EWY - Korea Fund: Accumulate On Stronger Export Data

2023-12-25 23:14:29 ET

Summary

• South Korean equities rally on positive economic data and export growth.
• The Korea Fund's discount to NAV remains favorable, and South Korea trades at a substantial discount to India and Taiwan.
• South Korean equities are attractive in terms of valuation and innovation potential, with Samsung outperforming IBM in 2022.

Opportunity Overview

South Korean equities have rallied slightly on the back of more positive economic data in the country in the past two months. Export growth has picked up again, which could bode well for the market.

The Korea Fund (KF) has slightly outperformed emerging market equities in the past month. The Korea Fund's discount to NAV still remains favorable on a historical basis, and the broader South Korean market still trades at a substantial discount to markets like India and Taiwan. I think that now is a good time to continue accumulating shares of this fund.

It is still crucial to monitor certain headwinds, such as South Korea's rising household debt and economic risks in some of its main export destinations. However, the market appears to have priced in some of these concerns. There may be a short term correction in certain areas of the stock market, such as banking stocks.

Exports are Beginning to Recover

In my last article , I mentioned how slower export growth could result in a weaker macro environment and potential pullback in South Korea equities. South Korea's economy has shown initial signs of recovery despite weaker than demand from key countries like China.

South Korea's exports began to rebound in October for the first time since September 2022. Recent data from December has also been very positive, as exports increased by over 13% during the first days of the month. This increase mainly occurred because of the increase in demand for its semiconductor exports.

This decline caused growth to bottom out before rebounding slightly in the last quarter. Exports account for around 36% of the country's total GDP. South Korea's economy barely dodged a recession in 2023 , after facing its first recession since 1983 in 2020 .

Valuation is Still Very Attractive

In my view, South Korean equities are trading at very attractive levels, and the market is a bargain if it trades at a discount to other larger MSCI constituents like Taiwan and India. The market's valuation is still in line with MSCI Emerging Markets ( 11.5x forward earnings ), despite the fact that it has many developed market characteristics .

South Korea trades at a massive discount to both India and Taiwan on a forward earnings and price to book basis. This fact could lead many investors to increasingly focus on South Korea, especially since its export growth is beginning to improve.

The South Korean 10-year bond yield has been increasing steadily in the past five years. The 10-year bond yield currently exceeds the dividend yield of the stock market, so some investors may prefer bonds over equities in a riskier market environment in 2024.

Innovation

In my view, there should be some form of innovation premium for the market, which should cause the market to trade in line with other major emerging market equities in the worst case scenario.

Samsung topped IBM in 2022 in terms of the number of patents filed in the United States. LG Electronics also received over 2,000 patents in the United States last year.

New Trade Partners and Offshoring Manufacturing

South Korea has many potential geopolitical advantages it could exploit, but has not potentially been utilizing this to its fullest extent. Relations between South Korea and Japan could improve in the coming years, as both countries are now holding economic talks for the first time in eight years .

This transition could help boost South Korea's exports, given that Japan is currently a relatively smaller trade partner . Moreover, South Korea can continue to utilize other regional peers, such as Vietnam, that are on the lower end of the manufacturing value chain and have lower labor costs. Diversification could help South Korea lower its exposure to China and potentially deliver more stable export oriented growth.

Another new trend to note is that the United States overtook China in terms of South Korean imports. Exports to the United States rose by 22% in 2022 , while they fell by 10% in China during the same year. South Korea could benefit from continuing to diversify its export structure to focus more on Japan and the United States. Moreover, there is room for growth in China to pick up in subsequent years, as slower growth in 2022 resulted from its previous zero COVID policies.

Banks and Credit Growth

Household debt in South Korea has risen to new highs, which may lead banks to pursue slower growth and stricter lending criteria leading into 2024. Rates have maintained relatively low, although the Central Bank has had to hike interest rates by 275bps since 2020 .

Banks have been relative under-performers in this environment.

Shares of leading banking companies like Woori Bank ( WF ) and Shinhan Financial Group ( SHG) have slightly underperformed the broader market, and could continue to do so in 2024 if banks lower growth targets and tighten lending criteria .

Overall Economic Outlook

The latest Central Bank projection is only calling for 2.1% growth in 2024 . Some of the main issues that may hold back growth include rising household debt and the surge in real estate prices, which may result in slower credit growth in subsequent years. On a positive note, there is room for exports to recover in 2024 due to rising demand for semiconductors and other electronics. The S&P Global Electronics PMI Index has declined substantially since 2021, but may pick up again.

The Korea Fund Discount

The fund's current discount of around 16.3% is in line with its historical 52 week average. A discount between 15-20% is very appealing given that there have been several macro improvements in recent months. Moreover, South Korean equities are still trading at a discount to some emerging Asian peers.

The Korea Fund has the potential to run ahead of the broad market in the event that there is a bull run in Korean equities.

The Korea Fund has outperformed the iShares MSCI South Korea ETF ( EWY) so far this year.

ETF Comparison Top Holdings: The top five holdings of the Korea Fund include the following: Samsung Electronics ( SSNLF), SK Hynix, LG Chemical, KB Financial, and Naver Corp ( NHNCF). Many of these are similar to some of the top holdings of the iShares MSCI South Korea ETF.

Final Thoughts

The Korea Fund has move sideways in the past six months, even though its economy has improved slightly during this time period. I think it makes sense to hold this fund, and to potentially accumulate banking shares during any market sell offs. The days of the South Korea value trap may not be very long-lived.

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