African Dawn: Why African markets will rally in 2018

Imagine a continent which leads the world in mobile telephony banking and in fourth generation (satellite) internet access. This is a continent which has achieved remarkable advances in health outcomes as evidenced by levels of infant mortality and life expectancy, and in education over the last two decades. And which is now enjoying supercharged growth.

This continent has been attracting direct investment on a massive scale from both the West and from the new superpower, China, whose construction companies are ubiquitous there. Its natural resources are abundant. Its agriculture has massive potential (which is why the Chinese and others are buying farms there). Its infrastructure is gradually improving by leaps and bounds.

I’m talking about Africa. What a pity, then, that so often when the word Africa is uttered, many people think of famine, pestilence, poverty and war. It is true that a few African countries are still benighted – mostly due to civil war, corruption and poor governance. But it’s time to shed our prejudices and to acquaint ourselves with a continent of opportunity. 

Last year the leading African stock markets surged ahead. I predict that this year momentum is likely to be sustained for reasons that I shall explain. Last month I foresaw that the outlook for the US and UK markets was bright. This month I foresee that returns in selected African markets could be stellar this year for investors with knowledge and courage.

The lords of misrule are (slowly) dying…

I am not going to pretend that Africa has not had more than its fair share of nightmares, often caused (or at least exacerbated) by poor governance as much by natural disasters such as periodic drought. Under the heinous kakistocracy of Robert Mugabe, the beautiful nation of Zimbabwe was demoted from one of the wealthiest countries on the continent to one of the poorest, with a GDP per capita of just over $1,000 in 2015. With the displacement of Mugabe by Emmerson Mnangagwa in November last year, there is light at the end of the tunnel for Zimbabwe – but investing there is still only for the very brave…

South Sudan, since gaining official independence, has proved unable to establish political stability in what was always an extremely arid and poor region of the continent (so different from neighbouring Kenya, large swathes of which are lush and fertile). Somalia remains a desperately troubled country – a failed state in fact – where private armies, terrorists and pirates strangle all hope of progress. The Democratic Republic of Congo (DRC) also is controlled largely by local militias. Corruption is still endemic in Africa. For these reasons, sadly, the poorest people on the planet are Africans. But that is not the whole story…


The lords of misrule who validated their grip by owning the history of “colonial liberation” are being replaced by a technocratic class of pragmatists – many educated at British and American universities. (Their predecessors were often educated in Moscow.) President Zuma of South Africa is another old school ideologue who is on his way out. Canny investors should look beyond the horror stories. And the story that emerges for much of Africa is one of steady progress and rising living standards, as well as of new investment opportunities.

Why am I so optimistic about investment prospects in Africa? Basically, I note four key long-term trends in play.

Four long-term trends which ensure Africa’s centrality to the world economy

The first factor is economic growth. In the first phase of the post-colonial period, economic growth in Africa was sluggish, and often negative. That has now changed. In 2017 the fastest-growing economy in the world was Ethiopia (at 8.3 percent as against 2.7 percent for overall global economic growth)[i]. Tanzania was sixth at 7.2 percent growth and Djibouti seventh at 7.0 percent.

The second factor, closely related to the first, is the recovery in commodity prices. In a world of seven-and-a-half billion people, all commodities – energy and agricultural – are in huge demand.

Africa produces more than 60 of the most precious strategic metals and minerals required by modern industry. These include gold, platinum group metals such as palladium, diamonds, uranium, manganese, chromium, nickel, bauxite and cobalt. It is reckoned that about 30 percent of our planet’s mineral reserves reside in Africa, including 40 percent of the world’s gold, 60 percent of the world’s cobalt – demand for which will increase with the rise of electric cars, though much of that cobalt resides beneath the surface of the DRC. An estimated 90 percent of the world’s platinum group metal reserves are to be found in Africa.

It’s time to shed our prejudices and to acquaint ourselves with a continent of opportunity.

Moreover, geologists regard the continent as relatively unexplored. New discoveries of mineral reserves are relatively common in Africa. Mozambique, Nigeria and Madagascar are just three countries where intensive mineral exploration is proceeding at a brisk pace. Major new discoveries in recent years include diamond beds in Mauritania and potential marine diamond deposits off the coast of southern Namibia.

