China/India alternative vs valuation

While China and India are definitely the flavor of the day and have had amazing runs:

    
      Source: Bloomberg

China and India have much more expensive valuations as a result (60-65% higher P/E multiples):

    
      Source: Bloomberg / Quest Management, Inc.

In reality, many Thai industrial companies which have little or no exposure to the volatile domestic sector are excellent, world-focused, and can be bought at a significant discount to Chinese or Indian companies because they are overlooked and under-owned.

We believe that politics will be more stable in Thailand than in China over the next five to ten years. As Chinese workers’ lifestyles improve and they move up the hierarchy of needs, it is likely that they will feel dissatisfied with their extremely regimented lifestyle and lack of personal freedoms. Unlike China, Thais have enjoyed great personal freedom and democracy for the last 77 years.
 

Earnings Growth and Capital Gains

When I arrived in Thailand over 20 years ago, Thai investors and brokers told us not to waste our time trying to estimate the earnings of Thai companies, because prices move on insider trading, not earnings.

In a new study, we recently looked at all stocks listed from year-end 2002 until year-end 2007 (five years), to see the relationship between EPS growth and total return (see below).

      Earnings Growth vs Total Return
      Source: Bloomberg & Quest Management

Of 220 stocks that had earnings per share (EPS) and price data, the top 10% grew their earnings by an average of 308% and made an average total return of 699%.

The worst earnings performance stocks drove average EPS from 0.33 baht per share to a loss of 0.47 baht per share (-242% growth). This bottom 10% had average total returns of only 41%.

The SET Index had a total return of 194%, so we can see that the Thai market really rewards companies that produce big earnings growth and punishes companies with bad earnings.

Data from 2003 until 2009 shows similar trends (see above).
 

What’s going on in the Thai Economy?

In terms of government stimulus, Thailand is much closer to the US rather than the Chinese timetable. While the Thai government passed two huge stimulus programs totalling $46 billion (18.4% of GDP), actual spending to date only amounts to about $4 billion. In 2010, the budget calls for spending about 5% of GDP. With this level of government spending in mind, the consensus real GDP growth is 3.5% for 2010 and 4.5% for 2011.

In addition, macroeconomic policy after the 1997 currency crisis has forced Thai banks to focus on basic banking business, so there are no banking problems in Thailand.

We also feel that, given the huge printing of US dollars with no underlying economic activity, the Thai baht will continue to strengthen against the US dollar.

     Thai Baht per US Dollar
     Source: Bloomberg

We think that dollar weakness will also translate into higher commodity prices even in the face of moderate demand, because commodities are traded in US dollars.

We believe that China and other manufacturing nations that have very large US dollar surpluses are actively using those excess dollars (soon to be devalued) to buy several years’ worth of raw material inventories.

This explains why we have oil at $79/bbl off a bottom of $30, zinc at $2,530 per ton off a low of $1,047, rice at $600/ton off a low of $300, and the BDI shipping index at 3,000 off a low of 663.

It is also a brilliant strategy by manufacturers to lock in their largest costs during a period of comparatively weak prices for future expenses that that they know they will incur, while simultaneously diversifying out of the US dollar.

Inflation in Thailand is still low, due to the slower spending of the government stimulus and substantial slack in manufacturing capacity utilization (see below).
 

     Thailand Consumer Price Inflation
     Source: Bloomberg

The big unknown is politics. Political uncertainty primarily affects the retail and entertainment sectors, as well as infrastructure, because consumers tend to pull back on spending and bureaucrats prefer to delay action on major projects when there is no clear government leadership.

However, overall GDP growth under political uncertainty has held up very well until the global banking meltdown in 2008 (see below).