Insurance companies don’t make for great conversation fodder at parties, but few other businesses can match their potential for creating wealth. The Nigerian Stock Exchange is home to one particularly interesting opportunity in the space that now trades at a P/E ratio of 12.1 and a juicy 11.3% dividend yield.
Photo by Clara Sanchiz/RNW
Insurance companies don’t make for great conversation fodder at parties. Trust me on this.
But few other businesses can match their potential for creating wealth.
Done correctly, the insurance business generates a steady stream of premium income that it may or may not be required to pay back to claimants at some future date.
In the meantime, it invests the cash and keeps the returns.
Reinsurers operate on the same model, but instead of insuring individuals and small businesses, they provide coverage to other insurance companies – helping to reduce their risk from major catastrophes or otherwise high levels of claims.
In Africa, where insurance penetration rates are the lowest in the world, such a business offers substantial upside potential to investors.
The Nigerian Stock Exchange is home to one particularly interesting opportunity that trades at a P/E ratio of 12.1 and a juicy 11.3% dividend yield.
An unassuming, under-appreciated Nigerian stock
Lagos-based Continental Reinsurance (CONTINSU:NL) is one of Africa’s largest reinsurers. It boasts 200 customers across the region, serving them from offices in Lagos, Douala, Abidjan, Tunis, Nairobi, and Gaborone.
The firm covers all sorts of risks, but its bread and butter is reinsuring non-life policies, primarily in Nigeria and Cameroon.
While the underlying business has been consistently profitable, its recent share performance hasn’t been anything to write home about. The stock is down 4.9% since the start of the year.
But Continental Re’s third quarter results suggest the shares might be worth a second look. Net premium revenue surged 25% in the first nine months of 2015 and underwriting profit (the cash the company pockets after covering claims and expenses) jumped 26%.
Unfortunately, substantially higher administrative expenses and receivables write-offs conspired to keep earnings growth to a modest 7.5%.
Still, the result translated into a healthy addition to investable float. Unearned premiums, which represent much of the capital the company can deploy, have nearly doubled over the past five years.
To buy, sell, or hold Continental Re
So, do the shares look like a bargain at their current price of NGN0.97 per stub?
I believe so. Here’s why.
Regulators in the company’s largest market, Nigeria, have made property insurance compulsory and now require that businesses provide life insurance to their workers if they employ more than four people.
With a population of some 170 million, these moves should translate into accelerated premium growth in the next few years.
Continental Re has grown its book value at annualized rate of 4.0% since the end of 2009.
That’s not at all exciting until you consider how much cash the company distributes to shareholders in the form of dividends. It paid NGN0.11 per share in 2014, an amount that appears well within reach again this year. This translates into a dividend yield of 11.3%.
If this payout is maintained at the same level over the next five years and the stock’s price/book ratio expands to 1.0 from its present level of 0.7, investors at today’s price stand a good chance of netting an annualized return in the neighborhood of 17-18%.
Performance like that may not enthrall your friends at parties, but it’ll do wonders for your nest egg.
But the support companies that keep the planes flying and their customers comfortable are a very different story.
Due to long-term contracts, reduced exposure to variable costs like fuel, and less intense competition, the performance of such companies is relatively easy to forecast.
If people are flying, profits soar. If they’re staying home, earnings take a nosedive.
A high-flying caterer
Founded in 1996, Nigeria’s Airline Services and Logistics Plc (AIRSERVI) runs in-flight catering, restaurants and duty free shops at Nigeria’s two largest international airports – Murtala Muhammed in Lagos and Nnamdi Azikwe in Abuja. It bills itself as Africa’s largest independently owned airport logistics firm.
After listing on the Nigerian Stock Exchange in 2007, the company enjoyed a strong economic tailwind for several years, growing profits 444% between 2008 and 2012.
But the company encountered turbulence in 2013, when a new competitor, French multinational Servair, squeezed margins tighter than a Boeing 737’s middle seat.
A savvy deal struck by CEO Richard Akerele in faraway Rwanda appears to be propelling the uplifted performance.
Akerele, who happens to be Nigeria’s Honorary Consul to Rwanda, secured a 15-year exclusive concession to run in-flight catering at Rwanda’s increasingly busy Kigali Airport. The deal includes an optional 15-year extension.
The key word here is “exclusive.” No other in-flight caterer can operate out of Kigali during the agreement.
Terms of the deal also grant the company export processing zone status, which essentially means its operations in the country can be conducted tax-free.
The company is reportedly pursuing a similar deal in Sierra Leone, although I’m guessing the Ebola outbreak may have delayed finalization of the agreement.
