Investors Chronicle | 15 August 2008
Written by: David Stevenson
Africa is booming. From Mauritius to Botswana, Ghana to Uganda, African economies are growing at a rate of 5-6 per cent a year. Hedge funds, retail fund managers and private equity investors are swarming all over the continent, with the biggest potential seen in an area called SSA, or sub-Saharan Africa.
Naive investors would probably attribute this new-found fortune and enthusiasm to just one spectacularly successful industry – the resources business. And it's certainly true that SSA has more than its fair share of oil – both Angola and Nigeria are now huge producers of oil for western markets. Other important African export commodities include iron ore, timber, manganese, cobalt, copper and chromium.
But the resources sector is only half the story. Successful investors such as New Star's Jamie Allsop – a classic value investor – are scouring the continent using old-fashioned value ideas, looking for solid trading companies benefiting from the much bigger economic transformation under way. Greater prosperity has created a growing middle class – the World Bank estimates that the sub-Saharan middle class will be 43m strong by 2030, up from 12.8m in 2000, with most in South Africa but other countries such as Zambia, Nigeria, Kenya and Ghana featuring prominently. That means billions will be spent on consumer goods, telecoms, and infrastructure projects. And there are already many well run, solidly profitable companies in all these markets – they form the core of a vibrant and growing equity culture taking root in Africa.
Two decades ago, there were just five stock exchanges in SSA. Today, there are 18 with 1,500 separate listings. It has been reported in Fortune magazine that, excluding South African shares, African stocks have climbed an annualised 43 per cent since the end of 2006. In particular, since 2001 the Mauritian, Botswanan, South African and Namibian stock exchanges have outperformed the Dow Jones index by 483 per cent, 375 per cent, 202 per cent and 188 per cent respectively.
London-based research and broking firm Exotix, which specialises in frontier markets, also boasts its own large-cap index of SSA companies – its top 30 increased their market capitalisation by 126 per cent or $40bn in the period between 2006 and 2008, outperforming South Africa and the MSCI indexes for Eastern Europe and the Far East. It also noted that volatility was lower. According to New Star Fund management, "growth has outpaced the OECDs average every year since 2000 and is forecast to reach 6.75 per cent in 2008".
Of course all this economic boosterism shouldn't blind private investors to the very real dangers of investing in Africa. The biggest problem for investors is accessibility – there aren't many listed companies that can be bought via UK brokers. We've highlighted a number of specialist fund managers and a few businesses with western listings below, but the choice isn't huge.
The much wider problem is the more obvious one – lots of Africa is still very poor. Take one of the brightest success stories of recent years – Zambia. Unlike its neighbour Zimbabwe, it's not lapsed into a corrupt one-party dictatorship. Instead, it has embraced reform, privatised industry and invested in its infrastructure. It is also home to a growing and affluent middle class. Yet, according to one recent report from the FinMark Trust, which aims to develop financial markets in Africa, just one in every 1,000 Zambians has a housing loan from a bank.
Incredibly, just 16 per cent of Zambia's 11.5m people have salaried jobs. It's little surprise, then, that western trends such as house ownership have failed to take off – it can take six months or more to transfer titles for purchased plots, and loans cost 40 per cent a year. And because of the Aids epidemic, the average Zambian lives just 38 years – that means lenders demand that any mortgages are paid off by the age of 55.
There have also been political problems, with the first generation of post-colonial leaders helping to turn much of Africa into a disaster story.
Now, though, old Africa hands such as Christopher Hartland Peel – Africa equity specialist at Exotix – are in a surprisingly chipper mood. Even the recent 'big hiccup' in Kenya doesn't worry him terribly – he believes that Africa has profoundly changed and that the real motor of change doesn't lie with resources and commodities in the ground, but with leadership.
Across Africa the number of democracies has risen from 10 in 1980 to 34 by the end of 2007. "The older leadership are retiring and the new western-educated elite are taking control and they see the grinding poverty and realise that something has to change," says Mr Hartland Peel.
That something increasingly means privatisation, respect for the judicial framework, the growth of capital markets, and the removal of price controls. He even thinks there's good news on corruption.
Looking at Nigeria, he believes the private sector is largely behaving itself and is becoming cleaner by the day.
So, how do you invest in Africa? The key is to look at Africa not as one big market but to break it down into regions, sectors and specific investment vehicles.
