Shining a new light on an old continent
Africa entered the 21st century in style. The continent is now showing unprecedented opportunity after the ‘lost decade’ of the 1980s was followed by a long period of slow and discreet recovery. Although still amplified, conventional mass media stories of the
war-ravaged, starved and corrupt continent are slowly making way for a much more positive message.
It is not surprising, therefore, that international investors are finally waking up to the significant potential that exists on this continent
of 950m people. Fixed investment still dominates portfolio inflows, with many of the capital markets still in their infancy, dominated by domestic (local) individuals and institutions.
Africa offers handsome potential returns at significantly lower risk levels than generally accepted, for both direct and portfolio investors. Why? In summary, the clear and significant improvement in sovereign governance is driving faster economic growth and improving business environments.
Firstly, the number of countries where voters hold real power to dismiss non-performing governments is growing very rapidly. We see more and more freely contested, fair and peaceful elections, where the result is gracefully accepted by the defeated parties. (The Zambian recently being a good example.) This maturing of democracy is leading to an improved focus on service delivery by governments-in-power, as well as a reduced incentive to assume power by violent means.
This has been complemented by growing fiscal discipline, which is having a profound impact on almost any macro-economic measure one should care to examine. Indeed, African economies are increasingly run by technocrats (rather than ‘big men’ cronies) - impressive individuals with top-class tertiary qualifications and remarkable private sector employment track records.
Secondly, we are observing a new spirit of African economics as evidenced by increasing implementation of free market principles across the continent - governments are recognising the crucial role of the private sector in meeting the economic challenges of their countries. To mention a few examples, previously committed socialist countries such as Ghana and Tanzania are adopting free-market principles with gusto, and are revelling in the resultant improved economic growth. The Egyptian economy has been restructured significantly, and the resultant buoyant corporate earnings growth and almost astounding real estate development are clearly visible.
These changes translate into higher sustainable growth rates. The International Monetary Fund estimates that the African economy will grow at 5.5% this year, up from 4.9% in 2005. In fact, Africa’s GDP has been growing faster than the global average for the last five years (which predates the oil and commodities bull market of the last two years). This growth is
also well-distributed, with half the countries in Africa expected to grow their GDP per capita by more than
3% per annum (real) in 2006.
The last decade has seen African capital markets developing rapidly. Companies are increasingly using African capital markets to raise capital. More than 400 companies have listed on African bourses over the past decade and the IPO pipeline continues to grow. Established stock markets now exist in over 20 countries, as far-flung as Algeria, Cote d’Ivoire, Uganda and Malawi. Cameroon opened its stock exchange this year, and Angola is expected to follow soon.
Most African capital markets are still in the ‘frontier market’ stage of development - young, small and illiquid - even by emerging market standards. However, they also have significant development prospects in terms of depth (ie, listings), breadth (ie, market capitalisation and turnover) and infrastructure (ie, efficient regulatory, clearance, settlement and custody structure).
Along with other emerging markets, the returns from African stock markets have been phenomenal over the last three years. But when other emerging markets from Asia to Latin America took a beating earlier this year, Africa’s stock markets emerged unscathed (with the notable exception of South Africa and Morocco).
While the MSCI Emerging Markets’ Index fell 10.5% in May, two of Africa’s markets, Nigeria and Kenya, which have both more than doubled in size in US dollar terms over the past three years, rose 6.2% and 5.8% respectively. Indeed, our group’s segregated portfolio investing in Africa has returned 39.5% for the year to date to September, well ahead of the MSCI return of 12.7% over the period.
Given the explosion of China’s - indeed Asia’s - appetite for commodities, the natural resource sector is very much in the forefront of investor’s minds. Interestingly though, apart from the Johannesburg stock exchange, most other resource-focused companies tend to list on markets outside of Africa (Toronto, London and Sydney). Africa, however, has more to offer the investor than just raw materials - to mention a few:
q Telecoms - Africa’s scramble to get connected: Owing largely to underdeveloped fixed line infrastructure, the mobile telecoms sector in Africa has taken off at breakneck speed, with the rate of subscriber growth continuing to beat expectations. What makes this sector so compelling is not only the relatively low market penetration, but also the limited number of licences. While the UK, for example, has about six mobile operators fighting for share of a market that already has over 80% penetration, a country like Egypt has only three operators in a market with a population of 75m and penetration of less than 20%. The operating environment is characterised by high subscriber growth rates, low churn rates and low acquisition costs. A very interesting factor is the ‘average revenue per user’ metric which is much higher in Africa than in other emerging markets such as China, Brazil and India. Most operators have very high operating profit margins and produce healthy cash flows resulting in either attractive payout ratios or growth into other low-penetration markets.