Other expansion plans include catering deals with oil and gas companies working out of Port Harcourt, Nigeria, an upgraded processing facility in Abuja, and a new cold-storage operation in Lagos.
This growth doesn’t come cheap. Evidence of this comes in the form of an increased debt load, which has risen to 28% of total assets from a level of 12% one year ago. Finance charges in the first quarter of the year skyrocketed more than 500%.
But the company’s operations have been consistently cash-generative, so I expect the bank will take less of a bite from earnings in future quarters.
Lofty performance, down-to-earth valuation
The stock presently trades at a P/E ratio of just 5.6 and sports a dividend yield of 5.7%. Adding to the appeal, is a price to book multiple of just 0.58.
Note, however, that this is strictly a share for smaller investors. With a market capitalization of just north of $6 million and trade volumes that rarely exceed $10,000 per day, institutional investors will find it exceedingly difficult to build a meaningful stake.
But for smaller pockets, the stock’s potential is sky-high. If CEO Akerele continues to pilot this company as deftly as he has done in recent years, I expect investors will be delighted with their returns from the shares five years from now.
When Africa’s richest man, Aliko Dangote, announced a 40% price cut on bags of Dangote Cement last week, Nigerian consumers rejoiced.
The stock market’s reaction, on the other hand, was decidedly less enthusiastic. Shares of the company have plunged nearly 19% since the news broke.
So, will the stock weigh down a portfolio’s performance going forward or does it have a solid foundation for market-beating gains? Let’s take a closer look.
When Africa’s richest man, Aliko Dangote, announced a 40% price cut on bags of Dangote Cement last week, Nigerian consumers rejoiced.
The stock market’s reaction, on the other hand, was decidedly less enthusiastic. Shares of the company have plunged nearly 19% since the news broke.
So, will the stock weigh down a portfolio’s performance going forward or does it have a solid foundation for market-beating gains? Let’s take a closer look.
Digging into Dangote Cement
There’s no disputing it. A 40% price cut will take a big toll on profitability.
But it’s important to keep in mind that Dangote Cement (DANGCEM) boasts a 63% share of Nigeria’s cement market. Thus, because cement is essentially a commodity, Dangote’s competitors have little choice but to cut their prices, too. In fact, one has already announced that it will do so.
The competition, however, is ill-prepared for a price war.
Over the past few years, Dangote has invested heavily in efficiency improvements that allow it to produce and distribute cement cheaply. The kilns at its two largest plants are now fueled primarily by natural gas, which is five to seven times cheaper than the more commonly used fuel oil. And an extensive network of cement depots and a huge fleet of trucks allow for deliveries direct to the customer, cutting out the middle man.
The table below shows the net profit margin of Dangote and its listed competitors over the first three quarters of 2014.
[table id=203 /]
So, with an average net margin of 19.7%, Dangote’s largest competitors can’t cut prices by 40% and remain profitable. They will be compelled to find ways to lower their cost of production or else cede their share of the market, giving a virtual monopoly to Dangote.
Meanwhile, Dangote is rapidly widening its geographic reach. By the end of the year it will complete construction on new cement plants in Nigeria, Senegal, Sierra Leone, Cameroon, Zambia, South Africa, and Ethiopia. The new facilities will double its production capacity to 40 million tons. And CEO Devakumar Edwin says additional expansion will increase this figure to 60 million tons by mid-2016.
Photo by Luke Blyth
Moreover, in spite of its huge capital investments, the company still generates gobs of free cash flow, helping to keep finance costs low.
But What’s It Worth?
Dangote shares currently trade at a price/book ratio of 5.1. That’s nearly the lowest level its ever traded at in its history as a public company. Meanwhile, one of its largest pan-African rivals, PPC Limited (PPC), enjoys a price/book multiple of 9.7 in spite of being far less profitable.
Over the past four years, Dangote has grown its book value at an average rate of 20.9% without any injections of additional capital. If the company manages to bring the additional production capacity on line as it plans, then I am reasonably confident that it will maintain this pace over the next five years.
If we assume that
net asset value grows at a rate of 20.9% over five years,
the shares continue to trade at a price/book ratio of 5.1 five years from now,
and that management freezes its dividend at 7.00 naira per share,
then investors at today’s price of N169.74 would realize a an annualized return of 22.8% between now and late 2019. Of course, if the multiple expands and the dividend rises, a much juicier return is possible.
So, at today’s price, I believe the stock makes for a rock solid addition to Africa investors’ portfolios.
What Do You Think?
Will Dangote’s price cut ultimately lead to higher profits? Do you think the shares are attractively priced? Let’s hear your thoughts in the comments!
