2021 Outlook on Korea - Fundsupermart
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2021 Outlook on Korea In this article, we will analyze the investment opportunities in the two Northeast Asian equity markets—Korea. We believe that the semiconductor industry in South Korea will deliver a potential upside. iFAST Research Team Published on Dec 31, 2020, 10:10 AM Research Market Update , Equity , Small to Medium Companies , Market Analysis , Equity Funds , General Photo by Su San on Unsplash South Korean Equity Market • The rebound in earnings of automakers will propel the market's earnings growth. • Semiconductor industry, dominating South Korean equity market, will benefit from the undersupply of memory chips in the second half of next year. • South Korean equity market is able to realize its current forward earnings, which will mainly be propelled by Samsung and the memory sector. • The target price of the KOSPI will be 2,850 by the end of 2022, which means a potential upside of 26%. Over the past ten years, earnings growth of South Korean equity market has been highly volatile and cyclical. During 2011 to 2014 when China’s economy slowed down, the sales in China accounted for a large proportion of South Korean companies’ sales, which led to their earnings recession for nearly four years. Then, due to the China-US trade friction and the trade disputes with its second-largest trading partner, Japan, between 2018 and 2019, the earnings of South Korean market slumped once again. The plummet in 2019 even created a record low since 2002, along with
the earnings of two major weightings, Samsung and SK Hynix, plummeting by 52.8% and 87% respectively in the year. The P/E of KOSPI was mostly at the historical average of 10x from 2011 to 2019. However, due to the sharp drop in earnings in the past two years and the sluggish earnings growth forecast of this year, the P/E jumped to +1 standard deviation last year, and it has risen to + 2 standard deviations since November this year. Chart 1: Earnings and P/E History of KOSPI Index Six Major Constituents dominate South Korean Stock Market The top six holdings of KOSPI account for 43% of the market capitalization, 40% of the total market earnings, and 52% of the MSCI South Korea Index. Among the six holdings, a mobile phone and semiconductor manufacturer, Samsung Electronics is the largest holding, accounting for 26% of KOSPI and 31% of MSCI South Korea Index. The second-largest constituent is a memory chipmaker, SK Hynix. The two memory/semiconductor companies altogether account for more than 30% of Korean stocks. Among the six major constituents, there are two lithium battery suppliers, LG CHEM and Samsung SDI. LG CHEM is one of the world's largest lithium battery suppliers and the main supplier of Tesla's factories in China. Benefited from the governments’ increased efforts in promoting new energy vehicles through their policies, the projected earnings
growth of the two lithium battery companies are still very strong this year despite the pandemic. On
a side note, NAVER is the parent company of the communication app, Line. Looking ahead, the
earnings growth of these six major constituents this year and the next two years are rather robust.
Table 1: The earnings growth of top six holdings remain robust
Index 2020 2021 2022 2020 2021 Est
Company Sector
Weighting Est EG Est EG Est EG Est PE PE
Samsung Electronics Co
26.45% Semiconductors 29.96% 29.96% 21.04% 16.52 12.71
Ltd
SK Hynix Inc 4.71% Semiconductors 84.23% 73.65% 52.64% 19.51 11.23
LG Chem Ltd 3.75% Chemicals 332.02% 41.82% 19.08% 42.54 30.00
NAVER Corp 3.06% Internet 43.07% 55.07% 24.90% 56.40 36.37
Celltrion Inc 2.90% Pharmaceuticals 96.08% 19.89% 12.33% 76.00 63.39
Samsung SDI
2.46% Telecommunications 62.98% 84.51% 25.96% 65.08 35.27
Co Ltd
Source: Source: Bloomberg and iFAST Compilations
However, excluding these six companies, the projected earnings growth of the overall market in
2020 is still sluggish and has been experiencing negative growth until Samsung and SK Hynix
announced better-than-expected third-quarter results. Since then, the South Korean stock market
earnings growth forecast was revised upward again to 4% currently. But in the coming two years, it
will grow strongly.
