By Forbes 01/18/2014

It’s funny how investors rarely mimic this type of behaviour. Stocks which have gone down in price are viewed with suspicion. Something must be wrong with them. If a company’s in distress, most investors will put it in the too-hard basket. As for neglected stocks or markets, well there must be reasons for the neglect and further investigation requires work which many aren’t willing to do.
So-called frontier markets suffer many of the attributes which put off investors. They’re priced well off pre-GFC peaks, they have companies and sectors in distress and they’re completed off the radar screens of institutional investors. Add to this that many of these markets are in faraway places, with unfavourable political regimes and hugely volatile stock market price action given thin liquidity – and you have a perfect recipe for investor neglect.
In Asia Confidential’s eyes though, some of these frontier markets offer the best opportunities for investors over the next decade. And one of the most exciting opportunities is in Indochina. Today, we’re going to look at one of these markets, Vietnam, which is starting to attract investor interest after five years in the wilderness. It underwent a massive credit bust and is just coming out the other side. In many ways, Vietnam is 2-3 years ahead of China, which has just started to undergo its own credit bust.

Vietnam’s classic credit bust

I was working at a stock broker in South-East Asia in 2007 and remember the excitement generated then by some of the region’s smaller markets. At the time, Vietnam became the “it” market. Asia’s top sell-side economists and strategists poured into the country and waxed lyrical about the growth story there. I don’t think some of them were quite as bullish as their research reports relayed, but being a bull brought in plenty of money at the time. They were the go-go days prior to 2008 where there was too much cheap money and booming frontier markets got some love.
Then the GFC happened and these frontier markets were taken to the cleaners. Vietnam’s main stock market went down ~80%. Given its reliance on exports, GDP growth in Vietnam dropped from more than 8.5% in 2007 to close to 5% in 2009. The government tried to revive the massive credit boom through an aggressive stimulus program in 2009.
The printed money led to reckless lending, with credit growth of 35% Cagr from 2007-2010 and bank loan to deposit ratios peaking at 136%. Inflation rocketed to 23% in 2011, resulting in foreign investment drying up.
The latter was crucial given Vietnam’s reliance of foreign direct investment (FDI) to the tune of about US$12 billlion each year (or about 6x that of Indonesia relative to the economy, to put that in perspective).
Due to spiking inflation, the local currency, VND, dropped 40% in value from peak to trough. Vietnam’s strict capital controls didn’t prevent massive capital flight as savers exchanged local currency for gold and U.S. dollars (Vietnamese are estimated to have 50% of their net worth in gold and US$).
The government was forced to raise interest rates by 500 basis points and implement significant macro-economic reform. GDP fell to 5% in 2012, its lowest level in 13 years.

People go to a retail store searching for bargains. If an item is priced at a 50% discount, they might buy it or search a nearby store or online to see if they can get it even cheaper. If a store has a closing down sale, crowds often turn up in droves. Others sometimes do extensive searches for niche stores where few people go but there’s value for money.
Much of the reckless lending went into real estate. From 2009-2011, the government implemented several regulations to reduce credit to the sector, such as increasing taxes and restricting the ability of buyers to “flip” properties. From the peak levels of 2010, real estate prices have fallen 60%.

The above isn’t to suggest that the government was pro-active in initiating reform. Far from it. Like most governments, the ruling Communist Party in Vietnam fiercely resisted reform until they were forced into action by the dramatic bursting of the credit bubble.
In fact, the government only just started to restructure the banking sector last year. And it’s still largely held off from overhauling other state-owned enterprises (SOEs). This isn’t surprising given the vested interests of SOEs which were the biggest beneficiaries of the credit boom via the corruption which flourished at the time (remind anyone of China?)

Things are turning around

There are several signs though that the worst of the credit crisis may be behind Vietnam:
GDP appears to have bottomed with fourth quarter growth of 6% expected.

A key sector, A key Asector, manufacturing, is also rebounding.

Inflation is under control, having fallen to just 6.5%. The central bank has also cut interest rates by 850 basis points since the first quarter of 2012.

The trade balance has shown dramatic improvement, from -US$18 billion in 2008 to -0.2 billion forecast for 2013.

Foreign reserves have increased from US$12.5 billion in 2010 to US$32 billion in 2013, thanks to the clampdown on inflation. 
Critically, the local currency has stabilised over the past two years, with the gap between official and black market rates having closed.

