After a tumultuous 3 months in the Thai market, here are our thoughts on the current situation in Thailand and how we plan to take advantage of future opportunities. 

In 2006, the SET index rose 10.27% in USD terms.  However, in local currency terms, the SET dropped 4.75%.  Even with the modest USD gains, the SET was one of the worst performing major global indices in 2006. 

In fact, the SET has remained one of the cheapest markets and seriously underperformed its potential for the last 3 years.  From SARS and tsunami in 2004, to bird flu concerns and an oil shock in 2005, to a worldwide emerging markets selloff and political tensions in 2006, wave upon wave of bad news has hurt sentiment.  

The market feels ready to rally, very similar to the feel in summer 2001 just before the WTC disaster.  In that case, the Thai market had rallied 15% and all appeared positive, only to be crushed by worldwide negative sentiment.  After the initial shock drop of 18%, the SET went sideways for 2 months and then began a 4 month, 45% liquidity-driven rally.

In the last 13 months, there have already been 2 aborted rallies.  First, in December 2005 and the first four months of 2006, the SET gained 26.5%, supported by a reduction in political tensions due to the King’s call for unity within the country, improving economic fundamentals, and a spike in market liquidity boosted by foreign buying and acquisition activity.  Beginning in May, however, emerging markets across the world suffered severe corrections.  While a major correction was needed in some markets like Korea and India that had surged in 2005 and early 2006, this was definitely not the case with Thailand.  However, Thailand was severely beaten down along with other emerging markets. 

Then again, after the recent coup d’etat by the Council for Democratic Reform under the Constitutional Monarchy (CDRM) on September 19^th, there was no major market correction.  Instead, the market dropped only 1.4% in its first post-coup trading day.  As it became clear that the coup leaders planned to quickly return power to civilian rule, the market again rallied 14.5%.  This rally was interrupted on December 19^th when the Bank of Thailand imposed heavy-handed capital controls in an attempt to stave off further appreciation of the Thai Baht.

So, with the Thai market trading at 15% below its January 2003 high, is this a good entry point?  The answer lies in 3 other questions:

1)  Is the current military regime stable, will it return power to civilian politicians in an orderly manner and on schedule?

In the early days following the coup, the CDRM moved quickly to assume all levers of control and did so in a manner that had the support of the vast majority of Thais. 

On October 1, the King approved an interim constitution, designed to govern Thailand for 12 months, and established procedures for the drafting and ratification of a new constitution.  New elections are targeted to take place by October 2007.  The CDRM appointed General Surayud Chulanont, retired army chief and member of the Privy Council, to be the new Prime Minister.  He, in turn, appointed a technocrat cabinet, mostly filled with well-known academics and senior civil servants, which was welcomed by both the Thai public and the investment community.  The prospect of improved political stability led to both a return of positive investor sentiment and to a jump in the market.

Unfortunately this initial honeymoon period did not last long.  On December 19th the Bank of Thailand imposed heavy-handed capital controls in an attempt to stave off further appreciation of the Thai Baht, which had gained 14.2% on a year-to-date basis.  The new measure placed a requirement on financial institutions to withhold 30% of all foreign currencies bought against onshore Thai Baht trades with the exception of transactions related to trades in goods and services.

While the new policy was aimed at discouraging short-term capital inflows and limiting further currency appreciation, the new measure’s greatest impact was felt in the stock market, which suffered its single largest one-day loss, dropping 14.9% the day following the announcement.  In the wake of the market collapse, however, the Bank of Thailand backpedaled on its decision and partially reversed its policy by lifting the 30% requirement on equity market related inflows and foreign direct investment.  This u-turn boosted market sentiment, pushing the market back up 9.9% the day following the market collapse. 

Despite the partial recovery in the market, both the Bank of Thailand and interim government suffered a damaging loss of credibility in the eyes of  foreigners.  This loss of confidence was further compounded by the New Year’s Eve bombings in Bangkok, which resulted in the deaths of three Thais and the wounding of 38 people, including nine foreign tourists. 

Almost immediately following the bombings the interim Prime Minister claimed that the blasts were most likely connected to the previous government as opposed to elements associated with the unrest in Southern Thailand.  Now, the rumor is that the bombings were carried out by a faction of the army that had participated in the coup, but did not receive any positions in the interim government.  The bombs, fortunately, were relatively small, and the intent appears to have been more about making a statement as opposed to maximizing destruction of property and the loss of life.  In the days following the bombings, the SET traded off about 7% amid minor selling by foreigners. 

