III – Panacea

Drugmaker Imexpharm is suffering the side effects of government remedies.

To clamp down on corrupt hospital managers overpaying for medicine in return for kickbacks, the Ministry of Health has instructed that only the cheapest medicines are to be purchased.

For Imexpharm, which imports higher quality ingredients from Europe and charges among the top prices as a result, sales to hospitals have plummeted.

The decline has deterred investors, causing its shares to trail returns on Vietnam's benchmark equity index. While Vietnam's stocks have typically been priced at twice the value of their assets, Imexpharm has languished at 1.5 times its book value.^1,2

The stock has been performing worse still by Franklin Templeton's own metrics. The amount in the company accounts used to calculate book value understates the true worth of assets. Along with machinery, Imexpharm's core physical assets are acres of factory, warehousing and office space in the Mekong Delta region – real estate that's been rapidly appreciating in price. Yet accounting standards require the company to depreciate the value each year.

Rather than relying on the stated book value, Mark's colleagues run their own estimates of net asset value. Their higher valuation shows Imexpharm's stock price equivalent to just half of its assets, with a price-to-NAV ratio of 0.5.

As the largest shareholder after the government, with a stake of over 15%, Mark has taken a hit from the underperformance. The stock has lost 36% in five years while his holding in rival DHG Pharmaceuticals has made him a 131% gain (Table 5.1).

Source: Data compiled by Bloomberg as of December 2014. Annual return is the average for 2007–2013. PetroVietnam Technical is from first full-year data in 2008. Holdings data from Franklin Templeton as of end 2013

Inspecting the factory and meeting with the company's CEO and her deputy will be key to deciding whether to take the hit and sell, or take advantage of the cheap price to buy more.

It's lunchtime as we enter the site, so we're whisked off to a private room at a restaurant a two-minute drive away. The five of us and two Imexpharm executives squeeze around a table that would seat four in any Western diner.

Mark orders an orange juice but quickly changes to a local beer to follow the lead of our lunch host, Vice General Director Nguyen Quoc Dinh. He pours a can of Saigon 333 for Dinh into a glass filled with a large slab of ice, the custom for keeping beer cool in the tropical heat. We follow suit by serving one another with drinks and from platters of Mekong river fish, fried beef and seaweed-wrapped shrimps, appreciative now of the close proximity of our plates.

Conversation moves quickly to Imexpharm's biggest challenge. The company can't compete with the cheaper drugs being sold to hospitals, says Dinh. Nor would it want to. These drugs are not only less effective in treating symptoms but could expose patients to dangerous side effects, he claims.

“There are a lot of unwanted ingredients and with low technology they can't extract those harmful ingredients,” says Dinh.

Many of the drugs bought by the hospitals are supplied by Indian and Chinese companies, taking advantage of a zero-tax rate on certain medical imports.

Imexpharm ships all of the ingredients for its antibiotics, fever and pain-relief tablets, vitamins and specialist drugs from Spain. Importing from the European Union ensures the raw materials meet the highest international safety standards, says Dinh, but they don't come cheap.

We cross back through town to the CEO's office in a shiny low-rise building overlooking the factory and research labs. Tran Thi Dao, a lifelong pharmacist, has been with the company 30 years. Health policies will swing back to the company's favor before long, she says, citing a proposed legal amendment to give priority to locally produced drugs.

“The prospects seem brighter because they will protect the local companies,” says Dao. “But then I worry that there will be fierce competition among local companies themselves to become low-cost producers.”

The solution, says Dao, is to reduce Imexpharm's reliance on the cost-conscious hospital managers altogether. The company is shifting its focus to drug stores. Pharmacies play a bigger role in dispensing medicine in Vietnam than in other countries because they can sell antibiotics without a doctor's prescription. Imexpharm earned 60% of its revenue from hospitals and 40% from pharmacies in 2012. Now that's been reversed and the company is driving toward 70% from over-the-counter sales.

It's exactly what Mark wanted to hear. “I like OTC better,” he says. “It has more profit margin.” He nods keenly as Dao sets out her strategy of “slow but stable growth,” paying dividends to shareholders and staying No. 1 for quality among Vietnam's drugmakers.

