So Long, BRICs! Make Way for the KINGs

You’ve no doubt heard of the BRICS countries, the emerging market quintet comprised of Brazil, Russia, India, China, and South Africa.

You may also have been introduced to the MINTs, a grouping of fast–growing economic heavyweights that includes Mexico, Indonesia, Nigeria, and Turkey.

Now, in an excellent post published on Seeking Alpha, Belgrad Kenne, Founder and Director of equity research firm, Phase One Associates, has coined a new acronym that captures the dynamism of Sub-Saharan Africa’s frontier economies – the KINGs (Kenya, Ivory Coast, Nigeria, and Ghana).

The Seeking Alpha article lays out the rationale behind the grouping, but I asked Belgrad to give us a bit more insight into the KINGs’ stock market performance over the past five years. He graciously agreed and also shared his thoughts as to why he believes these markets make for a compelling investment opportunity.

His analysis follows.

***

The KINGs’ Ascendancy

Whether referring to MSCI country indices or local stock market indices, the KINGs posted a 39% USD-adjusted, price return in 2013. That is above all other MSCI leading indices and the S&P 500.

We note however that this performance has been volatile. Such volatility is not significantly different from that observed in most emerging markets. Therefore, dedicated emerging and frontier market specialists are expected to build-in and manage this downside risk.

Looking at local stock market indices, risk-adjusted performance suffers from the massive flight to safety that occurred in 2008 and 2009 during the financial crisis. In Kenya, losses were magnified as the period coincided with the 2008 post-election violence. These unprecedented outflows resulted in unprecedented losses after a bullish year in 2007 that attracted many opportunistic, foreign, non-frontier investors.

Strong Market Performance, Despite Volatility

Returns of Local Stock Indices in USD (2009 – 2013)

	Kenya	Ivory Coast	Nigeria	Ghana
5y. Cumulative	18.59%	47.71%	47.33%	42.43%
5y. Mean	7.49%	8.92%	8.73%	2.05%
5y. STD	25.6%	29.3%	38.6%	37.5%
5y. Sharpe	0.23	0.29	0.188	0.015

Source: local stock exchanges, Phase One Associates

The market crash observed in various KING countries during this period reminds us that these markets are vulnerable to external shocks partly because a considerable number of investors are foreign-based. As an example, foreign investors are estimated at 51% in Nigeria.

Therefore, despite the value and growth opportunities they represent, frontier markets including the African KINGs are reactive to market sentiment and externalities. This is particularly true in today’s context with ongoing speculation around the Fed’s policy shift in its quantitative easing program that will trigger outflows and/or slow inflows mainly from opportunistic, non-frontier investors.

4 Reasons to Be Bullish on the KINGs

Here’s why we’re bullish on each constituent of the KINGs.

• Kenya

Kenya will continue to be attractive in the near and medium terms, as the successful elections held last year have paved a way to an enabling socio-political environment that supports its dynamic economy, which has been boosted by the recent oil discoveries.

• Ivory Coast

The case for Ivory Coast featuring in the KINGs is not just a formality, but is appealing for several reasons. The country is not only UEMOA’s hub but also its newly found growth engine since the end of post-election violence in 2011. Economic activity has resumed, driven by key sectors such as: agriculture, consumer-related sectors and public spending on infrastructure. From 2012 to date the BRVM has gained over 66% of which 7% at the beginning of this year! Government gross debt has gone from nearly 95% in 2011 to an estimated 39% this year.

• Nigeria

Following Qatar and the UAE graduation into Emerging Market status this year, Nigeria will soon become the second biggest weight in the MSCI Frontier Market index behind Kuwait. This not only highlights its potential, but also positions the country to Emerging Market status in the medium term; a move that will increase visibility and liquidity as more capital flows in. This is an appeal to gain first mover’s advantage.

Ongoing reforms in the power sector coupled with infrastructure improvement will yield multiplier effects on the economy by reducing costs, improving margins, bringing in efficiencies. Overall, this will accelerate growth and open new opportunities for businesses and investors. Similar multiplier benefits are expected from the oil and gas bill. The country plays a leading role in the regional common market, ECOWAS, and many businesses are expected to further benefit from this growing trend of cross-border expansion.

