Soaring Wages Make Kenya Airways a Sell

Recent labor disputes demonstrate employees’ leverage over KQ’s operations and increase doubts about a return to profitability for the East African airline.

Try as it might, Kenya Airways (KQ) just can’t seem to power through its many headwinds.

Photo by Plane Spotter NL
Photo by Plane Spotter NL

Just as the company appeared to have set a course to consistent profits, two recent labor disputes suggest KQ investors better prepare for turbulence.

First, the airline’s pilots threatened to strike unless the company’s board chairman, Dennis Awori, and CEO Mbuvi Ngunze, were removed from their posts, saying that they had no confidence that they could restore the company to a sound financial footing.

Both men have since resigned. Awori was replaced by Safaricom hero, Michael Joseph, while Ngunze’s successor is yet to be announced.

Then, just weeks later, the company’s engineers and mechanics downed their tools in protest of low wages and long exhausting schedules. They returned to the job following a promise to have their pay package reviewed in January.

Labor Unions Have the Leverage

So, what should we, as investors, make of all this?

Well, recent events make it crystal clear that the company’s success is at the mercy of its employees.

Dennis Awori served as board chair for less than a year and Mbuvi Ngunze was appointed as CEO in November 2014. Despite their short tenures, they’ve already guided the airline to its best financial results in years. The company’s operating loss of Ksh 949 million over the most recent 12 months was the closest KQ has come to operating profitably since 2012.

But pilots and mechanics possess rare skills. They’re expensive to train and tough to replace, especially in a relatively small market like East Africa’s. So, the airline needs to do everything in its power to keep them happy.

Rising Wages, Falling Profits

KQ has reported a big earnings loss every year since 2012, and its liabilities now outweigh its assets by nearly KShs40 billion.

Nevertheless, over the past decade, the average compensation package for a Kenya Airways employee has nearly tripled, rising at an average annual rate of 11.2%. This rate is nearly double the rate of pay hikes awarded to management (6.1%).

As you can see in the chart below, the average employee’s wage increased every year except last year, when Awori and Ngunze were in the cockpit. In light of this, it’s easy to see why both of them were sacked.

KQ EmpCosts Vs Revs

If Wages Can’t Be Cut, Alternatives are Few

Let me be clear. I’m not blaming KQ’s workers for the airline’s troubles. They deserve to be paid well for their unique expertise. But an increasing wage bill is a major reason that the airline can’t turn a consistent profit. In 2006, worker compensation was equivalent to 9.6% of KQ’s revenue. In 2015, it was 15.4%.

If labor costs remain at this lofty level, there are scarce few ways for the company to meaningfully widen its margins.

The passenger load factor of 71.6% is already near the top end of its historic range, and adding more flights or routes would entail higher investment in aircraft and substantially increased operating costs.

Headed for a Rough Landing?

Add in the risks of a turbulent election season, a rise in oil prices, or an interest rate hike, and this airline looks to have a very low ceiling.

Fortunately for shareholders, news of Michael Joseph’s appointment as chairman of the board propelled the stock 57% higher over the past two months.

But given the challenges Kenya Airways faces, this looks like a great time for them to collect their gains and disembark.

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Kenya’s Three Top Dividend Stocks

Three Kenyan stocks with high yields, low debt, consistent track record, and the potential for growth.

Co-operative Bank HQ
Photo by Ninara

Dividend stocks can provide a great foundation for an investment portfolio.

But plunking your hard-earned cash into the share with the highest yield could be a costly mistake.

At the moment, nearly a third of stocks listed on the Nairobi Securities Exchange sport dividend yields greater than 4%. But how do you decide which ones stand the best chance of building your wealth over the long-term?

Beware High Debt Loads

After identifying a stock with a high yield, the first thing you want to check is its debt load. Companies that borrow heavily often find it difficult to sustain their dividend when the economy turns sour and interest rates rise.

This is what happened to Kenya Power in 2013. Interest charges on its debt more than doubled when it borrowed to finance extension of the electricity grid, and management was forced to nix its dividend payout.

