"Wealth is being created at a turbo-charged rate, and the young, newly affluent population is engaging in a startling wave of (largely un-financed) conspicuous purchasing. Bicycles have been swapped for BMW’s in the streets of Hanoi and Ho Chi Minh. McDonald’s may be conspicuous by its absence but there is no shortage of high-end electronics retail outlets, mobile phone distributors and auto dealers challenging the spaces previously dominated by art and lacquer ware...", said strategists based in Hong Kong, including Spencer White, the chief Asian equity strategist for Merrill Lynch, one of the world’s leading financial management and advisory companies.
According to Merrill Lynch's strategists, the sources of this conspicuous wealth are probably a combination of the property cycle, the relaxation of investment rules, the shift in policy to encourage private enterprise and the flow of overseas remittances in Vietnam. "Vietnam is one of the last frontier emerging economies in the region that will demand serious investor attention over the next decade," White, Stephen Corry, Willie Chan and Alistair Scarff said. Accelerating foreign direct investment, the prospects of WTO-entry by 2007, opportunities to develop tourism much more significantly and a wide ranging infrastructure program, all important drivers of sustainable long term growth, make Vietnam highly attractive.
The Merrill Lynch's strategists rated Vietnamese shares a "10-year buy," pointing to the economic growth rate last year of 8.4 percent, the highest in the region after China. They supposed that Vietnam's equity market is understandably slow but steady. However, this equity market is also likely to be one of the fastest growing as more privatizations come through and, perhaps, some of OTC-traded private sector companies will be persuaded to go public. For now the majority of listed companies are ex-state enterprises. The ratio of market-cap to GDP is also amongst the lowest in Asia at just 4 per cent. The official target is to raise this to as much as 15 per cent by 2010 – even then it would still be the most under-represented in Asia - the regional average is 127 per cent).
Government policies currently revolve around such key areas as the development of the private sector, attracting FDI, the privatization of state-owned companies, membership of WTO and infrastructure development. In combination these will both act as a driver of growth but also provide alternative avenues of capital raising as the listed market gains greater breadth and depth.
The establishment of the Enterprise Law in 2000 set the stage for the rapid growth that has occurred in the private sector over the last five years. From less than 100 private companies at the time there are now more than 200,000 and the number continues to expand. Many of these are small scale and essentially family run businesses, in part because of the difficulty in accessing loan capital from the banks. However, as Alistair Scarff, Merrill Lynch's Regional Bank Research Analyst, notes this is beginning to change, especially as foreign banks are taking stakes and starting the process of upgrading credit assessment systems as well as credit products. The introduction of a unified tax rate (28 per cent) has also helped to improve both the transparency for companies as well as tax collections for the government. This begins with ‘equalization’, effectively an incorporation process that creates shares that are all held by the State.
The new Enterprise Law is due to come into effect from July, 2006, and this will require that all state owned enterprises are incorporated within four years. This will set the stage for a sustained privatization stream over the next couple of years. At the same time the government is also setting up a Temasek-type asset holding company to accommodate all the residual holdings. An important element of these IPO’s is the allocation of stock to management and employees as the joint stock entity is created – which can be as much as 30 per cent of the total shares in issue. This provides much of the liquidity that passes through the OTC market and provides a potential source of stock for institutional investors to access.
In regards of foreign investment, in 2005, FDI is estimated to have reached US$5bn representing an eight year high. Merrill Lynch's strategists see Vietnam attract capital "as a complementary production base to China as manufacturers seek to diversify supply chains". The Japanese have been amongst the largest investors, with US$590m committed last year and a cumulative total of US$4.5bn (close to 17 per cent of the total). Other key sources have been Korea, Hong Kong, Taiwan and Singapore. The recent Memorandum of Agreement signed with Intel, for an estimated commitment of more than US$600m, would be the single largest technology investment in the country.
Vietnam's negotiations for WTO membership are undergoing some renewed momentum, making membership by the end of 2007 a fairly credible possibility. According to the Merrill Lynch report "Asian Insights" released in February 2006, around Asia in the past decade, areas such as telecoms and financial services will be amongst those to face the most intense competition as the domestic market is opened up. However, there is likely to be resistance from areas dominated by the SME sector, such as distribution and retailing, due to the relative lack of sophistication and scale. For some, it will present the opportunity to capitalize on the expansion of the global supply chain into Vietnam.
Merrill Lynch's report affirmed that Vietnam badly needs to upgrade its infrastructure across many of the most obvious areas. Energy is probably the most important area that needs to be addressed. Power needs are rising at 15 per cent p.a. and the huge reliance on hydro (56 per cent of total generation capacity) leaves Vietnam vulnerable to droughts. Sixty new plants are planned by 2020 to meet the rate of domestic demand growth. For investors with an appetite for strategic, long term projects, the power sector in Vietnam is, from strategists' perspective, worth a very close look. Furthermore, there is no domestic refining capacity until the Dung Quat Refinery comes on line at 2008 at the earliest, and even then only 60 per cent of current needs will be met by this facility. This leaves Vietnam as a net exporter of crude oil and gas but a net importer of fuel oil and gasoline for the foreseeable future. Besides, transportation is another bottleneck to growth. Ports are running at full capacity and three large scale deepwater ports are under construction south of HCMC. Neither HCMC nor Hanoi suffer from the traffic congestion found in other major cities such as Mumbai, Jakarta or Bangkok, but at the current rate of growth in car ownership this can only be a matter of time.
However, there are several major risks that Merrill Lynch's strategists see for investors in Vietnam. Limited capacity is the most obvious, especially in terms of the equity market. Government policy makers could also reverse the path of current reforms, and if growth falls below 7 per cent there could be social unrest given the high numbers entering the workforce each year. Corporate governance and transparency is improving, albeit off a very low rate, which poses micro-level risks to investors.
However, they recommended that Vietnam now "should not be dismissed as more interesting than investible" and urged 'buy equity exposure now for your fund, for yourself and for your children. Buy now and tuck the investment away for ten years. In 2016 we can come back to discuss compound returns, the toys that you can buy or the college that they will attend".
Hai Chi
Vietnamese
