Nigeria is a harsh environment. So when speaking with the managers of some of the listed companies, their main concerns and the risks they flag are often different to what we as outside investors see. For instance, the number of civil servants not getting paid may have escalated, but it is not a new problem – there are always delays. Sourcing hard currency to pay for raw materials is taking longer, but then there are always delays. The traffic in Lagos has got worse due to a truckers strike, but traffic is always bad. So putting things in context is very important.

We met with a local business appointed as distributor for Diageo (brands such as Guinness and Johnnie Walker) and Procter & Gamble (brands like Pampers, Gillette, Oral-B and Ariel). The distributor margin is 8%. Theft varies between 2% and 5% of revenue, leaving very little for profit. So it is not surprising that plugging leaks and other operating challenges (such as the trucker strike) are far more top of mind than the slowing economy.

The Old Mutual Equities Africa team has just spent a week in the country. Nigeria’s business hub in Lagos is unlikely to go down as my favourite business destination − in fact, it is low down on the list − but it is our most important business destination. Saying this, I was actually almost enjoying the trip, until our journey back to the airport. After thinking that we had allocated sufficient time to get there, we ended up boarding just in time… and that included using the Nigerian airport helpers known as Protocol. There wasn’t even time for the usual stale polony sandwich from the food court! At one point on the way to the airport, we were driving on the dirt area adjacent to the main road, dodging (well, mostly) people, animals and pot holes. We then missed an offramp so the driver tried to head over the middle island and got stuck. That meant us exiting the mini bus and rocking it from side to side to free the undercarriage from the concrete barrier.

Industry exploits inefficiency

It certainly feels as if Nigeria has improved a little since my last visit, but it is a place that favours and thrives on inefficiency. Inefficiency creates opportunity. By not having central power for lights, there is an opportunity to sell generators, distribute fuel for the generators and create a generator servicing industry. Not having a sewage system also creates opportunity. By making the airport check-in process completely illogical and ridiculous, the whole Protocol Services industry thrives. And so it goes on.

The one interesting project that is underway is the start of the Lagos metro rail system, or Lagos Rail Mass Transit. Phase one was supposed to be completed in 2012, but it continues to face funding shortages. What is currently on the ground, though, is very impressive.

Currency controls

The one area that has, at least, got everyone thinking is the exchange rate. The Central Bank Governor and the President have committed to maintaining the naira at N199 to the US dollar. While many free-floating emerging market currencies have weakened, and in particular the oil exporters (like Russia, Kazakhstan and Angola), Nigeria has decided to keep its currency stable over the past six months. In fairness, the currency has depreciated by 20% over the last 12 months. Given that President Buhari has only recently been elected, it is unlikely that he is going to change his mind in the short term.

In the week that we were in Nigeria, the black market rate was 10% to 12% weaker than the official rate of N220 to N226 to the US dollar. If the currency doesn’t depreciate, then it is likely that exchange controls are going to get more severe. Already, just two months ago, Nigeria introduced a list of 41 items that could not be imported using the official channels. This list ranged from toothpicks (the most highly publicised item) to private airplanes and even rice, margarine and Indian incense. To further try and reduce demand for US dollars, the Central Bank introduced a law that disallows Nigerian banks from taking dollar deposits. So, we highlight that repatriating money from Nigeria could be a real problem in the short term.

Profits squeezed, but companies in for the long haul

Relative to other African countries, Nigeria has a deep stock market, with around 200 listed companies. We met a good spread of companies over the week, although the focus was on the consumer businesses and the banks.
The consumer businesses are under pressure. Volumes are down for most companies. The value segment continues to gain market share from the premium brands segment. GSK Nigeria indicated that the juice segment, for instance, was down 25% year to date. Interestingly, 70%-80% of GSK Nigeria’s sales are Ribena and Lucozade drinks, so a lot less of the pharmaceutical products that I normally associate with GSK are sold. Under these tough conditions, the companies are unable to pass through the price increases in raw materials resulting from the 20% weaker naira. Furthermore, wage increases were negotiated at around 10%. So we expect turnover growth to be low, and margins to compress. Part of the pressure is also extra competition. With Nigeria being seen as one of the next big growth markets in the world, competition has flooded in and existing companies have been expanding.

The key positive is that most of the consumer companies have significant spare capacity. Many of the businesses saw the long-term potential of the country and have been positioning ahead of the growth. It means that in the short term, despite pressure on profits, cash flows should be fine as capital expenditure is likely to reduce. The other reason to be wary of not owning the Nigerian consumer companies, is the potential for M&As. In July, Guinness Nigeria’s parent company Diageo made an offer to minority shareholders, and Unilever has made an offer for Unilever Nigeria. So parent companies are seeing the current market weakness as an opportunity.

We got our colleagues from Old Mutual Nigeria to take us around the city. These experienced shoppers quickly switched from high heels to slip-slops when we got to the markets. This allowed them to quickly navigate around the masses of traders, mud puddles, trash and live animals. The Nigerian markets we visited were the usual chaotic, busy places that are found in many African countries. The big difference, though, was the range on offer: In Nigeria, a tiny little store may have 10 different brands of pasta or 15 different brands of nappies (diapers), while a market in Zambia might have just one brand and each little store is selling the product at the same price. Nigeria is far more competitive. This explains why, despite inflation being reported at around 10% a year, the consumer companies complain that they are seldom able to increase prices.

Prior to my involvement in the African equity space, Nigerian banks certainly conjured up colourful images in my mind. While there are definitely a number of banks that I would not be placing any of my money with, there are one or two world-class operators out there. Some of the brands may be very familiar, given the amount of advertising they do on CNN and at Heathrow Airport. You may have heard of Zenith, GTbank, UBA and even Diamond Bank.

The Central Bank of Nigeria has introduced regulations that have been driving down sector profitability. While there may have been a small social drive behind this to save consumers from banks charges, it was more to do with them trying to cut the amount of money that the banks made out of the Government. This has meant that bank returns have been reducing for the past three years. These negative returns from regulation are now being compounded by potential bad debts. Nigerian banks have 20%-30% exposure to the oil industry, which is under pressure given the low oil price. Loans to the upstream companies (those pumping oil out of the ground) have already had to be restructured. These loans tend to be large and are therefore syndicated (shared) among the banks. Because these oil loans have been restructured from five years to seven years, they are (mostly) no longer classified as non-performing. But we remain very concerned. The other problem area for banks is lending to ”general commerce”. These are often loans to customers that are importing goods into the country. Many of these customers are in trouble because they can no longer source currency through official channels and their suppliers do not want to accept naira.

Overall, we remain underweight to Nigeria in our portfolios relative to the MSCI Africa indices. We are concerned about currency devaluation (although this is now unlikely to happen in the next few months) and we are worried about the economic slowdown that the low oil price and the currency restrictions will have on the economy. Our Nigerian exposure tends to be the higher quality companies. While the prices of the listed banks seem to be reflecting these concerns, the consumer stocks are, by our analysis, not building in any disappointing news in the short term. The call on Nigeria is a call on the oil price.

Cavan Osborne is a portfolio manager at Old Mutual Equities.