• Ghana

Ghana is known for its democratic institutions and conducive business environment. Despite macro economic challenges in the near term, the country remains an attractive destination despite short-term macro economic concerns over widening deficits and double-digit inflation.

How to Ride the KINGs Coattails

Which of the KINGs industrial sectors offer the most upside?

We like the four Cs:

• Consumer-related sectors (FMCG, retail, banking, and breweries)
• Communications (telecom and IT)
• Construction (including cement companies)
• Commodities

Overall, these sectors’ key drivers leverage on strong commodities prices and a growing trend of consumerism supported by a rising middle class and rapid urbanization. These dynamics coupled with better politics and policies and improved corporate governance all contribute to strong corporate earnings, and, thus, attractive investment targets.

Here’s how their valuations stack up against their global counterparts.

Industry P/E Ratios vs. Global Averages

	Banking	Telecom	Breweries	Consumer	Retail	Construction	Agriculture
World	12.42	24.89	15.92	61.52	27.34	16.83	25.91
SSAfrica	9.29	34.64	22.6	53.93	28.56	13.5	9

Source: Reuters, Phase One Associates, October 2013

And, specifically, which blue-chip stocks play in these sectors?

A quick survey of the top performing Sub Sahara Africa-focused mutual funds revealed that most of them hold different percentage allocations of similar stocks in selected industries within the African KINGs. The usual suspects are summarized in the table below.

	Kenya	Ivory Coast	Nigeria	Ghana
Banking	Equity, KCB	ETI	GUARANTY, FBNH, ZENITH	EBG, GCB
Consumer		NTLC, UNLC	NESTLE, UNILVER, PZ	UNIL, FML
Breweries	EABL	SLBC	NB, GUINNESS	GGBL
Agriculture	BAT	SPHC, STBC	FLOURMILL
Insurance	JHK, PAFR			EGL
Telecoms	SCOM	SNTS
Construction	BAMB		DANGCEM
Mining, Oil &Gas			OANDO, FO
Media	NMG
Diversified	ICDC

We refer to these popularly-held stocks as the KINGs Index.

The KINGs Index is diverse across countries and sectors. Note, however, that it is biased toward large, liquid companies.

The ability to mix these blue chips with smaller value and growth stocks is the key differentiating parameter between high and poor performing frontier Africa portfolios.

Value is often found at the bottom of African market listings, with “neglected”, illiquid stocks outperforming large caps. In Nigeria, small cap stocks grew by 56%, followed by mid-cap 53%, whereas large cap stocks grew by 31% in 2013, according to the Nigerian Stock Exchange.

For those investors challenged by regulatory requirements that restrict their abilities to invest directly into KING markets, or for those who are uncomfortable with share illiquidity, here is a summary of leading South and Pan-African companies operating in the continent’s frontier.

	Banking	Telecom	Breweries	Retail	Insurance	Media	Agriculture
Leaders	Standard ABSA*	MTN Telkom	SABmiller	Shoprite Massmart	Sanlam	Naspers	Illovo Sugar

Source: compiled by Phase One Associates
* Now Barclays Africa

Despite having a significant geographic presence across the continent, most of these companies with the exception of the MTN Group still generate the majority of their revenue in South Africa. As an example, Shoprite is present in over 16 Sub Saharan African countries yet it generates only 12% of its top line outside South Africa, according to its 2012 financial report.

This so-called “marginal contribution per country” is fast growing, yet still low to justify full exposure to Frontier Africa.

Long Live the Kings

In sum, we believe that Kenya, Ivory Coast, Nigeria and Ghana presented as the African KINGs best represent Frontier Africa’s investment opportunities.

And companies that operate in the four “C” sectors: consumer goods and services, construction, communication, and commodities look particularly well-positioned.

We welcome your thoughts on Africa’s sweet spots and sweet stocks in 2014. Let’s hear them in the comments!

Belgrad Kenne is the Founder and Director of Phase One Associates, a research firm specializing in African Frontier Equity Markets.