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  1. Home
  2. / Investing
  3. / Stocks

Get Defensive in South Korea With These 5 Stocks

Those playing this market should remain grounded in the real, not digital world.
By ALEX FREW MCMILLAN
Jan 28, 2019 | 02:00 PM EST
Stocks quotes in this article: ORINY, KEP, TM, HMC, F, BMWYY, VWAGY

It was a 2018 to forget for South Korean stocks. Despite the sunnier geopolitical outlook thanks to rapprochement between the two Koreas, investors devoted their attention to bad memory.

Not the historical kind. Chipmakers account for 40% of the net profit of the entire 891-stock Kospi index. Industry prospects and profitability darkened last year -- and it will pay to remain defensive for Seoul stocks in the year ahead.

Earnings for South Korean companies likely fell 8% for 2018, according to Nomura, which had initially forecast an 11% gain. The memory market is bumping its way through a hard landing, bringing Korean equities to a 10-year trough of around 0.8 x book value.

This historical low is merited if the poor prospects for the first half of this year bear out. Korean stocks have staged a recent rally, but don't expect it to last.

The Kospi sold off 22.4% between Jan. 30 last year and this Jan. 3. Equities have run up 9.2% since then, but the Korean market will likely experience volatile, choppy trade until the earnings picture for the chip industry starts to improve.

Meantime, investors should look to defensive sectors in Seoul. That means shipbuilding, healthcare and construction, not the sexier side to South Korea's wired world. Those playing the market should remain grounded in the real, not digital world.

Tickers such as Hyundai Heavy Industries KS:009540 are safe havens in a selloff storm. This tentacle of the Hyundai chaebol builds big ships -- bulk carriers, natural-gas tankers and the like -- and makes oil rigs. Oh and it makes massive machinery, for construction, power plants, excavation.

Hyundai Heavy has seen much heavier orders than its industry peers, particularly offshore shipbuilding demand for its liquefied natural gas carriers. Its merchant marine wing has drawn eight orders for containerships, while the government has been busy buying submarines. Order flow should be up 19% year on year.

Orion Oyj (ORINY) has made its name with the humble Choco Pie. That and its Pokachip potato chips are its biggest sellers for South Korea's second-largest snackmaker, behind Lotte Confectionery.

Orion has expanded production into China, Vietnam and Russia, boosting sales to 1.1 trillion won (US$998 million). It dabbles in entertainment and has a deal with the Everland theme park on the outskirts of Seoul to market the attraction as a fairytale candy world.

China has produced the trouble. Beijing orchestrated a boycott of Korean consumer goods in response to the 2017 installation of the THAAD missile-defense system on South Korean soil. Orion, although a competitor to the Lotte conglomerate whose land houses the system, suffered hard.

Business in China has now built back up to 80% of the total before the THAAD thud. With an aggressive product-launch schedule in 2019, Chinese sales should fully recover this year. Operating profit is already back and above pre-THAAD levels.

Widows and orphans stocks don't come with much better credentials than an energy monopoly. Turn to KEPCO (KEP) to find that. The Korea Electric Power Corp., as it's known in full, generates 93% of all power in South Korea, through nuclear, wind and coal. If that didn't make it defensive enough, it's also 51% owned by the Korean government itself.

The lower cost of crude oil and coal should feed through to KEPCO's earnings this year. After a 0.7% fall in power prices last year, the company is currently generating zero return from its power generation. The government is likely to allow a rise in tariffs of 1% this year, driving the company's fair rate of return back into low single digits, again feeding through to higher profits in 2019.

Hankook Tire KS: 161390 is one of South Korea's best-known non-tech brands. The tire company has its name blazoned across the Europa League, European soccer's second-tier club competition, and also sponsors Spanish giants Real Madrid, both ensuring global exposure. Stateside it's the "official tire of Major League Baseball."

Among the defensive plays, it's more global in outlook, so it is at risk from the global macro slowdown. But earnings should improve at its U.S. factory in Tennessee, from which it supplies Toyota Motor (TM) , Honda Motor (HMC) , Ford (F) , BMW (BMWYY) and Volkswagen (VWAGY) .

Hankook has been raising prices in the United States, driving global retail prices up 2% on average, year on year. That should help produce the turnaround it initially anticipated in 2018, then deferred in forecasts. Now if it could only sort out domestic Korean demand, which has fallen 10% per year, on average, since 2013. The company says market-share recovery in Korea began in the third quarter of 2018. We'll see.

For health-care exposure, turn to Mezzion Pharma KS: 140410. The company makes drugs for erectile dysfunction, overactive bladders and enlarged prostates. Away from the groin, it also targets high-blood pressure and lung disease.

Mezzion looks likely to get a 20-year patent on its drug Udenafil, which treats the rare disease Single Ventricle Heart Defect. If approved by the Food & Drug Administration in the fourth quarter this year as expected, that should be a billion-dollar drug, selling for US$53,000 per year to 19,000 patients in the United States. The FDA may accelerate approval for this "orphan drug," the only medicine to treat that condition, as well as offering US$100 million in vouchers and other incentives.

The drug would then be likely to see speedy approval in the European Union and Japan. That could produce the same kind of corporate trajectory as seen by Alexion Pharmaceuticals ALXN, which started with an "orphan drug," using that to expand out a broader portfolio of products from the cash generated by sales of the first.

Expect life to get a little easier for the Kospi in 2020. Meanwhile, Nomura forecasts that the index will track between a bottom of 1,950 to a high by year-end of 2,250 (it's now at 2,117). That leaves it little upside from here. Time to take shelter with those five safe-haven stocks.

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TAGS: Investing | Stocks | World | Asia

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