Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team
Over the past five years, the Korean index has risen at an annualised rate of 5.6% in U.S. dollars, almost exactly in line with the global emerging market index over the same time period.
Recently, Korea has begun to marginally underperform, rising by only 23.3% in U.S. dollar terms over the past year to the end of February 2018, compared to a 29.9% increase in the MSCI global emerging market index. This is despite a significant degree of outperformance on the part of a number of larger capitalisation stocks, with Samsung Electronics (+30.0), SK Hynix (+73.9%) and KB Financial (+43.2%) handily beating the overall index. What is even more surprising is that the small capitalisation index as represented by the Kosdaq index also significantly outperformed the overall market, rising by 46.7% in U.S. dollar terms over the past year.
Based on these numbers it is clear that there must be certain areas of the index that have significantly underperformed. Looking at the relative performance of a number of so called “value” stocks, that optically look inexpensive, the answer becomes a lot clearer.
Over the past year Korea Electric Power- Kepco (-20.8%), Korea Telecom (-17.0%) and SK Telecom (+8.2%) have all significantly underperformed the index. This is despite looking exceptionally inexpensive at first glance, with all of these companies trading on prospective 2018 price earnings ratios below 10x and 2018 EV/EBIDTA ratios below 5x.
The main problem for these “value” stocks in Korea is that they are often subject to a significant amount of government regulation that makes them private sector companies in name only. This is particularly the case for Kepco and Korea Telecom. As a result over the past three years they have seen very little increase in their EBIDTA in U.S. dollar terms. They also have an inconsistent and derisory approach to paying out dividends. The one stock that in the past has been more generous historically with shareholders, SK Telecom, is desperately looking to deploy its cash in less regulated businesses, such as biotechnology.
The irony is that in Korea it is not necessary to take the additional risk of government regulation in order to find companies selling at attractive valuations. The semiconductor manufacturer SK Hynix for example, which is expected to grow its earnings by close to 50% this year, trades on a prospective 2018 EV/EBIDTA ratio of less than 3x, placing it at a 25% discount to U.S. based Micron electronics.
Another example of the “Korean discount” to other markets is the on-line gaming company NCSoft, which saw earnings per share grew by over 60% last year due to the successful move of their PC game Lineage to a mobile platform. With an additional three games being introduced this year, earnings per share should increase again this year by over 50%. Trading on a prospective 2018 price earnings ratio of only 12x, NC Soft is valued at a significant discount to other gaming companies. Having met the company recently, an additional bonus would be any improvement in South Korea’s relationship with China. They currently have zero revenues in their budget from the Chinese market, something that could change rapidly should the current tensions with North Korea subside.
Korea continues to be one of our largest net long positions in the fund and still trades an attractive discount to other markets, taking into account sector differences. For this reason it remains unnecessary and often times foolish, to chase extreme “value” in this market. We believe that we are able to buy quality earnings streams at discounts to other markets without falling into the trap of owning stocks that will continue to disappoint.
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