Samuel Gichohi is a Senior Research Analyst at NIC Securities, a division of Kenya’s NIC Bank (NICB:KN). He generously agreed to help us navigate the process of opening a Kenyan brokerage account and to share his views on the best bargains currently on offer at the Nairobi Stock Exchange.
Samuel Gichohi: The Nairobi Stock Exchange (NSE) is currently a buyer’s market which presents foreign investors with massive bargain opportunities. This situation is a result of various factors that have converged to push stock prices to levels that are out of whack with the fundamentals on the ground.
These factors include a weakening currency (which has finally begun to stabilize), escalating fuel prices, a surge in local liquidity prompted by heavy bank lending to the private sector, and food inflation caused by the region’s persistent drought. The situation was further compounded by increased political uncertainty due to the MENA crisis and the trials at the Hague of individuals suspected of instigating violence in Kenya following the 2007 election.
As a result, despite healthy turnover levels, stock prices have suffered over the last six months. Only 13 out of 48 active stocks trade above their year-end levels.
But financial results for the 2010 fiscal year indicate that listed firms — especially the financial sector companies – enjoyed explosive bottom line growth. This trend continued in the first and second quarter of this year, which indicates that economic growth is still on course.
Considering that a majority of stocks currently trade at P/E ratios below their respective sector P/E ratios, and that 15 of the 29 largest-cap companies offer dividend yields above 3%, there is an obvious mismatch between stock prices and company fundamentals. This is bound to correct going forward.
In my view, the NSE is an ideal frontier market. It offers foreign investors exposure to the Kenyan economy, and — because many listed firms have expanded beyond Kenya’s borders — it also serves as an entry point to the regional economy. In the short term, foreign investors can capitalize by investing in the weak shilling and seek exit points as it strengthens against the US dollar.
Let’s suppose I am a US-based investor and want to buy shares of a Kenyan stock. How would I do so? Can you walk me through the account-opening process?
SG: The investor would need to open an account with a local stockbroker who will in turn open a Central Depository and Settlement Corporation (CDSC) account for them. The CDSC account is where all tradable shares are held electronically.
Account opening forms are typically available on stockbrokers’ websites. The potential investor would first fill the forms and attach scanned copies of a recent passport-size photo, a certified copy of their driver’s license or passport, and a certified copy of a tax return or utility bill. After the broker receives the documentation the investor’s account will be activated and details will be communicated to them within one business day. At NIC, we suggest that the documents be scanned and emailed to us. The originals can follow later.
How would I, as a US-based investor, place a buy or sell order through NIC Securities? Do I just send you an email?
SG: If the investor would like to place buy and sell orders by email, they can complete the email indemnity form and submit a one-off processing fee of KES200 (USD 2.30).
Otherwise, the investor can communicate their order to us and arrangements can be made to accommodate them as long as adequate security measures to facilitate proper identification are in place.
What expenses are incurred when trading Kenyan stocks? Can you give me a breakdown of the commission and fees?
SG: The Capital Markets Authority (CMA) regulated commissions for trades below KES100,000 (USD1,111) is 2.1% and 1.85% for trades above that amount. At NIC, lower commissions are negotiable depending on deal sizes.
Do most Kenyan brokers have minimum amounts required to open a trading account? To place a trade?
SG: At NIC Securities, opening a CDSC account is free and the minimum trade size is 100 shares of any counter. We, however, pride ourselves on having the capacity to handle very large trade sizes with very low turnaround times.
How are dividends delivered to foreign investors? Can they be deposited into my trading account?
SG: Dividends cannot be deposited into a trading account. This is a market regulation. However, dividends can be deposited directly into the client’s bank account and arrangements can be made to reinvest the funds from there.
Must an investor have a Kenyan bank account to collect dividends? Or can they be wired to a US bank account?
SG: When opening a CDSC account the investor is required to indicate their dividend disposal preference which could also be to have the money wired to their foreign account. The concern for the investor would be that they would have to bear the cost for the electronic funds transfer. Having a local holding account to allow the dividends to accumulate before being wired to the foreign account would be a good idea. Most local banks have dollar denominated accounts and these can also be used to hold the dividends to take advantage of currency fluctuations.
What sort of account reporting can an investor expect to receive? Do brokers send a monthly statement of my cash and stock holdings?
