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Kenya’s downward spiraling currency (USD/KES and EUR/KES are up 12% and 18% respectively since last November) coincides with soaring inflation (CPI inflation increased to 14.5% in June from 13% y/y in May) on the back of a hitherto rise in international fuel and food prices, the latter of which has been especially potent given poor domestic rainfall. That recently enacted, targeted subsidies failed to mollify the trend, while core inflation (7.9 versus 7.3 in May) ticked up as well–suggesting some entrenchment of expectations–should only stoke pessimism; indeed analysts with Absa Capital target further year-end rise to at-or-above 15% and a current-account (CA) deficit gap of nearly 9% of GDP from 7.4% end-last year. Indeed the recent hawkish flailing from the MPC ahead of its July meeting (a 175bp hike to 8% after only 50bp in cumulative hikes YTD) is hardly reassuring, much like its dogmatically stubborn maintenance of a 4 month FX/import cover ratio, a tactic which has had the not-so-curious effect of requiring perpetual replenishment given the bulk of import inflation is priced in dollars, while providing a telltale telegraph to speculators (whom the central bank now has in its crosshair; note the now-banned use of funds borrowed from the overnight window for interbank market or foreign exchange trading in an effort to curb volatility) that now-deeply negative real short-term rates are indeed for real while GDP growth (5.6% in 2010) will likely fall under 5% in 2011 (one reason why the 20-share index, down ~20.4% trails only Uganda YTD across SSA equities). Overseas remittances, meanwhile, are up a third from last year, meaning that if the state continues to suffer in its bid to borrow it may wish to try a more targeted approach. Yields won’t be topping for awhile.
UAE May CPI inflation rose 0.2% (1.4% annually) following five consecutive months of deflation, though as the breakdown goes, housing deflation persists (housing and related services such as utility prices constitute 39.3% of the UAE CPI basket) and thus price levels remain at the lower end of the GCC spectrum–a phenomenon which should continue to normalize through the remainder of the year but which will likely keep monetary policy accommodative. Against this backdrop, Barclays notes, the once maligned banking sector continues to show improvement as interbank rates remain on their steadfast downward trend, “reflecting improving liquidity.” That said per 1Q11 results the loan-to-deposit ratio fell to a 4 year low (99%) with “growth in credit to the private sector (3.2% y/y in April) [is] still in recovery mode” and appearing destined to remain that way for the near-term given recent restrictions on lending volumes and associated fees generated (historically ~2 – 4%/annum on retail portfolios) which should pinch those banks with the greatest retail exposure comparatively profoundly (per Kuwait’s Global Investment House, “for personal loans, ‘aggressive’ banks were lending at an average of 180 – 240x while ‘conservative’ ones were at 72 – 84x the monthly salary; analysts there note that First Gulf Bank (FGB) would be most exposed given 34% retail/total loan and 20% retail fees/total income ratios, roughly double those of the peer group median). Admittedly, pundits note, “these rules will benefit the banking system in the long run, the impact in the short-term will stifle credit growth and come at the worst time when banks are already struggling with corporate defaults and restructuring eating into the bottom-line.” On a relative value scale the industry as a whole thus continues to lag the GCC universe, trading at [2012e] ~.95 p/b despite a ROE (~16%) that would imply some 30-40% upside (to that end, Kuwait’s sector looks rich in comparison at ~1.95p/b, 14% ROE). This, however, is likely testament to hitherto opaque nature of certain imminent restructurings–Dubai Holding holds around USD9.1bn (AED33bn), while the Al Jaber Group (AJG) of Abu Dhabi holds roughly USD1.6bn (AED6bn) worth of debtthat needs to be renegotiated–and the possibility of meaningful exposure. That said on average the estimated impact on total income for 2011 is likely to be, on aggregate, under 2% for every AED500 of exposure, per analysts, meaning the three cheapest banks on an RV-scale (Abu Dhabi Commercial Bank, Emirates NBD and Union National Bank) could be especially ripe to converge, both within the domestic sector and the greater GCC region as a whole. Yet others point out that overall elevated non-performing loans (NPL) are likely to persist (6.67 percent at the end of April, up from 6.25 last December, versus the GCC average range of 1.5 per cent in Qatar to 8.1 per cent in Kuwait at the end of 2010), a theory in part linked to the commercial property market per Raj Madha of Rasmala, an investment bank: “The commercial property market is taking a double hit from falling rent and falling occupancy levels, so even if occupancy levels on new buildings reach 50 percent, that would still mean cash flow to owners is down about 75 percent from expectations,” he noted in late May.
