Frontier Market Focus: Africa – Cinderella offers great promise

By Hamlin Lovell, NordicInvestor

The Mercator map projection, named after Dutch cartographer Gerardus Mercator, is politically controversial in that it makes Africa (and other equatorial territories) look much smaller than they really are. But when it comes to market capitalisation, Africa really is tiny at the moment.

Africa is being substantially ignored by the majority of benchmark-conscious investors – and for good reason.

“In current benchmarks, it is a very low weighting or even absent. In MSCI World Equity, it is still mainly excluded, with only one share – Investec – making up 0.01% of the benchmark. In MSCI Emerging Markets Equity there is a bit more, but even so the value is relatively low with South Africa weighted at 5.6% and Egypt at 0.13%”, says Wytze Riemersma, CEO of Netherlands, Joure -based Trustus Asset Management BV.

“In the MSCI Frontier Markets, four African countries – Kenya, Mauritius, Nigeria and Morocco – make up about 20%”, he adds.

The demographic dividend

“But from a macroeconomic perspective there is a completely different picture”, he points out.

In general, frontier and emerging markets are relatively young (the China component within emerging markets is what brings average age up) and Africa is one of the youngest.

Africa fits perfectly into the demographic dividend. It’s a very young continent. Demographically, the population is 1.3 billion and 20% of global youth are in sub-Saharan Africa.

And by 2025, Africa’s GDP is forecast to be one third of USA GDP. In addition, by 2025, most of the 50 African states are expected to reach middle income status of at least USD 1,000 per person per year”.

China is contributing to Africa’s economic development. China is probably now a more important investor in African development projects than development banks such as the World Bank. “Though we do not have exact numbers, China’s investment in infrastructure; railways; highways; land rights; access rights and commodities, adds up to a lot”, he says.

The growth story is also one that is lowly correlated to developed markets: “In general, the correlation figures for Africa are very interesting. Investors could better diversify portfolios by adding frontier markets in general and specifically African ones”, he says.

African companies tend to list on their home country exchange, and this is one reason for their diversification benefits. Listing on a local exchange results in lower correlations than if they listed in London or New York. Sometimes it makes sense to use a Kenyan company as a play on Ethiopia, but in most cases Trustus invests in local companies.

Investible markets

Unfortunately, for now only about 11 of Africa’s 50 countries are realistically investable for public equity investors running daily, weekly, or monthly liquidity vehicles, in terms of liquidity and market caps. “The majority are not liquid enough, and are more or less private equity, despite having a stock-market. They are hard to get into and even harder to get out of”, says Riemersma.

The eleven most liquid markets are: Egypt, South Africa, Ghana, Botswana, Nigeria, Kenya, Mauritius, Morocco, Zimbabwe, Angola, and Malawi, he estimates.

The good news is that the investment universe growing with privatizations and IPOs. There were thirty IPOs in 2017 and 17 in 2018, including Cassava SmartTech in Zimbabwe; Bank of Kigali in Nigeria; Cipla QCL in Uganda and MTN Ghana. There have also been offerings in South Africa, Egypt and Morocco.

Many planned future offerings revolved around mobile networks: MTN in Rwanda and Nigeria; Liquid Telecom; Airtel Africa; mobile towers operators Helios Towers, Eaton Towers;

In March 2019, Africa’s answer to Amazon – pan-African e-commerce company Jumia – filed with the SEC for a New York listing.

Local business methods

“South Africa apart, African stock-markets are frontier markets where you always take a step back in time. The costs of account opening, local licenses, and trading are higher than on developed markets. But once you are in, it works well enough in the same manner as more developed markets. Normal trade settlement times are T+2 or 3; and we use local custodians”, he says.

“And it is possible to manage a well-diversified portfolio in frontier markets with enough liquidity for a daily liquidity fund, in frontier markets”.

“We prefer public to private equity because a private equity investor has to find out the risks for every deal. For listed investments, the price is determined 80-90% by the locals and only 10-20% by foreign investors. This means that local knowledge, risks and reputations are already reflected in the price”.

There have been some accounting related scandals, most recently concerning South Africa’s Steinhoff and KMPG South Africa. But these seem more the exception than the rule.

“Many frontier markets – in Africa and elsewhere such as Vietnam – are very keen on attracting foreign investors, to give them more status. So they work hard to live up to international standards, use one of the big five accountancy firms, and also bring knowledge and expertise. Standards look a lot like what we are used to. We are quite quantitative investors. We like to study annual and quarterly reports very thoroughly. They are fairly well readable, more or less in line with developed markets”, he points out.

Valuation dispersion and dividends

Market restrictions can play a big role in valuation differences. “In Morocco, institutional investors are forced to invest pension and institutional money, into the home market. This leads to its premium valuation of 17 times, higher than other African stock-markets. In contrast MSCI Nigeria, which contains many banks on very low valuations, averages a PE of 6 times”, observes Riemersma.

Overall, he judges that, “African valuations are close to the lows seen around the 2009 crisis, and at a discount to the average frontier market. MSCI Frontier Markets is on a PE of around 11.8, but Kenya is on 10.5, Egypt is on 9.25, Botswana 7.5, and Nigeria on 6 times. Many international investors are giving up on Africa”.

Dividend yields are also above average: “The MSCI frontier markets yields 4.5%. Our frontier markets portfolio yields is approaching 6% and the African sleeve of it is yielding 7%”.

“Withholding taxes on dividends can be as high as 15% in some African countries, but are zero in others”.

ESG, Impact Investing and Engagement

Certain companies and countries in Africa are associated with ESG issues, including corruption, pollution, blood diamonds, wars and conflicts. Trustus works with ESG ratings agency Sustainalytics, who screen portfolios each quarter.

The number of companies with low ESG ratings is actually relatively small, because the “quality” factor that Trustus prioritises in their stock selection tends to be correlated with high ESG ratings.

“We are very focused on certain types of stocks generally called quality stocks. We screen for return on equity; strong balance sheets, and high dividends over a number of years. These quality companies also tend to look good on ESG metrics. They are already very concerned with the future and shareholder interests – and do well on ESG criteria”.

“For a liquid portfolio, impact investing would result in a very concentrated portfolio with a very different risk profile versus a well-diversified portfolio. Public equity markets are not developed enough to do impact investing in in a diversified way. There is a trade-off between very strict ESG impact investing, and a very highly liquid and diversified portfolio, in Africa”, he argues.

Trustus is active on the ESG front in terms of engagement. “We always give feedback to companies. For example, Dangote Cement had issues with the security forces intimidating people and personel. We then put it on the watchlist, and had to remove it from our universe after the company failed to improve its behavior” says Riemersma.

2019-04-15T13:15:34+00:00By |Categories: Emerging Markets, Equities, The Nordic Brief|