Corospondent - January 2017
Coronation Africa Frontiers - January 2017
Coronation Africa Frontiers aims to maximise the long-term risk-adjusted returns available from investments on the African continent, through capital growth of the underlying stocks selected. It is a flexible portfolio primarily invested in listed African equities, or stocks listed on developed and emerging market exchanges where a substantial part of earnings is derived from the African continent.
THE YEAR IN REVIEW
Currency regimes have certainly been top of mind during 2016. Having flirted with the move to a free-floating currency, Nigeria ultimately opted to continue with a managed peg despite the dire consequences it has had on the economy. Egypt, on the other hand, has fully embraced a move to a floating-rate regime. This, coupled with the removal of subsidies and the $12.4 billion loan agreement with the International Monetary Fund, saw the economy completely reset and the country well positioned to put the past five years of hardship behind it.
However, the short-term impact has been very negative for the strategy over the quarter. Egypt, which is still the strategy’s largest country exposure, was down 24.4%, despite the market increasing by 54.4% in local currency terms over the past three months. Nigeria was down 5.3% and Kenya declined by 2.5%. In contrast, there was strong demand for equities in Zimbabwe, partly due to the introduction of the new ‘bond notes’. The Zimbabwean market was up 46% during the quarter. Against this backdrop, the strategy decreased by 5.5% over the past three months, compared to its benchmark (3 Month USD Libor + 5%), which was up 1.5%, and the JSE Africa Top 30 ex SA Index, down 6.3%.
As a whole, 2016 was a very difficult year for most of the major bourses across Africa, exacerbated by the weakness of African currencies against the US dollar. For the year, Nigeria was down 40.7%, Egypt declined 25.5% and Kenya lost 13.4%. The market in Morocco performed well over the calendar year, increasing by 27.4%, while a strong performance in the most recent quarter helped the Zimbabwean market to gain 25.8% for the year. This saw the strategy end the year down 4.9%, a better showing than the JSE Africa Top 30 ex SA Index and the peer group, but shy of our absolute return benchmark.
Over the past year, the largest contributor to performance was our investment in an Egyptian gold mine, Centamin (+3.1%). Our holdings in Zimbabwean companies – Zimplats (+1.8%), Econet (+1.4%) and Delta (+1.1%) – also made a positive contribution. Due to the significant devaluation of the Egyptian pound during the year, Egyptian companies were the largest detractors from performance, specifically Egyptian International Pharmaceuticals Company (-2.9%) and Eastern Tobacco (-1.9%).
Over the last five years, Egypt has been rocked by the Arab Spring protests, a soft coup, a collapse in oil prices and tourism all but disappearing over concerns around terrorism. We believe these events have resulted in corporate earnings for Egyptian companies being well below our estimate of normal. The Middle East’s most populous nation has also suffered from a history of regimes that sought to buy political goodwill through sizeable food and fuel subsidies, putting immense pressure on government finances. The fiscal deficit has blown out to 12.3% of GDP (2016E) and gross government debt levels have risen to 94.6% of GDP. This was not sustainable.
Given the managed peg exchange rate regime, the burden on the central bank rose steadily over the course of the year as foreign currency reserves dwindled. Sourcing US dollars with which to import goods or equipment became increasingly difficult and a black market for US dollars emerged. The black market rate moved well above the official rate of 7.8 Egyptian pounds to the US dollar, eventually peaking at 18 Egyptian pounds to the US dollar in late October. The government was left with little choice but to float the currency.
Since its floating as of 3 November 2016, the Egyptian pound has lost over half its value and currently trades around 18 Egyptian pounds to the US dollar. The impact of such an extreme currency move is that inflation has increased significantly, hitting 23.3% in December. The move has also meant that many economists believe the Egyptian pound is now one of the cheapest currencies globally. The Egyptian economy has seen an almost overnight improvement in the competitiveness of its exports and affordability of its tourism industry.
While the float is certainly a step in the right direction, it was one of a number of economic reforms that have been passed as the Egyptian government looks to address the underlying problems in the economy.
These reforms include removing fuel subsidies, increasing electricity prices, expanding the Suez Canal, improving power supply, the passing of the civil service law and implementing value-added tax. These changes, which have further added to inflationary pressures in the short term, will hugely benefit the country in the longer term.
The response from international investors has been immediate. In the month following the currency devaluation, the central bank recorded an estimated $4 billion in foreign capital inflows. Central bank reserves have swelled from $15.6 billion in October to $24.3 billion in December. A further $7 billion has flowed into the banking system as individuals have deposited their savings and remittances.
As with any African economy, information is not always as accessible or transparent as one would like, but foreign equity flows into Egypt have been estimated at $500 million, with a further $1 billion in fixed income inflows over the last two months of 2016.
We believe this is but the tip of the iceberg, with many emerging market and frontier funds once again starting to look at Egypt after a number of years out of the market. This return of foreign buyers partly explains the performance of the stock market.
While 2016 has been another tough year, we are encouraged by the step change we have seen in Egypt over the past two months. We believe that after a number of years of economic mismanagement and external pressures, the country is well positioned to return to growth once again. Looking across our portfolio, we are certainly excited to see what 2017 has in store for the excellent set of companies we own and for the strategy in general.
We remain committed to finding high-quality businesses trading at attractive valuations, and then in holding them we will wait for share prices to reach our estimate of intrinsic value.
*Please note that all returns are quoted in US dollars unless otherwise stated.