Analysts with Nairobi-based Sterling Investment bank wrote to clients this month that “the opening up of the East African region” per last year’s EAC Common Market Protocol “[should] provide dilution to the monopolistic position of East African Breweries Ltd. (EABL:KN) in Kenya”, majority owned by industry heavyweight Diaego Plc, which along with SABMiller and Heineken has been aggressively building up [its] presence in emerging and frontier markets to drive future growth. SABMiller, for instance, recently beat its forecast by reporting a 3% rise in beer volumes in the first 3 month of 2011, a performance predominantly led by Africa and Asia, and is set to re-enter the Kenyan market after Diaego bought out its 20 percent stake in Kenya Breweries Ltd., EABL’s primary subsidiary, as part of an agreement to end cross-shareholdings in each other’s operations. Yet those sounding EABL’s death knell may wish to hold off: the firm’s EBITDA margin and ROE (33.1 and 36.89%) compare favorably to SABMiller (16.25 and 10.35%, respectively) and given its 90% Kenyan market share, an 8% growth in volumes last year and the fact that the country is still in the early stages of convergence vis a vis its per capita consumption (12 liters compared to South Africa, Nigeria and Botswana with 59, 53 and 40 respectively), the long run looks, shall we say, rather tasty.
Moreover in addition to increased competition EABL looks set to counter oft-cited near-term headwinds (i.e. an inflation-fueled consumer shift into low-end brands such as now legal, “traditional” brews, as well as the rising global cost of barley) comparatively favorably: Sterling notes, for instance, that the firm is “implementing a raw material substitution strategy that aims to reduce the barley reliance to 60% and increases sorghum (which is more cost effective) input to 40%”, a strategy which in turn will help augment production of its lower-end brand, Senator Keg, and also help cushion overall operating profits. To this end the firm has been contracting more sorghum famers to boost production since it estimates its demand for sorghum (currently 12 tons this year) to rise 4x by 2014″, while the Kenya Agricultural Research Institute has concurrently come up with “a variety of sorghum which is drought resistant and fast maturing which EABL has confirmed to have ideal carbohydrates for brewing.” Finally, while market share will be eroded somewhat in Kenya, EABL continues to look outward to fuel growth: its majority stake in Tanzania’s Serengeti Breweries, increased capacity in Uganda and planned capex in Sudan and acquisition in Ethiopia (where the government now seems set on further state-owned brewery privatization) is part of an overall vision to “increase its regional footprint from 7 to 13 countries” and underpinned by hitherto cash flow growth, which stood at Ksh7.99bn in cash and cash equivalents end-FY2010 with zero debt. On the downside, Sterling writes (its SELL recommendation in late May stated a Ksh154 price target versus 189 currently), remains soaring inflation, higher excise taxes and the Alcohol Control Act which “continue to undoubtedly pose a downside risk to volumes in its main market.” Duly noted, but keep this one in mind once the dust settles.
