Thursday, August 14, 2014

ASIA FRONTIER CAPITAL – Country Snapshot – Mongolia

Although Mongolia is the least densely populated country in the world, with less than 3 million people living in a land area of 1.5 million km², the country has the potential to see the greatest growth of any market within the AFC Asia Frontier Universe.

Mongolia’s economy is traditionally based on herding and agriculture, but is expanding aggressively due to foreign investments in large mining projects that capitalize on the country’s vast deposits of coal, copper, gold, tungsten, tin, nickel, zinc, silver and iron. GDP growth has been under pressure in recent years due to government policies impacting the investment environment, however, the resolution of these issues will likely spur investment in mining and continued economic expansion. Mongolia’s growth is steered by high levels of agriculture production, commodity prices and the spillover from China’s epic growth.

Stock Market:

The Mongolian Stock Exchange (MSE), located in Ulan Bator, was established in 1991 and is the country’s sole stock exchange. The MSE lists over 330 companies and has a market capitalization of USD 860 million as of July 2014.

Country snapshots for all of AFC’s markets can be found on our website at
AFC Travel Report: Mongolia

In line with our process of being on the ground in the countries we invest in, AFC’s Regional Research Analyst, Scott Osheroff, travelled to Mongolia during the month of July to cover the country’s development for AFC from the ground.

It is easy to forget the role that foreign portfolio investment plays in Mongolia when you first arrive in Ulaanbaatar. If you have your finger on the pulse however you can begin to see the footprint of the stock market around every corner. Looking around you can see cashmere clothing on passersby and evidence of growing consumption which is typical of rapidly growing frontier markets. After peering through the window of a duty free shop in the Ulaanbaatar train station I saw vodka and other products for sale on the way to the night train where I settled into my compartment. As I waited to depart, I contemplated what was happening in the markets that day as the sales of cashmere garments, duty free shop and vodka that I had just passed were all driving revenues of companies listed on the Mongolian stock exchange.

At 20:00 we pulled away from the station, remarkably on time, heading west into the sunset. As the train gained speed we passed the ubiquitous ger districts until we broke through into the Mongolian steppe, on our way to Selenge Aimag (Povince) in northern Mongolia for a Naadam vacation. A ger is the traditional tent-like dwelling of nomads in Mongolia that is made from wood and felt. It is made to be easily collapsed and reassembled and is usually transported by horse, camel or yak. These days a ger will also fit nicely on the top of a small four wheel drive. As I saw the sun beginning to disappear beyond the hills from the train window I headed for my own shelter on the top bunk and tucked in for the night.

Eight hours later a tap on my shoulder from the train staff was followed by some Mongolian which I was able to decipher as “we have arrived in Sukhbaatar”, Selenge’s central city. More of a farming town than a city, I proceeded to an unmarked taxi and squeezed in with seven others as we began a ninety minute journey to a village, Tsaagan Nor, where I was to meet my friend and his family for the holiday.

Leaving Sukhbaatar at approximately 5am and en route toTsaagan Nor, I witnessed a gorgeous Mongolian sunrise which was a welcoming change to the complete darkness of the steppe. As the sun rose ever higher the darkness gave way to the rolling hills of Selenge and its vast wheat and rapeseed fields. Selenge is regarded as Mongolia’s breadbasket and is increasingly being transformed with modern farming practices allowing the country to become a net exporter of grains.

Having arrived at Tsaagan Nor to meet my friend, I was quickly introduced to his family before partaking in the establishment of a motorcade towards his summer home on an 8,000 hectare farm. Meandering our way through countless fields and occasionally losing our way on the wrong dirt tracks, we finally arrived atop a hill overlooking a 100 hectare produce farm my friend calls home during the summer months. I could quickly see why he spends three months per year here, as we were surrounded by open steppe, rolling hills and the Selenge River.

Upon reaching home the Naadam festivities began and a bow and arrow quickly appeared as we took turns shooting, getting better with each arrow. After seeing who had the best shot we proceeded back home and cooked a popular dish, khor khog, which in this case was a sheep whose meat was cooked in the carcass.

For those who live a nomadic lifestyle, this method of cooking is highly practical as one needs no stove, but merely hot, glowing, rocks which are put into the animal with the occasional vegetable. Contrary to what you might think, the cooked meat is fall-off-the-bone tender and could easily be served in a Manhattan restaurant as its flavor is rich and delightful. Ironically, the only seasoning is a pinch or two of salt. After our meal evening activities followed suit and everyone then went to bed.

The next morning, having a short period in Selenge, I departed my friend’s home and proceeded to the Mongolian-Russian border town of Altanbulag where a free trade zone had been inaugurated only weeks before. It was quiet arriving on a Saturday at 10am though Mongolian exporters were busy hawking their wares from cashmere products to spare auto parts. Mongolia has an opportunity to increase trade with neighboring Russia and it will be worth watching how Altanbulag develops in the coming months and years as it is only just gaining its proverbial legs.

Following Altanbulag, before boarding the train back to Ulaanbaatar, I asked my driver to take me west, down a dirt road on the opposite side of Sukhbaatar, where I would be left to my own devices on a short hike. Arriving at the top of a hill after a twenty minute stroll, I found myself overlooking a very special place called Saikhanii Khutul (“beautiful place between the mountains”). This is where the Selenge and Orkhon Rivers intersect before crossing the Russian border as they progress towards Lake Baikal. It was breathtaking, and I spent the next two hours exploring and reflecting as the scale of Mongolia is to the degree of which a camera often has difficulty capturing its beauty. The photos I was able to capture show but a mere glimpse of this great land.

