Intriguing Assets/1: In Frontier Markets, Vietnam Stocks May Shine

di Gabriele Zilioli (*) - 13/11/2012

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Since MSCI started publishing data on frontier markets trailing valuations (July 2008) they have fallen by 48%. After a recovery in earnings and dividends this leaves the sector on a P/E of 10.3X. That is to say frontier markets offer value combined with high growth. We expect that if developed markets muddle through their issues, frontier markets should do well. If developed markets recover, frontier markets should excel. This means foreign investors are not required to return “en masse” for frontier markets to rise: local investors are, more often than not, larger and more influential. 

The Arab States of the Persian Gulf are the largest frontier markets (Kuwait 30.28%, Qatar 15.31%, UAE 12.57%), followed by Nigeria (12.39%). Vietnam is one of the smallest, with a size of 2.42% that is roughly half of Pakistan, but it's also one of the cheapest and most interesting.

After a slow start to the year, growth in Vietnam picked up sharply in 2Q on the back of aggressive policy easing. The rebound was led by manufacturing production, while construction still remains muted. Following the improvement in data, economists have revised 2012 GDP growth forecast up to 5.2%; and while the global slowdown will impact the outlook for Vietnam, growth should remain relatively robust over the coming years. The country is well-positioned in the long term, benefiting from having a young and dynamic population, low cost of labour, proximity to China and WTO membership. 

Inflation has slowed markedly: from a peak of 23% twelve months ago: headline inflation in August was barely above 5%, but rose to 6.48% in September. In contrast to the dramatic food-led inflationary cycle in late-2010 to mid-2011, the latest bout of inflation risks are largely due to administered prices (in particular healthcare and education). After this belated adjustment, we do not see further price pressures. Total year-to-date interest rate cuts amount to 500bps, with the policy rate now at 10%. However, despite the recent pick-up in growth, our view is that Vietnam is not yet done with the easing, and the State Bank of Vietnam (SBV) may bring the rate down to 7%. In addition to aggressive monetary easing, Vietnam has also launched a round of fiscal easing and could do more on this front. As a result, we see the fiscal deficit widening to 4.5% of GDP in 2012.

IMF reports suggest that FX reserves were just shy of $15bn in early 2012. With a relatively low level of reserves the SBV has little scope to intervene in the currency market to support the dong, which is forecast to weaken. Having said that, Vietnam’s trade deficit has remained low, while net FDI has been resilient, meaning that reserves could gradually rise. We forecast a modest current account deficit of 0.7% of GDP in 2012.

Moody’s downgrades to B2 from B1, revising outlook to stable from negative, looks quite surprising since it's based on old information. It took 21 months since the downgrade in 2010 to realize that: 1) contingent risks from the banking sector will eventually involve government funds; and 2) that it is only mentioning growth prospects hampered by bank credit now, when Vietnam’s banking sector has been deleveraging since March 2011 (credit to GDP fell from a peak of 125.5% in March 2011 to 103% as of Sep 2012e). We think a more legitimate concern is how slow bank restructuring has been. Authorities do not have a clear picture of the scale of the problem. SBV Governor cited a higher 8.6% NPL ratio, while the National Assembly’s economic committee advices capital injection of VND250-300trn (~8.6-10.4% of GDP). There is also insufficient capacity to trade and dispose of bad assets. The longer this drags on, the more vulnerable Vietnam’s economy is to growth shocks, leading to even greater bank sector losses and contingent risks to the government. 

The Vietnam Index has essentially been in a "holding pattern" since bottoming at 378.17 points on the 3rd trading day after news of the arrest of the co-founder of Asia Commercial Bank (ACB) rocked the market in late August, with the trading range having narrowed to between 380 and 400 points. It appears that the market requires a stimulus to awake it from its slumber. The government has laid out a bank restructuring plan to deal with weak banks, provisioning for a NPL sale to an asset management company under the Ministry of Finance. $4.8bn of capital has reportedly been ear-marked for the new agency, however implementation of the plan does remain rather slow, while trust in the banking system is weak given recent banking scandals, and large or under-stated bad debts across the economy. 

