Vietnam - Time to go in

A top strategist explains how to invest in Vietnam.

Investors are becoming intrigued by the possibilities of investing in Vietnamese stocks. The economic story is clearly enticing. Vietnam has a population of 82 million, economic growth rates likely to be similar to those in India and China over the next few years and economic fundamentals are healthy.


ò We believe that the odds are high that Vietnam can achieve its target of 7.5-8% real GDP growth over the next five years.

ò The factors that can make this possible include:

favourable demographics; rising, and sustainable, fixed asset investment; and increases in productivity caused partly by a continuing shift out of agriculture into industry and services.

ò Management of monetary and fiscal policy has been cautious and supportive of stable growth with acceptable inflation, fiscal and current account balances, and debt ratios.

ò Capital demands to achieve this growth will be large, with investment/GDP expected to rise from 33% to 41-42% by 2010. The governmentÆs plan projects that $49.5-51.5 billion of this capital will come from abroad, with $9 billion expected to come from foreign portfolio investment.

But, until recently, few international investors had as much as glanced at the Vietnamese market. That is not surprising since, at the end of 2005, the Ho Chi Minh City Securities Trading Centre (HCMCSTC, the main stock market, which opened in 2000) had only 32 listed stocks and a market capitalisation of $460 million.

Much has changed this year. With two large new listings of privatised companies (Vinamilk and Sacombank), the market cap of the HCMCSTC has risen to $2.9 billion (as of August 25). Average daily turnover has increased from $680,000 in 2005 to $5.1 million in the past three months. Add the Hanoi market and OTC stocks, and market cap may be as big as $9 billion. The Vietnam Stock Index has risen by 70% year-todate û and that despite correcting 38% between May and July.

A number of catalysts will emerge over the next few months, which will bring Vietnamese stocks into the headlines.

ò After 10 years of negotiations, Vietnam is set to gain accession to the WTO.

ò The annual Asia-Pacific Economic Cooperation (APEC) meeting will take place in Vietnam for the first time on November 12-19. President George Bush is likely to visit Vietnam for the meeting û only the second time a US president has visited the country (following President ClintonÆs 2000 visit).

ò A number of large privatised companies are expected to list over the coming year. These include at least two banks, an insurance company, the electricity utility and two or more mobile phone companies, each of which could be capitalised at $1 billion or more.

ò A new Securities Law will come into force in January 2007. Among other changes, this will allow the clumsily named Ho Chi Minh City Securities Trading Center to call itself the ôVietnam Stock Exchangeö for the first time.

ò The limit on foreign ownership of stocks (currently 49%, except for banks and unlisted companies, for which it is 30%) could be raised to 100% as early as the end of the year.

From a point of view of regulations and structure, Vietnam is not a difficult market to invest in. Foreigners have free access to the market (subject to the ownership limits mentioned above), with no FX controls and no dividend or capital gains tax (just a transaction tax of 10bp on gross sale amount).

Opening a trading account is a little time-consuming, but not particularly onerous: investors do not need approval, only a trading code. Regulators are open to proposals on how to improve market mechanisms and have already introduced a number of reforms after investor suggestions. This openness contrasts with most other Asian markets (for example, Korea, Taiwan or China) which were much more restrictive on foreign access in their early days û and, in the case of China, still are.

There are three markets on which stocks can be traded in Vietnam:

ò The Ho Chi Minh City Securities Trading Centre (HCMCSTC) was founded in 2000, and currently lists 48 stocks and one investment fund. Two stocks, Sacombank and Vietnam Dairy Product (commonly known as Vinamilk) together comprise 53% of market cap and 43% of turnover.

ò The Hanoi Securities Trading Centre is only a marginal player for equities. Only 11 stocks are listed, with a total market cap of $664 million. One stock, Pha Lai Thermal Power (PPC) comprises 83% of market cap and almost 90% of turnover. The authorities are reconsidering what role the Hanoi Centre should play: it may be turned into a market for bonds and/or small-cap stocks.
ò The over the counter market. Most foreign writers on the Vietnamese market have missed the fact that the OTC market for unlisted stocks is far more liquid, and contains more interesting stocks, than the listed market. Brokers and fund managers in Ho Chi Minh City reckon that some 200 are traded openly.

Foreigners currently own about 26% of the stocks on the HCMCSTC; their share of trading has also averaged about 27% so far this year. One increasing problem is that a number of the most interesting stocks have recently hit their foreign limits, most notably Sacombank, REE and (it is rumoured, although no public data is available) the OTCtraded Asia Commercial Bank.

Debate has started about how to treat stocks that have hit their foreign limits. Some international investment banks offer Vietnamese stocks to their clients via participatory notes, and there are suggestions that these might trade at a premium offshore. Some investors have suggested the authorities create a foreign board, as in Thailand, with a portion of securities specifically reserved for foreign investors. Since the HCMCSTC uses the Stock Exchange of ThailandÆs trading system, this should be fairly straightforward to set up.

Overall valuations for the HCMCSTC are not unreasonable. PE is 22.1x 2005 earnings and 16.1x the past four quartersÆ EPS. That is higher than the average 2005 PE for Asia ex-Japan of 14.3x, but similar to IndiaÆs 21.8x. There are no systematic forecasts for earnings but fund managers in Vietnam believe that net profit should grow 20-25% this year and next and EPS 10-15% (less than NP because of a probable large amount of new equity issuance). Price/book ratio of 3.8x is also a little high by regional standards (the next highest, India, is on 3.2x), but this can partly be justified by VietnamÆs almost 24% ROE.

