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An admittedly lofty price target for Tanzania Breweries comes in spite of a restrictive cost of capital estimated using a somewhat convoluted approach that borrows concepts from valuation wonk and professor Aswath Damodaran, professor Vivian Okere’s 2007 paper on WACC and frontier markets as well as more unsystematic, within firm or “project risk” mitigating factors derived from the Erb-Harvey-Viskanta Cost of Capital Model.  As Okere notes, however, this “is not science”–a point reiterated by the relative illiquidity and concentration of frontier equity markets that makes gauging country risk premiums among other inputs so subjective.  To this latter question a 2011 IESE market risk premium survey conducted via practitioners within 56 different countries added increased color, though the self-reinforcing nature of herds is of little comfort. In any event it’s best to err on the side of caution, we feel, given that an overly zealous WACC can at worst be thought of as an implicit margin of safety if nothing else and there are plenty of other avenues within the valuation model to express optimism.

While headline inflation in Tanzania fell to 19 percent y/y in March (from 19.4 in February) on moderating food (25.7 versus 26.7), housing (17.4 versus 19.5) and transport (9.7 versus 10.9) metrics, core measurements (8.8 up from 8.6) remain sticky, a phenomenon we’ve observed particularly among net importers.  Interestingly in Tanzania’s case a deteriorating trend in the current account (-8.0, -13.7 and -12.5 percent of GDP respectively in 2010-2012f), however, has not seen a concurrent breakdown in import cover as gross reserves have actually remained fairly static over that period, rising at last count to $3.76 billion, or 4.1 months of cover, from $3.59 billion last June (3.6 months EOY11).  This despite the shilling’s ubiquitous freefall since 2009 and all-time low of 1,850 against the dollar in late October which has since retraced back to its 17-week consolidation low of 1,570 as aggressive central bank (BOT) intervention sought to mop up liquidity via hiking the repurchase rate and minimum reserve levels while a directive halving the maximum net open position limit forced banks to jettison dollars (a strategy similar to neighboring Kenya’s, for instance).  The 100-week support level of 1,550 appears likely should downside support break.

Given the reserves delta (i.e. rate of change) actually rose over the BOT’s intervention period, resiliency in terms of absolute levels of foreign reserves is likely a function of strong external financing of the balance of payments via FDI flows since existing regulations deny non-residents to ability to hold local currency assets, as well as diverse breadth and relative value of exports which tend to make Tanzania less exposed than peers to external trade shocks (evidenced by its relative Contagion score strength versus Kenya).  Speaking to the former point, given continent wide dynamics the country’s steady FDI backing isn’t surprising: a 2011 Ernst & Young study, for instance, predicts investment projects in Africa will roughly double to US$150bn by 2015 based in part on their attractive hurdle rates.[i]  To the latter issue while minerals (i.e. gold) made up approximately 40 percent of exported foreign trade flows, manufactured goods (~26 percent) rose over 90 percent y/y and account for an increasing portion of the export basket, though as a whole current account dynamics are still largely correlated with energy prices, gold prices and Chinese demand (~15 percent of exports), none of which are exactly strong tailwind catalysts at the moment.

We believe said correlations are likely to keep the shilling in a secular downtrend (and by extension keep monetary policy tight) given our opinion that its underlying drivers are more structural than cyclical (i.e. energy regulator EWURA’s recent 4.1 percent price hike should be offset by normalizing food price inflation following the drought), a function not only of wanting infrastructure (perennial power tariff hikes, reported and forecasted by stated-owned TANESCO, may be necessary for requisite foreign investment but they are the natural consequence of poor hydrology in catchment areas which negatively impact hydroelectric power generation[ii]) but also non-tariff trade barriers which the five-member East African Community (EAC) concluded in a 2009 study contributed to low regional trade flows despite member state commitment to abolish them.

JGW

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