Sad deaths in Britain

Source: World Bank, data as of Oct. 2019

I have been following this story about the tragic death of 39 people found in a truck in the UK and suspected to be Vietnamese. Four people and the truck driver have been arrested. A few facts and thoughts:

• Many more people are being smuggled from Vietnam to Europe than to the US : 18,000 vs 1,000 a year, according to this study. This is a bit surprising given how many people of Vietnamese descent are in the US, but maybe they are smuggled into Europe because there is no other way to get there.

• Most come from the poor central provinces. In this specific case, it appears to be Nghe An and Ha Tinh, in central Vietnam. “In the first eight months of this year, 41,790 people left Ha Tinh looking for work elsewhere, including overseas, according to state media.”

• One of the reasons they are leaving the province is because of pollution, specifically a toxic spill by Formosa Plastic’s steel mill in 2016, which killed sea life and tourism and hurt livelihoods. The company did pay $500m in fines, and this money trickled down to normal Vietnamese to the tune of around $2,500. That’s about a year’s salary. However, without jobs, many people left and continue to leave the province.

• But the upfront costs are high. It costs between $10,000-15,000 for a difficult journey to the UK, and $40,000-50,000 to travel mostly by plane. Either way, at the last moment, they have to get into a ship or a truck/lorry. This is an amazing amount of money for the Vietnamese: as much as 30 years of salary. But people are willing to pay it, because they can make that and more money in the West.

• In the UK, most of the women work for extremely low wages in nail salons. Of course this is not an issue just in the UK. The New York Times did a big expose about nail salons and the many nationalities of women that work (or are exploited) in New York.

• Men and boys are often “employed” on cannabis farms (which can be just regular suburban homes) for very little money and no freedom.

• While some of these trafficked people should be consider enslaved, a number do not think of themselves that way. According to the official UN definition, they should be considered smuggled rather than trafficked. They knew the dangers of going to the UK, but they took on these risks with the hope that it would be worth it.

• Here is a somewhat anti-capitalist critique of “raid and rescue operations.” The idea is that “rescuing” many of the smuggled Vietnamese actually makes their lives more precarious, because they may still have debt and/or they need to stay in the UK to make money.

• Moreover, while (most) everyone hates the idea of people being exploited, both the Vietnamese government and British consumers and corporations benefit. Remittances are forecast to make up 6.4% of Vietnam’s GDP in 2019, adding almost $17bn in hard currency. (See chart form the World Bank above). That also helps provide for low-income people in Vietnam. In SE Asia, only the Philippines make more from remittances.

• To give a sense of the scale, there were 2.6m Vietnamese who emigrated in 2013, compared to 6.0m from the Philippines. Cambodia was just behind at 2.5m, and probably many of these came to Vietnam.

• And of course British business benefits from low wages, which trickle down in the form of very cheap manicures and pedicures (or pot) among other things. And, while it is contested, it may also hurt wages in certain areas, resulting in a blowback from citizens.

• Illegal immigration is a difficult problem with no easy solution. And just letting it happen without really dealing with it is probably not acceptable. I am generally in favor of more open borders, but we have seen the response to the Syrian refugee flood in Europe and illegal immigration in the US. My view is that these two trends pushed people towards more populism/nationalism and paved the way for both Brexit and the election of Donald Trump, not to count the rise of right and far-right parties in Europe. This is not just a EU/US problem. In fact, almost every country has this problem. Look at South Africa.

I read an amazing book by Patrick Radden Keefe called Snakehead, which was about a middle-aged grandmother who smuggled people, mostly from China, to the US. People really liked using Sister Ping, because she would treat the smuggled well and also had a money-back guarantee. She was so successful, because she was trusted so much more. While it deals mostly with Chinese workers, the stories appear to be very similar.

Hat tip to Joe Buckley and his Vietnamese Labor newsletter who linked to a few of these stories.

Friday roundup

Vinamilk

Source: Vietstock

This is a bit of an old story, but it continues to increase my love of Vinamilk. The company will export dairy to China. This is in addition to news that the company announced in June that it will build an organic milk farm in Laos.

The stock is trading at a forward P/E of 22x (according to Vietstock), 3% dividend yield, and some revenue growth (3% in 2018). the stock has done alright, but not amazingly so.

My very superficial take is that margins are too high in Vietnam, so that any investment abroad means lower margins/returns. So investors may be wary about paying for that sort of growth. I will have to do more research here. It is kind of puzzling.

Hanoi water

I have not posted about the Hanoi water crisis, but that doesn’t mean I don’t think it is serious. Environmental issues are going to be a bigger and bigger driver of social unrest, economic uncertainty and potentially new regulations.

Anyway, water in Hanoi’s southwestern districts was contaminated with styrene at dangerous levels, but that has been cleared up by the local government. The government has and will continue to supply clean water by trucks for a little while.

The water crisis plus other issues including air pollution are starting to piss people off in Hanoi. HCMC will likely see more of this as well, even though they haven’t had a big crisis like Hanoi’s water. Pollution is a serious threat, not just for health, but for the economy and for political stability. I feel like investors and governments are slowly starting to wake up to that fact. We will have to see if they wake up in time.

Homelessness in Ho Chi Minh City

We have a new census out of Ho Chi Minh, and it turns out that there are only 39 homeless people in the city. Problem solved! I bet San Francisco and Los Angeles would love to hold a census like this.

All kidding aside, statistics are boring, but super important. If an organization puts out bad statistics that people use to make decisions, then those decisions are going to be bad as well.

Let’s not pick on HCMC or Vietnam here. This isn’t a problem solely in developing countries. Take the US: Facebook inflated its video metrics, meaning it told its partners (media companies, mainly) that their videos were viewed many multiple times more than they were. 150% to 900% more. So let’s say i put up a video, and Facebook says it has been viewed 1 million times, I would probably start making a lot more of that sort of video, because think of all the advertising on that video.

It turns out that the video was viewed only 120,000 times. That’s a lot less viewers leading to less ad impressions. And a lot less money. Unfortunately, I already shifted lots of investment into making more videos without the potential revenue to back up this investment. Conclusion: I go bankrupt. Facebook is now paying a $40m fine for inflating these metrics.

Anyway, back to homelessness in Vietnam. The reason why there were so few families counted as homeless is because anyone who had any home at all, such as living under stairs with a partition of some sort, was counted as homeless. Or if you are living on the street but some family member had a home that you could go to, you aren’t homeless.

This is part of the 10-year census. Let’s see what other interesting insights the census has. More results will come out this year and the full printed census will be out in 2020.

Returns and Dupont

Sorry. I found an error in my spreadsheet yesterday, and one that I should have easily fixed.

It turns out that my figure for debt at Vinamilk (VNM) was wrong. It was a simple excel error that I should have caught, especially because I thought the number looked weird. Make this be a lesson to you: when a number looks weird, check it!. The revised charts are here:

Source: Company data, Vietecon.com, Vietstock

Source: Company data, Vietecon.com, Vietstock

The big takeaway (besides my idiocy) is that VNM actually looks extremely safe. I have more to say about this in today’s post. I also checked my figures for SSI, and they are still correct. So that is the company with the lowest revenue and operating profit compared to debt. Basically, it is highly levered on most metrics.