To minimize this risk, only consider stocks with debt levels lower than 70% of their book value. We calculate this debt to equity ratio by dividing all of the company’s interest-bearing debt by its total equity.

Companies with low debt-to-equity ratios are generally resilient enough to weather tough times without immediately cutting dividend payments to their shareholders.

Don’t Forget Growth

The next thing to look for is the potential for growth. If a company isn’t growing, then it’s unlikely that it will be able to consistently increase its dividend. And if a company isn’t consistently boosting its dividend, you might as well invest in a bond.

Companies often reveal their potential for growth by the percentage of their earnings that they pay out in the form of dividends.

If a company pays out just 10% of its earnings, then it is likely investing the remainder in expansion. Therefore, it stands a good chance of increasing its dividend in the next year. If, however, the company pays out 90% of its earnings, management is essentially saying that it doesn’t have many good ideas about growing the business, so it’s likely that dividend growth will soon stagnate.

So, if a steadily increasing dividend income stream appeals to you, it’s best to avoid companies like Bamburi Cement and Nation Media Group. Both paid out more than 90% of their earnings over the past 12 months. Stick to companies with payout ratios lower than 70% instead.

Consistency is Crucial

If you find a high-yielding company with low debt and a low payout ratio, the final step is to check out its dividend payment history.

You want to avoid companies that slashed their dividend at any time during the past five years. Why? Because if they reduced their dividend one time, there’s a good chance that they’ll be tempted to do it again.

The Dividend Diamond Screen

To recap, screen the market for shares that meet the following standards:

1. Dividend yield > 4%
2. Interest-bearing Debt to Equity Ratio < 0.7
3. Payout Ratio < 70%
4. No dividend cuts in past five years

Kenya’s Top Dividend Stocks

As of September 11, 2016, the following three NSE stocks passed the above screen.

Yield LT Debt/Equity Payout Ratio
Carbacid 4.9% 0.0 43.2%
Co-operative Bank 7.0% 0.3 31.3%
Equity Bank 7.6% 0.5 32.7%

What Do You Think?

Do these results surprise you? Do you have a favorite dividend idea to share? Let’s hear your thoughts in the comments.

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How to Begin Investing on the Nairobi Securities Exchange

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How to Begin Investing on the Nairobi Securities Exchange

A quick, easy guide to opening an account to invest in Kenyan stocks.

Kenya Shillings
Photo by KlnDonnelly

Kenya boasts a diverse economy, improving infrastructure, and a young, dynamic population.

But high interest rates and instability in the banking sector have left many Kenyan stocks trading at multi-year lows, offering investors a great entry point for exceptional long-term returns.

So, how do you get started investing on the Nairobi Securities Exchange (NSE)? Here are a few tips.

Start By Bulletproofing Your Finances

While investing in stocks is one of the best ways to build wealth over time, a positive return is not guaranteed.

Volatility, however, is pretty much a sure thing.

So, to minimize risk, it’s crucial that your finances be ironclad.

If you’ve answered each one of these questions with a hearty “Yes!” you’re in a great place to begin thinking about investing on the NSE.

Find an Online Broker

Before you can start putting your money to work on the NSE, you must first open an account with a licensed stockbroker.

There are more than 20 brokers trading on the NSE, but I’m partial to those that offer an online trading platform. Online trading gives you the freedom to buy and sell shares whenever and wherever you want.

Here’s a list of Kenyan stockbrokers that presently offer online trading:

Mind the Fees

Almost all of the above brokers will charge an account opening fee, an account maintenance fee, or both.

The amount of these fees varies from broker but is typically about Ksh1,200.00 (roughly US$12.00) to open the account and Ksh100.00 (roughly US$1.00) per month to keep it active.

There is no minimum amount required to fund your account, but when you decide to purchase a stock, you must buy at least 100 shares.

At this moment, the least expensive share listed on the NSE was priced at KES 1.05. You could, therefore, buy 100 shares of this company (Mumias Sugar) for KES 105.00 plus the broker’s commission. But, if you’d like to purchase shares of Jubilee Holdings (currently priced at KES 470.00), you’ll need to invest a much larger sum (KES 47,000.00).