SG: Brokers provide periodic and ‘on demand’ statements which show the securities that an investor holds with that particular broker at any point in time. Total portfolio holdings (which can be held through more than one broker) will be sent via email to the investor by the CDSC every six months for dormant accounts, and at the end of any month in which there is any trading activity on the account.
A couple Kenyan stockbrokers failed recently, are there now safeguards in place to protect investors and prevent similar events from happening again?
SG: A number of market reforms have taken place recently in an effort to protect investors’ funds. They have resulted in the introduction of an automated trading system, more stringent capitalization and disclosure requirements, the adoption of a standard stockbrokerage platform, and the eventual demutualization of the NSE.
The minimum capitalization requirement has resulted in most of the smaller brokerage firms being acquired by banks. Investment banks which have not reached the KES250 Million capital threshold have been relegated to stock brokerage status, which requires a minimum capitalization of KES50 million.
The government plans to increase the investor compensation fund and investors are being educated on how to identify and report fraudulent behavior.
What is your favorite Kenyan stock right now?
SG: I have three favorites.
First is Scangroup (SCAN:KN). It is East Africa’s largest advertising holding company with an 80% market share. It faces no local competition, which enhances its ability to attract and retain the region’s best talent. Being a listed company means it can also retain its top employees through stock options. In a human-capital intensive field such as advertising, this is extremely important.
The company’s 2010 results were affected by costs related to its acquisition of Ogilvy East Africa, a former competitor. We expect the merger to result in cost advantages going forward. We’re also bullish on the company because competition in East Africa’s banking and telecoms industries is heating up. This will ensure higher ad-spends and thus more revenues for Scangroup. We expect annual profit growth north of 20% this year. It currently sells at a PE of 20, but we consider it undervalued because of growth opportunities.
My second pick is Equity Bank (EQBNK:KN). It is the fastest-growing bank in Kenya and boasts a market share of deposits that has grown from 1.7% in 2005 to 6.2% in 2009. The deposit growth has been driven by branch expansion — particularly in Kenya’s rural areas – and by mobile phone banking.
Equity Bank caters primarily to the SME and lower income segment with most loans being below KES100,000.
This “banking the unbanked” model has yielded impressive results, evidenced by deposit growth of 44% during the first half of this year.
Equity has also done an admirable job at containing costs and maintaining the quality of its loan book. Both of these factors should lead to improved margins.
Finally, for the income investor, I like KenolKobil (KNOC:KN), a downstream oil marketer with a skillful and motivated management team. The company is focused on growing its storage capacity and distributional efficiencies, which is imperative for survival in the Sub-Saharan African fuel-marketing industry. As competition increases and margins decline, the company will be able to take advantage of its scale economies.
I also like that it is well diversified both geographically and in terms of its product range. The company has a heavy presence with over 400 service stations in East and Central Africa as well as Southern Africa.
All this is backed by the additional effect of increasing property prices that could lead to significant profits when the company disposes of some of its non-core assets.
The company is currently selling at a historical P/E of 10 and a half-year dividend yield of 5%. At the current price, the full year dividend yield will be approximately 10%; with profit growth, and a dividend pay-out ratio of 40-45%, the company is a cash cow.
Do you have questions on how to invest on the Nairobi Stock Exchange? If you do, share them in the comments.
Whenever I travel to Africa, I always make sure to leave plenty of space in my suitcase. I’m not reserving room for souvenirs. No. This nerd is saving space for any annual reports and financial statements that I manage to beg, steal, or borrow during my visit.
You see, tracking down financial reports is one of the biggest challenges to investing in Africa’s frontier markets. Many listed companies in the region have only rudimentary websites (if they have them at all), and investor relations doesn’t seem to be a priority for far too many firms. Fortunately, this situation improves with each passing month, but obtaining current financial data for African companies remains a scavenger hunt.
So, where can an investor turn if a company’s website doesn’t post financial results? Here’s a list of my favorite resources.
If you’re looking for an annual report, your first stop after checking the company website should be AfricanFinancials.com. To my knowledge, this is the most comprehensive collection of free African annual reports on the web. The library presently consists of more than 3500 reports from 18 African countries. It’s brilliantly organized by country, year, and sector.
The biggest downside of the site is that the vast majority of files are not in PDF form. Instead, they are posted in an unwieldy Flash-based format. I’m pleased to see that the site is beginning to post some PDF files. Hopefully, the entire library will soon be available in this format.
The only other limitation of the site is that it does not (yet?) post interim financials – only annual reports.