Now to today’s post.

Because I have this (newly scrubbed) data set of companies, I also wanted to look at a returns, the other component of this growth in balance sheets.

At the same time balance sheets have grown, returns have falling. As we talked about yesterday, if returns fall, to keep the absolute profit level stable you need a bigger balance sheet. That balance sheet can be either equity (very safe) and debt (safe at low levels, unsafe at high levels).

Source: Company data, Vietecon.com, Vietstock.com

Looking at Vietnam, returns for the companies in our sample have a few facets:

• Return on assets are much lower than return on equity. Think of return on assets as the weighted average of return on debt and the return on equity. Debt returns (to the lender) are lower than equity. Sometimes they are fixed. Generally, debt doesn’t get any upside but is supposed to be protected from downside, due to the equity buffer. (Losses flow to equity first).

• Return on equity is 13.8% on average. At first, that seemed high, but looking at the S&P500, it actually is the same. That shocked me, although maybe it shouldn’t have. Also, I guess I’m easily shocked.

Assets/equity=RHS. Source: Vietecon.com

Finance professionals have come up with a neat method of breaking down the returns on equity. It’s called the DuPont analysis. Return on equity is just (net income/equity), and so let’s add a few terms, and break it into 3 parts: (net income/sales), (sales/assets), assets/equity). Cross out sales and assets, and you get back to net income/equity. Charts on the right show the DuPont figures for a few companies that I want to highlight.

• The components of the RoE are a bit different in Vietnam than in the US - margins are lower in the US (16% net margin in Vietnam vs 9% for the S&P) and the equity multiplier, or assets/equity, is much lower 244% (VN) vs 470% (US). These basically counteract each other, resulting in a similar RoE.

• The difference points to what Levy is talking about - in the US, returns have fallen, and balance sheets (assets) have gotten much larger. Look how much higher the black dot is for the S&P than for the VN average.

• Vinamilk (VNM) is kickin’ butt and takin’ names. It’s mostly due to extremely high margins (19%) and asset turnover (136%). That means that the company makes very good use of its assets. If it buys something for $100, it gets $136 in revenue from it. Then it gets $26 in net income from it. The equity multiplier is pretty low at 140%.

• Just for a second on that Vinamilk net margin - I was right, it is high compared to a quick survey of companies. Three in the US (LWAY, DF and KHC) all had losses last year. The one I know from Saudi, Al Marai, actually has quite high margins at 13.8% (2018), but it gets support from the government. And it is still low compared to VNM. [There is a whole story about chickens and Al Marai, but let’s not go there.]

• No one else comes close, but Vinhomes and Masan Group are both over 20% RoE. Vinhomes surprises me more than Masan Group, because investment banks like Masan usually have a relatively low equity base and few assets. Vinhomes, though, should be extremely levered as a property developer, and it is. But it also has very high margins (25%).

Basically, compared to US (or US-listed) companies, Vietnamese listed companies have better margins, make better use of their assets and have lower leverage. That’s all to the good. Now I need to look at how this has changed over time, which might take a bit longer to do.

But before I go, I wanted to just touch on the original report and why I think it holds meaning for Vietnam, despite being focused on the US. From the report (page 5):

“Although the focus of this paper is on the U.S. economy, swelling private sector balance sheets relative to incomes and the consequent increase in the riskiness of financial behavior are global phenomena. In this business cycle, much of the most reckless risk taking by both U.S. and foreign investors and financial institutions is international but with direct implications for the domestic economy.”

Debt burdens at the company level - not so bad

It seems like everyone is talking about balance sheet bubbles and recessions. Much of it stems from this paper by David A. Levy from the Jerome Levy Forecasting Center.

The thesis is this (condensed into simplified bullet points):

• Since the 1980s, balance sheets have grown while incomes have not. Or to put it another way, to keep the same level of income, private balance sheets have had to grow.

• We have had a number of crises over the past 40 years, and each one has necessitated or resulted in larger balance sheets during boom times. This has been caused by or resulted from much lower yields. Basically, yields are falling, while balance sheets are growing.

• Each crises has led to the next - a recession causes balance sheets to expands to bubble levels. The bubble bursts, leading to a recession. Rinse and repeat.

Source: American Council of Life Insurers (ACLI) and Real Capital Analytics (RCA), via Bernstein Journal

An easy way to think of it is real estate, because yields are central to investment decisions there (and I have a lot of experience in the sector). Back in the ‘80s, commercial real estate (say office buildings) would return a 10% yield. It stayed at this level until around 2000, and then it started falling. This report points to a low point of 7% in 2006 (see chart to right). It has been low since then. According to this report, it was just 6.3% in August.

These real estate yields are higher than most other “safe” assets like bonds. But they are still relatively low. And it doesn’t look like it changes.

Back to my point: Let’s say in 1999, you could buy a building for $1 million, and expect around $100,000 in net operating income (after all expenses) a year. Inflation was low, so were interest rates (relative to recent history at the time). But today, to get the same $100,000 in income, you would need to invest $1.59 million, or 59% more. Even if you raise your equity investment in percentage terms (keeping a down payment of 25%), debt will grow from $750,000 to $1.19 million. Just to keep the same amount of income.

Now do this for all assets all over the world, and you start to see why balance sheets have increased. Interest rates are low, and banks are willing to lend, so it doesn’t seem too scary now. But if there is a recession, and incomes fall, it will be more difficult to pay off these big debts.

Bringing it back to Vietnam

There is a lot more to get into in the report, but I wanted to look at how this is playing out in Vietnam. As you know, economy wide debt data is not great. But public companies have to disclose balance sheets and income statements every quarter, so I looked at the big constituents of the VNM Index based in Vietnam (we talked about these companies when we discussed the 1H2019 results here, here, and here).

Source: Company data, Vietecon.com, Vietstock

I looked at two main areas: debt-to-equity (both book equity and market equity) and ability to service the debt (debt-to-revenue and debt-to-operating profit, more on why this latter figure later).

A few things stand out:

Source: Company data, Vietecon.com, Vietstock

• Debt-to-equity isn’t too bad, especially in terms of market cap. On average it is 1.2x D/E and 0.4x D/MC One way to think about this is to think of it as how much cushion is there before debt holders start to lose money. Book equity is one way of looking at it, while market cap (which takes into account the market’s view on company value) is another. Both have their downsides.

• Having large amounts of debt isn’t that big a deal, if you can service it (meaning pay the interest and principle when needed). Debt/revenue is on average 1.1x, while debt/operating profit is 5.2x. I really should look at Debt/EBITDA, but that’s kind of hard to find for Vietnamese stocks (annoyingly), and I am lazy. Also, to be frank, it should be NOPAT (net operating profit after taxes) to give a real sense of what debt burden the company can bear.

