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Thailand: as inexpensive as it can get

Based on indicators, investment climate in 2007 is a lot more attractive than in 1996 or pre-Asian crisis
Rohit Chawdhry

With Asian markets going gangbusters, and valuations getting stretched, many investors are still grappling with their asset allocation strategies for 2007. This time of the year usu-ally marks major asset shuffling across markets and also across asset classes.

Initial evidence suggests that many of them are deploying away from India and China with increasing amounts of re-allocation done in markets such as Singapore, Malaysia and Taiwan. Interestingly, masked below the allocation of these investors is a relatively ignorant attitude towards a better known market in 1997 – Thailand.

Thailand now
During the crisis of 1997, short-term debt, excessive liquidity and never seen capacity build-up created a mini euphoria. Thai baht was overvalued by 15 per cent. Fast forward to 2007, Thai baht is undervalued by 30 per cent. Investment climate in 2006 is a lot more attractive than in 1996 or pre-Asian crisis (See table on opposite page). The only metric which is a lot lower than 1996 is the fiscal surplus: 7.3 per cent in 1996 vs 0.5 per cent in 2007. But that is not necessarily bad as fiscal surpluses of 1996 went in to fund capital expenditure resulting in excess capacity in the economy or the reason for Asian crisis. Despite such a good record, investors are shunning Thailand, quite a cont-rast to 1996 when it used to be the favourite.

Victoria’s Secret, the Gap and Calvin Klein have left the country. The companies closed shop and moved to China. To regain the competitiveness of the local economy, Thailand’s central bank twice tried to introduce measures to discourage speculation in the currency. It didn’t work. Then in December ’06, the central bank did the unthinkable: restrictions were placed on foreign investors but had to do a quick volte-face by partially reversing them.

The announcement of the restrictions caused panic in the stock market, with the benchmark index falling by 15 per cent in one day. That evening, the restrictions were partially reversed, and the market recovered. The shares may have recovered, but the credibility of Thai-land’s interim government can’t.

The changes
Interest rate cycle has started to reverse
A cut in interest rates is the most prominent change. Bank of Thailand (BoT) cut its key inte-rest rate (in January ’07) to 4.75 per cent to boost economic growth and confidence in the country. The decision to lower the rate from 4.94 per cent is the first cut in six months, and comes amid lower domestic demand and falling inflation. Using core CPI as deflator, Thailand’s real policy benchmark, 14-day repo-rate, had risen more than 150 bps over the past year and is up 100 bps since mid-2006. The peak in interest rate cycle is likely to be a positive catalyst for the economy and the equity market.

Supportive policy changes
The first half of 2007 is expected to be a period of constructive reform progress across several fronts. With the military-backed caretaker government in power through at least the third quarter of 2007, there is a window of opportu-nity where politics will be less of a constraint on decisive administration. As such, reform advocates across the Thai bureaucracy are angling to speed favoured reforms through a much more streamlined process. In particular, policy cont-acts note significantly improved prospects for passage of energy reform next year. And several financial sector reforms in particular appear poised to go forward in the near to medium term as well, including the Financial Institu-tions Business Bill. This bill will change the Thai financial landscape leaning toward commercial banks and retail banks, away from the current hodgepodge of finance companies. According to the BoT, at least ten new bank licences would be granted over the next two years, but the total number of financial institutions would fall as a result of mergers and downgrades. These changes are not yet priced in the stocks. What are not discounted by Thai stocks now?

1) A resumption of robust public investment spending in the first quarter
2) Beneficial structural reforms in the financial and energy sectors
3) Interest rate cuts

Thailand logged the second-strongest year-over-year export growth in east Asia in the fourth quarter and capacity utilisation is at a historic high of 73-74 per cent. So a pickup in domestic construction/investment activity appears sure. These EPS-supportive characte-restics, alongside relative defensive qualities (low multiples, high dividend yield, modest levels of foreign ownership), limit downside and keep Thai stocks compelling. These stocks also show the highest aggregate return on equity (ROE) in the region (at 23 per cent) and the second-highest dividend payout ratio (at 36 per cent). From here, both equity multiple expansion and a firming of 2007 EPS consensus appear likely. We also anticipate structural reforms that could boost Thailand’s revised rules on foreign ownership levels, effectively reducing the level of capital investment in local firms by eliminating loopholes enabling foreign companies to boost control through local nominees and enhanced voting-right shares.

Several factors create a compelling cyclical bull case for Thai stocks, beyond the potential for near-term volatility. The P/E ratio for Thailand is among the lowest in the emerging market universe, while returns on equity is among the highest. Furthermore, interest rates have started declining, which will induce an expansion of stock market multiples. It is notable that net earnings revisions for Thai equities are bottoming at very low level. The Thai equity market is cheap and is in a sweet spot from a business cycle perspective.

Baron von Rothschild grew his wealth by following his famous saying, “buy when there’s blood in the streets.” Assets are the cheapest when uncertainty is the greatest. That’s exactly where we are in Thailand now; we just need to modify the maxim just a bit. It happened to be a bloodless coup but we have a country being deserted by foreign firms. And, that’s the clinc-her for contrarian investors like Buffett or Soros.

Guidelines to play in Thailand
There are several ways to invest in Thailand. One could buy Thai fund (code TTF, current market price US$10.5) listed in US. The fund owns blue-chip stocks like Siam Cement, Bangkok Bank, and oil company PTT as top holdings. The only catch with funds like the Thai Fund is that they usually trade at a premium to the value of the underlying shares they own. As regards to other funds, Aberdeen Asset management has a growth fund along with a small cap fund.

Quest Thai asset management is a third option. For those investors, who hate to dish out a premium, ‘dial the broker’ option is always there. On a conservative note, investors can look to double their money in TTF over the next year or two, along with some sumptuous currency gains for GCC investors.