Dividends lure foreigners back to Kospi

South Korean shares are poised to test historic highs in the coming months after hitting their best levels in four years last week, as foreign investors are lured by cheap valuations, signs of earnings recovery and increasing dividends.

The benchmark Kospi index has gained 12 per cent in the year-to-date to break through the 2,100-mark, buoyed by foreign buying worth a net Won8.9tn (US$8.34bn) since February. The Kospi hit 2,173.41 last Thursday, just 55 points shy of its high of 2,228.96 reached in May 2011.

Foreign investors bought a net Won4.6tn worth of Korean shares in April alone in a 15-day buying streak, as ample global liquidity boosted their risk appetite for emerging market assets.

Although South Korea's strong performance has been overshadowed by China and Japan, the Kospi has outperformed most emerging market peers in the region this year as it joined the liquidity-driven global rally after falling off the radar of foreign investors over the past three years.

"Foreign investors finally began catch-up buying this year after being significantly underweight Korea for the past several years," says Bryan Song, head of research at Bank of America Merrill Lynch in Seoul.

Their interest in the country's shares was reignited by the Bank of Korea's interest rate cut to a record low of 1.75 per cent in March to help shore up flagging growth in Asia's fourth-largest economy. South Korean growth advanced at its slowest pace in two years in the first quarter. Expectations of further monetary easing and fiscal stimulus have also fuelled market optimism in the country's outlook.

"The market environment is the most favourable of any time with record low interest rates and ample liquidity, which is shifting investors' attention to risky emerging market assets," says Choi Kwang-wook, the chief investment officer at Assetplus Investment.

Analysts say Korea's recent rally has largely been powered by low valuations as the Kospi trades at 11.1 times projected earnings for the next 12 months, versus 16.4 for the MSCI global index. And the growing prospect of earnings recovery, thanks to low oil prices and cheap financing, have contributed to improving investor sentiment.

"Stabilisation of oil prices moderates earnings pressure on cyclical exporters and thus the expectation on earnings recovery does not appear too distant," says Gil Kim, an analyst at Credit Suisse.

Technology companies including Samsung Electronics are driving hopes of a turnround in earnings. Operating profit at Samsung, the Kospi's bellwether, making up 15 per cent of the index's weighting, bounced back in the first quarter after a fall in profits last year, boosting its share price more than 20 per cent over the past six months.

Memory chipmaker SK Hynix reported a net profit of Won1.3tn in the first quarter, beating analysts' consensus estimates, while LG Display posted a four-year high operating profit. Among mid-cap shares, cosmetics maker AmorePacific has been the darling of investors, with its share price surging 75 per cent this year on increasing Chinese demand.

Investors have also been encouraged by hints that big Korean companies will raise dividends, as corporate Korea faces unprecedented government pressure to raise its miserly payouts, which are by far the lowest of any large economy in Asia.

After the government last August announced new tax measures to discourage companies from hoarding cash, Samsung and Hyundai raised their dividends for 2014 by 40 and 50 per cent respectively, while LG Electronics said it would double its payout.

"When the economy is no longer growing as fast as it used to, their capital management is an important factor to consider, especially how much they return to investors," says Mr Song.

Still, investors remain unconvinced over how long the liquidity-driven rally would last, given the country's weak economic fundamentals. The country's exports fell each month of this year as the stronger won, which hit a 7-year high against the Japanese yen, undermines their competitiveness in sectors including auto, machinery, and shipbuilding, while domestic spending remains sluggish.

"The market seems to have overshot its fundamentals," says Mr Choi. "Corporate earnings are unlikely to rise as much as expected due to structural problems with Chinese rivals catching up fast and Japanese players regaining momentum on the back of the weaker yen."

Oh Sung-shik, fund manager at Franklin Templeton Investments, stresses that there should be greater improvements in shareholder return to offset weakening economic fundamentals, in order to convince global investors that Korea is a market to stay strong.

"How far can the Kospi go when the export-driven economy is losing steam?" he asks. "We have seen some progress in shareholder return, but such progress has been too little and too slow to satisfy investors."

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