Some individual stocks look rather more expensive û particularly those that foreigners might like to buy. Most blue-chip stocks are trading on PEs of 20x or more. In particular, the average forward PE for banks is 29x, and the average PB 6x. That sounds expensive by comparison with other Asian markets û Chinese listed banks, for example, have an average PB of 2.6x. But Vietnamese bank ROEs are decent û ranging from 13% to 31% û and profits are growing by 50% a year, so that could probably justify a premium.

The number of tradable stocks is likely to grow rapidly over the next year or two. The government has already equitised almost 3,000 companies, with the amount growing each year: it has done 600 already this year. It plans to complete this process, including the equitisation of all the state-owned banks, by the end of 2009.

Typically, the company will sell 30% of its equity to outsiders via the auction, and allocate 30% to directors and employees (at 60% of the public sale price), and 10% to associates and strategic partners (at 80% of the price). The state usually retains a stake of about 30% (although it can be as high as 50%). Once the shares have been auctioned, they often trade actively on the OTC market for a few weeks as initial buyers take profits.

Equitised companies do not automatically list on one of the trading centres. In other words, the process of the IPO and listing is separate. However, in future equitisations of large companies, particularly the state-owned banks, companies may equitise and list simultaneously. Vietcombank, for example, is reportedly planning to do this in mid-2007. The bank has chartered capital of $600 million, and so, at a PBR of 2.5 or 3x, this could be close to a $2 billon deal.

So what û besides the fundamental story û makes Vietnamese equities attractive? We would point to a number of attractions for this market.

ò Openness to foreign investment. The initial limit on foreign ownership was 30%, but this was raised to 49% for listed stocks (except banks) last October, and may be scrapped completely late this year or in early 2007 (although there are suggestions that the government will retain restrictions for strategic sectors such as banks, telecoms and resources).

Foreign investors say they sense no anti-foreign sentiment. On the contrary, the Vietnamese authorities and companies understand they need foreign capital to finance future growth.

ò Low state ownership. The state owns only 26% of listed stocks (less than foreignersÆ share). In only four of the 48 stocks does the state still own a majority of shares (but even the largest state stake, in Vinh Son, is only 60%). In a number of the largest companies, state ownership has fallen to zero. Investors report that, even when the state does own a significant stake, it tends to be a silent partner and does not seek to control management. The state also plans to sell many of its stakes down further. This situation is unlike China, where the state almost invariably retains majority ownership.

ò Managements have a significant stake in their own businesses. As explained above, in the equitisation process, employees generally end up owning 30% or so of the shares. This incentivises the management, generally retained from those running the firm when it was stateowned, to focus on increasing profitability. In many cases, the company has been run so inefficiently in the past that management is able to generate an explosive increase in profits relatively easily.

ò The lack of dominating shareholder groups. With shares in most companies spread evenly between management, strategic partners, foreign investors, local retail buyers and the state, there are few vested interests: everyone is a minority shareholder. Unlike the situation in most Asian countries, there are no powerful families, no state holding companies (as in Singapore or Malaysia), and no chaebol/zaibatsu groups (at least not yet).

ò The new Securities Law, which comes into effect next year, will clarify the legal position of the market. Among changes that the law will introduce: the Ho Chi Minh City Securities Trading Centre becoming a full stock exchange with jurisdiction over listings; the separation of securities brokers and asset management companies; and the requirement that any public company with 50 or more shareholders, whether listed or not, must disclose financial information. Besides the obvious risks û an economic downturn, high beta in the event of a global equity correction, and the Vietnamese equity market being derated from its current somewhat elevated valuation level û there are a number of structural risks that investors in Vietnamese stocks need to be aware of.

ò Reliability of financial statements. Listed companies disclose quarterly financials, which are audited (but only by local auditing firms). Statements are fairly basic, usually without detailed notes or the sort of breakdown found in more developed markets. Fund managers say they do not pay much attention to financials. For most companies, the quality of management and its ability to grow the business are far more important. The significance of good financial data, rather, say fund managers, is that it shows the company has effective management information systems, which allow executives to monitor whether execution is proceeding according to plan.

ò Excess capital raising. After the rise in the market this year, many listed companies are planning large new share issues. Sacombank, for example, intended to issue 30 million new shares (representing dilution of 16%) this summer, but had to postpone the deal after the market fell. The potential magnitude of large listings over the next year is positive for the market in the sense that it will increase capitalisation, but it might take some time for such a volume of paper to be digested.

ò The negative impacts of rapid change. There is always the risk of a backlash against economic reforms. Like China, Vietnam remains a socialist country, with a clash of ideology between hard-line communists and a new generation who are concerned with making the country wealthier. The gap between rich and poor will inevitably widen, and outside a few main cities, infrastructure remains poor and could generate disaffection towards the government. Vietnam does not, however, seem to suffer as much as China from over-zealous development by local governments that results in inhabitants being removed from their land or houses. The opposite risk, of corporate managers in charge of state-owned companies becoming excessively greedy, should also be borne in mind.

ò Could Vietnam end up like China in the early days of its stock market? Many investors will remember that the Shenzhen B share index fell by 52% between 1993 and 1998, despite ChinaÆs GDP growing by an average 10.6% a year during that time. However, we do not believe this is a valid comparison. As described earlier, the equitisation process in Vietnam has been much more thorough and resulted in real privatisations. Foreign investors have much easier access to the market. There is no complicated set-up with H, A and B shares. Individual wealth in Vietnam is much more limited than in China, and so there is unlikely to be the same speculative scramble to buy shares. And, perhaps most importantly, Vietnam has been able to learn from ChinaÆs mistakes.

Garry Evans is pan-Asian equity strategist for HSBC, and this article first appeared in the Winter issue of Private Capital.
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