Asia Frontier Capital (AFC) - August 2015 Newsletter
"A blind man who sees is better than a seeing man who is blind"
In August 2015, the AFC Asia Frontier Fund lost -1.4%, outperforming the MSCI Frontier Asia Index (-8.1%), the MSCI World Index (-6.8%) and the MSCI Frontier Index (-5.8%), which all dropped significantly. The year to date performance of the AFC Asia Frontier Fund A-shares stands now at +0.7% versus the MSCI Frontier Asia Index which is down -7.4% during the same period. The AFC Asia Frontier Fund has now returned +38.9% since inception.
The AFC Iraq Fund has now finalised its second month of investment activities and in August 2015 the fund returned –5.2%. This was an underperformance versus the Rabee Securities USD Index which dropped only –0.8% in August after the -12.6% drop in the previous month. Though oil prices have continued their downward slide and global markets, including Iraq, have been under strain in recent months, the AFC Iraq Fund has performed in line with the Rabee USD Index since inception.
The AFC Vietnam Fund returned –4.6% in August bringing the net returns since inception to +33.3%. By comparison, the performances of the Ho Chi Minh City VN Index (-11.8%) and the Hanoi VH Index (-12.4%) were significantly lower in USD terms. The year to date performance of the AFC Vietnam Fund stands at –1.7% versus the VN Index and VH Index which have returned -1.0% and -11.6% respectively, in USD terms, over the same period.
While global and emerging markets have seen a monumental increase in volatility as well as significant downwards movements in equity markets, AFC’s funds have been performing relatively well despite the selloff. Part of this has been due to good stock selection, part of this has been to do with strategic sector allocation as well as portfolio construction, and part of this is due to the nature of Asian frontier equity markets more generally. Each of our funds has an actively managed niche strategy which is not benchmark constrained, allowing for flexibility. As well as this, each portfolio is designed to minimise downside risk and maximise long term returns in their respective markets. The diversified nature of the AFC Asia Frontier Fund and AFC Vietnam Fund has also acted as a buffer for the recent market downturn and this approach has helped to preserve investors’ capital.
As an asset class Asian frontier markets perform very differently to emerging and developed market equities. Asian frontier economies, as well as their stock markets, are primarily driven by domestic factors and, due to the extremely low levels of foreign investor participation, they are much less responsive to external negative market shocks. Also, because they are domestically driven, Asian frontier markets have the characteristic of being less correlated with each other which reduces our overall portfolio risk. This factor, along with portfolio construction, has helped the AFC Asia Frontier Fund to produce a volatility profile lower than the MSCI World Index since inception. Though each investor’s personal portfolio is different, an allocation to the AFC Asia Frontier Fund, AFC Vietnam Fund or AFC Iraq Fund should reduce the overall volatility of your equity returns as our funds generally have a low correlation with most other asset classes.
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AFC Asia Frontier Fund (AAFF) USD A-shares lost -1.4% in August 2015, outperforming the MSCI Frontier Asia Index (-8.1%), the MSCI World Index (-6.8%) and the MSCI Frontier Index (-5.8%). The year to date performance of the AFC Asia Frontier Fund A-shares stands now at +0.7% versus the MSCI Frontier Asia Index which is down -7.4% during the same period.
It was a tough month across global markets. As readers are aware, the trigger was the devaluation of the Chinese yuan by -2% on August 11. This led to panic in investor’s minds with respect to the scale of the economic slowdown in China and led to fears of currency wars in the region as other countries would follow suit. Regional currencies across the region did depreciate sharply in the latter part of August. From the fund’s key markets it was the Vietnamese dong which depreciated the most, by about 3%, as exports are now playing a key part in the country’s development as well as in managing its current account. The other fear playing on investor’s minds is the increase in interest rates by the U.S. Fed in September 2015. So we have two events leading to uncertainty in global currency markets.
Investors frequently ask us what we think the impact of rising interest rates in the US can have on our markets. It could lead to increased volatility in currencies but looking at our key markets, only a few corporates have USD debt or are significantly leveraged with USD debt. Further, the government debt which is in USD is long term in nature, so while interest payments would be higher, the risk of capital flight is not high given the lower participation by foreigners in these markets. Lower oil and commodity prices have been positives for many net importers such as Bangladesh, Pakistan and Sri Lanka which has allowed them to improve their foreign exchange reserves and manage their deficits. Therefore, though markets may be prone to bouts of panic in the coming months, the economic fundamentals of the key markets appear to be in better shape than they were 12-18 months ago.
