Southeast Asia - The Year Ahead - Waverton Investment Management

Southeast Asia – The Year Ahead

Summary

    –   After a tumultuous year in 2020, Southeast Asian markets made an astonishing Q4 recovery
    –   Every major regional economy except Vietnam experienced a deep recession in the past year
    –   A weak dollar, resurgent global trade and rising commodity prices now form a constructive backdrop
        for EMs
    –   The roll-out of vaccines across Southeast Asia may take longer than markets currently expect
    –   Domestic liquidity is highly supportive of every regional equity market, whilst foreign selling may
        have peaked
    –   Our All-Cap and SMID-Cap Southeast Asian strategies are positioned for further rotation to value
        and cyclicals

Review of 2020

Where to begin? It was a tough year to encapsulate with the lone adjective, but we will settle for
“tumultuous”. In common with the rest of the world, Southeast Asian markets have crashed and then made
an astonishing recovery in the last twelve months, but it should not be forgotten that, when Covid struck, we
were already deep into bear market territory in this part of the world. From its peak in January 2018, the
MSCI ASEAN index declined by 13% over the two years to the end of 2019, and by a further 14% in January
and February of 2020. When the rest of the world really started to wake up to the disaster of Covid in March,
Southeast Asia still managed to outpace the declines in the MSCI World index. Meanwhile, the region’s small
cap stocks could best be categorised as a disaster zone over the same period, declining by 55% from their
January 2018 peak to their March 2020 lows.
Against this background of a long, drawn-out bear market, the recent recovery in regional markets has not
been quite as impressive as it might appear at first glance. Although the MSCI ASEAN index bounced by
50% from its March lows to year end, and the small cap index by 87%, both remain way below their historic
peaks, at a time when other world markets, and even other emerging and North Asian markets, have been
surging to new highs. There are many reasons for this poor relative performance, but the overwhelming one
is that the region offers few investment opportunities in the digital economy space, which has dominated
investor thinking over the last few years, as an ultra-low interest rate environment has supported momentum
investing and the seemingly endless upward revaluation of growth stocks. Southeast Asian economies, by
contrast, have a more traditional emerging markets profile, dominated by cyclicals and value stocks. Only in
the fourth quarter of 2020 did we begin to see signs that the region’s long ice-age may be approaching a
thaw; with a weak dollar, resurgent global trade and rising commodity prices all pointing to a strong economic
recovery and rising corporate earnings in the year ahead.
Covid-19 is far from being under control in Southeast Asia, but the promise of a vaccine has raised hopes,
especially in the hardest hit countries of Indonesia and the Philippines. In the meantime, the news remains
dire, with almost every country except Singapore once again in the grip of rising cases, and movement
restriction orders re-imposed in Thailand, Malaysia and Indonesia. The impact of Covid on economies has
been painful in the extreme, with every country except for Vietnam experiencing a severe recession in 2020.
The Philippines’ economy is expected to have shrunk by 9.5% in 2020, Malaysia by 6.8%, Thailand by 6.3%,
Singapore by 6.0% and Indonesia by 2.0%. Vietnam’s growth rate will decline from 7.0% in 2019 to 2.7% in
2020. In part, these numbers reflect lower levels of stimulus payments and fiscal support than in the
developed world, but they also underline the potential for strong economic recoveries as vaccines are rolled
out. There are legitimate concerns about how quickly this can be achieved, especially in the archipelago
nations of Indonesia and the Philippines, but for the moment markets appear willing to look through these
concerns, believing that economies that have fallen the furthest should eventually rise the furthest.

Country Review

   1. Indonesia is emerging from 2020 in better economic shape than could have been expected around
      mid-year, given the rapid spread of Covid around the country at that time, and a series of strict
      lockdowns that still endure. GDP is now forecast to have declined by just 2% in 2020, and to rise by
      4% in 2021. Stocks fell by 9.5% for the year and small caps by 10.3%. The rupiah, usually the first
      link in Indonesia’s economic chain to show signs of stress, has been remarkably stable. Foreign
      investors however have continued to exit the market, with negative flows of US$6.7bn for the year.
      This remains our one of our best hunting grounds for stocks. President Jokowi continues to deliver
      on pro-business policies, with infrastructure spending sustained at high levels, and the Omnibus Law
      passed in in Q3 2020 helping to make Indonesia more competitive as a destination for FDI, by
      reducing red tape and cutting labour costs. Vaccinations are a huge logistical challenge, given a
      population of 270m spread across an island archipelago, but the country has made a good start by
      ordering 250m doses, the highest coverage ratio of any Southeast Asian country except for
      Singapore. The government’s aim is to vaccinate every citizen over the age of 18 in 12-18 months.
      We think the market can continue to bounce back. Valuation is at approximately 16x prospective
      2021 earnings, but for stock pickers there are plenty of cyclicals and small caps selling at much
      lower valuations.

