Upgrade South Korea to 4 Stars: New Asian Tiger primed and ready for an export driven rebound

• The KOSPI Index delivered returns of more than 15% (total returns in SGD terms) across 2023 despite challenging trade conditions.

• The World Trade Organisation expects global trade conditions to improve in 2024, with exports from Asia rising by 5.1%. This should fuel an export driven recovery for South Korea. 

• Given the country’s strong industrial base (particularly in the area of memory chips), we expect Korea to be one of the main beneficiaries of the semiconductor upcycle, where sales growth could reach as high as 40% by 2Q25. 

• Valuations for Korean equities remain undemanding, with an upside potential of approximately 31% by 2025. All things considered, we have decided to upgrade Korea from its current rating of 3.5 Stars “Attractive” to 4.0 Stars “Very Attractive”.

2023 was a year marked by slowing economic growth, high inflation, and interest rates. Rising geopolitical tensions, supply chain disruptions and a sharper than anticipated slowdown in China resulted in lower global trade, which according to forecasts by the World Trade Organization (WTO) is expected to grow by only 0.8% year-on-year in 2023. This is less than half its previous forecast of 1.7%, which was announced back in April 2023.

The cooling trade outlook meant that headwinds were plenty for export-oriented countries such as South Korea. But despite the challenging economic conditions, Korean equities on aggregate managed to finish the year in the green with share prices rising more than 15% (total returns in SGD terms) - an unexpected surprise for a such a heavily trade reliant economy (Figure 1). In this article, we’ll take a closer look at why South Korea (one of our newly minted Asian Tigers) has the potential to continue its outperformance.

Figure 1: Despite challenging conditions, South Korea managed to end the year strong

Promising outlook for South Korea as global trade conditions improve

South Korea is the fourth largest economy in Asia. As an export-oriented nation, Korea is naturally more sensitive to changes in the external environment, particularly trade conditions. In 2022, exports were estimated to account for close to 40% of its total GDP.

Recently, Korea reported 3Q23 GDP growth of 0.6% quarter-on-quarter, beating the median consensus estimate of a 0.5% increase. A significant portion of this growth was driven by a recovery in exports, which contributed 1.6% to the headline number - again underscoring the importance of trade to Korea’s economy. 

Following a period of tepid growth, the WTO projects that exports from Asia will rise by 5.1% in 2024, the highest across all regions. As for Korea, signs of an ongoing recovery are already visible with the country recording three consecutive months of positive export growth as of December 2023, marking a reversal from a nine-month slump (Figure 2). 

Figure 2: Korean exports rose 5.1% year-on-year in December, its third consecutive increase

Among its various trading partners, exports to the US surged 20.8% to USD 11.3 billion, while those to China fell -2.9% to USD 10.9 billion. This marks the first time since 2003 that the US has overtaken China in terms of exports, highlighting the differing prospects of both economies. Although we expect China’s economy to remain weak for the foreseeable future due to the myriad of structural issues it faces, growing trade with other countries such as US and Japan are expected to make up for it. Following the recovery in global trade, South Korea’s trade balance has also swung back into the green (Figure 3). 

Figure 3: After a prolonged period of trade deficits, South Korea’s trade balance is now in the green

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Rising chip demand to propel South Korea’s future growth

In terms of products, semiconductors are without a doubt one of the most important among Korea’s exports, accounting for close to 20% of the total. After a contraction that lasted more than a year, Korea’s chip exports jumped 21.8% year-on-year in December on the back of rising prices and improving demand (Figure 2). 

We believe that the global semiconductor industry is once again on the cusp of a new revolution, powered by the rapid adoption of Artificial Intelligence (AI). Similar to the PC, mobile and internet revolutions in the past, we believe that the AI revolution will bring tremendous opportunities for chipmakers over the next decade (Figure 4). 

Even though the industry is still going through a downturn, we are confident that chip sales will top 40% year-on-year by 2Q25, which will have a significant positive impact on the earnings of semiconductor companies. AI applications, which tend to require highly advanced processors that are capable of handling huge, complex workloads efficiently will be a key driver of semiconductor demand over the next decade. 