More importantly, on these occasions of fear in markets, bottom up opportunities arise as the fundamentals of companies the fund has invested in have not changed significantly as input prices remain low, most of the fund’s holdings are not heavily leveraged, and only a few of the holdings have exposure to USD debt.
Given the panic that played out in the latter part of the month, the fund continued to be in positive territory even till 20th August when it was up approximately +1.2%. It was the significant sell off between 21st August and 27th August which impacted performance the most with the fund being down approximately -2.75% on 24th August, the most it was down this month. The last few days of August saw a recovery which led to the –1.4% performance for the month. This performance is better than the fund’s nearest benchmark, the MSCI Frontier Markets Asia Index as well as all other relevant indices.
The reasons for outperforming the benchmark in a tough month are (1) the diversified nature of the portfolio (2) the performance of the top two holdings of the fund, a Bangladeshi pharmaceutical company and a Pakistani pharmaceutical company which were up +17% and +15% respectively and (3) having no exposure to heavily weighted oil & gas stocks in Vietnam which corrected this month. The fund has stayed away from some of the oil & gas names in Vietnam given the lack of clarity on future earnings and the high correlation between their stock price and crude oil prices. Overall, in spite of an extremely volatile month, the fund was stable in terms of performance relative to the benchmarks.
Once again we would like to reiterate, we would be buyers if there is further panic in the market.
The best performing indices within the AAFF universe in August were Sri Lanka (-0.3%), followed by Bangladesh (-0.5%) and Pakistan (-2.8%). The poorest performing markets were Cambodia with (-12.3%) and Vietnam (-9.1%). The top-performing portfolio stocks were a Vietnamese brewery (+28.9%), followed by a Mongolian construction material producer (+27.8%), a Pakistani pharmaceutical company (+16.7%) and a Bangladeshi pharmaceutical company (+14.7%). The pharmaceutical companies are also AAFF’s largest and second largest single stock positions which contributed massively to the outperformance of AAFF versus the various indexes.
In August we added to existing positions in Mongolia, Myanmar, Sri Lanka and Vietnam. We completely exited an entertainment company in Cambodia and reduced further our holding in one company in Vietnam.
As of 31st August 2015, the portfolio was invested in 115 shares, 1 fund and held 4.8% in cash. The two biggest stock positions are a pharmaceutical company in Bangladesh (5.2%) and a Pakistani pharmaceutical company (5.0%). The countries with the largest asset allocation include Vietnam (27.0%), Pakistan (20.6%) and Bangladesh (14.4%). The sectors with the largest allocation of assets are consumer goods (40.9%) and materials (13.9%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 14.63x, the estimated weighted average P/B ratio was 1.53x and the estimated portfolio dividend yield was 3.53%.
AFC Iraq Fund Class D shares returned -5.2% in August 2015 which was an underperformance against the Rabee USD Index (RSISUSD) which returned -0.8% in USD terms. Though oil prices have continued their downward slide and global markets, including Iraq, have been under strain in recent months, the AFC Iraq Fund has performed in line with the Rabee USD Index since inception.
In August, the AFC Iraq Fund continued to build positions in several Iraq companies in the financial, insurance, and banking sectors as well as other sectors including pharmaceuticals, telecommunications, and real estate. It made no changes to current foreign listed holdings, which derive the majority of their business from Iraq, in the energy and oil sectors. The fund has only undertaken buying activities and as yet has not made any full or partial exits.
While the RSISUSD index dropped -0.8% in August, eight of its ten constituents, accounting for 75% of its weighting were down -6.6% while the remaining two stocks were up +9.5%. Notable index underperformers included Baghdad Soft Drinks (-5.5%), Gulf Commercial Bank (-6.7%) and Iraq Middle East Bank (-7.9%). Outperformers included Bank of Baghdad (+10%) and Mamora Real Estate (+6.9%). The index is down -11.6% YTD and -13.8% from its June 2015 high but remains up +34.8% since the recent bottom in March 2015.