While Saudi Arabia’s state-run energy company Saudi Aramco (which currently charges its petrochemical companies $0.75/mmbtu) is still likely to increase the price sought (to $1-$1.25) for ethane (which comprised 70 percent of total feedstock–i.e. the basic raw material that is converted into another product in a chemical process–for petrochemical makers last year) at some point in the near-term (despite recent ambiguity) given the realities of tighter supplies, not only does the sector’s marked, global cost advantage remain intact–the average global market price for the gas is 6x higher at roughly $4.50 per million BTU–but it looks set to meet rising Chinese demand (which comprised roughly one-third of global needs in 2010 from one-quarter in 2006) as the Kingdom plans to invest some $100bn within the next five years to boost output to more than 80 million (from 60) metric tons/year (used, in turn, in the manufacture of numerous products such as synthetic rubber, synthetic fibers and plastics). Two firms in particular, SABIC and Sipchem, down approximately -0.4 and -14.6% YTD respectively in response likely to regional capacity additions and Chinese monetary normalization, should benefit given fairly sticky projected gross margins in the face of a feedstock price rise: the former has both higher fixed costs (in cost of sales) and a more diverse downstream capabilities compared to peers which has hitherto allowed it more robust pricing power, while the latter finally finally seems ready to capitalize on the fruits of its latest expansion. Meanwhile, while analysts with Al Rahji Capital, a regional investment bank, note that China is in the midst of adding substantial capacity, at the moment its trade imbalance has never been so pronounced and furthermore “it will take a few more years for these capacities to come on-stream.” China’s petrochemical imports grew 42.3% in 2010 to $324.5bn after a dip in 2009 and per observers three specific drivers should indirectly underpin this trend going forward: “1) China‟s huge government spending on infrastructure (its government has allocated $1.3 trillion for infrastructure development over the next five years in the 12th Five Year Plan announced in the early 2011); 2) increasing domestic consumption which is expected to grow by 2 to 3 percent over the next five years; and 3) continuing housing construction (the government plans to build approximately 36 million affordable housing units by 2015).”
Recent bond price action, the fact that FRAs (forward-rate agreements) currently price in a 50bp hike by South Africa’s Pretoria-based Reserve Bank (SARB) by November 2011 and a recent breakeven rate uptick all suggest that the market now views inflation risks to the upside, particularly on the back of news that various municipalities have applied to raise electricity charges as much as 28 percent from July 1 versus the electricity regulator’s 20.38 percent guideline. Yet some analysts counter that given CPI’s hitherto muted trends (core roughly 3 percent through the first four months of 2011, with headline at 4.2 percent annualized in April) the Bank, which contrasts price data with a 6 percent implicit upper band target, will more likely hold off until January 2012 given recent manufacturing (up 0.4 in April, down from 4.9 percent in March) and wholesaler and retailer business confidence data (48.0 compared to 55 percent in the 1st quarter) that underscores a lingering output gap (manufacturing and mining production remain below pre-recession levels by ~14.5 and 3 percent, respectively, the former reflected again by a disappointing Q1 79.4 percent manufacturing capacity utilization level)–rationale which should serve as the foundation against premature tightening. To that end, demand-pull inflationary pressures look moderate, according to Absa Capital, as both retail sales (9.8% y/y in April after March’s revised 5.3% growth) and credit metrics may have now peaked such that elevated consumer debt levels (77.6% of disposable income)–which initially pushed annualized retail price inflation (1.8 y/y in April) back into post-crash, positive territory–will now serve as a headwind and stunt further spending momentum. Until the recovery is truly “broad-based” look for the SARB to remain dovish and the rand to weaken.
Saudi Arabia’s recent pullback shouldn’t overshadow the fact that while net credit issued during April reached SAR3.2bn, well below the SAR7.4bn in March, YTD figures are still more than double the amount seen during the same period last year–an upward trend in extended private sector credit that analysts expect to persist in the near-term against the backdrop of King Abdullah’s hitherto mandated fiscal expansion plans (i.e. a new housing loan guarantee scheme by the Real Estate Development Fund and an increase in wages). A sneaky way to tap this phenomenon as well as the Kingdom’s ever-impending paradigm shift in mortgage financing could be through Oman-listed Al Anwar Ceramics (AACT.OM) which, per Fincorp, an investment research firm, “enjoys a 50% market share in Oman and is seeing growing acceptance of its products in markets such as Saudi Arabia and Abu Dhabi, where demand for ceramic tiles remains robust.” In fact, per one observer the GCC region remains a net importer of ceramic tiles, with factors that fuel demand including opening up of property ownership, growth in tourism, and the growing young population that props up demand for housing units. A game changer for AACT, so to speak, came recently when the firm was allocated natural gas by Oman’s Ministry of Oil and Gas (in lieu of the firm’s originally-planned use of costly liquefied petroleum gas) sufficient for its 3 million square meter expansion which, per EFG Hermes, an investment bank should help bump gross profit margins going forward. “The recent allocation of gas coupled with a cash flush balance sheet has increased AACT’s prospects of organic growth over the next three years [whereas] the lack of gas allocation would have challenged the company’s ability to expand organically,” it wrote to clients. To date this year AACT has achieved 7% y/y growth in sales revenue and a 5.4% increase in net profit; its current ~10 p/e at projected 2012 EPS indicates some 33% upside in the stock versus current levels.
