The following industry analysis is provided by Woori Investment & Securities. -Ed.
△ Excessive weighting in IT and auto; is portfolio rebalancing needed?
By Clemens Kang
The Kospi’s upside momentum has weakened due to heavy redemption demand from equity-type funds. However, given that analysts’ earnings forecasts have been revised up in 2Q, as well as in 1Q, and the Korean National Pension Service (NPS) is also buying equity, following foreign investors, we expect the uptrend to remain effective. Accordingly, the key question should be whether to maintain current portfolio weighting, which is heavily weighted to IT and auto, or carry out rebalancing in order to enhance relative returns
Difficult to reduce weighting in IT and auto given improving earnings and heavy demand: As IT and auto generated record high earnings in the low demand season of 1Q, it is not easy to reduce weighting in the two sectors in the high demand season of 2Q. In particular, 40 to 50 percent of foreign buying is concentrated on IT and auto (market cap of 35 percent) and domestic institutional investors facing redemption pressure are selling off other sectors, resulting in a rise in IT and auto weighting. As such, we recommend portfolio adjustment, shifting to second-tier auto and IT companies or beneficiaries of capex, instead of premature sector rebalancing, unless redemption pressure subsides for domestic institutional investors and capital inflow diversifies including pension funds.
However, we also advise gradually increasing exposure to the chemical and energy sectors, given inflationary risks, oil prices, and forex rates. If the yuan appreciates, the strengthening of the won could gain traction, and commodity prices and inflation could also rise. Thus, it is necessary to focus on commodity plays for inflation hedging. In particular, chemical and energy tend to pass higher commodity prices onto ASPs more quickly than other sectors. In conclusion, we recommend maintaining the weighting of semiconductor and auto, while overweighting chemical and energy.
△ Five buffers against margin erosion from strengthening won
By Michael Sohn and Inwoo Park
Market worried that won appreciation will erode Korean auto makers’ margins. The market is concerned that the strengthening won will: 1) weaken Korean auto makers’ export competitiveness and erode their margins; and 2) hinder their US market share expansion by limiting incentives.
However, we expect the following five buffers to protect Korean auto makers’ margins from won appreciation.
1) Rising utilization rate: Hyundai Motor (HMC) and Kia Motors’ global inventories are only 2.5 and 3.1 months, respectively. In line with new model releases, the two auto makers’ utilization rates should continue increasing in 2Q. And, as seen in the past, we expect utilization improvement to protect Korean auto makers’ margins during won appreciation.
2) Sales contribution of mid/large-sized cars: HMC and Kia’s domestic sales contribution of high-margin mid/large-sized cars climbed 4%p y-y and 16%p y-y, respectively, in 1Q. As such, profitability per unit sales is increasing.
3) New car sales contribution: We should focus on HMC and Kia’s improving gross margins thanks to their rising new car sales contributions. Although HMC paid huge incentives to employees in 4Q of 2009. Kia’s gross margin also started to improve as its new car sales contribution surged from 1Q of 2009.
4) SG&A expense-to-sales ratio: Korean auto makers have reduced their SG&A expenses (ie, overseas promotion expenses and provisioning for warranties) during won appreciation and spent more under won depreciation. Over 2004~2009, their SG&A expense-to-sales ratios have fell 2%p on average for won appreciation of W100/US$, off setting margin erosion.
5) US subsidiaries’ earning improvement: Even though HMC cut its US cash incentives per unit by 985 dollars year to year to 1,762 dollars in 1Q, its US market share climbed 0.1% percent year to year. Therefore, we believe sales of its new model, the “YF Sonata,” will accelerate in 2Q, and thus, its US plant’s utilization rate and equity-method gains should improve.
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