Vietnam: A Beneficiary of Foreign Investment, Urbanisation and a Growing Middle Class

Members of Platinum’s Asia team recently travelled to Vietnam, visiting companies that we already own and scouting for potential new investments. Immediately as we disembarked, we could sense the energy and buzz on the ground. Our insights and key takeaways are below.

Having closely witnessed China’s growth over the past two decades, we see a strikingly similar story developing in Vietnam today, namely, its structural growth is underpinned by:

- Rising foreign direct investment (FDI)
- Increasing urbanisation driving demand for infrastructure and real estate
- A growing middle class.

An attractive destination for foreign investment

Vietnam has experienced phenomenal economic growth, growing at an average annual pace of 6% over the past decade.^[1] The country has benefited from growing FDI as multinational corporations (MNCs) looked for new production bases in the region to offset the rising cost of conducting business in China after the double-digit percentage increase in the cost of labour there over the past decade.

Fig. 1: Vietnam real GDP growth (% Year on Year)


Source: CLSA, CEIC.

Fig. 2: A relentless rise of FDI in Vietnam (US$ bn)


Source: Dragon Capital.

While we don’t believe that MNCs will pull out of China in any significant way, there is growing acceptance of the China-plus-one strategy as a viable sourcing approach. Vietnam stands out over its regional peers in several regards, namely:

- Significantly lower cost of labour (see Fig. 3 below)
- Geographic proximity to China allows it to tap into the Chinese supply chain
- An abundant supply of a young and well-educated labour force. The working population (aged between 15 and 64) accounts for 70% of Vietnam’s total population, and the national literacy rate is 95%.^[2] 

Fig. 3: Vietnam’s labour costs are half that of China’s
Manufacturing labour costs per hour for China, Vietnam and Mexico from 2016 to 2020 (US$)

Source: Statista.

While workforce productivity will take time to reach levels comparable to China, we heard anecdotes of employers’ high regard for the work ethics of local employees.

The signing of multiple trade agreements in recent years,^[3] together with rising trade frictions between the US and China, should further propel Vietnam as a preferred location for manufacturing.

While the pace of growing exports in the headline numbers is to be marvelled, rising from US$114 billion to US$365 billion over the past decade,^[4] the composition of Vietnam’s exports by products shows a clear shift from a decade ago, with electronics and components becoming more prominent than textiles and footwear and representing 45% of total exports.^[5] Lured by the monetary incentives offered by the Vietnamese government in the form of tax concessions, large Korean conglomerates set up their operations in droves, pledging to invest US$15 billion in new plants, including US$6 billion from Samsung and LG Electronics. As these giants established their bases, their upstream component makers followed them into Vietnam, often with plants located nearby.

In an industrial park in Bac Ninh Province, 50 kilometres from Hanoi, we saw rows of neatly laid out industrial properties that have been taken up by well-known electronics makers, including Apple’s principal assembler Foxconn and smartphone acoustic component maker Goertek.

The industrial park operator told us that it takes 3-5 years to get one industrial property up and running. The process is fairly cumbersome. A feasibility study needs to be submitted, farmers who currently occupy the land need to be compensated, a 50-year land lease agreement with the government needs to be entered into, and a land use certificate needs to be issued, followed by a sublease to industrial tenants. The government has recently tightened requirements on industrial property operators; hence, the review process has become more stringent. Given such an involved process, we are of the view that investing in local companies that are well versed in navigating the red tape, is a sensible investment strategy.
 
Urbanisation is driving infrastructure and housing

The rising urbanisation rate, together with household formation, is driving new demand for infrastructure and housing. Our guide informed us that the entire country has only 600 kilometres of highways (400 kilometres in the north and 200 kilometres in the south) for a population of 95 million, with over 15 million people residing in the two major metropolises of Ho Chi Minh City and Hanoi, and an annual rural to urban migration of 1.5 million people.^[6] Further, there are 500,000 new households formed through marriages each  year.^[7]

It is our view that the housing market is at a relatively nascent stage of development, and consequently, the affordability ratio is comparatively good. A two-bedroom, mid-end apartment with 80 square metres of floor space in Ho Chi Minh City and Hanoi can be purchased for US$150,000. For couples in the top 15-20% income bracket earning a combined income of US$23,000, that’s around six-and-a-half times their household income. Rental yields are running at an attractive 4.5-5% in Hanoi and 4-4.5% in Ho Chi Minh City.^[8]

The new Ocean Park mega property development located 40 minutes from downtown Hanoi, is still in a nascent stage. Our commute over the expressway passed through sparsely populated farmland on the eastern side of the Red River. We sensed an ongoing reluctance among most residents to commit to that type of daily commute, with most buyers opting to use their new purchase as their second home. The project comes with extensive amenities, including a man-made beach (locals call it a salt lake), an outdoor gym area, a mega retail mall, an international school, and a university that are operated by the developer’s related entities. The scale of the project reflects the ambitions of the developer as well as the realisation that there is a significant cost advantage from extensive land banking and a phased launch of projects due to the general upward trajectory of land prices.

There are issues within the property sector that the government is trying to resolve, which is currently in the eye of the storm. Due to the slow project approval process by local governments since the introduction of anti-corruption laws in 2016, developers have prioritised the sale of premium projects while neglecting the mass segment where the bulk of demand lies, thereby creating a demand/supply mismatch. Moreover, there’s the problem of these so-called “developers”, who are merely speculating on the value of their prime land plots without actually engaging in any real development. These land premiums are often funded through bond issuance and marketed to retail investors based on yield enhancement, without the underlying development project delivering any cashflows to fund bond interest payments.