The distinction between the Anglophone countries – principally in Southern Africa, as well as Uganda, Tanzania, Kenya, Ghana and Nigeria – and the rest (the Francophone countries in central and West Africa plus the Lusaphone or Portuguese speaking nations of Angola and Mozambique), is particularly important.
According to Mr Hartland Peel, the English-speaking countries by and large are embracing capitalism and stock markets and have a sound legal framework based on respect for property rights. The French-speaking countries tend to be more dismissive of an equity culture, have greater issues to do with governmental corruption (although the English-speaking countries are hardly immune) and possess a very different legal framework.
The Portuguese-speaking nations of Mozambique and Angola are, paradoxically, seen as potentially more alluring if only because their fall from favour was so spectacular. Angola was once seen as the civilised bread basket of Africa before lunging into a long and brutal civil war. The stabilisation of these countries has underlined their huge resource potential. But Mr Hartland Peel is cautious about Angola. "Every year it's been promising a stock market and it still doesn't have one. There aren't a lot of real investable opportunities, and there's no local currency available although, theoretically, the economic potential is huge given its oil reserves," he says.
Most institutional investors in Africa have made straight for the banking sector, with the big Nigerian banks featuring prominently in many international portfolios. In Exotix's recent Africa study, 18 of the top 30 companies in SSA were banks with a combined market capitalisation of $46bn (65 per cent of the entire index). It's easy to see why they've been tempted. Traditionally, the big Anglophone banks in West and East Africa have been relatively well run, have great growth prospects (in Nigeria think of all that recycled oil wealth) and have been producing impressive returns on equity – 15 per cent is standard, with some producing closer to 30 per cent.
However, this huge potential has resulted in some weighty valuations – it's not unusual for leading Nigerian banks to trade on well over 30 times current and even forecast earnings. These high valuations prompted a sell-off in the first half of the year – the AfriFinance index of Nigerian banks is down 15 per cent for the year to date.
More ominously, JPMorgan recently initiated research on the Nigerian stock market as a whole by noting that the banks were overvalued, with some trading at more than 57 per cent over its estimate of fair value. Oil is another worry – researchers at investment bank Renaissance Capital estimate that there's a 0.91 correlation between rising oil prices and Nigerian stocks, and banks in particular. But there are still some interesting value-based anomalies. Many analysts recommend firms such as Equity Bank in Ghana, or the Ghana Commercial Bank, both of which are trading in the low teens in PE ratio terms. Exotix also likes Barclays Bank Kenya – it has the highest interest margin to total assets ratio in Africa at 7.2 per cent and the lowest bad debt provisions to total loans ratio at just 2.4 per cent.
Land and Agriculture
Agriculture is the continent's most important economic sector – it still employs more than half the labour force yet remains one-fourth as productive as its counterparts around the world. One recent survey of this huge sector concluded that part of that productivity gap can be explained by the fact that nearly two-thirds of Africa's agricultural land has been degraded by erosion and misused pesticides. In Ethiopia, 85 per cent of the land is damaged. Correcting this damage is therefore critically important – agriculture contributes at least 40 per cent of exports, 30 per cent of GDP, up to 30 per cent of foreign-exchange earnings, and 70 to 80 per cent of employment. Get it right, and the wider economic benefits could be huge – the UK-based Overseas Development Institute points out that of the 30 fastest growing agricultural economies, 17 are in SSA.
Investors have started to take notice. Cru, a small specialist fund management firm, recently launched a Malawi-based fund called Africa Invest. The retail-orientated (and capital protected) variant of the fund can be accessed for as little as £4,000. The fund has made an initial investment of £2m in 2,000 hectares of land that's producing paprika for western supermarkets. With land prices starting at £800 per hectare (compared to £10,000 in the UK) it's relatively easy to amass large farms that can be upgraded with new technology, mechanisation and better production methods. According to Cru, annual returns on capital should exceed 30 to 40 per cent.
A much larger version of this scheme is being marketed by hedge fund Emergent. It's targeting a total return of 400 per cent over the next five years, partly off the back of rising land values, investment in better technology to improve productivity and the introduction of a new form of farming called no till agriculture.
To demonstrate the potential, it's been running a trial 7,200 acre project over the last three years that's showed an average 33 per cent annual gain in output from soft agricultural products and a total return of 120 per cent. Emergent points out that the return was based on much lower historic soft commodities prices, which have nearly doubled in recent years. This new fund believes that returns on equity for maize should be 35 per cent a year, and 25 per cent for soybeans.