   2. Malaysia saw GDP decline by around 6.8% in 2020, but stocks down just 1.7%, whilst small caps
      rose by around 30%. This was an astonishing performance, particularly as the market had to
      sidestep a background of political turmoil and high Covid infection rates. The small cap gains were
      achieved largely as a result of rubber glove manufacturers seeing both profits and multiples rise
      sharply. The main market also held up well, due in part to the fact that the country has few foreign
      investors left, and local institutions, including the sovereign wealth and pension funds, are captive
      investors unable to exit the market. Malaysia will begin vaccinating with the Pfizer vaccine in Q1, but
      has so far purchased relatively few doses. On the positive side, the market is not especially
      expensive on a multiple of around 15x prospective 2021 earnings.

   3. The Philippines has had a brutal year, with GDP declining possibly by as much as 9.5%. The main
      market fell by 9.7% and small caps by 13%. The government has struggled to control the spread of
      Covid-19 and faces huge logistical challenges in vaccinating across the islands. It has so far
      purchased a lower ratio of vaccines to population than other major Southeast Asian countries, with
      the exception of Thailand. Bright spots in the economic picture include the fact that OFW remittances
      have held up well, whilst the equity market is under-owned by foreigners after many years of
      negative fund flows. When Covid-19 is finally brought under control, the Philippines should be in line
      for a strong recovery from such a low base, but this may not happen until 2022. Meanwhile, the
      overall market is not cheap on 18x prospective 2021 earnings, but, as in Indonesia, there are many
      interesting situations for stock pickers among the cyclicals and small and mid-caps.

   4. Singapore was the second worst performing Southeast Asian market in 2020, with stocks declining
      by 12.8%, although small caps did better, falling 4.3%. Singapore’s economy took a heavy hit from
      collapsing global trade in Q2, but by year end was recovering strongly. The country will almost
      certainly be one of the first in the world to vaccinate its entire population, and has done a predictably
      excellent job of preventing the spread of the disease. Singapore’s recovery will be closely linked to
      global trade, and we expect growth of around 5.5% in 2021, but the country’s economy is unique in
      Southeast Asia due to its high level of development. We tend to find more investment opportunities
      among the emerging markets of the region, but there are also companies listed in Singapore that
      offer exposure to other economies around Southeast Asia.

   5. Thailand faced huge challenges in 2020. Although Covid has not been anywhere near as prevalent
      here as in Indonesia or the Philippines, the pandemic wreaked havoc on the tourism industry, with
      Thailand effectively closing its borders to foreign travellers. As tourism represented at least 12% of
      GDP in 2019, and probably more, it is remarkable that GDP is expected to have declined by only

6.3% in 2020. This was achieved mainly through an increase in infrastructure spending and an
          improvement in the balance of trade. Agriculture too has gained from rising prices. The country has
          faced political unrest in Bangkok, with students demanding constitutional reforms, and unfortunately
          these protests look set to rumble on. A recovery in tourism is unlikely until Covid is under control, but
          Thailand has been slow to acquire vaccines, which Prime Minister General Prayut has defended on
          safety grounds. As a result, it seems unlikely that mass vaccinations will be underway before Q3 at
          the earliest, and a recovery in tourism has almost certainly been pushed back to 2022. A persistently
          strong Baht is also a growing threat to Thai exporters. The Thai market, like other markets in
          Southeast Asia, has been supported by strong domestic liquidity. Money supply is surging, but with
          GDP growth negative, there is not much demand for loans, hence this excess liquidity has gone into
          financial assets such as deposits, bonds and equities. With the Thai market the most expensive in
          Southeast Asia on around 19x prospective 2021 earnings, there are relatively few under-priced
          opportunities compared to most other Southeast Asian markets.

