Goldman Sachs - Jun2014 Korea Macro Headwinds

June 20, 2014
Asia Pacific
Korea: Macro headwinds,
micro shortfall

Portfolio Strategy Research
Moving to Marketweight
Macro headwinds: a blend of DM/EM exposure + FX strength
Despite being a global cyclical market, Korea equities have benefitted less
than Taiwan from the US recovery as Korea also has meaningful EM
exposure. We expect the US to stay strong, but China may continue to
face growth headwinds despite the current cyclical uplift. The mixed
impact of the two-speed world is a very slow recovery in Koreas
external demand growth, and in this environment a strong Korean Won
has a much more negative impact on exporters margins. These two
macro headwinds may continue to impede Korea equity performance.
While Overweight, MSCI Korea outperformed MXAPJ by 2% (USD).
Likely weaker-than-expected EPS recovery, and partly priced
Korea earnings declined 5% last year and missed consensus meaningfully.
We forecast 18% EPS growth in 2014, with 7pp coming from a
normalization of one-offs. Our numbers remain below consensus, and the
recent P/E multiple expansion suggests the market has already priced in
some of this EPS recovery. Korea is not as attractively valued as suggested
by the headline multiple, which has been weighed down by a few mega
caps, and is 50%+ higher than the equal-weighted figure.
Move to Marketweight; focused implementation approach
We expect Korea to perform in line with the region, with a 12-month KOSPI
target of 2,200 (previously 2,350). We recommend investors to (1) favor
inexpensive earnings recovery stocks, and (2) take profits on names that
have rallied on valuation expansion.
Chinas growth headwinds + partly priced in EPS recovery = Marketweight
Source: FactSet, MSCI.

Richard Tang, CFA
+852-2978-0722 richard.tang@gs.com
Goldman Sachs (Asia) L.L.C.

Timothy Moe, CFA
+852-2978-1328 timothy.moe@gs.com

Goohoon Kwon, CFA
+82(2)3788-1775 goohoon.kwon@gs.com
Goldman Sachs (Asia) L.L.C., Seoul Branch

Kinger Lau, CFA
+852-2978-1224 kinger.lau@gs.com

Sunil Koul
+852-2978-0924 sunil.koul@gs.com

Charles Fang, Ph.D.
+852-2978-1585 charles.fang@gs.com

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The Goldman Sachs Group, Inc. Global Investment Research
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MSCI Korea
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USD indexed performance
June 20, 2014 Asia Pacific

Goldman Sachs Global Investment Research 2
Executive Summary
Neutralizing our Overweight: deltas to our views
We are neutralizing our long-held Overweight stance on Korea. Since we raised our view
to Overweight (on November 29, 2012), MSCI Korea has outperformed MXAPJ by 2%.
Over the past 12 months, MSCI Korea has outperformed MXAPJ by 8% in USD terms, with
the majority of outperformance concentrated in 3Q13. The deltas to our views are below.
1. Our latest analysis suggests that although Korea is a global cyclical market, its
exposure is a blend of both DM and EM.
Fundamentally, Koreas revenue exposures to the US and China are of similar weights
(about 12%). This is different from Taiwan, where exposure to the US is meaningfully
larger at 25% of listed corporate revenues. Empirically, our analysis suggests that the
China growth factor is increasingly more important in trading Korea equities.
Our macro expectation is a steady recovery in the US, but continuing subdued growth in
China. Despite recent better macro data, we believe China is undergoing a moderate
cyclical uplift but continues to face growth headwinds given its structural challenges. The
US or DM exposed part of Korea may contribute positively to the market, but the gradual
deceleration in China demand may be an impediment to performance.
2. The Korean Won is now at its strongest level since the Global Financial Crisis.
The mixed impact of a stronger US/DM but subdued China/EM is a slow recovery in
Koreas external demand growth. In this type of environment, the impact of a strong
currency on exporters net margins is more negative.
3. We expect a moderate earnings recovery, but the market may have moved ahead
of this.
We forecast MSCI Korea to grow its earnings by 18% this year, with 7pp coming from a
normalization of one-offs. Our forecast remains below consensus (23%). The negative
revision cycle may continue, albeit with milder downside. Earnings estimates were cut
sharply late last year, but the market has arguably looked ahead and priced in some
earnings recovery. Equities have held up relatively well, thus leaving less upside in coming
months.
4. Korea market is not as attractively valued as we previously believed.
Our latest finding shows that Koreas seemingly low valuation (cap-weighted) has been
weighed down by a handful of mega caps which have de-rated by 20-30% since 2011. The
markets equal-weighted P/E (14.0X, 1.0 SD above average) is more than 50% higher than
the cap-weighted headline (9.2X, 0.2 SD below average). Korea is still trading at a lower
multiple vs. the region, but the magnitude of discount halves on an equal-weighted basis
(12%, vs. 25% in cap-weighted terms).


