South Korea: A Rising Powerhouse in Technology and Green Innovation

At the end of May, we visited South Korea, where we engaged with over twenty companies at their offices, toured a company site, and held discussions with numerous local analysts and contacts. More than half of our meetings were with companies from various climate-related sectors.

A Land of Global Challengers

South Korea is a fascinating country. After the Korean War (1950-53), it was one of the poorest countries in the world, but it underwent a remarkable transformation. It successfully transitioned to an export-oriented economy, initially focusing on heavy and chemical industries. From the 1980s onwards, it was one of the "Asian Tigers" alongside Singapore, Taiwan, and Hong Kong, marked by rapid growth in high-tech and manufacturing industries. However, the Asian financial crisis of 1997-98 hit hard, requiring a bailout from the IMF. The country restructured significantly and, like many other emerging markets, learned valuable lessons. Today, South Korea boasts many companies that are global leaders in their sectors. Those looking for "Global Challengers" will certainly find them in South Korea.

Birth Rate at Record Low

As per capita income has long exceeded the average for emerging markets, South Korea now faces different challenges. Birth rates have been declining year after year. While the rate was 4.5 in the 1970s, it has been below 1 since 2018, and in the capital, Seoul, it is currently 0.55. The total population is projected to peak in 2030. A declining population typically leads to lower consumption, increasing the fiscal burden on a government that needs to support an aging population. This increased financial burden is passed on to the working population, potentially leading to conflicts between older and younger generations. However, we are not there yet. This partly explains why, from an investment perspective, the most interesting publicly traded companies in South Korea are not primarily focused on the domestic market but are often export giants.

The Dominance of the Chaebols

A defining characteristic of South Korea is that a small number of family-controlled conglomerates (known as chaebols) have historically driven the economy. Even today, approximately 85% of the MSCI Korea Index's weight is controlled by individuals or families (for comparison, in other emerging markets, this is 35%). The third generation is now in power, focusing more on retaining control than creating or maximizing shareholder value. This has led to complex structures involving holding companies and cross-shareholdings, partly due to inheritance taxes that can reach up to 60%. These high inheritance taxes are a major reason why many families do not benefit from significantly rising share prices. Additionally, dividends are subject to the marginal tax rate, making dividend payouts unattractive for these families. This clear conflict of interest between controlling and minority shareholders has led to significantly lower valuations compared to most other stock markets, a phenomenon known over the years as the "Korea discount." For many investors unfamiliar with this specific South Korean context, this is usually a strange realization, as family control in the stock market is generally seen as positive in the West. However, in some emerging markets, especially in South Korea, the opposite can sometimes be true. Therefore, a seemingly low multiple or valuation (Price/Earnings or Price/Book) does not always mean that the stock in question should be considered cheap.

Value Up

It will not surprise you that numerous initiatives have been launched in the past to address the issue of the "Korea discount." However, these have never led to lasting success. Earlier this year, a new attempt was announced under the name "Corporate Value Up." The aim is to encourage companies to pay higher dividends, reduce cross-shareholdings, cancel treasury shares, and generally improve capital allocation. Though, the program is voluntary, which immediately tempers expectations. Additionally, the result of the most recent elections in April was not ideal for its further development. The center-left opposition party won the elections decisively, leaving the president without a parliamentary majority for the rest of his term. Since lower inheritance and dividend taxes are crucial to incentivize the families behind the chaebols to change their behavior, the chances for success seem reduced.

Nevertheless, "Corporate Value Up" is a step in the right direction, and it is likely that some relatively small changes will be implemented. We do not expect significant improvements in corporate governance in the short term, which would undoubtedly lead to a revaluation of the South Korean stock markets. However, this does not prevent companies from taking steps towards better capital allocation themselves. Positively, since the beginning of this year, more companies have already decided to cancel treasury shares than in the same period last year.

Strong in the Green Transition

All the aforementioned factors confirm that in South Korea, we are not looking for companies whose future heavily depends on the success or failure of the "Corporate Value Up" program. Instead, a strict bottom-up stock selection and consistent investment process remain crucial.

Over half of our company meetings were in various climate-related sectors. The global electrification of vehicles is still in its early stages and will remain a key growth segment over the next decade. South Korea has secured a strong position in the production of electric vehicles (EVs) and their batteries, becoming a significant exporter. We spoke with companies such as Ecopro BM and LG Chem, which produce cathode materials for EV batteries, competing with Umicore. Ecopro BM, primarily supplying Samsung SDI and SK Innovation, admitted they had focused too much on NMC (nickel, manganese, cobalt) batteries in the past and are now launching a pilot project for the cheaper LFP (lithium, iron, phosphate) batteries. They are also developing solid-state batteries, which some experts consider the future solution for hybrids and EVs. These batteries promise to be safer, with higher energy density, longer lifespan, broader temperature range, and faster charging times. We also met with automaker Kia, which indicated it is not focusing on solid-state batteries. Given the increasing popularity of hybrid vehicles, Kia aims to gain market share with new hybrid models in growth markets like India. Notably, the combined market share of Kia and Hyundai Motors (part of the same group) in EVs in the US is rising, currently exceeding 11%. Generally, they also noted that significant profitability improvement through economies of scale is expected only after launching new mass-market EV models (not before 2027).

Another recurring theme in several meetings was the importance of raw materials for many climate technologies, their supply, volatility, and geopolitical aspects. The battery recycling company SungEel HiTech seemed well-positioned, particularly strong in recycling lithium, cobalt, and nickel, with an average recovery rate of 95%. They also highlighted the impact of rapidly changing battery technologies (NMC vs. LFP) and the necessary flexibility required. However, the company bears a high debt load and faces significant capital expenditures for future expansion, making a capital increase likely. We will continue to monitor the company but are currently not investing in its shares.

