The following is an excerpt from an Exotix Capital report, titled Affordability in Africa.
The rise of the African consumer continues to present a significant opportunity for local and multinational consumer companies operating in the region, given relatively strong economic prospects over the medium to long term and favourable demographics. However, there is growing frustration among these companies over whether this opportunity will be realised, given disappointing sales growth in the region in recent years owing to weak consumer spending underpinned by a broadly weak macroeconomic environment (characterised by high inflationary pressure and severe currency weakness) and political uncertainty. This resulted in lacklustre performance and even the demise of a number of local and multinational firms. Examples include Tiger Brand’s divestment from Dangote Flour in 2015, its planned divesture of Haco Industries in Kenya and Truworth’s closure of its operations in Nigeria in 2016.
We share these frustrations. After all, the net earnings of our universe of consumer companies in Africa (28 companies in nine of the region’s largest markets) has grown merely 2% p.a. in local currency over the five-year period FY11-FY16; much worse in dollar terms owing to local currency weakness over the same period. Figure 1 blelow highlights notable weakness in net earnings in FY13, FY14, FY15 and FY16, which coincides with the deterioration in GDP growth across the region, highlighted in Figure 2.
Adoption of affordability has been low
That said, we argue that the challenges and underwhelming performance of most of these companies is not because the opportunity does not exist, but because of their inability to adapt adequately to local nuances. In particular, that of consumer affordability, which essentially is the production and sale of consumer products and services at price points that are within reach of most consumers. This would include the use of lower and affordable packaging formats – the most notable being sachets. This is not a new concept in the region as it has been adopted to a partial extent by a wide range of regional consumer companies. However, what is lacking is the depth of focus on affordability, for reasons we discuss later. Nevertheless, we observe there has been notable adoption in the beer industry, which in our opinion will shape the future of the industry in the coming years. We believe that this could spread to other consumer segments in the medium term, as adoption accelerates.
In the following sections, we discuss why we think that affordability in critical, why we believe that its importance has risen to prominence recently, the factors that will enable its greater adoption and the implication for investments in the region.
Why is affordability important in Africa?
Affordability in an African consumer context is important because it opens up the consumption of products and services to a group of consumers who previously could not access them, enabling consumer companies to realise the Africa consumer opportunity more quickly. In other words: Africa is a poor economy, and to succeed consumer companies need to sell affordable products. We think that affordability is and will continue to be a critical theme for the success of consumer companies operating in the region, primarily because of the region’s demographics, particularly: 1) relatively low household income; and 2) a large informal consumer market. We discuss these below.
Relatively low household income. Relative to more developed markets, household incomes in Africa are low, with a significant part of the population living below the national poverty line, mainly due to inequality in the distribution of wealth. Figure 3 below highlights that 64% of Africa households survive on less than US$2,600 annually, according to the Centre for Affordable Housing in Africa. This reflects why the focus of expenditure of the average African household is on essential products and services such as food, beverages and housing, emphasising the region’s relatively low gearing to discretionary products. While we expect household income will grow over the longer term, helping to realise the Africa consumer promise, growth over the medium term will be marginal at best, in our view, given low regional GDP growth – albeit an improvement vs the recent past.
A large informal consumer market. Africa has a large informal sector, which applies to the consumption of products and services due to the availability of lower priced goods and services in informal markets, even though they come at the expense of quality. According to a recent IMF study, sub-Saharan Africa’s informal market represented 38% of its total output, the second-highest region in the world after Latin America, as highlighted in Figure 4. Notably, sub-Saharan Africa markets such as Nigeria and Tanzania are at the high end of the regional spectrum, with informal markets of 65% and 54% respectively. This represents both an opportunity and challenge for consumer companies, in that those consumers could be converted to formal/branded products. However, at the same time, capturing that opportunity can be difficult depending on the operating model of the business. We expect that over the medium to long term, the size of the informal market will continue to shrink in favour of the formal market, as a result of improvements in household income and affordability. Progress over the past 20 years has been marginal, with only a 4% move to the formal sector in the region, but we believe that much more can be achieved with the accelerated adoption of affordability in corporate strategy.
Given this backdrop, we believe that it is essential for consumer companies seeking to build scale and achieve sustainability in earnings growth over the medium to long term to incorporate affordability as a significant part of their strategy. Based on the performance of consumer companies in our universe, we observe that firms which made greater moves to tackle affordability were more resilient over the past two tumultuous years, relative to those who did not.
