Vietnam – The Birth of Capitalism

Life is tough at the bottom, especially if you are the world’s lowest cost producer. A claim that will last until the next country undercuts you. And there is no shortage of countries lining up to do so. Over the last few years, China had been widely touted as the lowest cost producer in the world. I remember seeing several broker reports, including one titled, “What if China was the lowest cost producer of everything?” That claim didn’t last too long though. As the number of factories in a certain location within China rose, labour shortages and high turnover rate inflated wages quickly. This was compounded by China’s strict (but necessary) domestic migration policies (to stop half its population potentially descending into cities and industrialized zones).

However, let’s not forget that although Vietnam has a sizable population (around 86m people at last count), it is still only the size of a large province in China. There are still significant hurdles to overcome in Vietnam, not in the least of which will be infrastructure bottlenecks, which are already starting to appear, at this early stage of its development. Having said that, Vietnam also has some potentially unique opportunities, not only because of the rapid pace of liberalization that it is undergoing but also because of the demographics of the population, which even by Asian standards, is extremely skewed towards the younger age. I noted that in the evenings, everywhere you looked, there were wedding dinners. So, when I think Singapore, I think private bankers haven. Perhaps for Vietnam, it will be wedding planners heaven.

This potentially amazing macro story does not seem to have been missed by the markets and the astounding amount of money chasing the limited ways to play Vietnam has resulted in an even more astounding performance in the stockmarket, which was up 146% in 2006 and 40% for January alone!

With a market capitalization of only US$15bn, the Vietnamese stockmarket may not necessarily be the best way to play the rapidly growing economy, especially as the average local investor has little understanding of valuations. My meetings with local brokers, including one that transacts more than 60% of the foreign volume in the Vietnamese stockmarket, yielded little beyond “more buyers than sellers” and the fact that investors are willing to pay higher prices even now.

Still, share ownership levels are impressive, with already close to 150,000 accounts (compared to Thailand’s 100,000 accounts but of which less than half are active), largely driven by the government’s privatization push, which is putting share ownership into the workers’ hands (aka Maggie Thatcher style) and creating awareness of the stockmarket (albeit in a potentially risky and dangerous manner given little education on valuing companies) at an early stage. However, some of the larger privatizations remain tricky, with limited domestic liquidity and foreign participation, and consequently may be more restricted, compared to what we have seen recently over the past twelve months. “Blue chips” (a definition that is loosely applied given less than a couple of years of track record for some of the larger companies) are trading at heady valuations, with the largest private commercial bank, recently listed, trading at 36x FY07 PER and 8.4x PBV. Although net profit is forecast to grow at 73% over next two years, EPS will be shrinking at an almost frightening rate of -19% over the same period due to increasing capital required to fund the growth.

Credit quality, albeit furthest from anyone’s mind currently, over the longer term is likely to become a huge potential issue. Recent moves by some banks to allow credit approval authority to be extended to branch managers, in order to promote stronger loan growth, is not necessarily a risky move, assuming the right controls and credit approval processes are in place. However, when it comes on the back of certain “stories” we hear, such as bank managers taking a commission of up to 10% of loans extended, we can’t help but feel some déjà vu, some nostalgia from Thai banks’ pre-crisis lending practices. Investors chasing after growth (especially if it is associated with Vietnam, or even China for that matter) are so willing to pay a premium for that growth that all risks are discounted to an almost non-existent level. (Does that remind you of the dot com boom anyone?) The perennial assumption that the one or two steps back is not going to matter much in the five steps forward scenario. Looking at the stockmarket though, it seems like most investors there are factoring in the ten steps forward scenario with no steps back…

Growth is only one aspect of the Vietnam story. How to continue to grow at the neck breaking pace is another potentially more important question, one not focused on much by investors. One thing I noticed was that there all roads were basically two lane or four lane roads at most. Given the rapid industrialization going on, there’s no doubt in my mind that the traffic is only going to get worse. The picture below for a two lane road going in and out of Ho Chi Minh is a frequent scene. Guess what will happen when the locals start having enough money to buy cars. The first thing I would recommend is for them to put some traffic lights into all their crossroads. I thought driving in China would be a nightmare, but that was until I sat in a car in Ho Chi Minh.

