Genghis Khan's land beckons

The name conjures up images from school textbooks of the 13th century Mongol conqueror Genghis Khan who overran almost all of China and Central Asia. Today, the commodity-rich country is surging ahead to slowly catch the attention of investors from different parts of the world, even Dubai. For the Emirates NBD's chief investment officer, the business trip to Mongolia two weeks ago ignited enough interest to explore investment opportunities there. Medium to long-term investors — with a horizon of at least two to three years — could do well to start taking an interest, do research and invest in some of the commodity companies that are expected to achieve high profits, according to Gary Dugan. If not under the radar anymore, Mongolia is still a new story — barely a year old — within the arena of frontier markets for international investors like him and his colleagues. But risks, including from overheated growth and poor infrastructure remain. . Geologists, engineers and financiers are rapidly discovering the country. During his visit, Dugan attended a conference that had a presence of 60 delegates. Last week, one of his colleagues visiting Ulan Bator called him to say he was part of another conference with about 200 delegates. Dugan found the country's growth to be mirroring the likes of emerging market giants such as India and China. According to the International Monetary Fund (IMF), Mongolia's GDP is expected to grow at an average of 7.6 per cent annually over the next three years and 15 per cent during the following four years. The Mongolian stock market, still small and illiquid, is up 31.45 per cent this year, cooling a bit from the all-time high in February when the MSE Top 20 Index reached 32,955. In June 2009, the same index read 4,686. That's a 314 per cent jump in exactly two years. Mongolia was the best performing stock market in Asia last year. Three motivations There were three motivations, according to Dugan, for him and his team to explore the landlocked country that is snowbound for about seven months in a year. One, a lot of the emerging markets are well picked over. There are hundreds of analysts covering places like China, Russia, India, Brazil and others these days. Secondly those markets typically have done well and valuations are already higher than the developed world. Thirdly, most of the same markets are facing problems such as rampant inflation that may mean that they may not really give much substantial performance over the coming one to two years, he said. Also of interest is the fact that about $40 billion (Dh146 billion) of the stock market value is quoted on well-known global stock markets such as Toronto, Hong Kong, or New York, Dugan said. That means an investor can gain access to the Mongolian stocks without taking the country-specific risk within the stock market there. Dugan added he has never seen such a concentration of good talented people from international markets already in a frontier country. "Mongolians are very embracing of international management and they are embracing an international community of top geologists, top capital, and top investors. They are very investor focused. Also, number of very well educated Mongolians are coming back now." The country has something that the world needs — metals and raw materials such as iron ore, gold and copper and coal and "rare earths." Most of those metals, in raw ore, are just sitting on the surface of the ground," Dugan said. Selective Mongolian mining and metals companies could well represent a high-growth diversification story within the commodity markets space, he said. With economic growth, investments in property will come about. "There isn't a shopping mall of any kind and the country needs one," Dugan said. Retail investors can buy some of those companies that are quoted on stock markets such as in Canada and Hong Kong. Eurasia Capital, a Ulaan Baator-based investment bank, in their Mongolia Outlook 2011 report noted their key investment themes for the year local and Mongolia-focused international stocks, private equity/pre-IPO/M&A, real estate, the MNT and corporate and government bonds. Their top picks among local equities are Tavan Tolgoi (coking coal), Mongolia Development Resources (real estate) and APU (beverages). Mongolia Mining Corp (coking coal), Prophecy Resources (thermal coal), Petro Matad (oil) and Aspire Mining (coking coal) were their other top picks among the 30+ international and locally listed companies that are members of the Silk Road Mongolia Index. Ivanhoe Mines, which has a 67 per cent stake in what will be the largest copper mine in the world, is one such company which got ‘buy' recommendation from Desjardins Securities in late May. South Gobi and Mongolian Mining Corp got buy ratings last week by BNP Paribas Securities Asia, Bloomberg reported. Price factor Referring to those commentators who think that some of the companies already look pricey, Dugan noted that the ones traded internationally don't. The companies had a massive run locally and some have had P/E multiples of 50 or 60 or 70. "If you look at the