This week GSK Nigeria (GLAXOSMI) announced that its profits through the first nine months of 2014 dropped 23% compared to the same time period last year.
The news came as a bitter pill to investors. The stock has fallen nearly 16% over the past thirty days and now trades at its lowest price in 16 months.
Are the shares bad medicine? Just what the doctor ordered? Or something in between?
Let’s have a closer look at the numbers and see what they reveal.
This week GSK Nigeria (GLAXOSMI) announced that its profits through the first nine months of 2014 dropped 23% compared to the same time period last year.
The news came as a bitter pill to investors. The stock has fallen nearly 16% over the past thirty days and now trades at its lowest price in 16 months.
Are the shares bad medicine? Just what the doctor ordered? Or something in between?
Let’s have a closer look at the numbers and see what they reveal.
GSK Nigeria: More Than Just Drugs
GlaxoSmithKline Consumer Nigeria markets and manufactures a wide range of pharmaceuticals and vaccines. Its line-up of wares includes everything from acetaminophen to cancer drugs, many of which it produces at a factory just west of Lagos. Most are distributed in Nigeria, but it has recently begun to export to Ghana, too.
Perhaps surprisingly, however, GSK Nigeria’s best-selling products are beverages – not medicines. In 2013, sales of Lucozade (an energy drink) and Ribena (a fruit concentrate beverage) accounted for over half of the company’s revenue and operating profit.
The Big Margin Squeeze
Photo by FHKE
The heavy dependence on these two brands helps explain GSK Nigeria’s lackluster performance of late.
The firm’s parent company, GlaxoSmithKline (GSK), sold Lucozade and Ribena to Japan-based Suntory Beverage and Food Group (STB) last year.
Alarmed at the prospect of losing its most lucrative products, GSK Nigeria’s management scrambled to negotiate a deal with Suntory which would allow it to continue to manufacture and distribute the drinks in West Africa. They worked out an agreement, but the terms included a licensing fee that dented GSK Nigeria’s profit margins.
The company’s first half results clearly show the deal’s impact on profitability. Licensing fees squeezed the gross margin from 14.6% in the first six months of 2013 to 7.5% a year later. With such a sharp spike in the cost of sales, it’s little wonder that the bottom line has slipped.
On the Mend?
But here’s the good news for GSK Nigeria shareholders. Management is doing an excellent job of containing costs apart from the new licensing fees. Administration costs have been slashed nearly 15%, and ongoing upgrades at its Agbara factory look to widen the product offering and improve efficiency.
The impact of this can be seen in the most recent results. Earnings in the third quarter of 2014 actually grew 22.5% compared to the same period last year.
How Nice is the Price?
GSK Nigeria currently trades at price equivalent to 4.2x its net asset value and at a dividend yield of 2.53%.
Over the past twelve months, the company’s book value increased 10.9%, considerably slower than its annualized rate of 14.6% over the past five years. Since 2009, the stock’s price/book ratio has ranged from a high of 5.8 to a low of 1.8.
Let’s assume that the company grows net asset value at a rate of 10.9% over the next five years and that management raises the dividend at a similar pace. Let’s further assume that the market values the stock at 3.8x book value five years hence – the midpoint of its range over the past five years.
Under these assumptions, the company’s share price five years from now would rise to NGN83.85 from its current level of NGN54.00. If we add five years of dividends to that price, investors would reap an annualized return of 11.4%.
That’s not a great return considering that the yield on a 10-year Nigerian government bond now hovers around 12.6%.
But if management can find a way to compensate for the reduced profitability of Lucozade and Ribena and grow book value at its 5-year average of 14.6%, then investors can expect a juicier annualized return of 15.0%.
As for me, I’m staying on the sidelines for the time being, but if the stock’s price drops further on no substantive news, I may be enticed to pick up a few shares.
What Do You Think?
Do shares of GSK Nigeria look like a good buy here? Tell us why you do (or don’t) like the stock in the comments!
Stanbic IBTC is Nigeria’s best-performing bank stock. Its share price has climbed 40.5% this year and 55.4% over the past twelve months. Is it nearing the end of its run? Or is the market still offering investors a discount to the bank’s real worth?
Here, Godfrey Mwanza, CFA shows us how he values the company.
Stanbic IBTC is Nigeria’s best-performing bank stock. Its share price has climbed 40.5% this year and 55.4% over the past twelve months. Is it nearing the end of its run? Or is the market offering investors a discount to the bank’s real worth?
Here, Godfrey Mwanza, CFA shows us how he values the company.
