Safety margin required for Nigerian holdings, says Tundra

The latest “Nigeria Travel Journal” published by frontier markets investor Tundra Fonder has suggested that while longer term opportunities abound in Nigeria, the near term investment environment requires a considerable margin of safety before committing to local equities.

Mattias Martinsson, chief investment officer at Tundra visited the country earlier this year at at time when the local stock market had halved since the summer of 2014 in dollar terms.

One of the first meetings Martinsson and his team had was with Flour Mills, one of Nigeria’s biggest food producers. However, the impact of sharply rising import costs of ingredients such as wheat – which cannot be grown economically in the local climate – meant that the near term outlook was not good from an investor point of view, despite a share price fall of some 80% already experienced from a peak in 2013.

Clear also from the meetings with energy companies and local banks is that there is execution risk and other types of risk inherrent in the response to sharply lower energy prices being formulated by the country’s oil and gas sector constituents. Energy policy is an area in which there is uncertainty over policy measures, which raises risks for international investors, Tundra suggests.

More interesting in terms of sustainable margins, are services in areas such as wealth management, which Tundra found to be a growing market. Local banks have seen their shares hit hard by the downturn in local stock market valuations but as Martinsson said of United Bank of Africa: “the valuation of just above a P/E of 2 discounts for possibly overestimated profits for years to come. It is required however also that such a bottom is reached without a subsequent recovery in the years that follow thereafter. We believe there is value to be attained in the shares.”

“There are several conclusions to be drawn from the journey,” he concluded.

“We do not believe in a sudden collapse of the Nigerian economy. The banks appear to be well-prepared, most likely  due to the fact that the crisis of 2008-09 and 2011 is so close in time. If oil prices remain below $50/barrel for several years, the country will be facing a major restructuring that even with the strongest political commitment will take time to implement. From an investment perspective, we see that the banking sector tends to be early to discount new conditions. Prices have been pushed to what are likely to be excessively low levels on risks we believe are relatively obvious. Current levels offer strong future returns which can not be completely ignored even though the through in prices will be hard to call.”

We are much more cautious towards the consumer sector. Here too prices have fallen sharply, but valuations are still high in the wake of international investors’ sometimes overly naive search of “safe and structural growth” in recent years. Too much has been paid for too little growth historically. The correction has thus been initiated from already inflated levels. There is likely more downside ahead. Most of the companies in the consumer sector import a large part of the goods used in the manufacturing process because of lack of local options.”

“Most likely, we will see a further significant weakening of the Naira which increases production costs for those manufacturers. Given weaker domestic demand, such costs will be difficult to pass on to the final consumer, which could squeeze margins. After the presidential shift and with the new government in place we expect a harder (necessary we think) attitude regarding tax collection. The clearest example is the requirement of Africa’s biggest mobile operator MTN to pay a specified tax liability of above $3bn, taxes that were allegedly hidden from the tax authorities of Nigeria. In the absence of oil  money, the new regime will need more alternative incomes.”

“One of the world’s lowest alcohol taxes (6% of the factory price) with a newly appointed Muslim president is a specific risk to the largest Nigerian company, Nigerian Breweries (we don’t own the shares).”

While not wanting to come across as too pessimistic, Martinsson concludes that:”To invest in Nigeria at this point of time requires a signficant safety margins in valuations.”

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