Ample opportunities in South Korea

The country is fiscally sound, with relatively low government debt and budget surpluses. South Korea’s biggest challenge is in keeping inflation under control because of ever-increasing wages and upward price pressure on energy and other raw materials that the country needs to import.

But companies in South Korea are flexible, focused on increasing efficiency through automation and prepared to move production to lower-wage countries, says Mark Mobius, executive chairman of Franklin Templeton Investments Corp.‘s emerging-markets group in Singapore.

On the flip side, there is North Korea, an extremely poor but very militaristic country with active nuclear and ballistic missile weapons programs. But South Korea doesn’t have to cope with this alone. The situation is a global concern; generally, China and the U.S. deal with North Korea.

There is new leadership in North Korea, which could lead to reforms and the eventual reintegration of the two Koreas. Mobius believes this will happen, and says it would create a powerhouse by combining the south’s industrialized base with the north’s cheap labour and abundant mineral resources.

South Korea is a major exporter, with foreign sales equivalent to about 60% of GDP – which is even bigger than Canada’s 40%. Major exports include semiconductors, wireless telecommunications equipment, motor vehicles, computers, steel, ships and petrochemicals. China is South Korea’s biggest customer, accounting for about 25% of total exports; the U.S. accounts for 10%; Japan, 7%.

Much of the production is in the hands of large family-controlled conglomerates, known as “chaebols.” These include Samsung Group, LG Group and the groups of companies that bear the Hyundai and Daewoo names.

South Korea has copied Japan’s model of encouraging the development of large conglomerates to establish world-class industries but has improved on it. Mobius is impressed by the way the chaebols have created strong brands through advertising and the degree to which they have penetrated emerging markets while also selling strongly in the West. In some industries, South Korea is more competitive than Japan.

The only drawbacks to the chaebols, says Mobius, is that they are family-controlled and more interested in increasing market share than in building value for minority shareholders. As a result, their shares trade at a discount.

However, says Mark Lin, vice president, international equities, with CIBC Global Asset Management Inc. in Toronto, many of the chaebols’ subsidiaries are publicly traded and offer more focused investments.

Here’s a look at the major sectors and the particular companies that analysts favour:

– Electronics. Samsung Electronics Co. Ltd.’s Galaxy S smartphone is the only such device that’s capable of competing with Apple Inc.’s iPhone, says Lin. As well, the firm benefits from Apple’s sales, as it makes components for Apple’s flagship products, including the iPhone and iPad. Samsung also has overtaken Japan’s Sony Corp. in sales of TVs, and benefits from Sony’s sales as the manufacturer of LCD panels for Sony.

Despite a 60% increase in Samsung’s share price since October, analysts with J.P. Morgan Securities (Far East) Ltd. in Seoul have an “overweight” rating on the stock and expect 2012 earnings will be “well above consensus.”

– Automobiles. Hyundai Motor Co. is gaining market share in the U.S. and is the second-largest seller in China, which is now bigger than the U.S. market. The lower-end Kia cars, made by KIA Motors Corp., also are doing very well. Hyundai Mobis Co. Ltd. supplies auto parts for both Hyundai and Kia, and thus is benefiting from their strong sales.

The J.P. Morgan analysts are “overweighted” on all three companies but particularly like Hyundai, which, they say, “remains a compelling mid-term investment case despite short-term headwinds in the U.S.”

– Shipbuilding. This sector is very cyclical and currently is in a “down” phase because demand has shrunk in the wake of the global financial crisis and recession. But South Koreans make very sophisticated ships, as well as platforms for offshore oil and gas development.

Eng Hock Ong, managing director with AGF Asset Management Asia Ltd. in Singapore, likes Hyundai Heavy Industries Co. Ltd. and Daewoo Shipbuilding & Marine Engineering Co. Ltd.

J.P. Morgan analysts, for their part, are overweighted on Samsung Heavy Industries.

However, Lin cautions, China has been catching up to South Korea in the shipbuilding sector and says, “You don’t want to stay in China’s way with its low wages.”

Lin adds that China is not yet in high-end electronics or cars.

– Retail. Higher-end shopping is doing pretty well, says Mobius. He considers Lotte Shopping Co. Ltd. “interesting.”

J.P. Morgan analysts have an “overweight” rating on that stock, saying they foresee early signs of a turnaround in overseas operations, which “could provide for a long-absent catalyst” if it continues.

Ong prefers LG Household and Healthcare Ltd., noting it has very good management. The firm is an acquirer of both growing businesses and troubled companies that it has turned around.

However, the stock price is not cheap, and the J.P. Morgan analysts rate it “neutral.”

Still, Ong thinks it’s worth buying, noting that “the company has delivered. It’s very good at execution.”IE

© 2012 Investment Executive. All rights reserved.