Column: Don't expect 'Korea discount' to disappear-Raychaudhuri

Korea Zinc

17/12/2024 22:00

(Repeats item, text unchanged. The views expressed here are
those of the author, chief executive officer of Emmer Capital
Partners Ltd.)
    By Manishi Raychaudhuri
       Dec 17 - South Korea has recently been in the news for
all the wrong reasons, with a brief spell of martial law,
continuing political uncertainty and market ructions. But the
sharp underperformance of the country’s equity market long
predates the turmoil involving recently impeached President Yoon
Suk Yeol. The deep-rooted problems suggest the so-called ‘Korea
discount’ is unlikely to budge even after political calm has
been restored.
    Korean equities have underperformed their Asian peers for
more than a decade. The country’s forward price-to-book multiple
has been below that of the Asia ex-Japan market since 2009, and
the forward price-to-earnings multiple has typically traded at a
discount over that period.
    Korea’s market enjoyed a brief respite after the
announcement last February that the country was implementing a
“Value-Up” programme, modelled after Japan’s successful
programme of the same name. This initiative seeks to improve
Korean companies’ capital efficiency and investor
communications.
    But Korea’s programme has been a damp squib in comparison to
Japan’s. The Nikkei 225 is up 40% since the Tokyo Stock Exchange
(TSE) released value-up guidance in March 2023, while Korean
equities collapsed after only a short-lived spike in early 2024.
     
    WHAT AILS KOREA?
    What accounts for the Korea discount? In a nutshell, very
low return on equity and weak corporate governance. Low ROEs
partly reflect bloated corporate balance sheets that are, in
turn, a result of companies’ reluctance to distribute cash to
shareholders in the form of dividends. 
    Corporate governance has been hindered by the cross-holding
structures of many family-owned conglomerates, known as
chaebols. These structures often give founding families
disproportionate control over the company at the expense of
minority shareholders.
    Korea’s value-up program unfortunately doesn’t appear
stringent enough to tackle these issues. It merely encourages
companies to disclose their capital efficiency plans – their
medium- and long-term goals as well as their timelines and
strategies for achieving these goals. Various tax incentives
were designed to support this initiative, but they have yet to
be approved by parliament. 
    More importantly, unlike the Japanese programme, there’s no
“name and shame” element to Korea’s value-up drive. The TSE has,
since January, published a list of companies that have disclosed
their plans to increase capital efficiency, thereby indirectly
naming companies that haven’t. This peer pressure appears to be
encouraging more Japanese companies to comply.
     
    STUMBLING OVER TAX LAWS
    South Korea’s tax laws also remain a stumbling block.
    Investors have long believed that the country’s inheritance
tax of roughly 50% encourages chaebols to deliberately suppress
the market capitalisations of their companies. The government of
the recently ousted president announced a plan in July 2024 to
reduce the tax, but its implementation is obviously doubtful in
the current political environment. 
    The government also assesses a tax of around 15% on
dividends paid to Korean residents, which appears to be
discouraging dividend payouts. 
    A comparison with Taiwan is revealing. Taiwan eliminated the
double taxation of dividends in 1999. Dividend yields and payout
ratios in Taiwan have remained high since then, elevating the
stock market’s ROE, in stark contrast to Korea’s.
    WHAT NEXT?
    Despite all the headwinds, there seems to be some lingering
optimism for investors in Korea.  Recent buyback announcements –
including over $7 billion at Samsung – have ignited hopes that
Korean companies will begin moving in a more
shareholder-friendly direction.
    Shareholder activism also appears to be on the rise in the
country. For example, the founding family of Korea Zinc, the
world’s largest zinc refiner, was recently forced to scrap an
unpopular plan to issue new shares to fend off a takeover bid
from the co-founding family, after investors strongly resisted.
    But the gears of change move slowly. 
    Optimists may look to China for inspiration. Its equity
market was almost as cheap as Korea’s until recently. But
Chinese equity valuations have risen sharply since the
government began announcing meaningful monetary and fiscal
stimulus plans in late September. 
    It’s unclear what catalyst could generate a similar rerating
in Korea.
    Realists may instead look to Japan. Tokyo set out to improve
governance standards in 2015, but success has only started
showing up recently. And that may have as much to do with yen
weakness as corporate reforms. 
    In other words, it’ll likely take time for Korea’s reforms
to bear fruit, especially given the political backdrop. So it’s
safe to say the Korean discount isn’t going away any time soon.
     
    (The views expressed here are those of the author, the
founder and CEO of Emmer Capital Partners Ltd. and the former
Head of Asia-Pacific Equity Research at BNP Paribas Securities.)

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
South Korea trades at a discount to Asia    https://www.reuters.com/graphics/GLOBAL-EMERGING/xmvjbqxabvr/chart.png
Taiwan's dividend payout ratio dwarfs South Korea's    https://www.reuters.com/graphics/GLOBAL-EMERGING/znpnlqowopl/chart.png
And so does Taiwan's Return on Equity    https://www.reuters.com/graphics/GLOBAL-EMERGING/akveejrbbvr/chart.png
Korean equities are the cheapest, but they also have low ROEs   
https://www.reuters.com/graphics/GLOBAL-EMERGING/klpyqjoxzpg/chart.png
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
(Writing by Manishi Raychaudhuri
Editing by Anna Szymanski and Peter Graff)
((anna.szymanski@thomsonreuters.com))