CalPERS may have packed its bags, but other investors are checking back into the region.
By Nick Cumming-Bruce
May 2002
Institutional Investor Magazine
Maybe the third time will be a charm. Thai share prices rose 20 percent in the first five months of 2001 as populist billionaire Thaksin Shinawatra won a landslide election as prime minister and gained control of parliament. But almost immediately, Thaksin got himself into legal and political hot water, and the market sagged. Last August, as his problems subsided and hopes grew for a meaningful global economic recovery, the market surged anew. This time the fallout from September 11 and deepening economic worries cut the party short. By November the Stock Exchange of Thailand’s benchmark index had fallen to 265, just shy of where it started 2001.
Then optimism stirred again. A December rally was further stoked by the arrival of overseas money early this year. “You,d think foreigners woke up on January 1 and said, ,Hey, this is going to be a good year, Thailand,,” says Shane Gunther, head of research at UBS Warburg in Bangkok. By April 10 the SET index had closed at 372, 18 points off the year’s high but still 23 percent up from the start of 2002 and 40 percent above November’s doldrums.
Thailand wasn,t the only market to benefit. Across Southeast Asia, bourses sprang to life. By early April Indonesia’s stock market had surged 31 percent in 2002, Malaysia’s had risen 18 percent and the Philippines, had gained 17 percent , easily besting U.S., European and other Asian markets. “Liquidity is driving the markets, and that’s coming mostly from abroad,” says James Squire, the Hong Kong,based director of Asian equities at Baring Asset Management, which oversees $2.6 billion in Asia ex-Japan.
The interest was strong enough that it appeared to be drawing money away from some of Asia’s more formidable markets. In 2001 South Korea pulled in nearly $8 billion from net foreign buying, but so far this year, more than $1 billion has departed the country. By contrast, Thailand, after three straight years of net foreign selling , including $162 million in the last quarter of 2001 , enjoyed a first-quarter inflow of $428.5 million. Meanwhile, the Philippines, which received $86 million from foreign buyers in 2001, attracted $59 million in just the first quarter of this year. “People are now more aware of [Southeast] Asia and are taking it more seriously,” says Squire.
Of course, a trickle of foreign funds goes a long way in Southeast Asia’s tiny markets. And by all accounts, most of the overseas money is coming from hedge funds, which don,t tend to hang around for too long. As Ray Jovanovich, head of portfolio management at Crédit Agricole Asset Management, which handles more than $2.4 billion in Asia, says, “It’s not the kind of [longer-term] money that drove these markets from the late 1980s to 1997.” Indeed, one source of patient money, U.S. pension giant California Public Employees, Retirement System, made a widely publicized decision early this year to abandon most of Southeast Asia over governance concerns.
Still, the 2002 snapback has brought renewed attention to markets that large foreign institutions have mostly ignored since the Asian financial crisis of 1997 , despite substantial economic, political and regulatory reforms. Can Southeast Asia sustain the gains? Or was CalPERS correct to leave until more progress is made on reform? No one’s predicting straight-line improvement for the markets , or in government and corporate practices , but experienced Asia hands think reluctant investors are missing an opportunity: “You,re more likely to make money now than at any time since the late 1980s,” says Squire.
Why? For one thing, these markets are cheap. “Don,t overlook the element of catch-up,” says Stewart Aldcroft, managing director of Investec Asset Management Asia, which runs $300 million and advises on a similar amount from Hong Kong. “There has been little or no foreign investment,” he says.
Even after the recent surge in prices, multiples still look reasonable given the growth forecasts for corporate earnings this year, says Citigroup/Salomon Smith Barney’s Hong Kong,based head of Asia-Pacific strategy, Ajay Kapur. Overall, Thai companies are expected to see 28 percent earnings growth, he says. Indonesia looks “ridiculously cheap,” Kapur adds, promising an average return on equity of 30 percent this year. For that, “I,m prepared to pay five times price-to-book; in Indonesia we,re at about half that multiple,” he says.
With their heavy reliance on exports, Southeast Asian countries also offer a leveraged play on the U.S. economic recovery. “You have an absolutely magnificent cyclical story,” says Simon Flint, Singapore-based senior strategist of Bank of America Corp.'s global strategy unit. Globally, a typical country’s exports account for about 20 percent of GDP. In Southeast Asian nations, the export dependence is at least twice that , with the U.S. a prime overseas market. “If you believe in global growth and recovery in the U.S.,” says Flint, “what better place to go?”
The increasing likelihood of a solid U.S. recovery has set off a wave of revised growth predictions for Southeast Asia in the past month or two. Brokerage CLSA Emerging Markets started 2002 forecasting no GDP growth in Thailand this year, for example. After the first quarter, the firm upped its projection to 3.3 percent. Similarly, CLSA anticipated that Malaysian GDP would shrink by 0.9 percent in 2002. It later revised its forecast to 3.2 percent growth and has since pushed it up to 4.4 percent. Forecasts for Indonesia and the Philippines have undergone similar boosts.
Whatever their shortcomings, Southeast Asian governments look more secure than they have at any time since the 1997 crisis. Thailand’s Thaksin managed to sidestep the self-dealing charges that threatened his administration last year, and he now commands an unprecedented majority in parliament. Malaysia’s prime minister, Mahathir Mohamad, has weathered the protests that erupted after the 1998 dismissal and imprisonment of his former deputy, Anwar Ibrahim. Talk of a leadership change has quieted. In the Philippines the corruption-tainted presidency of Joseph Estrada has given way to a reformist administration under his former deputy, Gloria Macapagal Arroyo. Even volatile Indonesia, run by Megawati Sukarnoputri, has found some respite from the turmoil that brought down ex-president Suharto and two successors in three years. “The outlook for these folks is much better than what we had two to three years ago,” says Citigroup/SSB’s Kapur.
Stronger growth and a measure of stability have also helped these countries make strides in cleaning up corporate balance sheets. For instance, net debt-to-equity ratios among Thai companies dropped from 141 percent in 1997 to 91.5 percent last year and are expected to fall to 81.5 percent this year, according to CLSA figures. In Indonesia the figure peaked at 206.4 percent in 1998 but fell last year to 65 percent.
To be sure, there are problems. CalPERS, with $150 billion in assets, pulled money out of Indonesia, Malaysia, the Philippines and Thailand in February because the countries didn,t meet its new guidelines for transparency, press freedom, regulatory environment and investor protection and labor standards. The disclosure set off a slide in Southeast Asian markets, most pronounced in Thailand, where the SET index fell 7 percent in the next two days.
The CalPERS decision , and the markets, brief but dramatic response , only reinforces the region,s reputation for risk. Thailand and Indonesia have been slow to tackle the mountains of bad debt saddling banks. Rather than writing off the loans, Thai banks have preferred to raise capital in the hope that stronger growth will rescue strapped borrowers. Meanwhile, the Indonesian Bank Restructuring Authority has been criticized for proceeding at a snail’s pace to clear up banks, distressed assets.
Southeast Asia’s lackadaisical approach to corporate restructuring similarly mars its recovery outlook. Contrast South Korea’s determined drive to reform corporate management to that of Thailand, which still has huge excess manufacturing capacity.
Investors applaud Malaysia’s progress in limiting political influence at major companies. But “we are watching to see if the leopard has changed its spots,” says Hugh Young, the Singapore-based managing director of Aberdeen Asset Management Asia, which oversees $4.5 billion.
Indeed, despite the recent surge of investor interest, Southeast Asian countries will have a hard time regaining the kind of favor they enjoyed a decade ago. They,ve slipped so far in the past five years that they,ve become a rounding error to big, index-conscious investors. At the height of the Asian boom, markets in Indonesia, the Philippines and Thailand accounted for some 25 percent of the MSCI Far East free ex-Japan index. Now they are down to 4.5 percent. As a result, Crédit Agricole’s Jovanovich has about 1 percent of his portfolio in Philippines equities but 8 percent in just one Korean stock , Samsung Electronics. “Investors are not penalized if they have no exposure [to Southeast Asia],” Jovanovich notes.
While willing to concede that there are risks, many investors and regional strategists are convinced CalPERS made a mistake. Its decision may remind government and business leaders that much still needs to be done, but it doesn,t account for the progress. “Financial-sector risks are declining, economic growth prospects are improving, and investors are beginning to buy into that story,” says Credit Suisse First Boston,s Singapore-based Southeast Asia economist PK Basu.
CLSA regional strategist Christopher Wood says CalPERS’s advisers are “fighting the last war.” Corporate governance worries are already largely priced into the market, he argues.
Each of the Southeast Asian markets is making progress. Thai companies, for instance, have made great strides in their returns on invested capital, notes UBS Warburg Asia strategist Ian McLennan. The gains started in 1999, when these returns rose to 10.5 percent, from 6.8 percent a year earlier. In 2001 they hit 16.1 percent , “commendable by global standards,” says McLennan. Even the banking sector looks better. Kapur says, “Provisioning [for bad loans] this year could be negligible, and that could be a big kicker in the earnings.”
Aberdeen’s Young isn,t ready to buy Thai banks or telecommunications companies quite yet. The exception to his general aversion to large caps is PTT Exploration & Production. At 9, its price-earnings multiple is still “quite cheap,” he says, and the oil company’s management and operations are very strong. Another favorite: computer chip maker Hana Microelectronics Co. Its P/E has risen to a lofty 17, but Young still likes it as a well-run business with a balance sheet that’s “strong enough to survive another tough year. If it’s a good year, great.”
Malaysia also offers investors promising earnings gains. Returns on invested capital have risen from 1998’s 7.1 percent to 10.1 percent last year , healthy enough, if “nothing as dramatic as Thailand,” says McLennan. Young prefers to avoid companies like Telekom Malaysia and power company Tenaga Nasional, which are still plagued by governance problems, in favor of the country’s “best-run bank,” Public Bank, and Malaysian Oxygen, an industrial gas supplier.
Even Indonesia, shaking off the impact of years of political turmoil, offers opportunities , albeit from a limited menu. Adjusted for inflation, earnings rose about 10 percent last year. The stock market, which several analysts claim could rise sharply this year, boasts only six companies with market capitalizations over $1 billion. Crédit Agricole’s Jovanovich rates department store chain Ramayana Lestari Sentosa among the most efficient companies in the region, while Young is keen on food maker Unilever Indonesia. Although it,s gotten a little pricey at 14 times 2002 earnings estimates, he still views it as a long-term buy.
Investors have also begun to review the hard-hit Philippines. The Arroyo administration is tackling large fiscal deficits, and a host of economic indicators have greatly improved. Both Jovanovich and Young like Bank of the Philippine Islands as a beneficiary of the gains: It was recently trading at about 1.5 times book value and is expected to post double-digit earnings gains in 2002. “This is potentially the breakthrough year for the Philippines,” says Jovanovich. The same could be said of Southeast Asia.
