Vietnam Has Outperformed – What Now?
Investment Q&A: Why we remain bullish on Vietnam, the consensus market view, opportunities and risks
This Insight is not investment advice and should not be construed as such. Past performance is not predictive of future results. Fund(s) managed by Seraya Investment may be long or short securities mentioned in this Insight. Any resemblance of people or companies mentioned in this Insight to real entities is purely coincidental. Our full Disclaimer can be found here.
This Insight is an extract adapted from the Panah Fund letter to investors for Q1 2018.1
In late March, the CFA Institute chapter in Vietnam kindly invited me to participate in the panel discussion at their Annual Forecast Dinner. The discussion covered a broad range of topics related to the Vietnamese economy and markets, as well global issues relevant to the country.
I am most grateful to the local CFA committee for providing me the opportunity to participate in this event. The session was moderated by an experienced local fund manager. She and the two other Vietnamese panel participants – a respected economist for a local Vietnamese bank, and a dynamic strategist for a local fund management house – were undoubtedly better-qualified than me to comment on the Vietnamese economy and markets. Nevertheless, we hope that the perspective of a foreign fund manager was of some interest to those who attended.
The comments and analysis in this section of the report draw on the issues addressed by the panel. We have also added insights from other recent meetings with companies and fund managers in Vietnam. This Insight is structured as an imaginary Q&A session, a different format from usual. We hope that it answers some pressing questions about Vietnam following the country’s recent outperformance.
The Panah Fund is heavily invested in Vietnam and will likely continue to invest in the country in the coming months and years. We hope that this overview helps to highlight both what we perceive to be the current consensus thinking on the economy and markets and the most significant risks. We round off the section with a brief review of a Vietnamese company that is a recent addition to the Panah portfolio.
TABLE OF CONTENTS
Over the last few years, you have consistently been bullish on Vietnam’s economy and stock markets. Is Vietnam’s long-term structural economic growth story still intact?
Not many people outside Vietnam pay attention to the country’s bond markets – what’s been happening there, and can bond yields stay low?
The rally in the Vietnamese equity markets over the last year or so has been nothing short of remarkable! What has driven this outperformance, and can it continue?
So why not carry on playing the momentum game and just buy banks and consumer stocks?
It sounds like a good time to sell your stocks in Vietnam! They have performed well, so why not lighten up?
Is there any way to short the Vietnamese equity market or currency, and would you recommend hedging or even going short outright?
So, what are the Panah Fund’s largest Vietnamese company holdings right now, and are they still attractively valued?
Have you found any other interesting new investment opportunities in Vietnam recently?
1. Over the last few years, you have consistently been bullish on Vietnam’s economy and stock markets. Is Vietnam’s long-term structural economic growth story still intact?
In short, yes! The structural growth story for Vietnam, as outlined in previous Panah quarterly letters, still looks attractive.2
As summarised in an earlier report: “The bank recapitalisation process is now well underway, and Vietnam’s credit cycle is at a much earlier stage than in larger neighbouring SE Asian countries. Favourable demographics, cheap labour costs, and a good location near well-established trade routes mean that Vietnam is well placed to capture market share in low-end manufacturing. The recent surge in FDI and trade exports underline that over the coming decades, the country is well-placed to pursue the ‘Asian tiger’ export-manufacturing growth and urbanisation model. Vietnam’s recently signed international trade treaties provide a solid base.”3
A political transition at the beginning of 2016 went smoothly. The new government seems to have done a reasonably good job of balancing the demands of different interest groups both abroad and at home. For instance, officials now seem to be striking a more realistic balance in foreign affairs (i.e., between their neighbour to the north and their former foe on the other side of the Pacific).
While the technocrats still hold sway, the value of market-oriented systems are recognised and are being given freer rein in various areas where it is desirable to promote development. Informed observers have been particularly encouraged by the backlash against some of the worst excesses of corruption seen under the previous regime.
Last year, Vietnam’s real GDP growth came in at +6.8% y-o-y and has reportedly accelerated to +7.4% in Q1 2018. Inflation has been fluctuating around the ~3% level for the last year.
A healthy degree of scepticism regarding market and economic data in less developed countries is always advisable (for instance, Vietnam miraculously manages to report quarterly GDP a few days before the end of each quarter).4 Nevertheless, in the case of Vietnam, the official growth numbers do appear to be broadly in line with other economic activity data.5
Foreign Direct Investment (FDI) has surged, to a record total of US $21.3bn in announced inflows in 2017. Exports – which underpin the bull case for Vietnam – grew at +21.6% y-o-y in 2017 and the first quarter of 2018. As export earnings have been recycled into the economy, retail sales have been growing at a pace of ~10% y-o-y per annum for several years.