projections of the next two years, growth of the economy and sales growth of those companies you can see those multiples coming down and they halve every year, or just because profit growth is going to be so spectacular. But it's fair to say there's more of the growth discounted than ever before in the Mongolian stock market. But you could still be really surprised I think by how much GDP growth is achieved and by how much profit growth is achieved in that region over the coming couple of years." Risks remain and that's a common trait of all frontier markets. In Mongolia, those include poor infrastructure that could hamper growth of companies in terms of meeting production targets. While Dugan agrees that there is a risk associated with its infrastructure growth, he has noticed that with general elections to be held next year, the government has accelerated its spending on infrastructure. The award-winning independent broker Christopher Wood in his Greed and Fear report (June 5), likens Mongolia as the "Saudi Arabia of Asia," but he notes that much would depend on China's growth being intact. Wood writes: "A few meetings in Ulaanbaatar made it clear that the fundamental issue for this landlocked country is whether it will be able to develop the infrastructure, notably transport linkages, to take full advantage of its massive resource wealth. If it does, Mongolia will be to industrial commodities what Saudi Arabia has been for oil — assuming, of course, that the Chinese macro story remains on track." Dugan is sanguine about continuing growth in China and India. "Commodities are a medium term positive story, even if readers read scary stories about the market in India and China slowing down," Dugan said. "India and China are not going into negative growth. Every year they have a positive growth they take more of these raw materials away from the market and force prices higher." There could be other surprises. "This isn't a place that's over analysed where you know all the information, but having said this [it] is a market that has gone up 100 per cent locally, in straight line and where many companies in mining have given strong performances," Dugan said. One needs to be cautious. "Things can go up 100 per cent, and they could also halve, they should be only a small part of the portfolio if they want to — normally that is five maximum 10 per cent in frontier markets as a whole," Dugan said. "You got to kind of commit to these markets for at least two to three years." Also he pointed out that in five to 10 years from now, the stock market could go up maybe 1,000 per cent and that has a risk of a bubble which eventually bursts. "Like every frontier market if it gets over-excited and too much liquidity goes in and too many local investors who know nothing about stocks and buy the market, these things are almost inevitable because these markets are growing and that's why investors should see these as small part of their allocation and not all their allocation or 50 per cent of their allocation," Dugan said. Mongolia is more sensitive to inflation because they have to import basic materials. Cash handouts and increase in government emplyee salaries exacerbates the inflationary situation. Money supply growth has been running at 50 per cent per annum, said Dugan, adding that in tackling the surging inflation, they are getting it "half right." The Eurasia Capital report said: "The Central Bank of Mongolia is in a difficult position trying to balance the need to control inflation as well as manage currency fluctuations." "These are the growing pains of an emerging economy, monetary policy is quite sensible and local interest rates are somewhere between 8 and 15 per cent," he said. "There's no real credit market at the moment, it still has to be developed but they do have the institutions, they have the central banks and they are about to issue some bonds, and the government at worst is running a small deficit." Research Research on the companies is of utmost importance, Dugan said. "You really do need to know people on the ground, people who have a consistent interest in maintaining a contact in Mongolia, because you really need to have local knowledge," he said. "Knowledge about the legal practices there, about regulations is very necessary." In Mongolia, Dugan and his colleague toured a couple of mines, met the entrepreneurs who run these mines, consulted about the conditions of the workers and checked the international standards of the geological results. "We found that many of the companies are run by geologists — people who had dug up Canada, dug up Australia — now they are digging up Mongolia. They never found it so easy to find the minerals and also never found minerals in such quality and in such accessible places," he said. "Always in a frontier market, it looks great on paper but it's possible it may not exist," he says. Emirates NBD is more likely to be looking at private equity opportunities and keeping on top of some of new individual equities. For the fund, the bankers are talking to a couple of fund providers, but also are talking to a number of clients, Dugan said.