Tuesday, 3 March 2015
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Feb 12 2013 | 5:29am ET
By Louie Nguyen, CIO, Soledad Investment Management -- In 2006, with waves of foreign capital rushing in, virtually all investments were lifted in Vietnam, as rising tides are apt to do. The stocks of the Ho Chi Minh Exchange became progressively propelled by momentum investors. In turn, both local and foreign speculators made ever greater bets. Throw a dart and investors were bound to hit a profitable investment. Macroeconomic data and positive demographic trends were held up to justify tremendously high valuations. Some six years later, as the global economic collapse sucks capital out of the Vietnamese economy, many investments are now beached and countless investors are revealed to be swimming naked.
As capital dries up, companies with strong management, serious corporate governance, and clear strategic vision will separate themselves from the rest of the pack. We believe going forward Vietnam will be an intelligent investor's market. Careful and prudent investing will increasingly be a crucial factor. Opportunistically, we see a number of such companies in Vietnam currently trading at compelling valuations.
The Good, The Bad, The Unlucky (and where they are hiding)
Currently, we see three types of companies. On one end are the "good" companies with no debt that have remained profitable during this global downturn and, in some instances, have shown promising growth. We recently visited a debt-free company with a net margin north of 50%, operating at over 100% capacity, paying an indicated gross dividend yield of 14%, and trading at 5x 2012 earnings. We believe this company, and others like it, will continue to prosper in spite of the poor local or global economic environment.
On the opposite end are the low-performing “bad” companies that took on too much debt without proper strategy, discipline, or oversight. We would suggest most investors to stay away from such companies, as they are highly speculative.
In the middle are what we call the "unlucky" companies. These are companies whose business model and management are sound but whose poor timing or simple bad luck has saddled them with massive debt just as the global financial market collapsed in 2008. Perhaps we all know a few of these type of companies in the US and Europe. We believe there are very attractive investment opportunities in this space. For example, VinaSun, Ho Chi Minh City's largest taxi company, increased its total debt over 100% from the 2008 to 2012 period. Aside from the high debt burden, the company is fundamentally solid. It is servicing the debt burden reasonably comfortably (4x 2012 EBITDA), trades at a PE of 5x and has an ROE of 16%. Once the debt burden comes down, net margin should expand.
For many foreign investors, attractive long-term opportunities in Vietnam are difficult to find due to massive asymmetrical information flow. Because brokerage firms profit from trade volume, they are logically motivated to provide research reports on the large cap liquid Vietnamese stocks, such as Hoang Anh Gia Lai and Hoa Phat Group. While both of these companies are fine investments, the universe of available stocks for most foreign investors are then seemingly reduced to a fraction of the whole market. This creates significant market distortions, such as foreign capital inundating a selected number of companies. We believe many compelling “Good” and “Unlucky” stocks are currently experiencing low trading liquidity. As a result of their low liquidity, many of these companies are not receiving research coverage. As liquidity recovers, however, the brokerage firms will resume coverage, thus potentially providing a catalyst for valuation re-rating.
Clash Of The Titans
2012 was a year of mixed fortunes for Vietnam. After charging out the gates early in 2012 with a blistering 40% run, the Vietnamese stock market was slammed with news of arrests of several prominent banking executives. On August 20th, the founder and former chairman of a well-respected bank was arrested for reasons still unknown. This was then followed by rumors of a possible IMF bailout. Additionally, on October 15th, in perhaps the biggest news of the year, the Communist Party apologized to the nation for macroeconomic mismanagement but did not force Prime Minster Nguyen Tan Dung to step down from his position, a move that was widely expected to occur. Additionally, Moody’s Investors Service in September cut the rating on Vietnam’s debt for the first time since 2010 to B2, leaving it on a par with Cambodia and five levels below Indonesia. Vietnam’s banks have the highest level of bad debt in Southeast Asia, according to Moody’s.
Vietnam currently has a number of interlocking problems that create a vicious feedback loop. The state owned enterprises (SOEs) are highly inefficient, with non-core investments, such as real estates and stocks, accounting for as much as 12% of their start-up capital. The non-core investments were fueled by debt. With the downturn in both the equity and real estate markets, SOEs are now saddled with more debt than equity. Most of the debt are now non-performing loans (NPL) of banks whose cross-ownership structure includes SOEs and powerful interest groups as major shareholders. This ownership structure limits the ability of banks to clean up their balance sheets.
Conventional wisdom holds that the economy cannot grow at its historic rate without banking and SOE reforms. The SOEs, however, are highly linked to the government, making the formation and execution of reforms tricky and slow. SOEs then continue to be inefficient, eating up capital resources far in excess of their contributions to GDP.
Back To The Future
Of the markets in the world, few have as many necessary conditions for economic dynamism as Vietnam. These conditions, to name a few, include a young population of roughly 90 million people, a rapidly growing middle class, a high literacy rate, and membership in a fast growing ASEAN bloc. While macro overhang continues to weigh on the market, measures such as inflation, currency stability, trade deficits and even banking reforms are moving in the right direction.
Local investment capability and sentiments are also moving in the right direction. In the last several years, this commentator has seen a marked increase in the number of Chartered Financial Analysts (CFA) and has noticed that the language of valuation is now more diffuse. In particular, business owners have gained a greater appreciation for the valuations that would attract foreign investors.
A correction is to be expected. There is enormous debt, both public and private. Amid such negative macro news, however, this could be a highly profitable time to invest. Remember that China had its own period of economic instability in the early 1990s; it devalued its currency a number of times in the early 1990s, and finally abolished the two currency structure in 1994. From 1994 to 2000, however, the Shanghai Index appreciated close to 300%, turning in annualized returns of about 30% a year. We are focusing our investments in well-run companies that have managed to be profitable during this tough economic time. Though these companies are not typically covered by the average brokerage firms, they could produce exceptional returns for the intelligent investor willing and capable of doing the proper research.
Louie Nguyen, CFA is the sub-advisor of the Christopher Weil & Company Global Dividend Fund (CWGDX) and CIO of San Diego-based Soledad Investment Management. Soledad invests qualified clients’ assets in markets around the world, including Vietnam.
Disclosure: Soledad is an investor in the companies mentioned in this article.
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