By Cavan Osborne, Portfolio Manager, Old Mutual Equities
On arriving back from our trip to Nigeria, my six-year-old daughter asked me why I had naira notes. Now, around half the returns generated from investing in emerging markets are due to currency movements. Her question however forced me to quickly put exchange rate in simple terms. I explained that when I arrived in Lagos I changed my money into naira because when in Nigeria I needed to pay in the local currency. She then asked why Nigerians wanted my South Africa rand. Nigerians need the rand and other currencies because they do not have or manufacture everything they need. For instance, a Nigerian might want to buy a motor car that was assembled in South Africa, and would need rands to pay. In the same way South Africans need to buy oil, and so would need the naira to pay for Nigerian oil. Eventually though, she decided that Nigerians would swap my naira for my rand so that when they came for a holiday to South Africa they could have fun. And I would be happy to swap and take the naira so that I could have fun when I went on holiday to Nigeria. And she was very happy with this concept.
Searching for dividends and finding pizza
Our travel to Lagos, Nigeria’s busiest city, was driven by two things. Well, actually three if you include (a growing tradition!) of spicy chicken pizza from our best Italian restaurant, Pizzariah, a 20-minute walk from our hotel on Victoria Island in Lagos. Now, back to our other two motivators – we already knew that the Nigerian economy is under pressure, so we wanted to determine if:
1. The dividends from the banks invested in are secure for 2019; and
2. Are there any signs of a turnaround or bottoming out of the listed consumer sector?
I wish the answers to these questions were as easy as establishing that the pizza in Lagos is still the best we have found on our African travels. Using current expectations, many of the banks are trading on dividend yields in excess of 10%. These yields are very attractive, given that 12-month treasury bills recently traded at around 12%. The slow economy, lower interest rates and the Central Bank’s regular rule changes (such as increasing the loan to deposit ratio to 60%) are combining to put bank profits under pressure. Nonetheless, the banks still have a strong record of adapting and finding ways of making good returns. And assuming there are no further major rule changes, the banks we met with all seem on track to be in a position to declare dividends.
In the medium term, the outlook for banks is more uncertain. The mobile telecommunication companies (telcos) have just been awarded mobile money licenses and could cause disruption to banking. The adoption of telco-controlled mobile money is unlikely to be as fast as it was for Kenya’s Safaricom – the banks already have digital offerings and transfers are interoperable across different banks. This means customers can already easily send money from an account at one bank to another bank. It is also going to take time for Nigerians to trust that cash handed over to an agent (who previously sold airtime) will pop out at another agent, and not just disappear.
The country’s consumer companies have been delivering weak earnings for some quarters now. Nigerian Breweries actually reported a loss in Q3 2018, and I can’t recall any other leading brewer in a large population market like Nigeria (around 200 million people) ever reporting a loss. Most of the larger listed consumer companies have foreign controlling shareholders, such as Unilever, Nestle, Heineken, Diageo and ABInbev, and have reported weak results. Our analysis shows that while staff costs have been well maintained, raw material cost increases have eaten into margins. These companies have seen their share being eroded by alternatives, particularly cheaper options.
During the time of foreign exchange shortages (2016 and 2017), these foreign-owned businesses could access imported raw materials and had more control over selling prices. Following the devaluation of the naira though, the foreign exchange markets have opened up and the competition is making a comeback. It seems that consumer companies in Nigeria have lacked the nimbleness of the banks.
Using our process Nigeria is screening very attractively, particularly on valuation. Provided the oil price remains at around $60, Nigerian foreign reserves will be sufficient to keep the currency stable. Our sector preference remains the banks. The expectation of a stable currency and high dividend yields gives us confidence of strong returns.
Will Nigeria meet its potential?
We are, however, aware that the economy is slow and that under President Buhari there has been very little investment. It may be a function of the president being on sick leave out of the country more than being back at home. Sadly, of all the countries our team visit in Africa, Nigeria certainly stands out as being the one where development and progress is the least visible. The incomplete projects we saw five and 10 years ago, such as the Lagos light rail system, the Lagos airport, Eco Atlantic, are still not complete. Admittedly, we are in Lagos for most of our visits and have not seen much of the rest of the country. Over the last 10 years, Nigeria’s population has grown from around 155 million to 200 million – the increase almost matches the 50 million people of Kenya. So for now, the country’s potential remains but it is going to be up to the individual companies to drive growth as we don’t think they can rely on economic tailwinds to help.
This trip note was originally published by Old Mutual Investment Group.