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Malaysian Equities

August 2018

Trip notes: Diamonds in the Rough

A recent investment trip to Malaysia proves to be more than just a pulse check on investment ideas as Gita Ramakrishnan stumbles on the 'Silicone Valley' of the East'.

Shifting sands

Malaysia has fallen off the radar for many  emerging market investors as illustrated by the country weight falling from 33 percent at the inception of the MSCI EM Index in 1988 to 2.5 percent as of 20181. This has come on the back of unexciting, though stable, annualised real GDP (USD terms) growth of around 5 percent vs. world growth of 4 percent over that same period2.

Against that backdrop, investor expectations going into the recent general elections in May 2018 were muted - after all, having never lost a general election, the incumbent coalition party had comfortably been in power since the country's August 1957 independence. As such, the shock election results in favour of the opposition signalled a meaningful paradigm shift - with a wave of positive sentiment sweeping the country.

I had not expected my visit to Malaysia to be much more than a pulse check on current investment ideas but my trip in fact ended up being considerably more fruitful than anticipated. The confidence boost from a change in government seems to have tangibly energized the consumer. Spurred on by a temporary tax holiday on goods and services, spending accelerated across the hospitality and consumer discretionary goods sectors.

The confidence boost from a change in government seems to have tangibly energized the consumer

However meaningful change also brings some level of necessary pain and this is likely to hit fundamentals. The new government aims to tackle the surging budget deficit, which is linked to years of resource misallocation by the outgoing government and which is likely to take years to resolve.

While the populace seems happy to continue spending for now, investors and corporates remain largely hawkish, waiting for the dust to settle. Recent policy whispers appear fairly populist and years of supposed corruption leave any company with government related contracts open to the risk of scrutiny and governance investigations. 

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Exploring the Silicon Valley of the East

Although the post-election, on-the-ground feedback was valuable, the biggest finding from my trip involved a cluster of small to mid-sized technology companies in the state of Penang, recently dubbed the 'Silicone Valley of the East'. Penang is famous for its thriving food scene but exploring past the allure of the bustling food markets, I found myself in the middle of a burgeoning tech hardware hub.

Importantly, the state had been largely excluded from federal funding until now, as it had been governed by the then opposition party. The recent change of government could herald the start of significant infrastructure and state support for these fledgling industries, thereby creating an incremental positive driver in the sector.

Among the more interesting companies tucked inside the surprisingly lush Bayan Lepas industrial zone were ones focused on the Internet of Things (IoT) and visual testing for integrated circuit boards.

The applications for IoT based solutions are growing exponentially and should ensure an attractive earnings and cash flow cycle for some time to come. Many of these tech companies have developed intellectual property (IP) which creates meaningful barriers against competition and promotes further research and development, creating a powerful virtuous cycle.

Encouragingly, all the companies I met were entrepreneurial start ups, which have benefited from operating in a free trade zone. This has created a thriving information ecosystem. Additionally, being entrepreneur driven, many of these companies have robust dividend policies in place with payout ratios in excess of 50 percent. With healthy balance sheets (net cash), revenue growth of over 40 percent and returns on capital levels in the 30 percent area, these companies present the opportunity to invest in structural growth stories at attractive levels of returns.

The material drawback at present for most of these companies is the limited liquidity of the stock listings. However, as these companies mature and develop, the liquidity should increase substantially but unfortunately, so will the valuations.

To sum up, the trip to Malaysia yielded some exciting and many unexpected ideas. I believe we have been presented with the unique opportunity to build positions in stocks not yet fully understood by the wider market, much like buying raw diamonds before they shine.