Bottom line: KOSPI 2,200; earnings recovery, profit taking
candidates
Our updated 12-month target for KOSPI is 2,200 (previously 2,350), driven by the same
target P/E (9.1X cap-weighted; we estimate that brings equal-weighted P/E down to roughly
13.5X) but lower earnings expectations. We expect the market to perform in line with the
overall region. Given the unexciting headline return, we recommend a focused
implementation approach.
Earnings recovery: There are specific stocks and sectors where earnings recovery stories
are relatively less well priced. Together they are expected to deliver 62% and 28% EPS
growth this year and next, and are currently trading at 12.5X P/E.
Profit taking candidates: On the reverse side, we screen for stocks where ytd performance
is solely driven by valuation expansion, which puts them at risk of correction. Most of
these are small to mid caps.

Exhibit 1: China appears to have explained the
performance difference between Korea and Taiwan
USD performance of MXKR vs. MXTW, and MXCN

Exhibit 2: We expect US to continue its recovery, but
China growth to stay subdued
US and China IP growth vs. trend, forecasts in dotted lines

Exhibit 3: We expect earnings to recover, but the market
may have priced this in
MSCI Korea EPS and index level

Exhibit 4: The low aggregate valuation is weighed down
by a handful of mega caps which have de-rated
P/E change of MSCI Korea constituents

Source: FactSet, Haver, MSCI.
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MSCI Korea
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MSCI China
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US IP growth
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China IP growth
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EPS integer Index level
MXKR
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MXKR
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Currency
concerns
Regional sell-off
on QE tapering fear KEPCO
Hyundai
Mobis
SEC
Kia
HMC
SK Hynix
POSCO
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Market cap (US$bn)
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Almost all mega caps
have de-rated
A large number of stocks
have re-rated since 2011

Korea: still a global cyclical, but a blend of DM and EM
Our core investment thesis in Asia Pacific this year is the recovery in global growth. Our
Global Leading Indicator has constantly improved, albeit slowly, and is now edging
towards the Expansion phase. This generally points to an overweight in the global
cyclical markets in the region, which are Korea and Taiwan. The two markets, however,
have performed very differently year-to-date Taiwan has outperformed the region by 3%
in USD terms, whereas Korea has underperformed by 2%. This prompts a question. Has
the Korea market mis-priced the global recovery, or are there other forces behind this
lackluster performance?
Korea equities have priced in a mild recovery in global growth, but the demand
weakness in China/EM has been a drag on the overall index performance. As we
slice the index by broad economic exposures, we find that global exporters are the
second best performing bloc after defensives year-to-date. However, commodities &
EM exporters have sharply underperformed, reflecting the soft macro in the EMs, in
particular China.
This is clearly illustrated as we compare the performance between Korea and
Taiwan: Koreas underperformance vs. Taiwan seems to be well explained by the
weakness in China equities. In fact, we show that the China growth factor has become
increasingly important when trading Korea equities.
Fundamentally, even though both Korea and Taiwan are externally driven, their
granular exposures are fairly different. Comparing the revenue exposures to the two
largest economies, Taiwan generates 1.5 times as much revenue from the US as from
China (25% vs. 16%), while they are of similar weights for Korea (11-12%). In other
words, the US growth recovery may benefit Taiwan proportionally more than Korea,
and the reverse is true for the influence of China growth.
Our economists are expecting a two-speed world scenario, in which the US
growth outlook is more optimistic while China growth may stay subdued. The
world has become a less homogeneous bloc. Although the global economic cycle is
almost reaching the Expansion phase, this single, global indicator has masked the
divergent growth trends between DM and EM. Specifically, the much softer EM
demand for capital goods may contribute to a smaller improvement in Korean exports
this time, compared to the previous global expansion cycles in 2005 and 2007. Refer to
Asia Economics Analyst 14/16: Global expansion cycles and Asian exports Now
versus then, April 17, and Global Economics Weekly 14/17: What to expect when
Expanding: equity upside, EM unlikely to lead, May 8.
The investment outlook in Korea is complicated by recent moves in the currency.
The Korean Won is at its strongest levels since the Global Financial Crisis (partly
because of its continuously rising current account surplus), and we believe this may
raise market concern again regarding its export competitiveness, particularly against
Japan. In our previous work, we made the point that growth matters more than
currency for this market, and currency headwinds tend to be sector specific (refer to
Asia Pacific Portfolio Strategy: Korea: Time to accumulate, February 21, 2013 and Asia
Pacific Portfolio Strategy: Korea: Outlook improves as 2H approaches, June 4, 2013).
Our latest analysis reaffirms these two views, and finds that currency becomes a
stronger headwind to exporters net margins when the external demand is growing
below average. Our current expectation for Koreas external demand growth is a fairly
slow recovery (mixed impact from stronger DM and remaining subdued EM growth).
Before growth materially improves, currency concerns may remain an overhang on the
global exporters in Korea, in our view. Nevertheless, investors still need to be careful
of over-extrapolating the currency headwind to the whole equity market.