The recent arrest of a high-profile developer, along with changes to bond issuance rules, shows the government is serious about remedying these undesirable behaviours. With the overall housing construction sector contributing less than 4% to national GDP, we don’t believe that the housing sector is overextended or that it poses a persistent drag on the economy. We have avoided investing in Vietnam’s property sector to date, not because we have doubts about its long-term potential but rather due to the issues surrounding developers and the sourcing of land banks.

The rise of the middle class

One of the exciting domestic stories is the rise of the middle class in Vietnam. There are 24 million people who fit the global definition of the middle class, representing roughly 25% of the population.^[9] According to McKinsey & Company, less than 10% of Vietnam’s population were members of the middle class in 2000, and by 2030, this figure is expected to be close to 75%.^[10] With the growing FDI, there is a progressive shift in the workforce away from the agricultural sector to higher-paying manufacturing and IT outsourcing
jobs.^[11] This, in turn, is driving improvements in the standard of living, with rising ownership of household appliances and electronic devices.

As we’ve seen in other neighbouring countries, the emergence of a growing middle-class population tends to coincide with the transformation of the retail sector, from unorganised locally-owned stores to branded retail chains. Private enterprises, flush with funding from capital markets and seeking to replicate the well-worn playbook from other markets, are turbo-charging the build-out of modern trade. Armed with more sophisticated merchandising, marketing and site selection, along with an improved overall shopper experience, it is easy to see why investors are betting on the inevitability of this channel shift. Mobile World Investment (a holding in our Asia ex-Japan strategy) is a company that exemplifies this retail format transformation. Mobile World has close to 50% market share in consumer electronics and mobile phones and has built a strong footprint in grocery retail.^[12] One insight we heard on the ground was that urban mall visitation is currently hindered by the lack of transport infrastructure, with the metro railway yet to be completed. As two-wheeler scooters are the dominant form of private transportation, urban consumers still prefer street stores for their ease of vehicle access, but this is expected to change once the new railway is completed.

Vietnam has a relatively young demographic, with around half of its population aged 30 or below.^[13] This has been conducive to the rapid adoption of mobile payments and e-commerce, similar to what we saw in China over the last decade. We visited an e-commerce retailer’s logistic operations. The warehouse manager is an ex-pat who had previously worked at multiple global express delivery companies, and he saw a lot of opportunities to improve efficiency through greater standardisation. Speed of delivery is increasingly a differentiator, and e-commerce operators have had to build out in-house logistic capabilities to adequately compete. They operate many local warehouses under a ‘hub and spoke’ model close to consumers to increase delivery speed and reduce the costs of delivery. This also proved helpful during COVID-19, when there were movement restrictions across different regions. The main challenge is that with consumers demanding faster deliveries, the cost of warehousing close to the city is getting more expensive, forcing operators to move outwards from the centres.
 
Dominant consumer franchises also provide an attractive investment opportunity in Vietnam, such as in the dairy industry, where there is plenty of scope to ‘premiumise’ product offerings as consumers become wealthier. We have exposure to this growing sector via VinaMilk (formerly Vietnam Dairy Products Joint Stock Company). VinaMilk is the dominant dairy producer in Vietnam, and we visited their packaging plant located on the outskirts of Ho Chi Minh City. We were impressed with its operations on our visit; the plant appears to be well managed, with stringent quality controls on raw materials conducted at multiple points and the use of advanced machinery imported from Switzerland, and packaging lines are well automated with minimal human presence.

Market and regulatory observations

There is much optimism among the local brokerage community that Vietnam is slated for an upgrade from a frontier market to an emerging market over the coming two years. Two broad issues still need to be resolved, namely, the lifting of the foreign ownership limit and the establishment of a central counterparty system to allow trading without deposit requirements.

We met with senior monetary policymakers at the State Bank of Vietnam (SBV). SBV has adopted an inflation-targeting regime since 2011, following a period of high inflation in 2008-09 that saw headline inflation exceed 20%. As the US Federal Reserve increased policy rates in 2022, SBV followed suit and also increased rates by 1% in September 2022 to 5% and another 1% to the current rate of 6% in October,^[14] as it prioritised curbing inflation over promoting growth. This looked slightly conservative to us given that the local inflation rate of 3.1% was far from alarming and below the SVB’s own 4% inflation target.^[15] We suspect SBV’s decision primarily reflects its desire to protect the currency, given that it was intervening in the currency market by selling its foreign exchange reserves. The subsequent 0.5% cut in the policy rate in early April, reflects a shift in priority towards supporting growth.

On the political front, despite the ruling party being communist, the governance system tends to be socialist. In our view, the government is pragmatic and willing to make decisions that are in the best interests of the population without being burdened by ideology. The government demonstrated administrative competency during the pandemic, where it was able to quickly bring COVID-19 under control, secure early access to vaccines, open up its borders and normalise the economy in 2022.

The recent corruption crackdown, which reached the top echelons of the Vietnamese government, unnerved many foreign investors. This, along with a crackdown on bond market activities, were the key drivers behind the 40% retracement in the local stock market in 2022. One would think that if the motivation of this campaign is strictly aimed at rooting out corruption within the party, that would be positive for boosting the confidence of foreign investors.

Summary

Our trip to Vietnam confirmed the importance of on-the-ground visits: local contacts and face-to-face company meetings and site tours are invaluable, especially given that Vietnam is still an under-researched market. Its growing economy, burgeoning middle class and rising urbanisation rates, which are creating infrastructure and housing investment, place it on a remarkably similar growth path to that of China’s, albeit on a much smaller scale given the population differences. Its attractiveness as a destination for foreign investment, particularly from companies seeking to reshore and diversify their manufacturing bases away from China, provides further support for the investment case. We are excited about the companies we have invested in that are tapping into these growth themes, and we will continue to explore further opportunities in this fast-growing, rapidly changing economy.