     6. Vietnam has undoubtedly been the jewel in the crown of regional economies over the past year.
        Covid never gained much of a hold, due to early measures by the government to control population
        movement, in a way that would only be possible in an authoritarian, one-party state. It worked. The
        country has avoided a recession, with GDP growing by about 2.7% for 2020, and the equity market
        rising by 13.2% for the year. The outlook for 2021 also looks promising. Vietnam benefits from
        China’s return to growth, but also from the desire among manufacturers to diversify global supply
        chains. Longer term, the country stands to be among the biggest winners from the Regional
        Comprehensive Economic Partnership (RCEP) signed in November 2020. The most troublesome
        concern has been the risk of the US designating Vietnam a currency manipulator, but with a change
        of Administration in Washington DC, there is a good chance that this can be averted. As elsewhere
        in Southeast Asia, foreign investors have been net sellers of the Vietnamese market throughout
        2020, with negative flows of more than US$1bn over the year, but local retail investors have more
        than stepped up to the plate. We think the outflows will probably reverse in 2021, as Kuwait rises out
        of the MSCI Frontiers index, guaranteeing a higher weighting for Vietnam and strong inflows from
        passive investors. Despite its performance last year, the market remains reasonably valued on
        around 15x prospective 2021 earnings.

Performance

Source: As at 31st December 2020
Strategy performance is calculated monthly by taking a market value weighted average of the underlying accounts (net of fees) return.

The SMID Cap strategy, launched in April 2011, recovered strongly from its Covid-19 lows in March 2020,
declining by 1.8% for the year as a whole, vs a decline of 6.4% for the benchmark MSCI ASEAN index.
Since its inception, the SMID Cap strategy has risen in value by 33.8%, vs the benchmark +18.6%.

The All Cap strategy was launched on 31st March 2020 and therefore we will publish performance data upon
the 12 month anniversary of the strategy, in accordance with regulatory stipulations.

Stock Review

A round up of some of the leading investments in the two strategies, beginning with the All-Cap:

    1. GT Capital Holdings (GTCAP PM) is a leading Philippines conglomerate with exposure to autos,
       banking, insurance, infrastructure and property. Through its 51% ownership of Toyota Philippines,
       GT Capital controls the country’s top auto brand, with a 42% market share. Metropolitan Bank &
       Trust Co (30% owned) is the Philippines third largest lender, with a strong consumer business and a
       corresponding opportunity to improve returns through digitalisation and lower branch costs. GT Cap
       also has a rapidly growing insurance JV with AXA and participates in infrastructure projects including
       toll roads, power generation and water utilities through listed subsidiary Metro Pacific Investments. In
       short, GT Cap is a proxy for the Philippines economy. Not surprisingly, the company had a difficult
       year in 2020, with revenue for the first nine months declining by 47%, and EBITDA by 57%. The
       outlook for 2021 will be determined by the pace of the country’s recovery from Covid-19, and in truth
       this will run over into 2022, but as a Covid recovery play GT Cap currently sells at just 7.7x its peak
       earnings per share in 2019.

    2. Hoa Phat Group (HPG VN) is Vietnam’s largest steel producer, with a 25% market share that is
       rising rapidly due to the company’s completion of highly efficient new capacity in HRC (hot rolled coil
       steel) that undercuts its fragmented competition. Hoa Phat has an increasingly dominant position in
       construction steel, currently a sweet spot in the Vietnamese market, as construction activity
       continued to rise in 2020, and pricing remains firm. Vietnam was the only economy in Southeast Asia
       to avoid a recession last year, in part because of increased foreign direct investment, and in part
       because the government has loosened fiscal policy to fight Covid and to address a bottleneck in
       transport and logistics. This is likely to keep demand for construction materials strong, and although
       Hoa Phat has performed well, the shares are not expensive at around 11x prospective 2021
       earnings.

    3. Kasikorn Bank (KBANK TB) is a leading Thai lender, and typical of our bank holdings around the
       region, in that we believe its provisioning has been conservative since the onset of the Covid crisis.
       In our view, asset quality should be the key consideration for investors in almost any bank at present,
       because limited visibility due to moratoriums in many countries has made it impossible to know
       where NPLs will head as debt relief measures draw to a close. In common with banks we own
       elsewhere around the region, we see evidence that Kasikorn’s provisioning has been conservative;
       whilst NPLs increased by 12% in 1H20, in line with peers, the ratio of credit costs to loans rose to
       3.25%, comfortably the highest in Thailand, and suggestive of over-provisioning. Kasikorn will benefit
       disproportionately from an economic recovery due to its high proportion of SME to total loans, and
       earnings could surprise to the upside if, as we expect, credit costs decline sharply. At less than 0.7x
       price to book, the shares remain attractively valued despite a good Q4 rally.

