Below is a trip note published by Old Mutual Investment Group following a visit by its Equities team to Kenya.
For some time, Kenya has been screening poorly. Valuations have been unattractive and our concern about possible currency weakness has been growing. In my view, the currency has been too stable for a country with a large fiscal deficit (that is, a government spending way more than it collects) and a wide current account deficit (importing more than it exports). South Africa was classified as part of the “fragile 5” and its combined deficits were around 7% of GDP in 2017. The combined deficits in Kenya were more than double that last year. The Kenyan shilling has been trading at around Ksh 102 to the US dollar for the past three years.
To fill the gap, the government has been on a borrowing spree over the past few years. More recently, it has turned to taxes to generate more revenue. In September, VAT of 8% was added to fuel, excise tax on bank transactions went from 10% to 20% and tax on mobile calls and data increased from 10% to 15%. The original plan was to increase corporate tax from 30% to 35%, but this wasn’t passed in the end. These increases in costs come at a time when economic growth has been slowing. Growth has been slow since the government capped the interest rate banks can charge in 2016. Instead of growing lending, many banks invested the collected deposits in government bonds. This helped the government fill its spending gap, but now the slower economy has put tax collection under pressure as company profits slow. In addition, with Kenya as the hub for East Africa, and the neighbouring states of Tanzania, South Sudan and Ethiopia all under pressure, hub activities are also slowing. It feels like the Kenyan government is in panic mode.
Spreading its wings
We flew direct from Cape Town to Nairobi on Kenyan Airways. It was chaos at passport control when we arrived late on the Sunday evening. The first Kenyan Airways flight to New York departed that evening. In order to comply with US flying regulations, the passport control process and airport needed to be reconfigured. The increased requirements to process arriving passengers led to bottlenecks similar to those of Nigeria’s Lagos airport. After finally being processed, we then got stuck in a midnight traffic jam in the pick-up area as President Kenyatta had been waving farewell to the first United States flight. Besides transporting passengers, the direct flights will open up opportunities for Kenya’s horticulture industry. Up until now, most of Kenya’s fresh flowers have been destined for Europe.
Since our last visit, the SGR (standard gauge railway) has started operating. Phase 1 of the project sees trains on the 490 km railway line between the main port city of Mombasa and the capital Nairobi. The passenger station just outside Nairobi is on a grand scale. Currently, it is running two services a day. The express train takes just less than five hours to cover the distance. An economy class ticket costs Ksh 1,000 ($10). First class includes a separate waiting lounge that serves drinks and snacks. This ticket costs US$30. The major role of the line, though, is for transporting cargo and encouraging investment. The plan is for the line to eventually continue on to Kampala in Uganda. However, during the week that we were there, some concerns about the second phase surfaced, as China threatened to pull the funding for the project after Kenya banned the import of Chinese fish.
The Kenyan authorities are putting pressure on companies to use the railway. My brother works for a South African-based retailer and explained that authorities will not clear imported goods at Mombasa port unless SGR is used. In fact, goods that are actually destined to remain in Mombasa are having to first be railed up to Nairobi before being transported back to Mombasa.
A sure bet for the taxman
The fastest-growing area in Kenya seems to be sports betting. The company we met explained that the sports betting industry has grown from $20m in 2014 to more than $2bn. Most of the betting is on football matches and most of the betting payments are done through Safaricom’s mobile money platform called M-Pesa. This growth has not gone unnoticed – firstly, by the government, who is introducing a new tax system and, secondly, by the churches as they are losing out on tithes. Although around 80 licences have been awarded, Sportspesa and Betin have more than 80% market share.
The listed companies we met are currently producing mixed results. Safaricom continues to deliver strong growth. In fact, its bottom line grew 20% for the six months to September 2018. Those companies that have direct or indirect dealings with the government are struggling with no or late payments. Barclays Kenya recently launched a mobile banking app called Timiza. Within four months of its launch in March, it had signed up two million new customers – taking the total customer base from 700,000 to 2.7 million. Of these new customers, 800 000 were issued loans. To me this suggests a desperate need for cash rather than simply a great mobile app.
On a positive note, in the last few weeks, Kenyan runners have broken both the men’s half and full marathon world records. Eliud Kipchoge’s marathon time equates to running every 100m in 17 seconds, or a kilometre every two minutes 53 seconds.
Despite Kenya not appearing to be a happy investment destination right now, our process shows that Africa (excluding South Africa) is the most attractive it has been for a number of years.
Cavan Osborne is a portfolio manager at Old Mutual Equities.