The continued poor performance of the market since the June peak is mostly related to strains on local liquidity from lower oil prices and the short-term dislocations from the recent political reform package. The significant drop in oil prices led to sharply lower government revenues exaggerated by the continued escalating costs of the ISIS conflict. The implications for the economy are huge since government spending is a key driver and the government is currently the country’s largest employer. The upshot for the ISX is distressed selling combined with anaemic local buying resulting in meaningful declines on low volumes.
Net foreign inflows to Iraq were strong for the month after a weak performance in July. Excluding the inflows in June 2015, August’s figures were the highest since October 14, solidifying a turnaround in inflows that began in February 2015. This most likely reflects continued confidence in the end of conflict in Iraq, further spurred by positive implications of the Iran nuclear accord and the reform package announced by the Prime Minister during the past month.
The chart shows the stabilization of net proxy portfolio flows, indicating that foreign buying in the face of distressed local selling given attractive levels following the declines. Interestingly a similar situation developed in such flows in February while the index continued its decline bottoming over a month later before the strong rally in May and June.
The liquidity shortages were most keenly felt in the Kurdish Region of Iraq (KRI) which was struggling with a significant crunch from escalating costs of the war with ISIS and the significant influx of refugees from Iraq and Syria which amount to over 25% of the KRI’s population. Although the oil agreement between the Federal Government of Iraq (FGI) and the Kurdish Regional Government (KRG) signed in December of 2014 provided relief in the form of resumed payments, only small payments were made which meant that the crunch worsened over time. In June the KRG, with seemingly the tacit but not official approval of the FGI, started direct oil sales which netted the region about USD 1.4 billion by mid-August which indicates that the worst of this crisis is over for the KRI.
Following the Iran-nuclear accord, a number of Iranian banking officials visited Iraq to develop closer banking ties to facilitate the expanding trade following the expected lifting of sanctions. Iran’s Islamic Regional Cooperation Bank for Development and Investment in Iraq, with 11 branches in Iraq, is expected to play a major role in facilitating the expected growing trade. As discussed last month, Iraq’s banking system would be one of the first beneficiaries of this accord.
The demonstrations across Iraqi cities continued for the sixth Friday demanding the implementation of the reform package announced by the PM a few weeks ago with calls from the religious leadership for an expansion of these reforms to all aspects of the country’s institutions including the judiciary. The PM has started implementing these reforms, however as expected, the political class across all parties which was a prime beneficiary of the prior regime, has started an active rear-guard action to derail the reforms, although publically supporting them. The combined strong support of the religious leadership and the public should enable the PM to continue with reforms, however, given the entrenched interests this will likely be a non-linear process.
Of direct relevance to the fund are earnings announcements from the top-tier Iraqi banks for the second quarter which show a continued stabilization & uptick in earnings that started in the first quarter after a difficult 2014. On the flip side, telecom earnings in the second quarter were worse than the first, implying a later than expected recovery. These earnings were likely made worse by the introduction for the first time of taxes on pre-paid cards, which account for 97% of all subscribers. This would have dampened demand and driven price competition resulting in continued margin erosion that was not offset by the introduction of 3G with its expected margin expansion.
Looking at the portfolio, as of 31st August 2015, the AFC Iraq Fund was invested in 14 shares and held 0.8% in cash. As the fund invests in both local and foreign listed companies that have the majority of their business activities in Iraq, the countries with the largest asset allocation were Iraq (88.0%), Norway (6.7%) and the UK (5.3%). The sectors with the largest allocation of assets were financials (51.2%) and consumer staples (20.8%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.62x, the estimated weighted average P/B ratio was 1.14x and the estimated portfolio dividend yield was 2.84%.
A note on the Rabee USD Index:
The AFC Vietnam Fund returned –4.6% in August bringing the net returns since inception to +33.3%. By comparison, the performance of the Ho Chi Minh City VN Index (-11.8%) and the Hanoi VH Index (-12.4%) were significantly lower in USD terms. The year to date performance of the AFC Vietnam Fund stands at –1.7% versus the VN Index and VH Index which have returned -1.0% and -11.6% respectively, in USD terms, over the same period. Since inception the AFC Vietnam Fund has outperformed the VN and VH Indices by +28.6% and +27.5% respectively, in USD terms.
