A Good Korean Turnaround Play

08/30/2007 12:00 am EST

Focus:

Yiannis Mostrous

Editor, The Capitalist Times

Yiannis G. Mostrous, editor of the Silk Road Investor, says a Korean power company offers good exposure to a vibrant economy.

I'm very bullish on Korea. The economy has more defensive qualities than is commonly believed and will be one of the least-affected economies in Asia if the credit crunch goes catastrophic.

The county has learned its lessons from the financial crisis ten years ago and the credit card crisis of the early 2000s. Most important, though, Korea has been successful in diversifying its export base, becoming much more than a tech-oriented economy.

Cars, ships, industrial machinery, chemicals, metals, and petroleum products have become increasingly important pillars of the economy. Diversification is why the country was able to show good export numbers in the last two years, even while tech exports were weak.

Korea has been also raising interest rates, which will allow monetary authorities the opportunity to cut if the need arises. Inflation is well within the central bank’s target range. I’m sticking to my long-held view that the Korean economy will perform well going into 2008.

A [good Korean] turnaround play has come to my attention: Korea Electric Power (NYSE: KEP).

KEP is 51% owned by the government. It controls 100% of the national grid network and has 90% of wholly owned generation capacity. The company recently began investing overseas (mainly in China and the Philippines) and intends to invest another US $1 billion over the next ten years.

KEP’s strength lies in its strong cash flow generation capability. The result of this is a sharp fall in debt with net debt-to-equity ratio falling from 77% to 42%. At the same time KEP trades at attractive valuations and it offers a modest but sustainable dividend of 2.5%.

It's made several changes that will help its performance. And I expect that the new government that will emerge from the upcoming December elections will also work to improve the operating environment.

KEP is planning to sell stakes in at least three subsidiaries for around US $750 million, boosting cash flows and earnings. This will also help with the expansion of its nuclear fleet, a project scheduled to start in the next couple of years.

The new government will, according to what the front-runners have indicated, try to create a more efficient state-owned-enterprise (SOE) sector. In KEP’s case that translates to changing the existing power tariff system. Electric power sector reform is in the offing in Korea, allowing for greater profitability and earnings visibility.

[KEP is] a turnaround play that can offer a long-term upside of two to three times the current stock price. (The ADRs closed Wednesday above $22—Editor.) 

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