The Great Sub-Saharan Opportunity

by: Philippe Casey

Given the recent performance of its many (and surprisingly diverse) economies, Africa has captured the attention of investors worldwide. Over the past decade, six of the world's ten fastest growing economies were found on the continent, with Angola acting as the global pacesetter with an average annual GDP growth of 11.1%. The IMF projects this trend will continue for the foreseeable future, a sentiment seemingly echoed by many large multinationals, many of whom have explicitly targeted the Sub-Saharan region as a core driver of future growth.

Newcomers like Walmart (NYSE:WMT) (through its acquisition of South Africa's Massmart) are scrambling to gain market traction, while companies with a long history in the region like SABMiller (OTC:SBMXY) - Africa's largest brewer - are doubling down. Increased investment in Sub-Saharan Africa is not limited to any particular industry or sector. DHL, the German logistics and shipping company present in 52 of Africa's 54 nations, recently announced that it has increased its service points on the continent from 300 to 1000 and hopes to reach 10,000 in the not-too-distant future. Meanwhile, Coca-Cola's (NYSE:KO) large investments in the Sub-Saharan region (ex: $187mn earmarked for Tanzania alone over a three-year period) seem to be paying off: sales volume in the Eurasia/Africa unit rose 10% in the fourth quarter, in stark contrast to a 5% same-period drop experienced in the European market. Last year, GAP (NYSE:GPS) opened its first African store in Johannesburg, and the head of Samsung's (OTC:SSNHY) African business stated his intent to double the company's share of the Sub-Saharan smartphone market by the end of 2013.

Skeptics, however, will quickly point out that much of the region's progress can be attributed to cyclical increases in commodity prices, large oil discoveries, and the fact that high growth rates are easier to achieve when beginning from such a low base. It is indeed true that the economic footprint of an average Sub-Saharan nation remains extremely small, and it is noteworthy that South Africa and Nigeria combined still account for 51% of all consumer expenditure in the region. Much work does remain: the regulatory environment must become less bureaucratic and more business-friendly, anti-corruption laws must be strictly enforced, and government investment in infrastructural development must expand. These talking-point criticisms, however, omit the significant gains that have been made and do not accurately reflect Sub-Saharan Africa's great growth prospects.

Despite the surge of global interest and corporate investment, stock prices in Sub-Saharan Africa remain remarkably deflated. According to HSBC, regional equity markets are still trading at a 40% discount from pre-crisis levels in August 2008 - a poorer recovery performance than most emerging market indices. There are several possible reasons for this seeming paradox. Firstly the African bears - citing the above criticisms of the continent's growth - may have managed to plant doubt concerning the sustainability of Africa's economic progress. Indeed, in the minds of many Westerners, Sub-Saharan Africa is associated with conflict, corruption, colonization, and disease. Though an incomplete picture, this perception was shaped by media coverage of events in the 20th century. When an analyst casts doubts about the region's prospects, then, it may reawaken previously dormant fears and preconceptions regarding the region.

There is another explanation for the undervaluation. It is easy to be an optimist when one does not have a vested stake (ie, capital at risk) in the region. While the general macro picture does look favorable, performing proper due diligence on individual African equities can prove to be both time-consuming and costly. When the time comes for the "rubber to hit the road", many investors may simply find it safer and more convenient to invest in traditional markets. Lastly, illiquidity and continued barriers to foreign ownership make the prospect of investment on smaller African exchanges far more daunting. At the end of April 2010, for instance, the bid-ask spread in Kenya was a staggering 11.8%.

There are ways around these hurdles, however, and the region holds many intriguing investment opportunities. Frontier market stocks generally hold a low correlation to the S&P 500 (only 0.29 in April 2011) and can thus serve as an interesting portfolio hedging tool. Additionally, large African companies are increasingly bypassing the JSE (Johannesburg Stock Exchange) to list in London. Investors can therefore gain exposure to Sub-Saharan Africa by investing in multinational companies that derive a significant portion of their revenue from the region, Ireland's Tullow Oil (OTCPK:TUWOY) serving as a wonderful example. Vodafone's (NASDAQ:VOD) 40% stake in Safaricom - creator of the famed mobile payment system M-Pesa - gives the company a strong foothold in the region's booming telecommunications sector and makes it an attractive investment opportunity with significant upside potential.

Despite continued challenges, the overall outlook on Sub-Saharan Africa is overwhelmingly positive. Regional poverty has dropped from 40% in 1980 to less than 30% in 2008 and is expected to fall to 20% by 2020. Increased political stability, a growing middle class, and large (illiquid) investments by foreign corporates are further indicators of a bright future. Those who do not take the region's development seriously may well be missing out on the world's next great growth story.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.