In addition to the account maintenance fee, your stockbroker will charge commission and fees on every trade you execute. The commission rate is the same across all stockbrokers and is equal to:

  • 1.78% of the total value of transactions less than KES 100,000, or
  • 1.50% of the total value of transactions more than KES 100,000.

The Documentation You’ll Need

In order to open an account you’ll need to provide your broker with the following:

  • Two color passport size photos
  • Your national ID document or passport (a notarized copy is acceptable for investors living outside Kenya)
  • A signed CDS-1 Form (click here for sample)

Most brokers will also ask for one or more of the following: a copy of a recent utility bill, the first page of your bank statement, or a copy of your PIN certificate.

When the process is complete you will be the proud owner of a Central Depository System (CDS) account.

A CDS account is an electronic account that stores all of the shares you own. Think of it as a satchel (or portfolio). You can move this satchel from stockbroker to stockbroker, and all of the shares that you have accumulated move along with it. So, if you find the level of service from your broker to be lower than you expected, rest assured that you can easily take your business elsewhere.

After the account is set up, your broker will instruct you how to fund it and how to place an order to buy shares.

Do You Live Outside Kenya?

If so, you may find it difficult to collect dividends. Typically, Kenyan companies deliver dividends via direct deposit into a specified bank account or by a cheque denominated in Kenya shillings, which can be next to impossible to cash in the US or UK. And Kenyan banks require you to appear in person in order to open a local bank account.

Therefore, unless you’ve got plans to visit Nairobi in the near future, make clear to your broker that you would like to open a nominee account. This allows the broker to collect dividends on your behalf and to deposit them directly in your trading account.

Mission Accomplished

So, there you have it. Follow these steps and you’ve got everything in place to start investing in Kenyan shares.

But how do you choose that first stock? We’ll cover that in the next post.

It’s Your Turn

What questions do you have about investing on the NSE? Let me know in the comments, and I’ll do my best to get answers for them.

Kenya’s Battered Bank Stocks Look Like Bargains

Kenyan bank stocks were hit hard by the new cap on interest rates, but the resulting selloff left most priced for attractive long-term returns.

Every once in a while, the stock market offers you a gift.

Stocks on sale
Photo by Anthony Easton

In Kenya, this appears to be one of those times.

At the beginning of last week, shares of Kenyan banks were already trading at valuations near their lowest in a decade.

Then, on Wednesday, things got crazy.

In a surprise move, President Uhuru Kenyatta signed a law that put a ceiling on banks’ lending rates and a floor under deposit rates.

Interest rates on loans are now capped at four percentage points above the benchmark interest rate, which presently stands at 10.5%. Deposit rates, meanwhile, must now be at least 70% of the benchmark rate.

As you might imagine, the market didn’t like this news one bit.

Bank stocks tanked. They all ended the week at least 6% lower than where they started it. And the prices of three of them, Co-operative (COOP.NR), Equity (EQTY.NR), and NIC (NIC.NR) plunged 23%, 22% and 21%, respectively. The bloodletting continued on Monday with four banks dropping another 9%.

When the closing bell rang on August 29, the price-to-book ratios and dividend yields of the ten largest Kenyan banks looked like this.

Kenyan Bank Valuations as of August 29, 2016

Company  P/B Ratio Dividend Yield
Barclays Bank Kenya (BBK.NR) 1.1 11.5%
CFC Stanbic (CFC.NR) 0.7 9.6%
Co-operative Bank (COOP.NR) 0.8 8.2%
Diamond Trust Bank (DTK.NR) 0.9 1.8%
Equity Group (EQTY.NR) 1.3 7.5%
HF Group (HFCK.NR) 0.4 10.0%
I&M Holdings (IMH.NR) 0.9 4.5%
KCB Group (KCB.NR) 0.8 4.1%
NIC Bank (NIC.NR) 0.6 5.2%
Standard Chartered Kenya (SCBK.NR) 1.3 12.1%

What to Expect Now

Now, I don’t want to spend too much time discussing the merit of the new regulations, but, in their wake, I think the following three things are near certainties:

  • Banks’ growth rates will slow.
  • Large banks will continue to find ways to make money.
  • Banks’ asset quality will improve.

