Tuesday, September 25, 2018

Vietnam, an Opportunity Amongst An Emerging Markets Meltdown

Vietnam, an Opportunity Amongst An Emerging Markets Meltdown
By: Michael Molman

            So far 2018 has been shaking up to be a much more interesting year in the financial markets than 2017. Trends that have held for years have suddenly broke amidst a refreshing bout of volatility. This presents investors with an opportunity, if they know where to look. Some of the best opportunities could be found in specific Emerging and Frontier markets. 
Recently Emerging Markets (which were some of the best performers in 2017) have been going through a sharp downturn. The MSCI Emerging Market Equity Index has fallen into a bear market (a drop of over 20%) since hitting a high in January (after being up 32.5% in 2017) while the MSCI EM Currency Index is down 8.5% over the same period. Much of the sell-off is due to a combination of rising U.S interest rates, contagion from economic meltdowns in specific Emerging Markets (namely Venezuela, Argentina and Turkey), and a brewing trade war between the U.S and China. Throw in a rising U.S dollar and a slowing Chinese economy and you get a good old fashioned panic in Emerging Markets. However in the blind dash for the exit, investors are abandoning some markets that are largely healthy. These healthy markets are now trading at much lower valuations then previously, which presents an amazing buying opportunity. Amongst the best looking is Vietnam. 
Chart of iShares MSCI Emerging Markets Equity ETF from 2011 to September 25th 2018. Emerging Market Equities have fallen 20% from their highs.