Exhibit 5: Korea market has priced in a mild recovery in global demand (and in turn the
domestic economy), but was weighed down by the weakness in China and EM
Korea performance by sector (market cap weights are shown in brackets)

Exhibit 6: Koreas underperformance vs. Taiwan ytd can
be well explained by Chinas lackluster performance, in
our view
USD performance of MXKR vs. MXTW, and MXCN

Exhibit 7: The China growth factor is increasingly more
important in trading Korea equities
Rolling T-stats of multivariate regression of Korea
performance on US growth (wavefront basket) and China
growth (China cyclical basket)


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Indexed performance
EM exporters
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Defensives
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Global
Exporters
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MSCI Korea
Financials
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Domestic
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MSCI Korea
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Rolling T-stats
US growth
China growth

Exhibit 8: Korea is a globally cyclical market with a high portion of revenue from external
demand, split roughly equally between China and the US
Sum of and difference between US and China exposure of Asian markets

Source: Bloomberg, FactSet, Reuters, MSCI.
Exhibit 9: Relative to trend, US IP growth is above and
growing, while China is below and slowing, opening up
the largest gap since the late 1990s
US and China IP growth vs. trend, forecasts in dotted lines

Exhibit 10: Similarly, the US PMI continues to extend
relative to China
US/China PMI spread

Exhibit 11: The relatively weak exports growth in Korea
recently is due to weak capital goods exports to EM, in
our view
Korea export growth in USD by market and segment

Exhibit 12: Exports in Korea in local currency terms have
barely grown since 2011 because currency strength has
hurt growth in a period of tepid global expansion
Exports index (2011 vs. 2014)

Source: CEIC, FactSet, Haver, MSCI.
Taiwan
India
Korea
Hong Kong
Australia
Singapore
Philippines
Indonesia
Malaysia
Thailand
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Higher external
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Higher US
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PMI spread
90th percentile
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49%
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Cons. Goods
(EM)
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Jan 07
Mar 14
Exports in USD (YOY%) Exports in USD (YOY%)
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Exports (sa) in 1Q2014 in local currency terms
Exports (sa) in 1Q 2014 in USD terms
Exports Index (2011=100)

Exhibit 13: A strong USDKRW spot has been followed by
weaker margins, with roughly a 1.5 year lag, although
the relationship recently seems to be coincident
Net margins of global exporters (s.a.) vs. KRW (parent basis)
Exhibit 14: The correlation between stronger Won and
weaker currency has gradually increased
Correlation between global exporters margins and KRW

Source: Bloomberg, Quantiwise, MSCI.
Exhibit 15: The significance of currency impact vs. revenue growth varies with the macro
environment; currency tends to be a stronger headwind when external demand is weak
Rolling T-stats of multivariate regression of global exporters net margins on their revenue
growth and KRW

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Net margins of
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Correlation between margin and USDKRW
1.5 year lag
Coincident
Relationship
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coincident
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Revenue
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Korea external demand growth
Average
FX was a stronger headwind
to margins during periods of
weaker external demand

Exhibit 16: Margin deterioration in Korea in recent years has come from sectors other than
global exporters; investors need to be careful of over-extrapolating the currency headwind
to the whole Korea market
Net margin series of different sectors (parent basis)