Let’s briefly consider each one in turn.

Bank Growth Will Slow

At present, all Kenyan banks do at least a portion of their lending at interest rates greater than 14.5% (the new, effective maximum rate). And they all pay interest on at least a portion of their deposits at rates lower than the new minimum (7.35%).

Thus, with the new cap and floor in place, the margin between the amount of interest a bank collects and the amount of interest that it pays out will be squeezed, making it tougher for the banks to grow net interest income.

Large Banks Will Remain Profitable Over Long-Term

But don’t shed too many tears for your banker. Most large banks will be just fine.

Sure, banks that do a lot of business with small, riskier customers (e.g. Equity and Co-operative) will likely be hit harder than their peers, but they will find a way to remain profitable in the new environment, whether it be through more efficient loan underwriting, higher fees, or new terms for savings accounts.

It’s important to note that usury laws are not unusual in capitalist economies. In fact, they exist in 49 of the 50 U.S. states (Utah’s the only exception).

Asset Quality Will Improve

Now that the cap on interest rates is in place, the first step most banks will take is to reduce the amount of lending they do to riskier borrowers. After all, why would a bank lend to a small business at a rate of 14.5%, when they can invest in a government bond yielding 15% instead?

As banks shift away from high-interest, unsecured lending, bad loans will no longer present a major threat to the quality of their assets. And, in theory, a bank’s share price should at least be roughly equivalent to its book value per share.

A Conservative Forecast

So, given the above, what kind of returns might we expect from the bank stocks over the next five years?

Let’s make some assumptions for what we’ll see between now and the end of 2021.

  • Banks’ average growth rate will be cut by a third.
  • Bank stocks currently trading at a premium to book value will see this premium cut by a third.
  • Bank stocks currently trading at a discount to book value will see their price-to-book ratios remain at their current level.

Please note that these are strictly assumptions, but I believe them to be relatively conservative. (Let us know in the comments if you think any of them are way off the mark.)

Now that we’ve made these assumptions, we can plug in the numbers and arrive at a forecast return (including dividends) for each Kenyan bank stock. They appear in the chart below.

Company Est. BVPS Growth* Est. P/B Ratio* Est. Annualized Return*
Barclays Bank Kenya 3.9% 1.1 12.5%
CFC Stanbic 2.7% 0.7 9.9%
Co-operative Bank 10.5% 0.8 17.1%
Diamond Trust Bank 16.2% 0.9 17.7%
Equity Group 13.4% 1.2 17.8%
HF Group 6.1% 0.4 14.2%
I&M Holdings 14.4% 0.9 18.1%
KCB Group 15.7% 0.8 19.0%
NIC Bank 13.1% 0.6 17.4%
Standard Chartered Kenya 8.6% 1.2 16.6%

* Forecast to 8.31.2021

A Bevy of Bank Stock Bargains

So, as you can see in the chart above, most Kenyan bank stocks now appear priced to deliver annualized total returns well above 16% over the next five years. KCB, I&M, Equity, DTB, and I&M look like the pick of the litter with 19.0%, 18.1%, 17.8%, and 17.7% forecast returns, respectively.

And if my assumptions turn out to be too conservative, which I believe is more likely than not, the returns to long-term investors at these prices could be very special indeed.

Disclosure: At time of publication, I held a beneficial interest in shares of KCB and I&M Bank.

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7 Reasons You Should Be Investing in Shares

Investing in shares on the Johannesburg Stock Exchange offers a host of benefits for the long-term investor. Here’s a handful.

Meet Cassandra – Cassy for short.

Cassy graduated last year – Honours in Tax – and has landed her first real gig. She got a job with a multinational company and is coming in as a junior to learn the ropes.

Cassy is long-term oriented and knows the importance of saving for the future.

