3 Reasons the Kenyan Economy Is Set to Boom

In this guest post, Robert Rayford of Dealmarket.com argues that Kenya merits a long look from global investors.

Throughout Africa there are a number of potential economic giants waiting to awaken from their collective slumbers and lay down a marker both on the continental and global stages. Due to the well-documented troubles encountered by the continent, be it famine, corruption, or something else, the potential for growth there is among the highest and most attractive in the entire world.

Kenya is one such country where all the stars appear to be aligning at the same time, so to speak, and the East African nation could be set to be the big African economic success story of the next decade.

What is happening, or has happened, in Kenya to leave it on the cusp of an economic boom period?

In this guest post, Robert Rayford of Dealmarket.com argues that Kenya merits a long look from global investors.

Throughout Africa there are a number of potential economic giants waiting to awaken from their collective slumbers and lay down a marker both on the continental and global stages. Due to the well-documented troubles encountered by the continent, be it famine, corruption, or something else, the potential for growth there is among the highest and most attractive in the entire world.

Kenya is one such country where all the stars appear to be aligning at the same time, so to speak, and the East African nation could be set to be the big African economic success story of the next decade.

What is happening, or has happened, in Kenya to leave it on the cusp of an economic boom period?

1. 2013 Elections

The prospect of peaceful democratic elections taking place in early 2013 is an important indicator of the potential of Kenya. While the country was wracked by violence following its 2007 election, a raft of reforms designed to safeguard citizen rights and check the power of elected officials has increased the likelihood of a peaceful vote. Thus, while the eyes of the world may be casting negative, nervous glances at the country come election time in March, the perception of risk appears to be greater than the actual risk.

2. Diversifying Exports

Kenya has done much work to move away from their reliance on tourism and tea exports. Although these are still huge revenue generators for the Kenyan government, natural resources and textiles are now being seen as having the potential to be just as lucrative, with the exploitation of these opportunities crucial to creating a stable and sustainable economy for the long-term.

Photo by Erik Hersman
3. Attractive Investments

Kenya as a whole is an attractive investment proposition for private equity firms. Generally speaking, this is down to the ability to acquire a quality product, and more of it, in the country, and at a cheaper price.

While there are concerns that many private equity investors are taking advantage of the country, for example buying fertile land from farmers at a reasonably cheap price, only to build property with a view to making a huge profit, many accept that this is an inevitable consequence in a country that aims to be fully industrialised by 2020. At the same time, the land being brought is generally that which has been historically used for growing coffee, a crop that has been in terminal decline in Kenya for most of the last century anyway.

The Future

The Tatu City development, being built outside of the Kenyan capital Nairobi, is the perfect example of where the country sees itself in the future, and shows why an economic boom here is inevitable. The development aims to create over 110,000 permanent jobs and permanently house 70,000 residents. With prospects that promising in contrast to a globally bleak backdrop, it is no wonder that so many investors are looking to Kenya, and Africa in general, for the future.

6 Kenyan CEOs Who Bet Big On Their Own Stock

In a recent blog post, African stock market pundit, Coldtusker, argued that Kenya Airways’ dismal share returns can be at least partially explained by the fact that its CEO owns zero shares of the company.

His reasoning is that a boss with no skin in the game has little incentive to manage a company in shareholders’ best interests.

To test this theory, we measure the stock performance of five Kenyan companies that are managed by heavily vested CEOs to see if they beat the market over time.

In a recent blog post, African stock market pundit, Coldtusker, argued that Kenya Airways’ dismal share returns can be at least partially explained by the fact that its CEO owns zero shares of the company.

His reasoning is that a boss with no skin in the game has little incentive to manage a company in shareholders’ best interests.

Putting Their Money Where Their Mouths Are

Intrigued, I dusted off some old annual reports and put together a list of the six Kenyan CEOs who owned at least $250,000 worth of their own companies’ stock at the end of 2008. They appear in the chart below.

[table id=113 /]

As you can see, these aren’t just token amounts. The financial interests of each of the above CEOs were clearly aligned with those of other shareholders.

Taking Care of Business

So, in theory, the average return of these companies should have crushed the market since then.

Photo by World Economic Forum

Why?