Most recently, the government announced proposed changes to the Foreign Business Act (FBA).  This time, the government did consult foreign business leaders but then ignored their suggestions.  The SET fell about 4% in the following 2 days, but the government reacted to the sell off by rapidly announcing modifications, and pointed out that only 6 of the 450 listed companies would be affected by the proposed changes.  Since the modifications, the SET has traded up about 8% on steady net buying by foreigners.

While the recent moves by the Bank of Thailand and the Ministry of Finance are far from optimal, we think the fact that they did revise their positions in the face of criticism is positive.  The bombings appear to be the work of a dissatisfied minority of the military, and hopefully will not expand.  The drafting of the new constitution is proceeding on schedule, and we believe that the elections scheduled for October will be held on or around that time.

In short, we think the political process will return to normal in the near term.  Things could get marginally worse from here, but the path to the election is clear.

2)  Are the fundamentals of the market attractive?

Bloomberg shows the market trading on about 10.7x P/E, with earnings declining about 15%.  However, a big part of the decline is due to oil and bank stocks, which represent about 46% of the market capitalization.  Excluding energy and banks, the market eps growth is about –5% with a P/E of about 13.5x.  This still makes it the cheapest market in Asia, as can be seen in the following table based on Bloomberg data:

In addition to being very cheap, as we mentioned before, there is an election coming up.  In the last 7 elections, the SET index staged an average 15% rally in the 3 months preceding to the one month following the election, as politicians practice the art of money politics and some of that money flows into the stock market.

In addition, oil prices have declined and the Bank of Thailand yesterday began what may be a series of interest rate cuts, both of which stimulate economic activity and are very good for stock prices.

Further, with the end of political turmoil in sight and domestic infrastructure projects finally moving forward, we expect the economy to do well this year and next.

So, from a market perspective, we think that investors in today’s market can easily expect an election rally and re-rating gain of at least 20-30%.

3)  Are the fundamentals of our portfolio attractive?

In addition to an improving political/economic situation and cheap valuations, we have found several pockets of deep value.  Our core positions remain largely unaffected by recent developments. 

We have examined the forward P/E trading distribution of each of our stocks for the last 3 years, and then applied our estimates of 2007 earnings to these multiples.  Based on this approach, we think that our average stock has  64% upside and only 3% downside from today’s prices.

The weighted average P/E for our portfolio is only 7.0x, and our expected eps growth is 34%.

To give you a flavor for the type of stocks in our portfolio, here are details of three of our large positions:

Banpu PCL (BANPU)

Banpu, the Fund’s single largest investment position, is one of Asia’s largest coal producers and owns and operates a diversified portfolio of power generation assets in both Thailand and China.  It is in our opinion one of the cheapest large market capitalization, liquid stocks in Thailand.  The stock has experienced strong growth in recent years in each of its key operating segments.  

On the coal side, results this year should be buoyed by 1) continued growth in volumes of high quality coal from key mines in Indonesia, 2) steady to possibly firming average selling prices on both contracted and spot sales, and 3) a boost in margins following the Indonesian Supreme Court’s recent decision to rescind a 5% tax on export sales.

As for power generation, we expect to see a very significant contribution from the full commencement of operations at the company’s 50% owned BLCP Power Limited (BLCP) unit, developer of a 1,400MW coal-fired power plant in the country’s Eastern seaboard.  BLCP, which is categorized as an independent power producer (IPP), operates under a long-term power purchase agreement with Thailand’s Electric Generating Authority (EGAT).  In 2007 we expect BLCP to contribute approximately $50 million, or 6.6 Baht per share, to Banpu’s bottom line.

Power generation results are also expected to benefit from full year contributions associated with the company’s Peak Power (PPIC) unit.  PPIC, which was acquired by Banpu in March of 2006, owns and operates three coal-fired power plants in China.

In terms of valuation, Banpu is currently trading on an adjusted EV/EBITDA multiple of less than 4.0x, which we believe is attractive given the company’s prospects for continued growth in earnings and cash flow over each of the next three to five years.  The company’s earnings are also largely insulated from the risks associated with any further political fallout or misguided policy intervention in Thailand.  Its earnings profile has defensive qualities, given continuing positive trends in both volume and coal quality, and the company benefits from broad geographic diversification and long-term take-or-pay contracts tied to its utility operations.  Finally, Banpu boasts one of corporate Thailand’s strongest management teams, supported by an impressive corporate governance, transparency and disclosure track record. 

