After our trip to Ho Chi Minh City, we still regard Vietnam as the most attractive country story in our frontier and small emerging market coverage, but accessibility for foreign institutional investors remains problematic.
Compared to a year ago, we note four changes:
(1) Delays related to the anti-corruption drive by the government.
(2) US-China trade war, China consumer weakness and Samsung handset market share loss in China is having a dampening effect on handset exports to China.
(3) Vietnam equities are not attracting the rabid interest they were from investors of all types (and perceived high pricing of the Techcombank IPO still rancours for many).
(4) Bank non-performing loans and capital needs are rarely mentioned, apart from STB (legacy related-party lending) and BIDV and CTG (both majority state-owned).
Three aspects of Vietnam have not changed:
(1) Overall, high macroeconomic growth remains on track (evidenced by record high foreign direct investment commitments).
(2) Ad hoc regulation, introduced with little public consultation, remains a feature (e.g. the recent decision to abolish minimum commission rates for stock brokers).
(3) Access to free float in the best, liquid equities remains a major obstacle for foreign institutional investors (and the government agenda appears to have shifted from a potentially quick change to raise foreign ownership limits to a likely long process to introduce non-voting shares).
Macroeconomics humming but anti-corruption, ad hoc rules and China mentioned as challenges.
Real estate and construction companies mentioned delays in permits for development as a result of the anti-corruption agenda of the government. GDP growth in Q1 was 6.8%, slower than 7.3% in Q4 18 and 7.5% in Q1 18 but still very healthy. But within the Q1 data was a shocking c65% yoy drop in handset-related exports to China (although note that total exports to China are less than a third of those to the US and the EU).
These factors were mentioned more in often in our meetings than the negative impact from decelerating loan growth, tighter liquidity in the interbank market, real estate pricing or the recent agricultural slowdown (Africa Swine fever). Nevertheless, because of the broad-based nature of growth (exports, infrastructure investment, foreign direct investment, household consumption) and very low core inflation (c2.5% yoy) the overall situation remains benign.
As a positive signal for the long-term, it was instructive to hear that China currently accounts for the largest share of planned FDI (much of which is routed via Hong Kong), which could be a response to US-China trade friction. Overall, deployed FDI was up 10% yoy in 2M19 and committed FDI was up 150%.
Prohibitive premiums for foreign ownership limit stocks.
We estimate that merely c25% of the market capitalisation of MSCI Vietnam (an index of the ten or so most liquidly traded stocks) is accessible for new foreign purchases (i.e. where there is still room below foreign ownership limit). Excluding the two largest constituents (VIC, VNM) this drops to below 10%.
To buy stocks at foreign ownership limit, existing foreign shareholders are charging a premium of up to 50% to the listed share price. The upfront hit to net asset value makes this prohibitive for the majority of foreign institutional investors, even if they believe that long-term upside to valuation can compensate.
Our conversations with local market participants suggest that the foreign room problem is unlikely to be addressed, contrary to prior expectations, via further higher effective foreign ownership limits or privatisations with significant free float. However, discussions in the government are underway to introduce locally listed, non-voting depositary receipts (based on the Thailand model). However, the bureaucratic process (e.g. coordinating between Ho Chi Minh and Hanoi exchanges, as well as the Ministry of Finance) will likely take 2-3 years.
Overall, equities have only partly recovered from mid-2018 de-rating.
The equity market, measured by the weighted average of the Ho Chi Minh, Hanoi and UPCoM indices, is down 15% / up 10% in US$ total return terms in the last 12mths / ytd (compared with down 14% / up 8% for MSCI FM and down 4% / up 14% for MSCI EM).
This weighted average of local Vietnam indices is valued on trailing P/B of 2.3x for 15% ROE; this P/B is a 25% premium to the 5-year median, compared to a 65% premium a year ago and a 1% / 9% premium currently for MSCI FM / EM). The weighted average P/E is 15x, which is in line with the 5-year median.
Vietnam public equity exposure can be segregated into six segments:
(1) Proven businesses in sectors that foreign emerging market investors are typically very comfortable with (e.g. banks, consumer, telecom), which provide clear investor communication but which are at foreign ownership limit, e.g. ACB, MWG, PNJ, FPT – we see little reason for those foreigners already invested to exit.
(2) Proven businesses which have foreign room but are in sectors that foreign emerging market investors typically embrace less readily (e.g. commodities, real estate development, airlines), e.g. HPG, VHM, VJC – we think Vietnam is a strong enough top-down story to consider these.
(3) Small cap stocks with very low liquidity but high growth, cheap valuations and foreign room, e.g. VHC, STK – these merit further investigation but they are likely too small for many foreign institutional investors.
(4) Relatively large, liquid companies with foreign room but with risks associated with conglomerate capital allocation (VIC, MSN) or valuation (SAB, VJC, VCB, VNM, VRE) – these are unfortunately the only alternatives for most large, actively managed foreign funds looking to build a material new position in Vietnam.
(5) State-owned enterprises with minimal free floats and, in some cases, minimal interest in engaging minority investors, e.g. ACV, POW – despite some of these enjoying very attractive quasi-monopoly positions and high growth potential, e.g. ACV, we are unsure about the alignment with minority interests, financing requirements, the exact nature of asset ownership and scope of operations, and timing and visibility on regulated pricing and rates of return.
(6) Third-party funds run on passive (ETFs) or active (e.g. VEIL LN from Dragon Capital) strategies, which are not really options for most foreign institutional funds but we see much more attraction in the actively managed option (the passive strategy results in large exposure to companies with very poor business models and governance, but with large index weights, e.g. the case of FLC Faros Construction, whereas, in the case of Dragon’s actively-managed, listed VEIL fund, there is disproportionately high exposure to stocks which are at foreign limit.