Because many listed companies are managed by CEOs who don’t eat their own cooking. Managing Directors without substantial ownership stakes tend to be motivated by a paycheck or prestige — not share performance.

Let’s see if the theory worked in practice.

The below chart shows the share performance of each stock since 2008.

[table id=114 /]

Apart from AccessKenya Group, that’s very solid performance.

Let’s see how a portfolio comprised of these six companies would have fared against the return on the entire Kenyan stock market over the same time period.

[easychart type=”line” height=”150″ width=”350″ title=”Average % Return for CEO-Owned Companies (Local Currency)” groupnames=”CEO-Owned Companies, MSCI Kenya Index” valuenames=”12/31/2008, 12/31/2009, 12/31/2010, 12/31/2011, 8/9/2012″ group1values=”0, -4, 65.3, 24.4, 55.8″ group2values=”0, -1.4, 32.6, -3, 26.7″ minaxis=”-10″ groupcolors=”5E7B3B,0070C0″]

After a sluggish start, five out of the six CEO-owned stocks outperformed the market’s 26.7% return, and together they beat it by a whopping 29.1%!

Granted, this is a very small sample, but it did not run counter to the theory that CEO-owned companies tend to outperform the market over the long-term.

What Do You Think?

Does this theory hold water? Do you know of other African companies with heavy CEO-ownership that we should compare to the overall market? Let us know in the comments!

Ranking Kenya’s Most Efficient Banks

Last week I posted a list of Africa’s 100 largest frontier stocks. You didn’t have to examine the list very closely to see that banks were disproportionately represented. In fact, of the 100 companies, 35 are banks.

So, as Africa investors, we’d do well to develop some skills in analyzing bank stocks.

Today, we’ll start with a basic measure of bank profitability – the efficiency ratio.

Last week I posted a list of Africa’s 100 largest frontier stocks. You didn’t have to examine the list very closely to see that banks were disproportionately represented. In fact, of the 100 companies, 35 are banks.

So, as Africa investors, we’d do well to develop some skills in analyzing bank stocks.

Today, we’ll start with a basic measure of bank profitability – the efficiency ratio.

The Efficiency Ratio

The efficiency ratio is simply the portion of operating revenue that a bank spends on non-interest expenses like staff salaries, rent, provisions for bad loans, and depreciation.

To calculate it, divide a bank’s total operating expenses for a given time period by its total operating income over the same time period. It’s usually expressed as a percentage.

Photo by GenVessel

A low efficiency ratio (under 50%) suggests a lean, mean banking machine. A high ratio (over 70%) may be a clue that a bank is wasting shareholders’ money.

Ranking the Efficiency of Kenya’s Banks

The table below lists the efficiency ratios of Kenya’s 10 listed banks.

[table id=96 /]

What does this chart tell us?

For starters, it says that for every shilling that NIC Bank collected after accounting for interest charges, it kept 54 cents as pre-tax profit. CFC Stanbic kept less than 28 cents.

That’s a huge difference.

Essentially, at this rate of efficiency, CFC Stanbic needs twice as much operating income to generate the same amount of pre-tax profit produced by NIC.

A Note of Caution

Does this mean that we should immediately sell our shares of CFC Stanbic and rush to buy NIC? Absolutely not.

The efficiency ratio is only one piece of the puzzle. A low efficiency ratio may mean that a bank has run out of expansion opportunities and can only increase profits by reducing operating costs. Meanwhile, a high efficiency ratio may indicate a bank that is laying the groundwork for growth by investing in quality staff, services, or facilities.

In future posts, we’ll look at some other analytical tools that will help us separate great bank stocks from mediocre ones.

What Do You Think?

In the meantime, I’d love to hear Kenyan investors’ reactions to the table above. Would you have guessed that NIC and Standard Chartered operate more efficiently than other Kenyan banks? Did it surprise you that CFC Stanbic posted such a high efficiency ratio? Let us know your thoughts in the comments!

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Stock Showdown: Ranking Kenya’s Best Banks

So far, we’ve scoped out bank stocks in Nigeria and Ghana, analyzing their profitability, growth, risk, and value to separate the bargains from the bunk.

Now it’s time to turn to Kenya, East Africa’s largest economy. Ten banks call the Nairobi Securities Exchange home. All of them possess different strengths and weaknesses.

