AFC Asia Frontier Fund - Bangladesh - Excellent growth prospects hampered by uncertain policy-making

Dear Investors and Newsletter Readers,

As part of our continuing on the ground research, Ruchir Desai, co-manager of the AFC Asia Frontier Fund, recently traveled to Bangladesh for an investor tour. Photos are by Asia Frontier Capital.

Flying into Dhaka one needs to be prepared for a long wait at immigration. Having travelled to Bangladesh multiple times over the last few years I have gotten used to the very slow-moving immigration lines at Hazrat Shahjalal International Airport. This time however the slow speed reached a new level - it took me so long that I had to collect my checked bag from the “Lost & Found” desk! Moral of the story: do not show your displeasure to the immigration officer as the “waiting time” could get longer and you could be told that your passport has been ”reported” – the bureaucracy always wins! However, no complaints as these are some of the quirks of investing in frontier markets.

The Gulshan area in downtown Dhaka

Given the ongoing lack of quality hotel supply in Dhaka, most foreigners as well as foreign investors stay at the Westin hotel, as it is well located in Gulshan, which is an upscale district in the heart of Dhaka and home to many embassies. This time, however, the Westin was fully occupied and some of the tour participants had to stay at other nearby hotels. Usually, most of the foreigners at the Westin are either Indian or Chinese nationals but this time there appeared to be a lot of different nationalities staying at the hotel – it seems the security concerns of 2017 are long gone!

Hilton Dhaka coming up opposite the Westin

On this trip, some of the investors came a day early so that we could visit the factories of two companies as this gives one an opportunity to get a feel of what is happening on the ground. Given the traffic situation in Dhaka, the meetings with corporates are almost always held at the Westin hotel so getting on the road is welcome. There were two site visits planned for the day beginning with an ice cream and frozen food manufacturer followed by a truck and bus assembler. The ice cream and frozen food factory was located in Gazipur which is about a 90-120 minutes drive north from the Westin hotel in Gulshan. The absolute distance between both locations is not large (25-30 kilometres) but given the traffic situation in and around Dhaka it usually takes this long. Having said that, infrastructure investments continue to be made, with work on the Dhaka metro already underway.

The ice cream and frozen food assembly lines were both modern, using imported equipment from Europe, and the ice cream market in particular appears to have a lot of growth potential as per capita consumption of ice cream in Bangladesh is still very low with the industry growing in the mid-teens annually. After sampling a large selection of ice cream, we were off to our second site visit which was located in Dhamrai, a drive of about another 90 minutes. The highways that we encountered were mainly two lanes which leaves a lot of room for greater infrastructure investments and certain important highways such as the Dhaka-Chittagong highway have already been expanded to four lanes while highway expansions are also on the cards for other important road links. 

Sampling ice cream during the factory visit

The truck and bus assembler whose plant we visited is the Bangladeshi partner of Ashok Leyland, the leading Indian commercial vehicle manufacturer. We had a very well informed tour of the entire facility which was very modern with enough room to expand if the need arises. The commercial vehicle market in Bangladesh holds immense potential since it can benefit from sustained industrialisation and an improvement in the road network, both of which are improving and growing in the country. The total number of commercial vehicles sold annually in Bangladesh is less than 30,000 units, which for a population of 167 mln people and a nominal GDP of close to USD 300 bln is abysmally low. Vietnam, on the other hand, which is more industrialised and has a nominal GDP of USD 260 bln, sells more than 70,000 commercial vehicles annually. This leaves a lot of room for growth for the Bangladeshi commercial vehicle industry. However, certain issues like a lack of commercial vehicle financing by banks as well as non-banking companies is impeding growth but eventually this should change as the financial services sector matures.

At the IFAD Autos-Ashok Leyland assembly plant

Traveling by road in Bangladesh is not, however, for the fainthearted as aggressive over-taking, especially by bus drivers, is par for the course. Luckily for us we had a driver who could manage the intricacies of Bangladesh’s traffic. 

After the factory visits, the next two days were spent meeting various companies at the Westin hotel across the consumer appliances, cement, financial services, pharmaceuticals and telecom sectors. One common theme among most corporates that we met was the soft or negative sentiment regarding policy-making as well as the current poor stock market sentiment. Despite having one of the fastest growing economies globally as well as a relatively stable macro environment and very favourable demographics, stock market returns over the last two years have been disappointing and this has hurt overall corporate and investor confidence.

Investor sentiment in Bangladesh has been weak but valuations now attractive

There are two main causes for this poor sentiment. The first has to do with the banking sector, as the Central Bank over the past year or so has been pushing for regulating the net interest margins of the banking sector which is clearly not market friendly. In addition to this, there has been an increase in non-performing loans especially in the state-owned banks. Both of these factors have led to a slowdown in private sector credit over the past year as banks (especially private banks) have become reluctant to lend in light of this uncertain regulatory climate. 

The second major issue for investors is the protracted regulatory tussle between the telecom regulator and Grameenphone, the largest mobile phone operator in the country. The telecom regulator has claimed a large amount of USD 1.2 bln for past dues relating to taxes and fees for a twenty year period between 1996 and 2015. Despite this regulatory issue being known to investors over the last few years, relations between the regulator and Grameenphone began going downhill from the beginning of 2019 as the regulator, besides making its claim for the past dues, also took measures which could impact the expansion plans as well as operations of the company. 

Grameenphone, with a weight of around 16%, is the largest component of the Dhaka Stock Exchange Broad Index (DSEX) and this battle with the regulator has hurt not only its stock price but also overall market sentiment given the lack of investor appetite for regulatory overhangs which already persist in the banking sector. 

Grameenphone stock price movement sums up market sentiment in Bangladesh

Besides this, as we have discussed in our monthly manager comments, on a bottom up basis companies in the pharmaceutical and consumer appliance sectors in particular look very attractive given the under-penetrated segments that they operate in. On the ground, overall consumption remains strong with most consumer and pharmaceutical companies posting earnings growth of 10-15% over the past year. Bangladeshi pharmaceutical companies have also moved more aggressively into export markets with the factories of the leading players such as Beximco Pharmaceuticals and Square Pharma receiving approvals from the U.S. FDA which allows the companies to get market approval for certain of their products in the U.S.

Store opening of Domino’s Pizza in Bangladesh – consumption story remains very strong

There was a lot of investor enthusiasm after the parliamentary elections took place in December 2018 with the DSEX rallying by 8% in January 2019. Since then, however, the regulatory impediments that have come up have been disappointing to investor confidence since expectations were for policy makers to further leverage the country’s growth prospects. 

Bangladesh has a lot going for it in terms of more favourable macroeconomic metrics relative to regional neighbours. It has become the second largest garment exporter globally after China which is helping it to raise income levels and also build foreign exchange reserves. The current trade tensions have had a positive impact on garment exports to the U.S. but over the last few months, garment export growth has been weak which has also raised investor concerns. However, the European Union’s (EU) recent decision to revoke duty free rights for certain Cambodian garment products is a positive for the Bangladeshi garment sector since affected factories in Cambodia could look to relocate to Bangladesh as the country’s  garment sector has duty free access to the EU.

Besides the garment sector, the country is doing very well in diversifying its manufacturing base with local assembly of automobiles and smartphones witnessing increased interest from foreign multinational companies. In 2018, Honda began local assembly of motorcycles with a 100,000-unit capacity while in the same year Samsung began assembly of smartphones for the domestic market. Furthermore, Bangladesh now meets most of its smartphone demand through domestically assembled handsets with 2 million smartphones locally assembled in 2019 compared to 0.7 million a year ago, with 65% of smartphone demand being met by local production.

The country should leverage the unique position it is in, in terms of its demographics, its position as a beneficiary of trade tensions and its geographic location between two large regional power houses. Sustained focus on “regulatory” issues risks turning these tailwinds for the economy into future headwinds!

For further viewing, here are some interesting and relevant news links related to Bangladesh:

• Bloomberg Radio: Vietnam And Bangladesh Offer Good Opportunities
• Bloomberg: Trump’s Trade War Is Turning Out to Be a Boon for Bangladesh
• The Daily Star: Solving bank troubles, GP-regulator issues key for DSE
• The Daily Star: 15 lakh Samsung smartphones assembled in Bangladesh in 1yr
• South China Morning Post: Move over, ‘Made in China’. It’s the ‘Made in Bangladesh’ era now
• Finanz und Wirtschaft: Bangladesch ist Favorit für die Industrialisierung - Interview with Thomas Hugger (in German)

For information about the AFC Asia Frontier Fund click one of the following links:

I hope you have enjoyed reading this travel report. If you would like any further information about the AFC Asia Frontier Fund, please get in touch with me or my colleagues.

With kind regards,
Thomas Hugger
Fund Manager

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