Logistics – Still Adolescent but Growing Up Fast

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September 11, 2015.

Still Adolescent But Growing Up Fast

Vietnam’s USD 50-60 billion logistics industry is growing fast but is still in the early stages of development. The sector has been growing at ~20% per year and is expected to sustain double-digit growth for at least the next 5-10 years. Most Vietnamese logistics players are 2PL (secondary party logistics) providers unlike in more developed markets where 3PL providers and integrated supply chain management vendors dominate.

The sector provides broad exposure to the country’s emergence as a manufacturing hub… After stagnating in 2011 and declining in 2012, total disbursed FDI into Vietnam grew by over 9% CAGR since then to reach USD12b in 2014, with around 70% of this coming into the manufacturing sector. Major upcoming free trade agreements should accelerate this trend, thereby driving sustained demand for a whole range of logistics services in the coming years.

…while simultaneously allowing one to ride fast emerging domestic consumption themes like the growth in organized and internet retailing. Vietnam has become one of the fastest growing retail markets in the world. Retailing sales grew at 17.5% from 2009 to 2014 to reach VND 1,751t (USD 80b) in 2014 and is expected to touch VND 2,202t by 2019. The modern trade channel penetration is less than 15% in urban areas and just 0-1% in rural areas (4-5% nationwide) but this is increasing fast with several global and domestic players entering the market. This is spurring demand for logistics services while also creating demand for specialized logistics capabilities like cold chain management (for grocery retailers). Internet retailing is another rapidly emerging sector, having grown by 43% in 2014 to VND 11t in value. The complex last-mile delivery and payment collection requirements of internet retailing in Vietnam is driving demand for specialist logistics services.

Inefficiency is still a major hindrance to the industry, depressing the valuation of logistics companies… The lengthy customs and regulatory procedures in Vietnam increase logistics costs while also leading to delays in cross-border cargo movement. The underdeveloped transport infrastructure in the country further exacerbates this problem. This “inefficiency” discount is reflected in the relatively low median P/E of 7.4x for the universe of listed logistics companies in Vietnamese versus 15.1x in the Philippines, 19.8x in India and 23.1x in Thailand.

…but the continued flow of FDI and rapid infrastructure development will boost efficiency and close this valuation gap with regional peers. Vietnam is continuing to see strong FDI flows into high-tech manufacturing segments like electronics, which have complex supply chain requirements, involving several imports of multiple precision components and exports of high-value, fragile finished goods. This will pressure existing logistics players to upgrade their capabilities. The huge spending underway in road, rail, port and airport infrastructure will, in turn allow local players to improve their efficiency, and consequently, profitability.

The Vietnam Logistics Industry is at an inflection point

Vietnam’s logistics market, by some estimates, is ~US$60 billion in total value. In total, there are around 1,000 logistics firms, 25 of which are foreign firms. Foreign firms of note are Maersk Logistics, APL Logistics, NYK Logistics and MOL Logistics. Most foreign firms can offer third or fourth party logistics (3PL or 4PL) services while Vietnam domestic firms can only handle 2PL services. Foreign firms in Vietnam currently dominate the market, with a collective market share of approximately 80%.

The sustained growth in the country’s economy and trade with the rest of the world over the past two decades has led to rapidly increasing levels of transportation demand, which have put a strain on limited resources. To date, Vietnam’s transport and logistics system has been able to accommodate fast growth despite limited connectivity. However, the shift in the industrial base towards more sophisticated manufacturing (electronics, chemicals and automotive assembly) and the development of modern retail formats are increasing the complexity of supply chain requirements with heightened needs for timeliness and efficiency. This creates an unprecedented opportunity for domestic logistics players to upgrade their capabilities and evolve from 2PL vendors focused just on forwarding and transportation into 3PL providers that provide the entire spectrum of supply chain services and offer tailored solutions to clients. The industry is divided into four main categories: transportation, forwarding, warehouse, and other value-added services.

