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Harry Koza

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Rubber Seoul

Harry Koza

 

I shall make that trip. I shall go to Korea.”

— Dwight D. Eisenhower, 1952.

TORONTO (GlobeinvestorGOLD) — South Korea in 1960 had a mostly agrarian economy with per capita GDP equal to that of the poorest countries in Africa. In just one generation, the country leapt into the modern age, and by the late 1980s, its economy was equal to many of the EU nations. A system of close ties between government and the Chaebols*, import restrictions, directed credit, strong labour participation (the work week was only reduced from 6 to 5 days a week in 2003), and government sponsorship of specific industries, all helped to create an export giant.

The government encouraged the importation of raw materials and technology, while restricting consumer imports in order to encourage savings and investment. This worked a treat: from 1962 to 2003, Korea’s Gross National Income (GNI) increased from $2.3-billion (U.S.) to $606.1-billion, with its per capita GNI soaring from $87 to about $12,646.

It wasn’t a smooth path, however. In 1997, the Asian financial crisis exposed the flaws in the system: a banking system with Japanese-style bad debt problems; the Chaebol strategy of expanding through debt rather than equity, which saw the 30 biggest Chaebols hit average debt/equity ratios of 518 per cent by 1997; and 30 years of industry/government collusion that saw companies engaged in projects at the government’s instigation and the government picking up the tab for failed ventures; and a too-short term structure on the country’s external debt.

When the Asian crisis hit, the economy shrank 6.8 per cent in 1998. The government reacted quickly, forcing the banks to write down non-performing loans and establishing the Korean Asset Management Corporation (KAMCO) on the lines of the U.S.’ Resolution Trust, to buy the bad debt from the banks and repackage and resell it to distressed bond and vulture investors. (This created something of a field day for U.S. vulture funds, but that’s another story).

Some serious corporate restructuring was also needed. The Chaebols, the primary instrument of economic growth for over 30 years, were highly leveraged, and their interlocking and overlapping corporate structures had become an obstacle to recovery.

The biggest Chaebols, led by Samsung, LG, Daewoo and SK groups, restructured in seven sectors: semiconductors, petrochemicals, automobiles, aircraft, rolling-stock, power generation, shipbuilding and petroleum refining. Merging companies in the same businesses reduced their subsidiaries from 804 in April 1998 to only 544 in 2000.

Other financial reforms included eliminating cross-company loan guarantees, stronger shareholder rights, tougher accounting and auditing rules, greater transparency of corporate governance, and a massive improvement in corporate capital structures.

By 1999, much of the economy had recovered, and GDP grew by 10.8 per cent in 1999 and 9.2 per cent in 2000. In 2001, Growth slipped back to 3.3 per cent because of the global economic slowdown, which lowered exports. But with a growing middle class, increasing consumer spending and rejuvenated export growth, economic growth in 2002 was an impressive 6.2, despite still-anemic global growth, followed by moderate 2.8 per cent growth in 2003.

Korea’s foreign currency reserves, a mere $3.8-billion at the end of 1997, soared to $155-billion by the end of 2003, and the country has entirely repaid the emergency $13.5-billion loan from the IMF. On December 16, 1999, the IMF declared that the foreign exchange crisis in the Republic of Korea was completely resolved, and the nation’s sovereign credit rating was restored to investment grade.

So, while the road has not been without a few major potholes, the Republic of Korea has enjoyed an average annual growth rate of 8.6 over the past 30 years, and is now the world’s 12th biggest trading nation, and one of the world’s leading shipbuilders and manufacturers of electronics, semiconductors and automobiles. Today, Korean firms are well positioned to make significant contributions to the task of building the infrastructure to enable China to make the same sort of giant economic leap that took Korea into the modern age in a single generation.

Investing directly in Korean stock markets isn’t easy for Canadian individual investors, but there are some interesting situations over there nonetheless. Here are a few that I like, including two stocks, and an exchange-traded fund. (Disclosure note: I do not own any of these securities at present).