Further down the EV value chain, we spoke with battery manufacturers LG Energy Solution and SK Innovation. These two companies, along with Samsung SDI, are among the largest non-Chinese EV battery producers worldwide. A common theme in these meetings was the contracts between them and EV manufacturers. These contracts include a minimum off-take guarantee (often 70-80%), but with the current market pressure on EVs, penalty clauses are not being strictly enforced. Imposing penalties on major customers (for LG Energy Solution these are companies such as General Motors, Tesla, Volkswagen, Hyundai Motors, and Stellantis) is obviously challenging. Although conditions for some penalty clauses are already met, no company reported enforcing them. This forces battery manufacturers to creatively manage the current lower-than-expected utilization rates of their factories. Positively, there were updates on further technological developments to use more silicon anodes in batteries alongside graphite, aiming for significantly shorter charging times. Overall, most companies were cautiously optimistic about the global growth prospects for EV sales in the coming years, given the expected launch of new models and stricter emission targets. Additionally, LG Energy Solution recently announced an agreement with Hanwha Qcells to establish one of the world’s first battery plants dedicated entirely to energy storage (ESS) in Arizona. The global demand for batteries for energy storage systems is expected to grow strongly as these are essential for decarbonizing the power grid. Since renewable energy sources often generate more power than is needed at any given time, battery storage can prevent waste and support the grid when renewable sources produce less energy.

In the offshore wind industry supply chain, we spoke with CS WIND. This manufacturer is a world leader in wind turbine towers and recently entered the market for offshore wind foundations through an acquisition. Their main customers include Vestas, Siemens Gamesa, GE Renewable Energy, and Goldwind, with growth expected primarily from China in the coming months and a return to the US and European markets next year. They confirmed, as other players have noted, that a significant bottleneck in this market remains the limited availability of ships, including names like Cadeler, DEME, or Fred. Olsen Windcarrier.

Lastly, at Doosan Fuel Cell, we discussed their initiatives to reduce carbon emissions from maritime transport, with a new milestone reached in a demonstration project with their fuel cells. Furthermore, hydrogen regulations continue to evolve, which should eventually translate into higher order visibility.

Technology Giants

Earlier this year, the South Korean government announced a multi-year plan to significantly boost domestic chip production. Aiming to strengthen its position in the ongoing chip war, the government plans to build a new semiconductor cluster in Yongin, south of the capital, Seoul. We were eager to hear updates from Samsung Electronics and SK Hynix, two of the world's largest memory chip makers.

Currently, we are in a new semiconductor cycle due to the combination of structural growth from new AI and high-performance computing applications and a cyclical demand resurgence following a period of inventory reduction. In the memory chip segment, SK Hynix stands out as it is currently the primary beneficiary of the demand for HBM (High Bandwidth Memory) in AI applications. They have been collaborating with Nvidia for over a decade and are now their key HBM supplier. SK Hynix is largely sold out for this year and the next, and with an increasing portion of HBM in the product mix, margins are expected to rise significantly. As more production capacity is devoted to HBM, prices for traditional DRAM chips (DRAM is a type of computer memory that helps your device, such as smartphones) run smoothly by temporarily storing the data it’s actively using.) are also on the rise. In the NAND division, much is expected from their subsidiary Solidigm (acquired from Intel). They specialize in an optimized NAND memory (NAND is a type of memory used in devices like USB drives and smartphones to store data even when the power is off.) technology (called QLC), and their SSDs (Solid State Drives) are in high demand among major tech companies. The growth of data centers, which use these drives for their AI servers due to their speed, space efficiency, and lower power consumption, is driving significant growth in this market segment.

The competition is also advancing, with rival Samsung Electronics claiming that they will soon surpass SK Hynix technologically with their new generation of HBM chips (12-Hi HBM3E). Samsung is confident about soon being qualified as a supplier to Nvidia. However, they noted that in this cycle, the highest margins from the previous cycle are unlikely to be matched because the longer-duration contracts for HBM chips, while providing more visibility, also mean prices cannot be easily raised later. Since Samsung had fallen behind in the development of HBM memory chips, recently replacing the head of their semiconductor division, the atmosphere was somewhat subdued. However, if they succeed in becoming a supplier to Nvidia, sentiment around this company could quickly improve. They were also cautiously optimistic about a possible turnaround for their loss-making foundry division, anticipating new orders in the second half of the year.

Other Companies We Met

We also spoke with Naver, often referred to as the Google of South Korea. Over the years, they have expanded their offerings to include e-commerce, fintech, and cloud services. Their main competitor is Coupang, sometimes dubbed the South Korean Amazon, and the competition is fierce. Naver has a notably conservative approach to AI investments, with only 5% of their customer base currently having access to their AI search engine. They adopt this cautious strategy because they see limited opportunities to generate additional revenue that would justify the significant AI investments. While a cautious approach is commendable in some respects, it leaves them vulnerable to global competitors who are heavily investing in AI.

We also had interesting meetings with companies such as Samsung Biologics (biopharmaceuticals), Amorepacific (cosmetics), Park Systems (microscopic measurement and analysis instruments), NCSoft (gaming), Classys (medical aesthetics devices), and many others. Often, these were leading players in their specific niche markets.

South Korea remains a particularly interesting country and seems to have sufficient strengths to remain among the world's leaders in various growth markets in the coming years.