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CHART 4: REGIONAL VALUATIONS

[Chart 1: P/E RATIO (12M FORWARD) - Line graph showing trends from 2011 to 2017]
[Chart 2: P/B RATIO - Line graph showing trends from 2011 to 2017]
[Chart 3: RETURN ON COMMON EQUITY - Line graph showing trends from 2011 to 2017]
[Chart 4: DIVIDEND PAYOUT RATIO - Line graph showing trends from 2011 to 2017]

LEGEND: [Blue Square] MSCI ACWI [Orange Square] MSCI KOREA [Grey Square] MSCI ASIA EX. JAPAN
Source: Bloomberg

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Hong Kong and China. Despite the recent strong performance, the market is still inexpensive relative to other regions and indices. MSCI Korea’s price-to-book (P/B) ratio of 1.1x and price-to-earnings (P/E) (12 month forward) ratio of 9.4x are 30% and 31% lower than MSCI Asia ex. Japan Index, respectively as shown in CHART 4.

Three Korean industry groups or sectors currently offer compelling relative valuations when contrasted against other geographies. The Korean Automobiles and Components industry group currently trades at a P/B ratio of 1.0x which compares favorably to Japan’s P/B ratio of 1.4x. When comparing the automobile original equipment manufacturers (OEM), Korean OEMs trade at a P/B ratio near 0.5x book, which is a steep discount to their Japanese rivals. The Korean Automobiles and Components industry group appears undervalued when you also consider the fact that the five-year average return on equity (ROE) was 14.4% versus 11.8% for the Japanese group.

Utilities is another sector where the valuation disparity is stark. Korea’s largest electricity producer currently trades at a P/B ratio of 0.4x despite three stellar years of strong operating margin and prudent capital discipline. By comparison, the Japanese utility sector currently trades at P/B ratio of 1.0x with the Tokyo regional electricity producer trading at a P/B ratio of 0.6x despite ¥10 trillion of possible unreserved liabilities stemming from a 2011 nuclear disaster. Finally, Korean banks are currently trading at a P/B ratio of 0.8x, which compares favorably to Japan’s 1.0x and Italy’s 0.9x. It is estimated that the loan portfolios of the Korean banks have improved in recent years as evidenced by improving ROE. In the most recent fiscal year, Korean banks generated ROE of 7.7%, outperforming Japan’s 7.5% and Italy’s 6.7%.

These discrepancies in valuation have just started to close with the new president and the formation of his cabinet, but Korean market multiples have the potential to converge closer to global levels with a successful execution of corporate reform. We are not advocating that the new government implement heavy-handed methods to incite change among the chaebols. Instead, we believe that working with the chaebols in enhancing governance, minimizing cross holdings, creating board independence and minority shareholder protection, would be well received by global investors and mostly rewarding to chaebol valuations. For a further look at corporate governance in South Korea, please see the following article by Dr. Mariela Vargova.

GLOBAL FORESIGHT THIRD QUARTER 2017 13
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