Tourists are also flocking to Vietnam, a total of 13mn people in 2017 (+29% y-o-y). Finally, forex reserves have grown strongly as the central bank has intervened to weaken the Vietnam Dong and keep exports competitive.
2. Nothing to worry about then?
There are of course still plenty of challenges…
On a mid- to long-term basis, we are concerned about environmental issues, particularly in the Mekong Delta as a series of upriver dams in neighbouring countries (Laos, Cambodia and China) contribute to downstream issues in Vietnam such as drought, saline intrusion, lack of sediment, and erosion. From a geopolitical perspective, this has the potential to cause just as many problems as the more well-publicised tensions in the South China Sea.
Agriculture is still immensely important for Vietnam’s economy and employment, and rapid environmental deterioration in the Mekong Delta – the rice basket of Vietnam – would likely lead to social issues and a rapid increase in migration from rural to urban areas.
It would also be wise for the Vietnamese government to think carefully before allowing investment (foreign or domestic) in highly polluting industries which have significant negative externalities.6
The Vietnamese government is getting close to reaching its debt ceiling of 54%. With a fiscal deficit running at ~5.8%, it has been necessary to proceed at a fairly rapid clip with the divestment of State-Owned Enterprises (‘SOEs’) to help balance the books. While this is good news,7 the divestment process has fallen short in a few instances.8 If the government would like foreign investors to remain enthusiastic about participating in Vietnam SOE divestments, it will have to up its game - especially if global risk appetite were to wane further.
Indeed, given the importance of FDI, exports, and now also portfolio investment, it will be necessary for external conditions to remain stable for the country to fulfil its potential. Progress on NPL resolution for the banks has been disappointingly slow, although it is hoped that a new law will accelerate the process.
Vietnam has been prone to boom-bust cycles in the past, and policymakers will have to work hard to maintain monetary and financial stability in the future. Credit has been growing at a rapid clip (~+18.2% y-o-y for 2017). While bank deposit growth has kept pace, there does seem to have been some speculative activity and misallocation of capital in certain areas.
Real estate – which has been vulnerable to excesses in previous cycles – does not appear to be too worrying. Construction activity is robust, though price gains have not been excessive and transactions in Ho Chi Minh City have been dominated by purchases of mid-end apartments.
Other areas, however, are looking a little frothy. Large cap stocks have experienced a melt-up over the last year or so. This has been driven by solid earnings growth but also by a rapid expansion in valuation multiples. Bond yields have collapsed to their lowest levels on record.
3. Not many people outside Vietnam pay attention to the country’s bond markets – what’s been happening there, and can bond yields stay low?
The Vietnam 10-year bond yield has fallen from 6.10% at the start of 2017 to just 4.25% at end-March 2018. This represents a spread of just ~1.1% over the US 10-year Treasury yield. Meanwhile, at the short-end of the curve, Vietnam’s 1-year yield has fallen to just 2.31%, at a discount of ~35bps to 12mth LIBOR. There are various reasons for these historically low rates.
First, inflation has remained subdued at ~3% despite robust growth. This allowed the State Bank of Vietnam to cut the refinancing rate by 25bps to 6.25% in July 2017. Second, the supply of bonds in Vietnam has been constrained over the last year as the disbursement of fiscal funds has been slower than usual (possibly linked to the disruption of patronage networks which existed under the previous regime). Third, demand has increased from multiple sources, including banks, asset managers and also insurers which are now seeing premium growth of ~+30% y-o-y.
There is a reasonable chance that these tailwinds will not be so supportive in 2018. Inflation should increase on the back of strong growth and a lower base effect. Bond supply should pick up again as fiscal disbursements normalise. While demand is likely to remain robust, this is also to some extent dependent on liquidity remaining supportive, which is in turn affected by foreign inflows.
4. The rally in the Vietnamese equity markets over the last year or so has been nothing short of remarkable! What has driven this outperformance, and can it continue?
Over the last 15 months (to end-March 2018), the VNIndex has returned a world-beating +82.8%. Much of this (a return of +46.0%) came in the last six months alone.9 Even as global markets sold off in February and March, Vietnam rebounded to hit new all-time highs in early April.
Notably, this rally has been driven by only a few sectors and a handful of stocks. More than two-thirds of performance for the VNIndex and VN30 since end-2016 has been driven by just three sectors: financials, consumer staples, and real estate.
