Sentiment within African markets remains incredibly low. While most global markets have recovered materially from their March lows, African markets, with the exception of gold shares, remain depressed. For many equities there is a dearth of buyers and a long list of sellers, and the headline news flow is generally negative.
It is easy to come up with reasons as to why Africa is too risky a place to invest. It feels uncomfortable to be investing in Africa amidst a global pandemic, especially when governments appear to be behaving erratically in response, historical returns have been poor, and the pandemic may last for an unknown duration.
But bargains in investing seldom emerge when the mood is jubilant, and interest is high. Long-term, contrarian investors like ourselves get excited by moments like this. Look through the noise, and it is the price you pay that matters. The valuations on offer within the African universe are among the most attractive we have seen over the past decade. Many companies have excellent long-term track records, yet they now trade on less than five times historic earnings and dividend yields of over 10%.
Nigerian banking stocks are trading at a steep discount
One such example is Zenith Bank – one of the largest banks in Nigeria, with over 11 million customers and a market share of over 10% across deposits, assets and loans. Over the last decade, Zenith has grown earnings by approximately 19.4% per annum in Nigerian naira and 8.8% in US dollars. It has consistently paid out dividends throughout this period. Yet the share price has moved in the opposite direction, contracting by 6.3% per annum in US dollars over this same time. As a result, Zenith currently trades at just 2.5 times the last 12 months’ earnings and a 16.7% dividend yield. In the current climate, despite the turmoil brought on by COVID-19, an economy under pressure due to depressed oil prices, and a 28.6% higher bad debt charge, Zenith was able to grow earnings in the first half of the year. The bank’s return on equity (ROE) remains above 20%. This high profitability buffer, combined with a strong capital adequacy ratio north of 20%, provides the bank with material protection should the situation in Nigeria continue to deteriorate.
We believe the likelihood of a material currency devaluation is high, but the incredibly low valuation more than compensates for this. Were the currency to halve in value, Zenith is still incredibly cheap. We are finding similar value across the banking sector in Nigeria, including Guaranty Bank and Stanbic.
Tobacco companies grow earnings
We continue to be excited about some of our ideas in the tobacco industry. The economics of tobacco companies are generally quite compelling: Sticky customers, high barriers to entry, strong pricing power, and high free cash flow generation. These last two factors are particularly important, as they allow these companies to return a substantial portion of earnings to shareholders, while continuing to grow earnings year on year; and our investments are no different.
Eastern Tobacco has a market share in excess of 90% in Egypt. As with most companies, Eastern has not been unaffected by the challenges presented by COVID-19 and the government’s response, but it has managed the environment well. While earnings were down in the fourth quarter to June, for the full year they were marginally up and, importantly, given the cash-generative nature of the business, it has proposed a dividend 40% higher than last year. Over the last decade, Eastern has grown earnings at a compound rate of more than 16% per annum in Egyptian pounds, and dividends by more than 25% per annum, yet it currently trades on a forward dividend yield of more than 11%.
BAT Kenya is the dominant tobacco company in Kenya. Similar to Eastern, it has more than 90% market share in legal cigarettes in its domestic market. While its historic earnings growth has not been as stellar as Eastern’s, it has consistently grown earnings over time and paid out the vast majority in dividends. BAT Kenya currently trades on a dividend yield just shy of 10% and should be able to conservatively grow earnings by 5% or more per annum in real terms for many years to come.
Despite the challenges African markets currently face, we still retain conviction in the majority of our investment ideas and are excited about the opportunities that the prevailing negative sentiment has presented.