For many Americans when they think of Vietnam, they picture American helicopters needlessly bombing a jungle or maybe they think of Rambo. In reality though Vietnam is one of the most dynamic developing countries in the world. Over the last 30 years the country has become significantly more attractive to foreign investors eager to take advantage of the country’s young, well-educated population, cheap labor and rapid development. The rapid increase in foreign investment has led to strong economic growth and development. This growth is only expected to continue, PricewaterhouseCoopers (PWC) even estimates that by 2050 Vietnam would be the 20thlargest economy in the world. Not bad for a country that has been a backwater for most of its history. However to fully understand the opportunity the current Emerging Markets panic has created in Vietnam, it is necessary to understand what is driving the country’s economic boom.
Vietnam’s shift from a communist backwater to a Frontier Markets jewel started in the late 1980’s when the country started the transition from a highly centralized planned economy to socialist oriented market based one. The country moved to open up its economy to foreign investors and began to privatize many state owned companies while encouraging small business practices. According to World Bank statistics these reforms (dubbed Doi Moi) helped turn Vietnam from one of the poorest countries in the world to a low middle income nation. To understand just how much Vietnam transformed one must only look at the country’s basic economic numbers. According to the World Bank, in 1985, Vietnam had a GDP of just over $14 billion, the latest data from 2017 shows the country now has a GDP of over $223 billion, that’s an outstanding rate of growth. Meanwhile the country’s population has expanded from 60 million in 1986 to 95 million in 2017 (it is expected to grow to 120 million by 2050), 70% of the population is also younger than 35. Vietnam’s young and growing population is certainly a positive sign for the country’s outlook but it is the nation’s emerging middle class that demonstrates how promising of a market the country can be. Currently 13% of Vietnamese households are considered middle class, but that percentage is expected to increase to 26% by 2026 (some firms including Boston Consultancy estimate that almost 1/3 of the population will be middle class as early as 2020). A large emerging middle class means more disposable income making the Vietnamese market prime for even more growth. Not only is Vietnam’s population is growing in wealth and size it is also relatively better educated then most of it peers. Vietnamese students consistently score high on international tests distributed by the Program for International Student Assessment (PISA). 
Vietnam is also a regional leader in infrastructure investment, with 4.5% of GDP getting invested into roads and other infrastructure, as of now 90% of the country’s population is connected by all-weather roads. Access to household infrastructure has also improved, in 2016 99% of the population had access to lighting, compared to just 14% in 1993. That year, only 36% of the population had access to sanitation facilities and only 17% to clean water, those statistics now stand at 77% and 70% respectively. A large, young, well-educated population and developed infrastructure has made Vietnam a prime destination for new industrial production especially as companies increasingly want to diversify out of China. In 2017 Foreign Direct Investment (FDI) in Vietnam hit a record $17.5 billion. The vast expansion of industrial production and FDI have led to increasing exports, which in turn continues to propel the economy to new heights. 
In 2017 Vietnam’s  GDP increased over 6.8% and growth in 2018 has remained strong, with GDP growing at annualized rate of almost 7% in the 2nd quarter. This represents the strongest 2nd quarter in 11 years and shows the continued resiliency of Vietnam’s manufacturing and exports. The country also continues to attract foreign direct investment, which is 9.2% higher in the first 8 months of the year compared to the same period in 2017. The global ratings agency Moody’s forecasts that Vietnam’s economy will continue to expand at an average annual rate of 6.4% until 2022, and as a result upgraded the country’s external debt on August 10thfrom Ba3 to Ba1 (this link shows Moody’s debt rating scale; Moody's Ratings Scale). Meanwhile the World Bank has upgraded its forecasts for Vietnam’s growth this year to 6.8% from 6.5%, and some analysts, especially from Standard Chartered, are even more bullish believing growth for 2018 could top 7%. The International Monetary Fund (IMF) also decided to chime in on Vietnam’s growth prospects in its first review of the nation’s economy since 2014. In it’s report the IMF proceeded to upgrade its forecasts for GDP growth and praise the government’s  continued efforts to privatize and reduce the size of state owned enterprises. 
Chart showing Vietnam’s GDP from 1985 to 2017. The country’s economy has grown at an annual rate of 5% since 1990.
All the bullish data coming out of Vietnam has not gone unnoticed by investors. The country’s stock market has had 6 straight years of gains, surpassing 6% and surged 48% in 2017 and another 19% in the 1stquarter of 2018. This made Vietnamese stocks some of the hottest in the world as investors bid up prices in the effort to get in on the action. Vietnamese stocks not only benefitted from the strong economic growth but also from reports that Vietnam will be officially classified as an emerging market by MSCI. This would mean inclusion in various broad based Emerging Market ETF’s and increased buying of Vietnamese equities (at the moment Vietnam is classified as a Frontier Market). 
However, market optimism, especially in emerging markets, is often a delicate thing. Developing countries, including Vietnam, have obvious risks that investors are only too eager to highlight when conditions suddenly change. At the moment Emerging Markets are under pressure from a number of different external factors. These factors include the renewed strength in the U.S Dollar, which has rallied over 9% between its low in late February and it most recent high in mid-August. A rising U.S dollar hits countries who have large current account deficits and are reliant on dollar loans for financing. A stronger U.S dollar makes repaying these loans much more expensive and as the dollar rose, countries like Argentina and Turkey, who have large amounts of dollar denominated debt, started to topple. 
At the same time the rising dollar coupled with an economic slowdown in China has depressed the price of commodities. Most commodities are priced in dollars and a more expensive dollar makes commodities more expensive to purchase for none U.S buyers, thereby reducing demand and by extension prices. Meanwhile China is the largest consumer of raw materials in the world so any slowdown in the Chinese economy has outsized effects on the price of raw materials. This is particularly damaging to emerging markets since many developing countries rely on commodities exports to fuel economic growth. 
Another thing hurting sentiment in emerging markets is the tightening of U.S monetary policy. Higher U.S interest rates mean investors no longer have to hunt for high yield in risky developing countries and could instead invest their capital in the relative stability of the U.S. In the decade since the Great Recession Emerging Markets benefitted strongly from the low rate environment. However as interest rates begin to normalize, foreign investors are starting to pull their money from these riskier markets. When you include all these factors and throw in an escalating trade war between the U.S and China, it is easy to see why emerging markets are in the midst of an economic bloodbath.
