Holding Companies Enjoy High Dividend Income
The author is an analyst of NH Investment & Securities. He can be reached at dongyang.kim@nhqv.com. -- Ed.
Despite rising stewardship code adoption and the NPS’s ongoing efforts to encourage socially responsible investment, shareholder participation and ESG integration activities have remained somewhat tepid in 1H20 owing to sluggish market conditions amid Covid-19. However, we expect ESG investing to expand again, backed by a recovery in the stock market, mandatory disclosure of corporate governance reports, a return of the dividend payout season, and qualitative changes in companies’ governance structures.
Covid-19 effects will inevitably weigh upon earnings at holding companies in 2020. However, given that dividend income represents a major part of holding companies’ cash flow, we advise taking a selective approach focusing on firms whose subsidiaries possess high earnings visibility and are thus able to further enhance their shareholder return policies. We like SK Holdings and Samsung C&T, noting that SK Holdings is to enter a virtuous cycle as an investment holding company on the listing of SK Biopharm, and Samsung C&T is to enjoy strong dividend income as well as stable earnings.
NPS ushers in stewardship code era
Since the NPS introduced a stewardship code in Jul 2018, an increasing number of domestic firms have been adopted it. As of May 2020, 125 companies have adopted the stewardship code, with another 35 are expected to follow suit.
In line with the growing penetration of the stewardship code, institutional investor dissent regarding various types of management proposals (eg, financial statement/dividend payouts, and appointment of executives) surged at shareholders’ meetings in 2019.
While institutional investors’ active exercise of their voting rights is unlikely to have a strong influence on the rejection or acceptance of management proposals, it could lead to an improvement of corporate governance structures. Of note, at general shareholders’ meetings in 2020, even amid increased stewardship code penetration, institutional investor dissent levels dropped slightly y-y, which might suggest that management proposals presented this year better suited shareholders’ interests (vs those presented in 2019).
Amidst spread of shareholder activism in Korea, NPS to more actively engage in corporate management
Shareholder activism cases increasing in Korea: Korea’s representative shareholder activism cases so far are SEC vs Elliot (2016), MKIF vs Platform Partners (2018), and HMG vs Elliot (2019). In response to activist hedge funds’ demands for adoption of unconventional shareholder-return policies and improved enterprise value, companies have presented more reasonable solutions.
In the wake of: 1) the establishment of shareholder activity guidelines (end-2019); and 2) the revision of the Financial Investment Services and Capital Market Act (Feb 2020), the NPS changed its share ownership purpose regarding 56 listed companies from ‘pure investment’ to ‘general investment’. Going forward, the NPS is to more actively engage in shareholder activities (eg, change in Articles of Association, etc) regarding dividends and governance structure improvement.
Companies making efforts to improve shareholder value
Faced with greater dividend demand from institutional investors and rising pressure to strengthen shareholder-return policies for minority shareholders, more companies now present mid/long-term DPR targets and adopt interim dividend policies. In spite of a y-y decline in NP last year (W138tn→W77tn), Korean companies worked to minimize dividend cuts, with 2019 DPR upping to 42.1% (vs 23.7% in 2018), the highest since 2001. With the Kospi rebounding to pre-Covid-19-levels, overall DY has been declining (3.2% on Mar 19, the stock market bottom, to 2.3% today).
Holding companies enjoy high dividend income
Dividend payout ratios (DPRs) for holding companies remain high. On an average basis over 2016~2019, consolidated DPR and non-consolidated DPR for nine major holding companies came to 23.6% and 50.2%, respectively.
With their subsidiaries planning to raise DPRs over the mid/long term, holding companies should enjoy higher dividend income. Holding companies should also keep their high DPR policies in order to enhance shareholder value. That said, due to a possible decline in 2020 profits stemming from Covid-19, holding companies could face a reduction in dividend income in 2021.
Higher discount rates need to be applied to holding companies
Since 2018, the average discount to NAV for holding companies has escaped from the previous band of 20~40%, affected by the trend of avoiding investment in companies with portfolios consisting of diverse businesses.
While discounts to NAVs explain 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 estimate adjustments for listed and unlisted subsidiaries tend not to be promptly or fully reflected in share prices, and hence, holding companies’ NAVs. Accordingly, in our view, despite Kospi rallies, higher discount rates need to be applied to holding companies in order to better reflect changes in earnings estimates and future values.