South Korea: Reforms to resolve the ‘Korea discount’ will improve shareholder returns and valuations

In early 2024, we saw some Korean stocks rally, particularly those trading on a ‘low price to book (P/B)’ or paying decent dividends.

Why is this? Ahead of the general elections in April, politicians and regulators in Korea have been promising to narrow the ‘Korea discount’, by improving shareholder returns and corporate governance. The ‘Korea discount’ refers to an investment view that Korean companies are undervalued compared to other Asian countries.  

Inspired by the success of the Japan’s Tokyo Stock Exchange over the past 12 months, moves are now underway to introduce coordinated measures to encourage companies to boost share price returns and valuations.

This is music to our ears. Our Asia and emerging markets strategies are overweight Korea, where we believe that gradual improvements in corporate governance are being underappreciated.

Korean financials have been showing the way and are amongst the best performing stocks in early 2024. This suggests that if regulators do eventually come up with meaningful measures, they’ll be pushing on an open door in some parts of the market.

Timeline of events so far

Before the finance minister pledged to narrow the ‘Korea discount’, President Yoon in mid-January discussed efforts to encourage Korean companies to seek higher stock market valuations in his speech at a Town Hall-style event. He also pledged to reform a tax system that has hindered stock market development.

There was a particular focus on addressing inheritance tax. This is charged at 65% for those with assets more than KRW100bn (US$75m) and is relevant for the chaebol (family-controlled conglomerates) as they face large tax bills on inter-generational transfers.

The Financial Services Commission (FSC) has also announced a ‘Corporate Value Up Program’. This zeroed in on companies with low P/B’s and suggested that management should be accountable for improving governance. The program proposed boards should measure P/B and return on equity (ROE) and should be forthcoming to investors as to why they are underperforming.

These metrics should also be published on a relative basis versus industry/peers and that those succeeding should be included on a premium index tracked by ETFs. These measures are similar to Tokyo Stock Exchange’s ‘name and shame’ strategy, which continues to build momentum.

We’ve recently seen the suggestion that treasury shares cancellations may be enforced. There’s been potential rules excluding treasury shares from market cap calculations and preventing their use in M&A and other corporate actions. Stock cancellations can help boost shareholder value by reducing the number of shares outstanding.

Signs of improvement in dividend growth

Politicians and regulators have been coordinating on measures to improve corporate governance for years. Initiatives introduced in 2014 by President Moon Jae-in promised similar improvement. Since then, we’ve identified signs of gradual improvement in the growth of dividends for Korean companies.

But culture changes slowly. We’d expect more announcements from government and regulators in the coming months, and that more Korean corporates will be trying to improve appearances in dividend pay outs and balance sheets. We’re not saying that the experience in Korea will be the same as Japan, but you can’t argue with the direction of travel.

Two other important factors to consider are the role of local investors in Korea. Retail share ownership continue to climb, while new investment themes can attract significant attention.

This was seen in the hype that engulfed the electric vehicle battery supply chain stocks last year. We’re also working from a low base. The valuations of Korean stocks are attractive. They are cheap, too cheap!

As can be seen in the chart below, the valuation of the Korean market in terms of price/book is just 0.9x, with over 50% of companies trading below book value.

The message is filtering through

The early 2024 rally in financials was supported by positive surprises on buybacks, dividends and share cancellations in the latest earnings season. So, it does seem the message is finally filtering through, which should give sceptics pause for thought. There’s a strong chance that other banks and insurers will follow suit.

The payment of better dividends is not a new trend (as can be seen from the chart below). 

Our strategies are overweight Korea, and it appears to be a differentiator, given that it’s a perennial underweight in many of our competitors' portfolios.

Our positioning reflects the strength of bottom-up opportunities that we can find in Korea, rather than any top-down view or belief in catalysts. We suspect more positive news on this front could be the trigger for managers to close underweight positions as the upside/downside asymmetry becomes more visible.