Apart from AI, broader trends such as the increasing number of semiconductor applications and the rising silicon content in them will also contribute to greater chip demand in the years to come. 

Figure 4: South Korea is a market that will likely benefit from the AI revolution

Source: iFAST Compilations 
Data as of 3Q23

Structurally higher chip demand is a critical reason why we think South Korea can continue to outperform, especially given the country’s strong industrial base (particularly in the area of memory chips). Two of the Korea’s largest chaebols, Samsung and SK commands a market share of more than 50% in the NAND market. Their dominance is even greater in the DRAM space, with a combined market share of more than 73% as of 3Q23. 

While both companies are still reporting losses for their semiconductor divisions in their latest quarterly earnings (3Q23), it is worth noting that the losses (both the absolute amount and margins) have been narrowing on a quarter-on-quarter basis (Figure 5). Looking forward, the duo expects demand to gradually recover as customers complete their inventory adjustments. An uptick in average selling prices will also boost the earnings for these companies. 

Figure 5: Losses for both companies have been narrowing in the recent quarters 

Both companies are also ramping up capacity for high bandwidth memory 3 (HBM3), a relatively newer type of memory used mainly in high-performance applications such AI. HBM3 is expected to be a cash cow for memory makers as they tend to be several times more expensive than regular memory chips. As a matter of fact, SK Hynix’s CEO said in a recent statement that the market cap of his company could double in three years because of this. 

The government is also very supportive when it comes to developing the country’s semiconductor industry, offering large tax breaks for chipmakers who invest in Korea. Lastly, brighter prospects for Samsung and SK will no doubt have a positive impact on Korea’s equity market, as the two companies are the largest and second largest constituents of the KOSPI index. 

Related Article: Chip sales to top 40% year-on-year by 2Q25. Here’s how you can capitalise on this opportunity

Potential appreciation of the KRW could add to returns 

Heading into 2024, we expect the KRW to fare better against the USD. With US interest rates likely at their peak, we see less room for the dollar to appreciate. On the contrary, the persistent weakness of the KRW has left it relatively undervalued vs the USD, which could trigger a reversion to the mean. South Korea’s growing current account surplus, which is largely driven by higher exports should also support the KRW’s appreciation (given the improving outlook for trade).  

Earlier last year, Korea’s Ministry of Economy and Finance announced a plan to reform the foreign exchange market, with the goal of improving market accessibility, improve the attractiveness of KRW denominated assets and support the overall development of its capital markets. If these reforms were to materialise, it could give a tremendous boost to the nation’s bid to be included in MSCI’s developed market indices, which could have positive repercussions on the economy. 

Upgrade South Korea to 4 Stars “Very Attractive”

Given our expectation for an improving trade outlook and structurally higher semiconductor demand, we see a brighter future ahead for South Korea. The country’s large industrial base, particularly in the area of memory chips will allow it to capture the benefits of an increasingly digitalised world. And with the impending upcycle for the semiconductor industry, we see potential for stronger earnings growth over the next two years, led by chipmakers Samsung and SK Hynix. 

While the KOSPI index has done well relatively well in 2023, valuations remain undemanding, and we believe that there is still plenty of room for share prices to appreciate. Based on our fair PE multiple of 12X, we arrived at a target price of 3220 for the KOSPI Index by the end of 2025. This implies an upside potential of approximately 31%. All things considered, we have decided to upgrade Korea from its current rating of 3.5 Stars “Attractive” to 4.0 Stars “Very Attractive”.

Table 1: Korean equities are expected to see strong earnings growth as the trade outlook improves and semiconductor demand recovers

Figure 6: In the long-term, share prices are predominantly driven by earnings 

In summary, with a consistent current account surplus, supportive government policies, technology leadership and world class brands, we believe that Korea has what it takes to become a new Asian Tiger. Those who are interested to invest in Korea can consider the iShares MSCI South Korea ETF (NYSE:EWY). Alternatively, you can also consider the LionGlobal Korea Fund SGD or the JPMorgan Funds – Korea Equity A (acc) USD. 

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.