Interview‘Korea is our top overweight market': J.P. Morgan strategist

J.P. Morgan Asia Equity Strategist Mixo Das / Courtesy of J.P. Morgan

Korea has been and will continue to be the top overweight market in Asia, underpinned by a substantial removal of governance-related discount, enhanced corporate restructuring and financial strengthening within Korean companies, according to an Asia equity strategist at J.P. Morgan.

The country’s benchmark KOSPI index could reach 6,000 points in a bull market scenario over the next 12 months, a rosier revision from the previous scenario in October when its bull scenario had it at 5,000 points, J.P. Morgan Asia Equity Strategist Mixo Das said in an interview with The Korea Times on Wednesday.

Korea’s two world-class semiconductor manufacturers SK hynix and Samsung Electronics are still among the firm's top picks. The SK affiliate’s overvaluation concerns have been largely dispelled, since it is still very cheap on a price to earnings basis, underpinned further by robust demands for inference artificial intelligence (AI).

“Korea is our top overweight market in the region and has been since we upgraded it in June. This continues to be the case,” Das said. “We noted that heading into the June election, and posted our upgrade to overweight that month ... the room for upside in Korea was and still is very substantial as a full removal of governance-related valuation discounts is nowhere close to being priced in. We recommend adding into any pullbacks here.”

The KOSPI surged about 72 percent year-to-date on U.S. dollar terms as of mid-October, the best performing major market in the world this year.

However, the benchmark index is trading at about 1.35 times book value, below what he considers appropriate — around 1.6 times — when factoring in valuations based on the return-generating capability of the Korean market and the strength of Korean corporate balance sheets.

Also advancing the positive outlook is the recent months of rally stemming largely from semiconductors and higher global equities, not the removal of governance discount.

“The recent months of rally happened not only because of the removal of the governance discount. A lot of it has also happened because global equities are higher and the AI rally has restarted and memory names have participated, and so on.”

To isolate the governance impact, the strategist estimated a governance discount of 0.8 times book in May. Out of this, only 0.2 times book, or 25 percent, has been recovered in price to book ratio, he added.

“So, in our estimate, 25 percent of the governance discount removal has happened, which is why we say that there's still a long way for it to be fully priced in.”

Korea’s outperformance

Korea has outperformed Japan by almost 50 percent this year, with Taiwan’s relative performance versus Asia being flat year-to-date.

This year’s strong performance followed last year’s underperformance of about 33 percent, propped up by additional upside drivers both on memory and from the governance discount removal.

“I think the rally in Korea has been justified. If you look at relative performance China, which is very close to Taiwan, both have been flat year-to-date, although on different trajectories. India and ASEAN have underperformed a lot. If global equities are going to be significantly higher over the next few months, which is our view, then a higher market like Korea should continue to outperform.”

SK hynix headquarters in Icheon, Gyeonggi Province / Yonhap

Overvaluation?

Whether SK hynix is overvalued compared to other peers in the AI space is debatable, in his view.

Historically, people have looked at hynix on a price to book basis because it's a very cyclical business. However, memory is becoming more of a structural business, a more stable profit generating business.

This warrants a calculation on a price to earnings basis, he added. SK hynix is a cheap price to earnings stock.

The view is similar to a Monday SK Securities report which set the share’s target price to 1 million won ($690).

The previous “build first, receive orders later” model is shifting to a more stable “secure orders first, expand capacity later” approach, warranting a price to earnings basis valuation.

The strategist said many AI firms in Korea are not of high valuation compared to their global peers.

“The AI names in Korea to my mind aren't really expensive when you compare them to other peers in the AI space. The greatest amount of upside is going to be in the deployment of AI inference, which is more memory-heavy than training-related workloads. Our preference within AI has been with the memory names for several months now and so the Korean IT names fit the bill there," Das said.

Gov’t market communication

The government’s drive toward a third commercial code revision and tax reforms would move shares to the upside.

“If and when mandatory cancellation of treasury shares is enacted, companies with treasury shares, which are primarily insurance and holding companies, will do well. If dividend tax rates are cut, banks, autos and insurance companies, which are the higher yielding stocks, will do well. So there's some room for catch up in those areas. We are pretty happy with how Korea has multiple upside drivers.”

The government’s willingness to listen to market concerns is another positive. Lowering the maximum dividend tax rates to 35 percent is an example.

In July, the finance ministry announced a tax reform plan under which dividend income would be taxed separately at a maximum rate of 35 percent. Previously, dividend income was combined with other financial income such as rent and interest, with a top rate of 45 percent. However, the market considers the rate of 35 percent still high.

“As for the tax reform, there's been a lot of back and forth in terms of what is the right way to do it. The fact that the government is willing to listen to feedback on this matter to me is very positive," Das said.