Mr Moon’s election as President of South Korea last year raised hopes for improvements in both corporate governance and the geopolitical situation. We look at the status one year on.

Corporate governance: Samsung and Hyundai lead the way

Samsung Electronics recently increased the number of independent directors on its board. This represents a real advance in terms of corporate governance. The company continues to improve the treatment of its shareholders via share buybacks as well as increasing its dividend. In the last two years, the share price has almost doubled, buoyed by robust prices for memory chips, of which Samsung is the world's leading supplier.

However, it is still very weakly valued, despite the company doubling its profits in two years. Following Samsung's lead, it was likely that Korea’s second-biggest group, Hyundai, would also embark on reforms. The company has already announced that it intends to simplify its complex shareholding structure to achieve better transparency. It is engaged in efforts to unwind the cross-shareholding structures between the group’s entities, which give the Chung family excessive power to the detriment of other shareholders.

It will take time to improve corporate governance in Korea, but it is not inconceivable that the country will follow the example of Japan, which embarked on this process a few years ago.

Improving corporate profitability

Valuations of Korean companies are still bumping along the bottom, for several reasons:

• Poor corporate governance 
• Very low dividend yields 
• Cash that cannot be used and therefore contributes to driving down the companies’ profitability 
• Shareholder structures characterised by cross-shareholdings giving control to the founding families even though they do not have majority voting rights

North Korea opening up?

The Korea discount is also partly linked to the fact that the two Koreas are still virtually at war. An armistice has been signed by China, North Korea’s main ally, and the United Nations (UN). But not by South Korea... which means that no peace treaty has actually been signed and that the two parts of the peninsula have officially been at war with each other for 65 years. The big surprise over the last few months has undoubtedly been North Korea intensifying its efforts towards opening up.

The change of tone at a diplomatic level is certainly very striking. Although it is too early to predict an improvement in the geopolitical situation, significant economic benefits would be generated by the northern neighbour opening up, particularly in the construction, infrastructure and consumer goods sectors. Naturally therefore, any sign of rapprochement between the two countries could also play a part in reducing the Korea discount.

Challenges

It hasn’t all been rosy on the domestic front either, since Mr Moon stepped up to power. The recent 16 % increase in the minimum wage and the introduction of a 52-hour limit on the working week have had a negative effect on the incomes of the poorest households, which could hit growth in domestic consumption.

We also note that the recent threats of increasing protectionism worldwide could damage Korea since exports account for half its GDP. On a geopolitical level, despite recent signs that North Korea’s position is easing, it is unrealistic to expect Kim Jong Un to permanently give up his nuclear weapons.

Outlook

In the current context of generally high share prices, Korean companies are cheaper than the average for other companies worldwide. At the same time, their profits and return on equity are clearly improving. This discount could narrow in the future if the current trend towards an improvement in corporate governance, greater transparency and better treatment of minority shareholders continues.

It is also worth noting that, if diplomatic relations with North Korea continue to thaw, this will only heighten the attractiveness of Korean companies.

TANGUY KAMP, PORTFOLIO MANAGER