The Botswana Stock Exchange posts company financials for listed companies here. Click on the company that you are researching and the files are listed in descending chronological order in the box labeled “Company Announcements” in the upper right corner of the page.
Note that the site doesn’t always post copies of annual reports, but it does have a fairly comprehensive collection of interim and year-end financials in PDF format.
Do you speak French? If so, you can make use of the Bourse Regionale des Valeurs Mobilieres’ (BRVM) collection of downloadable financial updates. The files are organized solely by the date that they were published – not by company – which is not very user-friendly, and it does not include annual reports, but the collection is comprehensive otherwise.
Trying to find financial data on a Ghanaian company? Try Annual Reports Ghana. The site has a very good, intuitively organized collection of annual reports and interim financials in PDF format. My only complaint about the site is that the annual report files are typically only extracts from the complete report. The files contain the financial statements, but omit management commentary and footnotes. [Update: Annual Reports Ghana will provide complete annual report files upon request. Simply contact them via this enquiry form and specify which report you’d like to receive. You will then be emailed a temporary link to the complete report that is usable for 24 hours.]
The Ghana Stock Exchange also posts financial reports here. Unfortunately, they are not archived terribly well. If you are looking for a particular report, you will need to know an approximate date on which the report was released, as they are not organized according to company. Note, too, that the Ghana Stock Exchange does not compile annual reports – only interim and year-end statements.
The Nairobi Stock Exchange advertises a library of annual reports and company financials, but they charge about $11 per month for access to it. I’ve never subscribed to it, so I have no idea how comprehensive it is. Buyer beware.
The Stock Exchange of Mauritius posts downloadable company results (but not annual reports). But if you’re looking for a report from years past, you’re out of luck. Only the most recent updates are available. Older reports soon fall off the site.
Looking for a good source of downloadable annual reports and financials for Nigerian companies? So am I! If you know of a good one, please post it in the comments. [Update: Naija Lo Wa and Proshare both post numerous financial reports on Nigerian companies. Most of the files are broker-authored, but a determined researcher may be able to turn up an obscure annual report or set of audited results.)
The Dar es Salaam Stock Exchange links to company financial results here. Like most African stock exchange websites, the results do not include annual reports and they are not arranged by company. You must scroll down the chronological list to find what you need.
The Lusaka Stock Exchange curates a small library of Zambian annual reports and financials. It’s far from comprehensive, but the files are downloadable.
You can find a very small collection of Zimbabwean financial results on the Zimbabwe Stock Exchange’s website. The few reports available are current, but it’s not clear to me how diligently the exchange posts results. If you’re looking for older reports, you’d better look at AfricanFinancials.com or the company’s website.
Have you found a good source of financial reports for African companies? Tell us about it in the comments!
Michael Abrahams knows banking. Since receiving his PhD in Economics from UC Berkeley, he has helped craft bank policy in Washington, analyzed bank financials on Wall Street, served on the boards of financial institutions, and advised a village-level savings and loan association in Uganda. Now he’s putting his extensive expertise to work as the General Partner of the New Markets Financial Fund, LP, which invests primarily in firms that provide banking services to underserved communities. African stocks constitute over 50% of the fund portfolio, which has posted a 16.6% CAGR since inception in January 2007 through year end 2010.
Mike graciously agreed to give me some insights into his investment approach last week.
You invest primarily in financial firms that cater to the un-banked. Why have you focused your fund in this way?
Michael Abrahams: This is an extraordinarily exciting market that is being pushed by both the demand and supply sides of the equation. The World Bank has estimated that there are 2.5 billion unbanked adults worldwide; while some have incomes too low to be served, this hurdle is declining every year. In addition, the demand for banking services increases more than proportionately with income, that is as incomes rise, the demand for banking rises even faster. This large and growing demand is being met by an increasing supply of services: technology and greatly improved operating strategies are enabling financial institutions to profitably provide the small accounts and transactions needed by many of these potential customers. While banking in the US is characterized by overcapacity, weak (if any) profitability and negative growth, our market, largely in emerging and frontier markets, is rapidly growing, has wide margins and is providing tremendous benefits to its customers.
It sounds like a pretty specific niche. How large is your investment universe?
MA: It is bigger than you may think. Last year, we totaled up the market cap of all publicly traded banks in emerging and frontier markets that we could find and it came to $2.3 trillion. This is an overestimate of our universe since there are banks in this group that serve a different niche within emerging and frontier markets than we have an interest, for example, wealthy individuals or corporations. However, it does give you an idea of the magnitude of this market.
