Africa’s  economies  are  in  the  midst  of  a  downturn  –  but  that  doesn’t  mean  good investment opportunities aren’t there. Rafiq Raji presents his top ten.

Sub-Saharan Africa is expected to expand by 1.6% in 2016, according to the IMF. Only two years ago, the sub-continent grew by 5.1%. So what happened? Lower commodity prices, drought, power  shortages and bad policy choices are just a few of the reasons why. A growth drought in the continent’s two largest economies – Nigeria and South Africa – is also weighing significantly on the outlook.

Some of the headwinds are self-inflicted. In Nigeria’s case for instance, the country’s fixed exchange rate policy was a major drag as oil prices continued to languish. Confidence was further eroded as the administration of President Muhammadu Buhari underwhelmed  investors. Policy reversals since – for the better this time (for example, Nigeria’s new free-floating currency, which is now valued by market forces) – suggest lessons have been learnt. However some would argue that these reversals have been too costly and a bit too late, considering that the Nigerian economy will likely contract this year.

In South Africa’s case, drought-induced effects on agricultural output, a volatile exchange rate and increased perceived political risks continue to be major  weighing factors. The necessary tightening stance of the country’s central bank has expectedly come at the expense of growth. In July, the South African Reserve Bank cut its growth forecasts: it now expects no growth in 2016. Even this may be a bit optimistic: a contraction this year would not be farfetched.

Continued growth in East African and francophone countries is making up for the continent’s currently weak  giants. The investment cases for Kenya,  Tanzania, Ethiopia and Rwanda are extremely strong. St. John Bungey, Chief Executive Officer for Africa investments at Sanlam Investments, who only considers  investments outside South Africa, is very bullish on East African opportunities; off-market ones especially. And even in West Africa, Bungey is happy with his holdings in Ghana’s retail property sector. At an expected growth rate of 4% in 2016, Ghana would still do better than the continental average.

Regardless, there is a general sense that no matter the headwinds, the consumer and retail sectors will do well across the continent, especially in African countries with large populations like Nigeria and Ethiopia.

Ramped-up efforts to close the continent’s infrastructure deficit gap also provide ample opportunities for plays in that sector, especially as projects under increasingly viable public-private partnership (PPP) structures are supported by local authorities and development partners.

“Despite global economic uncertainties, we will continue to see investment deals transacted every day across Africa,” says Zemedeneh Negatu, Managing Partner of the Ethiopian operations of global consultancy Ernst & Young.

African countries that are fundamentals-focused will also continue to be attractive. These countries are investing in infrastructure, building power plants and pushing for industrialisation. However, commodities will still continue to play a significant role in a still largely resource-based continental economy. And a bearish commodity market means there are quite a number of attractive opportunities in the sector. But two decades from now, attractive African economies will be  those that succeed in diversifying their  economies away from commodities or forward integration to beneficiation.

At the moment, “there is still significant interest in investing in  oil and gas, particularly upstream  and midstream infrastructure such as rigs, storage facilities, processing plants, pipelines and gas compression/liquefaction facilities,” says Wale Shonibare, Managing Director and CEO at Shonibare Consulting and a veteran African investment banker. Even so, “resource sector deals are fewer than before and deal sizes are smaller,” according to Negatu.

Agriculture is considered a winner

“People still need to eat,” says Andrew Alli, President and Chief Executive of Lagos-based Africa Finance Corporation, who also likes sectors “that are currently beaten down”; natural resources, for instance.

“Infrastructure, financial services and consumer goods are still long-term plays,” he believes. It is hard to argue with that thesis: from farmland investing in Ethiopia to inputs for food processing in Nigeria, Africa’s agricultural sector is proving to be resilient to the downturn. Global arable land per capita is estimated to reduce to about 0.5 acre by 2030 from almost one acre in 1980. Africa has 25% of the world’s arable land. Still, the continent only accounts for about 10% of global agricultural output: about 90% of Africa’s estimated 400 million acres of arable land is uncultivated. And at least half of this is damaged, say experts.

Agricultural investors need to be picky. Nigeria and Ethiopia are good agricultural investment destinations. In Ethiopia, for instance, there is a three million-hectare farmland opportunity for cotton production. Harvests could feed the newly-built industrial park in the city of Hawassa, south of the capital, Addis Ababa, which will be entirely focused on the manufacturing of textiles and garments

African infrastructure plays are a no-brainer

Power is in short supply, roads are inadequate or in bad shape, new airports are needed, decent housing is limited – the list could go on. The asset class is almost a sure bet. Uninformed moves tend to be costly, however. Terms of PPP arrangements get reversed when administrations change. Populations often resist paying for services, with populist governments buckling to pressure. Nonetheless, Ivorian, Kenyan and Nigerian authorities have earmarked significant sums to build roads, power stations and mass housing via PPPs.

Verner Ayukegba, Principal Economics and Country Risk Analyst for sub-Saharan Africa at London-based IHS Markit, a research company, suggests investors should look out for “opportunities in the second wave of investments in power (and other infrastructure) assets when the first movers are either selling off or bringing in more strategic international partners.” And there are quite a number of those as well as numerous planned greenfield ones.

