HSBC - Vietnam Monitor 16 - Earnings become murkier

We have argued previously that investors would react positively to any Asian market where the authorities showed signs of getting serious about inflation. After the suite of measures taken by Vietnam in June (including raising interest rates by 2 percentage points), the stock index rose 34%, before correcting a little, by 12%, in the last week of the month. Moreover, the rally was accompanied by a sharp pick-up in market turnover: the Ho Chi Minh exchange turned over, on average, USD29m a day in July, compared to only USD12m in June. So is Vietnam out of the woods? Are the macroeconomic problems now largely sorted, so that the market can resume the role that it held 18 months ago as Asiâ?Ts bright new hope?

Unfortunately, maybe not. The key for Vietnam now, in our view ?" as, indeed, for most Asian markets ?" is how much growth is going to slow, as a result of the government?Ts anti-inflationary measures and because of weakening global conditions. The government has lowered its target for this year?Ts real GDP growth to 7% (from 8.5%)
?" and HSBC?Ts economists are even more pessimistic, forecasting 6%. The consensus forecasts 6.5% this year, followed by 7.2% in 2009.

For the stock market, of course, and particularly one as underdeveloped as Vietnam?Ts, most important is what happens to corporate earnings. Stock prices certainly look fairly cheap, even after
the recent rally, with the VN Index trading on 12.2x historic earnings. If we assume that EPS will grow by 10% this year and next (cf 40% in
2007), the 12-month forward PE is only 10.6x, which would make Vietnam the third cheapest market in Asia, after Thailand and Korea (both of which should have far lower longterm potential earnings growth).

Murky earnings picture

The problem, however, is that Vietnam?Ts earnings outlook is becoming increasingly cloudy. H1 earnings have to be filed by end-July and, at the time of writing, about half the large listed companies had announced them. The picture is very polarised, with some companies producing spectacularly good results (for example, PV Drilling, where new orders pushed net profit up by 134%, and banks, where profits grew by 50- 100%) but others producing surprise losses or profit drops. The downside surprises came about for a variety of reasons:

- Write-offs of securities?T losses. Bao Viet Securities, for instance, made a VND393bn provision in H1?" more than its total profits for the previous two years. REE also made a loss of VND268bn ?" 46% of its revenues for the half.

- Rising raw materials costs. Brewer Habeco, which IPO?Td in March but has yet to list, saw a 9% drop in profits before tax because of
higher prices for malt.

- Higher borrowing costs. Vinpearl, a resort operator, for example, saw profit before tax fall by 62% y-o-y, despite revenues increasing by 25%, because interest expenses quadrupled. Bank lending rates in dong are now typically around 20%.

- Tax increases. Companies have a 50% break on their corporate tax bill for the first two years after listing. For most listed companies, this expires this year or next. Moreover, there are grounds for thinking some of the bad news will not be released until the end of the year. Quarterly results in Vietnam are not audited. And a number of earnings scandals recently ?" for example, Bach Tuyet Cotton restating its 2006 and 2007 earnings as losses ?" have led investors to question how reliable reported numbers are.

What will domestic investors do?

The key to the direction of the market over the remainder of the year will be domestic investor sentiment. Foreigners have been steady buyers of the market this year, buying between USD28m and USD122m every month. Even when the market was in freefall, the country funds that raised money last but had not had the opportunity to invest it, continued to put money into Vietnam. But nor does the stock market rally in June and July appear to have been driven by foreign buying. We know of one or two small funds that put additional money into the country, which shows the 10-day moving average of foreign net buying of Vietnamese stocks, does not suggest much of an acceleration. In the current jittery global environment, we do not expect much in the way of new foreign money to find its way into a market as risky as Vietnam. Domestic investors, then, seem to be the key, but their behaviour ?" and thus that of the market ?" is very hard to predict, particularly since Vietnamese have had such limited experience of stock markets. Our feeling is that, although the June low may well prove a bottom for the market, the going will remain volatile and nervous for some time to
come, with the market probably trading in a range until the picture on earnings growth becomes clearer ?" and that may not happen until audited full-year numbers for 2008 are released in January and February.

So, while the long-term Vietnamese story may well remain exciting, at the moment investment in this market remains only for the brave. For those who do want to dip their toes, our recommendation is to buy not the index but the small handful of blue-chip stocks that stuck to their core businesses, avoiding the temptation of diversifying into real estate, banking and stockbroking, and where therefore earnings
visibility is relatively good. One encouraging feature of the market in the past three months is that the performance of stocks has begun to
diverge (Table 7). Hopefully, the quality companies will be rewarded.