Emergent isn't the only player in the agricultural space – palm oil companies are very active in West Africa and Lonhro has also spotted the potential to provide capital, technology and know-how to Africa's farming sector.
Africa's infrastructure sector faces enormous challenges. In a surprisingly candid presentation to the World Water Forum in Mexico in March, African ministers put the total annual investment required in their water sector alone at $20bn. Separate research from the World Health Organisation research indicates that $23.5bn a year would be saved by providing basic access in SSA – 5 per cent of the region's gross domestic product.
Water is a must have, whereas electricity is often regarded as something of a luxury. Average electricity access in SSA stands at about 25 per cent, and the World Bank expects 60 per cent of sub-Saharan Africans to still lack electricity by 2020. A report by Tanzania's Economic and Social Research Foundation calls for a doubling of generating capacity over the next 10 years, while Nigeria, which has only a tenth of South Africa's power output for three times the population, plans to more than double its capacity by the end of next year.
It's not all bad news, of course – mobile phone penetration in countries like Nigeria is already very high and growing incredibly fast. However, it does underline the huge potential for companies and countries that can supply this new infrastructure.
The Chinese, for example, are building a huge four-lane highway through the Katanga province of the Democratic Republic of Congo to reach the more developed resource infrastructure present in Zambia. Huge new oil ports are being built around the Gulf of Guinea – Lonrho is behind one big project in the oil-rich minnow state of Equatorial Guinea – and opportunities in the power sector in the Republic of South Africa are huge.
Perhaps one of the most interesting ways of playing this story is via building materials. New roads, oil terminals and ports need an awful lot of cement. Exotix has created an African Cement index (a tracker fund is soon to follow) with 10 companies. One of their favourite plays in this index is Kenya-based Bamburi Cement, which trades at 18 times earnings, has a return on equity of 25 per cent and no debt.
Guinness and SAB Miller have been making huge profits from various parts of Africa for decades now. For Mr Hartland Peel at Exotix, it's the great long-term value play. "Look at where the greatest growth in consumer disposable spending is going to go on – beer. Most companies face only one or two competitors – that means they have a great competitive moat – and they produce very decent cash flow," he says. Many of the leading players have listed their shares on local exchanges, although the big western holding company still owns a majority stake. Examples of good-quality plays include Guinness Nigeria, which has a return on equity of 34 per cent, an operating margin of 27 per cent and a PE ratio of 17, and Kenya-based East African Breweries, which also trades at 17 times earnings and pays a dividend yield of 5.4 per cent.
Mobile phones are big business in Africa. Vodafone, for example, is trying to beef up its African portfolio with a bitterly contested takeover of a Ghanaian operation. The International Telecommunications Union recently noted that: "Growth in Africa's mobile sector has defied all predictions. Africa remains the region with the highest annual growth rate in mobile subscribers." The UN agency adds that no less than 65m new subscribers signed up in 2007. "By the beginning of 2008, there were over a quarter of a billion mobile subscribers in Africa and mobile penetration had risen from just one in 50 people in 2000 to almost one-third of the population today."
World Bank officials now estimate that an astonishing $14bn has gone into telecommunications in Africa in the past five years, with the number of mobile telephone lines rising to 135m last year from 15.6m in 2000 – a compound annual growth rate of almost 54 per cent, compared with 24 per cent globally. Yet this growth has only scratched the surface – mobile penetration across the continent is still only 15 per cent. Morgan Stanley estimates that mobile-phone penetration in SSA will rise to 42 per cent by 2012.
The latest poster boy of this sector is Kenyan firm Safaricom, which recently floated on the local market. It boasts 10m subscribers and in its IPO in April the government cut its stake from 60 per cent to 35 per cent. The growing number of firms listing on local – and international – markets has also sparked outside, particularly western, interest as liquidity improves. Investors operating in this space think that the next targets are likely to be Sonitel (listed in the Ivory Coast but active throughout West Africa), Burkina Faso's Onatel (still a subsidiary of Maroc Telecom) and Mauritius Telecom.
Many western investors are also excited by Zambian operator Celtel – big investors include Jamie Allsopp's New Star fund. It was recently rated 'overweight' by US investment bank Morgan Stanley. According to analyst Sean Gardiner: "Celtel Zambia is attractively valued with a dominant 84 per cent market share" in the country. For a really long-term bet, investors might also want to keep an eye on small Zimbabwean operator Econet.