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Institutional Investor special report, September 2008 (Thailand material authored by Ben Davies)

Asian stock markets are suffering – even more than the US markets whose banks precipitated the credit crunch. While the S&P 500 index was down 12.2% in the year to August 18, Hong Kong’s Hang Seng index is down 24.7%, Singapore’s STI 19.9%, India’s Sensex 27.8% and China’s CBN600 an eye-watering 55.5%.

While the experience has been painful for investors, many feel that the decline represents a rare buying opportunity in Asia. There might be worse to come, but almost universally analysts and fund managers feel that investors with a long term view will be rewarded. The question is: where to pick?

The consuming issue of the moment is just what is happening to China. China’s economy is slowing, but all things are relative: it has slowed from 11.9% year on year GDP growth in 2007 to 10.1% in the second quarter of 2008, which by the standards of any other market is still breakneck speed. Even bears like Kenneth Rogoff, a Harvard economics professor and former International Monetary Fund economist, speak only of a “significant growth recession in China” to “at least one year of sub-6 per cent growth,” still dramatically higher than is routine in the developed world. The threat, though, is chiefly inflation, which hit 8.5% in April; on top of that, a US and European recession would clearly hit exports.

In the short term, some are still bearish about China. Stephane Mauppin-Higashino heads a product specialist team at Credit Agricole Asset Management, which offers a global emerging markets fund. His fund is overweighting Russia and Brazil at the expense of China and India. But looking further ahead, he has little doubt about the country’s prospects. “We believe the growth is here to stay,” he says. “Whether it’s nine or 10 or 11 or six, China will grow. It will average seven to eight per cent annualised growth through the cycle and we don’t have much of an issue with it falling below the trend, even to five per cent, if it were to happen.

“The issue we have had with China is the price: valuation, and inflation. It’s been a fantastic story but too expensive.” 

Some investors are also troubled by transparency in Chinese listed companies. Hugh Young is the managing director of Aberdeen Asset Management Asia in Singapore; he actively avoids most Chinese stocks. “At the company level, we really don’t have a clear view of earnings because of the lack of transparency,” he says. “Aside from that, so much depends on policy action: the level of stamp duty, the pipeline of IPOs, the release of non-tradable shares, and so on.”

That said, most foreign investors in China don’t go anywhere near the so-called A-share markets, which are domestic Chinese stocks listed in Shanghai and Shenzhen. Generally, they can’t, except through tightly controlled occasional institutional allocations from the Chinese state. Instead, they are more likely to invest in H-shares (Chinese companies listed in Hong Kong), red chips (Hong Kong listed and incorporated companies with substantially mainland operations and management), or Greater China plays – and in this regard Taiwan is looking increasingly interesting.

Taiwan has been a perennial underperformer over the years. “Over the last eight years the market has consistently disappointed, primarily due to policies that have encouraged capital flight,” says Adrian Mowat, chief Asian and emerging equity strategist at JP Morgan in Hong Kong. But when a new government was voted in on March 22, there was great hope of a change in fortune. President Ma Ying-jeou was elected on a platform that included a much more friendly relationship with mainland China than his predecessor, Chen Shui-bian. Ma will not push for independent statehood for Taiwan as Chen did, but will instead look for a better economic future for Taiwan predicated on greater freedom of trade, investment and general cooperation with the world’s most populous and vibrant nation.

An initial euphoria that prompted a 20% climb in the stock market in the run-up to and through the election has since unwound, partly because of the behaviour of world stock markets, partly because of the outlook for electronics stocks that dominate Taiwan’s economy, but also with a sense of reality about just what can be achieved in pro-China relations. Still, as CY Huang, the president for Greater China investment banking at the Taipei financial institution Polaris, points out: “Nobody can make magic in two months.”

And change is taking place. The iconic moment came with the announcement of direct flights between Taiwan and mainland China, albeit only on weekends. But there are more substantial shifts happening in investment and financial services. A long-standing limit on Taiwanese companies obliging them to invest only 40% of their net worth in China is being raised to 60%, and is likely to rise further. In June, limits were relaxed on the amount Taiwanese funds can invest in Chinese stocks. Additionally, an equally long-standing ban on Chinese investment in Taiwan’s stock and futures exchanges has been lifted: qualified domestic institutional investors, or QDIIs, which are Chinese institutions with approval from Beijing to invest overseas, will be permitted to buy in. Foreign mutual funds backed by Chinese capital can also now come in to Taiwan. “The government wants to attract PRC money to come into Taiwan,” says Huang. “Previously, you needed a declaration: if HSBC wanted to bring money in it would have to declare none of it came from China.”

