South Korea: Asia's Forgotten Market

Includes: EWY, KB, KF
by: Semi-Standard Deviation

Investors have been reaping the benefits of big gains in the Asian market this past year, as iShares' China 25 Index (NYSEARCA:FXI), Singapore index (NYSEARCA:EWS) and Malaysia Index (NYSEARCA:EWM) rose 81%, 42% and 33.4%, respectively. The Ho Chi Minh index leaped 154% while Indonesia's index saw gains of 54%. Yet not all of Asia's markets were on fire, as Japan and South Korea were laggards.

Seoul's Kospi index rose 3.75% while the Nikkei rose 5.71% in '07. There was weakness in Japan's small caps and the arrest of activist investor Yoshiaki Murakami scared the market as well. Within South Korea, the headline grabbing event of the year was North Korea's bomb detonation and also worrying investors were economic concerns over interest rates and the value of the Won.

These concerns appear to be losing their footing though as "the rate increases may have stopped, and the Bank of Korea last week said the won had peaked," as Leslie Norton of Barron's reported. South Korea should have a strong year and makes a fine choice for investors looking into Asian diversification.

Many investors may fear shakeout or profit taking in these large gains that emerging markets have displayed, but South Korea is still trading around 10-11 times and is still considered a value. Interviewed by Barron's in their January 1st issue, Arjun Divecha, an emerging markets pioneer, pegs South Korea as a favorite:

"The economy is still recovering from a credit-card bubble that happened in 2002 and 2003. Consumer debt went from around 30 to 40% of GDP to 110% of GDP in just a few years. The boom turned to bust, and as a result there has been really no growth in personal consumption since 2003. That is starting to wash out...It is hard to say in the next few months you are going to see a big recovery. But that's OK. Give me a market that's cheap and I'll buy it and hold it."

He feels there is room to grow and South Korea's GDP numbers only echo that. As of '05, South Korea had the 11th largest GDP in the world, at 787,567 million USD. This comes out to around $16,123.20 per person, compared to Japan, which registers about $35,833.30 per person. While it would be unfair to say that these two markets hold the same leverage, Japan is a useful barometer. The Korean market still has considerable room for GDP growth, as major players like Samsung and Hyundai gain favor in the U.S., and domestic brands reach out to booming nations in Asia.

Looking at iShares South Korea Index Fund (NYSEARCA:EWY), it should be noted that the P/E for this ETF is 16.47 (as of 11/30/06). 20% of the ETF is allocated to Samsung, while 7.2% is positioned in Kookmin Bank (NYSE:KB). Kookmin has ADRs trading on the NYSE and is in a position for growth. It currently trades at a P/E of 11.35, with a forward P/E of 9.25. It is South Korea's biggest lender and was named bank of the year in '06. It has been interested in buying out Korea Exchange Bank since March, but efforts have stalled due to investigations into Lone Star's handling of their KEB buyout. Investors reacted favorably to the deal at the time, but shares have since leveled off due to the legal entanglements.

Looking at Kookmin's financials, its 3rd quarter, 06 operating income rose 16.2% from the previous year's quarter and it's net income rose 23.5%. If you take a closer look though, you will see that the increase in net income shouldn't look so spectacular. The previous year's 3rd quarter held a large severance payout around 255 billion won (booked to non-operating expenses), compared to this year's number of 3.8 billion won, thus producing the greater increase in net income. That said, it would be more appropriate to use the change in operating income as your reference.

Kookmin is going through a bit of restructuring, as they focus on expanding their marketing and presence in Asia. This has made the number of loans they issue grow at a slower rate than other lenders. Kookmin has also announced that it will be tightening its rules on mortgages, which has caused concern over potential revenue. In the most recent quarter, there were also concerns about Kookmin's net interest margin, or the percentage of interest income over interest-bearing assets, [which] fell for a second straight quarter to 3.59 percent, down from 3.81 percent in the preceding quarter. "The figure doesn't look good," said Im Dong Pil, an analyst at Dongbu Securities Co. in Seoul. "It will take some time for Kookmin to improve its net interest margin'" (

Kookmin's hope is that the overseas expansion will help improve these interest margins as it branches into countries such as Indonesia, Cambodia, Vietnam, and China and Im is correct in thinking it will take some time, as Kookmin is sending out staff to seven Asian countries in 2007 to explore their potential.

Looking at Kookmin's prospects, I would hold off for the time being and wait until their 4th quarter 06 results come out, as their tightened credit rules and slowing growth rates will effect them negatively. In 2007 we can hope to see some M&A as KEB becomes more accessible and they branch out into neighboring countries. Their chief executive, Kang Chung-won said:

We are seeing more (growth) than this year, but we will not stretch ourselves too much in the domestic market. For the long term, our strategy is to grow more abroad.

According to Reuters:

Kang said M&A would be among its options for foreign expansion, adding its current stake in an Indonesian bank and M&A-friendly regulations there would help it broaden its footprint in that country.

With regard to the long-term, I see Kookmin as a buy due to its reliable domestic business (which, as a market, has room for growth), desire to expand at home (KEB acquisition), and potential to grow in neighboring countries.

KB 1-yr chart: