Vietnam vs India

April 28, 2016

Vietnam and India: unlikely cousins…and why Vietnam is a better long-term bet

In the midst of all the turmoil engulfing emerging markets and the anaemic growth in the developed world, there are 2 conspicuous spots of optimism screaming “investors, when you start fretting, please don’t throw the baby out with the bathwater”. Both are in the developing world, although one economy is 10x the size of the other. But size differences apart there are some striking similarities between these two economic hotspots.

India and Vietnam have plenty in common. Demographically, they are eerily similar – Vietnam has a median age of 28 years while India’s median age comes in at 27. Both countries have experienced their “baby-boomer” phases and now, as these youngsters start entering the workforce over the next 2 decades, both will experience a sharp decline in their dependency ratios. No other sizable countries in the emerging world are as well positioned to realize a demographic dividend – in one camp you have China and Russia which are ageing rapidly even before they have become wealthy while in the other camp you have African countries like Nigeria with rapidly growing populations that are adding so many babies to their ranks that, despite having youthful populations, they will experience an increase in the dependency ratio for a while to come. In short, India and Vietnam are both in a rare demographic sweet-spot.

India and Vietnam also have virtually identical urbanization rates of around 32-33%. That means, both are still well poised to continue to ride one of the biggest drivers of economic growth – urbanization. Both countries have the exact same and high proportion of their workforce tied up on farms (47% for both countries) which means that the migration from agricultural work to higher-productivity factory and service jobs will continue to drive economic growth for a while to come. This is in sharp contrast to other emerging markets like China where the rural-to-urban and farm-to-factory migrations have already played out and future growth will have to come from productivity gains (54% of China’s population lives in urban areas and only ~ 35% of its workforce is now employed in agriculture).

Now for the economic vital stats. Both India and Vietnam are hovering around the USD 2,000 GDP per head (USD 5,800 for India and USD 5,700 for Vietnam on a PPP basis). This has empirically been observed to be an inflection point in the evolution of consumer demand patterns in several countries around the world – in particular, demand for branded food and beverages, consumer durables, etc. tend to take off at this point. This means that the vibrancy of domestic consumerism in each country is just the tip of the iceberg – the party has only just started and will be a long one.

Both countries are also growing their wealth at a rather similar and – may I add, rapid – clip. Vietnam’s real GDP growth for this year is forecasted at around 6.5% while India’s is expected to come in at 7.5% according to the ADB; both countries are experiencing a cyclical recovery after a period of slow growth and surging inflation. If it were not for a bit of statistical tweaking employed by the Indian Statistic bureau which revised its GDP measurement methodology this year, India’s 2015 GDP growth rate would probably be virtually identical to Vietnam’s. And both countries owe a good deal of their improving economic prospects to the moribund global commodity price landscape. Vietnam and India are both sizeable importers of energy and other commodities and both have inflationary tendencies. Vietnam’s inflation rate hit 20% in 2011 in large part due to sky rocketing commodity prices. India’s inflation also touched double-digits in 2012 driven by an overheating economy and high energy prices. This weighed on the currency of both countries – the VND tumbled by 9% in 2011 and the INR appeared to be in freefall in 2013 before the new central bank governor came to rescue with his hawkish inflation targeting policies. It seems that the Vietnamese leadership has also learnt a thing or two about the importance of managing inflation – the “growth-at-all-costs” approach of yester years seems to have given way to a focus on quality of growth and a strong distaste for boom-bust cycles. And regardless of whether the policy-makers in each country take their eyes off the inflation gauge or not, both countries should continue to see benign inflation through 2016 as the commodity outlook continues to be bleak. This gives them room to give that little extra push to growth. Contrast that with the rest of the emerging world where commodity price declines are hammering currencies, leading to budget crises and putting the brakes on growth – Brazil, Russia, Indonesia, Malaysia and a host of sub-Saharan African countries come to mind.

Incidentally, both Vietnam and India are also beneficiaries of another tectonic shift underway in the global economic order – China’s declining cost-competitiveness and intentional transition away from a manufacturing export-led growth model. Average factory labour in both countries is just around a third of the levels in neighbouring China and, unlike Cambodia and Myanmar, both have sizeable-enough workforces to attract large manufacturers that are looking to move their bases out of China. Both countries are well aware of the opportunity and have been aggressively courting manufacturing FDI (worth noting that India had nearly bagged Intel’s $2 billion chip fabrication plant project before the company had a last-moment change of heart to head to Vietnam instead). And both have been plagued, in their quest for manufacturing investment, by their weak infrastructure. India was ranked 54 globally in terms of logistics performance in 2014 while Vietnam came in at 48 out of a total of 160 countries surveyed. Pretty close if you ask me. Road transportation is a major bottleneck in both countries and the railways in both countries are antiquated relics of their respective colonial eras (although the British did build better railways than the French, to India’s benefit). Both countries have extensive coast lines (Vietnam ~ 3,260 km, India ~ 7,517 km) but rueful port capacity – clogged ports and just a handful of deep-water facilities. The good news is that both countries have realized this and have started pushing infrastructure development aggressively; and because governments of both countries don’t have enough cash in their coffers to splash out on mega projects (public debt in both countries accounts for around 55-60% of GDP), both have been flirting with public-private partnerships with mixed results. And both have found a “sugar-daddy” to bankroll their infra spend – Japan.

India and Vietnam both have the same hostile 800-pound gorilla on their northern border – yes, China. And both had brief but fierce border wars with China rather recently – India in 1962 and Vietnam in 1979. The consequent hostility continues to shape foreign policy till today; tellingly, both countries experienced major incidences of Chinese violation earlier this year – the Chinese army came 18km into Indian territory and camped there for a week before withdrawing, causing severe embarrassment to the Indian leadership and defence establishment while Chinese ships and offshore rigs came deep into Vietnam’s territorial waters to purportedly kick-start exploration activities. Yes, at current crude prices. Really. In comes Japan – another country that is bearing the brunt of China’s expansionist tendencies. At a time of growing alarm in Japan over China’s belligerence and Japan Inc’s building unease over its exposure to China as a manufacturing base, both Vietnam and India have become pivotal to Japanese initiatives to now build a “multipolar” Asia to counter Chinese hegemony. Guess what that means? More Japanese funding for infrastructure projects and more Japanese FDI. Vietnam’s gleaming new expressways are being built with Japanese ODA and just last week, India signed a landmark deal with Japan to build its first high-speed railway connecting the industrial hubs of Mumbai and Ahmedabad. Similar talks of a Japanese built and funded high-speed railway linking Hanoi and Ho Chi Minh City have been doing the rounds in Vietnam of late – were it not for the land acquisition issues involved, this might have already started becoming a reality. And this is a symptom of another similar trait between the 2 countries – decentralized government.

Vietnam’s single-party, communist leadership is deceptively like China’s on the surface of it but, dig a little deeper, and you see some similarities with India’s federal and parliamentary system. Even though Vietnam is not a democracy, the legislative and decision-making process in government here is much more consensus-based and conciliatory. Just like the central government in India has to broker deals with the various state governments, Vietnam’s central leadership has to drive consensus among the various provincial authorities. The result is a complicated and cumbersome process to infrastructure development and master-planning but a process that comes with the checks-and-balances to ensure that any appallingly poor decisions don’t see the light of day. China’s complete disregard for the environment in its quest for manufacturing pre-eminence is unlikely to be repeated in India or Vietnam. All the better for the long-run.

I could go on about the similarities. But let me pause here and briefly talk about how these two countries stack up against each other as investment destinations. India gets the “big market premium” – the result of being a giant economy and having significantly deeper capital markets than Vietnam (India’s stock market to GDP ratio is around 65-70% versus only 25-30% for Vietnam). Hence, despite similar economic and corporate earnings growth prospects the Indian stock market is currently trading at 16-17x trailing PE versus only 11x for the Vietnamese market. That’s a pretty big “frontier discount” for Vietnam. And here is why it is not warranted:

Vietnam is an FDI magnet: Vietnam has a unique advantage because of its geographic proximity to China. Given China’s decades of dominance in manufacturing for exports it is still the centre of gravity for global manufacturing. The well-developed ecosystem of suppliers is something which will be very difficult to replicate in another region such as South Asia or Africa. For a company that is looking to diversify its manufacturing base out of China, a new factory in Vietnam can be simply “plugged” into its regional supply chain as opposed to one farther afield in South Asia which will still need to import components from China. Given Vietnam’s proximity to southern China, it could become a natural southward extension of the Pearl River Delta which is the beating heart of China’s vast workshop economy. This is already being reflected in the FDI numbers – Vietnam’s net FDI inflows as a % of GDP were around 5% last year versus just 1.7% for India. Vietnam’s could well be the last in a generation of Asian economies to export its way to middle-income status. With 70% of its FDI coming into the manufacturing sector, Vietnam seems to be on the cusp of an export-boom which will have multiplier effects across the economy. Vietnam’s competitive advantage in attracting manufacturing FDI is also underscored by the fact that it performs very well on 2 critical inputs of industrial production – electricity and water. Vietnam has already electrified 99% of its households, an unusually high number for a frontier market and significantly higher than India’s 79% coverage. In terms of water supply, Vietnam is one among very few rapidly industrializing countries that is facing a water crisis. China, India and large swathes of sub-Saharan Africa are all facing imminent water crises. Not only will this put the brakes on industrial activity but it could also lead to internal strife as communities fight over what is a very basic resource as well geopolitical tussles with neighbours over control of rivers

