Markets & economy

Valuation of Nigerian and Zimbabwean holdings in the Allan Gray Africa ex-SA Equity Fund

Nigeria

The Central Bank of Nigeria (CBN) has established a new foreign exchange (FX) platform for investors and exporters, effective 24 April 2017. The exchange rate for the new platform will be as agreed between a willing buyer and willing seller and authorised dealers (banks) will facilitate the process of trading and matching orders.

The CBN also established a new reference rate – the Nigerian Autonomous Foreign Exchange Rate (NAFEX) – to serve as a benchmark or reference rate for transactions on the new FX window. This rate will be based on a poll of authorised dealers. On 28 April 2017, the NAFEX rate closed at NGN375/US$ compared to the official exchange rate at NGN310/US$.

We have chosen to value the Allan Gray ex-SA Equity Fund’s Nigerian assets at the new NAFEX rate and our benchmark index provider has made a similar change. The price discovery process is not yet perfect but we believe that the NAFEX rate is now the best approximation for investors (versus the official interbank rate) – both to get cash into and out of Nigeria. It is possible that the new FX window will initially face liquidity challenges and may not gain credibility with investors. However, if it operates as intended, we expect that the new FX regime will attract foreign investors who have stayed away from Nigeria due to the inability to get their money out at the official exchange rate.

While many investors have avoided Nigerian equities as a result of the FX risks, we have found attractive opportunities at what we consider to be rock-bottom valuations. For example, the Fund has 20% weighting in Nigerian banks at a weighted average 4.5x price-to-earnings ratio and 0.8x price-to-book ratio. Initially, the change to using NAFEX has a negative 3.6% impact on the Fund’s price. However, the Fund is well-positioned to generate attractive returns if a functioning FX regime develops in Nigeria that helps attract foreign investors.

Zimbabwe

At the end of December 2016, the Fund started applying a 20% discount to the value of Zimbabwean listed assets. We have chosen to increase the discount from 20% to 25% which has resulted in an incremental change of -1.3% to the Fund price at the end of April 2017.

The shortage of US dollars in Zimbabwe has worsened after the introduction of a surrogate currency (“bond notes”) in November 2016. This has resulted in businesses charging higher prices when customers pay with bond notes rather than US dollars, as the businesses subsequently have to pay a higher price on the black market to source US dollars. The bond notes were intended to trade at parity (1:1) with the US dollar, but some businesses are reportedly charging 1.30 in bond notes for an equivalent 1.00 US dollar.

The Fund’s largest investments in Zimbabwe are telecommunications group Econet and brewer Delta. Earnings have slumped reflecting the challenging macro environment, but these businesses have dominant market positions and current valuations are highly discounting Zimbabwe’s well-known risks. After a recent capital raise, Econet is trading at 2x enterprise value (EV) divided by earnings before interest, taxes, depreciation and amortisation (EBITDA), while Delta is one of the cheapest brewers in sub-Saharan Africa at 7.6x EV/EBITDA.

Changes to the Fund over Q1 2017

During Q1 2017, we increased the Fund’s exposure to top tier Kenyan banks. We remain cautious about Kenya’s high fiscal deficit and currency risks, but banking sector stocks have re-rated in the midst of regulatory uncertainty. There is a reasonable probability that in due course, the new banking law, which caps interest rates, will prove untenable. In the interim, the top tier banks are extending their competitive advantage and many smaller banks may not survive this regulatory crisis. See our March 2017 commentary for further details.

Other changes in the portfolio during Q1 2017 included an increase in the Fund’s exposure to Nigerian banks and a reduction in exposure to Global Telecom Holding.

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