South Korea: The Market Investors Love To Hate

| About: KB Financial (KB)

Investors have a love-hate relationship with the South Korean market. When the global economy is barreling forward with a full head of steam, they pile on to their positions in the South Korean market.

Likewise, investors sell off their South Korean holdings en masse when weakness sets in. This behavior is typical of a market that’s viewed as a cyclical, high-beta bet on global growth. Consequently, South Korean equities have underperformed this year, as investors have fretted over Europe’s brewing sovereign-debt crisis and a potential second recession in the US.

These woes aren’t unique to South Korea. Foreign investors have looked askance at Asia in recent months, selling close to USD21 billion worth of Asian equities from the beginning of August through Sept. 5. The South Korean market was one of the biggest victims of this bloodletting; investors sold off about 0.5 percent of the market’s total capitalization.

But South Korea deserves another look from investors who have a long-term perspective. I acknowledge that dangers abound in the global economy and that another sell-off of South Korean equities could be in the cards. Nevertheless, the investment case for South Korea remains persuasive.

The first pillar of my argument is valuation. With a price-to-book ratio of 1.23, South Korea has one of the cheapest Asian stock markets—even after equities rallied from their Oct. 5 low. At current valuations, the market still offers an attractive return on equity of about 13 percent.

The second reason is the growing strength of South Korea’s corporations. Once the junior varsity squad of Asia’s corporate world, South Korean companies have evolved into some of the world’s most familiar and well-established names.

Corporate profit margins have been stable and these companies have made great strides to reduce debt. In the past, South Korean companies typically had a net debt-to-equity ratio of about 300 percent. Today, that astronomical number has fallen to a little over 30 percent.

US-listed shares of South Korean banks offer investors a convenient path to establishing a foothold in the South Korean market. Shares of South Korean banks were hit hard during the selloff this year. These banks have seen their stock prices decline by about 40 percent in dollar terms. But this performance belies the group’s strong financial results, with higher earnings across the board.

One of my favorite South Korean financial company’s I track in my advisory services, Global Investment Strategist, is KB Financial Group (NYSE: KB) - Seoul: 105560. This Seoul-based financial holding company increased its net interest margin (NIM) by 45 basis points in the second quarter to more than 3 percent. Domestic banks in South Korea generate about 80 percent of their operating margins from interest income; NIM is a crucial measure of the health of a South Korean bank. KB Financial Group also posted a 4 percent increase in loan growth in the first half of the year and accumulated deposits of about USD34 billion.

KB Financial Group’s shares trade at 0.5 times book value and seven times earnings. In 2008 the stock traded at 0.44 times book value. In, 2009, the lender’s shares traded at 1.2 times book value. The bank’s Tier-1 capital ratio stands at 10.91 percent, which is among the highest in its peer group.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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