Let’s put them through our ranking exercise to help determine which ones merit a more detailed analysis.

So far, we’ve scoped out bank stocks in Nigeria and Ghana, analyzing their profitability, growth, risk, and value to separate the bargains from the bunk.

Now it’s time to turn to Kenya, East Africa’s largest economy. Ten banks call the Nairobi Securities Exchange home. All of them possess different strengths and weaknesses.

Let’s put them through our ranking exercise to help determine which ones merit a more detailed analysis.

1. Profitability

If you’re in the market for a bank stock, chances are you’d prefer one that actually makes money.

Return on Assets (ROA) measures how effectively management deploys the assets under its control. I’ve calculated ROA as after-tax profits from continuing operations divided by average assets. Then, because bank earnings can be inconsistent, I averaged the ROA from the most recent five fiscal years.

Photo by DEMOSH

To calculate a score, I divided the range between the most profitable bank and the least profitable one into deciles. The banks with ROAs in the highest decile were awarded 10 points. Those in the lowest decile scored just one point.

Here’s how they stacked up:

[table id=39 /]

2. Growth

Profitability is great, but Africa’s best banks are constantly growing their assets. They’re tapping new market segments, expanding into new territory, or acquiring smaller competitors. And because the banking industry is particularly conducive to building economies of scale, a larger asset base generally translates into greater profitability.

To measure which banks are growing the fastest, I simply annualized the growth of each bank’s total assets over the most recent five fiscal years.

Here’s what I found:

[table id=40 /]

3. Asset Quality

A bank’s challenge is to lend as much money as possible for the best return possible. In their zeal to do so, some banks end up lending valuable assets to some rather uncreditworthy customers. When these customers default, the loans must be written down to zero – a bad thing for profitability AND growth.

One of my favorite ways to measure a bank’s asset quality is to determine how much of the loan portfolio isn’t performing as planned. I do this by dividing non-performing loans by total loans. A lower ratio implies a lower degree of risk in the bank’s loan book.

Look here to see which banks are Kenya’s most conservative lenders:

[table id=41 /]

4. Value

Investing, of course, is all about value. The most profitable, fastest growing, well-managed bank in Kenya can end up losing you money if the price you pay for it is too dear.

When evaluating bank stocks, I take a close look at price/book ratios. Book value is simply the difference between a bank’s assets and its liabilities. Stocks with low price/book ratios generally have less downside risk. The lower a price/book ratio gets, the less risk there is of the bank disappointing the market and the greater potential there is for it to outperform expectations.

I prefer the price/book ratio over the price/earnings ratio for bank stocks. Why? Because bank earnings can be erratic. Thus, the P/E ratio for a bank coming off a particularly good or bad year will be skewed. Assets, on the other hand, are much less volatile and relatively easy for an accountant to value.

[table id=42 /]

5. Dividend Yield

Dividend yield is a function of both profitability and value. Generous dividends also suggest a confident management team. Dividend cuts typically wreak havoc on a stock’s share price. Therefore, most banks won’t raise dividends beyond a level they believe they can sustain.

[table id=43 /]

Ranking the Banks

Now let’s put all the scores together and count them down from worst to first.

10. National Bank of Kenya – Oh my. This 44-year-old bank doesn’t appear to be aging well. It’s put together a decent ROA of 1.96% over the past five years, but that is the only highlight. A small dividend, anemic asset growth, and high relative price put it at the bottom of the chart. If anyone knows of any redeeming qualities for NBK, please post them in the comments.

9. Co-operative Bank of Kenya – Co-operative Bank occupies one of the most distinctive buildings in the Nairobi skyline, but it failed to make much of an impression in the showdown. It’s been profitable, but its shares are relatively expensive at 2.3x book value.

8. NIC Bank – NIC Bank sports one of the lowest price/book ratios of this bunch at 1.24. But it’s also miserly with its dividend. The shares yield a sector-worst 1.59%. This may reflect the bank’s intention to add more branches to its network at home and elsewhere in the region. It’s re-investing profits in expansion instead of returning them to shareholders. Potential investors should note the bank’s intention to raise additional capital from the market later this year.

7. Barclays Bank of Kenya – BBK’s eceptional profitability and generous dividend will prove tempting to many investors, but its growth rate is the slowest of the sector. Factor in a relatively large bad loan book, and this “blue chip” fails to break into top tier status.

