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Opinion

Nigeria: Time to take the plunge with fresh capital?

Stuart Culverhouse & Hasnain Malik, Exotix Partners
May 19, 2017, midnight

Word count: 736

With the macroeconomic picture characterised by green shoots on oil revenue, FX liquidity and structural reform and with equity and fixed income valuations largely reflecting well understood concerns, the case for investment of fresh foreign capital merits a revisit.

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With the macroeconomic picture characterised by green shoots on oil revenue, FX liquidity and structural reform and with equity and fixed income valuations largely reflecting well understood concerns, the case for investment of fresh foreign capital merits a revisit.

The risk-reward associated with new investment into USD denominated debt instruments is, on balance, still more attractive than that in Naira equities.

But the moment for Naira equities to come back in from the cold for foreign investors is nearing. The key issue is not whether there are cheap stocks (there are, for example, in Tier 1 banks), but whether the new FX window for portfolio investors becomes sufficiently liquid (to offset repatriation, or “trapped capital”, risk), transparent (in terms of price-setting) and the FX rate prevailing in this window (the NAFEX) sufficiently depreciated. 

This window (opened on April 24) does not quite meet these criteria yet, but it at least establishes a path to partial normalisation of the investment case in Naira equities for foreigners. 

The issue of whether the NAFEX (which has traded around 400) has sufficiently depreciated depends on the size of trapped foreign portfolio positions in Naira equities. We estimate this amounts to $0.5-2.5bn and this compares to daily transactions in the window which are a fraction of this (c$40m currently). Therefore, we advocate waiting for liquidity and transparency in the window to improve, the NAFEX to blow out (as trapped positions are exited) and to then turn much more bullish (in terms of fresh capital allocation). In general it did not pay to allocate fresh capital to EGP equities prior to the devaluation, but it made much more sense immediately afterwards. But that was an FX regime that very quickly became much more liquid and where the FX rate very quickly blew out.

The NAFEX window does not mirror that picture just yet (and the likelihood of a full-blown FX liberalisation remains low). An immediate plunge into Naira equities only makes sense for those who have the risk appetite to tolerate low liquidity and opacity of NAFEX and assume (in virtuous circular fashion) that trapped positions will not be repatriated if there is a swing towards a positive consensus. In this report, we review Nigeria’s macroeconomic outlook, the lessons from Egypt’s devaluation for foreign equity investors and our Naira equity (market-wide and sector specific) and US$ fixed income (sovereign and corporate) strategy.

In the example of our top stock pick, GTB, our expected total return of c. 30% needs to be offset against a risk of persistent low liquidity in the portfolio investor window (i.e. continuing difficulty in repatriation) and further depreciation in the NAFEX (pent-up selling of previously trapped positions). FX issues aside, we are positive on the Tier 1 banks (top picks GTB, Zenith, UBA and Stanbic, because they are cheap and should see resilient margins and improving operating efficiency offset higher loan loss provisions and weaker NIR) and Dangote Cement (which should see selling prices increase more than costs and continues to be the best-in-class operator).

Meanwhile, we are generally cautious on Tier 2 banks (where returns and therefore valuations will persistently trail the Tier 1 banks) and Consumer (only top pick UAC has sufficiently cheap valuation to offset the sector’s persistent headwinds of input cost inflation and weak household spending; among the larger stocks Nigerian Breweries, while not attractively valued, has relatively low gearing to imported inputs and implied FX risk).

For now, Nigeria is underleveraged externally and we think debt service on the US$ sovereign bonds is eminently manageable, even at a significantly more depreciated FX rate. We have a Buy on the 2032 bonds, with a yield of 6.9% and a z-spread of 462bp (mid basis as of May 18). We have a mix of Buy and Hold recommendations on the banks’ Eurobonds. All seven issuers were profitable in FY16, and Q1 17 results at most were better qoq.

Bond performance YTD has been impressive: all banks’ Eurobonds are tighter than was the case at the start of the year and have outperformed most of the government’s Eurobonds. Double-digit yields are now much more difficult to find, but we still think these bonds offer value. Key risks to our view include weaker oil prices, deterioration in FX liquidity and increased bond supply. We see the GTB 2018 bond, with indicative yield of 3.87% and z-spread of 247bp, as the most resilient to these risks.

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