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Avoid South Korea Oil Plays, Buy Utilities Instead

South Korean oil counters may have posted solid gains in recent trading sessions due to firmer oil prices but CLSA warns that the sector "in trouble."

Shaun Cochran, head of research, Korea at CLSA, says the rally in oil prices may not be sustainable, as the Federal Reserve noted in its recent minutes that rising crude prices is becoming a concern.

"That is a clear and significant risk for the commodity complex, in particular energy prices, because he (Federal Reserve chief Ben Bernanke) is clearly targeting that in order to keep inflation under control, which is higher than he would like right now," Cochran said on Monday.

He says investors should sidestep the energy sector, and gain exposure to the utilities space instead.

"If we see commodity prices, in particular, energy prices come off, they (utilities) will benefit. They are also defensive. Yet if we see tariff hikes come through to improve the energy efficiency of Korea, which is a structural goal of the economy, that could work (too)," Cochran said.

Market analysts are expecting the South Korean government to hikes electricity prices soon, following news it is considering Korea Gas' request for a 5.6 percent hike in city gas prices from July to reflect higher fuel costs — a move that would benefit power companies.

Besides the energy sector the CLSA researcher also favors Internet stocks as he believes they offer a better and safe rate of return.

"High quality companies in the internet space (will) do quite well because they have good earnings growth, the multiples are not demanding and the cash flows are very strong," noted Cochran.

He also suggests investing in Korea's auto sector in order to gain some beta in the portfolio.

"We still like the auto space because that is a structural Korea-specific story that is brand-driven, that is about product improvement."