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Why Korea?

Even today, after decades of impressive growth, the Korean equity markets remain an attractive investment opportunity

End of Deflation spiral, Inflation cycle to begin

As soon as the transition from deflation to inflation occurs, higher inflation expectation will encourage consumption and investment

In the past, as inflation expectation rebounded, personal savings declined signaling a rise in consumer spending

President-elect Donald Trump pledged his commitment to increase infrastructure investment

Consumption and Investment likely to improve

China PPI turns positive for the first time in 5 years

PPI turns positive +1.2% driven by China’s restructuring and rising commodity prices

The strengthening in the PPI signals the end of deflationary spiral

In line with PPI, capacity utilization has also started to rise

Transition from monetary to fiscal stimulus

US: Fiscal Deficit to GDP -3.5%. Normalized after GFC when deficit exceeded -10%

China: Fiscal Deficit to GDP from -2.4% to -3%

In 2017, China’s target fiscal deficit will be expanded to a -4% level

Corporate earnings show solid increases

In 2016, Net Profit expected to increase up by 13% yoy to KRW 95 trillion

We believe that net profit will remain in a strong uptrend posting 12% rate of growth, up to KRW 107 trillion in 2017

Resurgence from sluggishness during the past 5 consecutive year. Solid earnings growth expected

Major detractors since 2011 such as Cyclical sectors, namely Energy, Materials, and Industrials are anticipated to bottom out

Operating margin is expected to significantly improve from the 6.8% (2014) to 9.3% (2016F)

Margin improvement is mainly driven by corporates’ extensive operational reform

Assuming OP margin is widened, operating income can accelerate when revenue recovers

Cyclicals’ earnings have become stronger than Defensives

Shareholder friendly policies

Investor favor dividend stocks as dividend yield exceeds bank deposit rates since late 2015

Total dividend payout made by listed companies in KOSPI increased up to KRW 18 Tn, up 28% yoy

Companies continue to expand shareholder return policies

Samsung Electronics and major construction companies have announced shareholder friendly policies inclusive of dividend expansion: SEC committed to pay up to 30~50% of FCF, Construction companies including Daelim’s CFO has been positive since 2014

The current dividend payout ratio of Korean companies is 20.2% (global average: 43%)

Improved shareholder friendly policy will stimulate re-rating of the market

The case for US market in the 1980s: Increased dividends rather resulted in lower dividend yields. Share prices roared up since dividend increases were recognized as strong catalysts

Free cash flow

We expect a turnaround in investments once we advance into the inflation cycle. Cash level of Korean companies?

Cash to Asset – 6.5% – is at its historical high. 35% level including quick assets

Cash Flow from Operating Activities is also at a historical high level

CFF net outflow: Amid delayed investment plans, FCF was used to reduce debt

CAPEX to Revenue is at 6% at its historical low since 2000

FCF to Revenue is at 4.2% at its historical high since 1990

Provides enough ammunition for investments and dividends

Once the economy enters the inflation cycle, we expect Korean companies to reinstate investment activities (Initially investments will be made to enhance operational efficiency)

Key changes will lead to a market rally

We anticipate KOSPI to move up to 2,300 pts level next year (2,300 pts = Current EPS 210P * 2017 earnings growth 12% * x 10.0 PER)

KOSPI’s valuations are currently at x9.4 FWD PER and x0.90 FWD PBR

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