There are also some U.S.-based Korean market mutual funds, and you can trade ADR’s (American Depository Receipts) of several Korean corporations on U.S. markets.

Let’s start with the ETF first.

Barclay’s Global Investors offers the iShares MSCI South Korea Index Fund. It has a 0.75 per cent MER, and currently trades around $31.64. The 3-month return is 9.9 per cent, year-to-date 7.35 per cent, one-year 13.31 per cent, three-year 11.48 per cent. Like other ETF’s it is a low cost, simple way to invest in markets that are otherwise difficult for the individual investor to access. Total market cap is $336.65-million. It’s had a nice pull-back from its recent highs, but I’d wait for the chart to turn back up before taking a position. Do note that EWY has a Beta of 1.41 vs. the S&P 500 index. (Simply put, Beta is a measure of market risk: a security with a Beta of 1.41 vs. the S&P 500 is expected to move at 1.41 times the movement that the SPX makes. It is a measure of systematic risk, the risk that cannot be diversified away. You could write a whole column on how to use Beta — not to mention Delta — used in options, and Gamma trading, and, for all I know, the rest of the Greek alphabet into the bargain.)

Next up is Korea Electric Power Corp., or KEPCO.

KEP has a trailing 12-month dividend yield of 3.769 per cent, 1.86 per cent relative to current prices. The partially privatized company is still majority owned by the Republic of Korea government. Kepco runs the electricity generation, transmission and distribution system in South Korea. Through its six consolidated generation subsidiaries, the Company generates about 95 per cent of the electricity consumed in Korea. Internationally, the company is expanding. It generates one seventh of the electricity produced in the Philippines, and has generating and network projects in Vietnam, Taiwan, Myanmar, North Korea (two nuclear reactors under construction), China and Pakistan. It is moving into the North American market in a big way, and has provided technical evaluation and due diligence services at 11 power plants in the U.S. and Canada. It has 5,800 MW of new generating capacity at various stages of construction.

I really like the electric power business in general, and KEP is a high-quality utility company with local monopoly power and good international growth prospects. You can find out more at the company website.

One interesting statistical measure of the company’s quality and attention to detail, possibly of particular interest to customers of Ontario Power Generation and Hydro One, is the company’s average annual blackout time. In 2003, KEP cut its average blackout time to a total of 19 minutes/year/customer. Compare that to the U.S. average of 122 minutes and the average for France of 57 minutes. Up here in Richmond hill we seem to have regular small outages, and the Big Blackout in Toronto not long ago would have skewed Ontario right off the scale.

Another Korean stock I like in the ROK is Pohang Steel, or POSCO.

It currently trades around $48.79, off its 52-week high of $55.65, and has provided a one-year total return of 41.65 per cent. Forbes Magazine ranked POSCO as its most admired steel company in the world in 2004, and also in 1999, 2000 and 2003. One of the world’s leading steelmakers, Posco earned $1.66-billion in net income on sales of $12.05-billion in 2003.

Find out more at the company’s website.

Steel making is often characterized as a “rust-belt” or “sunset” or “old economy” business. If you’ve ever been in a steel mill, you know that steel making is an incredibly high-tech business, one in which continual process innovation and reinvention to cut costs is of paramount importance. I was quite interested to read about POSCO’s FINEX process, an environmentally friendly steel-making method that eliminates the need for sintering and coke plants, and utilizes cheaper coal fines and powdered iron ore (more available and 23 per cent cheaper than pellets). The process also produces far less emissions than conventional steel-making processes.

There are other ROK companies that are worth a look. Seems like all the appliances in the local stores these days are made by LG or Samsung, and people keep telling me how great Hyundai cars are. They must be doing something right.

There’s a lot more to the Republic of Korea than Kimchee.


*Chaebol is a Korean term for a conglomerate of companies linked to one parent company. These companies are often run by one family and typically hold shares in each other. Similar to the Japanese term keiretsu (source: InvestorWords.com). Return to text.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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