The bottleneck at the ports could get even worse. Demand is estimated to rise from 2.5m TEU currently to 6m TEU within the next five years. However, with estimated capacity of only around 1.5m TEU currently, demand already exceeds capacity. Current excess demand is being handled by the military/Navy port but that’s only a temporary solution. Part of the problem is that required infrastructure spending over the next few years is estimated to amount to close to US$145bn with Vietnamese government looking to fund less than 1% of that. This means huge opportunities for private sector funded projects, and also part of the reason for the huge privatization drive that we are now seeing throughout Vietnam, some of which is trickling through in the stockmarket.

The government not only realizes that it will require enormous private funding to build some of these infrastructure projects (meaning a myriad of direct investment opportunities) but will also require private sector help in providing jobs for the 1.5m people enter the job market every year. With each job provided by the state sector costing US$20,000 versus US$1,000 in the private sector, the Vietnamese government cannot afford not to privatize. Other bottlenecks that will surely crop up include the capacity of the existing airport, roads and expressways not only to ports but also within the city itself, some form of mass transport system and probably most importantly, the legal system.

One of the most impressive aspects of capitalism as driven by social principles is the evolution of the agricultural sector. Vietnam is currently one of few countries in Asia which is a net exporter of food. In a period of less than 10-15 years, Vietnam has become one of the largest producers in the world of rice, cashew nuts, pepper, coffee and in the future, potentially rubber.

Part of the reason for this is that a substantial portion of crop planting in a particular area is initially government designated. Once an area is designated for certain crops, the government divide and allocate plots of lands within that area to different farmers, who in effect ‘manage’ their designated plot with a profit sharing arrangement with the government (in effect paying ‘rent’ for the land). As such, what we see is an unprecedented scale of coordinated farming set by socialistic needs but driven by capitalistic principles (farmers are incentivised to maximize yield for their particular plot given profit sharing arrangement).

The above combination of factors does indeed provide a unique set of investment opportunities, particularly in direct investments given the lack of public funding for the majority of the designated infrastructure spending that is desperately needed. The stockmarket remains the easiest channel for most investors to play this growth opportunity, and given the lack of depth (and education in the finer points of valuations for local investors), pricing for most investable stocks remain lofty. Although we will continue to explore investment opportunities in Vietnam, helped somewhat by our proximity, our investment criteria (as with China stocks) is likely to screen out most investable stocks in the market. We are in the process of opening an account in Vietnam and obtaining our identification code to trade in the stockmarket but frankly, at this juncture, we’ll probably be watching from the sidelines for a while longer.

Thailand, despite many missteps, mismanagement and just general incompetence (largely due to political antics) has always been able to meander through its problems, partly because geographically, Thailand is well positioned as a hub (which is why Thai Airways continues to scrape through despite being one of the most poorly managed airlines around) and partly because it really is not a bad place to go to for your holidays. However, if Thailand doesn’t watch out, it might just start seeing a serious challenger in its next door neighbour.

Biggest supporters of US$ starting to lose faith?
On a separate note, the Malaysian government recently announced that it was starting to diversify some of its US$80bn foreign reserves away from US$. Asian central banks have never been particularly adventurous with their cash piles of US$ (excepting Singapore) but this recent move comes on the back of murmurings from other Asian Central Bankers, particularly the Chinese and Japanese, both of whom have denied any intention to seriously consider diversifying their investments. Still, with continuing weakness of the US$ expected, the pain tolerance for the slower accumulators of foreign exchange reserves (particularly the ASEAN countries) are likely to be lower and consequently, may be the first group to look to diversify. Given that our portfolio is positioned largely to benefit from weaker US$, we would be unlocking the bolt if we could, but the Thai government just doesn’t seem to be playing ball. Still, wouldn’t want to be standing in front of the door when the rush does start.