This recent economic tumult has not spared Vietnam. The country’s stock market plunged over 25% between April and July, while volatility surged to an 8 year high. Declining share values led to margin calls in the heavily leveraged and relatively expensive market, which exasperated the selling. Foreign Investors, who had only months before were consistently buying Vietnamese large caps (foreigners net bought $1.48 billion worth of Vietnamese equities in the first half of the year), started to dump their holdings. This only worsened the sell-off as Vietnam’s top 20 blue chip companies (which were favored by foreign investors) account for 2/3 of the total stock market capitalization, and any large selling in them tends to bring down the rest of the market. For 75% of the days during this period investors pulled money out of the market. Foreigners dumped $70 million worth of Vietnamese stocks in the first half of July alone. 
At first sight dumping Vietnamese assets right now makes sense, especially as the U.S-China trade war intensifies. Vietnam counts both nations as its top trading partners, which means the country may find itself in the middle of a trade war between the 2 largest economies on Earth. As I mentioned earlier, Vietnam has been reliant on exports (as well as FDI) for much of its economic growth. Shipments surged almost 4 fold between 2008 and 2017 and annual exports topped $226 billion in the 12 months ending in March 2018. Trade as a percentage of GDP currently stands at 200% which means any dent in global trade will have negative effects on the country. More concerning is Vietnam’s trade dynamic with China and the United States. 
China is Vietnam’s largest trading partner and the nation relies heavily on its far larger neighbor to the North for raw materials, equipment and capital for its labor intensive manufacturing industry. As such Vietnam runs a huge trade deficit with China, at the same time the United States is Vietnam’s largest export market (you might notice how a lot of your basic goods now say “Made in Vietnam”). As a result Vietnam enjoys a large trade surplus with the United States. This dynamic could mean that the small South East Asian nation may earn itself the ire of U.S President Donald Trump who has vowed to renegotiate trade pacts and reduce America’s trade deficit. Pressuring a small export dependent country like Vietnam with tariffs would not be out of character for the unorthodox President and is a major concern for investors in the small nation. In fact $5 billion worth of Vietnamese exports that are part of Chinese supply chains may already be exposed to U.S tariffs. Vietnam also houses many production hubs for the Chinese manufacturing sector, which only exposes the nation more trade frictions. 
As these risks mount traders are pushing down the value of the Vietnamese currency, the Dong. The currency is loosely pegged to the U.S Dollar and in a bid contain the currency the Vietnamese central bank quietly devalued it by 1.1% this year. If exports start to slip, it is likely the central bank will take more aggressive actions,  which does not bode well for Vietnamese assets. Throw in rising inflation (which in June and July topped the central bank’s target of 4%) and you can understand why investors are fearful of increasing their exposure to Vietnam. However, it is possible that these risks are overstated and that the recent sell off in Vietnamese equities actually presents a long term opportunity. 
Chart showing Vietnam’s dependency on exports. As you can see Vietnam is much more dependent on exports then its other South East Asian peers. This exposes the Country to trade friction.
          To understand this opportunity investors have to look deeper into the factors behind the recent sell-off. Let’s start with the elephant in the room, the main driver behind the recent flight from Vietnam, the rapidly escalating trade war between the U.S and China. Any trade war, inevitably causes collateral damage, not just to the intended target but to the many players involved in the various sprawling supply chains. However, in this case, a trade war between the U.S and China might be accelerating a trend that has been benefitting Vietnam and other South East Asian countries. This trend is the shift of the manufacturing and industrial bases away from China. As wages at Chinese factories continue to rise, multi-national corporations are increasingly moving out in search of cheaper labor. With Chinese made goods now the target of U.S tariffs, companies have all the more incentive to move away from the country. 
Vietnam is a natural place for companies to set up their new Asian production centers. According to VinaCapital (one of Vietnam’s largest asset managers) Vietnamese laborers are 66% cheaper and just as productive as their Chinese counterparts. This coupled with the nation’s relatively well educated, young population and a rapidly developing infrastructure, make Vietnam an attractive destination for new industrial investment. Multiple companies have already moved their production to the country. One of the larger ones has been Samsung, which has invested $17 billion in Vietnam and now uses the country as its main manufacturing hub for its best-selling smart phones. Clothing companies are also shifting their manufacturing, the U.S Fashion Industry Association released a study in July which shows that 2/3 of all textile companies are expecting to lower their production in China. Some of these companies, like Adidas, have already moved to Vietnam (Adidas now manufactures twice as many shoes in Vietnam as it does in China). As the production processes continue to flee China in favor of South East Asia, it makes sense that Vietnamese manufacturers continue to see new growth. In August the Nikkei Vietnam Manufacturing Purchasing Managers Index (which measures manufacturing activity in the country) recorded in 33rdstraight month of increases.
In fact, despite the massive broad based pull back from Emerging Market, cashflow from other Asian countries into Vietnam is still trending up. Properties in the country are priced at a significant discount, compared to those in neighboring Singapore and Thailand, and properties in Ho Chi Minh City are 1/10ththe price of similar properties in Hong Kong. This makes Vietnam one of the best real estate plays in Asia and gives the country a strong advantage over other South East Asian countries viewing to attract industrial investment.  So even as investors fear that a trade war could dent Vietnamese exports and hurt the country’s stellar growth, it is actually attracting greater FDI and is expanding the nation’s industrial and manufacturing base. 
The other risks that have weighed on Vietnamese markets may also be exaggerated. Let’s take the higher dollar and rising interest rates for example. As was mentioned before, these things hurt nations with large amounts of dollar denominated debt and who run current account deficits. Vietnam is not Argentina or Turkey, although the country maintains an uncomfortably high debt to GDP level (which is at 61.5%) the government has taken concrete steps to solidify the nations finances. These steps, which include deficit reduction and divestment of state owned enterprises, are expected to contain public debt. About ½ of Vietnam’s external debt is financed through favorable terms with large multilateral institutions, like the World Bank, IMF and the Japan International Cooperative Agency. This is in stark contrast to other Emerging Market countries who have financed there growth primarily with bank loans.
 The Vietnamese government has also restricted lending to less productive industries and has been forcing banks to reduce their bad debt (the bad debt ratio for the Vietnamese banking industry fell to 2.09% in late June compared to 2.46% in late December of 2016). In addition to these actions the Government has moved to modify the country’s debt structure in order to reduce reliance on foreign denominated loans (something that has sunk the economies of Argentina and Turkey). According to Moody’s this has made the Vietnamese economy less vulnerable to external shocks, which incidentally explains why Vietnam’s credit rating is being upgraded even as fears of default rise in other Emerging Markets. Meanwhile, the country’s strong exports mean the nation runs a steady current account surplus which only reduces the need for foreign debt. Throw in robust growth in personal consumption caused by rising household incomes and expansion of private credit and it is hard to be concerned about Vietnam’s growth and finances.
