Why Korea: Consumer Staples: A New Growth Engine
Editor’s Note: This is the first in a series of posts intended to introduce South Korea as an investment destination from Korea Investment Management, a leading asset manager in South Korea.
Following the financial crisis, the global economy has faced a “general glut”. Specifically, there is an oversupply in manufacturing due to excess capacity and soft global demand, which has resulted in poor conditions for corporate investments. Accordingly, consumer spending has replaced investments as the core growth driver in most countries. Similar to the US and Europe, China and Korea had traditionally relied on manufacturing but now have to focus on fostering domestic consumer spending.
In major developed markets (DMs), consumer spending accounts for 60-70% of GDP. In Korea, private consumption accounts for less than 50% of GDP, lower than the major DMs, but this weighting is expected to rise gradually.
Before the financial crisis, Korea’s economic growth was traditionally driven by export-orientated manufacturing sectors, including home appliances, automotive, shipbuilding, steel and chemicals. And, investments were primarily focused on these industries. Since the global economy has entered a slow growth phase since the crisis, margins are being squeezed in these sectors on fading demand and excess capacity. Furthermore, the long-term growth outlook for Korea’s traditional export sectors is low due to the narrowing technological gaps with Chinese competitors.
On the other hand, Korean consumer sector, including household goods and food & beverage, continue to generate stable earnings regardless of macro conditions. And backed by substantial retained earnings, Korean companies in consumer sector have been investing for the long time to overcome the limits of the domestic demand-oriented companies. Since 2000, many companies have aggressively expanded operating networks across Asia aimed at regional diversification. Furthermore, these companies are also investing in product development to enter new categories, in addition to bolstering the quality and brand value of existing products. Accordingly, we believe Korean consumer staples continue to generate better sales and profits than traditional exporters even after the financial crisis, backed by new regional markets, new products and an improved product mix.
Within consumer sector, we recommend closely monitoring the performance of consumer staples over consumer discretionary. For consumer staples, selective investments in a concentrated brand portfolio centered around mega brands should capture sustained sales growth. For consumer discretionary, sustained large investments will be necessary to maintain market leadership amid technological and policy changes. Despite the slow global economic growth, consumer staples are continuing to generate stable earnings momentum, which is reflected by shares.
Similar trends are also emerging in China. While investments continue to account for most of GDP, China’s economy is gradually shifting towards consumer spending. In fact, the contribution from private spending has gradually increased since 2010. Given the growth outlooks for the service sector and consumer markets, consumption-related companies should benefit going forward.
Recently, Chinese spending patterns have been evolving gradually. As such, Korea consumer products have been gaining market share backed by high product quality and relatively lower prices compared to developed market brands. In particular, Chinese demand has been especially robust for Korean cosmetics and baby products, with China-related sales for these products growing by more than 30% p.a. In addition to consumer staples, Chinese demand is also growing for Korean medical services and tourism. And, this should continue to fuel rapid growth backed by the close geographical proximity.
Korean companies that are positioned to benefit from changes in Chinese consumer spending patterns should grow over the long term, and stocks of these companies are currently being re-rated.