    4. Media Nusantara (MNCN IJ) is an Indonesian FTA (free to air) TV producer, with four national TV
       stations, for which it produces 23,000 hours of content per year. The company has a content library
       of 300,000 hours and a fast growing digital business, where revenues increased by 50% in Q3 2020,
       both via its own app and through sharing content with YouTube and Facebook. MNCN has more
       than 2 billion views per month on YouTube and 168 million subscribers across its various digital
       channels. The company recently received a 50-year patent for its eTV Mall, where viewers can order
       advertised products via their mobile phone, using QRIS codes displayed on the screen. This
       generates revenues from the advertiser as well as commissions from e-commerce players. We
       anticipate a cyclical pick up in traditional TV advertising, as the economy recovers once vaccines are
       rolled out, as well as secular growth in digital advertising revenues. With the shares selling at around
       7x prospective 2021 earnings, we think there is plenty of upside in the next few years, with a
       possible double whammy from higher earnings and a re-rating.

    Plus a couple of companies held in both strategies:

5. Alliance Global (AGI PM) is a Philippines conglomerate whose listed subsidiaries include 84%
   owned distiller Emperador and 44% owned property developer Megaworld. Emperador is the world’s
   number one brandy producer and the world’s number 5 whisky producer. Alliance Global’s stake in
   Emperador alone is currently worth US$2.76bn, which is US$660m more than Alliance Global’s
   entire market cap. In other words, we are being paid to own the remaining assets. These include a
   stake in listed subsidiary Megaworld, valued at US$550m, (which owns 26 property townships, 4300
   hectares of development land around the Philippines, several hotels, 13m sq ft of rentable office
   space, and 8m sq ft of shopping malls), plus the McDonald’s franchise in the Philippines. It seems
   like a reasonable deal.

6. Silverlake Axis (SILV SP) is a Malaysian-based (Singapore-listed) market leader in core banking
   software around Southeast Asia, with 8 of the region’s top 20 lenders on its platform. The company
   has been a disappointing investment in recent years, because of weak capex at its major clients.
   Covid-19 has only made this worse in the short term, but we remain optimistic for a number of
   reasons. First, the business is extremely sticky; in fact, Silverlake has never lost a major customer,
   due to the high risk for a bank of migrating to a different software platform. As a result, barriers to
   entry are high. Second, although banks’ capex has been weak in recent years, Silverlake’s recurring
   revenues from maintenance and service of the installed customer base account for 83% of total
   revenue, and are very stable. Third, gross margins remain high at 62%, but should improve further
   when software sales pick up again. We think this is a question of when, not if, because the region’s
   banks must invest if they want to address the competitive threat from Fintech, which gives us indirect
   exposure to the digital economy theme. Finally, the company is highly cash generative, with a strong
   (net cash) balance sheet, and free cash flow to fund share buybacks and dividends. Meanwhile, the
   shares sell at around 12.5x prospective June 2021 earnings, with the potential for strong growth
   when banks’ IT spending recovers.

And three from the SMID-Cap strategy:

7. Ho Chi Minh Development Bank (HDB VN) is a private-sector Vietnamese bank, free from the
   constraints and obligations that come as part of the package with state-owned peers. HDB’s loan
   book is dominated by SME (45%) and consumer (43%), whilst the company also has a 51% share in
   HD Saison, a JV with Credit Saison (part of the Mizuho Financial Group of Japan), which is the third-
   largest consumer finance company in Vietnam and growing rapidly. Of total loans, 92% are from the
   main bank, and 8% from HD Saison, but in pre-tax profit terms the split is more like 65 to 35. HDB
   focuses on mid to high-end customers, whilst HD Saison targets low end and the “unbanked”, who
   may eventually become the bank’s customers as their incomes rise. With its economy still growing
   despite Covid, Vietnam is at a different stage of the asset cycle to other Southeast Asian countries,
   and loan growth should still be the key measure for investors in our view. With HD Saison opening
   up new and profitable markets for this lender, return on assets of 2%, and earnings growing at more
   than 25% per annum, we think that the valuation of 2x price to book and 10.4x prospective 2020
   EPS is fully justified.

8. Link Net (LINK IJ) is the second-largest fixed broadband and pay TV operator in Indonesia. Low
   fixed broadband penetration in Indonesia implies a long runway for growth, whilst online schooling
   and “work-from-home” during Covid have underlined the attractions of fixed broadband, driving
   strong subscriber growth. The company leases the right to use state-owned utility PLN’s electricity
   poles, and the high costs associated with this are behind Link Net management’s proposal to build
   out the company’s own network of poles over the next two years. This will require IDR 3 trillion
   (US$210m) in capex, and in the short term it is possible that the shares have run far enough in
   recent months, given this unwelcome new demand on cash. Longer term, we continue to think the
   company is undervalued on a multiple of around 9.5x prospective 2021 earnings, given the growth
   opportunity of providing Indonesia’s rising middle class an increasingly essential service.

