Indonesia and Malaysia: Uncovering Quality in Southeast Asia

Dilip Badlani and David Nadel in front of the Petronas Towers, Kuala Lumpur, Malaysia

The Association of Southeast Asian Nations (ASEAN) is a geopolitical and economic organization made up of 10 countries: Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam. The acronym is not currently at the top of the minds of global investors, being far outshined by BRIC (Brazil, Russia, India and China), which has been the darling of the investment community for most of the past decade. However, from the 1980s to the late 1990s the countries of Indonesia, Malaysia, the Philippines, Singapore, and Thailand attracted significant investor interest. In fact, at times during the early 1990s, daily turnover on the Kuala Lumpur Stock Exchange (now known as Bursa Malaysia) was the highest of any exchange in the world.¹

When I was a child, my family made annual visits to Indonesia, where my mother was born and my grandparents lived. Back then, I did not fully appreciate the remarkable growth that was occurring in the country. Yet with each return trip during the 1980s and '90s, there would be improved roads, shiny new malls, and, most importantly to me, more American brands and TV shows. I left Asia to attend college in the U.S. and made my first trip back in January 1998 for a cousin's wedding in Indonesia. During the course of the wedding festivities, the Indonesian Rupiah collapsed, sending the country's economy into a freefall. It was devastating to witness.

The Asian Financial Crisis threw the entire ASEAN region into turmoil that resulted in the withdrawal of Foreign Direct Investment (FDI). Indonesia, which is the largest economy in the region, received $6.2 billion of FDI in 1996, but saw a net outflow of $4.6 billion in 2000.² Now, more than a decade later, the economies of the region have stabilized, growing by 7.7% in 2010.^3,4

The ASEAN countries as a group generated GDP of $1.8 trillion in 2010,⁵ which would make it the third-largest economy in Asia behind China and Japan. The group also boasts a combined population of approximately 600 million people. The region has been receiving attention from multinationals looking to target its growing middle class. Ranking third behind China and India, Indonesia is estimated to have over 100 million middle class consumers.⁶ China's rapid increase in wage costs has also benefited the ASEAN region, as companies have looked to open factories in the latter area to take advantage of the lower labor costs.^7,8

Indonesia and Malaysia

Recently, David Nadel and I visited companies in Indonesia and Malaysia, which respectively represent the largest and third largest economies within ASEAN, with a combined GDP of close to $1 trillion. Both countries possess similarities in terms of religion, culture, and language, and both are democracies. However, the two countries have achieved notably different levels of economic growth. Malaysia has a GDP per capita of $8,423, which is more than twice Indonesia's GDP per capita of $3,015.⁹

Indonesia and Malaysia have relatively conservative public debt ratios of 26% and 53% of GDP respectively,¹⁰ a legacy of the IMF's strict requirements when providing assistance during the Asian financial crisis. Companies in both countries also typically have clean balance sheets with little to no debt, often running in net cash positions as CEOs have been scarred by the debt restructurings that some companies were forced to undertake during the 1998 crisis.

Challenges

One of the challenges facing investors in the region is corporate governance standards, which are on the lower end of international standards.¹¹ Given the high degree of insider ownership at companies, decisions are often made to the detriment of minority public shareholders' interests. Additionally, due to the relative immaturity of the Indonesian capital market, companies often do not possess a significant history of public financial statements.

Inflation is a key cause for concern in both Indonesia and Malaysia. Each country's government is facing the challenge of ensuring that food and fuel prices do not outpace wage growth and thus increase the burden on the poor. The wealth divide between the rich and poor in Indonesia is also a worry. The poorest 10% of the people share only 3% of the wealth, with the richest 10% sharing over 30%.¹² While the wealth disparities are not as extreme in Malaysia, they are widening there as well.¹³

Malaysia also needs to balance internal tensions between Malays, who represent 70% of the population, and non-Malays.¹⁴ Malaysia's affirmative action policies were put in place through the creation of the New Economic Policy (NEP), which was designed to redress inequality and poverty after deadly race riots took place in 1969 between Chinese-Malaysians and local Malaysians. These policies had put in place pressures such as a requirement that all initial public offerings (IPOs) set aside a 30% share for Bumiputra (local Malays) investors. Under the leadership of Prime Minister Najib Razak, Malaysia has been working to address the affirmative action policies that have favored ethnic Malays.

Indonesia

Indonesia is the fourth-most populous country in the world and is a land mass spread out over 17,508 islands. Under Suharto, the second president, Indonesia saw its GDP per capita (at current prices) grow from $83 in 1970 to $1,170 by 1996.¹⁵ However, this growth was driven by significant public indebtedness, and the economy began a downward spiral in mid-1997. Foreigners began questioning the ability of the country to repay its debt, and Indonesia's currency, the Rupiah, which had been in the 2,600/$1 range at the start of August 1997, fell to 11,000/$1 by January 1998. As a result of the economic mayhem, real GDP contracted by 13.7% in 1998, prompting a bailout from the IMF. Since the crisis, successive governments have engaged in prudent economic policy and, as a result, the economy today is on more stable ground.¹⁶

From our perspective, the growth of disposable income for the Indonesian consumer will represent a good opportunity going forward. Car ownership in Indonesia is still at a relatively low level. Indonesians own an average of 21 cars per 1,000 people, which puts it among the lowest levels of car ownership in the world.¹⁷ As income rises, more Indonesians will be able to afford cars, though in many cases, only with the help of financing. Companies that provide financing for automobiles stand to benefit. Critical factors for success in this business will be the breadth of relationships with used car dealers, access to credit, and the ability to successfully check the credit history of customers, all of which are present in one of our investments in Indonesia.