Over the last 15 months, more than half of the +88.5% performance of the VN30 came from the top five stocks in the index, while more than two-thirds of the +82.3% performance for the broader VN Index (consisting of 351 stocks) was attributable to its ten largest members.
Almost ~20% of the performance of the VNIndex came from new listings such as VietJet and Sabeco. In contrast, the performance of the FTSE Small Cap Vietnam Index over the same period (+39.6%) has been somewhat pedestrian.
Foreign inflows to Vietnamese equities clocked in at US ~$1.2bn last year. Indeed, as far as we can see, much of the Vietnam rally has been about foreign investors aggressively buying into the Vietnam ‘growth story’, and by local investors following the flows.
Rather than spreading their purchases evenly around the 1,684 stocks listed in Vietnam,10 foreigners have of course focused their firepower on the largest and most liquid companies, pushing up these stocks and dragging along the index. For these big investors, it has also made sense to participate in the new IPOs to get instant ‘market access’.
5. So why not carry on playing the momentum game and just buy banks and consumer stocks?
Indeed, during my recent trip to Vietnam, this seemed to be the consensus view from both fund managers and retail investors alike: “Even if the fundamentals don’t match, just buy the flows!” was a frequent refrain, especially from fund managers who were worried about underperforming the index.
While these momentum trades might well continue to outperform in the near-term, we worry that this strategy might unravel quite fast when foreign fund flows do dry up. There is little valuation support for most large caps, and retail investor leverage is high.
While Vietnam’s top stocks were trading at more reasonable valuations in early 2017, the top ten stocks in the VNIndex are now trading at a trailing P/B ratio of 6.1x and a trailing P/E ratio of ~26x. If one then makes appropriate adjustments to earnings for Bonus and Welfare (‘B&W’) funds and Employee Stock Ownership Plans (‘ESOPs’), the multiples rise higher still.11
In contrast, the broader index is trading at headline valuations of 1.8x P/B and 19.5x trailing P/E. This is of course distorted by expensive large caps, and many smaller companies are trading at much more attractive valuations.
In particular, we note that several companies in the utilities sector are trading at extremely low cash flow multiples despite good growth potential. Over a five-year horizon, we would expect such stocks to generate more attractive absolute returns than the current favourites.
6. What’s the biggest risk for Vietnam this year?
For most of the last five or six years, Vietnam didn’t attract much in the way of foreign fund inflows. This clearly changed in 2017.
There is of course the potential for more foreign inflows over time, especially if Vietnam can implement the reforms needed to reach Emerging Market (‘EM’) status.12 However, our biggest concern is a near-term reversal of foreign flows. This would likely hit the popular large caps hardest, though would no doubt affect the entire market.
A reversal of foreign flows might be catalysed by a global ‘risk off’ event, which at present is no idle fear. We have already seen cryptocurrencies spike up in late 2017 then collapse, and most major global stock markets peaked in January and have since seen steady declines.
At present, Vietnam appears to be the last market left standing. If global stock markets continue to struggle, there is then a reasonable risk that foreigners decide to take profits in their outperforming Vietnamese investments.
7. It sounds like a good time to sell your stocks in Vietnam! They have performed well, so why not lighten up?
While many of the larger stocks in Vietnam are now trading at valuations best described as expensive, there are many more small- and mid-cap stocks with good growth potential which are still trading at attractive valuations. The rally over the last 15 months has left many of these stocks behind.
We still believe that Vietnam probably has the best growth potential of any Asian country over the next 5-10 years. Various small- and mid-size companies seem even better positioned than the large ones to benefit from this economic transformation.
Trading liquidity for many attractive mid-caps is adequate in most cases, especially if one wishes to sell stock in a company trading at or near its maximum Foreign Ownership Limit (‘FOL’). If we were to divest our core holdings now, however, there is no guarantee that we would be able to buy back a stake in any of these companies in the future, even when markets are weaker.
For those who hold significant positions in liquid and expensive large caps, we believe there is a strong case for taking some profits now. However, we still have long-term confidence in our core holdings.
Even if it is inevitable that Panah’s holdings would also be affected in the near-term by any general market correction, at present these companies are still trading at attractive valuations and we are inclined to hold.
8. Is there any way to short the Vietnamese equity market or currency, and would you recommend hedging or even going short outright?
One can hedge exposure to Vietnam, although it’s not particularly easy to do so.
A decade ago (during the last bull run), it was possible to short the Vietnam Dong via non-deliverable forwards, but unfortunately this option is no longer available.