Though there seems to be an air of repetition recently we will again begin our monthly manager commentary with an update on the continued developments out of China. The stock market movements seem to have completely decoupled from other economic and company-specific factors and there was one thing spreading throughout the world of finance in August - fear!
The Chinese stock market is being referred to as a bubble that finally burst but, as of the end of August, it was still trading 45% higher than a year ago. At the same time emerging markets have already lost nearly half of their value in comparison to the major world stock market indices over the past four years. These boom-and-bust cycles that arise in emerging markets are quite common and a correction of global stock markets since 2011 has been long overdue.
Dow Jones Industrial Average 2011-2015
Eventually the world will come to realize that the times of annual growth rates of 7-10% in China are over and that investors must look to underdeveloped markets, such as Vietnam, to ride the next wave. Over the past decade, China has been repeatedly advised to better balance its economy by increasing domestic demand to become less dependent on “cheap” exports to, ultimately, stimulate sales of foreign products to China. This is a process that has happened in other economies such as in Europe as well as Japan after WWII and later in the tiger economies in Asia. It goes without saying that such massive transformations within economies, as well as structural rebalancing and the resulting slowdown in economic growth, doesn’t create a smooth linear path.
South Korea GDP Annual Growth Rate
Without delving too deep into the theoretical underpinnings of the drivers, it can be seen using the example of Korea above that with the increasing degree of economic development, the GDP growth rate continuously - but with a high volatility - declines. This can also be seen anecdotally by looking at the growth rates in the advanced versus developing economies.
Due to the global negative sentiment, the Vietnamese market has also seen a few trading days in panic mode. Not only were the gains of recent months wiped out within a few days but also the HCMC VN Index is now trading -16% below the level of the previous year in USD terms.
Ho Chi Minh City (VN) Index - 31st August 2014 to 31st August 2015
Rather than dwelling on the volatility of past events, we are much more interested in the future outlook for Vietnam and our fund. The situation looks much brighter for investors if we focus on the initial reasons why we have invested in Vietnam and put the short-term turbulence aside for a moment. The companies which we have invested in have delivered fairly good Q2 earnings numbers and our full year estimates have been confirmed. All of the 83 companies in our portfolio should be profitable in 2015 and we continue to see enormous long-term upside potential for the fund with an expected average price earnings ratio for 2015 of only 7.4x. Due to the recent quarterly results, we increased the average sales estimates by +2.5%, while the outlook for earnings growth remains unchanged.
Also, if we review the latest news coming out of Vietnam, it confirms our optimism for the future of the market. The first companies have begun to announce that they will increase their Foreign Ownership Limits (FOL) to over 50% (specifically the first brokerage firm announced an increase of their FOL to 100%) while at the same time macroeconomic numbers continue to be encouraging. The Vietnamese Ministry of Planning and Foreign Investment Agency announced last Thursday that foreign direct investment had reached USD 13.3 billion as of August year to date. This was an increase of over +30% compared to the previous year to set a new record. Inflation has also fallen again in August and now stands at 0.6%; it seems likely to stay below 2-3% for the whole year.
In addition to the general market decline, the two-time non-scheduled devaluation of the Vietnamese Dong is also responsible for compounding losses for foreign investors. The currency weakened by -3% versus the USD in August and has been to the detriment of our comparatively strong fund performance. Despite this fact and the chaotic stock market movements this month, the loss for our portfolio was relatively modest. It is worth touching on the current situation for the Vietnamese currency from the government point of view. The widening of the USD/VND trading band from 1% to 3% has not been officially viewed as a currency devaluation but, similarly to China, as a step towards a more realistic exchange rate level. They also moved to assure markets that there would be no further devaluation until the first quarter of 2016 – though you will have to interpret from this what you will.
USD-VND Exchange rate 2011-2015
The previous large depreciation of the Dong, in 2011, happened in a completely different economic environment than today. At the time Vietnam had a double-digit inflation rate, a real estate and a banking crisis developing at a time of weak economic growth. This month’s devaluation was primarily in response to external problems impacting the recovery of the economy in a very low inflation rate environment (below 3%). Looking at the comparison with other emerging market currencies and commodity-exporting countries puts the recent Dong weakness into perspective. Even leading global currencies, such as the Euro, appreciated by almost +5% in three days this month, before rapidly declining -5% again.