The reason why the affordable theme is more important now is because of recent changes to the consumer environment, particularly pertaining to: 1) weakness in consumer spending across the region on the back of a weaker macro backdrop; 2) greater inflationary pressure; 3) greater competitive pressure; and 4) higher direct and indirect taxes as the authorities respond to greater fiscal pressure.
A more pronounced impact on the beer industry
So far, the impact has been more pronounced in the beer industry and by extension spirits, where we have seen dramatic downtrading in favour of affordable beer and spirits. This shift has had quite a disruptive effect on regional markets, particularly Nigeria and Tanzania likely due to their relatively larger informal market. We also believe that the deliberate affordable strategy adopted by key players in those markets, also exacerbated the trend. The impact was more severe on beer producers such as Guinness Nigeria, which was unprepared given its relatively higher gearing to premium and mainstream products. We discussed this in research we published on Nigeria beer producers on 30 May 2017, titled “Nigerian brewers – cost efficiencies critical amid flight to affordable beers”.
In the research, we noted that affordable beer had grown to represent 44% of total beer sales in Nigeria in 2016 versus 21% in 2013 and would likely continue to grow, reaching 58% in 2019. We believe that the impact on the beer industry has been profound, owing to a low base effect vs other consumer industries where there had been earlier adoption of affordability, albeit largely in the form of smaller pack formats, notably in food and home-and-personal care (HPC) products. In addition, we note: 1) greater competitive pressure, particularly as affordability represented a core strategy for AB InBev’s businesses in the region; and 2) supportive government policy, particularly in east and southern Africa, where lower excise duties on opaque beers have bolstered growth.
Affordability was the single largest driver of the relatively strong performance of AB InBev’s subsidiaries in the region – notably, International Breweries and Tanzania Breweries. Others such as Nigerian Breweries and East African Breweries, which have grown their affordable beer portfolio in recent years, recorded a relatively resilient earnings performance in their most recent annual and interim results.
Owing to the catalyst for adoption of affordability in the beer industry mentioned above, we expect that the penetration of affordable beer will continue to increase in the region, especially as other beer producers raise their adoption to improve their competitiveness and boost sales growth. Consequently, we believe that over the long term, affordability could well be the single largest determining theme for winners and losers in the region’s beer market. Of the major brewers in the region, only AB InBev has shown commitment to producing and selling affordable beer as a strategy to develop beer consumption in the region. With respect to the others – Heineken, Diageo and Castel – we are not so sure that affordability will be core to their strategy in the region, despite having varied degrees of exposure to affordable beer as a result of market dynamics driving their business, instead of the other way around.
Affordability in other consumer industries could begin to accelerate
Developments in affordability in the beer industry, as well as the broadly weaker consumer environment in Africa, will reinforce the need for greater adoption of affordability in other consumer industries over the medium term, particularly those geared to discretionary income i.e. packaged food and drinks, HPC and electricals. Key players have an opportunity to differentiate themselves by innovating in affordability in this increasingly competitive environment.
As we noted earlier, the adoption of affordability by other regional consumer industries has been mainly via offerings in single-serve formats. This should expand over the medium term, but we would like to see more innovation in local brands, particularly from multinationals, which have historically focused on international brands that are out of reach of most regional consumers. The success of indigenous players in this regard is evidence that the multinationals can also be successful. The challenge that indigenous players have had maintaining that success has been related to challenges funding their business, following recent macroeconomic headwinds, particularly the devaluation of local currency, scarcity of FX and high inflation. The advantage for the multinationals is that they are better capitalised than their local peers and are therefore less vulnerable to macro headwinds.
Challenges with the low adoption of affordability
We gather that some of the challenges with the low adoption of affordability in the sector are: 1) quality of earnings dilution, given that affordable products generally have lower margins and profitability profiles; 2) lack of adequate local raw materials, often forcing local consumer companies to rely on imports, which are highly susceptible to currency fluctuation and global market sentiment; 3) scarcity of lower currency denomination; and (4) global brand mentality – mainly exploited by the multinationals for scale and synergies, which do not necessarily apply in the region.
Esili Eigbe is an analyst at Exotix Capital.