Morocco and Tunisia’s CDS history to date continues to reiterate the market’s notion that Maghreb’s geopolitical backdrop and macro fundamentals are more or less indistinguishable even though hitherto (a) one underwent a full fledged revolution and the other’s demonstrations look tame in comparison (for now?) and should lead to certain reforms; (b) sharp declines in both industrial production and tourist arrivals (6% of total domestic output) underscore a likely -0.5 y/y 2011 real GDP contraction (and the associated decreased direct and indirect tax receipts) in Tunisia (versus +4.1% in Morocco, where growth indicators, rather, including credit growth have remained intact throughout the year) as well as a widening of the former’s CA deficit (6.2% forecast from 4.8% in 2010), an uptick in inflation (4.8% forecast versus 4.4% last year and 2.8% projected for Morocco) and a downturn in reserves (whereas thus far sticky FDI flows, at 2.5% of GDP, should allow Morocco to grow theirs to roughly 1/4 of nominal GDP, versus ~15.9% for Tunisia).
That said both countries remain vulnerable to both EU oriented trade and investment ties (54% of exports and 86% of remittances, per Morocco, and a similar relationship for Tunisia though a higher export percentage) as well as to other exogenous shocks; Barclays noted for instance that the external financing needs of the region’s oil importers (i.e. Egypt, Lebanon, Syria, Tunisia, Morocco and Jordan) “will exceed USD165bn for 2011-13, and, over the same period, their fiscal financing needs amount to another USD145bn, without taking into account the implications of their post-transition reform agendas. In a recent report prepared for the G8 meeting, the IMF states much of this financing gap will need to come from external financial support by the international community because it expects private debt and capital markets to remain cautious towards countries in the region, increasing their risk premium and their cost of borrowing.” At least one commentator bemoans the phenomenon, arguing that too much aid perversely “will hobble the Arab spring”, while debt sustainability measures (i.e. public debt to GDP ratios) aren’t trending down like they are in, say, Lebanon. Yet as economist John Sfakianakis duly noted last week in reference to the GCC’s recent outreach “the economic benefits of accession favour the two prospective entrants” such that it may be fair to say that at least one main driver of inflation in Morocco could be tempered going forward (and not a moment’s too soon per global wheat prices). With all of this in mind interestingly Moroccan z-spreads on euro denominated, 2020 paper have widened versus Tunisia comparable credit since late January and have failed to correct despite CDS convergence over that same period; in highlighting the discrepancy and in accordance with the above analysts note Morocco’s “comparatively stable political situation and solid economic performance and external position contrasts with the growing uncertainties in Tunisia.”
Those looking for convergence between du (Emirates Integrated Telecommunications Company), MENA’s top telecom YTD at +10.5% through end-May (20.1x 2011e P/E and 7.1x EV/Ebitdba) and Etisalat (-5.1%; 7.8x and 2.9x, respectively), which was recently ranked the GCC’s second most valuable portfolio brand (USD3.622bn) by Brand Finance, a consultancy, may have to hold on. Analysts with Egypt’s CI Capital Research recently noted for instance that risk averse capital and bank deposit flow into the UAE from relatively unstable regional geopolitical backdrops “should in turn boost subscriber growth and limit average revenue per user (ARPU) erosion.” To this end, it wrote, “driven by mobile services, du continued to deliver a positive performance in 1Q11, where earnings more than doubled [y/y].” Moreover both players should benefit via the impending introduction later this year of long-term evolution (LTE, or “4G”) and voice over internet protocol (VoIP) services (i.e. the ability to make phone calls over the internet), as well as mobile number portability (MNP) which mark a paradigm shift within the sector towards liberalized, revenue diversification outside of the traditional fixed-line and mobile voice segments. Etisalat’s agreement with France’s Alcatel-Lucent in mid-February to help develop its LTE network, for instance, which will enable high-speed access to multimedia content such as video conferencing, was predicated on said shift: “Over the last year we’ve witnessed a 200% growth in data roaming traffic. There is an exploding demand for new technologies and large bandwidth to support and enable the surging data traffic,” commented Marwan Zawaydeh, Etisalat’s chief technology and information officer at the time. Yet to date du has been more aggressive in its rollout: this spring it successfully conducted and completed its first LTE pilot, a move which followed the launch of the latest 42Mbps mobile broadband services, currently the fastest in the country, after having recently upgraded its network to next-generation DC-HSPA+ technology.