It must have been rough sailing for these stocks a few years ago. How did you navigate the 2008 financial crisis?
MA: That was our second year and it was a challenge. However, we had been concerned since 2005 about the US real estate market and the US banking system. In 2008, we were heavily short US financials, something that helped mitigate our losses to about half that of the S&P500.
Tell me a bit about your investment process. What criteria do you use to size up a potential investment?
MA: We first make sure that we are relatively comfortable with the country where the company is headquartered. Then we’ll examine whether their strategy has a reasonable chance of success. When we find a company whose market and strategy we like, we evaluate its returns, how it generates those returns and how well it does so by looking at some of the contributors to earnings quality such as the net interest margin, the sources of non-interest income, and the level and trends in problem assets. I then like to rank potential and current investments by their PEG ratio to give me some idea as to how expensive the shares may be relative to other companies’ shares.
Sometimes companies change their strategies — particularly in a market that is growing in many new directions like this one. When they do, we re-evaluate our position. For example, African Bank Investments (ABL:SJ), a South African microlender, purchased one of the largest furniture dealers in South Africa a few years ago in order to accelerate the growth in their loan portfolio, in this case with furniture loans. But the retail furniture business is very different than the loan business and we sold our position.
You made a great call on a South African firm called Capitec Bank Holdings (CPI:SJ), which you’ve ridden to a 411% gain. What tipped you off that the stock would be a winner?
MA: Here was the key for me: the bank understood their target market, the un- and underbanked of South Africa, and designed the bank’s products and services specifically to meet their needs. None of their business appeared to be a rehash of existing products and services designed for wealthier customers. I can’t overstate the importance of this —translating an ATM panel into different languages, as we have seen in the US isn’t enough, it isn’t even a start. I felt Capitec had the right products and had done everything imaginable to drive their costs down so that they could profitably offer small accounts and services. In addition, unlike many others who serve or try to serve this market, Capitec has a strong focus on deposits. This is critical for their customers’ long term financial health and development and for Capitec’s long term funding stability. They had little to no competition among formal financial institutions, although some has since developed, and faced a market in South Africa of millions of potential customers. And they had margins you could drive a truck through. To make it better from my own selfish perspective, the little research coverage they got kept saying they were too expensive. They were too expensive if you compared them to FirstRand (FSR:SJ) or Standard Bank (SBK:SJ), but neither of them were growing at 40%+ a year with high returns on equity on unlevered capital bases.
And (you knew I was going to ask this) what was one of your biggest losers?
MA: Blue Financial (BFS:SJ). They had a really great story as a pan-African microfinance lender. However, they couldn’t execute on their strategy. I think in part because it was a more complex task to develop a pan-African lending platform than they expected and underwriting suffered as they sought rapid growth. They probably needed a more experienced and cautious management and board team than they had.
What is your biggest challenge as an Africa investor?
MA: The biggest challenge is politics. In the first quarter of 2011 alone, Egypt closed their market for almost two months and Cote d’Ivoire moved their exchange to Mali for a few months after the forces of the former President raided their offices. Turmoil continues there today. And on a smaller level, Net1UEPS (UEPS:US) has been volatile and a very poor performer for three or four years because of the ongoing uncertainty regarding contract discussions with their largest client, the South Africa social benefits administration.
The next biggest challenge is inadequate disclosure. It does vary. Many South African companies have excellent disclosure. Other countries and companies have much more limited disclosure. For example, some of the banks we have looked at in the Cote d’Ivoire release their full year end financials in October with the half year results about a month later.
Do you see any bargain African banks right now?
MA: There are many attractive investment opportunities. If I had to pick one today, I would pick Letshego (LETSHEGO:BG), the Botswana-based micro-lender. And we are looking very closely at expanding our investments in companies playing key roles in providing mobile phone banking. Paul Volcker said in 2009 that the only innovation in banking in the past 20 years was the ATM — I would add mobile phone banking which will have a much bigger impact.
You recently traveled to Nigeria. What is your take on its banking sector?
MA: Nigeria is a tough one. It is the most populous country on the continent with well-recognized problems with resource-dependency and corruption. However, things are improving on many fronts including banking and the regulation of banking which is more than we can say about the US. I will feel more confident in my ability to evaluate Nigerian banks when they shift to IFRS accounting from their current use of Nigerian Accounting Standards. There is huge potential in this market and there are some serious and dedicated people and institutions working on reforming it.
