By Cavan Osborne, Portfolio Manager, Old Mutual Equities
We were advised that early August was not the best time to visit Egypt – the weather is extremely hot, many management teams are away for their summer breaks, most companies would not have yet released their mid-year results, and South Africa had just knocked Egypt out of its own African Cup of Nations football tournament.
Nonetheless, our visas were expiring soon and we were keen to remain in touch with happenings on the ground – so we headed to Cairo anyway.
It all worked out in the end; the temperature peaked at around 37°C (which was perfect), and because Eid was scheduled for the following week, most management teams were available as they wanted to finalise and announce results before enjoying the Eid break. The only blight on our visit was an explosion a few kilometres from our hotel the night we flew from South Africa to Egypt.
Having said that, the terrorist activity seems to have calmed down significantly since our team’s first visit to Egypt in 2012. Despite the odd terror act, Egypt has been an impressive recovery story since the time of the Arab Spring when former President Hosni Mubarak was ousted in 2010. The Egyptians have had to deal with huge energy subsidy cuts, high interest rates and high inflation, and yet economic growth has shown a steady improvement.
This growth has largely been driven by investment from the government and the army. The banks we speak with told us that the high interest rate means that very little private sector investment has occurred. This means that when interest rates do fall, with the expectation being for a 4% reduction in the benchmark (currently 16.75% ), the private sector is likely to invest and consequently provide another leg to Egyptian growth. This investment phase should last some time, as there is a need for both maintenance expenditure and expansion investment given that the economy is growing.
Another factor influencing private sector investment is the risk of the army – which has vast business interests in Egypt. Their interests are wide, from fish farms and electricity production to hospitals and electrical component manufacturing. Official (or especially accurate) numbers are difficult to come by, but most estimates gravitate to the army representing around 30% of the economy. Egypt’s President el-Sisi (formerly the Head of Defence) tries to minimise the army’s role by saying the military’s contribution to the economy is 2-3%. However, it must be noted that army businesses receive advantages such as tax breaks (VAT exemptions), cheap funding from state-owned banks and in some instances ‘free’ labour. So not all business decisions are returns driven. In the last year the army has opened an enormous cement plant, which has flooded the market (adding a 12mt plant to a market which consumed around 50mt in 2018 and already had 85mt of capacity), leading to cement prices falling to such an extent that the rest of the industry is largely loss making.
The latest visible army venture is into fuel service stations. The army has just opened its first fuel outlets branded ChillOut. So, it is probably not a great idea to own any of the fuel marketers in Egypt at this time.
Given this context, the private sector is a little wary of investing due to the risk of the army getting involved.
Banking on the future
Still, a trip to Egypt always seems to bring out some interesting investment ideas. The banks are still performing well, benefiting from high interest rates and increasing penetration. When our team first looked at these banks in 2012, only an estimated 8% of Egyptians had bank accounts. Even the government would pay salaries in cash. Now around 15% have an account. The banks are also confident that when interest rates fall, the peak in investment will offset the fall in interest revenue because of the lower yields.
The consumer companies have been going through a difficult period. Firstly, after the devaluation in late 2016 the price of anything imported basically doubled, be it finished goods or raw materials.
At the same time, the government has been reducing subsidies on energy and food. This has made it a very expensive period for the people and, consequently, the consumer companies have struggled, particularly those selling more luxury items such as cakes and cars. The good news is that the currency has been stable and the final phase of the energy subsidy removal was in July this year. This means that conditions should normalise from here, and typical emerging market-type growth will return.
Egypt is one of the African countries we are most excited about at this time. It is the greatest exposure of any country in the fund. This exposure is broad-based and includes banks, consumer companies, healthcare and even industrial shares. One of our favourite holdings at this time is Credit Agricole Egypt. This bank is controlled by its French parent company and is expected to pay a dividend yield of 9% at the current share price.
This trip note was originally published by Old Mutual Investment Group, following a visit by its Equities team to Egypt.