Vietnam is an oasis of stability in a region of domestic political upheaval: Vietnam is one of the few countries in the region that is politically stable. Thailand is a ticking time bomb, Indonesia a chaotic democracy with religious and ethnic tensions always simmering below the surface and although Myanmar may well be on the path to democracy, risks abound. India, while a well-functioning democracy, has a famously fickle electorate and increasingly divisive politics – with Hindu nationalism stoking religious tensions, one wonders whether this might boil over at some point. Despite securing a historic majority in Parliament, the current ruling party has been unable to get important legislation through an increasingly raucous and fractious parliament. Efforts to engage the opposition mean watered-down reforms. Vietnam, on the other hand, has a stable government that is undergoing a generational change. Next year, the current Prime Minister’s camp is likely to consolidate its power which is good news given the strong reformist zeal that the PM has displayed. The passing this year of a slew of reforms including the new Housing Law which relaxes foreign ownership of real estate as well as the new law lifting the foreign ownership limit on Vietnamese companies are all a precursor of things to come. Religious and ethnic tensions are virtually unheard of in the country and ISIS is unlikely to come knocking on Vietnam’s door. And what’s better, unlike its counterparts to the North, the Communist Party of Vietnam does not seem to be on an opposition-purging “witch-hunt” disguised as an “anti-corruption drive”. This is what I call a “political sweetspot” – a single-party state that has enough power to get more done than an elected leader in a multiparty democracy (read India) and, yet, is not repressive enough to have to worry about keeping a lid on seething discontent (read China).

Vietnam is riding the positive externalities of war and communism: While no one would wish war or major civil strife upon their nation, if there is a silver lining at all to such events, it is the observation that people of nations that go through such traumatic periods end up with more fire in their bellies. The Cultural Revolution in China ravaged the population and millions died in repeated famines but the result was a resilient population that would go to any lengths to ensure that there was never going to be a repeat of these events for the successive generations. The Vietnam War would have had a similar impact on the Vietnamese psyche – the current youth might not have any memory of the war but their parents’ and grandparents’ anxiousness to ensure that their children never live through the same hell, fuelled a surge in spending on education which will have long term positive impacts on productivity. And not to mention the fact that countries that have been through war or internal strife also end up with higher female participation in the workforce – as the men are drafted to fight, the women have to earn the bread and the ensuing poverty, post-war, means that working couples become the norm. The ensuing period of Communism in Vietnam further strengthened these foundations through universal provision of education and healthcare – school enrolment skyrocketed and broad access to basic healthcare lowered the disease burden while reducing infant and mother mortality. Healthier babies and mothers meant women could continue working and contributing to the economy.

The above factors set the stage for sustained and rapid growth in Vietnam’s economy. Exports will surge while a vibrant domestic consumption story continues to play-out. In a world of growing uncertainty and weak growth prospects, India stands out as a giant-sized beacon of opportunity. But don’t forget its smaller cousin to the South East that is punching way above its own weight.

Season’s Greetings.

VCSC Rating and Valuation Methodology

Absolute, long term (fundamental) rating: The recommendation is based on implied total return for the stock defined as (target price – current price)/current price + dividend yield, and is not related to market performance. This structure applies from 27 May 2015.

Unless otherwise specified, these performance parameters only reflect capital appreciation and are set with a 12-month horizon. Future price volatility may cause temporary mismatch between upside/downside for a stock based on market price and the formal recommendation, thus these performance parameters should be interpreted flexibly.

Small Cap Research: VCSC Research covers companies with a market capitalisation of up to US$50mn, inclusively. Clients should note that coverage may not be consistent and that VCSC may drop coverage of small caps at any time without notice.

Target price: In most cases, the target price will equal the analyst’s assessment of the current fair value of the stock. The target price is the level the stock should currently trade at if the market were to accept the analyst’s view of the stock, provided the necessary catalysts were in place to effect this change in perception within the performance horizon. However, if the analyst doesn’t think the market will reassess the stock over the specified time horizon due to a lack of events or catalysts, then the target price may differ from fair value. In most cases, therefore, our recommendation is an assessment of the mismatch between current market price and our assessment of current fair value.

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.

Risks: Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. For investment advice, trade execution or other enquiries, clients should contact their local sales representative.

Disclaimer