VanEck Vietnam ETF (BATS:BATS:VNM) is an exchange-traded fund that provides investors with direct exposure to Vietnamese equities. I last covered VNM in my article dated June 20, 2022, suggesting the fund was undervalued. Unfortunately since then, according to data from Seeking Alpha, VNM fell -20.72% compared to the 6.16% change in the US stock index S&P 500 over the same period.
A recent article by Bloomberg in early October 2022 was titled “Investors take long-term bet on Vietnam’s cheap valuations”. The article explained that risk aversion was due to concerns about rising interest rates (the State Bank of Vietnam assess is currently pegged at 6%, a sharp increase in October 2022 from 4% in previous months of this year). The current central bank rate of 6% also exceeds the prevailing US Federal Reserve rate of 3.00-3.25%.
Despite some Purchasing power parity models suggesting that the local currency is significantly undervalued, the Vietnamese dong has fallen significantly since my last article due to fairly high risk aversion towards Vietnam. The USD/VND exchange rate is shown below; the US dollar has appreciated by almost 9% against the Vietnamese dong (hereafter abbreviated as VND) since the beginning of 2022.
Keep in mind that Vietnamese inflation is actually quite contained, in line with historical averages (most recently 4.3% YoY).
Meanwhile, the locals 10 years tightened to 5.19%, indicating not only likely positive real interest rates over the longer term, but even positive real interest rates when considering only recent/confirmed short-term inflation rates. It is a restrictive monetary policy. Usually, higher real interest rates lend themselves to higher exchange prices; the recent fall in the VND therefore reflects a fairly severe risk aversion. It doesn’t help that Vietnam’s current account has fallen into a negative position relative to GDP.
A negative current account in 2021 suggests that the VND is likely close to fair value through 2021, while current account surpluses from previous years would have indicated undervaluation. VND actually strengthened in 2021, and given a larger interest rate differential, I would say that VND is most likely undervalued right now. A return to the 2021 lineup would seem logical.
The exchange rate is important, as the VNM ETF’s portfolio is made up of Vietnamese stocks denominated in VND. A stronger VND helps the portfolio, while the opposite (as happened most recently) drives the price of VNM down. While not providing too much comfort given recent declines, VNM’s core FX exposure is likely to strengthen rather than weaken further.
In terms of the portfolio itself, it doesn’t help that local interest rates are restrictive. Also, judging by the 2021 debt/GDP rate of 39.1% compared to 49.9% in 2020, the fiscal impulse is negative, which would present itself as a (negative) headwind to local growth and corporate profits until 2022. This helps to explain part of the recent decline. Furthermore, credit data available from the Bank for International Settlements suggests that total credit to the non-financial private sector in emerging markets (Vietnam is classified as an emerging market) is negative in both absolute and PPP adjusted terms.
In addition, Vietnam’s major export partners by 2020 data include China (17%) and South Korea (7%). By loyalty research, China is in recession, while South Korea is very close to recession territory. While other key export partners include the United States (26%), Vietnam’s exposure to other Asia-Pacific countries means that VNM’s portfolio has not been better positioned against to the economic cycle. As the US is earlier in its economic cycle, if/when the country enters recessionary territory, VNM’s portfolio could face further headwinds. One could say that VNM’s overall position is balanced, but it may take more than a year before all of its major export partners are simultaneously supported by favorable macroeconomic conditions.
In terms of VNM valuation, the morning star estimate that the fund’s forward price-to-earnings ratio is 9.92x, with a price-to-book ratio of 1.69x. This implies a high long-term return on equity of 17%. Earnings growth over three to five years is estimated at 11.16%, which should safely outpace local inflation. With positive real interest rates and a likely undervalued currency, and with positive real earnings growth, combined with high local return on equity, this would suggest that VNM is likely undervalued.
The forward price-to-earnings ratio implies a forward earnings yield of 10.08%. VNM has 59 farms per VanEck, with total net assets of $311 million as of October 28, 2022. This is a riskier emerging market focused portfolio that naturally has a less sophisticated/developed local stock market (compared to the US, for example). VNM five years the beta is around 1.15x, but that probably underestimates the relative risk compared to the US stock market. Teacher Damodaran previously (January 2022) assigned a country risk premium of more than 3.5% to Vietnam; given the fall in VND, we should assume that the level of risk perceived by the market is at least as high as before.
So if we take a base risk premium of 5%, and add 3.5% as the base arbitrary risk premium, we arrive at 8.5%. We can then add about 5% taking into account the local 10-year rate (risk-free rate) of the country; the result is 13.5% as the approximate cost of equity. If we assume that long-term inflation falls to 2% and we add up to 1% “real” earnings growth to infinity to account for VNM being exposed to an emerging market with a portfolio at high ROE, the net of – growth cost of equity is around 10.5-11.5%. Dividing 1 on this range gives an implied forward price/earnings ratio of 8.70-9.52x. This compares to my 9.92x figure taken from Morningstar earlier.
If earnings grow as fast as Morningstar analysts’ consensus estimate of more than 10% a year, that would help support valuation. However, based on my work, the VNM ETF is probably not currently “cheap”, but rather the implied yield is simply still strong. Since my last article, earnings have been understated (judging by lower return on equity) and valuations have fallen (judging by lower forward price-to-earnings ratio, partly no doubt due to the rise in local long-term risk-free rates).
Given the positive real interest rates locally, it is possible that the Vietnamese 10-year local yield could fall back to around 4% against more than 5% currently; this would improve our future earnings multiple range to 9.52-10.53x. At the high end, this would generate around 6% upside potential on its own. However, given the currently tight monetary and fiscal policy (on a dominance basis) and the recent decline of the VND against the US Dollar, I would err on the side of caution.
VNM likely still offers a strong cyclical opportunity, but the timing will be trickier than ever. However, as we move forward into 2023, the adverse effects of the contraction in local fiscal and credit impulses should start to fade given the base effects. The next few months should also allow time to see if the USD/VND exchange rate remains stable. As I believe the exchange rate is still fundamentally supporting VND appreciation, a tailwind should take effect over the next 3-12 months. A normalized VND should also help stem risk aversion, which could help compress local equity risk premia and thus support VNM’s valuation. VNM isn’t “cheap” given the country-specific risk, but it’s still priced for returns of over 10% per year, which I think is achievable.