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Net margin
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MXKR
Domestics
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Fundamentals: less connected with macro given margin swings
The top-down macro story for Korea revolves around three pillars, namely US growth,
China growth and the currency. Moving from macro to micro, however, the fundamental
picture is more complicated given the weaker linkage between earnings and economic
growth. Corporate profits in recent quarters have disappointed investors by a wide margin.
We believe this is due to a combination of several sector-specific drivers, some of which
may reverse to contribute positively to earnings going forward. Our top-down earnings
forecasts are still below consensus, although the magnitude of further earnings cuts should
be milder after a 20-30% reduction in estimates over the past 2 years.
Analysts have often overestimated earnings for Korea. Analysts have
overestimated MSCI Korea earnings 8 out of the past 10 years, and they have
overestimated KOSPI earnings every year since 2007. Therefore Korea has been in an
earnings downgrade cycle most of the time.
The macro sensitivity of Korea earnings has reduced due to a combination of
several sector-specific drivers. The relationship between EPS and GDP revisions in
Korea used to be stable, but has recently declined. We attribute the breakdown in
relationship to two non-macro reasons. First, in the non-financial sectors, net margins
have lowered, which offsets part of the revenue growth, and similar to the overall
region we believe the issue of overcapacity is a contributing factor. In addition, the FX
translation losses (due to strong Won) and cost overrun provisioning in the
Engineering & Construction (E&C) companies overseas business have depressed
margins further in 2013. Second, there has been substantial one-off provisioning by
banks on their exposure to shipbuilding and construction sectors throughout 2012 and
2013. The result of all these is a very weak earnings progression over the past few
years: Koreas EPS level in 2013 is still 10% below that of 2010.
The impact of one-off provisioning is significantly negative to 2013 earnings,
which has reduced the EPS growth rate by 6pp, but may boost 2014 EPS growth
by 7pp if they normalize. The majority of provisioning comes from banks and E&C
sectors, for which we estimate the amounts to be W1.5-2tn each in 2013. Based on
1Q14 results, it appears that the cost overrun provisioning cycle is closer to an end for
the E&C companies. Banks were still recognizing some additional provisioning, but
have also started to book some write-backs and partial reversal of previous provisions.
We forecast 18% EPS growth for Korea this year, compared to consensus of 23%.
The earnings weakness in 2013, besides the meaningful one-offs, was also driven by
the soft demand in China (for Commodities), weak product cycles (for autos, and to
some extent for tech), as well as structural trends going on in the retail sector (change
in consumer behavior). Looking into 2014, we expect earnings growth to be
contributed by, in addition to the normalization of one-offs, profit recovery in a few
sectors, including KEPCO (tariff hike & stronger KRW), insurance & securities (loss
reversal of securities), chemicals (recovery in the ethylene and broad plastic supply
chain), autos and consumer electronics (turnaround in the product cycles). Compared
to last year, earnings growth this year is more evenly distributed. Our 2015 forecast is
15% growth.
Net margin reversal will be the primary driver of ROE improvement and value
creation. Corporate profitability in Korea has slipped significantly in the past 3 years
given lower asset turnover, falling margins and constant deleveraging. The cost of
equity at the same time has risen (rising risk premium offsetting lower funding cost),
and hence many fewer companies are now value-creating. For this trend to reverse,
we think margin improvement is the key, especially if deleveraging is to continue, and
we dont see significant room for asset turnover to rise (its at par with the region).

Exhibit 17: Analysts have often overestimated earnings for MSCI Korea
MSCI Korea earnings revisions

Source: I/B/E/S Global Aggregate.
Exhibit 18: as well as KOSPI
KOSPI earnings revisions

Source: I/B/E/S Global Aggregate.
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
F
e
b
A
p
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F
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b
A
p
r
MXKR earnings revisions
2004
2005
2008
2009
2015
2011
2014
2006
2007
2013
2010
2012
T-2 T-1 Actual year (T=0) T+1
Analysts
have
overestimated
MXKR
earnings
8
out of the
past 10 years
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
F
e
b
A
p
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J
u
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A
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F
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b
A
p
r
KOSPI earnings revisions
2009
2008
2015
2011
2014
2007
2013
2010
2012
T-2 T-1 Actual year (T=0) T+1
Analysts
have
overestimated
KOSPI
earnings
every year
since 2007

Exhibit 19: The overestimation of earnings results in the
second worst subsequent earnings cuts in Korea
Median over/underestimation of EPS
Exhibit 20: The relationship between earnings revisions
and the changes in macro has significantly weakened
Rolling R-squared of multivariate regression of MSCI Koreas
EPS revisions on GDP growth revisions of US, China and
Korea

Exhibit 21: given weaker non-financial net margins due
to one-off provisioning, as well as non-operating expense
such as FX translation losses
Breakdown of margins

Exhibit 22: and financials suffered from a low interest
rate environment and one-off provisioning on
shipbuilding and construction exposure
EPS growth of MSCI Korea financials

Exhibit 23: Korea in 2013 was still making 10% less
profits than in 2010; its expected to exceed the 2010
level this year
Market EPS as % of 2010

Exhibit 24: We expect the normalization of one-offs to
boost earnings growth by 7pp, with the remaining core
earnings growth contributed from various profit
recovery sectors
Contribution to 2014 EPS growth by sector