South Africa, Ghana, Zimbabwe, Tanzania, Zambia and the DRC dominate the African mining industry, whilst countries such as Angola, Sierra Leone, Namibia, Zambia and Botswana rely heavily on mining as a major source of foreign currency. True, several of the continent’s pernicious civil wars have been funded by these commodities, in particular diamonds, for example in the cases of Liberia and the DRC.

Major new mines opening in Africa or under development are distributed between South Africa, Namibia, Botswana, Tanzania, and Gabon. These will produce gold, diamonds, niobium (used mostly in steel alloys), platinum group metals and chrome; plus base metals (iron, nickel, lead, zinc and copper).

All of the big international mining firms are active in Africa. Rio Tinto (LON:RIO) mines lead and zinc in South Africa. Norilsk Nickel (VIE:MNOD) mines nickel in Botswana. BHP Billiton (LON:BLT & ASX:BHP) mines titanium in South Africa and Mozambique.  Generally speaking, these multinationals have maintained cordial relations with host governments. Interestingly however, the conduct of the four Chinese-owned copper miners in Zambia (all subsidiaries of China Non-Ferrous Metals Mining Corporation – a state-owned entity) has attracted negative publicity in Zambia, and was a major issue in the 2011 presidential election there.

Africa is also a major oil producer, though the petroleum industry is concentrated in just four countries – Nigeria, Angola, Libya and Algeria. (Equatorial Guinea and Gabon are minnows, but rank high in GDP per capita terms given their tiny populations.) Nigerian National Petroleum Corporation (state-owned) is ranked in the top ten in the world in terms of proven reserves. Nigeria was the 13th largest oil producer in the world in 2016. Libya also has massive oil reserves, though currently production is hampered by the country’s extreme political fragility.

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The third factor is that Africa has transformed itself from a continent riven with hunger into a major net exporter of food. African agriculture is flourishing. The area under cultivation is rising rapidly and, at the same time, an increase in agricultural productivity has facilitated a reduction in staple food prices.

According to a study by the International Food Policy Research Institute (IFRPI), for many years agricultural production in Africa failed to keep pace with population growth. That has now been reversed. One shining example of success is Kenya where horticultural exports have increased five-fold since 1975. Horticultural exports include both food and fresh flowers. If you buy roses in the British winter the chances are that they were grown in one of the huge hot houses that surround Lake Naivasha.

The growth of Kenya’s horticultural exports, like South Africa’s fruit exports, has been supported by the growth of cheap and frequent air freight cargo to Europe and beyond – the same flights that ferry tourists back and forth – another major source of foreign currency income.

These successes have been largely driven by the systematic application of modern farming techniques. Soil and water conservation initiatives in many countries have mitigated declining fertilizer subsidies. Effective pest control and animal vaccination have also boosted yields. And, yes, African farmers have also been much less timid about using genetically modified organisms (GMOs) than their European counterparts.

The IFRPI reckons that Cassava yields have increased by over 40 percent since the late 1970s. The cultivation of hybrid maize has also yielded dramatic improvements, especially in Zimbabwe and Kenya. And West Africa’s share of global cotton exports has grown from zero in the 1960s to around 15 percent today, making the region the third largest supplier of cotton after the USA and the former Soviet Union.


The fourth factor is that, despite many political setbacks, Africa is more peaceful today than at any time since the post-colonial period began. The bloody civil war in the DRC is now over. Sudan too is now at peace after the resolution of the bitter Darfur conflict, though, admittedly the new state of South Sudan is wretchedly poor. Ethiopia has advanced rapidly since the secession of Eritrea was resolved. And West Africa looks more stable than ever, with Ghana considered a model of African enterprise and democracy.

The Arab Spring of 2011 of course toppled regimes across the Maghreb. The political landscape is still tense there though it does seem that Egypt and Tunisia have stabilised. Libya, without a strong central government and beset by competing factions, is now vying with Somalia for the status of failed state.