Concerns over rising inflation and the falling Dong also seem to be overplayed as well. Although fears of inflation increased over the summer (inflation in June and July was 4.67% and 4.46% respectively) as the Dong sold off, there are signs that prices and the currency are stabilizing. The State Bank of Vietnam and a survey of economists conducted by Focus Economics expect annual inflation to run below 4% (which is the Central Bank’s target) in 2018. The country has also been steadily increasing its foreign exchange reserves, which it could use to prop up the Dong if necessary. In March the nation’s FX reserves stood at 25.7% of GDP compared to 21.75% in December of 2017. However as the dollar begins to stabilize, following its recent surge and Vietnam’s strong growth continues, it is unlikely that the Dong will depreciate further. Despite the devaluation of its currency, the Vietnam’s central bank has done a good job keeping the Dong pegged to the dollar. The state bank has ensured that the Dong does not shed more than 3% against the U.S dollar annually. This explains why Vietnam’s currency is only down just over 1% against the greenback while other South East Asian countries like Indonesia have seen their currency plummet as much as 10%. So when you consider the fact that FDI is expected to continue increasing, the decreasing dependency of foreign denominated debt, stabilizing currency and contained inflation, it is easy to see the recent sell-off in Vietnamese assets as an opportunity. 
Chart showing Vietnam’s Current Account from 2013 to 2018. The country has run relatively consistent current account surpluses which makes the country less vulnerable to external shocks.
Chart showing Vietnamese FX reserves from 2008 to 2017. The country has been building up its reserves which allows it to prop up its currency. 
           It has become clear that investors have been trading emerging markets as a block with little regard for the fundamentals of specific markets. This presents an opportunity to dive back into emerging markets that have proven to be more resilient to the turbulence, markets such as Vietnam. Even as Vietnamese shares sold off in the face of foreign liquidations, earnings have continued to grow at a historic rate. This means earnings multiples for Vietnamese stocks are at the lowest level they have been in a very long time, giving investors a perfect entry point into the market. 
            Prior to the Emerging Markets sell-off, some analysts were concerned that Vietnamese large caps had gotten too expensive. This is understandable given that at the top of the market in March, Vietnamese stocks traded at an average P/E of over 20x, a much higher multiple than other emerging markets. However, following the recent market sell-off that multiple has fallen to around 16x, and if you do not include the top 5 listed companies, the average P/E for Vietnam’s main Ho Chi Minh index is about 14.5x. This puts Vietnam’s equity valuations just about in line with other South East Asian countries and 21.32% below their own historical averages. Additionally, but when you compare Vietnam’s equity valuations to GDP growth, it becomes obvious that Vietnamese stocks present much better value than stocks in other comparable nations. For example, Vietnam’s GDP growth in 2018 is expected to be around 6.5%, and as mentioned before, it’s main equity index has a P/E of around 16x. The Philippines has a higher expected GDP growth of 6.8% but on average its equities trade at a high P/E of 19x. Thailand, meanwhile, has equities trading around 15x forward earnings but has a much lower GDP growth of 4.5%. Other South East Asian countries, the Philippines and Indonesia specifically, have also been running consistent current account deficits and have been gorging on dollar loans. This makes them vulnerable to the same external shocks that sent Argentina’s and Turkey’s economies reeling. Throw in the added political instability (yes Philippines I am talking about you) and you can understand why Vietnamese stocks trading at the same valuations as equities in its neighboring countries presents an opportunity. 
            This dynamic could explain why Vietnam fared better in the current situation then its neighbors and why, despite the broad sell-off in emerging markets, foreign investors still net bought Vietnamese equities this year. According to Dragon Capital, foreign investors withdrew $5.6 billion from the Thai market this year through August, $3.7 billion from Indonesia and $1.6 billion from the Philippines. Meanwhile foreign investors net bought $1.8 billion worth of Vietnamese stocks. Vietnam’s general statistics office views these capital flows as a positive sign, despite the increased volatility in the country’s financial markets. Some Vietnamese based funds, including Dragon Capital and VNDirect Securities, have echoed this sentiment. With every industry reporting earnings growth in excess of 20% year over year through the end of the 1stquarter, and with equities trading at these valuations it’s hard not to be excited about Vietnamese stocks. 
Chart showing Vietnam’s main VN stock index from 2016 to September 25th2018. The index soared 48% in 2017 before falling over 25% between April and July. It is currently up 13% from its lows.
           Vietnamese stocks look relatively cheap to their historical averages, earnings and international peers. When you consider the country’s macroeconomic stability and growth it is easy to see why Vietnamese equities have rallied 13% since hitting their lows in July. Unfortunately, it is difficult for retail investors to get in on the action since it is virtually impossible to invest directly in individual Vietnamese stocks. Luckily, there are a number of liquid ETF’s out there that allow small investors to gain exposure to the country. 
            The most popular one is the VanEck Vectors Vietnam ETF (VNM). This U.S traded ETF is probably the most pure way for investors to gain exposure to Vietnam. The ETF has total assets of about $278 million and is composed of companies that are incorporated in Vietnam, generate half their income in Vietnam, or have half their assets in the country. The funds main objective is to track the MVIS Vietnam index and managers invest at least 80% of the fund’s assets in securities of the underlying index. Another option for interested investors is the VinaCapital Vietnam Opportunity Fund (LSE: VOF). This fund trades on the London Stock Exchange and is a closed ended investment company aiming to achieve medium to long term returns in Vietnamese assets. The company mainly invests in Vietnam focused listed and unlisted companies, debt instruments, private equity, real estate and other opportunities. Given that the fund trades at a 18.9% discount to its net asset value, it gives investors a cheap way to gain access to a more actively managed Vietnamese investment portfolio. 
            Of course there are many risks in investing in Vietnam or any developing country for that matter. The country’s financial markets are considerably more volatile, prone to wild swings and asset bubbles. However, for investors willing to take on the additional risk, Vietnam offers an amazing macro based opportunity. The Vietnamese government continues to push for the privatization of state owned companies and is planning on loosening regulations to make it easier to start businesses and invest in the country. According to Deloitte, the government’s continued actions to open up the economy and encourage foreign investment will keep the Vietnamese market attractive for at least the next 5-10 years. With valuations in the country depressed following the sell-off in Emerging Markets, investors have a rare opportunity to gain cheap exposure to one of the most impressive developing countries in the world, just as it begins to realize its potential. 

