By Martin Hutchinson
With key countries in the world economy spiraling toward recession, and even India and China panicking about domestic inflation levels, there's one country in particular that still seems to offer good value in its equities markets, thanks to an economic outlook that combines decent growth and only modest inflation.
That country is South Korea.
We've talked about Korea several times before. But the truth is that it's worth a closer look. So let's begin our latest visit with a truly startling fact about this country and its economy: Both its exports and imports have grown at truly staggering rates recently.
Powerful Gains in Global Trade
In May alone, exports reached $39.5 billion, up 27.2% from a year ago. Imports were $38.5 billion, up 28.8% from a year ago. The sharp-eyed investor will notice one key point here: Although the balance of trade has deteriorated somewhat in the past year, exports still exceed imports. That's important, to be sure.
Just as remarkable is the fact that this staggering growth in both trade factors hasn't been caused by currency movements: The Korean won is down around 6% against the U.S. dollar over the past year, to its recent level of 1,019. That decline against the greenback has been caused by the increasing internationalization of the Korean economy, and its increasing importance in global trading patterns.
Politically, the last year has also been good for Korea. The pro-business candidate, Lee Myung-bak, won December's presidential election, and his won a handy majority in April's legislative elections.
This means economic policy is firmly anchored in a pro-business direction, after a decade of eccentric economic management whose most significant features were a steady increase in the size of government (though it is still substantially smaller than in the United States or most other rich countries) and a series of attempts to imprison the chairmen of the country's major chaebol conglomerates. Hyundai Motor Co. Chairman Chung Mong-koo received only a suspended sentence instead of the expected term of imprisonment on June 5; the remaining list of chairmen under indictment consists only of former Samsung Group Chairman Lee Kun-hee.
While there's now relief in the boardrooms of Seoul, the resolution of this legal mess will be an enormous liberating force to Korean businesses themselves, which for the first time in a decade will now be able to focus properly on international expansion, without top management worrying about a 4 a.m. wakeup call from the local constabulary.
Real Economic Muscle
Korea's growth remains strong, with the economy posting a year-over-year gain of 5.8% in the first quarter. The panel of experts at The Economist expects economic growth of only 4.5% in 2008 and 4.3% in 2009. But given the vibrancy of Korea's exports and its 10.0% April increase in industrial production, those projections are almost certainly much too low (The Economist experts may not have taken full account of the effect of better government policies).
Needless to say, when the "experts" appear too bearish on a particular market or economy, there's a very good chance that country's stock market is undervalued!
Only inflation – at 4.9% in the year to May 2008 – is a worry. But the combination of the weak won and surging global commodity prices are sufficient to easily explain this without suggesting that Korea needs radical monetary tightening.
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Three-month interest rates are currently 5.4%, just above the level of inflation, but 3% above those in the United States, which has a similar inflation level.
Profit Plays to Make Now
Since the Korean stock market currently trades on only 11 times earnings, it appears to represent a truly excellent value, given the country's favorable growth prospects. Because Korea has few raw materials, it is essentially an anti-commodities play: Its corporate earnings should mostly benefit if commodity and energy prices start to decline.
There are five Korean stocks that have American Depository Receipts (ADRs) fully listed on the New York Stock Exchange and that trade in reasonable volumes. Some of these are more attractive than others-Kookmin Bank, Posco and SK Telecom Co. Ltd. seem the best bargains.
Kookmin Bank (ADR: KB): The largest bank in Korea, Kookmin has been hit by investor disillusionment with the global financial-services sector; indeed, at one point it was down 50% from its 2007 high. It has rallied from its low and currently trades at a Price/Earnings (P/E) ratio of only 7.8 times forecast 2008 earnings. It also has a dividend yield of 4%, which is still more than you'll get out of U.S. Treasuries.
Korea Electric Power Corp. (ADR: KEP): Shares of Korea's electric power company, often referred to as KEPCO, are currently trading at 11 times projected 2008 earnings, and feature a dividend yield of 2.4%. KEPCO's steady growth should benefit from any acceleration in Korea's economic growth rate, but it is forced to buy coal from overseas, which has doubled in price in the past year. Right now, that makes the stock a borderline "Hold/Buy."
KT Corp. (ADR: KTC): Formerly operated as Korea Telecom, KT Corp. is now Korea's leading fixed-line telecom-services provider, which was privatized in 2002. Although the shares carry a P/E on trailing earnings of less than 9, the stock's forward P/E ratio is 13, as the company's margins are under pressure in the very competitive Korean telecom market. Even with a dividend yield of 4.3%, it is probably only a "Hold."
Posco (ADR: PKX): Posco is Korea's largest steel company, and its shares are trading at a P/E of 12 on estimated 2008 earnings. It also features a dividend yield of 1.9%. Posco has a large export operation to China, making it a participant in China's explosive growth. Although it's the world's third-largest steelmaker, it's the most efficient in terms of output per man-hour. Like KEPCO, Posco suffers from the rising prices of raw materials; in its case iron ore business, for instance, it was recently socked with a 65% price increase. Even so, as we've previously reported to you, let's not forget that when Berkshire Hathaway Inc. (BRK.A, BRK.B) Chairman Warren Buffett made his first investment foray into Korea last year, he took a 4% position in Posco – making it one of 20 Korean companies that he invested in. Posco is a well-run company that will become very attractive when the commodities bubble deflates, which may not be too long delayed. We rate it as a long-term "Buy."
SK Telecom Co. Ltd. (ADR: SKM): SK is Korea's largest mobile phone company, with operations in China and Vietnam. Its shares trade at 10.3 times estimated 2008 earnings, and it features a dividend yield of 4.8% – meaning that income investors also will do well from it. In China back in 2006, SKM invested in a $1 billion convertible of China's #2 mobile company China Unicom Ltd. (ADR: CHU): The bonds were converted in August 2007 and the resulting 6.6% share stake in is currently worth almost $2 billion. In Vietnam, SKM's 73%-owned Vietnamese subsidiary had 3.5 million subscribers in 2007, and that unit is aiming for 5 million in 2008. The only downside risk is in the U.S. market, where SKM's U.S. operation shows a loss, and where SKM management seems to want to make some acquisition, throwing good money after bad. Because of that, we rate this stock as a borderline "Hold/Buy."
Finally, you could look at the Korean exchange-traded index fund, the IShares MSCI South Korea Index Fund (EWY), an exchange-traded fund (ETF) that invests in the Morgan Stanley Capital International Korea Index. This ETF has a P/E of only 11, but a yield after expenses of only 0.6%.
News and Related Story Links:
- Money Morning Special Investment Report:
With New Leadership And a Tougher Stance, it's Time For Investors to Take a Look at Korea.
- Money Morning:
Warren Buffett and Berkshire Hathaway Purchase Stakes in 20 South Korean Firms, Including POSCO.
- Radio Station WTOP/The Associated Press:
Court again suspends Hyundai exec's jail term.
- Money Morning News Analysis:
The Samsung Group.