Stanbic IBTC Holdings Plc (STANBIC) is a financial service holding company in Nigeria with subsidiaries in banking, stock brokerage, investment advisory, pension and trustee businesses. Its three main business areas are corporate and investment banking (CIB), wealth, and personal and business banking (PBB).
Stanbic is a member of the Standard Bank Group (SBK) of South Africa which has a 53.2% stake in the company. Stanbic operates 180 branches and serves over one million customers in Nigeria. Total assets were NGN 907bn (USD 5.6bn) as at 30 June 2014 making it the country’s 12th largest banking group.
Godfrey Mwanza, CFA
Nigeria’s Banking Industry
Nigeria has a very low level of banking penetration compared to other frontier African countries, let alone global emerging markets. According to World Bank data, in 2013, Nigeria’s private credit to GDP was 11.8%. Much lower than South Africa (156%), Kenya (40%), Ivory Coast (18.5%), Uganda (15.5%), and Zambia (14.6%) to name but a few.
Over the next five years, the IMF expects the Nigerian economy to grow at 15% per year in nominal terms. Banking assets (primarily credit to the private sector) should in principle grow at a faster rate than that as penetration of banking services increases.
And what are you paying for that growth potential?
Well, the average forecast returns on equity for the nine Nigerian banks in our universe for 2014 is 18.7% and they trade on a price to book of roughly 1.20x 2014 forecast shareholders’ equity. Using the formula for justified price to book [PB= (roe-g)/(r – g)], assuming a conservative 5% terminal growth rate (g) and that the 18.7% ROE is sustainable over time, a 1.20x price to book implies a required rate of return of 16.4%, far higher than the 12.2% yield you will get from a 10 year Nigeria government bond.
The whole sector is cheap. You are paying little for potentially massive growth.
But when you look closer, what is most interesting about Nigerian banks is the extreme dispersion of valuations amongst individual stocks. For instance, Skye Bank trades at a 72% discount to that 1.20x average. And Stanbic IBTC trades at a 122% premium.
This has led to many analysts to recommend a sell on the stock on the basis that it is expensive. However, there is more to the Stanbic story than meets the eye and despite the stellar outperformance this year (price return of 45% year to date versus -6.5% for the Nigerian All Share Index -11.7% for the Nigerian banking index) I think a closer inspection will reveal that there is still hidden value in the name.
Picking Stanbic IBTC Apart
To find this hidden value, it is necessary to break the group into its three main operating units (wealth, CIB, and PBB), value them separately and sum up the parts.
The Wealth Business
Stanbic’s wealth business comprises their market leading pension administration, trusteeship and asset management. The business has 1.3 million retirement savings accounts and assets under management (AUM) of NGN 1.4trn (USD 8.8bn). AUM has grown by 36% per year for the last five years and makes up 35% of national pension fund assets of UDS 25bn which are a paltry 4.8% of GDP (compared to 90% in South Africa, 41% in Botswana, 17% in Kenya or 7% in Zambia). In 2013, wealth contributed 50% to PBT in 2013 versus 17% in 2008.
There are two main methods used to value an asset management company. A price earnings ratio is suitable for stable annuity-type asset managers whereas market cap/AUM is more appropriate for hedge fund types of asset managers which can have volatile earnings.
I took a sample of 10 asset managers from developed and developing countries and found that over the last decade they have traded at a median price to earnings ratio of 17.43x. I personally do not see why a market leading asset management business in fast growing Nigeria should be any different. But, to be conservative, I apply a 15x earnings multiple on NGN 9.8bn, my forecast for 2014 wealth earnings. The business unit achieved roughly NGN 5bn already in the first half of 2014.
I am comfortable with a 15x earnings multiple because I expect earnings growth to be faster than 15% for the following reasons.
First, it is conservative compared to the 29% per year growth over the last four years and there is still much room for growth in the sector.
Second, unless you assume Stanbic loses market share or Nigerian pension fund assets as a proportion of GDP decline, AUM should grow at least in line with nominal GDP or 15%. Indeed it should grow faster. As with banking assets, increased penetration implies growth potential faster than the economy. Recent policy changes also lend credibility to this faster-than-GDP growth argument. In July this year, the Nigerian president signed the Pension Reform Act 2014 into law, which repeals the Pension Reform Act, no. 2, 2004. The Act increases the minimum rate of pension contribution to 18% of monthly emoluments from 15%, with 8% contributed by the employee from 7.5%, while the employer contributed 10% vs. 7.5% previously. This clearly increases the monthly pension accretion to the pension fund administrators.
When we put all this together by multiplying forecast earnings by 15 and dividing by the total number of Stanbic IBTC shares, we arrive at an estimated value for the wealth business of NGN 14,65 per share.