Even her stated reluctance to entertain offers from foreign companies for fear of compromising quality control wins Mark's endorsement.

We leave the CEO's office for a tour of the factory but first we need to be dressed for the occasion. The investor controlling over $40 billion is handed plastic flip flops and a pajama-style blue shirt and trousers to minimize the risk of contamination. The matching night cap seems overkill on Mark's bald head.

We inspect bags of white-powdered antibiotics – doxycycline, produced in Spain – and a sugar-like coating used for the casings – maltodextrin. Giant machines dry and granulate the raw materials before shooting the deposits through a funnel for compression into tablets – 20,000 of them every hour. A processor, made in India, counts 2.5 million pills. The machines run day and night with operators taking 8-hour shifts.

In another room, thousands more tablets are being color coated in a giant tumble dryer that sprays a pink paint every few seconds. The process takes 12 hours.

Though Mark has clearly done this kind of tour a hundred times, he has the enthusiasm of Charlie in the chocolate factory. “You see,” he points, “you need to get every single one with the same coating.”

We stop to watch a worker – dressed exactly as we are – scooping up a few hundred pills and inspecting them for 30 seconds, before giving her sieve a shake and repeating the process again and again.

“I've been through a number of factories and you can see this company has very good quality control,” says Mark. “And they're running 24 hours, so they're utilizing the equipment very effectively.”

We climb into the van for the long drive back to Saigon.

“The CEO reminded me of my mother,” says Mark. “Kind but firm. The fact that she's not willing to succumb to a takeover by foreign investors is probably a good thing for us if they can improve the licensing, get more products and promote OTC.”

To Mark's mind now, the problem of government cost controls for hospitals has turned into a big opportunity. “It's actually a blessing in disguise because it's forcing them to promote OTC and to promote the brands.”

While Mark is impressed by Dao's restraint on expenditure and zero debt, the company is going to need to spend more on marketing its products to ramp up OTC sales.

“I'm sure many investors are skeptical of them being able to make the change, but most people are not aware of what we saw. This is one of the advantages of getting out to see the company. If they can keep the standard high and the image of top quality, the market will move up to them with incomes going higher.”

“Dao openly admitted this is going to be a tough year, but that's the time to buy, when things are looking bad.”

IV – Equitization

The Communist Party of Vietnam introduced a new word to the lexicon of capitalism: equitization.

The Collins English Dictionary defines it as the privatization of state businesses in Vietnam, though in reality the government mostly retains its control.

To encourage companies to equitize – raising cash for the state – they're offered 50% tax exemption. If they go on to list on the stock exchange, more incentives accrue.

Binh Minh Plastics, the pipes producer we're on our way to visit, equitized in 2004, transforming from a state-owned enterprise into a joint stock company. Then, in July 2006, it listed on Vietnam's stock exchange. Claiming both tax breaks, it skipped payments in 2004 and 2005 and cut the bill in half from 2006 to 2010. In retrospect, the Ho Chi Minh City Department of Taxation ruled, the company should only have been entitled to one concession at a time. It demanded payment of arrears plus a fine for administrative violations.

As we drive for an hour northeast from Saigon, we're briefed by Mark's head of research in Vietnam, Nguyen Thu Lam. “The tax department is changing the rules and the company is trying to appeal to various authorities,” she says. “It's not their fault. The tax department can't wait five years and then go back and say there's something wrong.”

Franklin Templeton owns 10% of Binh Minh, having increased its stake from 7% and reaped a doubling of the share price in 2013.

“The fact that Vietnam has this tax break is very encouraging,” says Mark. “It means the government would like to see these companies listed. There are a few other countries that have these incentives but not that many.”

“We've recommended to a number of countries that if they really want to get companies listing, they've got to give a tax break, especially in areas where there's a lot of tax evasion. It doesn't pay for a company that's been evading taxes to go listed and become transparent, so you've got to give them a carrot.”

We sweep through Binh Minh's main gate into a yard with wide crates stacked with pipes of every size and color. Blue pipes or black ones with a blue line are for water supply, while yellow is for gas and orange for electricity and telecoms. That's the coding in Vietnam at least.

