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LAGOS (Capital Markets in Africa) – The equity market could be headed for another tough year with economic concerns surrounding FX and weak corporate earnings continue to downplay the attractive valuations of blue chip stocks. We reiterate the strong correlation of the Nigerian equity market to oil prices and with the price of Brent crude oil hovering around $55/bbl coming into 2017, we think losses will be less steep this year with the potential for a positive year close – if the improvement in oil price reflects positively on Nigeria’s fiscal and currency crisis. We expect market performance in 2017 to be dictated by conditions in the economic environment and anticipate that the following key events and factors will influence the performance of the Nigerian Stock Exchange (NGSE) this year;
― Decisive policy response to the country’s fiscal crisis
― Improvement in FPIs on the back of a sustained rebound in oil prices and improved FX liquidity
― MTN Listing
― FY’16 Dividend Capture
Decisive policy response to the country’s fiscal crisis could set the tone for a bullish financial market
Significant market rebounds in the past were underpinned by serious economic reforms, and we think this would be the case going forward. A recent case study is the banking sector consolidation exercise when the market came off a downtrend to start an extended bull cycle as the consolidation took shape with most banks raising funds in the capital market – a decade ago. This bull cycle was further sustained by two notable events; first was a landmark deal between Nigeria and her erstwhile creditor, Paris debt club in 2005. The deal, which granted Nigeria a 60% relief (US$20 billion) of her total debt to the club, spurred foreign inflows to the country and particularly to the Nigerian equity market, given the improvement in the country’s credit-worthiness.
The second event was the reforms in the Nigerian pension industry, which started with the enactment of the pension reforms act of 2004. This revolutionized the erstwhile ineffective defined-benefit pension scheme to a more realistic defined contribution pension scheme, creating a pool of investible funds for the capital markets. By 2006, pension assets under management grew to N360 billion ($1.18 billion) and a chunk of these assets was subsequently invested in domestic quoted equity (2007: 29.68%, 2008: 20.27%). Interestingly, Nigeria is currently facing its toughest economic challenges since the 1980s and it would take more than “business as usual” to navigate these challenges. Therefore, it is imperative that policy decisions must be taken and implemented swiftly.
The economy is also likely to benefit from the continued implementation of the 2016 budget (CAPEX implementation improved to 54% in Q3’16 from 20% in Q2’16) which should roll through to 2017 until the new one begins. The government expects GDP to grow by 3% in 2017 after an estimated 1.5% contraction in 2016, according to the budget proposal. In our view, any recovery will hinge on more transparent and open foreign exchange activities in 2017, which would help to attract foreign inflows and reduce the pressure on the apex bank as the major supplier to the interbank market. Speedy implementation of the 2017 budget should support the recovery process, but further delays, as well as a continued absence of clarity regarding the exchange rate framework, will exacerbate the recession and delay market rebound.
Foreign investors’ liquidity inevitable for a sustained market rebound
Foreign investor participation on the bourse was tepid in 2016, accounting for c.40% of transactions (6-year average: 52%). We have witnessed softer risk appetite from international investors due to socio-political developments such as the UK referendum vote, and US presidential elections. These have no doubt deterred some investment. However, internal factors are more relevant; particularly, liquidity constraints in the foreign exchange market which have resulted in the extreme difficulty faced by many companies to repatriate earnings to their parent companies.
The FMDQ reported a total turnover of US$76.7 billion (N23.39 trillion) in the FX market (including derivatives) for the 11-month period up to November 2016, compared to a yearly turnover of US$140.5 billion (N42.85 trillion) in 2015. Given the commencement of a rate tightening cycle by the US Fed, many frontier markets will be vulnerable to capital outflows. Whilst we note that Nigeria, being the largest economy in Africa and a major frontier market, will continue to attract its share of the frontier and African market funds, without a firm resolution on FX liquidity, foreign flows may remain around their current levels for much of 2017. Efforts to improve ongoing or announced reforms to boost liquidity have not seemed enough. The government has announced some measures to improve this condition, but directions have not been quite clear or satisfactory for the market. A successful Eurobond offering in Q1’17 and the ability to attract funding in the form of concessional loans from multilateral agencies should boost confidence in Nigeria’s fiscal authorities and set the scene for a greater share of capital inflows.