[table id=200 /]
Corporate and Investment Banking (CIB)
Corporate and investment banking includes corporate lending, treasury (global markets), investment banking, stock broking and custody services.
Stanbic’s reporting is excellent and in the annual report you can see balance sheet and income statement segmentation per business unit. Based on this, one can calculate that CIB earned a 31.2% return on equity in 2013 and is in line to earn roughly the same in 2014 based on 12 month trailing CIB earnings.
To value CIB, I use a relative valuation methodology again but based on price to book rather than earnings. I ran a regression with the price to book as the dependent variable and return on equity as independent variable for a sample of twenty-three banking assets listed on the African continent in markets such as Nigeria, Kenya, Tanzania, Mauritius and Botswana. The result shows that a bank earning 30% return on equity should trade at 3.4x book.
But 30% ROE is an incredible feat and one can rightly argue that it is not likely to be sustainable. Further, on closer inspection, we find that Stanbic’s returns are accentuated by non-interest revenue particularly in foreign exchange trading, which most bankers will tell you is a choppy line item.
A DuPont profiling shows that if Stanbic’s CIB was a standalone bank, it would be a below average net interest income earner per unit of assets. However, on a transactions income basis, CIB is a market beater by some margin (5.8% versus 2.7% industry average).
3.4% of the 5.8% non-interest revenue profitability per unit of assets is derived from fixed income, money market and foreign exchange trading and while FY13 was particularly rewarding for Stanbic’s treasury desk, the average per asset profitability for that unit is 2.76% over three years and 3% over five years. This is remarkable when you compare it with an average of 0.38% and 0.41% average for Access (ACCESS), Guaranty Trust Bank (GUARANTY), Zenith (ZENITHBA) and First Bank (FBNH). Although the larger size of their balance sheets means there is a drag on that.
If CIB’s profitability in trading alone fell to the industry average of 0.41% then the CIB’s return on equity falls to 10%. I assume trading profitability falls to 1.6% (a mid-point between 3.4% 0.4%), bringing non-interest revenue / total assets to 3.9% which is still higher than the average. I assume the bank will maintain its competitive advantage in foreign exchange trading on the back of its track record and its associations with the international powerhouses of Standard Bank of South Africa (the ‘go-to’ bank for SA corporates expanding into the continent) and ICBC Bank of China.
Reducing non-interest revenue profitability to 3.9% lowers FY13 return on equity to 18.2% from 31.2% and, based on the regression, a bank earning 18% ROE in Africa should trade at a price to book of 2.30x. Applying this multiple to CIB’s net asset value as at 2013 results in a value per share of NGN 14.04.
[table id=201 /]
Personal and Business Banking (PBB)
PBB is the retail arm of the group’s business. It provides services to customers in personal markets, high net worth individuals and commercial, small and medium scale enterprises. Products include mortgage lending, asset finance, card products, lending and bancassurance.
This is the newest business segment and it is only just breaking even (only 70% of branches are profitable up from 58% last year) due to substantial investment in branches, banking systems and staff. This makes it difficult to value. In cases like this I prefer to back out the valuation implied by the market price. The chart below illustrates my process.
[table id=202 /]
The market is thus valuing Stanbic’s PBB business at NGN 2.1bn (roughly USD 13m).
Now I don’t know exactly what the PBB is worth, but I think it’s a lot more than USD 13m. Especially when you recognise that the business has NGN 285bn (USD 1.7bn) in assets, NGN 198bn (1,207bn) in deposits and already earns NGN 25bn (USD 154.6m) in revenue which is growing at 32% a year (1H14 vs 1H13).
The Bottom Line
It’s difficult to say exactly what PBB is worth and any judgement about its value requires a view about management’s ability to scale up by growing their customer base and sweating their investments. But if market prices are any indicator, PBB should be worth 4 to 10 times this implied value, suggesting a 12% to 33% upside to Stanbic’s current price (NGN 31.00 at this writing). I would expect that earnings results showing continued improvement in PBB profitability will provide the catalyst for the stock to make its final run towards fair value.
The risks to this scenario are model risk, unsustainable CIB profitability and failure by management to execute on their PBB strategy.
What Do You Think?
Does Stanbic IBTC look like a bargain to you? Or would investors be better off with another one of Nigeria’s bank stocks? Let’s hear your thoughts in the comments!
Godfrey Mwanza, CFA is a Fund Manager with Barclays Africa Group. The views expressed here are his own and not necessarily those of his employer. As of this writing, he did not own shares of Stanbic IBTC.
