African KINGs: Finding Value In Difficult Times

Includes: AFK, GAF, NGE
by: Belgrad Kenne


Despite poor performance in Q1, the African KINGs remain an attractive investment destination.

Value can be found beyond top tier consumer-related stocks.

In this article, we explore sectors and stocks that will outperform their respective markets in 2014.

In Q1 2014 the African KINGs performed poorly with respect to global equities, but have outperformed its peer benchmark, MSCI Frontier Africa. During the first quarter, the KINGs had a USD-adjusted return of - 0.73% compared to a -6.52% return for the MSCI Frontier Africa index. Meanwhile MSCI Frontier Markets had a 7.53% return, MSCI Emerging Markets has a -0.43% return, and the S&P 500 index had a 1.81% return.

The performance of the KINGs suffered as a consequence of poor first quarters from Nigeria and Ghana. Nigeria is victim of its dependency on foreign flows, while Ghana continues to be challenged by an unstable macro environment with widening deficits, depreciating currency and high inflation.

The Ivory Coast and Kenya on the other hand had strong returns to start the year. The Ivory Coast posted a relatively satisfactory performance as the market rides on a strong economic recovery supported by high growth, increased FDIs and public spending. Kenya was KING's star performer in Q1 2014 with a 5.3% USD-adjusted return. As the country awaits its Eurobond debut in international markets, it suffers less foreign outflows despite a 68% foreign investors' activity in 2013 compared to 51% in Nigeria.

USD-adjusted returns as of March 31st 2014



Ivory Coast








MSCI Frontier Africa


MSCI Frontier Markets


MSCI Emerging Markets


S&P 500 index


Source: local stock markets, MSCI, S&P indices

We also note that the traditional pillars of Frontier Market thesis are evolving:

Amid strong GDP growth, Frontier Markets are increasingly correlated with Developed and Emerging markets. Strong balance sheets coupled with then low yields in Developed Markets have led to a new wave of Eurobond issuance, thus further leveraging the issuer's economy in foreign-denominated currencies. A slowdown in China and poor performance in key Emerging Markets pose a threat to strong commodity prices whereas stock valuations, particularly in top-tier consumer-related sectors, are becoming expensive.

Each market presents unique opportunities

Kenya is KING's star performer year-to-date. As the country looks to its debut on Eurobond markets, stock market performance takes advantage of a stable macroeconomic environment amid pressure on the foreign exchange rate. While we expect 2013 top performers to maintain their momentum in 2014, we believe an Alpha strategy would consist of identifying upside opportunities from those stocks that performed poorly compared to peers or the overall market. Such stocks include Barclays Bank Kenya, Equity Bank, East Africa Breweries and BAT Kenya.

Ivory Coast: With increased FDIs and public spending, the country is on track for strong economic recovery despite legacy social tensions from the 2011 post-election violence. With a balanced number of foreign-domestic investors, the market is less exposed to foreign outflows and inflation has remained low alongside a strong currency. Utility stocks look particularly attractive as more households reconnect to water and electricity following resumed economic activity and income. In this respect, we highly regard Compagnie Ivoiriene d'Electricite and Societe de Distribution d'Eau. In banking, we identify BOA Burkina Faso as an under covered stock with significant upside potential.

Nigeria: With its 170 million people, Africa's biggest economy remains a consumer play. However, consumer stocks are getting expensive year on year with sector P/Es standing at 40 compared to 25 in Sub Sahara Africa. Top tier consumer stocks are foreign brands with a significant foreign ownership of free float by institutional investors. This creates vulnerability to external factors such as economic recovery in Developed Markets, Fed tapering and Emerging Markets selloff. The same applies to brewing stocks that are affiliates of foreign brands. Key highlights from recent FY 2013 results posted by consumer giants Unilever Nigeria and Nestle Nigeria show that the sector is currently challenged by declining margins, high input and operating costs. The banking sector is challenged by new regulatory requirements (Basel III) and increased cash reserve ratios introduced early this year while the cement sector is skewed towards blue chip Dangote Cement. We believe active strategies that explore 2nd tier sectors and/or mid cap stocks while mitigating forex will deliver alpha in Nigeria.

Recent findings by Phase One Associates show that in Frontier Africa, top tier stocks outperform in good times (strong GDP growth and overall market liquidity) and inversely whereas mid cap stock are less volatile. Small caps on the other hand are highly illiquid, trade infrequently and require a significant premium or discount (5% on average) to get in or out of a small cap, illiquid stock; on top of traditionally high transaction costs. For savvy investors, identifying value at times of illiquidity and exiting at liquidity could prove to be alpha generating. In order to mitigate the depreciating currency, this strategy could be complemented by identifying export-oriented companies or those with a significant portion of revenues in hard currencies. Such companies should have a strong record of paying dividends, for investors enjoy the short-term ride.

Our view is that opportunities in agriculture, insurance and mid caps in general remain untapped in Nigeria. Growth drivers in the insurance sector are anchored on the large, under-penetrated workforce. The sector however is highly fragmented, with 31 listed companies representing only around 1% of market capitalization. We identify Continental Reinsurance and Custodian Insurance as attractive long-term opportunities. The agriculture sector benefits from strong government support with ongoing plans to invest $1.5 billion into the sector and double agriculture share of bank loans from 5 to 10% in 2 years, in order to cut imports. Interesting stocks in this sector include: livestock feeds, Okomu oil, and Presco PLC.

In Ghana: The current challenging environment does not present the ideal entry point for foreign investors. We see 2013 star performers Enterprise Group, CAL Bank and PZ Cussons Ghana riding on the momentum to outperformer peers and the market in general, in local currency. As we expect strict implementation of austerity measures going forward, we anticipate the forex to revert back to its mean by the end of 2015. Therefore, long-term investors should not walk away from one of Africa's strongest democracies just yet.

Access to the KINGs

Despite high transaction costs and forex risk, we favor direct access to these markets, backed by active strategies.

Alternatively, US investors may consider a wide range of ETFs. Country-specific ETFs include the Global X Nigeria index (NYSEARCA:NGE), the van Eck Market Vector Nigeria (LGOS) and the newly launched Vetiva's Griffin 30 (VG 30 ETF) traded on the Nigerian stock Exchange alongside the commodity-based Newgold ETF. Other ETFs featuring KINGs' stocks include the Market Vector Africa ETF (NYSEARCA:AFK), the SPDR S&P Middle East and Africa ETF (NYSEARCA:GAF), the Lyxor Pan Africa ETF (PAF:FP).

Mutual Funds give investors the possibility of instant and diversified access to the KINGs through outperforming, Africa-focused open-ended funds. Among others, investors may explore: the Nile Pan Africa Fund (MUTF:NAFAX), Renaissance SSA fund (RAMSSAA:LX), Templeton Africa Fund (FTAFAAE:LX), Arisaig Africa consumer fund (ARIAFRI:MP), Standard Master Fund [STMAEAU:ID], Imara Africa opportunity Fund (IMARAAF:VI), to name a few.

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.

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