Kamal Govan
By Kamal Govan, portfolio manager of Allan Gray Africa Equity Fund
The macroeconomic environment in many African territories remains challenging, with most countries still facing inflationary risks due to high food and energy prices. These risks are generally exacerbated by country-specific issues such as sluggish economic growth, persistent fiscal deficits, balance of payments concerns, currency weakness and social risks.
In Nigeria, the promising beginning made by President Bola Tinubu was just that β a beginning. While we too are more optimistic, additional measures and policy corrections are needed to fully reverse the embedded unorthodoxy in the Nigerian financial system. For example, the initial easing of restrictions on the foreign exchange market in the last quarter only partially reduced the backlog of foreign currency repatriation. Investors will remain cautious until this backlog is cleared, liquidity returns to the market and the currency is allowed to move freely.
A weaker naira inevitably leads to a higher inflation footprint and the recently reported inflation numbers in Nigeria show just that. Conventionally, we would expect this to be coupled with monetary tightening, but we are yet to see the response from the Central Bank of Nigeria (CBN). At this point, the recent appointment of Dr. Olayemi Cardoso, a former Citibank executive, as the new CBN governor is encouraging, but again only a start. From an equity perspective, currency depreciation was positive for banks with net US dollar positions. Guaranty Trust Bank, Zenith Bank and Stanbic IBTC Bank fit the bill and reported significantly higher first-half profits due to large foreign exchange gains. The CBN has since prevented the payment of these profits to shareholders, directing banks to use them as countercyclical buffers. Nigerian mutual fund banks continue to trade at attractive valuations, whether from a price-to-earnings, dividend yield or price-to-book perspective.
In Egypt, tobacco major Eastern Company is a strong performer, with a total US dollar return of 35%. In an effort to increase fiscal financing and reduce its role in the economy, the Egyptian government sold 30% of Eastern’s shares to a UAE investment company. The implied transaction price was EGP 28.90 per share, which is above the spot price of the stock. The company then announced its intention to spin off its assets to investors in an attempt to unlock further value. We continue to find the company fundamentally attractive, primarily for its track record of growing US dollar earnings over time.
Zimbabwean miner Zimplats has been weak on a relative basis since January (-5% total return in USD), but has held up significantly better than South African-listed platinum group metals miner (PGM) (between -56% and -38% total return in US dollars). The PGM industry is affected by a combination of a weak PGM basket price (due to the growing threat of electric vehicles), significant input cost pressures and production risks at their South African assets. Zimplats is not immune to these risks, but its position near the bottom of the cost curve adds an element of defensiveness to its outlook. In addition, Zimplats’ strong balance sheet, which we see as critical to our investment thesis, will support their multi-year, $1.8 billion investment program to replace depleted mines, add mining and processing capacity, and build solar projects. Zimplats has an enviable production track record, having approximately tripled its organic production since 2009.
We are under no illusions about the macro and idiosyncratic risks facing such businesses operating across Africa. However, we remain cautiously optimistic about the long-term prospects of these opportunities, as attractive initial valuations and bad sentiment often provide the cocktail for substantial future performance.