The strong push is somewhat characteristic, however, and EFG Hermes, an investment bank, wrote in April that unlike its rival, which maintains a presence in multiple frontier markets, du is a pure play on the various Emirates and moreover “has managed to cement its position in the [UAE] market over the past two years, strongly pressuring Etisalat’s operational and financial performance to its own benefit. Operationally [it has] reached a 36% share of the mobile market and a 31% fixed-line market share only four years after its launch.” Plus, room for growth remains ample: UAE population and mobile penetration rates should rise from 4.9m and 245% in 2010, for instance, to 5.6m and 301% respectively in the next five years per analysts, and du’s higher-than-average expected growth (2010-2012 earnings before royalty growth 28.5% versus regional -1.1%) make it best in class, per a spring research note. In fairness, some observers wonder to what extent du’s high multiple is merely a product of artificial subsidy: it paid a 15 percent royalty fee to the government in 2010, while its rival, Etisalat , paid 50 percent of its annual net profit as royalties. Analysts with EFG admit that “there is little clarity on whether the Ministry of Finance will soon inform du of the royalty charge starting in 2011 or not,” and its sensitivity model indicates a fairly dramatic (~25%) increased intrinsic value per share if the royalty is cut even by as little as 10% this year. Etisalat’s shares would theoretically have even more to gain, however, given its hitherto under-performance as well as the thesis that the government is priming it for its own royalty cut in advance of allowing non-local ownership of shares which in and of itself should be a huge liquidity boon for an already attractive country and sector.
The Ivory Coast initially defaulted on a $29m coupon payment to its $2.3bn dollar-denominated eurobonds due 2032 and looks to do the same again vis a vis a $28.6m interest payment due by June 30, per Finance Minister Charles Koffi Diby, though in fairness if the Greeks can get away with putting lipstick on a pig and deeming it a “soft reprofiling” so should anybody else. To that end at least in the case of West Africa’s jewel there’s cocoa (not to mention oil, coffee, gold, cotton, palm oil and rubber) in them thar hills, a fact not lost on debt holders whose paper has now rallied 58 percent to roughly 55.286 cents on the dollar since its record low on March 16. Moreover it seems that the path to normalcy is at least doable in one case–the African Development Bank just gave $169 million in budget-support funding while the IMF’s Rapid Credit Facility (RCF) may disburse as much as USD130mn (as well as start talks on a new three-year program which in theory could grant relief for some $3bn of external debt) to repair public infrastructure, production facilities and private property when a committee considers the Ivory Coast’s request for support in July–whereas the other conjures up images of square holes and round pegs (Moody’s now gives you 50/50 odds). That said, as the IMF is quick to point out per the Ivory Coast, the security situation especially remains “a major concern,” adding that the state’s growth target of -6.3% (+2.4% in 2010) is “ambitious” and its fiscal position can be expected to “weaken substantially” in 2011 (a budget deficit of 8.5% is projected) given lower tax revenue collection and higher expenditures. Thus, as analysts with Barclays noted, “while the IMF viewed that budget support from bilateral and multilateral donors was likely to be sufficient to cover most of the deficit, it noted that it is unlikely to be enough to cover substantial external debt service obligations due to official creditors this year.” For now the wildcard continues to be cocoa, exports of which were halted during the crisis, and more pointedly how well President Ouattara is able to smooth over social division and quell ongoing violence–particularly in the western portion of the country which grows 250,000 tons a year, a fifth of national output, but [where] many farmers abandoned their plantations for months because of daily attacks from ethnic militias allied to one side or another [and where] villages were razed, and thousands of people displaced.” Keep in mind even pre-crisis the infrastructure underpinning yields was questionable at best; throw in deserted farms and the looming threat of black pod disease and the IMF may be right to question future cash flows.
JGW
Frontier Markets 