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Transportation is a vital part of the logistics value chain and will benefit from improving infrastructure

Transportation services account for the biggest chunk of the Vietnam logistics market. Providing basic transportation services is usually the first step in the evolution of the logistics industry in most market with other services developing around this core. Vietnam is no different and, given the relative immaturity of the logistics industry in the country, transportation services are still the dominant category in value terms. The vast majority of local logistics companies are just trucking fleet operators that simply move products from point A to B. The low entry barriers in the road transportation category have resulted in a fragmented supply-side with limited quality assurance. The sea-shipping and air freight category, on the other hand, is dominated by joint ventures between foreign players and local firms.

Road is by far the more popular medium for moving freight within the country and should continue to grow fast due to regional economic integration. Road is not only an important medium for domestic transportation but increasingly plays a role in cross-border goods flows, being the main form of transport linking Vietnam’s factories to the country’s port and also plays a key role in linking Vietnam with its second-largest export partner China. Vietnam’s road network is extensive at around 222,000 kilometres but only around 19-20% is paved and expressways are still relatively uncommon; most of the widest roads have fewer than 4 lanes and separate interchanges. Given its traditional dominance and popularity as a transportation medium, Vietnam’s road network is now congested with maximum traffic speed barely exceeding 60 km/h. Roads connecting industrial zones to major ports in both the North and South are particularly congested due to increased freight volumes in line with growing export-oriented manufacturing activity.

According to the General Statistics Office, the average transportation distance is relatively short at about 61 kilometres, reflecting the skew in favour of local-to-local transportation. Given the underdeveloped road infrastructure and the limited fleet size of long-haul trucks in the country, road transportation has not been a favoured means for long-distance transportation. Vietnam is now heavily investing in upgrading its road network with a particular emphasis on expanding its highway / expressway network from the current 600km to 2,000km by 2020. The improving national highway network, growing trade links with China, the formation of the upcoming ASEAN Economic Community (AEC) and a growing fleet of long-haul trucks in the country should all give a fillip to long-haul road transportation.

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Inland waterways are also a vital but underexploited domestic transportation medium. Vietnam has a large and intricate network of inland waterways that stretch for over 42,000 kilometres, which connects it extensively with neighbouring countries including China, Laos, Cambodia and Thailand as well as to Vietnam’s South China sea cost. However, the potential of these vast waterways is still relatively underexploited due to the low clearance of bridges over waterways and poor river port facilities. Most bridges on the two main rivers in Vietnam – the Mekong in the south and the Red River in the north – do not allow passage of barges above 96 TEU in capacity (to put this in perspective, barges up to 208 TEU use the Rhine River which connects most of Western Europe. Inland ports are generally small and in poor condition, with loading and unloading mainly carried out on the river bank because few ports have proper handling facilities. Yet river barges play a vital role in feeding cargo to most of the mainline vessels at Cai Mep-Thi Vai port in the South. With adequate investments, the dense river network connecting Vietnam with the rest of Indochina could position the country as a transit hub for Southeast Asia (particularly for land-locked regions like Laos and Northern Cambodia), much like the Netherlands is for Europe.

Rail has lagged heavily as a transportation medium due to underdeveloped infrastructure but this could change.
The rail system in Vietnam is rather underdeveloped and, being a legacy of the French colonial era, is heavily in need of upgrades and expansion. Rail is a vital medium in countries like China and India as it is capable of handling large freight volumes economically and reliably. Improving the rail network would make a significant impact in improving the logistics competitiveness of the country. Recent discussions around the Japanese providing funding assistance and expertise in upgrading and building-out the local rail network are positive steps in this direction. Once this happens – and once the Vietnamese rail network gets integrated into regional rail networks following the creation of the AEC – it is expected that the average rail freight transportation distance will increase considerably from the current 567 kilometres. This should further lower overall logistics costs in the country.

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Maritime transportation is important in supporting Vietnam’s growing participation in global trade but port quality is a constraint. Accounting for more than half of the total accrued FDI, investment in manufacturing, in particular, has been driving the country’s demand for international transport and logistics services. Situated in the southeast of the Indochinese peninsula and with a 3,200 km coastline situated along one of the busiest cargo lanes in the world, Vietnam depends heavily on sea freight transportation for its external trade. Since 2007, Vietnam’s container port throughput has been expanding at a CAGR of 12.5%, reaching 8.1 million TEUs in 2013, double the volume seen in 2007. Driven by exports from foreign-invested manufacturers and by the import of intermediate and capital goods, Vietnam’s external trade grew strongly last year, with exports and imports growing by 14% and 12%, respectively

Vietnam has seen a proliferation in the number of ports in recent years. With companies from Intel Corp. to Samsung Electronics Co. building multi-billion-dollar factories in Vietnam over the past couple of years provincial authorities have established competing ports capable of handling overseas traffic, causing plunging rates and losses for operators estimated at $1.5 billion or more, according to Seaport Consultants Asia. The highly decentralized decision-making process means that there is no coordinated strategy or master plan for port development. Additionally, ports development plans and ground transportation infrastructure development plans are not in sync, resulting in several ports being constrained by poor connectivity with factories and logistics hubs. The government wants to build even more ports, emphasizing “quantity over quality,” a World Bank report in January said. The overcapacity may undermine Vietnam’s ability to attract more higher-value manufacturing that demands efficient transportation systems, the report said.

On the brighter side, deep-water port capacity – previously a major constraint to efficient shipping – is now being addressed by the government. About $2 billion has been invested by foreign investors and state-owned and private Vietnamese companies in state-of-the-art terminals at Cai Mep port, Vietnam’s only deep-sea facility located at the mouth of the Cai Mep River and South China Sea. Opened in 2009, the port is part of the country’s goal to boost shipping volume more than 130 percent from 2012 to the end of the decade. As deep-water port capacity increases, there will be less need for transhipment to and from regional hubs like Singapore and Hong Kong, thereby slashing maritime shipping costs to and from Vietnam.

Within the Warehousing segment, Cold Storage is a promising and highly underserved niche

Cold warehousing is a high potential and underserved niche, comprising cold storage and cold transportation. According to Frost & Sullivan, climate controlled logistics is one of the highest potential and yet, most underserved segments of the logistics market in Vietnam. According to StoxPlus, the country’s total cold chain capacity is just 473 thousand tons which includes total system-wide capacity at a given point in time (goods in cold storage + goods in cold transit). The continued entry of major modern format grocery retailers and the increasing export of farming and seafood products are expected to create multiple opportunities for Cold Chain specialists. Additionally, due to Vietnam’s traditional “eating fresh” society, the “frozen food” retail sector is currently fragmented and the Cold Chain industry is under-invested. However, the demand for frozen products is increasing with changing lifestyles in urban areas, putting the limited existing Cold Chain infrastructure under pressure. Each year Vietnam incurs a loss of at least USD 2.5b in distribution of farming products and seafood. This is equivalent to a loss rate of approximately 25%, extremely high compared to other countries, even those at similar stages of development.

In order to remedy this situation, the government has introduced various financial incentives in order to attract foreign investment into this segment. Japanese firms currently make up the largest percentage of foreign specialists operating in the country.

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The Forwarding segment is seeing increasing participation from foreign players

Local companies are very active in this segment but should expect growing competition from foreign players. Some of the leading domestic players in this segment are Vinafreight and Vinalines. Local companies have, thus far, dominated the domestic freight forwarding segment as it requires strong relationships with the carriers or transportation service providers which, as pointed out above, largely comprise local companies. That being said foreign players have an advantage when it comes to overseas freight forwarding and, in recognition of this, they are increasingly moving into this segment of the logistics market.

The Port-Handling segment is growing, spurred by increasing trade and supported by an improvement in port capacity and connectivity

Soai Rap channel project: On June 21, 2014, the project for dredging the Soai Rap channel (phase 2) to accommodate vessels with a load of more than 50,000 tons was inaugurated. Before the completion of this project, vessels from the Eastern Sea entering Ho Chi Minh city had to go around the Vung Tau cape, Ranh Rai bay and rivers including Nga Bay, Long Tau, Nha Be, Sai Gon with a total distance of 85 km. Furthermore, Long Tau channel is too narrow to accommodate large cargo ships. Soai Rap channel can now allow large vessels to pick up goods at Hiep Phuoc port. According to government, the total annual cargo through Soai Rap could reach 120-150 million tonnes by 2025.

The development of transportation infrastructure will support increasing cargo volumes through Cai Mep port zone in coming years: The expansion of highway 51 was finished in 2015. Road 965 – the arterial road linking Cai Mep port zone with highway 51 – has also been completed making freight traffic more convenient between Cai Mep and major industrial areas around HCMC. Currently, work is also underway to complete the inter-port route connecting SP-PSA port and SITV port within Cai Mep port zone and should be completed within 2015.

Ha Noi- Hai Phong highway: As of June 2015, the construction of this highway was around 90% complete, which is improving connectivity between Ha Noi and Hai Phong. This is an important route as it connects the fast-emerging northern key economic zones with the second largest group of seaports in the country.

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Demand for other value-added logistics services should grow fast

Demand for other value-added logistic services is increasing as companies seek integrated supply chain solutions from vendors. Nonetheless, a large portion of these services is still operated in-house by companies operating in Vietnam. Based on the historical trend of a sharp increase in outsourcing of value-added services and the still relatively low % of these services that are being outsourced currently (relative to traditional logistics services like transportation and warehousing), the demand for such services will continue to rise over the medium-term irrespective of growth in the end-user industries. Companies will increasingly seek one-stop-shop solutions from 3PL vendors which will include value-added services in addition to traditional services like transportation and freight forwarding.
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Vietnam’s Logistics Industry is expected to grow in size and sophistication in the future…

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Vietnam’s logistics sector is growing fast but still at the early stages of development. It is growing quickly at a rate of 20 percent per year, and is expected to maintain a high growth rate in the coming two decades driven by a growing economy, growing size and sophistication of the manufacturing and export base, fast growing penetration of organized retailing, and, a thriving e-commerce sector.

The room for expansion in size and scope is huge. Most Vietnamese logistic companies are just 2PL (secondary party logistics) providers that use their own assets to provide basic logistics services such as transportation and warehousing. As customer needs become more complex, logistics vendors need to combine management skills and system technology along with their existing physical assets and labour resources to provide a broad spectrum of professional services. Only around 15% of Vietnamese logistics providers today are capable providing such 3PL services and, those that do, have a substantial competitive advantage.

As the sector matures, efficiency should improve substantially.
Vietnam’s logistics industry is still rather inefficient with most vendors providing basic services like transportation and warehousing and no providers of system-level integrated services and solutions. As a result, supply chains are put together in piece meal fashion, involving multiple vendors at each stage and the result is suboptimal at a system level. This, together with inadequate infrastructure and lengthy customs procedures has resulted in a nationwide logistics cost-to-GDP ratio of nearly 25% which is much higher than that of regional peers. As vendors graduate to 3PL status, logistics efficiency should improve over time.

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…despite the presence of some structural challenges..

Lengthy customs processes are a major impediment to efficiency but the government seems to have recognized this

Vietnam’s customs requirements are more stringent and cumbersome than those in many other Asian countries. According to a number of local and foreign logistics companies interviewed during a recent HKTDC Research trip to Vietnam, the country’s customs and regulatory practices act to increase the operational costs of many logistics companies servicing the region. Its customs practices are also seen as unpredictable and bureaucratic. It takes, for example, 21 days to export a cargo shipment from Vietnam, compared to 14 days for Thailand and 11 days for Malaysia.

