The Flying Dutchman:Korea: Don’t write off the export story just yet

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: The Hongkong and Shanghai Banking Corporation Limited View HSBC Global Research at: https://www.research.hsbc.com   It’s been a cold winter as China’s slowdown has hurt exports  But there are early signs of green shoots – niche tech markets and culture, for example  We remain neutral on Korean equities and offer stock ideas that should outperform the local index Tough going When China is the biggest market for your exports, life is going to prove difficult when the Chinese economy slows. Take Korean carmakers for example; only 15% of their sales are domestic, with around 50% coming from emerging markets, half of which are from China. Tech offers hope... But while exports remain soggy in the face of weak global demand, the news is not all bad. The recovery in domestic demand since the outbreak of the MERS virus last year has been impressive, while parts of the tech sector offer hope. For example, HSBC analysts believe folding screens will arrive sooner than first thought, while the continued electrification of vehicles is another area of potential. ...culture too Perhaps the most intriguing story is the Korean cultural wave, known as Hallyu, which covers everything from food, fashion, cosmetics and TV dramas. It continues to sweep the region, driving growth in tourism and retail sales, particularly in cosmetics, and offers opportunities for Korean entertainment content makers. Earnings and valuations Consensus forecasts 2016e EPS for MSCI Korea to contract by 3.1% y-o-y. This is unusually pessimistic for the start of the year. When earnings visibility is low, valuations become more important when making investment decisions. Again, opportunities are limited. At a 12-month forward PE of 10.2x, MSCI Korea is already trading at an 11% premium to its five-year average. In our view, it makes more sense to look at each sector individually. We believe utilities, consumer discretionary (autos), tech and telecom offer better risk-reward opportunity on a relative basis. We remain neutral on Korean equities. MSCI Korea sector valuations 12m fwd PE 5 yrs. avg Premium/discount to avg Utilities 4.9 12.4 -60.2% Financials 8.3 8.7 -4.7% Cons Discr 7.6 7.6 -0.6% Telecom 9.6 9.5 1.5% Energy 9.5 8.8 7.4% Materials 11.4 10.2 11.9% Tech 10.1 9.0 12.0% Industrials 15.1 12.1 24.9% Cons Staples 21.9 16.9 29.8% Healthcare 40.6 21.3 90.3% MSCI Korea 10.2 9.1 11.4% Source: MSCI, IBES, Thomson Reuters Datastream, HSBC 4 March 2016 Herald van der Linde* Head of Equity Strategy, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited heraldvanderlinde@hsbc.com.hk +852 2996 6575 Devendra Joshi* Equity Strategist, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited devendrajoshi@hsbc.com.hk +852 2996 6592 Brian Cho* Head of Research, Korea The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch briancho@kr.hsbc.com +822 3706 8750 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The Flying Dutchman EQUITIES EQUITY STRATEGY Korea Korea: Don’t write off the export story just yet  EQUITIES  EQUITY STRATEGY 4 March 2016 2 Shivering through Hong Kong’s coldest day in the last 60 years put us in the right state of mind for a visit to Seoul recently, both with regards to the weather and prevailing investor sentiment. The temperature on arrival was a character-building minus 15 Celsius, while in terms of mutual funds, Korea is the least loved market in Asia. However, could investors be rethinking their significant underweight positions on Korea, and if so, what was the mood at ground level? Mutual funds are underweight Korea... ... with relative holdings still deep in negative territory Source: EPFR Global, HSBC. Note: The red dot shows the z-score of the current fund weight with respect to the neutral benchmark, the black dot shows the same three months ago, and the grey bar represents the five-year range. Data as of Dec 2015 Source: EPFR Global, HSBC Judging by our meetings with investors, the mood matches the weather. This is understandable as Korea’s economy is export led and sluggish global growth is not exactly a secret. The recovery in domestic demand since the outbreak of the MERS virus is impressive but exports still look soggy, largely because of the slowdown in growth in China, one of the biggest markets for Korea’s manufacturing exports. But don’t write off the export story just yet. We see some green shoots emerging in the conventional sectors such as tech and other themes centred around the rise of inbound Chinese tourism and the popularity of Korean culture also show a lot of promise. Part of this is driven by the Japanese yen. The yen has depreciated by c28% against USD sinc