6. Housing Finance Company – This mortgage lender trades at just 74% of its book value, and it offers a substantial dividend, but its profitability pales next to that of its peers, and its non-performing loan ratio is one of the sector’s highest. Still, speculators may want to consider the company’s recent announcement that it will construct 162 new housing units in eastern Nairobi, funded partially out of its own reserves. This could be a very profitable investment considering the capital city’s shortage of affordable housing.

5. CFC Stanbic – It doesn’t seem to be making great use of its asset base, and it pays only a token dividend, but CFC Stanbic is one of Kenya’s more conservative lenders, and it’s available at an attractive 0.56 price/book ratio. Perhaps worth a closer look given its plans to expand into Southern Sudan. Investors should note however that the bank is preparing for a rights issue.

4. Diamond Trust Bank – An impressively solid loan portfolio coupled with surprisingly rapid growth would put DTB near the top of the rankings if it weren’t for its ho-hum dividend yield. The bank is conserving its capital to fund additional expansion. It also plans to raise more money from the market. DTB has already developed an impressive regional footprint, which includes Tanzania, Uganda, and Burundi.

3. Kenya Commercial Bank – KCB takes more risks in its lending than DTB, as demonstrated by its 6.15% NPL ratio, but it also currently offers one of the juiciest dividends on the Nairobi Securities Exchange. This is in spite of an ambitious regional expansion drive which shows no signs of letting up. It’s apparently on the lookout for an acquisition in Uganda.

2. Standard Chartered Bank of Kenya – SCB hasn’t been one of this group’s fastest growers, but it compensates for this with a conservative loan book and generous dividend. It’s not cheap at 2.3x book value, but you’re paying for quality here. And regional expansion is in the cards. Management is exploring the possibility of a rights issue to help fund new operations in South Sudan and Rwanda.

And the Winner Is ….

1. Equity Bank – Perhaps unsurprisingly, the hands down winner is Equity Bank. Incredibly rapid growth paired with excellent profitability make this an incredibly attractive bank. Foreign investors have already discovered it and now own roughly 43% of outstanding shares. I’ve considered buying some many times over the years, but always thought it looked a tad expensive. It’s proven me wrong again and again. It may soon be easier than ever to own a piece of this dynamic operation. The CEO remarked recently that the bank may soon cross-list in London, New York, or South Africa.

[table id=44 /]

What Do You Think?

Does Equity Bank deserve to be head and shoulders above the rest of the field? Which bank stock do you think is the best bargain? Let me know your thoughts in the comments!

[Disclosure: I have no position in any stock mentioned in this article, and I have no intention of taking any within the next 72 hours.]

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Why Are Kenyan Agricultural Stocks So Cheap?

Kenya investors don’t seem to like agriculture stocks, and I’m not sure I understand why. Almost all of them presently trade for a fraction of their book value and less than seven times their trailing earnings.

Granted, agricultural stocks do have their risks. But with the globe’s population growing and arable land becoming more scarce, I think the market’s pessimism is overdone.

Here are five agricultural stocks that put food on the table, and, possibly, profits in investors’ pockets.

Kenya investors don’t seem to like agriculture stocks, and I’m not sure I understand why.

Over the past five years, the Nairobi Stock Exchange’s benchmark NSE-20 Index lost 30.5% of its value. But each of the market’s eight agricultural stocks performed better than that. Much better. In fact, they actually posted a 41.8% gain during the same time frame.

Yet, today, they remain the NSE’s Rodney Dangerfields — they get no respect. Almost all of them presently trade for a fraction of their book value and less than seven times their trailing earnings.

Granted, agricultural stocks do have their risks. They are, to varying degrees, at the mercy of global commodity prices, the weather, and currency movements. And a proposed tax on tea exports has chilled the outlook for some companies.

But with the globe’s population growing and arable land becoming more scarce, I think the market’s pessimism is overdone.

Photo by CIAT

Let’s take a closer look.

The five Kenyan stocks below put food on the table, and (at these valuations) possibly some big returns in investment portfolios, too.