Most of the global currency movements have been even more dramatic in comparison to the VND and below is an overview of various exchange rate movements versus the USD in the first 8 months of 2015.
While some may see the volatility of recent months as a reason for caution we generally see panic in the markets an opportunity to pick up companies that we like at lower prices. All of the directors of the AFC Vietnam Fund used this summer as an opportunity to increase their personal holdings in our fund given the extremely favourable valuations. So far our CEO, Andreas Vogelsanger, looks to have had the most optimal timing with the execution of his investment this month. The AFC Vietnam Fund should be seen as a well-managed way to get exposure to the long term Vietnamese growth story and ‘buying dips’ as initial or subsequent investment can potentially help your upside by keeping your entry price low.
In August, the fund’s largest positions were: Sam Cuong Material Electrical and Telecom Corp (3.4%) - a manufacturer of electrical and telecom equipment, Nui Nho Stone JSC (2.0%) – a construction materials company, Bao Viet Securities JSC (1.9%) – a brokerage company, Thuan An Wood Processing JSC (1.8%) – a wooden furniture manufacturing company and Binh Duong Minerals and Construction JSC (1.8%) – a minerals and construction material manufacturer.
As of 31st August 2015 the portfolio was invested in 83 shares and held 5.7% in cash after inflow of new capital this month. The sectors with the largest allocation of assets were consumer goods (37.0%) and industrials (23.3%). The fund’s estimated weighted average trailing P/E ratio was 6.72x, the estimated weighted average P/B ratio was 1.07x and the estimated portfolio dividend yield was 6.32%.
Mongolia has some of the largest mineral deposits in the world of coal, copper, gold, molybdenum, oil, fluorspar, uranium, tin, and tungsten. Despite its vast natural resource wealth, Mongolia implemented protectionist policies in 2012, including attempting to renegotiate with Rio Tinto over the country’s largest copper and gold mine, Oyu Tolgoi, which rattled the psyche of investors. Mongolia has since come to a medium term settlement with Rio Tinto and in the process has liberalized its investment environment. Unluckily, this liberalization coincided with a peak in global commodities demand and a slowing Chinese economy leading investors to “wait and see”.
As a commodity-concentrated export nation, Mongolia has faced the same challenges as other resource-exporting countries (Australia, Indonesia, Malaysia, Brazil, Canada) in trying to keep their currencies from getting crushed by the strong US dollar. Through the first half of 2015, the Mongolian Tugrik was headed for a record low, having fallen 35% over the prior 24 months, and coming under pressure from depressed copper prices (its top export). China accounts for 85% of Mongolian exports and buys nearly half of the world’s copper, so Mongolia’s economic health is heavily reliant on the outlook for China. On August 26, copper hit a 6-year low in response to China’s tumbling equity markets, but has subsequently climbed as China’s outlook has stabilized somewhat.
In early September, a prominent analyst suggested that Rio Tinto is likely to buy out the majority of Turquoise Hill (NYSE:TRQ) shares that it doesn’t already own, at a premium, within the next 12-18 months. A positive prediction, this would add much needed stability to the OT project and Mongolian fiscal resources in addition to a buyout of the 34% stake the Government of Mongolia owns as the costs to service a phase II development of the mine will force Mongolia further into debt if they remain an equity holder. A transition from equity ownership to a straight royalty agreement between the Government of Mongolia and Rio Tinto would lead to a much more productive relationship for the mine and for the country.
Apart from natural resources, agriculture is another key sector for the economy. Mongolia is one of the world’s largest producers of cashmere, and also grows canola, wheat, barley, and potatoes. 2015, however, has presented severe challenges for the country’s agricultural sector, as a drought forced Mongolia to become a net importer of wheat this year as fodder supplies will be shipped from the distant provinces near to Ulaanbaatar in order to see cattle through the winter.
In July, the Mongolia Stock Exchange’s (MSE) CEO announced the country’s plans to sell government stakes in 10 state-owned enterprises, as well as a stake in the Tavan Tolgoi coking coal deposit. He also announced a potential sale of 66% of the Mongolia Stock Exchange to the public, as the bourse seeks to boost its market capitalization and catch up with other global stock markets in size. Despite many months in the red in recent years, the MSE Top 20 Index was the world’s best performing bourse in June, increasing 18%.
