governance (ESG) disclosure.
Value for money
Regardless of reform progress, the Korea discount means bargains for global investors. As of May 14, the country’s benchmark Kospi 200 index was trading at 10.5 times forward 12-month earnings, compared with more than 21 times for both the S&P 500 and Japan’s Nikkei 225, and about 19 times for the MSCI World. Meanwhile, the Kospi trades below its book value, while the Nikkei 225 has a price-to-book ratio of about two times.
Earnings for the Korean index are forecast to surge this year, thanks to the proliferation of artificial intelligence and its demand for semiconductors. Semiconductor-related companies account for more than a third of the Kospi’s market value. While it’s hard to predict how long the current upcycle in semiconductors will last, we think Korea’s economy will benefit from prolonged, AI-fuelled growth. Any bumps in the road will be worth tolerating.
At depressed valuations, Korea’s financial sector also offers a good way to capture the country’s economic growth. The sector’s price-to-book ratio is comparable to China’s, where property woes and flagging consumption are damping sentiment.
The Korea discount can be partially attributed to corporate governance concerns and limits on market access, which are what the value-up programme seeks to address. Draft measures in the programme include tighter disclosure rules, longer forex trading hours, phase-in of English filings, and easing restrictions for foreign investors. It remains to be seen when and how these measures will be implemented.
Other risk factors include the country’s high correlation with China, one of its biggest trading partners, and competition from Japanese exporters that benefit from a weak yen. In addition, the dominance of Korean Chaebols - family-controlled conglomerates - affects investor confidence.
And while Japan is widely recognised as a developed market, Korea’s status is somewhere between emerging and developed, with conflicting classifications by different global index compliers. This is despite the two countries having similar per-capita GDP levels.
Slow as the reform may be, we think Korea is moving in the right direction to unlock value over the long term. The country looks cheap for its growth potential, while the value-up programme, if successful, could be a bonus for investors. Bargains from the Korea discount may not last forever.