The conclusion of the deliberations of the current meeting of the National Assembly (scheduled to last until 21 November 2012), in the form of a plan and timetable to resolve the issues in the banking sector is a perfect catalyst to awake the bulls. Such a development, assuming that our optimism is not misplaced, should act to improve sentiment. After having moved beyond the successful resolution of the macroeconomic concerns of the past couple of years (excessively high inflation, a persistently weak currency and a large trade deficit), investors appear to have forgotten that the government is able to deal effectively with such problems when it sets its mind to it.

We have spotted another development which might well have an extremely positive impact in terms of stimulating foreign investor demand should our interpretation of the possible implications of a recent presentation by the State Securities Commission ("SSC") prove correct. Dr. Nguyen Son, Head of Market Development at the SSC, speaking at the latest Viet Capital's Vietnam Access Day, discussed the pending introduction of domestic exchange traded funds ("ETFs") and mutual funds. Whilst no precise details of timing or structure were shared with the audience, we have seen a translation of a draft Decision of the Prime Minister that seems to suggest that such vehicles will provide an exception to foreign ownership restrictions by having none themselves. We had been concerned that such structures would prove unworkable if foreigners were restricted to 49% ownership as they are with domestically listed closed end funds and would therefore be available only to domestic investors. To explain that; if a mutual fund had net assets equivalent to US$100, $51 of which were owned by domestic investors with the remaining $49 held by foreigners and a foreigner wanted to subscribe, he (or she, or it) would be prevented from doing so unless there was a concurrent slightly larger subscription from a domestic investor. Conversely, with the same ownership, if a domestic investor wished to redeem presumably there would have to be a "forced" redemption of foreign holdings.

Removing the restriction would enable foreigners to subscribe without limitation to domestic ETFs on, for example, the VN30 and HNX30 indices (for Ho Chi Minh City and Hanoi respectively) which would give indirect access to stocks at the foreign ownership limit (assuming that the current limits are maintained). Since the passive nature of ETFs generally means that shares are not voted, we do not see this as being necessarily sensitive and it would be much easier to introduce than a foreign board or non-voting depositary receipts, such as exist in Thailand. Whilst we have no official confirmation that the above is the intention we are convinced that it would act as an exceptional catalyst to foreign demand. The introduction of such products is also likely to prove positive on the domestic side by creating savings products outside of the mainstream banking system given the current (possibly understandable) lack of trust in the banks. 

The US remains Vietnam’s main source of exports at 18% of the total in 2011, then comes China with 11%. The recovery of housing sends an important message regarding the health of the US domestic sector and the Chinese economy seems finally bottoming out, avoiding the much-feared hard landing. These are extra reasons to look at Vietnam with more conviction.  Away from the banking sector and government interference/corruption there is a hive of activity in the country with people busy beavering away running small businesses, working hard and improving their lives. Vietnam is still at a nascent level of development; only 15% of the population have a bank account, many people work in the agricultural sector and have seen sharp improvements in their incomes as food prices have been firm. There are some very good companies trading at very approachable valuations. Other areas of the economy doing well are seeds (corn and rice), rubber, coffee, seafood, fertilisers, pharmaceuticals, construction materials, logistics and oil and gas exploration. 

At the current level the Vietnamese market appears cheap on a 2012 Price to Earnings multiple of 9.9x with earnings growing at 13.7% and a Dividend Yield of 4.6%. The market itself is somewhat distorted by foreign ownership limits and large Exchange Traded Fund flows that buy those stocks that are available regardless of value. It is also possible that higher foreign participation in the banking industry will be allowed to provide extra capital and expertise and this would move prices. It is worth remembering that the average P/E of Thailand, Philippines, Malaysia and Indonesia is 17.5x. So Vietnam trades at a large discount that offers an enviable downside protection in case the needed reforms take longer than we are expecting and forecasting.

There are several closed-end funds dedicated to Vietnam, but none US listed. Considering the size (AUM of $259.3MM), the liquidity (over 150K shares traded daily) and the low cost (gross expense ratio of 0.86) we think Market Vectors Vietnam ETF (VNM) is the best vehicle to play the market. With prices under $16 it is worth accumulating the shares right now. 

(*) Clicca qui se vuoi conoscere meglio Gabriele Zilioli

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