In the debt markets, Mongolia faces a precarious situation. In 2012, with a rosy outlook for the future, the country issued USD 1.5 billion of sovereign bonds and investor demand was USD 10 billion. As the NY Times’ Dealbook pointed out, that meant that Mongolia was in a position to borrow an amount nearly double its 2012 GDP of USD 4 billion! Now the IMF has warned that Mongolia will likely struggle to make its debt payments, which surely contributed to the May agreement that was reached between the government and Rio Tinto to relieve some of the country’s macroeconomic pressure. Although yields have jumped to 9% from 4%, Mongolia was still able to issue USD 500 million of bonds this year.
On the political front, Mongolia experienced some turbulence in early August when six ministers from the Mongolian People’s Party resigned from the cabinet after a bill to dismiss them was introduced by the Prime Minister, a member of the Democratic Party. The two parties had formed a political “super coalition”, intended to last until July 2016, to try and revive foreign investment to the country. But with an agreement reached between Mongolia and Rio Tinto in May to push forward the second phase of the Oyu Tolgoi project, a split between the two political parties was likely, as each party can now begin strategizing for its own political campaign in advance of next year’s national elections. However, Mongolia’s President, Tsakhiagiin Elbegdorj – also a member of the Democratic Party – opposed the Prime Minister’s decision to push for the cabinet members’ resignations out of fears that such political upheaval might undermine investor confidence further and present challenges for the Tavan Tolgoi project, a USD 5 billion coking coal deposit.
Despite recently sagging foreign direct investment, which fell 74% in 2014 year-on-year, a bright spot for the country’s outlook in recent years has been its push to develop infrastructure. Ulaanbaatar has continued to develop and change rapidly, and agreements have been signed to establish a northern railway connecting eastern Mongolia to Russia as part of a new Russian-Chinese rail corridor, an airport in the capital being financed by Japan slated to open in 2017, and regional road buildouts cutting travel time significantly. Such infrastructure projects will help to lay a solid foundation for the country’s development when foreign investment picks up in the future.
Rebuilding investor confidence in Mongolia will occur in alignment with a global commodity price rebound. However, if the last three years have taught investors anything, it is that to invest in countries like Mongolia, one must have a medium to long term investment horizon. Mongolia’s resources will still be here, patiently awaiting a more stable global climate for export. Asia Frontier Capital will be well positioned when this occurs.
In line with our process of covering frontier countries from the ground, this month AFC’s Regional Investment Analyst, Scott Osheroff, recounts his recent travels through Mongolia.
It is 6am in Ulaanbaatar and just out my apartment window the sound of steel rebar being positioned into the beginnings of a 30-storey skyscraper has become my regular alarm clock. With eyes half open, I peer out the window. The construction site is already a hive of activity as the distant sunrise slowly illuminates the newly opened Shangri-La Hotel across the street.
With the blunt hammering of progress pounding its way into everyday life in Mongolia, you could be forgiven for forgetting about the hurdles facing the local economy. The landlocked nation is dealing with a stimulus-induced construction boom which is showing signs of struggle, as the present global commodities slump hampers the growth potential of resource reliant economies like Mongolia. Looking forward, Mongolia must also work out how to deal with the rollover of the USD 1.5 billion Chinggis sovereign bonds coming due. These are a few of the factors building towards a situation where distressed asset prices in real estate and listed equities could soon become a value investor’s paradise for those willing to do the groundwork and research.
I arrived in Ulaanbaatar in early August to begin an extensive due diligence trip on AFC’s portfolio investments. Visiting listed companies and their unlisted competition to better evaluate the opportunities available, I met with management teams from the mining, cashmere production, real estate, media and consumer goods industries. There remain some great success stories amongst the overall malaise surrounding Mongolian business.
One of the more interesting companies that I visited was a tannery, Darkhan Nekhii, located in Darkhan City, outside of the capital Ulaanbaatar. One of the largest tanneries in Mongolia and an interesting business for us as investors, the company processes hides predominantly for export which is a sound strategy as Mongolia boasts over 60 million animals - roughly 20 for every person in the country. I spent the day with management who took me on a tour of the factory which appeared to be operating at full capacity, contrary to management downplaying their successes. It was an encouraging visit as Darkhan Nekhii is well positioned to grow its export market share and innovate its value add processes in order to remain ahead of increasing government regulation in the sector.
