Buy, Sell or Hold: Vietnam Right Now
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Vietnamese equity markets have been on fire since the beginning of 2012. The market made an intra-day bottom at 332.28 on January 6th, and other than a month-long pause in March has moved strongly higher, closing at 472.98 on Tuesday, April 17th, outpacing many developed markets by a 3:1 margin. Foreign investors have woken up to the situation as the AUM on the Market Vectors Vietnam ETF (NYSEMKT: VNM) has expanded $50 million since the beginning of March and is up 31.5% year to date. So, after this kind of performance over a relatively short period of time, is Vietnam a Buy, Hold or Sell right now?
Let’s take a look.
Historic P/E ratios may provide a clue. The 5 year high for the VN Index was made back in 2007 at a multiple of 45.37. The low was made in late 2011 at 8.35. Right now the VN Index stands at 11.31. Does that mean the VN is undervalued? Looking at the potential credit risks within the economy, it is hard to say yes. Total Debt to GDP though 2011 rose inexorably over the last decade. The percentage of it held by private enterprises was low, meaning much of the credit in the system is bound up in the less-efficient State Owned Enterprise sector. This was causing a drag on earnings in the latter half of 2011 as the full weight of ultra-tight monetary policy was beginning to be felt.
The VN Index tends to anticipate earnings. It made a bottom in early 2009 and reversed four months before earnings bottomed. Then in early 2010 the market stopped responding to rising earnings and multiples began contracting even though earnings continued to rise all through the first half of 2011. The Index kept falling until the nadir was reached in late 2011 and multiples had contracted to 8.3.
Why? The State bank of Vietnam (SBV) began a tightening cycle in December 2009 and immediately killed the equity rally. Interest rates peaked at 15% in the 4th quarter of 2011 and are now being brought down. Absent acceleration of credit growth, valuations will be suppressed. In the 1st quarter of 2012, total credit contracted 1.96%. The SBV hinted they would lower rates in 2012, which brought speculative buying into a market that was also trading at all-time low multiples.
The SBV felt it was able to begin loosening the monetary reins because CPI inflation was dropping rapidly month-to-month. March saw CPI growth of just 0.16%, or 1.9% annualized. By utilizing Open Market Operations the SBV was able to stabilize the interbank market’s liquidity situation in the 1st quarter of 2012. Once overnight and 7 day interbank rates began to drop in early March the SBV had the latitude to begin lowering interest rates on both borrowing and savings.
The current situation is a delicate balancing act between wringing the bad debts out of the banking system, forcing mergers and bankruptcies of uneconomic firms without stifling future growth, which would cause a deflationary spiral of credit. Most of the worst loans are concentrated in nine banks which represents 6% of the total debt outstanding. Akin to the Fed’s stress tests the SBV has reviewed each of the banks and assigned them a credit growth cap from 17% this year down to 0%, based on their relative health. Both the credit growth and deposit rate caps are intended to force a restructuring of the weakest banks quickly by shutting them out of the savings and loan markets. I get the sense that the SBV will remove the cap on savings once this is accomplished. The latest statements by the SBV suggest this may happen as quickly as June.
The SBV has also effectively taken control of the gold trade in Vietnam and is actively attempting to remove both gold and the U.S. Dollar from the day-to-day economy supporting the dong and protecting it from exported inflation from the Fed and the E.C.B.
In a long-term view the market is still going through another cycle of multiple-contraction after the 2007 speculative high and the present rally, no matter how impressive, has not given any indication that that situation has changed. In essence, the expansion that we’ve seen so far in 2012 could just be another bear market rally which will be met with liquidation once valuations become even remotely expensive.
Vietnam’s economy is beginning to show signs of counter trend strength. First quarter trade numbers reported a surplus of $224 million, or 0.7% of GDP, the first trade surplus in nearly three years. Their export markets are in products not currently part of the Fed’s suppression tactics. Coffee looks to have made a bottom in the $1.75 per pound area for Arabica. Rice prices have bottomed and have begun spiking. The trade surplus for the past quarter is even more impressive when one factors in that energy prices were at an all-time high, credit was actually contracting and major export crops were being held back for higher prices.