Source: FactSet, I/B/E/S, MSCI, Worldscope.
-20%
-15%
-10%
-5%
0%
5%
10%
15%
H
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K
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w
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Median over/underestimation of EPS (past 10 years)
0%
10%
20%
30%
40%
50%
J
a
n
-
0
8
M
a
y
-
0
8
S
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p
-
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J
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R-squared
How much of Korea's EPS revisions can be attributed to
GDP growth forecast revisions of US, China & Korea altogether?
Korea's EPS revisions
have become less "macro"
2%
3%
4%
5%
6%
7%
8%
9%
10%
04 05 06 07 08 09 10 11 12 13
From EBIT to net margin (as % of sales)
EBIT MARGIN
(+) Non-op inc
(-) Interest/tax
(+) Affiliates' income
NET MARGIN
41%
27%
-57%
-18%
59%
56%
-18%
-29%
-60%
-40%
-20%
0%
20%
40%
60%
04 05 06 07 08 09 10 11 12 13
EPS growth, MXKR financials
T/P
171%
80
90
100
110
120
130
140
150
160
T
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2013/2014E EPS as % of 2010
2013
2014E
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
E
&
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K
R
Ppt contribution to 2014 EPS growth
7pp contributed
from the "absence"
of one-off losses

Exhibit 25: Net margin improvement is critical to ROE improvement in our view, given
constant deleveraging and limited room for higher asset turnover
Dupont analysis

Exhibit 26: Profitability decline has led to a deterioration in value creation amid rising cost
of equity
Value creation analysis

Source: Quantiwise.
Year
Asset
turnover (X)
Net margin
(%)
Financial
leverage (X)
ROAE
(%)
2001 0.92 0.7 3.3 2.1
2002 0.92 2.9 3.4 9.3
2003 0.91 4.1 3.4 13.0
2004 0.99 6.4 3.1 19.8
2005 1.00 5.3 3.0 16.1
2006 1.00 4.5 2.9 13.2
2007 1.04 4.2 3.0 13.3
2008 1.07 2.0 3.3 7.2
2009 0.94 3.7 3.4 11.7
2010 1.01 5.3 3.0 16.3
2011 0.97 5.0 2.6 12.6
2012 0.98 5.1 2.4 11.7
2013 0.93 4.8 2.4 10.6
2014 0.91 5.9 2.3 12.1
2015 0.91 6.2 2.1 11.7
2014/2013 1.0 1.2 0.9 1.1
10.6
12.1
11.7
0
5
10
15
20
2001 2004 2007 2010 2013
MXKR ROAE (%)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
Breakdown by market cap
Value-creating cos
(ROE>COE)
Value-destroying cos
(ROE<COE)

Assessing Koreas valuation: Is it really attractive?
A typical pro argument for the Korea market has been its low aggregate valuations, both
relative to the region and its own history. We find that Korea is not as attractively valued
as the headline multiples suggest, although it is still trading at a mild discount to the region.
The Korea market is not as cheap as it looks. Aggregate P/E and P/B for MSCI
Korea are 9.2X and 1.1X, which are 0.2 SD and 1.3 SD below their respective 10y
averages. The multiples on an equal-weighted basis, however, are 52% and 27%
higher. The 14.0x equal-weighted P/E in particular is 1.0 SD above its 10y average.
Korea is trading at a lower P/E to the region, although the magnitude of discount
halves on an equal-weighted basis. Although it remains the second least expensive
market (after China), the discount reduces to 12% from 25% when we compare the
multiples on an equal-weighted basis (vs. cap-weighted).
The aggregate P/E has been meaningfully weighed down by the mega caps,
while the number of cheap stocks has actually constantly decreased. Since
2011, almost all mega cap stocks have de-rated, in the magnitude of 20-30%. The mid
and large caps have mostly re-rated, and this is reflected in the constantly decreasing
portion of Korea stocks that trade below aggregate market P/E. This explains why
investors have found it hard to find attractively valued stocks with good growth stories.
The large cap discount may be reflecting the corporate governance issue
arising from the chaebols cross-holding structure, and the unwinding of it may
help re-rate these stocks. The cross-holding structure, which is a feature in Korean
conglomerates, has allowed owners and their families to control the companies with
fairly small equity stakes. According to the Fair Trade Commission of Korea, the cash-
flow rights of the owners and families in their chaebols are less than 5% on average,
but through cross-holdings they were able to exercise about 50% voting rights, which
is 10 times leverage. This has led to rising conflicts between controlling shareholders
and non-controlling shareholders. The practice of cross-holdings used to be prevalent
in Japanese and German companies. Although the short-term impact of unwinding is
often negative, over the long-term this helps improve corporate governance, leading
eventually to better stock returns (refer to Japan: Portfolio Strategy: Enter the Dragon:
2012 Outlook, December 1, 2011 for a discussion).
Exhibit 27: The equal-weighted P/E is much higher than the cap-weighted one; the difference is smaller for P/B
12-month forward P/E and 12-month trailing P/B