The stereotypical response when a foreigner mentions “Mongolia” being “Chinggis Khan,” this elicits visions of an aggressive country and one not worth visiting. On the contrary, spending some time visiting the 18th largest country in the world (also the least densely populated) I wager you will find a romance to it. The kindness of individuals with the warmest hospitality I have ever experienced, coupled with the one-of-a-kind beauty of Mongolia’s wide variety of terrain, Mongolia is a hidden gem AFC is proud to be a frequent visitor to, as well as a participant in its phenomenal economic upside.
AFC Country Report: Mongolia

Once the darling story for bold investors and mining enthusiasts, Mongolia has struggled in recent years to maintain investor confidence and to capitalize on its enormous resource potential. With a small population of 3 million and lucrative mineral reserves, Mongolia was tipped as possibly becoming the next Qatar or Norway. Enthusiasm for the country has waned, however, as mining giant Rio Tinto has been embroiled in disputes with the Mongolian government over its mega-mine, Oyu Tolgoi. The Oyu Tolgoi project proved to be a litmus test for foreign investors, and frequent changes to legislation and government backtracking spooked many investors. GDP growth has slowed from its record-high of 17.3% in 2011, and the World Bank has lowered its previous forecast for this year from lofty double-digits to an even 10.0%.

The dramatic fall in Mongolia’s economic outlook has largely been attributed to the compounding effects of dwindling foreign direct investment (FDI) and an overreliance on both the domestic mining sector and on China. Rattled by Rio Tinto’s problems in dealing with the Mongolian government and the country’s position on foreign ownership of its resources, investors have spurned the country, with FDI decreasing 52% last year and 70% in the first half of 2014.

To offset the dramatic decline of FDI, Mongolia has increasingly turned to China, which accounts for 90% of Mongolia’s exports and 50% of its imports. Mongolia is in talks with China’s Sinopec Group to sign a gas project and supply accord in August to construct two coal-to-gas plants, with 95% of output going to China through pipelines and gas production expected to start in 2019.

But China’s economic slowdown and recently falling commodity prices have highlighted the danger of being too dependent on one trading partner and one sector – more than 80% of the country’s FDI goes into the mining sector. Exports, particularly coal, have fallen in line with China’s economy, and Mongolia’s earnings from coal exports fell 17% in the first half of the year. China’s growth in Q2 2014, however, was higher than expected and an upwardly revised full-year economic forecast for China’s economy would bode well for Mongolia.

To try and counter an overreliance on China, President Tsakhiagiin Elbegdorj signed a free trade agreement in July with Japanese Prime Minister Shinzo Abe that will cover all of Mongolia’s exports to Japan and 96% of Japanese exports. The agreement was also seen as a diplomatic move by Japan, as Mongolia enjoys an unusually close relationship with North Korea that Japan may seek to leverage as it tries to free a number of its citizens that are currently imprisoned by the government in Pyongyang. While Mongolia’s political neutrality makes it of strategically importance to Japan, the Ulaanbaatar government is likely keep a close eye on the ongoing events unfolding in Ukraine, which like Mongolia is an independent and democratic former Soviet Union country that shares a land border with Russia. Vladimir Putin’s territorial ambitions have likely caught the attention of Mongolia, which has vast resource potential and a small population.

On the macroeconomic front, the Mongolian government has pursued expansionary fiscal and monetary policies, which have led to external debt rising to more than 150% of GDP. The expansionary policies have contributed to inflation, and the national currency, the tugrik, has fallen 10% against the dollar this year. Currency reserves have fallen rapidly from USD 2.2 billion at the beginning of the year to USD 1.6 billion in May 2014, in spite of a narrowing current account deficit.

The effect of the macroeconomic policy is that Mongolia has received two ratings downgrades this year. In April, Standard & Poor’s cut Mongolia’s rating from BB- to B+, and in July, Moody’s cut its rating to B2, five levels below investment grade.

Moving forward, Mongolia needs to take firm action to rebuild confidence among foreign investors to catalyze the strong economic growth it experienced only a few years ago. Small yet encouraging steps have been taken, such as in April when Prime Minister Altankhuyag Norov introduced a “100 day action plan” to promote investment by approving changes to the 2006 Minerals Law and passing a new law on energy. But the “Wolf Economy” must now think from the perspective of damage control, and create effective policies and legislation to nourish the country’s economic and business environment back to health.

Despite the bearish outlook covered in international media and the slump of the Mongolian Stock Exchange (MSE) Top 20 Index, Mongolia remains an interesting investment story. For one, the MSE Top 20 has not been broadly representative of the overall performance of the country’s stock exchange. Many of the largest companies on the MSE by market capitalization, which are part of the MSE Top 20, are poorly-managed state owned enterprises (SOEs). In contrast, there are many small cap stocks of privately-controlled local companies that have posted strong performance. As local brokerage firm BDSec JSC has pointed out, the YTD return of the MSE Top 20 as of July 30th 2014 is -2.3%, but if you instead look at the performance of the top 20 largest privately-controlled companies on the MSE, the YTD return is 21.2%.

Although it is a contrarian investment case, Mongolia has many attractive small-cap companies with healthy fundamentals, and the bearish global outlook on the country has led to cheap prices for many of these stocks. In the longer term, we think that the government will take a softer stance in its negotiations with Rio Tinto to try and reassure foreign investors that Mongolia is open for business. After all, Mongolia’s GDP is roughly USD 12 billion, while Rio Tinto’s market capitalization is USD 107 billion! As the government gradually improves legislation and mining rights and FDI begins to trickle in once again, economic growth should pick up, boosting consumer spending and contributing to solid performance from mining stocks as well as domestic plays in consumer goods, textiles, materials, and hotels.

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