• Vietnam Dairy (VNM) is the one with the biggest D/E ratio, but it terms of D/MC, it isn’t too bad. Looking at the company’s ability to service the debt (in the second chart), it doesn’t look great. Seems like this is a pretty risky balance sheet.

• These is little difference between D/E and D/MC for SSI Securities, mainly because, as an investment bank, it ain’t got much equity. For comparison, Goldman Sachs has a D/E of almost 3.0x, and it has been at that level. It also stands out for having a very high D/Op profit.

• Vingroup also shows a very big difference between D/Rev and D/Op profit. This is a function of low operating margins - profit for $1 of revenue. Vingroup, as we have talked about, is enormous and has lots of nascent businesses. Hopefully, these will start to show better margins over time. It seems like it has been able to get plenty of money, so it should be fine. Plus, Vincom Retail (VRE) actually looks quite safe.

Conclusion, outside of Vietnam Diary and SSI, none of these figures bother me too much. It’s always hard to say what a “good” or “safe” debt level is, but most of these companies are fine. I need to now look at historical figures and see if we have seen a real growth balance sheets. If so, it might be more concerning.

Now remember, just because a few publicly-traded companies are fine does not mean that the economy in general may not have debt problems. That’s the bigger issue that Levy’s report talks about.

National Assembly

The National Assembly (NA) in Vietnam started yesterday! Democracy in action! This is the 8th session of the 14th NA. Big potential events include:

• It will consider a feasibility study for the Long Than airport. This is a big new international airport needed just outside of HCMC. It is sorely needed, since the current airport is wildly overcapacity. At one point, this new airport, which was expected to cost $6.7bn (for phase 1), was going to open in 2020!

• We already talked about one of the laws to be discussed: the labor code reforms (post here). It will be interesting to hear the discussion around this.

• There will also be an amended securities law. This may include a new rule that allows a shareholder with just 1% ownership to access to “confidential” information on the business. I am not completely sure what this means, but I guess it is greater transparency for a wider range of shareholders. That would be positive. Overall, allowing more foreign ownership would be good, especially for banks, which need more capital.

• There are also going to be discussions on amendments/supplements to a few important laws (for our purposes): The Law on Public-Private Partnerships, an amended Investment Law and a revised Enterprise Law.

Just a few other facts:

• The NA is elected for a 5 year term. We are more than half way through this one. My own need for order means that it annoys me that the elections aren’t in years divisible by 5. The next is in 2021. It should be 2020!

• Each year there are 2 sessions. The second session for 2019 started today and lasts until November 27.

• The NA is scheduled to pass 12 laws, 3 resolutions (or 4, depending on different news reports) and give opinions on 9 draft laws.

• But first: “the NA will review reports on the implementation results of socio-economic development plans and state budget in 2019, and decide on the plans as well as budget estimates and allocation in 2020.”

From what I understand, the National Assembly meetings over time have become less of a rubber-stamp and more of an actual discussion. As we can see from the pie chart above, if party-line votes happen, then there shouldn’t be any surprises. But still, the actual discussions might tell us a lot about how leaders are thinking and moving.

How to find the core earnings of a company

I worked in equity research for 12 years. That’s a long time. It was fun at times, but not always. There is a kind of grind to the job, and it is getting harder and harder to stand out. But I am glad I did it and learnt about a bunch of industries. I also talked to really smart people and had to really debate and defend my ideas.

One of the things that I got really good at was looking at financial statements. One of the first things that you find, and this changed over my career, is that there are GAAP earnings (those required by the accountants) and then there was “real” earnings. As an analyst, I would take the numbers, put them in excel. Then when I was forecasting future earnings, I would strip out anything that wasn’t recurring to get a better sense of the real earnings potential, based on what the company had done before. A video game company’s net income was boosted by selling a building? That’s a one-time deal. The government pays back a real estate company for some infrastructure works, and the company books it as revenue? Unlikely to persist. I would strip these things out to make sure I understood what the core earnings were.

Every analyst does/did this. In fact, it’s probably something that most analysts would say is a strong suit of theirs

So I was surprised to see that actually, analysts are not that great at stripping out non-recurring items.

This paper makes the case that analysts miss a lot of non-recurring items. But if you go deep into the financial statements, you can actually find core earnings that are different from those that the analyst report. The conclusions from this are:

• Core earnings are better at predicting future earnings/cash flows than GAAP earnings. But they are also better than analysts’ numbers, also known as Street consensus earnings. Street consensus earnings take an average of all of the analysts’ earnings. While, Street numbers are better at predicting future cash flows than GAAP earnings, but not as good as using “core earnings.”

• Finding “true” core earnings is even more important than it was historically, because the number of adjustments has increased over the past 20 years. It was 4 in 1998 and rose to 8 by 2017. It’s not only the number: the amount of the adjustments has increased and is significant - around 15% of GAAP earnings per share in 2017.

• You can use this data to make money, because the market is slow to incorporate this information on non-core earnings.

Source: Rouen, So & Wang (2019)

Why can’t we just use Street consensus? It turns out that analysts (like me) do make adjustments. Unfortunately, they make similar ones as managers. They are too willing to take management on faith.

Did I ever do this? I plead the 5th! No, actually, I tried to come up with my own views, but sometimes I probably went with what management said. Also, remember, analysts have calls on stocks. If information goes against their call, they may be hesitant to air it. I tried not to do this, but I am sure occasionally I presented my “buys” more positively than my “sells.”

So just to help equity analysts out there, the key non-core items to look at should be:

• Expenses related to acquisitions

• Currency revaluations/devaluations

• Discontinued operations

• Legal or regulatory events

• Pension adjustments

• Restructuring

• Gains and losses that are disclosed as “other”

Take all of these out to get to core earnings. And you can’t just use the financial statements and notes. It turns out that about 50% of the non-core items are hidden in the MD&A - Management Discussion and Analysis. So you gotta really get into the financials.

Here’s a business idea: start doing this for emerging markets as well. I bet there is a lot to be gained by it. You might want to talk to New Constructs first, though. They seem to have gotten this down to a science.

(H/t Matt Levine for writing about the paper)

Exchange rates and inflation - the case of Vietnam

Vietnam has an open economy. In fact, it has become more and more open over time, part of the doi moi economic reforms that started in the late 80s. Now, as I have written about, it has an extremely large export economy. At the same time the government maintains a managed “floating” exchange rate regime. Basically, it doesn’t want too much volatility in the exchange rate, plus it wants to favor exports over imports.

Having that exchange rate regime is interesting, because it means the government has to make decisions that can have real economic impacts, and they have to do it every day. Because of that, they need to really understand how the economy is affected by the fixed-ish exchange rate. One important element is inflation.

Does the exchange rate have an impact on inflation? Put another way, would devaluing the VND cause inflation, because if so, they might not want to do that. It turns out, people much smarter than me, have studied this! I found a great paper (Chapter 12, page 323) that looks at the inflationary impacts of exchange rate shocks on the Vietnamese economy.

Notes: Left axis (index, 2010=100): consumer (CPI), import (IMP) and producer (PPI) prices. Right axis: USD/VND exchange rate.

