The recent love affair between foreign investors and Thailand may be about to hit a rough patch. For over a year, foreigners have been the most significant force in the Thai market while local participation has been muted at best. The Thai market has been a huge beneficiary of foreign fund flows and is currently one of the most overweight markets in the region relative to its MSCI weighting. However, recent political disorder and other emerging risks threaten to dampen the ardour of foreign investors.
Thailand has hardly been at its most alluring of late. After criticism of his familyÆs involvement in the sale of Shin Corp, Prime Minster Thaksin Shinawatra called an election. Boycotted by the opposition, Thaksin was declared the winner but in the face of continuing protests he stepped down and appointed a successor. However, he declared that he would remain leader of his party, Thai Rak Thai, which holds a majority in parliament. It was recently announced that the new election will be held in October foreshadowing continuing uncertainty.
The current political instability and the focus on politics rather than the economy means that government spending, privatisation and regulatory reform are all on hold.
The entire privatisation agenda ground to a halt with a court ruling against the sale of EGAT, a state electricity company. While the court decision to block the sale should result in improved corporate governance and a more transparent privatisation process, it does not bode well for private investment in the short term or for government efforts to raise capital for its mega-project public investment programme.
Longer-term policy challenges are not about to be resolved either. These include the need to progress regulatory reforms in the telecoms sector. Telecom regulators may not be comfortable with making decisions in an environment where part of the opposition to ThaksinÆs leadership emanates from his involvement in the sector.
The government has also postponed plans to sign a free trade agreement with Japan and to negotiate an agreement with the US.
In this environment it is likely that both private and public consumption will decline this year.
Macquarie Securities recently downgraded its 2006 annual average GDP growth forecast to 4.5% from 5.6% primarily over concerns centred on the political environment. While 4.5% is significantly less than might have been hoped, it is still a reasonable, if below trend, result for Thailand, where growth has averaged 4.9% over the past five years. It looks increasingly as if ThailandÆs economy will be more externally driven this year, as the export picture remains robust but the domestic scene looks less inviting.
In addition to the political instability, there are a number of other negative risks to this outlook.
Given that 65% of ThailandÆs merchandise exports are high tech goods, a period of weakness in the US PC market could pose a risk for ThailandÆs exports in the 2H06. This could flow through to a weaker domestic economy.
High oil prices are increasing the Thai trade deficit and taxing the economy, especially so in Thailand as it imports 90% of its oil needs. Higher costs are pushing up inflation which means that higher interest rates are likely to pressure the economy.
So far, ThailandÆs political uncertainty has not spread to currency markets. The Thai baht remains very strong relative to its recent history, which may hold back export competitiveness in 2006. A protracted period of strong baht/weak dollar could eventually take its toll.
Heavily overweight foreign investors have so far been content to sit and wait things out, and strong regional fund flows could continue to drive the market higher based on blunt buying of a cheap-looking market. But Thailand remains amongst the most vulnerable to a foreign pull-back.
Consistent foreign buying has been supported by the argument that Thailand is cheap and recent price falls mean the market is starting to look more attractive. Further dips may present buying opportunities.
However, concerns remain that that the Thai market lacks positive catalysts and faces a growing set of macro downside risks. The market may remain dull over the next couple of months as the political impasse is unlikely to be resolved quickly.
Foreign money has already been waiting patiently for a market re-rating since 2004, and thus todayÆs buyers are far from contrarians. Patience could easily wear thin and result in foreign funds cutting back on Thai exposure.
Despite an increasingly negative macro situation, there are still great opportunities to make money in Thailand. While itÆs true that the Thai marketÆs valuations appear pretty cheap compared to the rest of the region, this is a stock pickerÆs market so be selective. In particular, select stocks that could benefit from the pressure of fund flows entering the market, but are backed up by compelling fundamental valuation arguments.
It is becoming more difficult to find good deals in the Thai market, with investors generally relying on re-ratings rather than growth prospects. Pressure from inflation and rising interest rates should begin to wear down consumer spending, or at the very least prolong buying decisions.
Stripping out the energy sector, earnings growth is likely to remain negative this year with a good chance of further earnings downgrades in the market.
From a fundamental perspective, bottom-up sector calls would suggest neutral recommendations on banks, energy, and telecoms and the only sectors to overweight are materials and shipping.
Macquarie SecuritiesÆ top choices for the year ahead are four large cap names in the bank and energy sectors with particularly compelling stories (Kasikorn Bank, Bangkok Bank, PTT, and Thai Petrochemical Industry), and two mid cap names that still look highly undervalued (Hana Microelectronics and Shin Satellite). All of these stocks have strong fundamental valuation arguments, coupled with the potential to benefit from a continuing flow of funds into Thailand. Key short ideas are overdone foreign favorites û TRUE, Land & House, and Italian-Thai Development.
Kasikorn Bank is trading near a two-year relative low vs. its closest comparable big bank peer, SCB, with lower prospective 2006E PER and P/BV multiples, based on our forecasts. Since Kasikorn Bank is as aggressively developing its retail infrastructure as SCB is doing, we rate the stock an outperform with a Bt75 target price.
Bangkok Bank is likely to be the most defensive bank over the coming months, in particular compared to recent high flier SCB. Also, should economic growth and loan demand surprise on the upside, BBL has an opportunity to re-leverage its asset mix with less pressure to acquire new funding. Another outperform with a target price Bt137.
PTT is a top pick in the Thai energy sector due to attractive valuations, strong financials, positive growth momentum, and prudent management. Growth prospects in the near term will be driven by strong upstream operations and additional profits from acquisitions, while growth in the long term will be supported by a steady 10% CAGR in domestic demand for natural gas. Outperform, target price Bt295.
Thai Petrochemical Industry is back on the map. During its infamous 8-year restructuring saga, TPI was virtually forgotten by most investors. It has now re-emerged on high trading volume with a strong balance sheet and PTT as a new major shareholder. TPI remains undercovered and under-owned. We are quite optimistic about this exciting turnaround story. The company also has a good balance sheet now and we believe is set to enjoy improvements and savings in numerous areas during the short to medium term. Hana Microelectronics faces worries over a weak dollar hitting earnings, but the fundamentals of its business are unchanged. The company has $70 million in net cash to absorb temporary weakness and continues to see its integrated circuits and printed circuit board assembly businesses grow rapidly. Strong growth continues to keep HANA below double digit PERs.
Shin Satellite holds excellent long term growth potential from the IPSTAR broadband satellite service across Asia and unrecognised value in its Laos and Cambodia cellular assets (recent global transactions û Investcom and Millicom û suggest they are worth up to two thirds of SATTELÆs market cap). We estimate profits to double in 2007 and then again in 2008, which should reward investors for the bold IPSTAR project.
With no immediate answer in sight to the debate over the next moves in Fed policy and global liquidity, Thailand and other emerging markets will likely remain volatile in the near term.
Domestically, strong May inflation numbers keep the pressure on the Bank of Thailand to continue raising rates and a resolution of the political uncertainty is unlikely before October at the earliest. However, the market has fallen by over 10% from its recent peak in May 2006 and bargains could start to emerge. The savvy stockpicker taking a long-term view to the relationship will still find things to love about the Thai market.
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