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Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor. 

Tuesday, August 14, 2018

Graphene, a Bet on the Future

Graphene, a Bet on the Future
By: Michael Molman 
Investors are always on the lookout for the next big thing. The piece of technology that will bring science fiction to life and transform the world. Occasionally this promise of the future leads to periods of investment mania. Where investors eager to own a piece of the future crowd into speculative new ventures, remember the 3D printing bubble or more recently, blockchain and crypto currencies? More often than not, these periods of mania do not last and interest in new technologies fizzles until only the true believers and innovators remain, to quietly develop the technology. One such technology that promises to revolutionize our lives but that has drifted from public view is graphene.

Picture of a Sheet of Graphene

Graphene is an emerging material made up of a single layer of carbon atoms that are bounded together in a repeating pattern of hexagons. The material is a million times thinner then paper yet stronger than a diamond and 100-300 times stronger than steel. It conducts electricity 200 times faster than silicon and is incredibly flexible. It was discovered in 2004 by University of Manchester Professors Andre Geim and Kostya Novoselov, who ended up winning the Nobel Prize in physics for it in 2010. Since then, billions of dollars has gone into graphene research and hundreds of startups have popped up hoping to advance the material that promises to lead to revolutionary new technologies that can change our lives. 
            The uses for graphene are potentially limitless, by being the thinnest, strongest, lightest most heat and electricity conductive material known to man it can be used to advance countless technologies. So far some of the biggest emerging uses for graphene include its use in solar cells. With the materials conductive properties it is possible to create more efficient solar cells that are hundreds of thousands of times thinner and lighter then silicon cells. Imagine the implications of making solar cells easier to transport and install, that alone could solve the worlds energy problems. 
Graphene could also lead to more powerful and smarter computers by making it possible to make transistors lighter and thinner. Adding more transistors to a computer chip makes it more powerful. Suddenly creating computer chips powerful enough to support machine learning and artificial intelligence does not seem too far out of reach (sorry for all those worried that Siri will take over the world). Graphene’s superior conductivity and translucent properties also makes it a perfect coating for touchscreen devices and its flexibility makes it possible to create bendable electronics and paper that connects to the internet. Imagine a laptop that you could bend together and put in your pocket! The material’s strength and light weight also mean that it can be used to replace Kevlar in protective clothing and make clothes that could charge your electronic device just on contact. 
Another exciting use for graphene is its potential to advance battery technology. Anybody who has been following the cobalt and lithium boom knows that battery materials are a huge and highly lucrative deal. Graphene’s use in batteries is also more than just theoretical. In November of 2017 researchers at Samsung’s Advanced Institute of Technology announced that they have developed a graphene ball, a material which would allow lithium ion batteries to charge 5 times faster and have 45% more capacity. In theory a battery based on a graphene ball could be fully charged in only 12 minutes. This technology, which is best described in the November 2017 edition of science journal, Nature Communications, (whose link I have included here http://www.nature.com/articles/s41467-017-01823-7), could make charging an electric car as easy and quick and as filling up a gas tank. These advances in battery technology could lead to the faster adaptation of electric vehicles and could mean your personal electronics could last days on a single charge. 

Image of Samsung's Graphene Ball.

With all these advanced technologies made possible by graphene you might be wondering why you are not already living inside your favorite science fiction show. The answer is, graphene is still in its infant stage and not currently mass producible to the point where it is cheap enough to produce broadly. Development of high quality graphene is also very expensive and difficult which makes creating a practical supply chain virtually impossible. In fact this is what led to graphene’s fall from the public eye in the first place. 
In 2010 following the Noble Prize win by the scientists who first discovered it, money poured into graphene research and graphene focused startups. Between 2010 and 2011 well over 400 patents for different graphene products were filed. The hype around this “magic” material promised large returns in the future. Unfortunately, once it became clear that graphene was a technology that will take years to fully understand and develop, investors lost interest and the material faded from public view. However, research into making graphene production simple and cost effective continues, scientists have already developed some new procedures that can possibly make graphene production more practical. This all means the long term opportunity remains. 

Chart showing the amount of graphene patents filed from 2005 to 2017. Patent filings peaked in 2011.

            At the moment there are about 200 companies studying and researching commercial applications for graphene (this does not include large firms such as Samsung who are also conducting research). Most of these companies are private startups and offshoots of University research departments. However, there are some publicly traded graphene focused stocks out there which give investors the opportunity to gain some exposure to the emerging material. 

Versarian (AIM: VRS)
            One such company is Versarian, a U.K based company founded in 2010 that is engaged in offering various engineering solutions. The company is publicly traded on AIM (a market operated by the London Stock Exchange) and operates in three segments including hardware and thermal products, but over the last several years has shifted its focus to developing and marketing different applications for graphene. 
            Most of Versarian’s graphene business comes in the form of majority stakes in other graphene companies, such as 2-D Tech Limited and Cambridge Graphene. Both these companies are spin off’s of University research departments (2-D Tech is a spin out from the University of Manchester, where graphene was first discovered, while Cambridge Graphene is a spin out from the University of Cambridge). Both companies now serve as effective subsidiaries of Versarian, which has benefitted significantly from being able to combine the research and expertise from two of the top graphene research departments in the world. Through its subsidiaries Versarian is exploring multiple different applications for Graphene including different types of graphene inks that could be used to make flexible electronics. However, one of the more exciting graphene products that Versarian has developed is nanene. Which is a very high purity type of graphene that according to the University of Manchester is one of the highest quality graphene products in the world. Versarian has claimed that it has the ability to manufacture nanene in large volumes at market leading prices. If that turns out to be the case, nanene would be one of the only commercially viable and mass produced graphene products in the world, that would make Versarian a market leader in this revolutionary new field. 
            However, don’t start maxing out your credit card to buy Versarian stock just yet, there are plenty of risks associated with this company. One of the more obvious ones is Versarian’s expensive valuation which was caused by the sharp increase in the company’s share price, the stock is up an astounding 548% over the last year. The company has a market cap of about 200 million pounds (about $260 million) which is enormous considering the entire enterprise brought in only about $7.7 million in revenues last year (granted that is a 35% year over year jump in revenue). Versarian also has about $8.45 million in net assets and showed a $1.56 million loss in 2017 meaning a valuation of ¼ of a billion dollars is obviously quite pricey. 
            Still despite the expensive valuation, Versarian is at the forefront of graphene commercialization. The company has already completed its first significant graphene sale, shipping $130,000 worth of GNPs (graphene nanoplates) to a European customer. It also has launched nanene, a graphene product that could be the first commercially viable graphene material ever. Versarian is committed to making more acquisitions and advances in the graphene space, so as this sector develops expect to hear more and more about Versarian. 