Source: SEACEN, page 327

This paper runs a lot of regressions on changes in the exchange rate on three price indices: consumer, import and producer prices. First, let’s just look at the chart on the right. It sure seems like devaluation of the VND/USD rate is correlated with increased prices, the CPI and PPI more than the IMP.

That makes intuitive sense - if it gets more expensive to import things, then those products will get more expensive in the store. But we need to remember a few things:

• Sellers set ultimate prices. They don’t just take their cost and add a set dollar amount or percentage. Let’s say their cost rises 10%, they might not want to raise their prices by 10% immediately, because it could hurt sales. So they might decide to charge less and take a lower profit margin.

• Plus, not everything in the country is imported - locally produced goods shouldn’t see much change in prices directly because of changes in the exchange rate.

• Not everything is priced on the USD/VND exchange rate - things imported from Australia will see different shocks. We talk about the USD because it is the most important currency, but it’s not the only one. Something that Americans need to realize.

• Oh, one more thing. It takes a while for prices to flow through. That’s because inventories are likely a mix of goods bought over time - some at old, lower prices and some at new, higher prices. Sellers have a bit of time before their margins are hurt.

Those are mostly direct impacts. But there are also indirect effects. If imports are more expensive, that has to mean that exports are less expensive for other countries. So there will be more exports, and then exporters will compete for labor and raw materials, bidding up those prices.

Source: Dang Thi Quynh Anh, Pham Duc Anh, and Le Thi Phuong Hoa (pg 335)

It turns out dollarization is a important contributor here. If prices are in dollars (like they are for luxury goods and cars in some countries), then you will see bigger effects. Vietnam actually was somewhat dollarized until fairly recently, but is much less so today.

Well, it turns out that the effect is significant, is positive, but isn’t that big. Looking at the table to the right, both PPI and CPI increase but both less than 0.1% (0.074 and 0.054, respectively) after a 1% shock to the exchange rate. Imports (IMP) increase the most, at 0.135, but that still seems lower than I would be expected. The author’s agree:

[T]he exchange rate could explain about 4% of the import price movements, nearly 9% of producer price movements and approximately 3% of consumer price movements after 6 months. This implies that the impact of the exchange rate shock on prices in Vietnam is rather modest

The paper also looks at commodity price shocks and demand shocks, both of which have a smaller impact on prices than changes in the exchange rate.

What does this tell us?

• The central bank probably shouldn’t worry too much about changes in the exchange rate leading to rampant inflation. In fact, it probably has room to devalue, in order to boost exports (although given already rising exports and fears of a US backlash, it would probably be best if it didn’t).

• Oh, and keep dollarization down. This is a good point overall, because it is hard to control an economy, when you don’t control the currency.

Household debt - is it driving credit growth?

Following up on my posts on the banking system, I wanted to look a bit closer at household debts in Vietnam. It turns out that unlike OECD countries, the data around household debt is not great, so most of the specific data on household debt ends in 2016.

Source: World Bank Doing Business

Where to start? Well, first, let’s start with getting credit in Vietnam. Looking at data from the World Bank’s Doing Business project, depth of credit information has been good, but credit bureau’s are very new (started in 2015) and the coverage of the credit registry is still fairly limited (55% of the population in 2019).

But that hasn’t stopped a massive increase in household debt. It went from less than 10% in 2000 to more than 45% in 2016. That is more than a 35pp increase.

Source: The SEACEN Center for household debt, World Bank for domestic credit

Other ASEAN countries have much higher household debt figures. In 2016, Thailand was at 79% in 2016, Malaysia nearly 70% and Singapore nearly 60% (for 2017). And each of these have seen a 20pp increase over the past 8-10 years. So in this context, Vietnam is just in line with its peers.

Also, while the increase in Vietnamese household debt is big, it pales in comparison to the overall increase in domestic credit to GDP. Household debt is a part of the increase, and a big one, but the real driver of domestic credit growth doesn’t seem to be households. [One discrepency here ist hat the paper seems to have slightly different domestic credit figures than I do - not sure why that is. My figures for domestic credit come from the World Bank databank.

Two potentially key numbers to remember about household debt:

• 85% or thereabouts- This is the level of household debt to GDP when it starts to be a drag on GDP growth, consumption and employment.

• 65% - This is the approximate level where the correlation between household debt and financial crises increase.

Now, I said potentially key numbers, because this is definitely contested by economics. What we can say is that there is a correlation between high household debt and lower economic growth after a certain level (c85%). Why? Well, ultimately, unlike governments, households run out of room to borrow. When they have to retrench/delever, they spend less, lowering aggregate consumption figures and therefore economic growth. And if households have high debt during a recession, they may not be able to pay off loans, which can cause difficulties for banks.

Importantly, the relationship between HH debt to GDP depends on exchange rates, which is negative for Vietnam.

The negative relation between the change in household debt to GDP and subsequent output growth is stronger for countries with less flexible exchange rate regimes.

That is probably because there is little room for the government to maneuver when exchange rates are fixed. They may have to keep interest rates high, even during a recession. Also, they may not be able to take on a lot of debt (for example, in Japan, when it faced a debt crisis, the government was able to stimulate the economy through spending that resulted in the government ultimately taking over the corporate and consumer debt. The latter have much lower debt levels now, but government debt levels are extremely high).

Source: World Bank

Now back to Vietnam. Household debt is very sensitive to interest rate changes and favorable lending conditions. And Vietnam has been on a long tear of lower interest rates. There was a bump after the financial crisis, but since 2011, lending rates have fallen from 17% to 7.4% in 2018.

And looking a bit more at the household debt, these lower interest rates have resulted in much more mortgage/home loan debt. It is growing significantly faster than overall household debt. See chart below.

HPI = Housing price index. Source: SEACEN

So to summarize:

• Lower interest rates plus greater access to credit have increased overall household debt.

• Household debt has increased dramatically from below 10% of GDP to 47% in 2016.

• It still makes up just a third of all domestic credit, by my calculations. So loans to households only partially caused the extremely large jump in domestic credit.

• Households generally took out loans to purchase houses, and that drove HH credit growth.

• While the growth in household debt is dramatic, it is still at a relatively low level (or at least it was in 2016) compared to levels where it might hurt growth.

• And it is also low in comparison to its peers, like Thailand and Malaysia.

• Right now we are seeing limited housing supply (I wrote about this a bit on October 4 - it’s driven by limited access to land), and limits on bank lending, so overall credit growth will likely slow. Household debt will not be immune.

• But, credit growth isn’t in recession - it is still relatively solid at 7-8%.

• This slowing credit growth would have been negative for growth, if all else was unchanged, but growing foreign investment is and will continue to push the economy. Plus an increase in productivity.

I hope that the State Bank of Vietnam starts to distribute more statistics, because it is really hard to find things that are normal in other economies. That would include the breakdown of credit lending, especially household debts. It shouldn’t be that hard. (But what do I know. I’ve never been a central banker!)