There’s still much work to be done though. As mentioned, banking reform is overdue. Banks have been reluctant to lend due to non-performing loan (NPL) issues as a result of the credit bust. No-one believes the official NPL figure of 4.7%. Most think it’s 12-15%. Until NPLs are cleaned up, lending growth can’t accelerate to further spur the economy.
The government set up the Vietnam Asset Management Company (VAMC) in July last year to buy the banks’ bad loans. Well, the VAMC won’t exactly buy these loans but act as a conduit to warehouse bad loans until a buyer is found. If there are no buyers, loans will be written down over five years. Without going into all of the details, the setting up of this company isn’t a brilliant solution but should incrementally improve the ability of banks to reduce NPLs and start handing out more loans.

Attractive long-term prospects

There are a number of things to like about the long-term prospects for Vietnam too:

1. The country has one of Asia’s most attractive demographic profiles. About 70% of Vietnam’s population are under the age of 45. Positive demographics don’t guarantee economic success but they help. Remember that GDP growth comprises population growth (more specifically, working-age population) plus productivity growth.

2. Vietnam is becoming a highly attractive destination for foreign companies. The country promises to be the next great Asian exporter of electronics and sophisticated mechanical products, with labor costs less than half those of China and Thailand. For years, Taiwanese and Chinese companies were setting up shop in Vietnam to manufacture footwear and garments. Now the largest FDI contributors are Japanese and Korean, focusing on higher-end tech and mechanical products. The below chart from the World Bank, courtesy of Asia Frontier Capital, shows why Vietnam is attracting significant foreign capital.

3. There’s an emerging middle class which should fuel a consumption story. Despite the downturn, anybody who’s visited Vietnam of late will notice still packed restaurants, retail shops and so forth.
4. Vietnam should be a primary beneficiary of the rise of neighbours including China, Myanmar and Thailand. I’ve written previously about the potential for Myanmar to reclaim its former glory as it opens up its economy again (it was Asia’s richest country in the 1960s before the current regime took over). The potential of Thailand shouldn’t be discounted either despite the political problems (which may soon provide another good buying opportunity).
Short-term catalysts

I first recommended buying Vietnam stocks in July last year. Back then, they were completely off investor radars. Since then, the market has had a nice run. Vietnam was the best-performing market in Asia ex-Japan, up 22%, in 2013. Institutions are starting to take notice.
Valuations are no longer dirt cheap but remain cheap nonetheless. At around 11x forward price-to-earnings ratio (PER), it’s close to the Asia-ex Japan average. But keep in mind that Vietnam earnings are coming off a remarkably low base, unlike the rest of Asia.
Also, the PER is deceptive. Using the median PER rather than mean (the former excludes outliers and is a better gauge), the market PER drops to 9x. Moreover, the market is distorted by ETF investment in the very large companies. A third of the stock market is under 7x PER. The market remains very cheap outside the largest stocks.
Add to this that the market remains close to 50% below its 2007 peak and it’s clear that Vietnam has plenty of room to go higher.
For it to do so though will require a few things. First, there needs to be further progress on the NPL issue. Second, the government has to get serious about SOE reform. Third, the government also has to follow through with promises to increase foreign ownership limits from 49% to 60%.
As an aside, there are a few ways to invest in the Vietnam stock market. You can do it via an ETF such as Van Eck’s Market Vectors ETF (NYSE: VNM). Or you can go through managed funds such Dragon Capital and Asia Frontier Capital, both of which are reputable.


No investment is risk-free and frontier markets certainly have their share of risk. For Vietnam specifically, the obvious risk is a failure to implement government reform. There are plenty of vested interests involved and you have a government which has made plenty of mistakes in recent years. The risk is that the government thinks its job is largely done in steadying the economy.
The long-term risk is that the economy recovers and a credit boom/bust cycle ensues again. You’d hope that the government has learned the painful lessons of the recent crisis but nothing is guaranteed in this business.
And, of course, there’s the broader risk of a renewed global economic slump which would hurt Vietnam disproportionately. That said, some of the current positive moves on the economic front would put the country in a better position to withstand such a slump.

AC Speed Read

- Frontier markets offer some of the best investment opportunities over the next decade.
- We particularly like Indochina, including Vietnam.
- Vietnam has been through a classic credit bust and is coming out the other side.
- Investors are starting to take notice but the Vietnam market remains cheap.