Vietnam has held back a significant amount of the 2011 harvest in anticipation of these price changes. A similar tactic in coffee did not fare as well, as the prices have collapsed 10-15% since the beginning of the year. With the troubles in Thailand, post-flooding, Vietnam’s rice exports will likely become the largest in the world this year. Prices look to be strong and rising in the coming months as well. The U.S. eased their anti-dumping tariffs on Vietnamese tra fish and shrimp recently and Vietnam is negotiating hard with the E.U. over their soft-tariff protectionism.
The longer-term picture for Vietnam’s commodities is one of more regional trade and domestic consumption as the young, consumer-oriented middle class continues to emerge. Year over year change in the latest trade numbers suggest that Japan iShares MSCI Japan Index (NYSEMKT: EWJ), ASEAN and E.U. trade is becoming more important to Vietnam while the U.S. less so. Industrial and mineral exports rose sharply as a percentage of the total and this tracks with the U.S. data as the garment sector represents a smaller portion of Vietnam’s total exports.
Vietnam’s oil exports are not tied to the U.S. and the E.U. so any further slowdown in those economies will not affect its outlook. Vietnam’s overall strategy is to export their light, sweet Ruby and Rang Dong crude and import/refine heavier, sour oil from China and other nations and does so at a slight trade deficit (~ $25 million per month). The refinery at Dung Quat and the ones under construction are tuned for these lower cost grades. The VNM ETF is heavily weighted in energy, 12.5% of the fund is invested in three foreign oil producers. Any drop in the price of oil, say Brent dropping back to $100 per barrel, will have little effect on the VN Index from this as the ETF will be forced to buy those companies to maintain their 70/30 weighting of Vietnam/Non-Vietnam assets.
Falling oil prices would be bullish for the Vietnamese economy, currently laboring a bit under very high energy prices. Since their oil balance of trade is negative, a drop in oil prices be a boost to the economy.
Having looked at some of the quantitative fundamentals as well as part of the current global picture I would say that if you are long Vietnam I would continue to hold. The current rally may be the beginning of something bigger but that has not been confirmed in the longer term picture.
The bearish case for Vietnam rests on the health of the banking sector. The moves by the SBV are very reminiscent of the period of 1979-82 in the U.S. where Paul Volcker raised the prime interest rate to 13% and money markets were paying 21% in order to wring out the excess credit created during the late 60’s through the end of Arthur Burns tenure as Chairman of the Fed. The radical change in the yield curve of the interbank market suggests that the timing for these rates cuts are acceptable. Since early March the overnight lending rate has dropped 1.03% per week and stands today at 5.88% down 5.93% year to date. The rate curve out to 360 days is now steadily rising, as the SBV is no longer injecting specific term liquidity to ease pressures at specific times.
The rapidly improving liquidity position of the major banks bodes well for a resumption of the expansion of credit. Loans are still difficult to obtain, as interest rates for new lending are still extremely high, but the threat of major bank implosions is off the table for the short term. There is still a lot of pain to be absorbed but the overall fundamental picture has improved drastically in the past 7-8 months. With the economy expanding at a more muted 4-5% but doing so at a positive balance of trade that will fund the plans to write down/restructure the worst banks and real estate loans.
At this point in time, with the market trading at a multiple of 11, I believe Vietnam is a hold for those who are currently long and a cautious buy for those wanting a medium term investment as the market looks likely to trade up to a multiple of 15. When one considers that the best value in Vietnam’s market are its mid-priced, medium market cap stocks the trade looks even safer. By observing the distribution of stocks by market cap and P/E in terms of price bands. Many low valuations are in the VND 30,000 to VND 60,000 range ($1.50 to $3.00 per share). These are the stocks that will support the VN Index at this point. Most of the higher priced stocks are both fully valued or have no Foreign Room and do not participate as much in momentum generated by the market in the short term as supply is very tight.
Something else to factor in is that there are a number of funds sitting on horrible losses on poor companies that have not been liquidated because many of the managers have not sold them so as to not impact their bonuses. As these hurdles are approached they may take longer clear, if at all, because these skeletons could be removed from fund managers’ closets and finally sold for modest losses. Lastly, if there are any balance sheet surprises left to be absorbed by the market they will all happen in the 3rd quarter of 2012. If the market has continued to rally to that point, it will likely take a breather there.
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