Labor updates

Two stories on labor caught my attention today. Both point to rising costs of labor in the country, which is great for workers (and as an socialist dilettante: Yay!), but maybe not great for companies looking to move to Vietnam (although I still think many will move):

First, this Voice of America story on potential labor code reforms (h/t Joe Buckley). This is being driven by Vietnam’s new trade agreement with the EU, which requires greater worker protection.

Positive aspects of the reform (from the worker’s perspective) include:

• The ability for workers to form unions (there is one official union now, but workers do not always feel represented by it).

• It would also do away with short-term contracts for all but foreigners and elderly workers. Some companies take advantage of this currently.

On the negative side:

• It would raise the retirement age for women to 60 from 55 and for men to 62 from 60.

• It would also make it easier to fire workers.

Vietnam made some concessions to the ILO recently that allowed more collective bargaining. We wrote about this on July 17, and I said then that it seemed unlikely these unions would be a permanent independent voice for workers. Maybe a temporary would form form to bargain with a specific company but after that was done, it woudl disband. Now there is a second chance for a more permanent organization to be founded. But the ILO representative in Vietnam thinks things won’t change with these reforms either:

“I am sure new workers’ organizations will emerge,” says Chang-Hee Lee, country director for the International Labour Organization in Vietnam. “But I can’t imagine they will disturb companies’ operations, because their number will be small and there is overall political stability.”

The issue is that unions have traditionally been most effective when they represent lots of workers at multiple companies in the same sector. Then collective bargaining is more comprehensive.

If these new unions are company-specific, then maybe they won’t be able to make much headway. However, workers are restless, and right now they have fairly high leverage, especially skilled workers.

That’s because Vietnam lacks skilled workers in large numbers. One of my first posts, on Jan. 2, was about the surprising high cost of labor in Vietnam. A few points from then and revisiting that now in the context of this article:

Source: World Bank. (pg 22)

There are plenty of workers in Vietnam. Factories can be filled. We talked about this with the relatively low levels of urbanization - about 55 million people DO NOT live in cities. That’s a lot of people that can move from farms into factories.

Productivity is not that bad, compared to other ASEAN countries, but it is woeful compared to China, Brazil or Russia. But those countries have much higher GDP per capita (in similar proportions - meaning Vietnam’s GDP per capita is about half of China’s, as is labor productivity).

But only low-level workers are productive in Vietnam. This World Bank report explains it well:

Estimations of the distribution of labor productivity suggest that it peaks at US$8,000 and that few firms produce more than US$60,000 of value added per worker...While labor productivity is higher in Vietnam than in Cambodia at low deciles of the distribution (e.g., US$2,766 vs. US$ 583 respectively at the 10th percentile), the reverse is true for the most productive firms (e.g., US$61,646 vs. US$ 92,378 respectively at the 90th percentile, and US$106,436 vs. US$287,632 respectively at the 95th percentile). This is suggestive of a weakness at the top of the distribution in Vietnam.

This comports with the facts of the article, where companies complain about the lack of high-qualified workers. “Only 12% of Vietnam’s 57.5 million-strong workforce are highly skilled, according to recruitment firm ManpowerGroup.”

Source: World Bank

The problem is that the level of education in Vietnam is low. You can see this in the percentage of people in tertiary education. It was just 29% in 2016 (this takes students in college/uni divided by the number of people in that age cohort). Thailand was 49%, Malaysia 46%, Indonesia and Philippines at around 35%. China was at 50% in 2018.

Looking back to 1999, Vietnam was just at 10%, so growth has been very impressive. And it will continue to grow. But it also means that the country might not be able to take full advantage of this moment, when companies are looking to move production to Vietnam. And this moment might not repeat.

Yum! Vietnam as the center of insect food

People are starting to worry about the ability of the earth to feed a growing population. Is there a limit? One of the ways to more efficiently use the earth’s resources is to eat more insects.

Why? Well, growing insect protein is actually quite efficient, unlike, for example meat protein.

“[F]arming insects use up to 50–90% less land per kg protein, 40–80% less feed per kg edible weight and produces 1000–2700 g less GHGEs (Greenhouse gas emissions) per kg mass gain than conventional livestock.”

In addition, according to the same article linked to above, crickets, palm weevil larvae and mealworm were all significantly healthier than beef or chicken.

Vietnamese have a long history of eating insects. Turns out, the country is also full of innovative insect food companies:

• Cricket Hop: A UK-based company with farms in Vietnam. It was started by two British chefs that were travelling in Vietnam. They mainly make cricket flour, which can be used in baked goods or things like smoothies and protein drinks. Not sure they have any funding.

• NutritionTechnologies: This is mainly animal feed that produces in Malaysia with supporting sites in the UK, Vietnam and Singapore. It is focused on the SE Asian market. They closed a Series A funding round of $8.5m in July 2019. The lead funders were Openspace Ventures and SEEDS Capital.

• Entobel: Company that makes animal feed, oil and fertilizer from insects. It is based in HCMC. It has raised $1.8m according to Crunchbase.

Insect farming is actually a big deal right now. Lots of companies have gotten funding. Ynsect, a French firm, raised $125m in a series C in February. Another French company, Innovafeed, raised $40m in late 2018. Agriprotein, a UK company, raised $105m in debt and equity in June 2018.

Vietnam really has an opportunity here, and it will be interesting to see if Entobel, which I wrote about back on March 18, or any of these other companies, are able to make it. I have eaten bugs before, but ultimately, I am not super excited about eating them. I am, however, pumped about using insects for animal feed. So much of farmland is devoted to animal feed, so anything to make that more efficient is great.

Do central banks drive stock returns?

Hat tip: Marketwatch

I saw some interesting reports on a Deutsche Bank report by the bank’s chief economist Thorsten Stok. His thesis is that stock market returns may no longer be driven by economic growth because Central Banks determine so much.

He points to the performance of the S&P (+17% YTD as of yesterday), despite an increasing chance of recession in the US.

Going back to basics, there are a number of reasons why stocks should perform. Key ones are:

Higher/lower future cash flows: The value of a company is the present-day value of all of its future cash flows. Those cash flows increase or decrease with economic growth, in very general terms. Obviously, some companies grow in recessions, and some companies loss money in good times, but in aggregate you should see earnings move in line with economic growth. And as the chance of a recession increases, expectations about future cash flows should fall, and stock prices should follow.

Source: Vietecon.com

Discount rate: But as I as said, the stock price is the present value of future cash flows. The present value is determined by the discount rate. The discount rate is the risk free rate plus a market risk premium multiplied by the Beta of the stock, or its volatility in relation to the market. Basically, cash flows are discounted by an amount that is higher than the risk-free rate, because everyone could get that. Say by investing in US government bonds.

So there are three things there that have a big impact: risk-free rate, the market risk premium and the Beta. This is all part of the capital assets pricing model (CAPM).

As we can see in the chart to the right, a change in the discount rate affects value a lot. Let’s assume a company that makes $10 a year for 25 years and then shuts down. It could be worth $250 if cash flows are not discounted, or $100 if the discount rate is 10%. To follow this all the way down, if have a discount rate of 100%, the company would be worth just $10 - the amount that could be taken out the first year.

