The Armchair Trader is not alone in being bullish on Korea. Hedge fund Blue Orca thinks the Korean stock market is the next Asian powerhouse too.
Korea has a surplus of publicly traded small to mid-cap companies that, despite positive trends in corporate governance and solid if unspectacular competitive advantages, do not receive the attention and interest they deserve from global investors.
Although there is high domestic market investor participation level in Korea, particularly among enthusiastic retail punters, the global investors, especially in the United States, are largely unaware of the critical mass of impressive companies often trading at excessively low valuations.
The Korean market can be difficult to trade, and because many company filings and press releases are only issued in Korean, and as a consequence several fantastic opportunities pass by unnoticed. Blue Orca reckons they have discovered one such hidden gem.
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DN Automotive Corporation
The hedge fund is long DN Automotive Corporation, a Korean manufacturer specializing in vehicle vibration management systems and machine tools. Despite robust underlying cash flows and improving margins, it languishes at a depressed valuation of 3.1x TTM PE, in part due to the cyclical headwinds in the automotive supply and machine tools industries and in part due to a lack of awareness of its under-the-radar business. This could be about to change.
DN Automotive is in the process of spinning off subsidiary DN Solutions, Korea’s largest producer of machine tools, in an IPO on the Korean stock exchange, expected in May 2025. Early indications are that the IPO will value DN Automotive’s machine tools division at a valuation up to 2x the current enterprise value of entire business. Not only would this be a substantial premium to DN Automotive’s current valuation, but investors would get a free option on the company’s robust automotive parts business.
Blue Orca believes that the forthcoming IPO of the machine tools division offers investors a unique opportunity with 3-4x upside on a near term, defined catalyst.
Beneficiary of supply chain decoupling
Another reason the fund manager likes this opportunity is because DN Automotive currently trades at a 3.1x PE multiple, near 20-year lows, despite an unlevered free cash flow yield of 9% in FY 2024 and a solid legacy auto parts business with significant upside to the EV supply chain.
Despite taking on debt to acquire DN Solutions, the business generated sufficient cash to pay off KRW 673 billion of debt from Q1 2022 to FY 2024. Furthermore, DN Automotive is positioned to be a beneficiary of the decoupling of U.S.-China supply chains, with facilities in China, Korea, and Mexico.
Operationally, the business has shown steady financial improvement. Pro forma EBITDA has increased by 486% since FY 2020. Yet, DN Auto’s valuation has not reflected this progress.
“We believe this disconnect is likely to be corrected with the upcoming spinoff of DN Solutions, which could serve as a catalyst to unlock value in what we view as a fundamentally strong, if historically underappreciated,business,” Blue Orca said in a note to media this week.
“If DN Solutions spins out at an industry average 10x EV/EBIT multiple, which we think would be harsh given that it reports far higher margins than most peers, it would still imply a KRW ~4.1 trillion enterprise valuation, a substantial premium on today’s trading price of the combined entity,” Blue Orca noted. “But we are far more optimistic, considering the superior profit profile of DN Solutions relative to other machine tool producers.”