Automakers drive market’s earnings growth
The earnings forecast of South Korean equity market this year are mainly dragged down by the
consumer discretionary and financial sectors. However, we believe that the consumer discretionary
sector dominated by automakers will rebound strongly in the next two years and contribute to the
earnings growth of the index. In fact, automobile manufacturers have faced production
interruptions many times this year, such as factory shutdowns and logistics and transportation
interruptions, plus the even larger influence by the epidemic. These pressures are expected to berelieved next year. The rebound in earnings of automakers will propel the market's earnings
growth.
Table 2: Estimated earnings growth of the top three auto manufacturer will bounce back strongly
Index 2020 Est 2021 2022 2020 2021
Company Sector
Weighting EG Est EG Est EG Est PE Est PE
Auto
Kia Motors Corp 1.54% -18.96% 113.59% 11.65% 15.99 7.48
Manufacturers
Auto
Hyundai Motor Co 2.49% -48.92% 199.11% 11.54% 24.83 8.30
Manufacturers
Auto Parts &
Hyundai Mobis Co Ltd 1.52% -22.96% 62.18% 12.21% 13.36 8.23
Equipment
Source: Bloomberg and iFAST Compilations
Earnings of Samsung and Semiconductor Sector will rebound strongly
Another driving factor is the rebounding demand and prices for memory chips. The second-largest
constituent, SK Hynix, is a pure memory chipmaker, while Samsung Electronics is the world's
largest memory chipmaker despite having a wide range of business. With reference to Samsung's
third-quarter performance this year, the smartphone business accounted for approximately 42% of
its revenue, and semiconductors accounted for 35%, of which 75% came from memory chips.Chart 2: Memory chipmakers remain cautious on Capex The rebounding demand for DRAM in mobile phones (estimated to account for about 40% of DRAM consumption in 2020) has made up for the declining demand for server DRAM. Affected by the pandemic, demand for DRAM used for data centres and servers has fallen, but it is expected to start rebounding from the fourth quarter this year. The world’s top three largest memory chip manufacturers have been largely reducing their capital expenditures since 2018. According to their latest guidelines, capital expenditures are expected to remain low until the first half of next year. In fact, the third-quarter results of the top three major memory chip manufacturers were better than expected, indicating that the actual demand was much stronger than estimated. In the third-quarter results teleconference meeting, Samsung suggested that they tended to remain prudent towards the oversupply last year and this year. They would hope to maintain a normal product level to consume the inventory. However, when the economy recovers, the demand for memory chips in data centre servers that have been hit by the pandemic will rebound strongly. From 2018 to 2020, the memory market has shown a pattern of weakening demand and falling prices. Yet looking ahead, we will see a reversal in memory chips demand and prices. Smartphone business contributes the largest part in Samsung's revenue, and Samsung seems to benefit from the plight that Huawei faces. In the second quarter, despite the suppression imposed
by the US, Huawei was able to surpass Samsung for the first time and became the world's largest smartphone manufacturer (in terms of shipments), but it mainly relied on increasing domestic market share (the domestic market share in total shipments increased from about 30% to 60%). However, Huawei didn’t sustain this trend in the third quarter with its shipments declining by 18% year-on-year, the first drop since 2014. At the same time, Samsung and a domestic brand, Xiaomi grabbed large shares from Huawei. In the short run, Huawei will still be prohibited from importing devices that contain US technology, resulting in a decline in production and shipments, which will significantly benefit Samsung's smartphone business. Also, Samsung has just released its latest foldable mobile phone, which is expected to become the main driver for the revenue generated from mobile phone business next year. Chart 3: Target price of KOSPI by end-2022 Considering the abovementioned factors, we believe the South Korean equity market can realize its current forward earnings, which will be mainly propelled by Samsung and the memory sector. Based on the estimated earnings of 2022 and a fair P/E of 12x, the target price of KOSPI will be 2,850 points by the end of 2022, which means a potential upside of 26%. Nikkei 225 Index will focus on new economic sector
As to Japanese market, Nikki 225 is a price-weighted index like the Dow Jones Industrial Average,
but it focuses more on new economy sector evidenced by technology stocks taking up more than
46% of the index. The top 10 constituents are dominated by companies with fast earnings growth,
such the Uniqlo's parent company, Fast Retailing, SoftBank, the third largest semiconductor
equipment manufacturer, Tokyo Electronics, a mechanical equipment manufacturer, FANUC, and
the telemedicine service provider, M3. Unlike KOSPI, Nikki 225 is more diverse without being
dominated by a single industry or stock.