Nowadays, equity exposure can theoretically be hedged by borrowing and shorting shares in the large Vietnam closed-end funds (listed in London), but this seems unwise given these funds’ superior access to some of the better stocks in Vietnam (not to mention that these funds are still trading at a discount to their NAVs). A domestic futures markets was launched in Vietnam last year, but access is limited due to operational technicalities, and liquidity is somewhat limited.13
The best Vietnam hedging option we have found is to borrow and short shares in the Vietnam ETFs (which are listed on various exchanges around the world).14 The ETFs are restricted to buying shares in those Vietnamese companies which are not trading anywhere near their FOLs. While there are now a few more quality companies which match this description (as FOLs are increased or removed), in reality the Vietnam ETFs can still only invest in a limited number of Vietnamese stocks.
While some of the stocks which can be bought by the ETFs are sound, bear in mind that most have been ‘rejected’ by other foreign investors, either for fundamental reasons or because of serious corporate governance issues.15 If the Vietnam ETFs cannot buy enough local companies, they ‘top up’ their Vietnamese exposures by buying stakes in foreign-listed companies which have a proportion of their sales or assets in Vietnam.
Since inception, this approach has laid the ground for continued underperformance of the ETFs against the VNIndex and the closed-end funds. While the ETFs have bounced in recent months, this is mainly due to strong performance from a couple of heavyweight members which are now trading at extremely expensive valuations.
We thus see these ETFs as particularly vulnerable to a reversal of sentiment. We thus see these ETFs as a sensible hedge for a portfolio of more fundamentally-sound and reasonably-valued Vietnamese companies. (Panah is currently short one of the Vietnam ETFs as a hedge.)
9. So, what are the Panah Fund’s largest Vietnamese company holdings right now, and are they still attractively valued?
We have described Panah’s conviction ‘value + quality’ investment approach in the letter to shareholders for Q3 2017 and the following Seraya Insight: ‘The Trials & Temptations of a Value Investor’. This methodology applies to our Vietnam investments just as it applies to our investments elsewhere.
We are ideally looking for well-managed companies trading at high cash flow yields (ideally in the teens), that are able to reinvest cash flows at the same high rates of return in the future as in the past, and with management who are willing to pay out any excess cash to shareholders. While this is certainly a big ask in any market, we believe that our main holdings in Vietnam meet most of these criteria.
One of the fund’s largest holdings is an industrial conglomerate which operates businesses involved in mechanical and electrical engineering services (M&E), air-conditioners, and real estate development + management, and also invests in various power and water infrastructure utility firms.16
The company has managed to compound book value per share (adjusted for dividends) at a rate close to 20% over the last decade. Despite the share price rising by +69.4% in the 15mths to end-March 2018 (to a market cap of US ~$510mn), the company is still trading on a single-digit P/E ratio, with a cash flow yield in the low-teens and a dividend yield of almost 5%.
We met with management and attended the company’s AGM in Vietnam in March. We remain confident that the company can grow at healthy rates in the coming five to ten years.
One of Panah’s other major holdings is a Vietnamese ICT firm. This company is the country’s dominant IT outsourcing company, third-largest wireless broadband player, and also owns a dominant private education business. It also operates wholesale and retail electronics businesses. While the company divested majority stakes in these two businesses in late 2017, it still owns substantial stakes in both (now equity method affiliates); they are now free to pursue their own growth paths.
The share sale in both businesses helped to boost returns in 2017. Nevertheless, the firm has been able to grow its adjusted book value per share in the mid-20% range each year for the last decade.
Current valuations are still attractive despite a 65% appreciation in the share price over the last 15 months (to a market cap of US ~$1.4bn). The firm is trading at a ~10.0x P/E ratio, with a high single-digit free cash flow yield and good growth potential.
10. Have you found any other interesting new investment opportunities in Vietnam recently?
Yes. In November 2017, we were fortunate to meet a recently listed Vietnamese air cargo company (with a current market cap US ~$494mn).
There is a duopoly for cargo handling services onsite at Tan Son Nhat Airport in Saigon, and this company is the only one which still has room to expand cargo-handling capacity at the airport. These expansion plans, which should help underwrite net profit growth of >20% in coming years, only require a minimal amount of capex. Net margins are close to 60%, with the potential to expand further as revenues grow.
One key question is how the company’s strong cash flow will be spent. While we expect increased shareholder returns now that debt has been paid down, there also seem to be opportunities to expand the company’s activities into some proximate areas and geographies.
