Matein Khalid: The Case For South Korea

South Korea is Asia’s most inexpensive major stock market at 9.8 times forward earnings. Value trap? Not so. The US recovery, a plunge in oil prices, the new Apple-Silicon Valley ecosystem and a major depreciation in the South Korean won mean it is credible to expect 15 – 16 per cent earnings growth next year.

This is exactly the liquidity and policy environment that could lead to a valuation rerating for South Korean shares in 2015.

Earnings growth in South Korean has been a mediocre five per cent since the slowdown in China, the Abenomics-inspired debasement of the yen and recession in Europe-hit chaebol export orders.

However, South Korea (and Taiwan) are beneficiaries of US growth next year and the Seoul government’s pro consumption policies could deliver 3 per cent growth, helped by strong property prices, lower energy and robust wage growth. As inflation is benign at 2 per cent, there is no need for the Bank of Korea to increase money market rates.

The tragic ferry disaster distracted Madame Park’s government in 2014.

But the government has now embraced financial reform, tax reform, a free trade agreement with China and a pro-dividend payout policy on the stock exchange. South Korea is one of the world’s true investment fairy tales.

A nation ravaged by mass slaughter in a civil war, ruled by a succession of military dictatorships, subverted by the Kim dynasty’s totalitarian North Korea, and almost bankrupted by the 1998 Asian meltdown is now one of Asia’s most successful high tech, export economies.

However, all is not hunky dory in the Hermit Kingdom on the Han River. The Bank of Japan’s shock and awe monetary easing meant that the yen depreciated by seven per cent against the won, a competitive blow to Korean exporters.

This is the reason South Korean exports performed the most poorly since 2012, when the yen traded at 75–80 to the dollar.

The new paradigm of “lower for longer” oil prices is hugely positive for South Korea, since energy imports are 15 per cent of its GDP due to the country’s cold winters and vast energy intensive steel, chemical and cement complexes.

The 35 per cent fall in Brent boosts consumer income, corporate profits and even foreign inflows into the local debt and equity market.

Geopolitical risks can never be discounted but China has made it clear that Beijing will not green light a fourth North Korean nuclear test. The Pyongyang regime dare not defy China, its only external patron. North Korea is also desperate for hard currency to keep the regime afloat – grounds for cautious optimism.

The South Korean stock market trades at a 24 per cent discount to Morgan Stanley’s Asia ex Japan index. The South Korean market is also dirt-cheap relative at 1.2 times book value (compared to India’s three times book).

I recommend GCC investors only buy megacap South Korean blue chips such as Hyundai Motors (a beneficiary of lower oil) and Samsung Electronics, second only to Apple in the mobile/tablet revolution.

I expect at least 20 per cent upside in the KOSPI index next year.

Taiwan is also an Asian export economy leveraged to US technology/capex spending that benefits from lower oil prices. Taiwan has world-class companies such as TSMC, Acer, Hon Hai and Fubon Financial.

The Taiwanese banking system is the most liquid and stable in Asia and its currency is anchored by a current account surplus that is 11 per cent of GDP. Taiwan shares are inexpensive at 12.8 times earnings, 3.4 per cent dividend yield and 1.8 times book value.

EPS growth in Taiwan will be at least 15 per cent next year and the corporate earnings revision momentum is strongly positive. It would not surprise me to see the TAIEX trade in the 8500 to 10500 range next year.

Australia and Malaysia must be avoided in 2015 since both economies are dependent on mining capex and commodities exports with minimal earnings growth momentum. India is another beneficiary of lower oil prices but is expensive at 16 times forward earnings and three times book value.