Today's Indonesian consumers are also using their increased wealth to bolster the protein content in their diets. Chicken, which is one of the lowest cost protein sources in the world, is seeing increased consumption. One of the key factors to achieve business success in Indonesia is maintaining a distribution network that can reach the entire country. One of our investments in Indonesia is the largest distributor of chicken feed in the country, as well as a large manufacturer of processed chicken in Indonesia.

Malaysia

The South China Sea separates Malaysia into two regions: Peninsular Malaysia and Malaysian Borneo (also known as West and East Malaysia respectively). In the 1980s, under the rule of former Prime Minster Mahathir bin Mohammad, Malaysia implemented economic reform policies designed to transition its economy away from mining and agriculture and toward manufacturing. These measures were quite successful, and Malaysia enjoyed a period of significant growth. Malaysian GDP per capita (at current prices) grew from $1,812 in 1980 to $4,774 in 1996.¹⁹ A significant portion of the GDP growth was driven by foreign capital, which dried up during the Asian Financial Crisis. Malaysia's currency, the Ringgit, did not fall as significantly as its Indonesian counterpart, but depreciated from 2.50/$1 to 4.80/$1. Malaysia refused a bailout from the IMF and thus was not as affected as its ASEAN siblings Indonesia, Thailand, and the Philippines because it did not have to engage in the same degree of austerity. However, its GDP still managed to contract by 7.5% in real terms in 1998.

Malaysia is rich relative to its ASEAN counterparts; its GDP per capita of $8,423 provides a vast opportunity for retailers catering to the lower-income population. Malaysian women, while maintaining their own fashion sense, still aspire to the same standards of fashionable women across the globe. While some Western brands have made inroads in the urban areas of Malaysia, they have not yet paid much attention to the more remote areas, where the population has a more limited budget. We believe that these outlying areas are underserved and represent an opportunity. We invested in a company that provides stylish women's clothing and shoes with a strong brand name, attractive price points, and an excellent distribution network across Malaysia.

Malaysia has been blessed with some very attractive natural resources. It is the world's largest producer of palm oil and possesses large natural rubber resources. The palm oil industry has been the beneficiary of increased demand as diets in China and India are improving, boosting palm oil prices. Palm oil plantation owners are looking to increase the yields they can generate from their planted acreage as the amount of land available for planting is not increasing in Malaysia. There is a company in Malaysia that has invented a production process that helps plantations achieve increased yields, while also being more environmentally friendly in their production process. This company should benefit from the high palm oil price environment, while not being as sensitive to palm oil prices and is therefore a truly differentiated investment from a pure commodity producer.²⁰

¹ http://www.nicholasvardy.com/global-guru/articles/malaysia-the-fifth-asian-tiger/
² http://www.google.com/publicdata?ds=wb-wdi&met=bx_klt_dinv_cd_wd&idim=country:IDN&dl=en&hl=en&q=foreign+direct+investment+in+indonesia
³ http://www.dfat.gov.au/geo/fs/asean.pdf
⁴ http://en.wikipedia.org/wiki/File%3AIDR_USD_exchange_1997-07-02_to_1998-05-21.png
⁵ http://ec.europa.eu/
⁶ http://www.earthtimes.org/articles/news/340077,rebalance-global-economy-says.html
⁷ http://www.china-briefing.com/news/2011/04/11/the-china-alternative-vietnam.html
⁸ http://www.jotasean.com/
⁹ Data refer to the year 2010. World Economic Outlook Database-April 2011, International Monetary Fund. Accessed on April 11, 2011.
¹⁰ Public debt, The World Factbook, United States Central Intelligence Agency
¹¹ http://www.gmiratings.com/GMI_Country_Rankings_as_of_09_22_2009.pdf
¹² http://www.globaleducation.edna.edu.au/globaled/go/pid/645
¹³ http://www.malaysia-today.net/mtcolumns/special-reports/38523-fracturing-malaysia
¹⁴ http://ahroslanharahap.blogspot.com/2010/08/resolve-widening-income-disparity-gap.html
¹⁵ http://www.google.com/publicdata?ds=wb-wdi&met=ny_gdp_pcap_cd&idim=country:IDN&dl=en&hl=en&q=indonesia+gdp+per+capita
¹⁶ http://www.indexmundi.com/indonesia/public_debt.html
¹⁷ Motor vehicles statistics - countries compared". NationMaster. http://www.nationmaster.com/graph/tra_mot_veh-transportation-motor-vehicles. Retrieved 2009-09-20.
¹⁸ http://lk.nielsen.com/news/20050316.shtml
¹⁹ http://www.google.com/publicdata?ds=wb-wdi&met=ny_gdp_pcap_cd&idim=country:MYS&dl=en&hl=en&q=malaysia+gdp+per+capita
²⁰ http://biz.thestar.com.my/news/story.asp?file=/2009/5/19/business/3931121&sec=business