Vietnam: Price And Value

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Even though the benchmark VN Index has risen 23% so far this year, it is still trading at an average P/E of 9.8, well below the historic mean level of 19. Vietnam has been working through a very difficult period of tight central bank policy to regain control of an economy that had spiraled out of control by early 2011. Inflation had risen to 23% and credit was expanding at 28%. The result was a spectacular housing and industrial boom that was as unfocused as it was impressive.

Once the State Bank of Vietnam moved to curtail this situation it did so swiftly; reversing the easy money policy and raising the benchmark lending rate to 16%. Since Vietnam is a country where three currencies circulate side by side by side, the Dong, the U.S. Dollar and gold, the SBV also had to move to curtail the use of both the Dollar and Gold to stabilize the Dong and increase its credibility with the population.

In short, all of these moves have worked in ways that former Fed Chairman Paul Volcker would approve of. Annualized CPI inflation has dropped to 8.34% with prices rising at a 6.4% rate year to date. In fact, prices have been essentially flat for the past three months according to the SBV's monthly price report. The effect has been that since bottoming near the beginning of 2012 Vietnamese stocks have been some of the best performing, albeit volatile, stocks in the world. The Market Vectors Vietnam Index ETF (NYSEARCA:VNM) is up 27.7%. The AUM of the fund, currently more than $310 million, has risen 15% since early March after reaching a high of nearly $350 million.

Taking the High Road

The SBV began easing rates at that point, in a bid to begin opening up credit and liquefying the interbank market for the strongest banks. There was a worry among analysts that the SBV had started easing too soon.

In early March the stress in the banks was very serious, with overnight lending rates higher than 14 day rates, almost zero lending longer than 14 days in term. But, the market began responding to the increased liquidity and money began to flow through the banks. It was concentrated in the largest banks as they had and still have the strongest portfolios. Total banking credit contracted by 2.55% in the first quarter but the country posted its first trade surplus in three years on the strength of strong exports to China and Japan.

All of this was happening against a backdrop of rapidly rising petroleum prices while Vietnam's primary commodity exports like Rice and Coffee were selling into falling or flat markets.

Having wrung out the worst of the excesses of the property boom and bust through the first five months of this year, many of the surviving companies are now well positioned to execute in a freer credit environment, while still very tight by developed market standards. The real estate markets in Hanoi and Ho Chi Minh City have still not bottomed and there will be more pain in those markets, but M&A activity in the country hit $1.7 billion in the first quarter of 2012, two-thirds of which were backed by foreign investors.

With the Japanese Yen, traded as the CurrencyShares Japanese Yen ETF (NYSE:FXY), so strong in recent months it would be expected for Japan's investments into Vietnam, which have already been substantial, to continue and may accelerate as the Yen trades openly with the Yuan, which will also help stop the flow of Dollars into Vietnam, putting a bid under the Dong.

Restarting the Engine

In short, Vietnam is such a small market in comparison to the titanic shifts in capital that are happening around it that a small spillover of the capital flight from the West could easily ignite another massive surge in Vietnamese equities, especially with the VN Index still trading at such a low multiple. SCIC, the state's sovereign wealth fund, is looking to divest stakes in another 250 companies this year.

At this point in time it looks like the SBV's rate cuts have come at a perfect time. The benchmark lending rate has been cut to 12% and the interbank market has stabilized to the point where the deposit limit cap on interest will be abolished soon.

A calm interbank market, falling bond yields and a stable currency have many funds are waking up to the potential for solid gains in maturing Vietnamese companies. In the event of a global meltdown, there is the potential for 20% downside risk as the VN Index could sell off to its January lows around 350. The best value in Vietnam is the mid-cap, mid-priced stocks. Those are the ones trading at the lowest multiples to earnings and have the potential to both weather any global storm and produce the highest yields.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.