“There's unfortunately no united international standard for pipes,” says CEO Nguyen Hoang Ngan, leading us past the workers' canteen to a private dining area next to the board room.

Over noodles, Ngan recounts how the company's appeal against the tax decision is still dragging on. “Because it's a very complicated problem, they have to get the opinion of the prime minister.”

A decision against the company could cut annual profit by about a quarter, he says.

Binh Minh's pre-tax earnings are around 500 billion dong ($24 million) a year. It makes about $24 for every $100 of sales for a gross profit margin of 24%. By Mark's criteria, anything above 10% looks positive. The high margin here is especially impressive given that plastic piping is normally a low-margin high-volume kind of business.

Binh Minh's margin is higher, says Ngan, because its prices are higher than competitors. “It's better quality, a better brand.”

It's also about size. The wider the pipe, the higher the profit margin and Ngan scours the world for the technology to grow ever-bigger. There are only five or six companies in Vietnam making large-diameter pipes, he says, which enables Binh Minh to charge top prices.

“Smaller companies can't compete,” he says. “We supply for some public projects, but some years the government projects will just stop.”

When the government does place an order, it can take over two years to pay. “Sometimes the government tells me the time I have to wait for payment depends on the Asian Development Bank or the World Bank,” says Ngan. “Small players can't do the projects, they can't wait that long.”

Ninety-five percent of Binh Minh's pipes are used for water and construction. Larger pipes are for longer distances before the line gets dispersed regionally.

“Last month,” says Ngan, “I was in Dusseldorf at the biggest plastics fair, where there are plastic pipes displayed from all over the world. They can produce a plastic pipe with a diameter of four meters.”

“Wow!” enthuses Mark. “If they can do that, that's tremendous because they can do long distance.”

In all the excitement and stretching of arms to gauge the size, Mark's water bottle topples over, narrowly missing our host. Then his investment analyst does exactly the same.

“In Vietnam,” says Ngan, “spilling water is considered an omen of prosperity.”

V – Automata

Fifty kilometers north from the chaotic streets of Saigon is an oasis of calm driving, courtesy and order. Vehicles give way to one another in plenty of time. There's no congestion or drivers tooting their horns. In fact – there are no drivers.

Welcome to Vinamilk. In an area the size of 20 football pitches, laser-guided vehicles go about delivering pallets stacked with cartons of milk. They offload to machines in a temperature-controlled warehouse. The machines then lift the crates 17 stories high onto shelves. On the way back down they pick up the milk first in to stack in trucks.

At a cost of $110 million, this ranks among the world's most advanced factories. The German-made automata churn out more than a million liters of milk a day nonstop, overseen by a few humans in white hats and lab coats.

Vinamilk is the stock market's star performer, soaring 50%-plus every year from 2011. Its popularity has lifted the portion held by foreign investors to the government-set limit, and that means anyone wanting to buy must pay a premium of somewhere between 5 and 10% to convince another foreigner to sell.

Franklin Templeton owns less than 1% of the stock. While the price at 17.4 times annual earnings is more than the average of 14 for Vietnam, it's below the price–earnings ratio of 24 for Nestlé, the second biggest milk producer in Vietnam, after Vinamilk. Across the border in China, equivalent dairy companies have been trading at p/e multiples above 30. Meanwhile, Vinamilk's profit margin is twice the average in Vietnam at 26% while Nestlé's is 15%.¹

The new factory – with enough spare capacity to double production – will enable earnings to grow in the order of 20% a year, estimates Mark's colleague Lam. Even after the building cost, Vinamilk has a lot of cash and no debt, so dividend payouts could go higher, she says.

Outside the factory in the Binh Duong province, giant milk vats tower over manicured lawns and sculpted hedges interspersed with fountains and concrete cows.

A real-life herd is the next big investment. Most of Vinamilk's produce comes from milk powder shipped in from New Zealand, Australia, the USA and Europe. The company plans to cut its reliance on imports by expanding its dairy herd of 8200 to 30,000 or 40,000.

“When we import from overseas or from third parties, there's some risk about the price and the quality,” explains plant director Trinh Quoc Dung. “So Vinamilk would like to increase local supply in order to better control our chain.”