Chan Lee and Albert Yong are instructors at Asian Investing Summit 2016.
[In 2015, we] shied away from some of the stocks trading at exorbitant valuations in certain sectors such as cosmetics, pharmaceuticals and biotechnology and bought undervalued stocks instead regardless of the short-term price movements. But we realized later that we were a bit too early in buying some of these undervalued companies, while the bubbles in some sectors lasted longer than we had anticipated.
We have recently seen one of the worst starts for global equity markets in at least three decades, mostly driven by China woes. But we would like to point out that China’s economy is not on the verge of collapse despite the late concerns over China’s management of its economy. In any event, because of Korea’s close trade relationship with China as well as its geographical proximity, the general perception is that Korea is one of the most vulnerable countries to an economic downturn in China. Although it is partly true, at least in terms of equity market performance, the Korean stock market seems to have held firmly compared with other equity markets despite the recent turbulence in the Chinese stock market. We believe this could be interpreted as a sign of the strength of the Korean market.
Although we think that Korea should no longer be categorized as an emerging market, the reality is that the Korean stock market has been performing in line with other emerging markets. As such, the Korean market has been sliding amid the recent emerging market sell-off. While we agree that many concerns about emerging market economies are legitimate, they do not necessarily apply equally to all emerging market countries. The most vulnerable countries at this time are the ones with commodity-based economy and a large amount of current account deficit. Korea is clearly not one of those countries given its consistent current account surpluses and its status as a net importer of natural resources. This may explain why both the Korean equity market and currency fared much better than those of other emerging markets during the recent turmoil. We also note that Korea’s current account surplus recorded more than US$100 billion in 2015.
Nevertheless, it is evident that the Korean exports suffered because the country’s exports to resource-rich countries have declined. Crude oil is a good example. While the short-term benefits to net oil importing countries from the late collapse of crude oil price have been minimal, the slowdown of the oil exporters’ economies has significantly affected the economies which rely on exports to those countries. Korea was no exception. Perhaps the precipitous decline in oil prices was too sudden and unprecedented. However, we believe that as a country whose net import of natural resources comprises a large percentage of the economy, Korea should benefit from the low price of crude oil over the long term.
Another big concern facing Korea as well as other emerging countries is rising interest rates in the U.S. Historically, most countries would subsequently follow the U.S. to increase their rates fearing capital outflow. This time, however, other developed economies, including the European Union and Japan, are moving in a different direction by bolstering their quantitative easing policies irrespective of the U.S. policy. Korea is likely to follow their suit. It is quite uncertain how this unprecedented global economic environment will affect the future U.S. monetary policy as well as the world economy.
It seems lately that wherever we look around the world, we can hardly find any positive news. However, history tells us that a stealth bull market often begins when we can find no rational reasons to believe that the bull market is around the corner. As Warren Buffett once said, “If you wait for the robins, spring will be over.” In that sense, we think that our portfolio companies are well-poised to perform well in the event of an eventual recovery in the global economy because most of our portfolio companies are capable of withstanding the economic hardship and likely to emerge stronger after the dust settles. As such, we will always stick to our core value strategy of buying only competitive companies that are significantly undervalued.
Portfolio Positions Discussion
As a value investor, we buy a stock when its market price is substantially below its intrinsic value and sell it when the price reaches the intrinsic value. Unfortunately, over the past several months, none of our portfolio companies saw their prices reaching their intrinsic value. Therefore, we have made little changes to our portfolio. However, as we are constantly looking for new investment ideas, we have a few stocks in our pipeline as usual. Of course, if we find better bargains in these new ideas, we will sell some of our existing stocks (even though their price has not reached a full value) and go after these opportunities. However, before we make such a decision, we always compare them with our existing stocks in the portfolio. Interestingly, we actually like some of our existing stocks even more as the stock prices have kept sliding down. We think this is mainly because of the recent stock market decline has disproportionately affected individual stocks, including the ones in our portfolio. Thus, we plan to buy more of some of our existing stocks as we get more capital inflow.
