Playing Korea's Recovery

First, remember Korean trading firms are not like the Japanese sogo shoshas (trading giants like Itochu, Mitsui or Marubeni) after which they were modeled. While the Japanese trading groups are loosely linked, the chaebol are tightly knit, with many intra-group transactions. The sogo shoshas are professionally managed, but their Korean counterparts are still run by family patriarchs. And the Japanese trading companies are much bigger players in global commodity markets. Moreover, while Itochu or Marubeni make piles of money in triangular trading - selling Latin American commodities to Europe or African commodities to America - most Korean trading firms concentrate on Korea-related exports (which account for about 70% of revenues) and imports. The major exceptions are Daewoo and Hyundai. Hyundai wants to become a triangular trader as well as a bulk commodities dealer (it has invested in oil fields in Vietnam, a coal mine in Australia and a zinc mine in Canada). Since Korea outlaws investment holding companies, many chaebol are centered around a trading company with complex cross-holdings that are so difficult to untangle that even the Fair Trade Commission, the Seoul body that monitors the giants, admits it is hard to figure out the true value of a group.

Park Shin Gyu, an analyst at Ssangyong Investment & Securities in Seoul, says: "On the face of it, this may not be the right time to be in general trading companies given the economic climate, falling exports and sluggish stock market," but when stocks get so beaten down, you wonder whether it's time to accumulate before everyone else starts jumping in.

Still, he says, "You should buy trading company stocks if you agree with one basic assumption: That there will be an export recovery within the next three months." If the yen stays close to 110 to a dollar and the global electronics slump is prolonged, then all assumptions of recovery will be thrown aside. Park explains why trading companies are hurting more than their manufacturing counterparts: "When exports are sluggish or export prices fall, the chaebol would rather trim the margins of the trading companies than of their manufacuring affiliates." For example: As DRAM prices plunged this year, the trading arm of Samsung, Korea's biggest chaebol, cut its margins on DRAM exports to the minimum. After all, if Samsung Electronics were exporting DRAMs through an independent firm, its profits would be even further squeezed. Since the trading and manufacturing businesses are part of the same group, the chaebol would rather starve the trading company to feed the flagship electronics firm, which needs the money to stay on the cutting edge of technology. Says Park: "From the owner's point of view it doesn't matter whether the left pocket has more or the right."

ING Baring's Greta Pak has a long-term buy on Samsung Co., and Park likes it too. He says: "The stock price has been more than halved in ten months and people are still very pessimistic." With such pessimism prevailing, he figures that a price below the 9,000 won level may be a bargain. The upside? When the recovery is in full gear sometime next year, Park figures Samsung Co. might easily sell around the 20,000-25,000 won level. He also likes LG International, the trading arm of LG group. LGI recently merged with the chaebol's textile and garment firm, Bando Fashion. Moreover, LG group in the past had allowed its LG Electronics and LG Semicon to do some trading themselves. "Now, everything goes through LGI," says Park, "and that will boost turnover and profits."

Jun B. Song of Credit Lyonnais Securities says Daewoo Corp is different from all other trading companies because its group trading volume is just 40% of its turnover compared to 75% for Samsung Co. He figures Daewoo Corp. is really three separate companies: a pure trading operation, an investment firm that holds stakes in lots of ventures and a construction company. "Their construction arm is active mainly overseas and in big projects within Korea. Unlike other large domestic builders, Daewoo has very little exposure to the glutted housing market." And while other trading firms have seen their revenues grow slowly because of falling exports, Daewoo's exports are up 50% in the first six months of this year.

Ssangyong's Park, however, has mixed feelings about Daewoo Corp. exactly because it is not like other large trading firms. In addition to operating a contruction business, Daewoo Corp. is the chaebol's investment vehicle that takes stakes in other Daewoo affiliates domestically and abroad, mainly in China, Vietnam, Eastern Europe and Latin America. Daewoo Corp. also has the largest triangular trading revenues of all Korean trading firms. "If you are betting on Korea's overseas expansion and you are bullish on emerging markets, Daewoo is a great stock," says Park. "But if you want to play the domestic recovery you might want to avoid it."

Song likes Kolon International, the eighth largest trading company in Korea: "They may be smaller than the big guys but they have better margins because they concentrate more on high-margin import business rather than low-margin exports." Kolon holds the franchise for automaker BMW.

Not all analysts agree that trading companies are the way to play a Korean rebound. Dongbang Peregrine's Rhee says: "Trading companies are diversified, and might give you exposure in construction or, in the case of Daewoo, projects in Eastern Europe. If you really want to play the Korean domestic recovery story, you should be buying cyclical stocks like chemicals and steel. "