Korea is the epicentre of escalating geopolitical tensions between the US, China and North Korea yet the KOSPI Index is near all-time highs. EAI analyst Eric Fong recently visited Seoul and the Demilitarized Zone (DMZ). The cosmetics and travel sectors remain poor risk/reward while the technology sector continues to offer good growth and value. Samsung Electronics and Naver are our top picks in Korea.
THAAD: The nexus of Korea, China and Trump Tensions
Terminal High Altitude Area Defence (THAAD) is a highly contentious US anti-missile system which is being deployed in South Korea. The aim of THAAD is to protect the South against North Korea, as Kim Jong-Un continues to test anti-ballistic missiles and pursue nuclear ambitions. China however, is very unhappy about THAAD as it increases American power in North Asia and the sophisticated radar tracking abilities which accompany THAAD could be used to track Chinese missiles in the event of a Sino-American conflict. Thus far, China has responded with economic retaliation against South Korea, primarily in the form of boycotting Korean products and banning travel to Korea by Chinese tourists.
The initial stages of THAAD deployment were rushed through in the last days of the Park administration. Moon Jae-In is the current front runner for the May Presidential election. He was a close ally of the late President Roh, who was pro- North Korea (Sunshine Policy) and focused on a stronger relationship with China. It is unlikely that the new Korean president will remove THAAD once it is in place. Therefore, it is our view that the new Korean President will shift blame for the programme to the previous administration and try and make peace with China in other areas. There was some speculation that the Trump/Xi meeting in Florda last week would address THAAD, but the meeting was largely overshadowed by events in Syria. Furthermore, over the weekend a US navy strike group was positioned into the western Pacific to provide a US military presence closer to North Korea, suggesting that tensions between Korea and the US are intensifying.
What We Own in Korea: Samsung Electronics & Naver
Samsung Electronics and Naver are the two largest Korean positions in EAI. Samsung Electronics is up over 75% since we first invested in 2015. Despite this stellar run, the stock remains inexpensive at 9x 2017 PE. We expect strong growth this year on account of the launch of the Samsung Galaxy S8 and continued strength in memory. The company’s generous share buy back also acts to support the stock.
Naver is the leading internet and social media company in Korea. It is often called the Google of Korea given its dominance in search, but its business mix also has elements of Tencent, Facebook and Snapchat. Naver is a high growth company with over 30% EPS growth expected this year. A Sum of the Parts (SOTP) valuation using peer multiples continues to show significant upside. The recent IPO of Snapchat reconfirmed our conviction in Naver’s inexpensive SOTP valuation.
What We Don’t Own in Korea: Cosmetics & Travel
Korea has some of the best cosmetics companies in the world. Unfortunately, these stocks have significantly de-rated due to THAAD related political risk (fewer Chinese tourists buying cosmetics at DutyFree). We took profits in LG H&H in mid-2016 on THAAD concerns and the stock is now 16% lower. Similarly, AmorePacific is now 22% lower than where we exited. Travel darling Hotel Shilla is down over 60% from its mid-2015 peak. In the two weeks since the Chinese tourist travel ban was imposed, DutyFree sales have reportedly fallen 30%. It is too early to tell how long this effect will last, but 1H17 earnings for tourist dependent Korean companies will likely be disappointing.
While Eric was in Seoul he heard other investors talking about a CYEAB price for Korean cosmetic stocks (Close Your Eyes And Buy). We never close our eyes when buying stocks and would prefer to miss the first few percentage points of upside than take undue risk trying to bottom tick a sector with significant headline risk and little earnings visibility. We plan to revisit our thesis once the new Korean President is elected in May.
We are underweight Korea as a country primarily because EAI is a growth fund and Korea is low growth compared to countries like China and India. Within Korea, we continue to like technology stocks like Samsung and Naver but are avoiding the China related consumer names until there is better risk/reward.