THD - THD: Thailand Is Pricey Despite The Political Overhang

2023-08-18 16:42:25 ET

Summary

• The near-term macro backdrop isn't great for Thai equities.
• Nor is the ongoing political wrangling post-elections.
• The iShares MSCI Thailand ETF is still pricing in a blue-sky outcome and looks vulnerable.

My bullish call on the iShares MSCI Thailand ETF ( THD ) hasn't quite panned out this year - despite tourist arrivals continuing to pick up. The key fundamental issue for Thai equities has been the country's linkage to a deteriorating Chinese economy, with the latest set of negative data points signaling that even the (conservative) +5% target could now prove to be too high a bar. Perhaps most importantly for valuations, the heightened political uncertainty in post-election Thailand is triggering significant foreign equity outflows.

For now, all signs point to a Pheu Thai-led coalition government and party leader Srettha taking over as Prime Minister, backed by the military parties (despite progressive party Move Forward winning the election). Things aren't quite certain yet, though - next on the timeline is a delayed Prime Minister vote, after which government formation is likely in late September.

Investors might be tempted to go tactically long THD in anticipation of a relief rally, but I would be cautious. Thai stocks aren't cheap at ~17x fwd earnings relative to consensus estimates for a high-single-digit decline in 2023 and a low-teens earnings rebound next year. Nor is it priced for political unrest should Move Forward's supporters take to the streets in the aftermath of an unfavorable post-election outcome. Net, I would be on the sidelines here.

Fund Overview - A Well-Diversified Portfolio of Thai Large-Caps

The iShares MSCI Thailand ETF, which tracks the benchmark MSCI Thailand IMI 25/50 Index, has seen its net assets decline this year to the current $297m. The expense ratio remains reasonable at ~0.6%, given the lack of single-country alternatives for Thai exposure.

From a sector perspective, the THD portfolio is better spread out than most other Southeast Asian funds, with Energy leading the way at 13.9%, along with Consumer Staples (12.4%). Other meaningful exposures include Health Care (9.7%), Industrials (9.0%), and Financials (8.9%). Of note, all THD's sector allocations run well above the 5% threshold.

The expanded 140-stock portfolio composition is largely consistent with prior quarters, with convenience store operator CP All ( OTCPK:CVPUF ) still the largest allocation at 6.2%. State-owned oil and gas company PTT ( OTCPK:PUTRF ) also gets a substantial weighting at 6.1%, along with Airports of Thailand ( OTCPK:APTPF ) and private healthcare giant Bangkok Dusit Medical Services ( OTCPK:BDULF ). The most notable change is the upsizing of THD's Delta Electronics (Thailand) ( OTCPK:DLEGF ) exposure at 5.5%. Like the sector breakdown, THD's single-stock allocation is relatively spread out, limiting concentration risk.

Fund Performance - Solid Long-Term Compounding Despite the YTD Weakness

On a YTD basis, the ETF has now declined by 10.2%, though its total annualized return since inception still stands at a respectable +5.0%. Like its Southeast Asian peers, however, THD's shareholder returns are back-end weighted, with returns over the last five- and ten-years screening poorly at -2.0% and +1.8%, respectively. A key drag on the recent performance has been COVID, given Thailand's tourism-dependent economy; this year's recovery has, however, also been derailed by political turbulence and China concerns.

THD's distribution trails other bank-heavy Southeast Asian ETF portfolios, but at 2.6%, remains respectable. While the fund is down for the year, its underlying fundamentals aren't that bad, as highlighted by the strong H1 2023 distribution. So assuming the pace of tourism recovery continues through H2, I would expect a modest upside to near-term distributions. And over the long run, THD's leverage to the Thai economy's growth potential should keep payouts on an upward trajectory.

Ongoing Political Turbulence Remains Top of Mind

The Thai stock market has extended its declines in recent months as investors de-risk following a surprise May general election that saw the pro-reform (and anti-establishment) Move Forward Party winning the most seats. But party leader Pita Limjaroenrat has since faced several roadblocks, including a subsequent failure to secure the minimum parliamentary votes (short of 51 votes vs. the 375 votes required). Not only have concerns arisen about the party's proposed amendment of Lèse-majesté (i.e., Thailand's long-established Royal defamation law) but also around an Election Commission ruling for Pita to be disqualified due to his minority stake in private broadcaster iTV. These concerns have proven insurmountable for Move Forward thus far, paving the way for the Thaksin-linked Pheu Thai party (the general election runner-up) to form a coalition with the military/incumbent government's parties.

Whether or not a PT win is justified, a PT-led government would almost certainly be more business-friendly, given its moderate economic platform. While PT has also committed to minimum wage hikes, it will do so at a far less aggressive pace than Move Forward (staggered over several years vs. immediate). The party is also more supportive of consumption-led stimulus measures, which should at least partially offset the margin pressure from wage hikes.

Considering the push-pull factors, though, I don't see a clear bull case for THD from here. Valuations are still elevated (on an absolute basis and relative to the Southeast Asian region) despite steep downward earnings revisions this year. With the political overhang also not yet lifted and near-term growth risks skewed to the downside due to Thailand's close trade ties to China, there isn't much of a margin of safety here. In the meantime, I would keep a close eye on potential street-level protests by Move Forward supporters in the coming weeks. The market seems to be factoring in a rather benign outcome, so any negative surprises here could reset valuations downward and potentially impact the tourism recovery as well.

Thailand is Pricey Despite the Political Overhang

It's been a torrid year for THD investors, as a promising start to the year has been marred by concerns about an external slowdown (particularly China) and prolonged post-election uncertainty. Alongside the technical overhang from foreign net selling, Thai equities have unsurprisingly underperformed against its regional peers.

But with a more moderate and establishment-friendly PT coalition now emerging as the favorite to take over, the political overhang looks set to clear sooner rather than later. For investors as well, this would be an ideal outcome, given the less punitive measures proposed by PT with regard to minimum wage hikes and corporate taxes.

Yet, I wouldn't be too quick to dip into THD just yet. The THD portfolio, despite this year's selloff, is still priced at a high-teens forward earnings multiple that isn't justified by its underlying earnings growth trajectory. The pricey valuation also limits the buffer against tail risks, including street protests from Move Forward's supporters or any resulting disruption to the tourism recovery. Pending a meaningful reset, I would be cautious.

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