[table id=8 /]

Kakuzi (KKZI.KN)

(P/E Ratio: 2.9; P/B Ratio: 0.6; Dividend Yield: 4.6%)

You could put together a pretty tasty breakfast consisting of nothing but produce from Kakuzi’s farms. It grows avocados, pineapples, macadamia nuts, and tea. The company also boasts herds of dairy and beef cattle.

The diversification has served the firm well. Over the past five years, it grew earnings at a 33.0% clip, allowing it to award a dividend increase for three out of those five years. It’s balance sheet is very strong. Kakuzi carries very little debt.

Yet the company trades at just 60% of its book value. What gives? Investors may be concerned about tea prices. Or they may be underwhelmed by Kakuzi’s 2011 earnings because they included an extraordinary gain resulting from the conclusion of a legal matter. Even so, after stripping out the one-time gain, the stock still trades at less than 4x earnings.

Kapchorua Tea (KPTC.KN)

(P/E Ratio: 6.4; P/B Ratio: 0.7; Dividend Yield: 6.5%)

The Kapchorua tea plantation sounds an idyllic place. Tucked into hills west of the Great Rift Valley, Kapchorua grows tea plants that receive worldwide acclaim for their full-bodied, floral flavor in forest-fringed fields. The operation is recognized for the fairness with which it treats its workers and carries the Fair Trade and Ethical Tea Production seals of approval.

Kapchorua earned KES282 million (roughly $3.4 million) over the past 12 months, which gives the stock a P/E ratio north of 6x. That’s actually on the high end for Kenyan agriculture firms.

Management has warned shareholders that it may have a tough time replicating recent performance due to higher fuel and labor costs.

Mumias Sugar (MSUG.KN)

(P/E Ratio: 4.6; P/B Ratio: 0.6; Dividend Yield: 8.1%)

Mumias is Kenya’s largest sugar producer, controlling 60% of the market. Management’s in the midst of diversifying its product mix to even out its vacillating, sugar-dependent earnings. It recently began burning sugar cane residue to produce electricity. In doing so, it produces enough energy to supply its own requirements and to deliver 26MW of much needed power to Kenya’s national grid. It also plans to produce ethanol and bottle water later this year. Both projects will provide an immediate boost to company profits.

These efforts cost money, but management has succeeded thus far in keeping its debts to less than 70% of equity. The Global Credit Company just rated Mumias’ long-term debt at “A+”.

We covered Mumia’s generous dividend last month. The share price has risen since then, but it still yields a sweet 8.1%.

REA Vipingo Plantations (RVPL.KN)

(P/E Ratio: 2.0; P/B Ratio: 0.6; Dividend Yield: 7.2%)

REA Vipingo is Africa’s largest producer of sisal, a natural fiber used to make rope and twine. It employs 3000 people at seven estates across Kenya and Tanzania that produce 19,000 tons of the stuff. Nearly all of it is exported through via REA’s own export company in Mombasa. The company is also diversifying into vegetable production.

High sisal prices and good weather helped the company to record profits in 2011. Earnings rose 553% over the previous year.

Fortune may have been smiling on REA Vipingo last year, making a repeat performance unlikely, but you’d think the market would agree that the company is worth more than 2x last year’s earnings and 60% of its book value.

Williamson Tea Kenya (GWKL.KN)

(P/E Ratio: 2.4; P/B Ratio: 0.6; Dividend Yield: 5.7%)

Williamson is one of Kenya’s largest tea companies. It is the parent company of Kapchorua and produces a range of specialty, fair trade teas for sale in the United Kingdom and elsewhere around the globe.

Williamson has strung together an impressive record of profitable years. In the most recent period, earnings spiked 76% thanks to the sale of a Nairobi property. Management keeps a very tidy balance sheet. Total debt comes in at less than 40% of equity.

Ironically, the most recent earnings report from the fair trade tea purveyor bemoans rising labor costs. Management won’t get much sympathy from me in this regard. Profits have increased nearly 18x since 2003. Even so, the company trades for a pittance at just 2.4x trailing earnings.

Conclusion

I believe all five of these stocks are priced at levels to outperform the market over the medium term. They’re profitable, carry manageable levels of debt, and produce basic commodities that are in more demand with each passing year.

What do you think? Am I lost in the weeds on this one? Let me know in the comments!

[Disclosure: I have no position in any stock mentioned in this article, and I have no intention of taking any within the next 72 hours.]