Haydale (AIM: HAYD) 
            While Versarian might be somewhat larger than other similar graphene focused companies it is far from investors only option when investing in this sector. Haydale is another U.K based company that trades on the same exchange as Versarian that is also focusing on commercial applications for graphene. While Haydale might have a considerably smaller market cap then Versarian (only about $18 million) it is operating in multiple sectors and has a presence in Europe, Asia and North America, making it a player in the new graphene space. 
            Haydale has been recently been shifting from Research and Development to more commercial ventures and the company has begun to apply its graphene materials to multiple industries. These include aerospace, where Haydale makes graphene enhanced resin components and composite materials for aircraft and unmanned aerial vehicles (UAV’s). The inclusion of Haydale’s graphene in these materials help protect aircraft from lightning strikes while also decreasing weight. Haydale has also partnered with BAC Mono (Briggs Automotive Company, a British supercar manufacturer based in Liverpool), to test and explore graphene’s potential applications in the automotive sector. In addition to these endeavors Haydale also makes proprietary graphene inks and coatings for the 3D printing and sensor market. The company’s graphene enhanced polylactic acid filaments have the potential to advance 3D printing by improving its speed, accuracy, and quality. At the same time it already has a regulatory approved ink that is used to make biomedical sensors.    
With multiple operations underway Haydale is legitimate option for investors hoping to gain some exposure to the emerging graphene industry. It is important to remember though, that most pure play graphene companies are small and microcaps that see considerable volatility in there stock price. Haydale stock is down almost 75% over the last year, which understandably terrifies most investors. However, as the company shifts towards being more sales focused its revenue growth has soared. Commercial revenues surged 85% in 2017 and according to the company’s most recent financial report (in December of 2017) it has a book value of about $19.5 million. That means, at least for the moment, the stock trades below the company’s net asset value, even while the company’s earnings potential is just being realized. This does not mean investors should not be cautious but it does mean it is possible to gain exposure to the growing graphene market without paying a huge premium. 

CVD Equipment Corporation (NASDAQ: CVV) 
            There are other ways to gain exposure to the graphene market other than buying shares in pure play graphene stocks. One of which is to invest in companies selling the equipment needed to produce graphene. One such company is CVD Equipment, a Long Island, NY, based company focused on developing engineering solutions for the semiconductor, solar, alternate energy and the Nano technology sectors. 
            In essence CVD Equipment helps develop commercially viable production techniques for new advanced technologies. The company serves many different sectors including, the aviation industry, the medical device market and the military, but some of its most interesting work comes in Nano technology and materials, like graphene. CVD sells a range of turn key systems called First Nano Easy Tubes, which can be used to grow graphene, experiment with different production techniques and for research and development. These First Nano system platforms come in different configurations that are designed to meet the requirements of specific clients. The cheapest First Nano platform is the Easy Tube 101, which the company describes as “perfect for a researcher with a limited budget and floor space”. Its most popular option is the Easy Tube 3000, which is described as being perfect for industrial R&D facilities and university labs. As well as selling these Easy Tube platforms, CVD also has a patent pending graphene growing process and system called the Easy Graphene Enclosure Box. This “Box” is meant to simplify the graphene growing process which would make graphene easier and cheaper to produce. 
            These processes mean the CVD Equipment is an important player in the graphene space, selling equipment that is critical in graphene production. It’s worthwhile to note that CVD’s First Nano Easy Tubes can also be used to create more than just graphene, they are used in the production of many different types of Nano materials. These materials include; carbon nanotubes (which are cylindrical structures of carbon atoms similar to graphene that are used in structural materials). They can be used to make Transition Metal Dichalcogenides (which are used in high speed electronics and next generation solar cells) as well as semiconducting nanowires, which can be used in optical computing. 
            The versatility of CVD’s First Nano platforms is certainly a plus when looking at the company from an investment standpoint. It means the company is diversified and not reliant on one specific advanced material to catch on. The company also has the benefit on being traded on NASDAQ meaning it is easier for U.S retail investors to gain exposure to CVD then to Versarian or Haydale, which are both traded in London. However, there are some problems with CVD Equipment, for starters the stock is down 38% year to date on concerns of lower then average return on equity and falling net income. In the 1stquarter of 2018 the company showed net income of $0.6 million much lower than the same period in 2017 when it showed net income of $1 million. On the surface this does not shine a very positive light on CVD Equipment, however when looking closer it becomes clear that the company is much healthier then it appears. Much of the decrease in net income is due to a large investments in the company’s material business and the construction of a new facility. Due the growth potential of new advanced materials making large investments in this business now could potentially lead to long term growth and profitability in the future. The company is also underleveraged when compared to its peers, showing a debt to equity ratio of just 31.84%, this means CVD has room to increase its leverage and therefore its profit. CVD also has plenty of capital available to grow its business, as of March 2018 the company had $13 million in cash and short term investments on its books as well as a book value of $41.4 million. When compared to its market cap of $46.5 million it’s clear that CVD Equipment trades at a very attractive valuation making this company another viable option for investors hoping to add some exposure to graphene. 

            Versarian, Haydale and CVD Equipment are far from the only companies involved in graphene. There are numerous small and large cap firms focusing on making this new material widespread and commercially viable. Companies like Samsung, Intel, Nokia, IBM and Sony have all reported that they are working on graphene and for investors hoping to avoid some of the volatility of smaller graphene names these large firms are a legitimate, if not a pure play, option. It is clear that graphene is a material that can change the world, as its development continues it is likely it will come up more and more in every day life. Investors who get in now at the beginning of its commercialization could potentially see massive returns down the line.


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Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor. 