Side note: In terms of sausage making, if you are an equity analyst and want to change the valuation without changing a lot of numbers, there are a number of easy ways to do it: change the discount rate by raising/lowering the beta, the target debt percentage, or the free cash flow in the final year, since so much of valuation is in the terminal value.

Demand: There is a third way that stocks are priced. And this one is maybe not as powerful as the other two. Basically the stock market is like any other market. Demand and supply matter a lot. Demand can change for a few reasons. Maybe more people are investing in stocks because they are looking for better returns than what they can find in the bank and/or because they are saving more. Central banks may actually step in and buy stocks. Or countries, say one of the big sovereign wealth funds, may decide to allocate more to stocks and/or have more money generally for some reason.

One of the hardest thing for me to answer when I was an equity analyst is this: who is going to be the marginal buyer for the stock? This question speaks to demand, and I didn’t always have a good answer. It could be anyone! But for the market as a whole, because I was looking at emerging and frontier markets, it mostly was investors allocating more to the asset class of emerging market stocks.

Back to the Slok’s article. Here’s what Slok thinks is driving the market:

• "Perhaps the answer is that equity and credit markets are no longer driven by fundamentals, but instead by Fed and ECB promises of lower rates, more dovish forward guidance, and QEternity."

• "In short, because of unlimited central bank safety nets — including in the new MMT form of aggressive fiscal policy — S&P500 may not decline, and credit spreads may not widen next time we enter a recession."

It doesn’t really seem correct to say that markets aren’t driven be fundamentals . His statements point to a few fundamentals of valuation:

• Lower future discount rates (because central banks are holding down the “risk-free rate”)

• Maybe some idea that recessions will be shorter or less bad, so that cash flows won’t fall as much.

• Potential demand from the central banks or from qualitative easing keeps demand high for stocks.

• Lower rates making bond yields look less attractive compared to stock returns.

What I don’t know is if stock prices will perform well in a true recession. I think it will depend on how bad the recession is. Basically, does falling cash flows offset a lower discount rate and demand from the government/QE?

Big cities sign climate agreement

There is a big conference in Copenhagen that gets mayors from the biggest cities in the world together to discuss climate change. These 94 cities make up 25% of world GDP and 1 in 12 of all people. This year’s summit started today and lasts until Saturday.

Source: C40

As part of the commencement, the leaders announced support for the global green deal. The goal is to “keep global heating below the 1.5°C goal of the Paris Agreement.” This includes inclusive climate action, and cutting global emissions in half by 2030.

It doesn’t look like anyone from Vietnam signed along. No one from either HCMC or Hanoi are speaking at the summit, but both are part of the C40 group. So this might mean actual progress. The problem is that words mean nothing without action. We will have to see what happens.

Short one today. I am busy with other things.

Air quality

I don’t really want to make this an environmental blog, but I feel like “people” are talking about air quality in Vietnam. (By people, I just mean some news stories).

But it seems like air pollution and air quality is something that people are more and more concerned about. For example, this story in VN Express, gives an indication that people are worried.

Part of the reason that people are paying more attention is because air quality is getting worse.

The PM2.5 particulate level reached a five-year high last month, according to a report from the Ministry of Natural Resources and Environment.

DALYs = disability-adjusted life year, or years lost to disability or death. Source: WHO

It really matters, because air quality is important for health. Looking at some figures from 2016, air pollution in Vietnam hurts health at a rate almost 50% more than in countries like the US and the UK. At least in 2016, Vietnam was actually not the worse, by a long mile, in ASEAN. Thailand, Philippines, Laos and China (not in ASEAN) are all much worse.

I would assume that these numbers are just increasing with the worsening AQI figures. As in China, the US Embassy has become the main source of AQI figures in Vietnam. But it doesn’t sound like the government is trying to hide it.

Solutions are quite difficult. One of the reasons developed countries like the UK and the US have higher quality air is because the dirtiest businesses are no longer there. These “dirty” companies are now in developing countries. As Vietnam grows and manufactures more, it is very likely that air pollution will grow unless the government takes some big steps quickly.

These include:

• Limiting private vehicles

• Using cleaner renewables (not biomass, but wind and solar)

• Adding more tree cover

• Keeping industrial emissions in check

These are all very difficult to do and not really something that the government has committed to (outside of renewables). Obviously public transport would be a big help, and there is a metro plan (albeit delayed). The push to electric buses also helps. But coal-fired plants are a step back, and it doesn’t seem like there’s a real commitment to greater tree cover. Development has been a big priority (and it should be - shelter is important). That’s why these are difficult.

China has made great strides in reducing air pollution in Beijing over the past five years, but it may have just moved out of the capital into other provinces. Let’s hope that this acute attention doesn’t lead Vietnam down the same path. The government may be able to make a difference quickly in Hanoi and Ho Chi Minh City, but hopefully not at the expense of poorer cities.

Climate change refugees

Source: World Bank

We have talked before about the increasing urbanization rates in Vietnam. As you can see in the chart to the right, Vietnam’s urbanization has increased 15 percentage points since 1991 to 35% of the total population. That’s a big jump. Now almost 35 million people live in cities, and it is increasing every day.

We talked about reasons for the move: agricultural jobs falling and manufacturing jobs increasing. It’s hard to determine the causality. It likely comes from both high and growing salaries in manufacturing while agriculture wages are not keeping pace.

Well, I should have also talked about another reason that people are moving: climate change.

This BBC story looks at climate refugees fleeing the Mekong delta. A few stats that caught my eyes:

• BBC quoted the Vietnamese Ministry of Agriculture and Rural Development saying that 30-100 meters of coastal land could be lost to erosion.

• The Vietnamese in the story say: “The weather has changed drastically. The river has moved closer to us.”

• 1,300,000 moved out of the Delta, and only 300,000 moved in in the past 10 years.The total population of the Delta is 18 million, so these are big numbers.

• Of those who moved, 15% did so because of climate change (or almost 200,000), according to “a study at a Vietnamese University.” This might understate the numbers - sometimes people move for economic reasons, and the economic reason is that there is not enough land to farm, or the land no longer gets enough water and is therefore barren, etc.

• Dams higher up on the Mekong are also a problem for the Vietnamese.

In response, the government, according to this report, created relocation programs for people in vulnerable areas. They have also constructed dykes in the river, but these may be affecting the health of the river.

It is a difficult situation, and it doesn’t look like Vietnam or the world is really prepared to the upheaval that will come from climate change. Yet, we, as humans, are still investing in coal plants.

It’s only 10 minutes, so I recommend watching the whole thing.

Property woes

I talked, in a very small way on August 13, about how the crackdown on corruption was hurting the property market. It turns out that the real estate is riddled with shady transactions. Who knew? Even in the West, real estate is shady, and it often involves government officials.

In Vietnam, the crackdown has meant that companies find it hard to buy land, resulting in a shortage of good land for development. Approvals are slow in coming, leading to less construction. Officials appear nervous about approving land sales and projects, because the government corruption probe might target them.