Consumer goods and retail sectors are resilient to economic cycles

The investment thesis for consumer goods extends from that of agriculture – and further. It is a manufacturing and consumption play. Sanlam Investments’ Bungey is particularly excited about the sector: “We are bullish on the consumer retail sector,” he says, especially as the consumer and retail sectors are much more wide-ranging, running across almost all the asset classes.

Opportunities in the consumer goods sector are set to expand even more as a continued commodity price slump has and Country Risk Analyst for sub-Saharan Africa at London-based IHS Markit, a research company, suggests investors should look out for “opportunities in the second wave of investments in power (and other infrastructure) assets when the first movers are either selling off or bringing in more strategic international partners.” And there are quite a number of those as well as numerous planned greenfield ones. The investment thesis for consumer goods extends from that of agriculture – and further. It is a manufacturing and consumption play. Sanlam Investments’ Bungey is particularly excited about the sector: “We are bullish on the consumer retail sector,” he says, especially as the consumer and retail sectors are much more wide-ranging, running across almost all the asset classes. Opportunities in the consumer goods sector are set to expand even more as a continued commodity price slump has spurred economic diversification drives by African resource exporters. This time around, the reforms may be sustained. Franklin Amoo, Partner at New York-based Baylis Funds, a frontier markets investor, believes African authorities might actually walk the talk this time. He sees them “applying more serious focus to diversification efforts and developing production capacity.” Currency devaluations are expected to encourage local manufacturing as consumption patterns shift to expectedly less expensive, locally-produced consumer goods.

In this sense, Nigeria is quite attractive, Kenya and Ethiopia also.

Dominant regional economies come highly recommended

“Ivory Coast stands out,” says Ronak Gopaldas, Head of Country Risk at Johannesburg-based Rand Merchant Bank (RMB). The francophone African country is expected to grow above 7% over the next few years. Political stability and a business-friendly environment are some of the reasons why the country is currently an investor’s darling. These, “as well as technocratic leadership aimed at ‘crowding in’ investment, has seen the country become an attractive bet for investors,” Gopaldas says.

Rebuilding after a civil war, the infrastructure sector is set to boom especially. Power plants are at capacity. With an annual 10% power demand increase, new ones need to be built and are indeed planned. And there is currently not enough liquefied natural gas (LNG) domestically for gas-fired power plants. Authorities plan imports to close the supply gap, with first shipments expected in 2018. So there is an opportunity to supply LNG, in the first instance, and to build LNG plants as a permanent solution.

“We think certain East African markets – in particular Kenya, Uganda, Ethiopia and Rwanda – offer compelling opportunities,” says Baylis Funds’ Amoo. More diversified economies, deep and long-established trade links with Middle Eastern and Asian markets and large urbanised populations are some of the key attractions of East African countries.

Considering it is the largest and most advanced economy in the East African regional bloc, has an open economy and its reputation for sound economic management is well known, Kenya is considered to be attractive. Even as the country operates twin deficits, AFC’s Alli likes it. Despite rising debt levels and political bickering ahead of elections in 2017, Kenya remains a highly regarded African investment destination.

 “The outlook for Kenya and the wider East Africa region is quite promising in our view,” says Randolph Oosthuizen, Africa Funds Analyst at Johannesburg-based Old Mutual Investment Group. As with most African economies, getting exposure is often the challenge. High-return opportunities are often not big or liquid enough. For Kenya, listed equities – the preferred asset class – in sectors of interest (telecommunications and consumer goods) are few.

Oosthuizen echoes as much: “From a listed equity point of view, we are often limited in our options. So in Kenya we have the choice of a fantastic telecoms business (Safaricom) but no large and liquid consumer companies to invest in.”

African giants Nigeria and South Africa – challenged though they are – remain worthy of a look as well. There is a consistency in the attributes investors search for: strong demographics, growth reserves, ease of doing business and market size. Nigeria, Africa’s largest economy, probably has the most scale with many sectors still in their early stages of development, providing ample opportunities. In general, economies that are open and run prudently are considered optimal choices. Investors cannot soon forget exasperating experiences in some African countries, Nigeria especially. Still, “Nigeria is too big to ignore,” says Gopaldas of RMB. This is a widely-held view. IHS Markit’s Ayukegba echoes similar sentiments.

Investors are cautious nonetheless: “Short-term, the economy is facing lots of challenges but there is certainly progress being made in addressing the many structural challenges and idiosyncrasies of Nigeria,” Oosthuizen says. For those still wary, a planned Eurobond issuance by the Nigerian government would likely offer excellent yields. A potential equities boom may also be on the horizon.

MTN, a South African telecommunications company with operations in Nigeria, is set to list on the Nigerian Stock Exchange (NSE). Valuation estimates for the Nigerian subsidiary, which accounts for almost half of the firm’s revenue, are as high as US $7 billion. Nigerian banks, hard-hit by authorities’ fiscal reforms – a Treasury Single Account policy has mopped up public funds from the banking system – and a sluggish economy, are currently attractive.

Medium-term returns could be rewarding. After a recently announced liquidity support programme by the Central Bank of Nigeria for Skye Bank Plc, a systemically important bank, there are indications others might be in need of similar assistance. Oil and gas-related non-performing loans are believed to be largely why. These bad loans are potentially rewarding restructuring opportunities

 

Published:16 August 2016

The article is republished with permission and the original article is available at: Africa Investor, 2016, Volume 14- Issue 4 No 37. Please click here for more details.

 

 

 

 

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