q Cement and construction - feeding off the housing and infrastructure bonanza: Whether it is government spending, private spending or aid flow, there is a housing and infrastructure boom taking place across Africa, creating a fierce demand for cement and construction services. Most cement producers and construction companies tend to have a local focus, except for Egypt, which is feeding the building explosion in the Middle East, and exporting cement as far afield as the US.
q Beverages/Beer - benefiting from the monopolies: There are really only two big players in this sector, SABMiller and Diageo. With market shares in excess of 90% in most African countries in which they operate, pricing power is a given. Add robust economic growth (on a per capita basis) and therefore volume growth, to pricing power and ‘abnormal profits’ results. Until now, penetration of the formal (or clear) beer market has been quite low, with a significant portion of the market made up of traditional or home brews. The beer companies are pulling consumers of traditional beer into the clear beer market through the introduction of lower end brands. Unfortunately, in many cases the stability and good prospects for the brewers are more than priced into the shares - it is not easy to find a ‘cheap’ brewer in the African markets.
q Banks - tapping into Africa’s retail banking boom: The banking sector in Africa is generally under-developed, with retail banking services lagging corporate banking. Debit cards, credit cards and mortgages are emerging products and are yet to be introduced in some markets. Banks in Africa have traditionally been prodigious deposit-takers, but reticent lenders. The balance of assets are invested in sovereign debt, at surprisingly attractive margins. This is changing rapidly, and we see a growing tendency to increase the level of retail and corporate lending, resulting in higher interest margins. As long as credit risk is managed prudently, this leads to enhanced profits and in fact, African banks generally have ROE’s that would make developed market bankers drool.
Of course, where there is opportunity for an investment return, risks lurk, but these can be managed and/or mitigated. The obvious risks include:
q Exchange rate volatility: Where this is high, a ‘natural hedge’ could be available through exposure to exporters who are hard currency earners. African currencies are not highly correlated to each other, and the portfolio-effect of investing in a number of uncorrelated currencies reduces the risk dramatically;
q Political risk: Ever present in emerging markets from Venezuela to Russia, the best approach for managing political risk is to exit early, which does require intimate knowledge of local political dynamics. For those in the know, Zimbabwe’s troubles afforded ample opportunity to exit before the real crunch occurred;
q Country-specific risk: With 21 markets to choose from, diversification across markets will mitigate country-specific risk;
q Cyclicality: The global economic growth cycle has a direct impact on resource-rich Africa. One has to balance this cyclicality (and its inevitable up- and downswings) with the positive effect of the structural reforms mentioned earlier. In addition, we are strong believers in a multi-decade period of demand pressure on resources as China and India industrialises;
q Tradeability: Low levels of liquidity in frontier markets inhibit easy buying and selling of stock. Because trading liquidity is tight, it takes time to build and unwind significant positions, making a long-term view important. It is also imperative to have local knowledge of companies and market character so ‘pitfalls’ can be identified early.
While loss avoidance is an important policy in frontier markets, the
‘discovery phase’ often brings the greatest capital returns for the patient investor.
Our firm offers two continent-Africa institutional mutual funds - a Guernsey-based pan-African Fund (which includes SA stocks) and a South-Africa domiciled African Fund (excluding SA). Our strategy is to invest heavily into pan-African investment capability, not just single country capability. Both funds have an absolute return focus and are managed bottom-up, with the geographical and sector exposure being primarily determined by individual stock selection.
Our approach to investing in Africa is fundamental - we look for quality stocks at attractive valuations. We find that the growth potential of African companies is often undervalued. This means that there are good opportunities for investors to find attractively valued, high-quality companies with good growth opportunities. In addition, companies in Africa tend to be under-researched, both locally and by the broader investment community, which results in frequent valuation anomalies (on the up- and down-side) in turn leading to good buying and selling opportunities.
African continent listed equity funds are simply the beginning of our focus on Africa. The African fixed income markets and private equity investment opportunities are in our sights.
Roelof Horne is portfolio manager at Investec Asset Management based in Cape Town