On the contrary, the cap-weighted TPOX is dominated by large old economy sector, including
Toyota, Sony, Nippon Telegraph, Mitsubishi UFJ, Takeda Pharmaceuticals, etc., which is totally
different from Nikki 225 in concepts. In fact, the holdings of Japanese equity funds are closer to the
allocation of Nikkei 225.
The six major holdings are likely to support earnings growth
The overall earnings performance of Japanese stock market this year has been dragged down by
multiple sectors, such as consumer discretionary, consumer staples, financial and industrial sectors.
Even so, these sectors are expected to welcome a sharp rebound in the years to come. Similar to
South Korean market, Japan's consumer discretionary sector contains many automakers. This sector
is estimated to make a comeback next year and contribute to the index's earnings growth.
Table 3: Six major constituents in the Nikkei 225 Index
Index 2020 2021 Est 2022 Est 2020 Est 2021 Est
Company Sector
Weighting Est EG EG EG PE PE
Fast Retailing Co
11.72% Retail 91.25% 19.83% 12.80% 49.38 41.21
Ltd
SoftBank Group
5.95% Telecommunications N.M -50.20% 14.86% 8.17 16.41
Corp
Tokyo Electron
4.84% Tokyo Electron Ltd 18.99% 17.78% 10.68% 25.12 21.33
Ltd
FANUC Corp 3.46% Machinery-Diversified -2.40% 50.17% 22.87% 69.21 46.09
Daikin Industries
3.23% Building Materials -14.79% 39.42% 18.51% 48.36 34.68
LtdM3 Inc 3.15% Internet 47.67% 33.13% 28.45% 189.56 142.38 Source: Source: Bloomberg and iFAST Compilations The six major constituents in Nikkei 225 come from different sub-sectors, accounting for 32% of the index. These sectors are predicted to rebound strongly in the next two years, with the only exception being SoftBank. The company recorded a loss of USD 12.7 billion in 2019 due to the decline in the fair value of its Vision Fund’s investments (such as in Uber and WeWork). Yet in the first half of this year, the company recorded earnings of USD 18 billion, which made up for the loss in 2019 and was close to the level of the whole year of 2018. We believe that the current market’s forecast of a 50% drop in earnings for 2021 is mainly due to analysts’ belief that the Vision Fund cannot repeat its strong performance in the year to come. On the whole, the market believes that Japanese stocks will have an earnings growth of 30% next year. We believe that this goal is not aggressive but achievable. Good earnings prospects expected for Japanese stock market, but high valuations limit its growth Chart 4: Earnings and P/E History of the Nikkei 225 Index
The earnings growth of Nikki 225 has been rather strong over the past decade, which is different from what people might be thinking. It recorded negative growth only in 2011 (suffering from 311 Tohoku Earthquake and Tsunami), last year and this year. Supported by the rising earnings growth, the P/E of Japanese market has declined from 20x above in 2011 to 15x in 2019, even though the stock prices went high. The P/E rose again due to the negative earnings growth in the recent two years. Historically, Nikkei 225 has a high correlation with its earnings per share. On the whole, we believe that the earnings prospects of Japanese stocks in the next two years are bullish without serious fundamental problems. However, the problem lies in their high valuations. Nikkei 225 is one of the best-performing markets year to date, with an increase of more than 13%, accompanied by a forecast of a 10% decline in earnings, causing its valuation to look quite expensive. Chart 5: Target price of Nikkei 225 by end-2022 However, similar to the Hang Seng Index, Nikkei 225 is more dynamic than TOPIX, and it consists of a higher proportion of fast-growing industries in recent years. Therefore, based on a fair P/E of 20x revalued upward, Nikkei 225 is expected to reach 30,000 points by the end of 2022. It can be seen that even though the earnings outlook is still healthy, the increase will be limited by its high valuation.
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