Notes from the road: Can Value-up nourish the Seoul?

I recently returned from a snowy week in Seoul, in which I met 20 South Korean corporates. South Korea is a key market in our investment universe, and with many asset allocators reconsidering their allocations to China it seemed like an opportune time to get a sense of how open for business South Korea is at present. It has a relatively mature equity market, for the region, with a number of globally competitive companies. But, there is somewhat of a stand-off at present between the corporate world and the government. The government wants companies to do more to attract foreign capital and promote South Korea Inc, through increased shareholder returns, while the companies are looking for the government to offer better incentives for them to do this. The purpose of this trip was to try and get a sense of what these incentives look like for the companies I was meeting.

Wait-and-see mode

It quickly became clear to me that most companies are either in ‘wait-and-see’ mode regarding the government’s Corporate Value-up programme and are looking for greater detail on what measures will be introduced or don’t see the need for further reforms. For example, a major corporate I met said it had already implemented reforms while another holding company spoke against an activist shareholder proposal to increase dividends and buybacks, saying that its current shareholder return plan had been established last year and it wished to show ‘stability’.

1. Tax reform

My biggest learning from the trip came in discussion with a South Korean bank on how tax reforms could significantly affect how companies allocate capital. South Korea has punitively high inheritance tax rates, which can be as much as 60% for the largest shareholders in firms. These high tax rates create a perverse incentive for the chaebol families to drive down the share prices of the companies they control to reduce their inheritance tax liability. A reduction in tax on dividends, which are subject to withholding tax and then taxed at the individual’s marginal tax rate, would incentivise companies to pay higher dividends. Other measures, such as replicating Japan’s public list for companies that are improving corporate value, in effect identifying and shaming those that don’t, could also be effective.

To date, there have not been any concrete policy announcements, but there have been a few crumbs during the time of writing. The first update of note from the government landed the day after I arrived back in London on 26 February, but it lacked teeth and fell short of market expectations. The government only went as far as to ‘encourage and support’ companies’ voluntary efforts to return more capital to shareholders and improve governance. Days later, the government followed up that it was considering introducing ‘de-listing criteria’ for non-compliant companies, which certainly gave the argument more bite. Detailed guidelines will be released in the first half of 2024; so we’ll keep our eyes peeled. However, unless powerful incentives are introduced [and not just discussed] we would not expect this to move the needle. Reforming a corporate culture that has lasted for more than 20 years will require strong medicine.

In another positive development on 20 March, we heard from the Finance Minister who explicitly stated – for the first time on record – that it was the intention of the sitting government to cut taxes to drive the Value-up programme forward. This was a timely reminder to the market that the government was in fact listening, but unlikely to announce anything concrete until after the legislative elections in April. It remains to be seen whether President Yoon, the most powerful voice calling for reform, will have the mandate to push through impactful policies.

2. South Korean industrial might

Another theme that emerged from my trip was South Korea’s status as the ‘last man standing’ in a number of cyclical industries that have experienced protracted downturns. Meeting Samsung Heavy, HD Hyundai Electric and Doosan Enerbility showed that in industries as diverse as shipbuilding, power grid equipment and nuclear power plant components, competitors have exited in lean times, while South Korean companies have maintained capacity. This is partly a consequence of poor capital allocation – shareholders have had to shoulder significant losses in prior years. But it has left these companies in a good position to benefit from these industries finally entering an upcycle for varying reasons; shipbuilding from LNG projects driving demand for LNG carriers, power grid equipment from capex for ageing US power grids and renewable energy projects and nuclear power plant components due to a wider acceptance of nuclear as necessary to achieve net zero with fears caused by the Fukushima incident fading.

3. The anti-China dividend

The final point that came across from my meetings was South Korea’s opportunity to benefit from geopolitical tension between the US and China. South Korea and China compete head-to-head in a number of fields and South Korea may win share as the US seeks to reduce dependence on China. For example, Samsung C&T sees its subsidiary Samsung Biologics as potentially benefiting from US drug companies being less willing to contract with Chinese competitor Wuxi Biologics. I met with the investor relations team of Korea Zinc who explained that it is investing in nickel sulphate production as the US inflation reduction act requires EV manufacturers to source battery materials from non-Chinese sources to qualify for subsidies.

Final word

In summary, South Korea is a good territory for our brand of bottom-up stock-picking. We are currently underweight South Korea but hold meaningful allocations to the country across our emerging market equity and Asia portfolios. This reflects our recognition that operating a business in South Korea’s current corporate climate is not straightforward and numerous hurdles exist. We are confident that the companies we are invested in can successfully navigate these hurdles and their respective business strategies provide the necessary growth levers. For us to make a more meaningful allocation we would need the government to beef up the Valueup programme, which still remains uncertain. The trip has raised several new research ideas in cyclicals and beneficiaries of US friend-shoring to add to our bench of investment ideas. We will continue to monitor any developments and remain ready to act in a nimble fashion if it looks likely that the government will put the required incentives in place to improve shareholder returns.

About the companies

• Samsung Heavy is one of the three large Korean shipbuilders and is generally seen as having an advantage in LNG carriers and offshore platforms due to the layout of their shipyards.
• Samsung C&T is a diversified holding company that owns 43% of Samsung Biologics, a leading biopharmaceutical manufacturer.
• Korea Zinc is the world’s largest lead and zinc smelter, with world leading smelting technology and refinery integration.
• HD Hyundai Electric is an electrical equipment and energy solution company, including power grid equipment.
• Doosan Enerbility is a combination of Energy and sustainability – focuses on manufacturing and the construction of nuclear power plants, thermal power stations and turbines and generators.

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Samsung Heavy, HD Hyundai and Doosan Enerbility are examples of high-quality durable companies in sectors that have experienced protracted downturns. Samsung C&T and Korea Zinc stand to benefit from a growing anti-China sentiment. This is not a buy, sell or hold recommendation for any particular security. For further information on specific portfolio names, please see the Important information section.

¹ Statista.com written and published by L. Yoon on 17 June, 2022. In 2021, the revenues of Samsung Group’s 15 biggest subsidiaries accounted for about 20.3% of South Korea’s GDP.