Madison by Novaland. Source; Novaland

But also, as we see in another story about Novaland Investment (Ticker: NVL) the government stops handovers for some finished projects. NVL has a development called Madison that is now embroiled in these corruption cases, so the government is prohibiting it from handing over the 187 apartments.

It’s a bit confusing, but here are the details:

[T]he reclamation is linked to a criminal case involving Phan Van Anh Vu, a businessman and ex-official at Vietnam's Public Security Ministry who was detained in January last year and subsequently sentenced to 15 years' jail for abusing his position and power while on duty. He was chairman of Bac Nam 79 Construction, which was granted the right to use the land upon which the Madison project was built by the Ho Chi Minh City People's Committee.

Basically, an ex-official got the land from the HCMC People’s Committee. He then partnered with Novaland to build and market the development on the land. Now the government says that things are not above board.

Most of the current owners in the building (80% according to the article) are holding out for a resolution, while the rest were able to get their money back. This is a black eye for Novaland, but not a new one. It appears to be hurting the stock, which is well down from its high in late October 2018. It’s still worth a bit less than $2bn, so it is still a big player. But not a great look for the company.

It will be interesting to see how other companies deal with issues like these. If the stock market is willing to mostly shrug them off, and the government doesn’t go after the companies too hard, things could start to normalize. We will have to see.

Bank credit

Banks are really confusing and, frankly, weird. Loans are an asset. Cash deposits are a liability. It mixes up the way we think about the world.

The banks analyst at my last firm, very smart guy, said just think of money as any other product. A company buys raw materials for $9, uses these to make widgets and sells them for $12. In the case of the bank, they buy money, and they sell loans. That is the basic model of banking, but it’s hard for me to get my head around it.

Unfortunately, banking is really, really important. In the US, finance and insurance represent 7.4% of GDP. This is the same size as healthcare.

Source: World Bank

Finance is also important because it can really drive economic growth, especially because lending is a big driver of investment, which can result in more GDP over time.

But at times credit-driven growth can come with its own problems. Over time, the debt burden of a country can become too big.

As I read in Crashed, the European banks were much bigger than their economies. For example, in 2008 Iceland had liabilities (deposits and wholesale liabilities) of more than 900% of the country’s GDP. Ireland was above 700%, and the UK was 500%+. The US, which is seen as the epicenter of the crisis, had around 100%.

Why is this bad? Well, 1) in times of crisis, the liabilities of these banks are impossible for the country to take on. Or at least very hard. 2) If this credit is going into the domestic economy (in Iceland a big portion was mortgages outside of Iceland), when it starts to be pulled back, you start to see problems with people that have been living on this credit. For example, if company needs to refinance a loan but credit is no longer available, then it may have to raise a whole lot of money to repay the loan. If the company can’t, it goes bankrupt. Also, and this is a tautology, growth depends on every increasing amounts: ever increasing homes, more remodels, greater consumer goods, etc. If there are no mortgages, then there are no new home sales, and therefor no new homes being built, meaning a declining real estate market. When this happens across the economy, you get a recession.

So does Vietnam need to worry? Maybe a bit: Looking at Vietnam right now, domestic credit to GDP is actually pretty high at 141% of GDP. That is still below those big European levels but is a bit more than other ASEAN countries. Much less than China (218%) and S. Korea (177%).

Is credit necessary for growth? This is the larger question. Intuitively, I would think so. More credit means more activity and more growth. But intuition is not always correct in economics.

So I looked at Vietnam, South Korea, Japan and the US. It’s funny, because for some of the countries, it seems clear that credit growth and real GDP per capita growth are necessary. Below I have the charts for South Korea and Vietnam, with real GDP per capita vs. domestic credit to GDP. If you look at these, then credit growth goes up with GDP per capital. And it appears to be increasing before the increase in per capita GDP.

Source: World Bank

Now let’s look at Japan and the US. Well, in this case, per capita GDP in the US didn’t increase in the same way as per capita GDP. In fact, per capita GDP grew despite a decrease in domestic credit at times. Japan is the opposite. Credit grew ahead of per capita GDP, then stopped growing in line with the GDP. It doesn’t seem like credit is necessary to drive growth in all cases.

Source: World Bank

Looking into the literature, it seems like looking at these four countries was actually pretty exemplary. Based on this survey of the literature there are a few findings:

• Development of finance is positive for economic growth (as we saw with Vietnam and S. Korea).

• But the benefit decreases as countries get richer. (as we saw with the US and Japan)

• As per capita GDP grows, non-bank financing becomes more important to drive further growth. That’s because these non-banks can be more innovative.

• Increased banking competition can decrease inequality.

Vietnam is probably in a place where more credit means more economic growth, but it could start to decline or the marginal utility of additional credit may fall. Surprisingly, Vietnam already has a fairly big non-bank sector, or at least a lot of non-bank (meaning VC and PE firm) interest in the country. I wrote about this on September 25 (scroll down).

In conclusion, credit is already high, it probably contributes to economic growth, but at some point its marginal utility will decrease. And that’s normal.

More on banks - capital needed

So following on from my post yesterday, there are a few concerns with the banking sector in Vietnam. In some ways its gotten better. Loan-to-deposits are generally low, non-performing loans are coming down (albeit slowly), and returns are improving. That means that building capital is not that hard. Banks could just lower dividends, adding capital organically. Or they could raise more equity, which is easier when you have good results.

But there does seem to be an increasing gap between the state-owned commercial banks (SOCBs) compared to the private ones. Looking at the CAR by type of financial institution. The SOCBs have a CAR of less than 10% (see chart below), and it is very likely that this will fall with the change in the calculation of CAR. Basel II changes the calculation of CAR by making the weighting on some assets different (lower/higher, depending).

But of all of the private banks, it looks like there are a few that meet the Basel II requirements, but even they probably need more capital to grow. Bascially, if a bank is right at that 8% requirement, then they can’t lend out until they get more capital. So even the private banks that are doing well need to get more capital. And to do that, they will need to raise money in the capital market.

Here are some estimates for the amount needed.

Moody’s: Moody’s-rated Vietnamese banks will need an additional USD7bn to USD9bn to achieve Tier 1 capital ratios of 11% in 2018 and 2019.

Fitch: Vietnamese banks will need USD4.1bn of additional capital, assuming they target a minimum 8% Tier 1 capital ratio and continue to rapidly grow their balance sheets.

These are very high amounts and most banks are not able to source this much from the domestic market. In the case that foreigners need to invest, there are some hiccups. Mainly, the foreign ownership limits (FOLs) are already low. The current limit is 30%. There has been some talk about the government raising it to 49%. Even this higher level would probably not be enough. The IMF says that foreign banks probably want control, which would mean the limit needs to be 51%.

If the Vietnamese really want to upgrade their banking system, and they probably should, they should raise the FOLs to 51% for at least some of the banks. And to 49% for all the banks. Hopefully that will bring in the capital and potentially result in better banking overall (more services, better quality controls, etc).