The presidential elections in Nigeria in 2011 were considered to have been fairly conducted, according to international observers, although tensions between the Christian and Muslim communities in the country are still a major cause for concern. Similarly, the first presidential election in Kenya of 2017 led to ugly tribal clashes; yet the second presidential election (with one candidate – Mr Kenyatta!) was largely peaceful and the country has now stabilised.

Post-apartheid South Africa has been stable, broadly democratic and economically successful. South Africa has been a role-model for other African states. But under President Jacob Zuma, with corruption rampant, the country has lost some of its moral authority across the continent and in the world at large. There are high hopes for the succession of Cyril Ramaphosa who – all things being well – will take over the South African presidency in the autumn of this year.

Africa matters

From a strategic perspective, Africa is the world’s second largest and second most populous continent after Asia. With a land area of 30 million square kilometres, it covers 20 percent of the Earth’s total land mass. Africa had an estimated population in 2016 of 1.2 billion people representing about 16 percent of humanity living in 54 different countries. No African nation has yet joined the ranks of the developed nations (as evidenced by membership of the OECD) but South Africa is now ranked alongside the BRIC countries and attends their inter-governmental conferences.

Despite many political setbacks, Africa is more peaceful today than at any time since the post-colonial period began.

The temperate northern and southern tips of the continent are wealthier than tropical sub-Saharan Africa. Within the tropics, East Africa (except Somalia), with its long pre-colonial history of trade with the Arab world, has tended to be wealthier and more stable than elsewhere. Ethiopia is an ancient Christian country with a rich culture, as are the Maghreb Arab Muslim countries of North Africa. Egypt is the most populous Arab nation and is the most cosmopolitan. Egypt, like Kenya, also has worldwide tourist appeal, though political instability since the Arab spring has hugely reduced tourist numbers.

The three largest economies in Africa are Nigeria (about 19 percent of the continent’s nominal GDP), Egypt (15.5 percent) and South Africa (13.75 percent). Nigeria is also the most populous nation in Africa with 190 million people (the seventh most populous nation on Earth) – and growing fast. The United Nations has estimated that Nigeria’s population, on current trends, will overtake that of the United States by mid-century.

African stock market performance in 2017

There is a compelling story to be told about Africa, but how can investors get exposure to this extraordinary continent? Apart from Johannesburg, all of the major bourses (Cairo, Nairobi, Abidjan and Lagos) are small by Western standards with a matter of some 50-100 corporations listed on each. They can be illiquid.

The BRVM (Bourse Régionale des Valeurs Mobilières SA) is the unique stock exchange for eight Francophone West African countries: Benin, Burkina Faso, Côte d’Ivoire, Guinea Bissau, Mali, Niger, Senegal and Togo. The BRVM, located in Abidjan, Côte d’Ivoire started operations on 16 September 1998. The BRVM was one of the laggards amongst African markets during 2017.

Table 1: African stock market performance in 2017

_{Source: African Markets[ii]}

2017 was a year of revival on African stock markets in the wake of good economic data across the continent. Inflation, current account, demand and other economic metrics showed positive trends in all the leading countries. This translated into excellent gains for the major stock markets (see Table 1).

Malawi, Ghana, Nigeria, Uganda and Kenya’s stock exchanges were the top five performers in 2017, excluding the exceptional and counter-intuitive performance of Zimbabwe. (This was probably the triumph of hope over experience; but, just conceivably, an intimation of things to come.) The Malawi MSE gained 62.1 percent. This benchmark benefited from positive sentiment following improved agricultural production as weather conditions improved, the inflation rate subsided precipitously and judicious fiscal reforms were enacted. African Markets expects that MSE’s performance will be mixed in 2018 as the 2019 presidential elections start to loom and fiscal pressures could reduce government spending.

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2016’s worst performers – Ghana and Nigeria – outperformed strongly in 2017 gaining 52.7 percent and 42.3 percent respectively. Ghana’s GDP growth rate rebounded to 9.3 percent in Q3 2017 from 3.5 percent in Q3 2016 driven by fiscal and monetary reforms put in place by President Nano Akufo-Addo, who took office in January 2017. Nigeria has seen its performance accelerate following the floatation of its currency for foreign investors, which has precipitated cash inflows in the country. Uganda’s index gained 32.8 percent as the country saw a strong economic performance.

