Sunday, June 7, 2020
Holding Company: Distinguishing Between Positives and Negatives in Absolutely Undervalued Zone
More Conservative Discount Rates Need to Be Applied
Holding Company: Distinguishing Between Positives and Negatives in Absolutely Undervalued Zone
  • By Kim Dong-yang
  • April 7, 2020, 10:00
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The author is an analyst of NH Investment & Securities. He can be reached at dongyang.kim@nhqv.com. -- Ed.

 

Amid the impact of Covid-19, the average discount to NAV of major holding companies has widened to 59%, an absolutely undervalued level. But, we believe that more conservative discount rates need to be applied. We suggest SK Holdings (with strong cash flow) and Samsung C&T (to show solid earnings momentum) as our top picks.

New phase requires new approach: Apply conservative discount rates; shareholders’ value rise to be key

Amid the impact of Covid-19, the average discount to NAV of major holding companies has widened to 59%, an absolutely undervalued level. Nevertheless, we believe that more conservative discount rates need to be applied to holding companies in order to better reflect changes in earnings estimates and future values. While discounts to NAVs explain the current corporate conditions, they fail to fully reflect changes in earnings forecasts. In calculating SOTP-derived NAV levels, the market values of stakes in listed subsidiaries represent up to two thirds of holding companies’ EVs. But, earnings estimates adjustments for listed and unlisted subsidiaries cannot be promptly and fully reflected in their share prices, and hence, holding companies’ NAVs.

In our view, it is important to adopt a selective approach, focusing on companies with: 1) smaller cuts to earnings forecasts; and 2) a likely steady rise in shareholders’ value. Given the inevitable influence of Covid-19 on holding companies’ earnings, the downward adjustments to our 2020 OP estimates (vs previous forecasts) are in the double digits at a minimum. The level of adjustment in these forecasts differs by firm depending on their business portfolios, with such differences to further widen as the crisis plays out. Meanwhile, considering the unique characteristics of holding companies, namely: 1) a high dependency on dividend income; and 2) high DPRs, concerns are arising towards a weakening in shareholders’ value in line with likely reductions in dividend income from affiliates next year. During an expected period of downsizing in dividend income from affiliates, asset disposal activities and/or the possession of a solid financial structure should translate into stronger dividend payouts.

Top picks: SK Holdings (boasts strong cash flow) and Samsung C&T (to show solid earnings momentum)

Moving ahead, SK Holdings should continue to show a steady increase in shareholders’ value, backed by: 1) anticipated annual dividend income of more than W1.1tn; and 2) cash influx led by the planned listing this year of SK Biopharm. Currently trading at a 53% discount to NAV, we view SK Holdings’ fundamental value as an investment holding company as remaining valid in light of its strengthening new growth business portfolios.

Meanwhile, the damage to Samsung C&T’s earnings momentum due to the impact of Covid-19 should be less than that at peers thanks to: 1) the securing of stable construction projects; and 2) a likely stronger OP contribution from its bio division. Samsung C&T is to continue booking healthy earnings in line with the strong dividend policies of Samsung Electronics (SEC) which accounts for roughly two-thirds of its dividend income. Samsung C&T’s shares are currently trading at a 59% discount to NAV.