The good news is that the Vietnam’s customs procedures are currently being modernized. A new electronic customs clearance system (‘e Customs’) was launched in April 2014 to address these issues. Delays are still common. These have largely been attributed to a number of inefficient, manual customs processes, including cargo inspections that have attracted criticism for lacking in both transparency and consistency.

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Inadequate infrastructure is another bottleneck but this is also being tackled quite aggressively.

Both local and foreign logistics companies often cite its relatively underdeveloped transport infrastructure as a major challenge for business development in Vietnam. In particular, logistics facilities, such as warehouses and container freight stations, are not convenient to use, as they are often standalone and located far from either ports or manufacturing plants. The road length and surface area growth has not kept pace with traffic growth, leading to congestion and causing delivery delays that increase transportation costs.

The fast growth in the number of industrial parks has outpaced infrastructural development. As of June 2014, there were about 290 industrial parks in Vietnam, 33 of which had been operating for just over three years. In particular, many of the highways linking the ports with industrial parks or city centres, as well as the port terminals, are highly congested. The problem is most severe in the northern provinces, where the infrastructure is less developed when compared with the south. Traffic and port congestion often leads to delays in transporting cargo from the factories to ocean carriers and can impede the delivery of imported parts and components, resulting in higher inventory carrying costs for manufacturers.

Current logistics facilities are not up to international standard on all measures, including a stable supply of utilities, efficient warehouse management systems and security. Although several modern facilities have been built recently, largely by foreign-invested logistics companies, the majority of the older ones are sub-standard. Significantly, many of the logistics parks in Vietnam have been planned and developed by private companies, rather than by the government, thereby depriving Vietnam’s logistics sector of the benefits of comprehensive planning and the subsequent emergence of an efficient logistics network.

But Vietnam’s aggressive recent investment in infrastructure is encouraging. According to KPMG, Vietnam is going to invest USD 170B in infrastructure between 2013 and 2020 to bridge this infrastructure deficit and a large portion of this will be funded through overseas money. A large number of landmark projects are already underway across the urban rail, road and airport segments.

…because of a host of supporting macro trends…

Foreign investment is boosting demand for quality logistics services

Vietnam is becoming a popular FDI destination due to a growing domestic market and a cost-competitive export base. Following Vietnam’s 2007 World Trade Organization (WTO) accession, the FDI into the country has been rising steadily. For the period 2008-2013, FDI inflow averaged US$10.8 billion annually – more than double the US$4.0 billion per annum average seen during the six-years prior to 2007.

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Investment in manufacturing, in particular, has been driving the country’s demand for international transport and logistics services, accounting for more than half of the total accrued FDI and around 70 percent of new FDI in the past year. Since 2007, Vietnam’s container port throughput has been expanding at a compound annual growth rate (CAGR) of 12.5%, reaching 8.1 million TEUs in 2013 (double the volume seen in 2007). Driven by exports from foreign-invested manufacturers and by the import of intermediate and capital goods, Vietnam’s external trade flourished in 2014, with exports and imports growing by 14% and 12%, respectively.

The country has evolved into an increasingly diversified manufacturing base for multinationals, with the import of production inputs and the output of finished products inevitably generating more business for logistics companies. Historically, ready-to-wear garments and shoes have dominated Vietnam’s labour-intensive, consumer goods exports. Intermediate and capital goods – such as machinery, raw materials, fabrics, electronic parts and components for manufacturing – now account for the lion’s share of Vietnam’s total imports and are mostly sourced from China, Japan and Korea. These products involve multiple components and complex supply chain dependencies which require higher-end logistics service capabilities.