The Nairobi (Kenya) exchange gained 28.39 percent. GDP growth slowed in 2017 following drought, political tension around the two presidential elections and caps on commercial banks’ lending rates which affected private sector investment sentiment.

One key event in 2017 was the well anticipated downgrade of South Africa’s long-term local and foreign currency credit ratings. And yet the Johannesburg index still added 17.4 percent.

Two British companies which are old Africa hands

DekelOil Public Ltd. (LON:DKL) is one of the leading commodity groups trading in palm oil. Britain’s involvement in African palm oil goes back to 1907 when one William Lever from Bolton was one of the first to import palm oil to make soap at his Lancashire plant. He then set off for the Congo with his brother James and established Lever Brothers. Lever Brothers merged with the Dutch company Margarine Unie in 1931 to form Unilever (LON:ULVR). Palm oil can now be found in half of all consumer goods in Western grocery stores from chocolate, ice cream, baked goods, soaps, lotions, and detergents. DekelOil has come a long way since its IPO in 2013. It runs a profitable seed to palm oil operation in the Ivory Coast which produced 39,000 tonnes last year. Its shares climbed steadily in January after it posted record production levels for Q4 2017 and was rewarded with a BUY recommendation by brokers Cantor Fitzgerald. Be aware that in mid-2017 the company’s shares fell from 14 pence to 9 pence after it revealed mechanical problems at its mill. 70 percent of production takes place between January and June and the outlook for 2018 is promising. DekelOil has palm supply agreements with many local farmers and does not operate company-owned estates as other commodity producers do. In 2015 London-listed New Britain Palm Oil was acquired by Malaysian palm oil giant Sime Darby (KLSE:SIME). Could DelekOil be another acquisition target?


The South African platinum miner Lonmin PLC (LON:LMI) came under the control of rival Sibanye Gold Ltd. (JSE:SGL) in December after a protracted period of low platinum prices. The company has been plagued by poor labour relations – you may recall a notorious incident in 2012 when 34 striking miners were shot dead by police. Lonmin was founded in 1909 and became one of the most famous conglomerates under the buccaneering leadership of Roland (“Tiny”) Rowland who used it as an acquisition vehicle in the asset-stripping eighties.

Outlook

If we take the South African stock market as a proxy for the continent as a whole, 2018 has started well for African markets. The MSCI South Africa Index was up by roughly ten percent in January alone. But then Emerging Market (EM) equities were up overall by 8.7 percent in the first month of this year in US dollar terms. EM bonds, the yields of which are up on average by 4.4 percent, are also outpacing European and US bills and bonds[iii].

Political risk in Africa remains high. In the Maghreb the dust has still not settled from the Arab Spring. Somalia is still a failed state. But for the first time in many years there are no major civil wars on-going.

South Africa and, to a lesser extent, Zambia could surprise on the upside. Three things need to happen to improve the outlook for South Africa. Firstly, fiscal reforms are required to stimulate tax revenues; structural economic reforms are much needed; and thirdly, state-owned companies need to be better managed. Zambia’s fundamentals could see improvement driven by increased demand for copper, energy reforms and fiscal discipline.

The African Development Bank expects African GDP to grow at 4.1 percent in 2018, up from 3.6 percent in 2017.

The African Development Bank expects African GDP to grow at 4.1 percent in 2018, up from 3.6 percent in 2017. Be aware that not all African countries will benefit equally from the improving fundamentals.

Many siren voices are warning that developed markets are looking overpriced – not least the USA. Bank of America Merrill Lynch warned in late January that many companies were trading at 3.5 times book value. In comparison stocks on the MI EM Index are trading at about 1.95 times book value.

Africa has long been the Cinderella of the so-called Emerging Markets. But there are now three short-term trends in play across the EM universe which will redound to the benefit of the leading African markets in 2018.

