They're crazy, these Koreans
Arnout van Rijn
Korea is a country of hard workers and heavy drinkers. According to the Organisation for Economic Cooperation and Development (OECD), people there work 50% longer hours, and according to the World Health Organization (WHO), 25% more alcohol is consumed there per adult than in the Netherlands. Indeed, there's an interdependency there: no sooner is their long office day over, Koreans start overindulging in the traditional soju (rice wine) over dinner with clients and colleagues, and later drink excessive amounts of whiskey and cognac at a night club.
Korea suffers from an inferiority complex: the country is constantly engaged in an economic and/or political struggle to keep up with its bigger neighbors, Japan and China. At the same time, threatening neighbor North Korea is a source of constant tension. When can this situation be expected to escalate out of control? And what will this mean for life in South Korea? Working hard and drinking harder seem to be the way to cope with this uncertainty.
In the long run, the Korean stock market, assessed on the basis of the local KOSPI Index, realizes fairly normal annual returns of some 9% in won terms, and 7-8% in hard currency. However, the country stands out because of what is known as the 'Korea discount'. Valuations in the market are invariably low. Compared to regional markets, this discount amounts to some 20-30%, and against the global average, about 30%. Why is this?
Korean investors can be considered rather manic. Their instinct is to forage the market in herds in search of attractive tidbits. Popular stocks can rise in price very rapidly, only to fall just as sharply when something new is found. Moreover, Korean investors often do the opposite to investors from other countries. In recent years, domestic investors have tended to back the selling side, while investors from other countries, in contrast, have been inclined to expand their positions. These foreign investors, myself included, recognize the considerable value of Korean equities and therefore want to buy them. In contrast, local investors, registering insufficient growth, sell their stock. This is because Koreans have an unhealthy growth fixation in an economy where such growth - in light of the demographic conditions and economic developments - is hardly easy to achieve any more.
Focus on growth
When I recently put the notion to a group of Koreans that they could also run their businesses with less focus on growth and more attention for shareholders, they were amazed. Stop growing? How would that work? They have been persuaded from an early age that only growth can lead to bliss. Hence their dreadfully long days in the office. Plenty of drink at the end of the day then provides at least a little joy. We wouldn't want to live that way, but in Korea this is stark reality!
At company level, the growth virus leads to an unhealthy tendency to reinvest or hoard the profits. Even if the balance sheets of the chaebol (large business conglomerates) show ample quantities of liquidity, they do not ensure high dividends. The biggest Korean company, Samsung Electronics, is a good example. Cash currently represents almost 30% of its market capitalization, but dividend returns barely reach 1%. Korea is persistently at the bottom of the ranking list of international pay-out ratios (dividend payment as a percentage of earnings). While the global average is 44%, Korea pays out 14%. Even in Japan, where traditionally there is some reluctance to pay dividends, this ratio now stands at 30%.
Finally, Korea is one of the few Asian markets where pension funds carry substantial weight. As a result of strong growth over the last ten years, the National Pension Service (NPS) has now become the fourth-largest pension fund in the world, with assets under management amounting to USD 400 billion. Twenty percent of the capital is invested in the local stock market, giving the fund a stake of 5-10% in most Korean companies. And this is where it becomes interesting: the NPS recently announced that it would promote higher dividends in talks with the companies in which it invests. President Park's government is the first to operate in relative independence from the chaebols. It has awarded the mandate to protect the interests of pension beneficiaries to the NPS. This opens doors for investors from other countries, who own almost 35% of the market and have similarly looked on in frustration for many years at the low dividend flow generated by their Korean portfolio.
To speak with Obelix...
In my opinion, this is the key to the Korea discount. Supported by a strong domestic entity, I believe that the chaebols in Korea will slowly rally and come through with higher dividends. The Samsung group is under most pressure, being the biggest and best-known chaebol to have hinted earlier that it intends to focus more attention on the group's so-called corporate governance. Will this put an end to the Korea discount? It's hard to tell, but things are moving in the right direction. We should first focus on the Japanese pay-out ratio. Dividend returns could then easily increase from today's 1.2% to 2.5%. To speak with Obelix: "They're crazy, these Koreans". But I think they will get back to being more normal again soon, and that this will ultimately have a positive effect on the valuations in the Korean stock market.
This column appeared at an earlier date in DFT