Measures like this have two effects: they mean that Taiwanese companies are more likely to use Taiwanese banks and other service providers to handle their business, rather than moving the whole lot offshore to avoid restrictions; and they mean there is a greater chance of capital flooding into Taiwan instead of constantly leaving it. It’s this sort of momentum that has attracted Mowat at JP Morgan to make Taiwan one of his four major overweights in emerging markets today (the others being China, Mexico and Turkey). “Our argument is that during the DPP administration [under Chen] you saw capital flight and the government appeared to have no economic policy. The KMT government has come to power, liberalised investment restrictions for Taiwanese going into China, and has improved relations with the mainland.” Taiwan has three prongs for accelerating growth in the next year, Mowat says: tax cuts, infrastructure development and deregulation.

Elsewhere, prospects vary from market to market. (India is a whole other subject, beyond the scope of this article.) In southeast Asia, markets are struggling, whether through basic economics (Singapore, which being fundamentally a country of service industries suffers more than most when the US and other major trading partners run into trouble) or unusual specifics (the increasingly fractious political environment in Malaysia).

But the turmoil has created some unlikely opportunities. Global fund managers searching for a combination of low stock market valuations and high earnings potential might want to take a second look at Thai equities. The Stock Exchange of Thailand (SET) not only trades on a 2008 PE of 9 compared with 12.6 in Malaysia and 11.6 in the Philippines, but it offers a dividend yield of 4.9%. Better still, after years of dismal returns, analysts are forecasting that corporate earnings will increase by 21.3% this year and by 6.6% next year.

In its latest strategy report on the Asia-Pacific, Merrill Lynch rates Thailand as one of the cheapest markets in the region and suggests that investors overweight it. Merrill is not the only one with a buy on the market. Andrew Stotz, head of research at CLSA also believes that Thai stocks look attractive. “With the Thai market down almost 20% this year and with valuations looking the lowest in Asia, we believe that investors should be aggressively buying the market,” he says.

As is so often the case in Thailand, however, there is one major problem. And that’s the political situation. Few analysts believe that the coalition government led by Prime Minister Samak Sundaravej will survive the next 12 months let alone its full term in office. Furthermore, despite the recent decision by deposed former Premier Thaksin Shinawatra to seek political asylum overseas, the threat of mass street protests and a possible violent confrontation has not gone away.

Concerns over the fragile political situation together with fears of rising inflation, which reached 9.2% in July, have already dampened expectations for the second half of the year. The Securities Analysts Association recently downgraded its forecast for the SET Index to a range of 628 to 828. That compares with a current level of 702.

Still with the SET index having fallen by 20% since the beginning of the year and by more than 60% since its all time high in January 1994, canny fund managers will certainly find bargains. Asia Plus Securities suggests that investors look at property company Land & Houses, coal miner Banpu and energy giant PTT. These companies are expected to show impressive second quarter earnings as well as solid long term growth potential. Meanwhile Kim Eng Securities recommends select blue chips like Bangkok Bank, PTT Exploration and Production (PTTEP) as well as Total Access Communication.

So after the recent sharp correction in equity prices, has the stock market finally bottomed out?  Poramet Tongbua, head of research at Tisco Securities in Bangkok, certainly thinks that it has. “We believe that the market already reflects more than 80% of the worse-case scenario for political developments, rising inflation and higher NPLs. Consequently we are convinced that Thai stocks now offer an attractive risk to reward ratio for longer term investment,” he says.

Perhaps the best news for investors is the fact that for the first time since 2005, managers of listed companies in Thailand have become significant buyers of their own stock, suggesting that they believe that their businesses are undervalued. According to Phatra Securities, so far this year management of 47 of the SET100 companies have been net buyers of their own shares on a cumulative basis. That compares to only 28 companies where management have been net sellers.

To date, foreign investors have shown considerably less confidence in the market. Since January, they have sold off Bt86 billion (US$2.6 billion) of stock, representing most of what they had accumulated since the beginning of 2006. As a result, large capitalized companies like Advanced Info Services, PTTEP and K-Bank are at their lowest level of foreign ownership for at least three years. If and when foreign investors decide to return, Ian Gisbourne, strategist at Phatra Securities believes that these stocks could be amongst the star performers.

But whilst Thailand does offer some compelling reasons to buy, fund managers would do well to remember that this has been one of the worst performing markets in the region over the past decade. And whilst by most measures Thai stocks look cheap, investors will want to know that this time round, the market really will go up. Stotz for his part remains upbeat. “In Thailand, analysts are at the tail end of four long years of earnings downgrades. To us, earnings look much more vulnerable in China, Singapore, India and Hong Kong.”

