South Korea: Reform is underway with the potential to improve stock valuations and shareholder returns

In early 2024, we saw some Korean stocks rally, particularly those trading on a low price-to-book¹ or paying decent dividends.

Why is this? Ahead of the general elections in April 2024, politicians and regulators in Korea have been promising to narrow the ‘Korea discount’, by improving shareholder returns and the way companies are governed. 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. Compared to the MSCI AC Asia ex-Japan Index, Invesco Asia Trust is overweight Korea, where we believe that gradual improvements in corporate governance are not fully appreciated.

Companies in the Korean financial sector have been showing the way and are amongst the best performing stocks in early 2024. This suggests that if government 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 organisations known as the chaebol (family- controlled conglomerates), as they face large tax bills on inter-generational transfers.

The Financial Services Commission has also announced a ‘Corporate Value Up Program’. This focused on companies with a low price-to-book and suggested that management should be accountable for improving governance. The program proposed company boards should measure price-to-book and return on equity² - and should be forthcoming to investors as to why they are underperforming.

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

Signs of improvement in dividend growth

Politicians and regulators have been coordinating ways 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 companies 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. Consumer share ownership continues 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. In our opinion, the valuations of Korean stocks are attractively priced. As can be seen in Figure 1 below, the valuation of the Korean market in terms of price-to-book¹ is just 0.9x, with over 50% of companies trading below their book value (i.e. the value of company assets less its total liabilities).

The message is filtering through

The early 2024 rally in the financial sector was supported by positive news on share buybacks³, 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 Invesco Asia Trust is overweight Korea in comparison to its benchmark, the MSCI AC Asia ex-Japan Index, and is one of the Trust’s largest country allocations (see figure 2).

Our positioning reflects the strength of individual company opportunities we can find in Korea, rather than any overarching market view or reliance on future news and events. However, we suspect more positive news on this front could be the trigger for other managers to increase their positions again as the risk and return picture becomes clearer.