9. Siam City Cement (SCCC TB) is Thailand’s second largest cement company, as well as producing
   branded construction materials including ready mixed concrete and wood substitutes. SCCC’s
   Saraburi cement plant is the country’s largest and lowest-cost facility, with proximity to the major
   markets of Bangkok and the Eastern Seaboard. In 2016, the company initiated a series of

acquisitions around the region from Holcim (following the latter’s merger with Lafarge) with the
        support of its major shareholders, and now has cement operations in Vietnam, Cambodia,
        Bangladesh and Sri Lanka. Although 2020 was a tough year, with sales volume declining sharply on
        lower overseas demand, domestic Thai demand proved resilient, due in part to rising government
        infrastructure spending that is heavily focused on the rapidly developing Eastern Seaboard. As a
        result, domestic pricing held up well. Combined with lower energy costs, and other cost cutting
        initiatives, this has helped projected 2020 revenue to decline by just 9.2% and EBITDA by 4.0%,
        which we consider a great performance in the circumstances. With the possibility of cement demand
        recovering around the region as Covid-19 is gradually brought under control, we think the shares
        remain attractive on a multiple of 12.8x prospective 2021 earnings.

Outlook

We have absolutely zero desire to dive into a lengthy discussion of US monetary and fiscal policy here, but it
is impossible to avoid altogether, given the close historical inverse relationship between the US dollar and
emerging markets. In short, a weak dollar is good for emerging markets, because it supports global growth,
lifts commodity prices, and encourages US capital to head overseas. It seems almost certain that US
monetary policy will stay extremely accommodative in the months ahead, and that, with the Democrat party
now in control of the White House and both houses of Congress, fiscal policy will become even more
expansionary. We believe this tilts the balance of probability towards a weaker dollar. A long period of dollar
strength may, in fact, be drawing to a close. Meanwhile, vaccination programmes are gearing up in the US
and other developed countries, and their economies are likely to look more “normal” in the second half of
2021. With high levels of pent up demand and cash conserved during the crisis, by the end of 2021 we could
see strong consumer and corporate spending, with fiscal and monetary policy remaining accommodative on
both sides of the Atlantic. This would be a very constructive backdrop for emerging markets.

For investors who believe in a strong global recovery, Southeast Asia has a lot to offer. Growth will ensure
that earnings rise strongly at economically sensitive cyclical companies. In that case, recent stock market
rotation away from growth and momentum, and into value and cyclicals, should have further to run. In
Southeast Asian markets, value and cyclicality are over-represented, as are small and mid-cap stocks. As
our stock reviews above hopefully demonstrate, both of our strategies sit close to a point on a Venn diagram
where these factors all overlap. Value and cyclicality are difficult to avoid in Southeast Asia, whilst even our
All-Cap strategy has around 2/3 of its holdings in small and mid-cap stocks. As bottom-up stock pickers, we
believe that is where we can add the most value. To give more colour on this, the All-Cap strategy currently
sells on a multiple of around 12.8x prospective 2021 earnings, versus 15x for the MSCI ASEAN index,
despite a higher return on equity (12% vs 8.2%) and stronger balance sheets (45% gross debt to equity vs
81%). The numbers for the SMID-Cap strategy are even more compelling, with a multiple of around 10.4x
prospective 2021 earnings (vs 15x), a price to book of 1.4x (vs 1.7x), a higher return on equity (11% vs 8.2%)
and stronger balance sheets (29% gross debt to equity vs 85%). In other words, we own better quality
companies than the benchmark, and at a meaningful discount to its valuation.

We see a number of factors that are likely to prove supportive of Southeast Asian equities in the year ahead.
Domestic liquidity across all regional economies is strong, whilst our markets are under-owned following
many years of selling by foreign investors, which continued throughout 2020. If the US dollar has peaked, we
would expect to see a return to favour for emerging markets investing, and for the relatively undervalued,
cyclical stronghold of Southeast Asia.

Current valuation & estimated earnings growth for the Southeast Asia All Cap and SMID Cap
Strategies

Source: Bloomberg, as at 25th January 2021

Brook Tellwright
15th January 2021

Risk Warnings

For professional investors only.

The views and opinions expressed are the views of Waverton Investment Management Limited and are
subject to change based on market and other conditions. The information provided does not constitute
investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or
an offer to sell a security. All material(s) have been obtained from sources believed to be reliable, but its
accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability
for, decisions based on such information.

Past performance is no guarantee of future results and the value of such investments and their strategies
may fall as well as rise. Capital security is not guaranteed. Future performance forecasts are not a reliable
indicator of future performance.

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