Tuesday, May 29, 2018

Opportunities in a Wrecked Shipping Industry: LPG Tankers

Opportunities in a Wrecked Shipping Industry: LPG Tankers
By: Michael Molman
This article is Part 3 in a 3 Part series about the investment opportunities in shipping
            As 2018 continues one thing has become clear, markets are far more volatile than they have been in 2017 or in recent memory. As the economy moves into the late stages of the economic cycle and with asset prices at record highs investors have to be careful about where they put their money. Shipping stocks trading at the most attractive valuations in 20 years present an interesting opportunity. More specifically shipping companies involved in the transportation of certain energy products such as Liquefied Natural Gas (LNG) and Liquefied Petroleum Gas (LPG) present even better opportunities as supply and demand for these products soars at the same time as fleet growth slows down. In part 2 in this 3 part series on shipping I wrote about the opportunities in LNG carriers, this article describes the opportunity in an even more niche and possibly lucrative area of the shipping business, LPG Tankers. 
            To understand the opportunity in LPG Tankers it is first necessary to understand the market for liquefied petroleum products. LPG is the liquefied form of hydrocarbon gases such as propane and butane which are byproducts of natural gas processing and oil refining. The uses for LPG are immense, its used throughout the world as a cooking and auto fuel, it is used in refrigerants and as a petrochemical feedstock (which used to make plastic or synthetic rubber), you use if you want to barbeque, you can use it to heat your home, the uses go on and on. It also has the benefit of being clean burning and easy to transport, requiring little or no infrastructure. LPG’s versatility has made it prime choice of energy for developing countries and demand has been expanding rapidly. At the same time shale drilling in North America has turned the U.S into one of the largest energy producers in the world and consequently the largest producer of LPG, production of which is only expected to increase through 2026. By that time the global LPG market is expected to reach $150 billion. The new rapidly growing market in LPG has in turn created a new highly profitable segment within the shipping industry and led to the rise of a new type of commercial vessel, the VLGC (very large gas carrier). 
            These vessels are about 230 meters in length and could carry up to 43,000 tons of LPG across the world’s oceans. As the market for LPG began to expand charter rates for VLGC’s soared, going from an average $28,800 a day during 2011-13 to an eye watering $57,100 during 2014-15 on some routes charter rates were over $100,000 a day. The increase was largely due to a sudden spike in propane demand from China caused by the opening of several PDH (propane dehydrogenation) plants, which are used to create propylene (a superior alternative to propane). The combination of increased demand for LPG, especially from China, and small number of VLGC’s able to carry it led to an amazing boom in this shipping sector. Unfortunately it was not to last, like any commodity business when prices get to high more supply and more players inevitably enter the market, dropping prices back down. 
            Shipping firms anxious to take advantage of sky high rates for VLGC’s began to order new ships on mass. In 2015 and 2016 the LPG Tanker fleet’s carrying capacity increased 17% and 18% respectfully. At the same time LPG production decreased as oil prices plunged, suddenly there were more ships then cargo causing the booming industry to crash. The recession in the LPG Tanker market continued through 2017, which was one of the toughest years in the history of the VLGC market. Charter rates for VLGC’s along the benchmark Arabian Gulf to Japan route averaged $12,500 a day, well below the breakeven price of $21,000. Even worse supply continued to squeeze the market with new ships ordered during the boom years hitting the market in 2017. Overall LPG shipping capacity increased about 9% in 2017 even as demand for seaborne LPG increased only 5%. New players entering the market also made the situation worse. Increased fragmentation and saturation reduces bargaining power for individual shippers and charterers. At the end of 2017 there were 62 companies in the VLGC sector, 17% more than at the end of 2013. Overall the market for LPG Tankers and VLGC’s has been depressed for several years, but that is the best time to look for opportunity.

