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Morning Focus October 5, 2018 Korea Morning Focus Sector News & Analysis Major Indices Close Chg Chg (%) Securities (Overweight) KOSPI 2,274.49 -35.08 -1.52 From average to “edge” KOSPI 200 291.78 -4.75 -1.60 KOSDAQ 789.00 -5.99 -0.75 Economy & Strategy Update Turnover ('000 shares, Wbn) Volume Value Fixed Income Monthly KOSPI 304,578 7,461 External uncertainties easing KOSPI 200 105,137 5,703 KOSDAQ 516,196 3,647 Market Cap (Wbn) Value KOSPI 1,522,077 KOSDAQ 262,857 KOSPI Turnover (Wbn) Buy Sell Net Foreign 1,995 2,521 -526 Institutional 1,562 1,625 -63 Retail 3,868 3,287 581 KOSDAQ Turnover (Wbn) Buy Sell Net Foreign 394 395 -2 Institutional 236 225 11 Retail 3,014 3,017 -3 Program Buy / Sell (Wbn) Buy Sell Net KOSPI 1,679 1,907 -228 KOSDAQ 235 203 33 Advances & Declines Advances Declines Unchanged KOSPI 257 587 54 KOSDAQ 332 874 63 KOSPI Top 5 Most Active Stocks by Value (Wbn) Price (W) Chg (W) Value Samsung Electronics 44,700 -1,000 510 DongsungPharm 28,900 4,950 413 Hynix 70,000 -1,700 401 KODEX KOSDAQ150 16,305 -175 272 LEVERAGE Amore Pacific 227,500 -37,000 234 KOSDAQ Top 5 Most Active Stocks by Value (Wbn) Price (W) Chg (W) Value SillaJen 95,200 3,800 298 FOODNAMOO 34,000 -9,350 135 Emerson Pacific 10,900 850 116 HLB 109,000 -3,800 99 NATURECELL 15,100 -200 87 Note: As of October 04, 2018 Mirae Asset Daewoo Research This document is a summary of a report prepared by Mirae Asset Daewoo Co., Ltd. (“Mirae Asset Daewoo”) and published on our website. Please review the compliance notices contained in the original report. Information and opinions contained herein have been compiled in good faith from sources deemed to be reliable. However, the information has not been independently verified. Mirae Asset Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy or completeness of the information and opinions contained in this document. Mirae Asset Daewoo accepts no responsibility or liability whatsoever for any loss arising from the use of this document or its contents or otherwise arising in connection therewith. Information and opinions contained herein are subject to change without notice. This document is for informational purposes only. It is not and should not be construed as an offer or solicitation of an offer to purchase or sell any securities or other financial instruments. This document may not be reproduced, further distributed or published in whole or in part for any purpose. Securities Overweight (Maintain) From average to “edge” The brokerage industry is starting to deviate from average profitability and profit models Firms with good capital efficiency and cost control are continuously delivering ROEs well Issue Comment above the industry average October 5, 2018 Capital increases and improving capital utilization are creating an oligopoly For large brokers with cost discipline, the level of efficiency of their increased capital will be a key driver of share prices Mirae Asset Daewoo Co., Ltd. [Securities/Insurance] Disintegration of the average model Gil-won Jeong +822-3774-1675 The profitability or profit models of brokerage firms have generally exhibited little or no [email protected] differentiation, as firms have commonly relied on commission-oriented, uniform profit models while experiencing margin pressures from intense competition and high fixed costs. As such, investment strategies for brokerage stocks were fairly straightforward. Investors simply adjusted sector weights depending on market conditions, and any differentiation in stock valuations was essentially meaningless. However, brokerage firms’ recent financial performances show the industry is starting to deviate from this average model. Looking at the top 15 brokers by equity capital during the most recent 29 quarters, we identified several firms that have continuously delivered ROEs (based on operating profit) above the industry average. Korea Investment & Securities (KIS), Meritz Securities, and Kiwoom Securities recorded above-industry average ROEs for 25, 27, and 28 quarters, respectively, far more times than the sector average (13 quarters). In some cases, their ROEs outperformed the quarterly industry average by more than 20-30%p. Characteristics that set them apart are the specialization (Kiwoom Securities), transformation (Meritz Securities), and diversification (KIS) of their profit models. Such firms at the edges also trade at a high premium to the sector average (over 0.5x relative to sector P/B). Figure 1. Number of times ROE outperformed industry average (during the past 29 quarters) and relative P/B (times) (x) 30 Number of times ROE outperformed industry 1.8 average (L) 25 Relative P/B compared with sector (R) 1.5 20 1.2 15 0.9 10 0.6 5 0.3 0 0.0 A B C D E F G H I J K L M N Source: FISIS, Mirae Asset Daewoo Research For brokerage firms, recurring ROE can be summed up as: (net operating revenue – SG&A expenses)/equity capital. This can be further divided into two components: 1) net operating revenue/equity capital, and 2) SG&A expenses/equity capital. The higher the former and the lower the latter, the better. Figure 2 shows the number of times these two components were better than industry averages during the most recent 29 quarters; quadrant “B” is the most ideal combination. Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. October 5, 2018 Securities Notably, brokers with large capital are concentrated in quadrant “C” because of their limited differentiation in the latter component. Conversely, brokers with small capital are skewed toward quadrant “A” due to their lack of distinction in the former component. This suggests that from an investment perspective, a key factor to consider is the potential for differentiated improvement in net operating revenue in the case of large brokers, and SG&A reductions in the case of smaller ones. We believe firms located at the edges (far from the averages) within each category, or those in or closer to quadrant B, offer the most compelling investment opportunities. Figure 2. Distribution of recurring ROE components (number of times each component was better than the average during the past 29 quarters) (Net operating revenue/equity capital) 30 25 20 15 10 5 0 0 5 10 15 20 25 30 (SG&A expenses/equity capital) Source: FISIS, Mirae Asset Daewoo Research Rise of oligopoly and importance of capital Another notable development is market oligopoly, or the concentration of profitability and equity capital. The Herfindahl-Hirschman Index (HHI) for equity capital has gradually risen from 550 to 650 as a result of larger brokers aggressively carrying out M&As and expanding their capital. The HHI for net operating revenue has also climbed from 450 to 560. For financial firms, profitability is usually determined by the utilization of equity capital. However, this had not been the case for the brokerage industry, which was highly cyclical and depended heavily on commission income (which is unrelated to capital utilization). The fact that the HHIs for equity capital and net operating revenue are rising at the same time suggests a correlation between capital utilization and profitability is emerging. Figure 3. HHI trends (net operating revenue and equity capital) 700 HHI(Net operating revenue) HHI(Equity) 600 500 400 300 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16 2Q17 4Q17 2Q18 Source: FISIS, Mirae Asset Daewoo Research Mirae Asset Daewoo Research October 5, 2018 Securities In the past, brokerage firms struggled with a vicious cycle of similar profit levels and profit models leading to dependence on the industry cycle and intense price competition, which, in turn, resulted in average ROEs. But now, that average model is disintegrating, and the variance in profitability is widening. The key factor determining profitability is also changing. For the brokerage industry, ROIC represents how much capital and SG&A expenses (specifically labor) are covered by net operating revenue. SG&A used to be an important factor under the traditional brokerage business model. However, that model has become increasingly ineffective, making capital a more critical component. In sum, we believe how well a firm utilizes its capital to specialize or diversify its profit model will determine whether it receives an above-average valuation. A necessary condition for this is the increase of capital (i.e., sizing up), an area where brokerage firms have been making progress. A sufficient condition is the consistent delivery of above-average profitability through a more sophisticated profit model. The difference between average and “edge” will ultimately provide compelling ideas for long-short trades. Mirae Asset Daewoo Research Fixed Income Monthly External uncertainties easing October yield outlook and bond investment strategy ■ Developed markets: Improved sentiment to limit downside to yields Fixed Income Report For developed markets, we expect improvement in overall investor sentiment to limit downside to yields. The preference for safe havens should ease on the back of the US October 4, 2018 Fed’s upward adjustment to its GDP growth forecast and expectations surrounding the US mid-term elections in November. In the eurozone, rising consumer prices should drive upward adjustments to inflation expectations. We also see sentiment improving on the back of waning political uncertainties and F/X volatility in emerging economies. Mirae Asset Daewoo Co., Ltd. [Fixed Income Strategy] We do not believe Italy’s expansionary fiscal policy will have a lasting impact, as the likelihood of Italy expanding fiscal spending has already been reflected in the market Hyeyoung Koo since May, as evidenced by the flight of foreign capital and yield hikes.
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