Source: FactSet, I/B/E/S, MSCI.
4
6
8
10
12
14
16
18
D
e
c
-
0
0
D
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c
-
0
1
D
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c
-
0
2
D
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c
-
0
3
D
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c
-
0
4
D
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c
-
0
5
D
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c
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0
6
D
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0
7
D
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D
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D
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D
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1
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2
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1
3
MXKR 12-month forward P/E (X)
Equal-weighted
Cap-weighted
14.0
Z-score: +1.0
9.2
Z-score: -0.2
Equal-weighted
0.5
1.0
1.5
2.0
2.5
3.0
J
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-
0
1
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0
2
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3
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4
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5
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2
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1
3
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-
1
4
J
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-
1
5
MXKR 12-month trailing P/B (X)
Equal-weighted
Cap-weighted
1.4
Z-score: -1.1
1.1
Z-score: -1.3

Exhibit 28: Koreas valuation discount to the region
halves if we consider equal instead of cap-weighted P/E
Valuation premium/discount vs. MXAPJ
Exhibit 29: Nevertheless, it remains the second least
expensive market in Asia
Valuation premium/discount vs. MXAPJ by market

Exhibit 30: The proportion of cheap stocks in Korea has
constantly declined
% of stocks that trade below headline P/E

Exhibit 31: Almost all mega caps in Korea have de-rated
since 2011; POSCOs P/E was inflated due to continuous
EPS cuts, and NHN re-rated on the secular internet
theme
P/E change of MSCI Korea constituents

Exhibit 32: Owners of Korean conglomerates and their families have less than 5% of cash-flow rights, but exercise about
50% of voting rights due to cross-holding ownership structure
Control structure of Korean conglomerates (left) and the ones with highest and lowest cross-holding wedge, defined as the
shares owned by affiliates as % of outstanding shares (right)

Source: FactSet, I/B/E/S, Fair Trade Commission of Korea.

-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
J
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9
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Relative P/E, Korea vs. MXAPJ
Cap-weighted
Equal-weighted
-12%
Z-score: 0.78
-25%
Z-score: -0.07
-40%
-20%
0%
20%
40%
60%
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P/E discount/premium vs. MXAPJ
Equal-weighted
Cap-weighted
0%
20%
40%
60%
80%
100%
D
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9
9
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2
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3
% of Korean stocks trading below market/region P/E
Market P/E
Region P/E
KEPCO
Hyundai
Mobis
SEC
Kia
HMC
SK Hynix
POSCO
NHN
-100%
-50%
0%
50%
100%
150%
200%
0 10 20 30 40 50 60
P
/
E

c
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s
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2
0
1
1
Market cap (US$bn)
210
Almost all mega caps
have de-rated
A large number of stocks
have re-rated since 2011
2.1
4.4
48.2
2.3
0
10
20
30
40
50
60
Owner Owner + family Affiliates Other related
Control structure of 43 conglomerates in Korea
77
68
67 66 65
39
36 35
34
17
3
1
10
4
16
3
2
4 4
35
0
30
60
90
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Cos. with highest and lowest "cross-holding wedge"
Affiliate holdings
Owner + family holdings

Exhibit 33: Mutual funds are generally underweight
Korea
Total Korea allocation in various regional funds
Exhibit 34: EM funds are overweight telcos, and
underweight Samsung and autos
Top 200 EM funds, AUM: US$340bn

Exhibit 35: Foreigners have bought US$2bn of Korea
equities ytd
Cumulative fund flows

Exhibit 36: Foreign flows had a high correlation with
KOSPI returns historically
Correlation between monthly fund flows and KOSPI returns

Source: Bloomberg, EPFR, Korea Stock Exchange.

Equity Funds
Total
Assets
(US$bn)
Avg.
allocation
(%)
Benchmark
(MSCI)
OW/UW
(bp) vs.
MSCI
Global ex-USA funds 405 2.3% 3.3% -100 bp
GEM funds 246 9.4% 16.0% -660 bp
Global funds 185 2.1% 1.7% 45 bp
AEJ Regional funds 89 12.5% 20.5% -800 bp
Overall (AUM weighted) $925 bn 5.1% 8.0% -285 bp
Korea
-100
-50
0
50
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(
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Korea allocation in EM funds (OW/UW, bp)
Underweight
Overweight
0
5
10
15
20
25
J
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a
n
-
1
4
M
a
r
-
1
4
M
a
y
-
1
4
Foreign fund flows to Korea since 2012 (US$bn)
(0.2)
0.0
0.2
0.4
0.6
0.8
1.0
J
a
n
-
0
1
J
a
n
-
0
2
J
a
n
-
0
3
J
a
n
-
0
4
J
a
n
-
0
5
J
a
n
-
0
6
J
a
n
-
0
7
J
a
n
-
0
8
J
a
n
-
0
9
J
a
n
-
1
0
J
a
n
-
1
1
J
a
n
-
1
2
J
a
n
-
1
3
J
a
n
-
1
4
Correlation between fund flows and KOSPI returns