Short-term Trend One: African nations – together with other EMs – are benefiting from the Synchronised Global Recovery

The World Bank report on the state of the world economy issued on the eve of the annual gathering of plutocrats in Davos could not have been more bullish. Global growth is predicted to rise this year by 2.7 percent on the back of a recovery in manufacturing and trade, improved market confidence and resurgence in commodity prices. Trade increased by around four percent in 2017, up from a post-crisis low of 2.4 percent in 2016, although it is still growing at below pre-financial crisis levels.

Table 2: GDP, Population and Credit Ratings of leading African Countries

Short-term Trend Two: Commodity prices are trending upwards as the dollar falls

On 25 January the Bloomberg Commodity Index edged up to a two-year high. It was up by ten percent since mid-December 2017. What is driving this is a weaker dollar which makes commodities cheaper in US dollar terms, combined with expansionary global economic conditions. Oil prices are also on the up. In late January Brent crude hit $71 a barrel for the first time since 2014. This represents a jump of nearly 50 percent since mid-2017.

Admittedly, there are exceptions in the commodity universe. The palm oil price was down by about 20 percent in 2017 mainly on account of the huge expansion in global capacity – from one million hectares under cultivation in 1990, by 2015 there were 22 million hectares in production. Agricultural commodities overall, however, are on the rise.

Short-term Trend Three: Default rates on Emerging Market debt are down to record lows – and African borrowers are sound

Last November Venezuela defaulted on two dollar-denominated bond issues by failing to pay interest. That was unusual: the number of governments in default to private creditors fell to the lowest level since 1977. Of the 131 sovereign debtors tracked by S&P Global, Mozambique is the only other country currently in default, having failed to make interest payments on its Eurobond and having failed to honour guarantees on loans to two state-owned enterprises.

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There is a school of thought that some sovereign defaults may in fact be hidden – by China. China is said to have rescheduled numerous sizeable bilateral loans to African countries without declaring so. But the real reason why the sovereign default rate has fallen is that emerging economies increasingly borrow in their own currencies. This is in line with the overall EM trend that there are fewer vulnerable countries and currencies in the EM universe than before. Even the Fragile Five (India, South Africa, Turkey, Brazil and Indonesia) have reduced their dependence on external financing by bearing down upon their current account deficits.

Fewer emerging market economies are pegged to the US dollar these days (though Zimbabwe is still using the dollar as a surrogate currency). Of 54 economies followed by the consultancy Oxford Economics, only 11 have foreign currency bonds outstanding amounting to more than 20 percent of their GDP – and none of them are African[iv]. Economists normally assert that countries never default on local currency debt because they can always print more of it. This obviously does not apply to eurozone members; moreover, Russia defaulted on its Rouble obligations in 1998. In some cases, sovereign default on domestic debt may be less catastrophic than a currency collapse.

Kenyan government bonds

For (mostly institutional) specialist investors who follow domestic government bond markets in Africa, there are real opportunities. Two-year Kenyan government papers are yielding 13-14 percent at present. Of course, the exchange risk for foreign investors is considerable but it is of note that the US dollar to Kenyan shilling exchange rate as I write (at KES102 = US$1) is roughly the same as it was exactly two years ago. You will need nerves of steel but the yield differentials between European and African government papers invite speculation.

Four African markets that have got my attention

Regular readers of the MI website will know that I am very keen on Kenya, which is not only a beautiful country with a vibrant extant tourist industry but one with massive potential in agriculture, manufacturing and services. I predict that it will become a very favoured partner of the UK post-Brexit – especially for agricultural products. Most of the French beans that you buy in the supermarket come not from France but from Kenya. Similarly, Kenya is one of the largest exporters of pineapples. The American food giant, Del Monte Foods (a subsidiary of the Singapore-listed holding company Del Monte Pacific Ltd (SGX:D03)) sources most of its pineapple from Kenya.

The Kenya stock market, the Nairobi Securities Exchange, has about 69 listed entities of which Air Kenya (NSE:KQ), Standard Chartered Bank Kenya (NSE:SCBK) and Safaricom (NSE:SCOM) will probably be most familiar to Western investors. The Nairobi Securities Exchange (NSE) is developing rapidly. On 18 January Treasury Secretary Henry Rotich announced that Kenyan investors will be able to lend and borrow shares from each other from November this year, with the NSE set to roll out a system upgrade within the next five months. The regulations will allow investors to short-sell listed entities[v]. Clearly, the hedgies are welcome in Kenya – and they shall enjoy the six-star hospitality in Nairobi and other centres.


