Standard Life Investments

Through the Lens

Engineering a new business model - Global Equities, Korea

The slowing of emerging Asian economies has led many companies to re-examine their business models as the landscape adapts to a period of lower growth, the ‘new normal’. The quest for market share, at the expense of profitability is no longer the holy grail. For many years profitability was a secondary consideration, increasing market share and building economies of scale with the expectation that profits would automatically follow appeared to be the mantra. Simply, there was too much focus on achieving growth in growing markets, resulting in a number of companies that were terminally unprofitable.

More recently, we’ve seen a drive to ensure that profitability is the ultimate goal and consequently shareholder value. Business models have changed to focus on accretive margins and sustainable growth. This is particularly important in developing economies which are diverse and changing, and competition is at times fierce.

Our Global Equities team is constantly analysing the key drivers of change in markets and through our Focus on Change investment philosophy we have identified Samsung Engineering as a prime example of a business that has changed its business model to pursing profit rather than market share. Given that the company has changed direction towards price discipline from volume aspirations it should result in margin recovery and lower working capital intensity. Future sales margins appear attainable in a competitive market, albeit the number of bidders per contract has significant reduced given the changing environment. Korean engineering and construction companies were once particularly aggressive at growing market share irrespective of profitability. Samsung Engineering is now tendering for fewer contracts and is examining terms and risks to ensure they are in line with the future direction of the company. A change in the CEO also signals the commitment to the change, coming from a subsidiary company he has a reputation for detail and strong execution capabilities. Furthermore, having identified that company growth had outpaced that of systems and key personnel, changes have been made to address these issues.

As emerging Asian economies slow/normalise, bringing the risk of potentially greater costs, achieving profitable growth could be challenging. Companies that have a granular understanding of the local market and profit potential are more likely to succeed. Our belief is that the market has yet to fully appreciate the change in strategy at Samsung Engineering, from one of volume aspirations to price discipline and we are optimistic that earnings potential will be the trigger for change. In the interim, we remain confident of our ability to identify those companies building profit-centric business and value for investors.