Implementation
Sector allocation
Our sector allocation does not have a strong cyclical bias as we are Marketweight the
country overall. Rather, we put more focus on the earnings outlook of individual sectors,
and how much it may be in the price. We favor Banks and Construction as their earnings
revisions may stabilize as the provisioning cycle may be closer to an end. We expect
earnings recovery for Staples, but we put the sector at Marketweight given its recent strong
performance. Our Overweight on Energy is a tactical reflection of recent oil price strength,
which may persist into 3Q. We are Marketweight on tech, within which we favor hardware
and internet over SEC & semiconductors. We are cautious on Retail and Steel given their
low visibility on how quickly earnings can turn around. We are also Underweight
Telecoms as we see a likely continuous decline in ARPU trend, and for its rich valuation.

Exhibit 37: We put more focus on the earnings outlook of individual sectors on our sector
allocation recommendations
Sector allocation in Korea

Source: Goldman Sachs Global Investment Research.

Sector allocation
Macro EPS Relative Overall GS
Views Sentiment Valuation Score Allocation
Banks Overweight
Energy Overweight
Construction Overweight
Tech Hardware & Semis Marketweight
Utilities Marketweight
Staples x Marketweight
Autos & Components x Marketweight
Insurance & others x Marketweight
Health Care x x Marketweight
Chemicals x x xx Marketweight
Shipbuilding x x xx Marketweight
Steels x Underweight
Retail x x Underweight
Telecom Services x x xx Underweight

Earnings recovery theme
Excluding the estimated 7pp boost to earnings growth due to the absence of one-offs,
we forecast core earnings growth for Korea this year to be 12%, which is merely in line
with most other markets. Beneath the headline, however, there may be individual stocks
and sectors which are expected to see stronger recovery in earnings, based on our
analysts and/or consensus estimates. We highlight a list of 12 such stocks in Exhibit 40.
Earnings estimates for these stocks seem to be bottoming out recently after a few years of
continuous downgrades. Price performance has begun to turn around too, and we believe
the upcoming 2Q reporting season will be a catalyst for further share price upside if the
results or forward guidance confirm earnings are on track. These stocks trade at 12.5X
2014E P/E on aggregate, with 62% and 28% EPS growth this year and next. We think their
earnings recovery stories are relatively less well priced, as their PEG ratio of 0.3 is less than
half of that of the broad market (0.6).
Exhibit 38: Relative performance seems to have
bottomed out
Relative performance of earnings recovery stocks

Exhibit 39: as have earnings revisions
Earnings revision series

Source: FactSet.
Exhibit 40: We screen for stocks with potential earnings recovery stories, with better-than-market growth/valuation
profile
Screening criteria: Negative 2013 EPS turning to positive in 2014, or negative 2013 EPS growth turning to positive in 2014; Listed
cap above US$2bn, ADVT above US$3mn; estimates and valuations are all based on I/B/E/S

NM: Not meaningful, T/P: Turning into profits (from losses)
Source: FactSet, I/B/E/S.
65
75
85
95
105
J
u
n
-
1
1
D
e
c
-
1
1
J
u
n
-
1
2
D
e
c
-
1
2
J
u
n
-
1
3
D
e
c
-
1
3
J
u
n
-
1
4
Relative perf
Earnings recovery
stocks vs.
MXAPJ
60
65
70
75
80
85
90
95
100
105
J
u
n
-
1
1
D
e
c
-
1
1
J
u
n
-
1
2
D
e
c
-
1
2
J
u
n
-
1
3
D
e
c
-
1
3
J
u
n
-
1
4
12-month forward EPS revision index
Ticker Company Name Industry
Quoted
Price
Listed
Mkt Cap
(US$mn)
6M
ADVT
(US$mn)
13E
EPSg
(%)
14E
EPSg
(%)
15E
EPSg
(%)
14E
P/E
(X)
15E
P/E
(X)
14E
P/B
(X)
GS
Rating
051910 KP LG Chem Chemicals 287,500 18,635 47 -15% 16% 22% 14.4 11.8 1.7 CS
086790 KP Hana Financial Banks 37,700 10,689 30 -48% 18% 21% 9.4 7.8 0.5 CS
096770 KP SK Innovation Oil and gas 103,500 9,360 36 -38% 24% 43% 10.6 7.4 0.6 B
010130 KP Korea Zinc Diversified mining 358,000 6,607 15 -20% 11% 13% 12.7 11.2 1.5 B*
000720 KP Hyundai E&C Group Industrials, conglo. 52,000 5,663 21 -1% 18% 23% 9.8 8.0 1.1 N
097950 KP CJ Cheiljedang Staples & Healthcare 329,000 4,217 17 -55% 90% 48% 20.9 14.1 1.5 N
138930 KP BS Financial Group Banks 14,950 3,307 7 -15% 23% 11% 7.9 7.2 0.8 CS
028050 KP Samsung Engineering Industrials, conglo. 78,400 3,067 24 -235% T/P 67% 23.4 14.0 3.0 N
042670 KP Doosan Infracore Industrials, conglo. 12,850 2,607 16 -129% T/P 161% 37.9 14.5 0.9 B
001450 KP Hyundai M&F Insurance Insurance 29,200 2,553 6 -33% 18% 20% 8.2 6.8 1.0 B
012630 KP Hyundai Development Industrials, conglo. 30,950 2,282 10 NM T/P 75% 21.7 12.4 1.0 B*
139130 KP DGB Financial Group Banks 15,300 2,006 3 -13% 13% 16% 7.6 6.6 0.7 CS
30 -49% 62% 28% 12.5 9.8 0.9 Portfolio (Aggregate Level)