The largest risks appear to be macro-economic trade threats (which might affect cargo volumes), and the development of a new airport in Saigon. It seems unlikely, however, that the airport will be built before the late 2020s.
Panah had established a respectable position in this company by early January 2018, when the company was still trading at a P/E ratio of 14.0x and with a high single digit normalised free cash flow-to-EV yield. This seemed cheap for a company with attractive growth potential and an RoE of >30%.
The stock has since rerated and is trading on more expensive valuations – close to a 23x P/E ratio for this year, and a mid-single digit FCF-to-EV yield. (The multiples will fall as strong growth is expected in coming years). Despite more expensive valuations, Panah has so far maintained its position in the stock as we anticipate various upcoming catalysts, such as a move to the Ho Chi Minh Stock Exchange in the first half of 2018.
Vietnam’s economic potential remains strong. There are also a variety of other interesting prospective investments among Vietnam’s ~1,500 listed stocks. We are currently working on several other opportunities and will update investors in the future.
11. Any final thoughts?
At some point this year, we would not be surprised to see Vietnamese large caps locked limit down as foreigners take profits, ETFs flows go into reverse, and leveraged locals liquidate their positions.
While this might cause some immediate damage to Panah’s P&L (as a sell-off of this sort would likely affect the entire market), we are hopeful that the fund’s Vietnam ETF hedge would help limit the damage.
We remain quietly confident in the ability of our companies to continue to generate significant returns for our investors in the years ahead, and – as elsewhere – would look upon periodic corrections as potential opportunities to pick up cheap shares in good businesses.
Thank you for reading.
Andrew Limond
The original source material has been edited for spelling, punctuation, grammar and clarity. Photographs, illustrations, diagrams and references have been updated to ensure relevance. Copies of the original quarterly letter source material are available to investors on request.
For more information on the investment case for Vietnam, see the Panah Fund letters to investors for Q2 2015 and Q2 2016, as well as the following Seraya Insights: ‘Vietnam: from Frontier to Emerging Market?’ and ‘The Investment Case for Vietnam’.
See the Panah letter to investors for Q3 2016.
In contrast with developed countries such as the US and Japan, which usually take 4-6 weeks to report initial GDP numbers. The statistics for developed nations are then subject to numerous revisions over the coming months as more information becomes available.
This is in contrast with some other Asian countries (such as India and China), which for the last few years have reported suspiciously high and steady GDP growth numbers that bear little resemblance to other economic activity data.
The lethal toxic spill from the Formosa Group plant in 2016 has done much to increase public awareness of environmental issues. The Vietnamese government’s attitude towards those who reported the incident is dismaying, although Vietnamese citizens are now increasingly cognisant of the trade-off between rapid development and the environment.
As anticipated in the Panah Q2 2016 letter to investors and the following Seraya Insight: ‘The Investment Case for Vietnam’.
For instance: Vinamilk in late 2016, when the government’s attempt to sell a stake hit avoidable obstacles; and more recently Sabeco, where there now appears to be a boardroom battle playing out after the acquisition of a majority stake by Thai Bev.
The Jardine acquisition of a ~8.9% stake in Vinamilk in mid-November 2017 appeared to boost market confidence, although the jury is still out on the wisdom of this deal.
As of end-2017, 994 stocks were listed on the Ho Chi Minh and Hanoi Stock Exchanges, with a further 690 stocks listed on the Upcom market - a total of 1,684 listed stocks.
For more information regarding B&W funds and ESOPs, see the Panah Fund letter to investors for Q2 2016 and the following Seraya Insight: ‘The Investment Case for Vietnam’.
To reach MSCI EM status, reforms are needed to resolve various operational and trading issues. Timely information disclosure in English is also required.
Foreigners who wish to trade Vietnamese futures are required to set up a separate onshore futures trading account with one of the local brokers.
The shortcomings of Vietnam ETFs were discussed in more detail in the Panah Fund letter to investors for Q2 2017 and the following Seraya Insight: ‘Passive Aggressive’.
For instance, see the description of Faros in the Panah Fund letter to investors for Q2 2017 and the following Seraya Insight: ‘Passive Aggressive’. Faros management have recently announced that they are seeking shareholder permission for a massively dilutive private placement scheduled for H2 2018. This would increase the share count by ~+60%. The issue is priced at a ~90% discount to the end-Q1 share price, and the shares will likely be placed with insiders who control the company. The private placement will likely be approved.
This industrial conglomerate is profiled in the Panah Fund letter to investors for Q4 2016 and in the following Seraya Insight: ‘“Capital Allocators” versus “Capital Alligators”’.
