Korean banking leader KB Financial Group is another interesting investment and perhaps an interesting case study of relative valuations for Australian bank investors. It is the domestic retailing banking market leader in a relatively mature Korean economy. The economy has high, but manageable household debt matched by relatively conservative net government and corporate debt levels. The banking market that has consolidated materially since the Asian crisis of the late 1990’s, with four major private sector players competing in the retail market against disinterested international banks and poorly run government institutions. KB is the leading digital bank in the country with its app downloaded more than any other.
Whilst that industry structure and positioning might sound promising or familiar, that is not why we hold the shares. The three reasons we hold the shares are our:
- Positive view on the economy and rising household asset prices
- Positive corporate restructuring
- Attractive valuation
Positive view of the economy
We believe the Korean economy looks strong given the following indicators:
- GDP growth is averaging a reasonable 3%
- Inflation is benign
- Construction activity, falling since 2008, is picking up
- Bank lending to households is now running double digit and can be maintained with lowering interest rates
- Government is running surpluses
- The hard working Koreans with their world class tech companies (Samsung) and car makers (Hyundai) are running a current account surplus of over 6% of GDP.
The factors listed above combined with the government’s desire to increase domestic spending relative to their strong exports provides a policy setting that is conducive to rising home prices, with KB being a clear beneficiary.
Positive corporate restructuring
Costs reduction, as we have seen in Australia, can be a powerful tool to grow profits in excess of assets for scale retail banks over the long term. KB, with a recently installed management who are focused on improving efficiency, has just announced they are offering packages to 5,500 employees, or 25% of the bank’s workforce. This is a material negotiation win with the unions which are notoriously tough in Korea. If 2,000 of these employees accept we think it increases NPAT by around 10% and we believe this is just the beginning of potential cost initiatives as KB continues to gain customers and market share as result of their digital initiatives.
Lastly is the price we pay. 0.6x tangible book value and a 2015 PE Ratio of 9x, 8x if we factor in the restructuring above. At this price we don’t need a consolidating market to increase margins, a strong economy, double digit household lending growth, rising house prices or a successful restructure to do well. We doubt everything will work out perfectly, but, in a country where the “smart money” is averse to borrowing for a house for fear of losing on the investment, we think the margin of safety provides us an investment with positively asymmetric potential outcomes at current prices.