Profit-taking candidates: stocks that have rallied on valuation
On the reverse side, we find a meaningful number of stocks, most of which are small to
mid caps, where ytd performance has been solely driven by valuation expansion. We
believe some of them are at the risk of correction.

Exhibit 41: We screen for stocks
Screening criteria: Valuation expansion in a larger magnitude than price performance; Listed market cap above US$500mn,
ADVT above US$3mn; Buy rated stocks are removed; estimates and valuations are all based on I/B/E/S

Exhibit 42: where ytd performance has been solely driven by valuation expansion
Return breakdown by earnings and valuation changes


Ticker Company Name Industry
Quoted
Price
Listed
Mkt Cap
(US$mn)
6M
ADVT
(US$mn)
Price
perf
(ytd, %)
f12P/E
chg
(ytd, %)
f24 P/E
chg
(ytd, %)
t12 P/B
chg
(ytd, %)
14E
EPSg
(%)
15E
EPSg
(%)
14E
P/E
(X)
15E
P/E
(X)
GS
Rating
168330 KQ Naturalendo Tech Staples and health care 70,700 738 9 44% 53% 56% -16% 23% 33% 28.0 21.1 NC
034730 KP SK C & C Software and services 169,000 8,264 12 25% 26% 24% 34% 131% 11% 17.6 15.9 NC
068270 KQ Celltrion Staples and health care 47,200 4,779 35 23% 58% 91% 43% 111% 42% 21.5 15.1 NC
006360 KP GS E&C Industrials 32,750 2,161 25 15% -7% 23% 19% - 50% 14.8 10.0 NR
037620 KP Mirae Asset Securities Insurance and others 43,500 1,782 4 13% 23% 30% 13% 66% 8% 12.8 11.9 NC
029780 KP Samsung Card Insurance and others 42,000 4,759 5 12% 13% 16% 10% 13% 7% 15.7 14.7 CS
035720 KQ Daum Communications Software and services 94,300 1,251 14 12% 47% 42% 13% -6% 28% 20.5 15.9 N
011790 KP SKC Co. Chemicals 33,850 1,199 5 11% 16% 22% 13% 52% 40% 14.1 10.0 NC
112040 KQ Wemade Entertainment Software and services 36,000 592 15 10% 57% 40% 14% NM 118% 33.2 15.3 NC
-20%
0%
20%
40%
60%
80%
100%
-20%
0%
20%
40%
60%
80%
100%
N
a
t
u
r
a
l
e
n
d
o
S
K

C

&

C
C
e
l
l
t
r
i
o
n
G
S

E

&

C
M
i
r
a
e
S
a
m
s
u
n
g

C
a
r
d
D
a
u
m

C
o
m
m
S
K
C
W
e
m
a
d
e
Price return (LOC, %)
Fwd 12M P/E chg (%)
Fwd 24M P/E chg (%)
Trailing 12M P/B chg (%)
YTD (%) YTD (%)

Disclosure Appendix
Reg AC
We, Richard Tang, CFA and Timothy Moe, CFA, hereby certify that all of the views expressed in this report accurately reflect our personal views about
the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly,
related to the specific recommendations or views expressed in this report.
Disclosures
Option Specific Disclosures
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For options settled by physical delivery, the above risks assume the options buyer or seller, buys or sells the resulting securities at the
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As of April 1, 2014, Goldman Sachs Global Investment Research had investment ratings on 3,662 equity securities. Goldman Sachs assigns stocks as
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