Recovery in oil prices key to market rebound
Using regression analysis on 20-year data of the Brent Crude and NSE ASI index, we establish that oil price movements account for about 70% of the variation in market performance. However, the market has mostly defied this correlation in recent times as macroeconomic headwinds including tight FX liquidity, policy malaise, cost-push inflationary pressure and economic recession outweighed the benefit of the recovery in oil prices. That said, we think it will take a strong recovery in oil prices to drive the market in 2017. According to the International Energy Agency (IEA), global oil markets are expected to “move into deficit during the first half of 2017, with demand potentially outstripping supply by some 600,000 b/d, if OPEC and non-OPEC producers manage to stick to the historic output cut deal”. Success means the reinforcement of prices and revenue stability for oil producers after two difficult years. IEA’s projection of Brent Crude at $55/bbl by year end indicates a 23% recovery from 2016 average price.
Thus, a 70% correlation suggests that amidst much volatility, the NSE ASI may potentially deliver 9% return in 2017 to 29,293 points. We note however that the NSE ASI/Crude Oil Price correlation has been weaker in recent times. Hence, the correlation will only play out if a major rebound in oil price directly translates into a significant increase in FX liquidity and supply. This depends on a sustained improvement or recovery in oil production.
Attractive dividend yields to spur local interest in 2017 Whilst FY’16 scorecards are not expected to deliver fantastic numbers, we anticipate relatively more attractive dividend yields, particularly for Financials on the back of depressed valuations, which we expect will partly support market activity in Q1’17. Based on our expectation of FY’16 dividends, we envisage an average dividend yield of 10% for the banks in our coverage. Savvy local investors are likely to ride on this early in the year, paying particular attention to companies with strong earnings potential and consistent high dividend paying histories such as GTBank, Zenith Bank, Access Bank, Fidelity Bank, Sterling Bank, United Capital and AfriPrudential Registrars amongst others.
We therefore expect a soft rally towards the end of Q1 when companies are expected to release FY’16 scorecards. Typically, the rally will be short-lived except it is supported by monetary and fiscal stimuli measures to improve FX liquidity and transparency. If the status-quo persists, many banks will continue to face earnings erosion from rising non-performing loans even as the consumer goods sector continues to contend with depressed incomes and higher input costs. Downstream oil & gas companies will however be net beneficiaries of the recent subsidy removal; however, we see little impact on overall market sentiment given the relatively low standalone weight of the sector. The Industrial Goods sector is another bright spot given recent moves to finally tackle energy challenges (gas to coal initiatives) which account for a major portion of production costs.
Will MTN listing revive IPO market?
Nigeria’s biggest telecoms provider, MTN, has met with the Securities and Exchange Commission (SEC) to discuss a possible initial public offering (IPO) of its shares on the Nigerian Stock Exchange (NSE) and how it wants to structure the share sale. The telecom firm said it would list its local unit on the NSE after agreeing to pay a reduced fine of US$1.7 billion in a settlement with the Nigerian Communications Commission (NCC) over non-registered sim cards. As part of the settlement arrangement, MTN Nigeria is expected to list on the Nigerian Stock Exchange in 2017. We expect this listing to yield a number of positives for the Nigerian equity market and possibly spur primary market activity. Given the anticipated value of MTN Nigeria ($5 – $8 billion using EV/EBITDA multiples), we expect improved appeal for the ICT sector.
We particularly expect investors to increase their exposure to the sector which would, in turn, result in increased activity and liquidity for the market. More so, the market is currently lacking in depth as a small tick in a heavyweight stock would easily sway the NSE ASI. This is largely due to the skewness of the market capitalization of a few stocks and sectors. With the listing of MTN Nigeria, the ICT sector will be another large cap sector on the local bourse, which will in turn help improve market depth. Overall we expect the positive outcome of the MTN IPO to spur other companies to consider raising capital.
How attractive are Nigerian Valuations?
Even if our expectations for a recovery in oil prices and federal government efforts at boosting FX liquidity materialize, how attractive are Nigerian equities? On the surface the NSE ASI does not immediately appear cheap, trading at a P/E and Dividend Yield of 14.3x and 4.5% relative to the 14.8x and 3.0% for the MSCI Frontier Market Index. However, on a sector-specific basis, we see significant value in the Financial Services and Industrial Goods sectors which are trading at discounts to their peers at P/E of 4.3x and 13.2x compared to peer averages of 8.3x and 17.1x respectively.
Source: Cardinal Stone Research Team, Nigeria