Darkhan Nekhii Factory
At present it is illegal to export raw hides. The government is trying to keep value add production onshore and is thus in discussions to also potentially ban exports of wet blue - a commodity product. Unlike its smaller competition, Darkhan Nekhii is in the comfortable position of already processing hides beyond wet blue and therefore won’t feel as great an impact as their smaller competition, perhaps allowing the company to do a roll-up, buying out smaller competition.
Outside of leather, another highlight from my trip was to Gobi Cashmere, the largest cashmere company in Mongolia and one of the largest integrated cashmere companies in the world. Supplying a global retail franchisee base of 47 stores and boasting well known corporate clients in the USA, Gobi is arguably one of the best run companies on the Mongolian Stock Exchange. It is also the second largest company by market cap, yet continues to trade at a sizable discount factoring in its double digit earnings per share growth rate. Gobi has weathered a deteriorating domestic economy through its overseas distribution and its steady source of foreign currency has buffered it against a decline of the Tugrik exchange rate which has dropped roughly -50% versus the USD since March 2012. Gobi’s international expansion is a reflection of management’s competency and vision. This year they pushed further into Chinese cities unabated as capacity utilization increased and reinvestment into growing its production lines supported their ability to fulfil continued robust demand for their cashmere.
Beyond company visits, it is important to see developments from the ground to get a more holistic view of the domestic economy. Since I was here seven months ago there have been continued signs of positive changes and the addition of new entertainment and food venues are helping Ulaanbaatar become a more palatable city for tourists and expats. New KFC and Pizza Hut locations outside of the city center have sprung up from the sites of old Soviet buildings and additional locations of well-known Korean coffee companies, such as Caffe Bene, and the American brand The Coffee Bean and Tea Leaf, have sprouted. This bourgeoning push towards café culture is reminiscent of similar trends in other parts of Asia, such as Vietnam and Cambodia.
The Coffee Bean
In Zaisan, an upper class neighbourhood, there was previously very little to do in the local scene but this is also changing. During my trip I took in a dinner of khuushur (fried meat pancakes) and kebabs in a newly renovated outdoor food court with friends before taking a hike to the top of a monument commemorating Russian and Mongolian partnership in WWII where our perched view over the city was a perfect venue to watch the sunset.
Sunset at Zaisan
The natural beauty of Mongolia can be truly staggering and it was a joy to watch the evening descend over the capital. Looking out to the horizon I contemplated how Mongolia would change in the coming years given that it holds more than USD 1 trillion in resources under the steppe. Mongolian investment represents a call option on global resource prices which is further supported by Chinese switching costs. With the infrastructure being built to support commodity exports of coal, iron ore as well as others, Mongolia has the opportunity to become the low cost supplier of bulk commodities to its resource hungry southern neighbour and could effectively price out Australia and Indonesia. There is no doubt Mongolia will rise again as a premier investment destination, the question is simply when? Patience and prudence when investing in Mongolia is the key to generating outsized returns and being in position when highly discounted Mongolian assets climb in value will help bolster the upside for investors in the AFC Asia Frontier Fund.
I hope you enjoyed reading our monthly newsletter and I would like to extend my gratitude to our guest writer for contributing the Iran travel report. If you would like any information about our funds or markets please let me know.
With kind regards,
Asia Frontier Capital Limited
This document does not constitute an offer to sell, or a solicitation of an offer to invest in AFC Asia Frontier Fund, AFC Asia Frontier Fund (non-US), AFC Iraq Fund, AFC Iraq Fund (non-US), AFC Vietnam Fund or any other funds sponsored by Asia Frontier Capital Ltd. or its affiliates. We will not make such offer or solicitation prior to the delivery of a definitive offering memorandum and other materials relating to the matters herein. Before making an investment decision with respect to our Funds, we advise potential investors to read carefully the respective offering memorandum, the limited partnership agreement or operating agreement, and the related subscription documents, and to consult with their tax, legal, and financial advisors. We have compiled this information from sources we believe to be reliable, but we cannot guarantee its correctness. We present our opinions without warranty. Past performance is no guarantee of future results. © Asia Frontier Capital Ltd. All rights reserved.
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