Thoresen Thai Agencies PCL (TTA)

TTA, one of the Fund’s long-established core positions, has managed a strong share price recovery ever since reaching lows back in June of last year.  Since that time, the shares have appreciated by nearly 71% in USD terms on a total return basis.  The current price, however, is still a far cry from earlier highs reached in 2005, at the height of the last bull market in bulk shipping freight rates.

Importantly, the shares have trailed the gains made by both the company’s closest listed peers, Pacific Basin (2343 HK) and Precious Shipping (PSL), and the most applicable industry benchmark, the Baltic Supramax (BSI) index.  Since early August 2005, when the BSI index hit its low, Pacific Basin, PSL and BSI have gained 79.2%, 23.8% and 115.8%, respectively.  During this same timeframe TTA dropped 5.3%!

The ongoing recovery in the TTA share price has mirrored the most recent upturn in bulk shipping markets, albeit on a lagged basis.  It also reflects the investment community’s newfound appreciation for the company’s ongoing efforts to diversify its revenue and earnings streams away from the inherently cyclical bulk shipping operations.  In particular, TTA has committed large amounts of capital to the oil & gas services sector via its 78% owned Mermaid Maritime (MML) subsidiary. 

We are encouraged by the rebound in the shares.  However, we remain convinced that the shares continue to lag the company’s underlying fundamentals as well as industry prospects.  We continue to maintain that spot freight rates are on the upswing due to favorable supply/demand trends in the sector.  Similar supply/demand trends are evident in the oil & gas services sector.

TTA currently trades on a PER multiple of only 4.0x.  Pacific Basin and PSL, in contrast, trade at an average PER of 6.6x consensus 2007 earnings.  We believe the discount is unwarranted.  A further catalyst for a re-rating exists once the company moves forward with its planned listing of MML, which is scheduled for mid-2007.  A listing of MML will highlight the underlying value and earnings potential of TTA’s oil & gas assets.  Oil & gas services stocks typically trade at multiples exceeding those prevailing in most shipping sectors.   Bank of Ayudhya (BAY)

BAY is one of the largest commercial banks in Thailand, with the 5^th largest deposit and 6^th largest asset base.  The company maintains a nationwide, 552 branch network and offers a comprehensive range of corporate and consumer financial services. 

In May 2006, GE Money Retail Bank, a wholly owned subsidiary of GE capital, submitted a letter of intent to buy a 25% stake in BAY.  After two months of deliberation, the Bank of Thailand and the Ministry of Finance approved the transaction.  Following the receipt of shareholder approval and a short delay brought about as a result of the coup, the deal finally closed earlier this month.

We believe the new shareholding structure will bring multiple long-term benefits to BAY, given GE’s expertise in management, systems and marketing.  GE’s entry will lead to a significant improvement in BAY’s banking platform and place it in a superior competitive position relative to the other large banks in the sector.  Although it now has only a 25% stake, the deal gives GE control over key management positions, including the CEO, CFO and risk management roles, and a total of four seats (out of 11, three of which are independent) on the board of directors.  The integration process is expected to also involve the transfer of up to $330 million of retail loans from GE’s predecessor Thai options.  BAY has historically been a net lender in the interbank market, which has weighed on the bank’s overall yield on assets.  The injection of existing GE loans should act to boost the loan/deposit ratio and enhance margins.

We also expect the GE deal will result in a re-rating of BAY shares.  Prior to the announcement of the deal, BAY historically traded at a discount to other stocks in the sector.  Compared to its closest peers, BAY’s provisions against potential loan losses were inadequate.  As a first order of business, we expect GE, backed by its fresh injection of capital, to clean up BAY’s balance sheet by either allocating further provisions for possible loan losses or by selling NPLs.

The three largest banks in Thailand currently trade on an average 2007 P/BV multiple of 1.5x.  BAY, however, trades at only 1.2x.  On a long-term basis, as the benefits of GE’s growth initiatives kick in, we would expect that gap to disappear and, in fact, for BAY to start to trade at a premium.  

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In short, we think that now is an excellent time to BUY THAILAND!