SMEs' Debt Repayment Capabilities Deteriorating

The author is an analyst of NH Investment & Securities. She can be reached at michelle.cho@nhqv.com. -- Ed.


We herein examine domestic business conditions in order to identify potential corporate credit risks that have emerged through the Covid-19 crisis. Moving ahead, it will be necessary to keep monitoring SMEs’ stability and debt repayment capabilities, which have been deteriorating over recent years. In our view, where Korean banks stand in terms of valuations reflects a significant amount of respective concerns.

Domestic corporate stability check

The signs of economic activity contraction and a slowing in the domestic economy due to the Covid-19 pandemic have been stoking concerns towards a potential rise in corporate NPLs. The Korean government’s announcement of a program to stabilize the domestic economy and financial markets worth W100tn or more at the end of last month implies liquidity provision in order to: 1) stabilize financial markets; and 2) prevent at liquidity crunch at SMEs/SOHOs. Our examination of management indicators at domestic companies shows that competitiveness, stability and debt repayment capabilities of SMEs have been all deteriorating over recent years.

Scenario analysis: If assuming the worst…

In order to determine whether the banking sector is undervalued, we conducted a scenario analysis, assuming the worst case. Under our worst case scenario (Scenario 4: write-off of loans to potentially challenged industries), banking sector P/B is estimated to inflate by about 38%. However, under all other scenarios (excluding the worst-case scenario), banks’ P/B multiples could inflate merely up to 11%. Given such, we believe that current bank sector valuations already reflect a significant amount of the concerns towards an economic downturn due to the Covid-19 crisis.

Until macro backdrop stabilizes, we believe that rock-bottom valuations of banks could be renewed at any time, with share price volatility to expand as a result. Against this backdrop, we adhere to our Neutral sector view, advising investors to wait until dust settles before accumulating banks.

 

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