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Free Trade Agreements are providing that additional oomph

Vietnam’s international trade is expected to increase with the finalization of many free trade agreements such as the Trans-Pacific Partnership (TPP) and several bilateral trade agreements. Additionally, the conclusion of the ASEAN Economic Community adhered to above will also provide a huge boost to intraregional trade flows. The resulting increase in trade will further boost demand for logistics services.

…and supportive regulatory and policy measures

The government has developed a master plan to boost port capacity in the country. Decision 1037/QD-TTg outlines future developments for the maritime business until 2030. The country’s port sector will be divided into six main areas. There will be a focus on developing ports that can handle ships with a capacity of 100,000 tonnes or more.

Government to incentivize cold storage investment to reduce post-harvest losses. Decision 63/2010/QD-TTg provides supporting policies to reduce losses of fresh produce and grains after harvesting. Enterprise that invest in cold storage can borrow up to 100 percent of machinery value to fund their capital expenditures. The State Budget will also subsidize 100 percent of interest expense in the first two years and 50 percent interest expense in the third year.

Foreign investment restrictions in the logistics sector are being relaxed gradually, stimulating growth in logistics capacity and quality. In January 2014, in accordance with World Trade Organization (WTO) service sector commitments, Vietnam began allowing wholly foreign-invested enterprises to enter the logistics market in almost every sector. However, the container-handling services and road transport services sectors still require a joint venture to be formed with Vietnamese partners, with foreign ownership capped at 51%.

In reaction to the liberalization of the sector and the perceived growth potential of Vietnam’s logistics market, foreign firms are now investing heavily throughout the country. For example, in 2013, DHL Supply Chain invested US$13 million in an expansion project. It is expected to build 141,000m2 in storage capacity and have roughly 100 shipping vehicles and 2,200 workers by the end of 2015. According to Oscar De Bok, General Manager of DHL Supply Chain in Southeast Asia, the company is preparing for the fast growth of the retail industry, consumer goods, tech products and automotive industry in Vietnam. Since its entry in 2001, DHL Supply Chain Vietnam has had an annual growth of 45 percent, compared to its annual global growth of 25 percent.

Maersk Line, ocean-shipping subsidiary of A.P. Moller-Maersk, has also constructed four new storage facilities and it is planning on an expansion project in 2015. From 2005 to 2010, Maersk Line’s operations in Vietnam grew by 200 percent.

The Vietnamese listed logistics universe is sizeable and trading at an attractive valuation

The majority of logistics companies in Vietnam are not listed on the stock market. Currently, there are only 25 listed logistic companies out of a total of approximately 1,000 operating logistic companies in the country.

The total market capitalization of the listed companies is sizeable, at over USD 1 billion. Port operators account for the lion’s share of the overall sector market capitalization.

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Vietnamese logistics companies are trading at a discount relative to regional peers. The mean and median P/E ratios for Vietnamese companies are 8.0x and 7.4x, among the lowest in the region. This probably reflects the current low capability of the Vietnamese logistics industry. As the industry matures and efficiency and profitability improve, Vietnamese logistics companies should close the valuation gap with regional peers, creating upside for early investors.

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Valuation Methodology: To derive the target price, the analyst may use different valuation methods, including, but not limited to, discounted free cash-flow and comparative analysis. The selection of methods depends on the industry, the company, the nature of the stock and other circumstances. Company valuations are based on a single or a combination of one of the following valuation methods: 1) Multiple-based models (P/E, P/cash flow, EV/sales, EV/EBIT, EV/EBITA, EV/EBITDA), peer-group comparisons, and historical valuation approaches; 2) Discount models (DCF, DVMA, DDM); 3)Break-up value approaches or asset-based evaluation methods; and 4) Economic profit approaches (Residual Income, EVA). Valuation models are dependent on macroeconomic factors, such as GDP growth, interest rates, exchange rates, raw materials, on other assumptions about the economy, as well as risks inherent to the company under review. Furthermore, market sentiment may affect the valuation of companies. Valuations are also based on expectations that might change rapidly and without notice, depending on developments specific to individual industries.

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