You don’t just invest in African banks, you’re personally involved in setting up village-level savings and credit associations on the continent. Has this work informed the way you manage your portfolio?
MA: Two experiences have influenced the way we look at our investments. The first is work training people in West Africa how to establish savings and credit groups through their local churches. The second was closer to home and was financing and then serving on the board of a Los Angeles based inner city check cashing company. Through both, I saw that the lives of the unbanked can be tremendously improved, if not changed, with basic banking services. But these services have to be designed to fit their needs; that is, offering them a $1000 CD, even if it is in Spanish, is not much help. But a savings account that they can regularly add a couple dollars to every week, pay some bills from and not be annihilated by service charges can be a hugely beneficial product. We look for well run companies able to profitably deliver products like this.
Disclosure: The New Markets Financial Fund holds a long position in Capitec Bank Holdings. Ryan Hoover holds long positions in Letshego Holdings and Net1UEPS.
Few mutual funds consistently beat the market because their fees tend to counteract any expertise that their managers bring to the table. But if consistent outperformance through active management is possible, it’s most likely to be possible in Africa.
Why? Because the continent is arguably home to the world’s most inefficient stock markets. As a whole, they tend to be illiquid, under-researched, and slow to react to events. That’s fertile ground for a skilled fund manager who can identify mispricings and then patiently wait for the market to catch up.
After launching one of North America’s first Africa-focused mutual funds, Larry Seruma and his team at Nile Capital Management are poised to exploit this opportunity.
Originally from Uganda and a former principal at Barclays Global Investors, Seruma has guided the Nile Pan Africa Fund (NAFAX) to a 13.9% annualized return since its inception at the end of April 2010. Over that same time frame the two pan-African ETFs — the Market Vectors Africa Index (AFK) and the SPDR S&P Emerging Middle East and Africa Fund (GAF) — returned 3.3% and 13.2% respectively.
Granted, this performance has not been adjusted for the fund’s 5.25% front-end load and 2.51% expense ratio, but the folks at Nile are off to a respectable start.
What’s their strategy for beating the market? The composition of the fund’s top five holdings as of March 31, 2011 gives us some clues.
African Minerals – (PE Ratio: N/A, PB Ratio: 3.8, Div Yield: N/A) This London-listed company is in the early stages of developing an iron ore deposit and associated port and railway infrastructure in Sierra Leone.
Afferro Mining – (PE Ratio: N/A, PB Ratio: 1.6, Div Yield: N/A) Another iron miner, Canada-based Affero plans to extract ore from deposits in Liberia and Cameroon.
Flour Mills Nigeria – (PE Ratio: 16.1, PB Ratio: 3.0, Div Yield: 2.5%) Primarily a flour miller and thus sensitive to global wheat prices, this conglomerate also generates a large portion of its income from the sale of cement.
Bellzone Mining – (PE Ratio: N/A, PB Ratio: 9.1, Div Yield: N/A) Yet another iron ore exploration company. This one’s main project is in Guinea.
Zenith Bank – (PE Ratio: 11.8, PB Ratio: 1.2, Div Yield: 6.1%) A relatively new position for the fund, this bank has the highest market capitalization of any Nigerian financial firm.
As you can see, the fund is heavily weighted toward mining stocks (which represent nearly 45% of the portfolio) and on iron miners in particular. Iron exploration and development companies comprise over 22% of the fund.
Iron ore prices have quintupled over the past five years, driven by China’s seemingly insatiable demand for steel. Nile is betting that this trend will continue. If it does, and the African ore deposits produce as advertised, their investors should see some nice gains.
The fund also has a large position in Nigerian equities, which represent more than 21% of the portfolio. We looked at the case for investing in Nigeria in last week’s post. It’s a diversifying economy of more than 150 million people that economists expect to grow at an 8.5% clip over the next two years.
Curiously, Nile doesn’t appear to be very active on the continent’s most inefficient stock exchanges. The majority of its assets are invested in stocks listed in Johannesburg, London, and Toronto. It would seem Seruma and company could better leverage their Africa expertise by searching for value in frontier markets like Ghana, Kenya, and Botswana.
That quibble aside, there’s a growing market for Africa-focused investment vehicles, and it’s nice to see a pioneer in the mutual fund niche.