Average charter rate for VLGC's from 2011-2017 and projected charter rate from 2018-2020. Charter rates are  expected to begin recovering over next 3 years.
            Due to the excess supply of ships in the LPG Tanker market VLGC operators have seen their stock prices collapse over the last 2 years. Many of these firms such as Dorian (LPG) and Navigator Holdings (NVGS) trade below book value which makes sense given the poor fundamentals for LPG shippers. However, there are signs that the market for VLGC’s is set to recover and given the cheap valuations in the sector this gives investors an interesting opportunity. 
            The first sign of a recovery could be seen when examining the global market for LPG itself. As was stated before demand and consumption of LPG is surging around the world especially from developing countries that are in need of cheap, clean burning and easy to transport energy products. In 2015 the global market demand for LPG was about 278 million tons, it is forecasted to exceed 380 million tons by 2024, that is a 36% increase. Much of this increase in demand is expected to come from Asian countries like China, India and Indonesia. This is mostly due the rapid population growth in these countries and government initiatives trying to promote cleaner energy. In China alone LPG imports are expected to surge 40% by 2019 to 25.3 million tons as the country plans to open two new PDH plants. Each of these plants could consume as much a 1 million tons of LPG a year and almost all of this LPG will be imported from abroad. These plants alone mean China will need 3.5 more VLGC imports every month. Although that does not sound like much when considering the fact that the global VLGC fleet consists of barely 260 ships, such an increase in demand from China will have a significant effect on the market. China is also not the only Asian country increasing its LPG imports, Indonesia, South Korea, India and even Japan are all thirsty for more LPG as those countries continue switching from traditional fuel sources like coal to cleaner cheaper LPG. 
            As the same time as demand is increasing, production and exports of LPG is also increasing. This increase is being driven by large oil production in North America and the United States’ shale fields in particular. According to oil and gas shipping consultancy, Poten & Partners, in 2019 total U.S LPG production is expected to be about 65.6 million tons, that is 7.7 million ton increase from 2017. Almost 5.5 million tons of that increased production is expected to be exported. This increase in LPG exports is being driven by strong demand from abroad and no significant increase in domestic demand. The strong outlook for U.S LPG exports is a very positive development for the struggling VLGC and LPG Tanker market. Shipping LPG from the U.S to customers in Asia leads to longer charters for ships, which leads to higher fleet utilization, which in turn leads to higher charter prices and greater profits. The U.S is also not the only country increasing its LPG exports. New LNG projects starting up in Australia  in 2018 are set to boost that country’s LPG exports as well, from 1.6 million tons in 2017 to 2.5 million tons by 2019. Some estimates from shipping consultants and energy analysts say the total LPG exports could increase 41% between 2017 and 2019. Overall strong demand from Asian countries and increased exports from the United States and Australia create a favorable environment for LPG trading, which provides a strong market for LPG Tankers. 
Chart showing annual growth of seaborne LPG demand from 2013-2017 and projected growth from 2018-2022. Demand is expected to grow between 3-5% over the next 5 years.
            Although global demand for LPG might be slowing it remains healthy and positive which is a strong benefit for LPG Tankers. However, the depression in the LPG Tanker market was not caused by turbulence in the LPG market but rather by an oversupply of LPG Tankers and VLGC’s. Therefore it’s the slowdown in fleet growth that truly signals the possible turnaround in this specific shipping sector. Fleet growth in 2018 and 2019 is expected to average between 4% and 5%, a much more manageable level then the last 3 years. In fact according to global shipping consultancy Drewry, a slowdown in fleet growth should begin a recovery cycle in the LPG Tanker market beginning in the latter half of 2018. 
            High fleet growth in 2017 put significant pressure of ship values and freight rates, in the first 10 months of the year 54 new LPG Tankers entered the market, 21 of which were VLGC’s. This sent second hand prices for VLGC’s falling by 8% and freight rates to record lows. However, demand for LPG Tankers is expected to start outpacing supply of ships in 2018 and this trend is predicted to continue until at least 2020. This will shrink overcapacity and increase freight rates across the industry. According to LNG and LPG shipper BW LPG, charter rates for VLGC’s will average above $20,000 a day in 2018. Analysts at Grand View Research predict that over the next 3 years charter rates for VLGC’s will average $23,400 a day, such prices would make VLGC’s and LPG shipping firms profitable again. However, current oversupply still hangs over the industry and orderbook for new vessels still stands at 11%. In 2017, 14 new orders for LPG tankers were placed, 7 of which were for VLGC’s. Overall 30 new VLGC’s are expected to hit the market between April of 2018 and 2020. This increase in ships will be balanced somewhat by an increase in scrapping. Due the young age profile of the LPG Tanker fleet scrapping of vessels has been limited, but according to the C.E.O of major VLGC operator Dorian LPG, 35 LPG Tankers are set to be scrapped over the next 2 years. Such an increase in scrapping would go a long way toward balancing the market. 
            Despite the current oversupply and still relatively large number of ships set to hit the market, strong U.S LPG exports driven by rising oil and gas production, coupled with the expansion of LPG import and export capacity will strengthen the market for VLGC’s. Even though the supply and demand picture will remain fragile, overcapacity is expected the start shrinking over the next 12-18 months and the market is expected to be completely balanced by 2020.  With stocks in the industry trading at below book value such a modest recovery would lead to outsized returns for investors.
Chart showing annual fleet growth for LPG Tankers from 2010-2016 and projected fleet growth from 2018-2020. Fleet growth is expected to fall off heavily starting in 2018.
            Of course there are significant risks involved in investing in LPG Tankers, the primary one is the brewing trade tension between the U.S and China. As was stated before Asia’s and China’s importance to the LPG trade is enormous. China is the world’s largest buyer of LPG and alone was responsible for 20% of the LPG market in 2017, up frCom just 6% in 2012. Much of China’s LPG demand had been met with imports from the U.S and the rapid growth of the U.S – China LPG trade has been very beneficial for VLGC operators. Unfortunately this trade is under threat from the current tensions. In response to tariff threats from the U.S, China has retaliated by proposing its own series of tariffs on a variety of U.S imports. One of these proposed trade barriers is a 25% duty on LPG imports from the U.S. Such an action would be sharp blow to the LPG trade and to the LPG Tanker market in particular. 
            So far the tariff threat remains just that, a threat. No firm action has yet been taken and no date has been set on the application of the proposed tariff on U.S LPG. The announcement has had little impact of the VLGC market as of yet, since many in the industry believe China’s threat is a shallow one, meant to scare the United States to the negotiating table. In fact current trade negotiations could end up benefitting the VLGC market. President Trump has made it clear that he wants a steep reduction in the U.S trade deficit with China. The one way to accomplish this is through China agreeing to purchase more goods from the U.S, if this is the case the obvious goods for China to purchase are energy products such as LNG and LPG. China’s ever growing appetite for cheap clean energy corresponds perfectly with the increased production and export capacity of such energy products in the U.S. China already has a deal with Cheniere Energy (LNG) to import 1 million tons of U.S LNG a year, a new trade deal with the U.S could lead to similar arrangements for LPG. Such a deal would be a boon for the LPG shipping sector. 
            With all that being said the LPG Tanker industry much like the rest of the shipping industry is volatile, prone to sharp boom bust cycles. For investors willing to take on the risk the best way to invest in LPG Tankers is through the stocks of VLGC operators and LPG shipping firms. Such firms include U.S based Dorian LPG (LPG), which operates 22 VLGC’s with a total aggregate capacity of 1.8 million cbm (cubic meters). Another option for investors is London based Navigator Holdings (NVGS) whose 38 ship fleet consists of 33 handy sized LPG carriers (ships that are smaller than VLGC’s and have a carrying capacity of 15,000-25,000 cbm). Yet another option for investors interested in LPG shipping is Bermuda based Avance Gas Holding (AVANCE) which operates 14 VLGC’s and is traded on the Oslo stock exchange in Norway. These are not the only companies involved in LPG shipping but for investors who want to gain exposure to the recovering sector, these companies are good options. 
            Overall the fundamentals in the LPG Tanker market are improving. With stocks in the sector trading at wildly cheap valuations, investors who are willing to take on the additional risk now  are likely to see remarkable profits down the road when the market becomes balanced and the industry returns to profitability. 


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Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor.