Opus 19: Investing Adventures in Bhutan
Finding hidden gems in the Land of the Thunder Dragon
I recently spent a week in Bhutan for personal travel. Bhutan is a small, land-locked country tucked away in the Himalayas bordering India and Tibet. The country is both the youngest monarchy (established 1907) and the youngest democracy which started in 2008. The monarchy is still very much active today with the King acting as the country’s president with many of the same governance power i.e. vetoing, military control, budget approval, etc. As you spend time in Bhutan, you see the immense respect that the people have for the King. I believe this love and admiration is sincere and not one driven by propaganda to frame the King as a benevolent dictator. The current King has greatly modernized the country with a focus on tourism, infrastructure, social benefits, and trade.
It is hard to describe Bhutan and its uniqueness. It is well known as the “happiest country on earth,” and this is tangible while you are there. The people’s happiness is contagious. Everyone smiles at you, even in more remote villages where seeing non-Bhutanese people surprises many. Socioeconomically, the country is in the bottom quartile of material wealth - ranking between Iraq and Jordan on a PPP basis. But, having visited countries in the same wealth band - India, Vietnam, Morrocco, and Namibia - in Bhutan, you get the feeling that you are in a far wealthier place. The infrastructure is impressive for the country’s wealth level, with great roads spiraling into the tallest mountains, functioning public transit across the country, and constant construction giving a sense of progress. The culture, much of which is centered around Buddhist values, is one of selflessness, giving, and family-first. No one prioritizes material wealth or financial success.
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I think everyone should try to go to Bhutan once in their life. At the very least, it is an important reminder that happiness can be had with very little, something I think most Westerners have sadly forgotten.
Stumbling Across a Ticker Tape
During our second day in Bhutan, we were walking down the street in the capital city, Thimphu, and came across a digital board that displayed some familiar-looking numbers:
Our guide explained that we were looking at the stock prices of the public companies within Bhutan. I was fascinated that such a small country - 700,000 people, <$2.5B in GDP - had an active domestic equity market. To provide a frame of reference, the entire country of Bhutan is less than half the population of Manhattan.
The building we were looking at was the leading insurance company’s headquarters, in which the stock market operations were located.
The Bhutan Securities Market
The purpose of this post is two fold. First, I wanted to understand the Bhutan stock market and share the learnings with everyone. Second, I wanted to see if there were any interesting opportunities in the country - this second point is partly inspired by Kuppy’s post from 2017 on the undervalued stocks in Kyrgystan. Maybe there were some equally special opportunities hidden away in the Himalayas.
The Royal Securities Exchange of Bhutan (RSEB) is one of the smallest in the world with a total market capitalization of its listed companies totaling ~$700M at the time of this writing. The exchange opened in 1993 and offered electronic trading in 2012. There are currently 19 companies listed on the exchange.
The Bhutan domestic market capitalization to GDP ratio (the “Buffet Indicator”) stands at 27% today. This is in a similar range to its geographic neighbor of Bangladesh at 26% but is far below most mature financial markets today, with many above 100-200% of GDP. Market liquidity (annual volume compared to GDP) is one of the lowest in the world at ~1.4%. This is due to a lack of domestic participation in the equity markets, explained by the average household excess savings and overall financial literacy / education of the population, and only a few open trading times per day. This lack of active trading is also a key factor in explaining many of the companies’ valuations, as there is no active market for accurate price discovery.
Equity ownership of listed companies is similar to that of many developed countries. The general population holds 25-40% of many listed companies’ equity with the balance being made up of institutional investors, insiders, and financial institutions within the country.
On the credit front, Bhutan is even earlier in its development, with only three corporate bond issuances in the last 5 years totaling ~$4M in total issuance. There is no credit rating agency in the country, so bond sales and trading have had very little regulatory infrastructure to build on top of.
Bhutan is an incredibly insular country which I say with a great respect and admiration for the country. They have what they need and do not want the outside world to tarnish it. No foreign person is allowed to own property or land in the country. FDI must be approved by the Bhutanese government (read: royal family), and there were only 100 FDI funded projects in 2022. Because of this, only four listed companies have foreign investors, with the largest ownership being 51% of Druk PNB Bank.
There are 100,400 opened accounts at the Bhutanese Stock Exchange as of EOY 2022 via their six registered brokers with seats at the exchange. The main broker (RICB Securities) traded 85% of all share volume in 2022 with many brokers seeing no volume at all in the year. It is important to note that the RICB Brokerage business is owned by The Royal Insurance Corporation of Bhutan, a publically traded company on the exchange.
The governing body for all securities regulation is Bhutan's Royal Monetary Authority (RMA), which is also their central bank, treasury, and stock exchange owner. This is a very different regulatory architecture when compared to most Western countries and even Bhutan’s neighbor India where SEBI is a completely independent body from the central bank and currency issuing entity.
For companies to go public in Bhutan, they must have 2 years of financial profitability before listing. Quite a stark difference when compared to the US where currently ~30-40% of small cap listed companies are unprofitable. Companies must also sell 10% of their share capital to institutional investors and have at least 50 separate public shareholders at the time of initial listing.
In an effort to boost public market activity, the Bhutan government has also provided a 5-year income tax holiday for any companies that are publicly listed. The country also has no capital gains tax for investors who purchase public shares.
Overall, the capital market regulation is quite light as one might expect given its relative size and lack of international capital.
From 2016 through 2021, the Bhutanese market capitalization of all listed companies grew from $420M to ~$700M today.
Compared to other markets, Bhutan’s performance is impressive given its size and lack of coverage. Over the last 5 years, the country’s market has returned ~12.5% per annum which is in line with the S&P 500 and Indian markets.
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Some Interesting Companies
Similar to the report on Kyrgyzstan, I was curious if there were any interesting opportunities to find deeply discounted equities in Bhutan. Kuppy was able to find a stable, growing airports business trading at <1x cash flow that also paid out a majority of its earnings in dividends. Could we find similar opportunities in Bhutan?
This is purely out of curiosity given I cannot invest in any Bhutanese securities due to the foreign investment rules and would need to seek a personal waiver from the King, something I don’t think I will be getting. Nonetheless, it is a fun exercise!
Bhutan National Bank (BNB)
Bhutan National Bank (BNB) is the largest listed company in Bhutan, founded in 1995 as the Unit Trust of Bhutan. The company was converted into a commercial bank and went public on the RSEB in 1996. The company sold 40% of its equity to the Asian Development Bank and Citibank in 1997. It is the most valuable company on the RSEB and currently constitutes 23% of the total public market capitalization of all listed companies. The bank is the second largest in the country behind the Bank of Bhutan (BoB) which is owned by the Bhutanese and Indian governments.
In 2022, BNB reported an ROE of 17.1%, which is incredibly high for any bank, let alone a frontier market bank. For reference, US banks have struggled to maintain an ROE >10% in a post GFC world given the new regulation from Dodd-Frank and other constraints. JP Morgan, arguably the best-run bank in the world, saw a 14% ROE in 2022. The bank published an 3.4% net interest margin on risk bearing assets in 2022 - materially above the US average of ~3% in the same year.
The bank grew earnings by 57%, an impressive feat considering Covid headwinds continuing to hurt the country until its reopening in November 2022. The bank grew its loan portfolio by 20% in 2022 and another 27% for the six months ended June 2023. Oddly, BNB did not increase loan loss provisions in 2022 or H1 2023, even with the ballooning in loans.
The bank is run quite conservatively with a CET1 capital ratio of more than 21% as of EOY 2022. The bank is shielded from global interest rates increases for the most part with investment securities (the bank does not break out fixed-rate loans vs. other securities) making up a small portion of the assets. Customer loans constitute 65% of total assets, with another 21% in corporate operating cash
The other side of the balance sheet is a bit odd at first glance. Customer deposits at most banks make up a vast majority of deposits, especially smaller, regional banks that do not participate as much in the overnight repo markets or borrowing from other banks. Many US regional banks’ deposits make up 80-90+% of their total liabilities. But, BNB’s deposits are only 58% of their liabilities with a large portion (27%) sitting in a line item called “Due to Banks and Financial Institutions,” which, with no other context, I have to think is outstanding debts at the Bhutan Central bank for short term liquidity borrowing. I am not intimately familiar with the recent Bhutanese rate environment but US-based banks saw a jump in their borrowing with the BTFP as part of the banking fallout earlier this year with many balance sheets now seeing 5-15% of liabilities sitting at the central bank.
The bank ended 2022 with a market capitalization of ~$150M. Overall performance since 2018 has been in line or slightly above the global banking industry performance with an average 7% / year share gain.
In terms of valuation, the bank traded at an average of ~1.8x the bank’s book value in 2022, which is by no means cheap. Domestic US banks are currently trading at 0.8-1.4x their book value, depending on size, exposure to rates, and market concentration. The bank reported $14.5M in operating income for 2022 - implying ~10.3x TTM PE. Again, not a cheap bank given many regional US banks are trading at <6x TTM earnings. The bank currently offers a dividend yield of ~4.3%, but their dividend ratio has been quite volatile in recent years.
Overall, the Bhutan National Bank is a premier asset in the country and is priced as such. Value investors won’t find much opportunity here and prospective investors would need to believe in the continued macro growth of the country in the coming years. Loan performance has been steady, with NPLs near historical lows, but given the new era of global rates, the variable rate loan portfolio at the bank could start to stress.
Druk Wang Alloys (DWAL)
The best-performing stock on the RSEB over the last five years is Druk Wang Alloys (DWAL). It is an industrial business that produces ferrosilicon, an alloy of iron and silicon that is used in steel manufacturing processes.
Over the last five years, the company has seen a 9.2x increase in equity value or a 55% CAGR. Performance of that level demands investigation.
In the same period, the business saw average annual revenue growth of 11%, with a 38% increase in the last year alone as Bhutan opened back up after Covid and trade, construction, and general productivity resumed. The company’s production levels remained relatively flat from 2021 to 2022, but it appears the company had incredible pricing power to charge far higher rates on their product.
Earnings increased an average of 64% over the 5 five years. In the most recent year though, earnings growth slowed behind top-line growth as the company’s expenditures ballooned.
On a per-share basis, the story gets a bit more complicated. In 2022, DWAL nearly tripled its outstanding share count through a primary share offering. Strangely, though, this share increase is not documented anywhere. Their dividend declaration and buyback program of 1.5% in 2022 are both documented but the share issuance is not mentioned in any reports, filings, or news articles. Because of the share increase, DWAL has seen its EPS decrease from $0.28 to $0.12, causing the PE of the stock to jump from 5x to nearly 13x even with the earnings jump.
The DWAL story has gotten more complicated in recent months, according to their H1 ‘23 report. Revenue in the first half of the year is down 30% compared to H1 ‘22, and earnings plummeted 70% in the same period. This drop, in combination with the share issuance, resulted in earnings per share decreasing from $0.25 to $0.3, a 90% drop. Looking at cash flow, the company saw inventories jump 135% in H1 of 2023 and a large receivables payment. These factors all led to a drop in cash from $4.2M to $1.3M from H1 2022 to H1 2023. As a result, the stock has retreated ~30-40% from its trading highs in 2022.
It appears that the company sold a large investment holding and raised cash in a share issuance in order to fix their main iron furnace (a 15-year-old asset) and build a new larger furnace to double capacity per the company’s 2022 report:
“The furnace has been operating over 15 years and is due for a major overhaul, we have experienced frequent breakdowns in the last year and anticipate similar performance this year. As a result of this, we have decreased our targeted production and sales for the year 2023. [...] company is installing a second 18MVA furnace to double its production capacity, most civil works are almost complete and we have started installation of the equipment. We plan to commission by the end of September 2023."
With dropping sales due to macro headwinds, a high CapEx year, and flying close to the sun with very little cash, it seems DWAL is in a precarious position but is building for the future. Management expects a flat year in 2023 and 2024 but an investor would need confidence in the ability to resume the strong historical growth and continued demand from India.
Druk Farro Alloys Limited (DFAL)
The main competitor to Druk Wang Alloys is Druk Farro Alloys (DFAL) which, as far as I can tell, sells the same grade and form of ferrosilicon. A quick financial comparison of the two businesses is a helpful starting place:
Interestingly, the two companies’ operating margins are nearly identical and in line with US public mining / metals companies as of 2022/23. The return on capital (45-60%) is where the companies outshine most, with mining, industrial, and manufacturing companies in Western markets producing 30-35% ROIC. It is important to note that DFAL sees a ~20% lower price point on a unit level when compared to DWAL. I cannot find any explanation for this as the purity / grade of their products are comparable, and they are both mostly selling into the domestic and Indian markets. DWAL might have pricing power as a slightly larger, longer-established player with better customer lock-in. This would also explain the outpacing in growth for 2022.
A Few Other Ideas
For value investors, there are several companies trading at 1-2x earnings in 2022 and 2023. This includes Bhutan Carbide and Chemicals (BCCL), which is also a ferrosilicon manufacturer, much like DFAL and DWAL mentioned above. Unfortunately, I have not been able to locate the company’s annual reports so it is unclear what has caused the poor performance, lack of profitability, and very cheap multiple of 1.5x earnings as of 2022. If you could see a path forward where BCCL is able to operate at the same efficiency and profitability levels as DWAL / DFAL, then there is an obvious rerating to happen for the business.
A similar business is Bhutan Ferro Alloys (BFAL) - different from the above Druk Farro - which is a joint venture between the Bhutanese government, a Japanese mining company, and the Tashi Group, which is the largest private holding company in Bhutan whose founder is the wealthiest Bhutanese national. It is unclear what the ownership structure of the business is between these three parties and the company's public float. Interestingly, BFAL produces more ferrosilicon than DFAL and DWAL combined with 32K megatons of production in 2022. But, the company has seen a material drop in profitability, with H1 ‘23 operating margin standing at 5.4%, down from 17% in 2022. Even with this drop in profitability and a flat revenue profile, the company elected to distribute the largest dividend in its history. The business traded at 1.9x earnings in 2022. The ferrosilicon business is a big one in Bhutan, as it makes up 65% of the country’s exports.
After an initial skim, it doesn’t seem there are any once-in-a-lifetime opportunities in Bhutan. Again, it would be quite difficult for a foreigner to take advantage of any opportunity even if there were. But, it seems the country has had a reasonably efficient market and resulting price discovery. The high-quality assets are priced as such, and the lower-quality ones are seeing distressed business valuations.
The search will continue in Bhutan as there are other securities to explore. Many surrounding economies provide equally hidden markets that will provide plenty of material to dig into.
Much of the analysis above was based on the companies’ public filings, which can be found on their respective websites.
I also leveraged the RSEB’s annual report from 2022, available here.
The Asian Development Bank also wrote an excellent report covering the Bhutan capital markets, their weaknesses, and recommendations for further developing the country’s capital market. That is available here.
If this type of content is interesting to you, I would highly recommend checking out Matt Lakeman’s blog.
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