She intends to open up her own tax consulting business after she has gained sufficient practical experience. In the meantime, she’ll be investing her long-term savings on the Johannesburg Stock Exchange (JSE).

Cassy has signed up with an online brokerage platform and has budgeted R700.00 a month for investing.

She’s done her homework and knows that there are costs involved in buying and selling shares.
So, to keep trading costs to a minimum, she intends to invest in the Satrix ALSI Index Fund. This fund is not only cost-efficient, but it gives her exposure to all the shares trading on the JSE, which diversifies her risk.

She decides to educate herself so that she can make her own calls on what shares to invest in next year.

If history’s any guide, her steady, consistent approach will yield a crafty little nest egg in the next 15 years – large enough for her to spread her entrepreneurial wings.

Why Cassy Loves Investing on the JSE

Cassy’s strategy capitalizes on three attractive features of investing on the JSE.

1. It’s convenient. Many South African stockbrokers offer intuitive online trading platforms. They’re easy to use and allow her to buy and sell shares with a click of a mouse.

2. A wide variety of index funds and ETFs make it easy to diversify her portfolio quickly and cheaply.

3. World-class financial reporting requirements give her excellent visibility into the goings-on at each listed company, giving her the information she needs to pick winning shares.

Meet DJ Deejay

Photo by Matt Rhodes
Photo by Matt Rhodes

Deejay is a house music DJ and has been making mad music for a good few years. His beats have proven quite popular on the Durban club scene, and he has managed to rake in some serious cash.

His friend Natasha suggested that he think about investing on the JSE:

“Deejay, take the advice of a good old friend – investing in companies on the JSE is a great way to build wealth over the long-term.

  • If you buy good companies at fair prices, you can expect the value of your shares to grow over time.
  • Many companies even pay dividends to their shareholders once or twice per year.

But keep in mind that owning shares is like being in a relationship – you don’t end it when things get rough. Buy shares of a quality company at a fair price and stick with them during tough spells. Your reward will be handsome if you remember this.”

Intrigued, Deejay contacts one of the well-known banks and informs them of his decision to invest his money.

His savings allow him to open up a premium account with access to a personal broker who will help him to build and manage a healthy share portfolio to match his long-term goals.

Why Deejay Loves Investing on the JSE

Deejay wants a decent return on his money, but unlike Cassy, he’d rather be at the club than spending an evening poring over financial reports. Investing on the JSE allows him to accomplish both aims.

4. Diversified share portfolios tend to appreciate in value over time. In fact, no other asset class has been so successful at building investor wealth.

5. Periodic dividend payments can provide Deejay with a valuable income stream as he patiently watches his portfolio grow.

6. The nature of share investing allows him to choose to be very involved in choosing stocks or, instead, turn over the task of managing his account to a trusted broker.

This Is Thulani

Thulani is a man of his word.

His photographs have been pulled off his cubicle “wall” and his mug from home is packed snugly in the box on the floor. This is it. He has finally made it.

Unlike many his age, Thulani is not afraid of retirement because he has invested enough of his income over the years in what is now a solid share portfolio to carry him through the later years of his life.

He would have loved to have his wife waiting at home for him, God is the best of planners after all.

His heart skips a beat when he thinks of his trip to Nairobi next week where he will be visiting his daughter and grandchildren.  He’ll Skype her first thing when he gets home.

Thulani will be selling off his investment in the Satrix 40 ETF month on month to cover his living expenses and a few trips here and there.

He is glad of the liquidity that his investment brings and is thankful to his younger self for thinking about him in his old age.

He hopes that his daughter has taken his advice and is investing 10% of her monthly salary each month.

Why Thulani Loves Investing on the JSE

7. In a word, liquidity. Unlike real estate and many other investment classes which take time to sell, investing in shares on the JSE allows Thulani to sell (withdraw) the money that he needs at the time that he needs it. He doesn’t need to worry that his cash will be tied up if an unexpected opportunity or financial emergency arises.

Your Turn

What questions do you have about the JSE or investing in shares more generally? Let’s hear them in the comments!