Against a volatile backdrop for global equities, South Korea has been the standout performer this year with the KOSPI rising over 80%. Incredibly, roughly three-quarters of this value has been created by just two stocks – Samsung Electronics and SK Hynix – which now represent over half of the country’s stock market that has overtaken Canada to become the world’s seventh largest. The flip side of this extreme concentration is that large swathes of smaller Korean companies remain undiscovered and undervalued despite tangible improvements in governance and balance-sheet strength. Amendments to the country’s corporate code last year have brought significant progress in addressing crossholdings and unrelated equity stakes – echoing the successful path taken by Japan several years ago. Aimed at closing the long-standing ‘Korea discount’, these reforms have spread across the nation’s small and mid-sized companies, creating a rich seam of opportunity for active value investors.
Untapped asset value conundrum
For us as value investors, of particular appeal are solid businesses coupled with significant asset backing – companies with stakes in other businesses in many cases unrelated to their core operations. Our portfolio holds several such examples where, following the large-cap rally, the value of these underlying investments now often equals or exceeds the entire market capitalisation of the smaller holding company. This implies that we can acquire the core business almost “for free”. In many of these cases, one catalyst for revaluation would be a reduction in the non-core asset base and subsequent return to shareholders through share buybacks or dividends.
For example, the dormant insurance company Samsung Fire & Marine holds a 1.5% stake in Samsung Electronics that is now worth the same as the property and casualty insurer’s entire market value. The smaller company, whose core business generates over USD 2 billion in operating earnings, also holds a substantial position in treasury shares which can and should be cancelled. The preference shares that we own trade at a 30% discount to the ordinary shares, offering an attractive discount-on-discount dynamic which contributes to over 75% upside we see in the company’s shares from current levels.
Another top ten holding, the scarcely covered building materials company KCC Corp, has a stake in construction company Samsung C&T which now exceeds its own market capitalisation. The building materials company also holds 17% in treasury shares alongside a potentially normalising core business in paint, coatings and silicone. Meanwhile, Hyundai Mobis owns stakes in Hyundai Motors and other companies that are worth roughly half its market value alongside the company’s own strong position in robotics through its ownership of and supply relationship with Boston Dynamics. Finally, discount retailer E-Mart holds a stake in Samsung Life valued above its current market cap; Samsung Life, in turn, holds a big stake in Samsung Electronics. In all these cases, we believe tangible capital allocation catalysts are taking shape in the form of higher pay-out ratios and potential share buy-backs at deep discounts to book value.
Korea kicker
This asset-backed thesis has driven the fund’s strong year-to-date performance. SKAGEN Focus was up around 15% in EUR in the five months to end-May, roughly 2% ahead of the MSCI All Country World Index after fees. Hyundai Mobis and KCC were among its top five positive contributors, together adding around 4.0% to absolute returns, while Korean construction company, DL E&C, added a further 1.7% before being sold at price target[1].
Korea represents our largest country exposure at around 18% of the portfolio and provides 7 of its 49 positions which have an average market cap of USD 5.5 billion. The fund trades at 0.7x book value and 9.5x earnings – significant discounts to the MSCI ACWI – with weighted upside of 70% to our price targets over a 2–3-year investment horizon.
Around a third of positions were initiated less than a year ago, reflecting strong sell discipline and brisk idea generation. Among the most recent holdings to join the fund is Hitachi Construction Machinery, a global producer of construction and mining equipment. Among the catalysts that we believe could drive 50% equity upside in the Japanese company is ownership and governance transition as Hitachi reduces its remaining stake.
A recording of the recent webinar hosted by SKAGEN Focus portfolio managers, Jonas Edholm and David Harris, is available here: Market update with SKAGEN Focus
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[1] Contribution to absolute return in NOK.