I am also bullish on Ghana. The country should perform strongly on the back of continued reforms, less dependence on the oil sector, lower inflation and fiscal discipline. Nigeria also should enjoy positive sentiment following higher oil prices, higher agriculture production and higher foreign currency liquidity thanks to recent measures taken by the central bank.

I am also enthusiastic about South Africa this year. To explain fully why will require a separate article but, suffice to say that South Africa has far and away the most sophisticated financial system in Africa and, come a change of government, and a much-needed burst of optimism, I am predicting excellent gains on the Johannesburg markets this year.

If I have favoured four Anglophone African countries that is not entirely a coincidence. You may have observed that the BRVA Index, which is a platform shared by eight Francophone West African nations, performed very poorly in 2018. This is at least partly because those nations, under French influence, are trying to shadow the euro (just as they previously shadowed the French Franc). This is much to their disadvantage for reasons that I shall explain soon in an upcoming article.

Action

For investors who want to get some African action there are a number of well-managed and diversified investment funds allocating across the continent. One such is the Africa Opportunity Fund (LON:AOF), a closed-end investment fund which is managed by Francis Daniels (based in Johannesburg) and Robert Knapp (based in Boston) and trades on the AIM in London. Both Daniels and Knapp are experienced Africa hands.

AOF’s strategy is to focus on investing at historically low valuations in companies with minimal debt that sell goods and services in short supply in Africa. It also invests in commodity-related companies, selectively, if it can purchase the underlying resources at a material discount to spot market values. The fund was launched in July 2007.

Possibly the easiest way to invest in Africa is via exchange-traded funds (ETFs). They are inherently diversified and cost less than building a portfolio with ADRs. Some of the most popular ETFs which provide exposure to Africa include:

• Market Vectors Africa Index ETF (NYSE:AFK)
• SPDR S&P Middle East & Africa ETF (NYSE:GAF)
• MENA Frontier Countries Portfolio (NYSE:PMNA)
• Middle East Dividend ETF (NYSE:GULF)
• Frontier Markets ETF (NYSE:FRN)

The mst popular South African ETF is the MSCI South Africa Index Fund (NYSE: EZA), which represents the only pure play to invest in the country. The SPDR S&P Middle East & Africa ETF (NYSE: GAF) also has more than 80 percent exposure to South Africa, which makes it a diversified play on the country and region.

There are alternative routes. Trine permits private investors to invest in renewable energy projects in Africa. A private equity fund which specialises in Africa is Helios Investment Partners. Founded in 2004, Helios is one of the largest Africa-focused private investment firms, managing funds totalling around $3 billion. Helios offers both private equity and direct lending opportunities in Africa.

Africa has always been a continent where white men should tread carefully, and that is still the case. For the first time in the post-colonial era, however, hope is out-pacing fear – and a refreshing post-colonial mentality is emerging. Europeans used to call Africa the Dark Continent – not because its inhabitants had dark skins but because much of the continent remained unmapped until the early 20^th century and large parts of it were impenetrable.

Maybe we should now call Africa the Bright Continent – for that would better describe its future.

[i] See: https://www.weforum.org/agenda/2017/06/these-are-the-world-s-fastest-growing-economies-in-2017-2/

[ii] Available at: https://www.african-markets.com/en/stock-markets/commentary/2017-a-revival-year-for-african-markets?utm_source=sendinblue&utm_campaign=2017_A_revival_year_for_African_markets&utm_medium=email

[iii] See: https://www.ft.com/content/cac11928-011f-11e8-9650-9c0ad2d7c5b5

[iv] See The Economist, 23 December 2017, The rarity of busts, page 93.

[v] See: https://www.african-markets.com/en/stock-markets/nse/nairobi-securities-exchange-upgrade-to-enable-kenyans-borrow-and-lend-each-other-shares