In terms of sectors, three have been particularly badly hit in Asia. One is financial services, although banks in Asia generally had very limited subprime exposure. The others are real estate and gaming.

Here, too, there is ammunition for the bold contrarian. “People are going to make an awful lot of money out of real estate in the next couple of years,” says Mowat. “But at the moment it’s incredibly out of favour, particularly Chinese real estate. We think it’s oversold.”

Nobody has escaped. Take Capitaland, the Singaporean blue chip often considered the best run company in the country, the unquestioned leader in Asia’s fledgling real estate investment trust sector, and a true real estate blue chip. By August 19 it had almost halved in value in the space of a year. Ascott REIT, one of its trusts based around serviced apartments, looks even worse: well over $2 a share a year ago, 99 cents in August.

The fall in stocks like these reflects a number of dynamics. A slowing economic outlook reduces demand for high-end residential property and commercial property. Stocks that have used a lot of gearing – this applies to many REITs – have been particularly badly hit. But generally property related share prices have fallen by much more than the prices of the underlying assets, which causes some fund managers to see a buying opportunity – if it can only be timed right.

The pain has hit the region’s other developed markets too, notably Australia, which has the most entrenched REIT market in the region. “It’s been incredible, really,” says Andrew Saunders, CEO of Real Estate Capital Partners, a Sydney-based real estate fund manager. “The A-REIT sector was worth about A$145 billion in June 2007. Now it stands at A$70 to A$75 billion.” Saunders says some REITs are trading at as much as a 45% discount to net tangible assets, despite being underpinned in some cases by world class assets – such as Australian bank Westpac’s head office on Sydney’s Kent Street.

Arguably the chief attraction of this sector is the extraordinary yield. Australia is a high-dividend market at the best of times – CommSec chief equities economist Craig James says the Australian stock market today is paying its highest yield for 17 years, with blue chips paying as much as 6 or 7%, particularly in the banking sector – but the REIT sector is more generous still.

Fund manager Stephen Hiscock of SG Hiscock & Co in Melbourne says the sector has a forecast yield of over 9% for 2009, and 11% if one big and distorting stock, Westfield, is excluded. One fund manager calls it “potentially the buying opportunity of a decade. But the problem is, you know it could still all halve again tomorrow.”

The other big listed property market in the Asia Pacific region is Japan, which at the start of this year had a higher market cap in its REIT sector than the rest of ex-Australia Asia put together, at US$46.035 billion, though it has fallen since. There are 42 REITs listed in Japan.

Japan’s property sector generally has been hit by a credit crunch despite the fact that Japan had little exposure to subprime. 43 real estate developers filed for bankruptcy in July alone, mainly because they could not access funds. This, rather than the underlying properties themselves, has been the problem: at a time when Jones Lang LaSalle puts Tokyo CBD office vacancies at only 3%, relatively big names such as Urban Corporation and Ardepro have been badly hit by concerns about their ability to access credit.

Once again, there’s a question of whether falls create opportunities for investors. A recent report by Merrill Lynch said around half of all J-REITs are now trading below book value. They also pay what is, by Japanese standards, an exceptionally high yield of over 5%. And among listed real estate developers generally, those with the strength of balance sheet to ride out the credit crunch are likely to be well positioned and modestly valued by the end of it, and even in a position to acquire from troubled peers.

Already, several landmark transactions have taken place this year: CBRE Research highlights the acquisition of the Resona Bank headquarters in Otemachi, with Mitsubishi Estate acquiring a 73% sectional ownership of the building for Y162 billion. Others include GIC Real Estate, the property investment arm of the Government of Singapore Investment Corporation, purchasing the Westin Tokyo from a Morgan Stanley real estate fund for Y77 billion; Morgan Stanley Real Estate Investment acquiring the Citigroup Centre in Shinagawa-ku from Citibank for Y48 billion; and another Morgan Stanley acquisition, of the Shinsei Bank Building in Chiyoda-ku, for Y118 billion. REITs, too, have been acquisitive this year, with examples including Industrial and Infrastructure Fund acquiaring IIF Haneda Airport Maintenance Center for Y42.2 billion, and Japan Retail Fund acquiring Aeon Sapporo Hassam Shopping Center in Sapporo for Y18.4 billion.