Despite the poor performance of the general market, we have a few winners. But these stocks are still trading much lower than their intrinsic value. The price of LG Chem Preferred rose significantly in year 2015 mainly because the successful turnaround of the company’s core chemical business and the positive outlook for its electric car battery business. We think that these favorable trends are likely to continue and that the stock has a lot of upside potential. In addition, we like the prospect that the price gap between preferred and common stocks is likely to narrow further in the near future. This is an extra option value for us. The stock price of Korean Reinsurance, Korea’s only reinsurance company, moved up nicely in year 2015. We think the company is still cheap because the stock is currently trading below its net asset value despite its growth potential in Asia.
Jahwa Electronics, a manufacturer of Automatic Focus Actuators (AFAs) which are used in a high definition camera module of a smartphone, used to be one of our worst performers in the portfolio. As the smartphones are becoming more “commoditized”, many smartphone manufacturers such as Samsung Electronics are increasingly focusing on camera function as a differentiation feature. As the market begins to recognize the growing demand for Jahwa Electronics’ high-end camera modules, the stock price began to rise in the second half of 2015. However, given the company’s growth potential and competitiveness in the core technology, we think the stock is still extremely undervalued.
The stock price of Hankook Tire rose in the fourth quarter 2015 and recovered its early losses in the year. The company is currently the 7th largest global tire manufacturer and is also the most profitable tire manufacturer in the world thanks to its efficient manufacturing facilities and cost advantages. We believe that the company can significantly gain the global market share in the not too distant future as its series of new capacity expansion are to be completed in year 2016 and brand power gets stronger. The company is probably the cheapest tire stock in the world at 8 times its earnings. This is why we think the stock has significant upside potential.
Although the stock price of Samsung Electronics recovered most of its early losses in the fourth quarter 2015, the stock basically went nowhere in 2015. This dismal return is due to its lackluster sales of smartphones as well as the less-than-expected performance of its semiconductor business amid a slowdown in PC sales. However, we think the company is undervalued because the market tends to overemphasize the difficulties of the smartphone business while overreacting to the temporary difficulties of the semiconductor business. But considering its brand power, competitiveness and technological superiority, especially in the semiconductor business, we think that the stock is significantly discounted and the stock price will eventually rise to its true value. Like LG Chem Preferred, we own Samsung Electronics Preferred because of the additional discount.
Unfortunately, some of the stocks in our portfolio went down more than the general market. Kumho Petrochemical, a major manufacturer of synthetic rubbers, synthetic resins and fine chemicals, is the Fund’s worst performer. The stock price went down significantly in 2015 partly because of the delay of the expected synthetic rubber business recovery. Another reason for the stock’s poor performance is that the profits from its combined heat and power plant (CHP) are likely to be smaller than the market’s initial expectation. But we believe that the market has overreacted to the slower-than-expected recovery in the synthetic rubber business. At the current price, we think the stock is extremely cheap because our initial investment thesis of the market cap being even smaller than the value of its combined heat and power (CHP) plant is still valid.
Petra’s goal for investors is to preserve their capital and compound it at a satisfactory return with taking minimum risk for a long period of time. Investors often make the mistake of equating performance with skill. In some instances, a good investment strategy can produce poor performance and a bad investment strategy can produce good performance. Therefore, the real measure of successful investing is whether or not making investment decisions based on the same investment strategy can repeatedly produce satisfactory returns over the long term. We think investing is a matter of probabilities. As such, we would like to emphasize that we have achieved our returns without taking much risk. In other words, if we continue to do what we have been doing in the past, we are confident that we can generate superior returns over a long period of time. Of course, we may experience occasional underperformance from time to time. We always feel lucky to have patient, long-term minded investors as our clients as they have chosen to be in the same boat with Petra for a long journey.
We expect the markets to remain volatile into year 2016, presenting both challenges and opportunities. We remain fully committed to the risk adverse investment of your capital, seeking to hold only compelling bargains. If you have any questions or comments, please do not hesitate to contact us any time.
Editor’s note: Watch Chan Lee and Albert Yong discuss value investing in Korea:
The above post has been excerpted from a letter of Petra Capital Management.
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