Of course, I really haven’t thought through what this will mean for the stability of the system as a whole, but long-term capital in the banking system may actually be pretty good for Vietnam.

As of April 2019. Source: State Bank of Vietnam

Banks in Vietnam

So I wanted to talk about the banking system in Vietnam, because I am reading this book, Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze right now. First of all, it is wonderful. Second, it also has so many illuminating insights into the world financial system that raise questions for Vietnam as well.

One of the things that he points to as the cause of the financial crisis is not a run on the banks but the inability of banks to source wholesale funding - it just dried up. Now why is that important? Well, as Matt Levine has said in a number of columns (here), banking is a magic show where short-term deposits are magically transformed into long-term loans. Oftentimes, short-term deposits (where you put your money in the bank) are actually pretty stable. Especially since most governments have stepped in and provided lots of guarantees around these deposits, meaning if the bank goes under, your money will be returned regardless.

But many of the big players in the US and European banking system were not funded by deposits, but were rather funded by wholesale lending in the interbank market. Banks were able to use their assets (in this case mortgage-backed securities or packages of these) to borrow in the interbank market. This money was used to fund loans and the purchase of securities, including things like mortgage-backed securities, etc. That stopped when people lost faith in the securities and in the bank’s ability to pay back the money. And it stopped all at once.

So I started to look at the Vietnamese banking system, and how it is funded. In this case, the banking system is fairly safe, with most credit actually funded by deposits (not wholesale funding), according to the government and the IMF. It is around 90% and has been stable.

Source: State Bank of Vietnam

I do think there are, let’s say, “areas of improvement” with the banking system in Vietnam that I would like to talk about over the next few days. In particular, about half of the assets in the system are in the state-owned banks that have significantly lower return on assets (RoA) than the private banks.

Also, capital adequacy ratios (CAR) are pretty low, especially with Basel III coming online in much of the world soon. It requires a CAR of 10.5%. Note that Vietnam is not even yet on Basel II, which at a 8% minimum CAR would be difficult for some banks. Or course the changes in Basel II and Basel III are not just the CAR, but also the risk-weighting of a bank’s assets, which can drastically alter the ratio.

Finally, credit is the main driver of growth in Vietnam. Total credit is greater than GDP (142% at yearend 2018). The figure is high but in line with the world average. Unfortunately, it is growing at a very fast pace and is driving overall GDP growth.

We will talk more about this over the next few days.

Trade imbalance has logistic implications too

California had many years of drought recently (now hopefully broken), and so there were a ton of “deep dives” into where water was going into the state. It turns out that most of the water was going into agriculture, California sun and such. A large portion was being used to grow alfalfa. In fact it was the third largest crop in California by acreage in 2018, after almonds and grapes, and at one point it was #1.

Alfalfa is a thirsty crop: “It’s a plant that’s going to yield pretty much proportional to how much water we’re able to get to it.”

So why was alfalfa being grown so much during drought times. Mostly economics driven by water and export costs. As Peter Culp and Robert Glennon characterized it in the WSJ: “In 2012, the drought-stricken Western United States will ship more than 50 billion gallons of water to China.”

It was economical to export alfalfa for two main reasons:

1. California has/had very antiquated water rights, and so farmers were not paying “market prices” for water. Alfalfa needs a lot of water, but it is good for the soil, is easy to grow and there can be as many as eight harvests a year.

2. Also, freight costs to China were very low. Cargo containers were going back empty to China, and the cargo companies needed something to fill the space at almost any cost. See, China had such a big trade imbalance with the US that 1 in 2 containers were being sent back empty. By the time Culp and Glennon were writing (October 2012), the cost to ship a ton of alfalfa to China was less than to ship it from southern California to the Central Valley.

Source: General Statistics Office of Vietnam

Now, why am I writing so much about this? Well, we are starting to see the same issue with Vietnam. It is difficult to find something to put in those containers (or planes, in this case) from the US to Vietnam. So the cargo companies stop in Singapore or elsewhere close by and then come to Vietnam before heading back to the US.

And it is going to get worse. Freight volumes are rising like crazy. Since 1995, they have grown 10x for a CAGR of more than 10%. That’s faster than GDP growth.

And that is just internal freight (which likely captures trips from the factory to the ship, but not all of the traffic from ships going to the US). “AirBridgeCargo (ABC) saw a 53% increase in Vietnam volumes so far this year, after upping weekly lift from Ho Chi Minh City and Hanoi to two and three flights respectively.”

But Vietnam is now committed to increasing imports from the US. Potential imports are energy, as we talked about with the LNG export contract (Sept. 19, 2019, scroll down). That will be good for the trade deficit. The second is agriculture, which is a perennial contender, since the US is quite good at producing agricultural products. There are already reports that American apples and cherries are reaching Vietnam.

It’s kind of weird to think of a country like Vietnam, which is not as developed as the US, exporting high-value goods to the US, while the US exports apples. But this is what happened with China, so it’s not new.

AB InBev IPO's Aisan subsidariary - what will that mean for Vietnam?

source: Globaldata, via Ab Inbev prospectus

The second biggest IPO in the world (after Uber, which is not looking so good these days) just happened in Hong Kong. AB InBev, the largest beer company in the world, sold a stake in its Asia-Pacific subsidiary, Budweiser Brewing Company APAC Ltd., raising USD5bn. The parent will use the money to lower its USD100bn in debt (on EBITDA of about USD19bn, ttm). It previously had announced it was selling its Australian business for more than USD11bn, again to lower debt. The balance sheet will still look stretched (about 4x EBITDA by my very rough calculations).

But what will this mean for Vietnam?

• Vietnam is very much a beer market (we talked about this back on June 13 when we looked at the beer market).

• And the market is growing. GlobalData, a data provider, expects beer volumes will rise 4% annually through 2023 and value will increase 9% annually. The premium market is growing even faster: volume at +9%, value at +14% annually for the next 5 years!

source: Globaldata, via Ab Inbev prospectus

source: Globaldata, via Ab Inbev prospectus

• Unfortunately for Bud APAC (or whatever they are going to be called), their market share in Vietnam is very low - just 1% in terms of volume. Probably a bit more than that for value. Within the premium and super premium market, they are #2, which is good.

• Consolidation is the name of the game. We could start to see acquisitions or mergers among the big Asian names. The subsidiary appears to have a fair amount of cash (USD1.0bn as of June 30) and less debt than that.

• Some analysts, according to this report, believe that ThaiBev, which owns the #1 brewer in Vietnam, SABECO, could be one.

• San Miguel of the Philippines, which is also on that list, recently said it would build a new brewery in HCMC, “as soon as market studies show good prospects.”

• Carlsberg and HABECO already have a tie up, so within Vietnam, SABECO/ThaiBev is the best bet for Bud APAC.

• SABECO’s stock price is up 20% yoy, but has not been doing that great since mid-July.

Should be fun to watch what happens with the beer segment in Vietnam. It’s important to note that the craft beer scene in Vietnam is “booming,” so there is going to be a lot of competition.