Monthly Highlights: February 2009

•  Nigerian financials appear fundamentally attractive on a relative basis
•  Brewers and telcos remain attractively priced
•  Less optimistic on Kenya although Mauritius offers significant value
•  Markets remain anchored by fund liquidations although improved macro backdrop points toward medium-term rebound
 

Nigerian financials appear fundamentally attractive on a relative basis

When reviewing our set of available investment opportunities, financials are the logical starting point as emerging economies cannot growth with out the presence of a robust banking sector. Nigerian financials, which dominate the African landscape in terms of market capitalisation and asset base, are presently trading at 0.7 – 0.8x book value and 4.5x historical earnings. On a relative basis, Nigerian banks offer excellent value when compared to Mauritius (1.15x book value, 5.6 – 6.6x historical earnings), Cote d’Ivoire (5 – 6x historical earnings), Kenya (8.5 – 10.5x historical earnings) and Malawi (4x book value, 13x historical earnings). Yet not all African banks are alike, and our two Nigerian holdings presently trade on historic P/Es of 4.5x and 3.6x with price-to-book multiples of 0.9x and 0.5x, respectively. Management is critical and these two banks have consistently generated return-on-equity in excess of 22%; in addition, they exhibit dividend yields of between 12 – 16%.

Brewers and telcos remain attractively priced

The African consumer is impacted by a litany of mitigating factors, many of which are domestic in nature. We focus on companies with strong cash flows, minimal leverage and sound management. Most investors are familiar with African breweries as the sector offers a number of liquid mechanisms through which to express this view. The sector boasts strong earnings growth, low P/Es and high dividend yields as evidenced by one of our Nigerian holdings who just reported earnings growth on the order of 35%, and is presently trading at 7.7x earnings with a dividend yield of 9.8%. Other opportunities exist in consumer products, health care and food supplies as one of our most attractive portfolio holdings is an Ivorian consumer play that is presently trading at 5.7x historical earnings with a dividend yield of 26%. Telecommunications remains a very exciting growth theme as penetration remains low in most African markets with the exception of Botswana where teledensity is presently 87% of the population. Again, management is a determining element when differentiating between companies although wireless telephony and its accompanying suite of value-added services (i.e. mobile banking, prepaid electricity, et al.) are fast becoming a necessity to everyday life. We presently own a handful of telecom companies with extraordinary forward growth prospects, P/Es of less than 7x and dividend yields in excess of 8%.

Less optimistic on Kenya although Mauritius offers significant value

On a regional basis, we are less optimistic about prospects for East Africa and Kenya, in particular. Recent earnings and corporate announcements have fallen far short of our own internal expectations, and the nation is suffering from elevated energy prices, rising food prices and reduced tourist arrivals. Although less of a concern, Mauritius has also suffered from declining tourism. Nevertheless, we believe that much of the negative news is currently priced into the sector which is presently trading at forward earnings of 4.4x and price-to-book multiples of less than 1x. Relatively speaking, Ghana and Malawi appear most overvalued while Nigeria and Zambia offer a number of attractive opportunities.

Markets remain anchored by fund liquidations although improved macro backdrop points toward medium-term rebound

Despite the rich opportunity set across Sub-Saharan Africa, a fresh round of fund liquidations will likely keep share prices under pressure over the near-term. Interestingly, the current price action and lack of overall market depth is strikingly reminiscent of 1998 when many large African funds were forced to fold their tents. Yet for those investors who survived the drawdown, African equities ranked among the best performing asset classes with USD returns in excess of 600% over the ensuing decade. The episode of 1998 was instrumental in the market’s evolution as it opened the door for a host of new investor constituents to enter the market, including: domestic pension funds, macro stabilisation funds, emerging market funds and hedge funds. We contend that a similar dynamic is presently underway as a host of new investors have entered the market in recent months – a trend which we believe is only now just beginning. Clearly, we are disappointed by the relentless selling pressure and its impact on African financial markets. That said, we have witnessed similar cycles in the past and there are three primary reasons to be greatly encouraged about the region’s forward-looking prospects. First, quantitative easing and the monetisation of government deficits were the same tools used to pull the global economy out of depression in the 1930s. A crucial element of the 1930s recovery was the strong gain in commodity prices. Commodities rose more than 80% in USD terms from 1933 to 1939. As a result, large commodity producers benefited handsomely and we expect a similar result this time around. Second, emerging markets are actively working to support one another and are now operating strategically to support their own national interests. China recently announced its intention to commit nearly USD 30 billion for investment in Africa and Russia has agreed to write off nearly USD 20 billion in debt owed by African nations. Such actions will undoubtedly lead to increased African trade and could well reduce the risk of competitive currency devaluations. Third, sharp devaluations have dramatically reduced the relative level of most African currencies. With the prices for consumer goods flattened by global competition, we believe that future productivity gains are more likely to be reflected in rising asset prices. Although Africa is clearly less productive than most developed and emerging market nations, the region’s future productivity gains are likely to be far greater on a relative basis. As such, we believe that local African currencies are poised to benefit handsomely in the years ahead.