Yuto Ohigashi, an analyst at Jones Lang LaSalle, sees opportunity. “While the type of real estate buyers has changed from high-leveraged investors to low-leveraged ones, the Japanese market remains attractive due to the sheer size of its investment grade property market compared with that of other Asian markets,” he wrote in a recent report. “Among Japanese real estate, Y490 trillion is held by corporations, about Y68 trillion of which is considered as revenue-generating properties. Part of the remaining real estate, which is valued at about Y420 trillion or more than six times revenue-generating real estate, is likely to be simply dormant, suggesting the enormous size of the potential market.”

The other sector to have been horribly hit is the gaming industry. Two years ago there was great fanfare and optimism in Macau. The state had opened up the gaming industry once dominated by Stanley Ho and awarded three concessions and a further three sub-concessions, bringing competition and money into a previously seedy sector. Groups like Las Vegas Sands, Wynn Resorts, Melco and Galaxy Entertainment had all committed considerable sums to casino development in the years ahead, and in terms of gaming revenue (as opposed to retail and entertainment in the same area), Macau has now overtaken Las Vegas as the world’s gaming centre. Many of the new ventures are very much in the Vegas style, combining world class entertainment and retail facilities with the traditional casinos, plus top-of-the-line hotels.

But if the share price performance in real estate looks bad, that’s nothing compared to gaming stocks. Consider Dore Holdings, which specialises in the VIP junket game, providing high-roller players to casinos. It has gone from HK$3.60 per share to HK$0.21 in a year – that’s a 94% fall. While not all stocks have suffered quite so dramatically, the situation has not been kind to anyone: when Sociedade de Jogos, the casino business owned by the ultimate gaming tycoon Stanley Ho, sought a Hong Kong listing, it took three years, more than 30 court cases, an application for judicial review on the eve of the float which caused half of the retail investors to back out of the offering, and a halving of the targeted amount to get away. And when it did, it promptly started sinking.

Part of the reason for the problems in Macau’s gaming industry are related to an apparent rethink on China’s part about just what it wants Macau to be. Over the course of this year it has introduced a number of measures designed to cool the growth of Macau’s gaming industry, to reduce the maximum length of time Chinese nationals can spend there, and to cut the frequency of their visits. Since the development of Macau is to a large extent based on the promise of China’s population, this has hit the industry hard. Increased competition is another concern.

But some consultants feel the future is much brighter than these headwinds would suggest, which again raises the possibility of buying opportunities. The Las Vegas based consultancy Globalysis estimates that Macau will experience 28.8% growth in gross gaming revenue (GGR) in 2008 year on year, to reach a total of US$13.5 billion. “It now looks like Macau will bypass not only the Las Vegas strip once again in terms of gaming revenue in 2008, but for the first time, also that of the entire metropolitan area of Las Vegas,” said Jonathan Galaviz, partner at Globalysis, in May when he launched his most recent report on Macau. “Macau’s continued growth in GGR is a reflection of the generally strong macro-economic environment that Macau finds itself within Asia.” If he’s right, then the sector is clearly oversold and presents opportunities.

A big question for the Asia Pacific region is what happens to commodity prices, which will have differing impacts in different locations. Of major markets, Australia is probably the one that has benefited most from the commodities boom: it is home (or a joint home) to world mining leaders like BHP Billiton and Rio Tinto, and its role as a quarry and breadbasket for ardent importers like China has led it to a stunningly protracted period of economic strength. Consequently Australia has not had a year of less than 2.5% GDP growth since the early 1990s, remarkable in a developed economy.

Australia’s market has been hit as hard as any this year though, and was down 21.4% year to date by August 18, partly as a result of market contagion spreading to the commodity sector. Those who believe the commodities boom has further to run tend to be more bullish on Australia than on other markets, although the short term is likely to be less favourable. “Given the relative important of resources in the Australian share market, Australian shares may underperform global share markets for a while yet as the commodity correction runs its course,” says Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors in Sydney. “Asian shares are likely to be key beneficiaries of the correction in commodity prices given Asia’s high reliance on commodity imports.”

Asia, then, as ever presents a wide range of differing stories. Putting money into such volatile markets requires some tough nerves and a willingness to ride out some likely losses along the way. But, as one fund manager says: “Contrarianism is where the real money is made.”

Chris Wright
Chris Wright
Chris is a journalist specialising in business and financial journalism across Asia, Australia and the Middle East. He is Asia editor for Euromoney magazine and has written for publications including the Financial Times, Institutional Investor, Forbes, Asiamoney, the Australian Financial Review, Discovery Channel Magazine, Qantas: The Australian Way and BRW. He is the author of No More Worlds to Conquer, published by HarperCollins.

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