Buy into Africa by David Stevenson (Investors Chronicle (uk), Aug 15, 2008)

Naive investors would probably attribute this new-found fortune and
enthusiasm to just one spectacularly successful industry – the
resources business. And it's certainly true that SSA has more than its
fair share of oil – both Angola and Nigeria are now huge producers of
oil for western markets. Other important African export commodities
include iron ore, timber, manganese, cobalt, copper and chromium.

But the resources sector is only half the story. Successful investors such as New Star's
Jamie Allsop – a classic value investor – are scouring the continent
using old-fashioned value ideas, looking for solid trading companies
benefiting from the much bigger economic transformation under way.
Greater prosperity has created a growing middle class – the World Bank
estimates that the sub-Saharan middle class will be 43m strong by 2030,
up from 12.8m in 2000, with most in South Africa but other countries
such as Zambia, Nigeria, Kenya and Ghana featuring prominently. That
means billions will be spent on consumer goods, telecoms, and
infrastructure projects. And there are already many well run, solidly
profitable companies in all these markets – they form the core of a
vibrant and growing equity culture taking root in Africa.

Two decades ago, there were just five stock exchanges in SSA. Today,
there are 18 with 1,500 separate listings. It has been reported in
Fortune magazine that, excluding South African shares, African stocks
have climbed an annualised 43 per cent since the end of 2006. In
particular, since 2001 the Mauritian, Botswanan, South African and
Namibian stock exchanges have outperformed the Dow Jones index by 483
per cent, 375 per cent, 202 per cent and 188 per cent respectively.

London-based research and broking firm Exotix,
which specialises in frontier markets, also boasts its own large-cap
index of SSA companies – its top 30 increased their market
capitalisation by 126 per cent or $40bn in the period between 2006 and
2008, outperforming South Africa and the MSCI indexes for Eastern
Europe and the Far East. It also noted that volatility was lower.
According to New Star Fund management, "growth has outpaced the OECDs
average every year since 2000 and is forecast to reach 6.75 per cent in

The problems

Of course all this economic boosterism shouldn't blind private
investors to the very real dangers of investing in Africa. The biggest
problem for investors is accessibility – there aren't many listed
companies that can be bought via UK brokers. We've highlighted a number
of specialist fund managers and a few businesses with western listings
below, but the choice isn't huge.

The much wider problem is the more obvious one – lots of Africa is
still very poor. Take one of the brightest success stories of recent
years – Zambia. Unlike its neighbour Zimbabwe, it's not lapsed into a
corrupt one-party dictatorship. Instead, it has embraced reform,
privatised industry and invested in its infrastructure. It is also home
to a growing and affluent middle class. Yet, according to one recent
report from the FinMark Trust, which aims to develop financial markets in Africa, just one in every 1,000 Zambians has a housing loan from a bank.

Incredibly, just 16 per cent of Zambia's 11.5m people have salaried
jobs. It's little surprise, then, that western trends such as house
ownership have failed to take off – it can take six months or more to
transfer titles for purchased plots, and loans cost 40 per cent a year.
And because of the Aids epidemic, the average Zambian lives just 38
years – that means lenders demand that any mortgages are paid off by
the age of 55.

There have also been political problems, with the first generation
of post-colonial leaders helping to turn much of Africa into a disaster

Now, though, old Africa hands such as Christopher Hartland Peel –
Africa equity specialist at Exotix – are in a surprisingly chipper
mood. Even the recent 'big hiccup' in Kenya doesn't worry him terribly
– he believes that Africa has profoundly changed and that the real
motor of change doesn't lie with resources and commodities in the
ground, but with leadership.

Across Africa the number of democracies has risen from 10 in 1980 to
34 by the end of 2007. "The older leadership are retiring and the new
western-educated elite are taking control and they see the grinding
poverty and realise that something has to change," says Mr Hartland

That something increasingly means privatisation, respect for the
judicial framework, the growth of capital markets, and the removal of
price controls. He even thinks there's good news on corruption.

Looking at Nigeria, he believes the private sector is largely behaving itself and is becoming cleaner by the day.

So, how do you invest in Africa? The key is to look at Africa not as
one big market but to break it down into regions, sectors and specific
investment vehicles.

The Regions

The distinction between the Anglophone countries – principally in
Southern Africa, as well as Uganda, Tanzania, Kenya, Ghana and Nigeria
– and the rest (the Francophone countries in central and West Africa
plus the Lusaphone or Portuguese speaking nations of Angola and
Mozambique), is particularly important.

According to Mr Hartland Peel, the English-speaking countries by and
large are embracing capitalism and stock markets and have a sound legal
framework based on respect for property rights. The French-speaking
countries tend to be more dismissive of an equity culture, have greater
issues to do with governmental corruption (although the
English-speaking countries are hardly immune) and possess a very
different legal framework.

The Portuguese-speaking nations of Mozambique and Angola are,
paradoxically, seen as potentially more alluring if only because their
fall from favour was so spectacular. Angola was once seen as the
civilised bread basket of Africa before lunging into a long and brutal
civil war. The stabilisation of these countries has underlined their
huge resource potential. But Mr Hartland Peel is cautious about Angola.
"Every year it's been promising a stock market and it still doesn't
have one. There aren't a lot of real investable opportunities, and
there's no local currency available although, theoretically, the
economic potential is huge given its oil reserves," he says.



Most institutional investors in Africa have made straight for the
banking sector, with the big Nigerian banks featuring prominently in
many international portfolios. In Exotix's recent Africa study, 18 of
the top 30 companies in SSA were banks with a combined market
capitalisation of $46bn (65 per cent of the entire index). It's easy to
see why they've been tempted. Traditionally, the big Anglophone banks
in West and East Africa have been relatively well run, have great
growth prospects (in Nigeria think of all that recycled oil wealth) and
have been producing impressive returns on equity – 15 per cent is
standard, with some producing closer to 30 per cent.

However, this huge potential has resulted in some weighty valuations
– it's not unusual for leading Nigerian banks to trade on well over 30
times current and even forecast earnings. These high valuations
prompted a sell-off in the first half of the year – the AfriFinance index of Nigerian banks is down 15 per cent for the year to date.

More ominously, JPMorgan
recently initiated research on the Nigerian stock market as a whole by
noting that the banks were overvalued, with some trading at more than
57 per cent over its estimate of fair value. Oil is another worry –
researchers at investment bank Renaissance Capital
estimate that there's a 0.91 correlation between rising oil prices and
Nigerian stocks, and banks in particular. But there are still some
interesting value-based anomalies. Many analysts recommend firms such
as Equity Bank in Ghana, or the Ghana Commercial Bank, both of which are trading in the low teens in PE ratio terms. Exotix also likes Barclays Bank Kenya
– it has the highest interest margin to total assets ratio in Africa at
7.2 per cent and the lowest bad debt provisions to total loans ratio at
just 2.4 per cent.

Land and Agriculture

Agriculture is the continent's most important economic sector – it
still employs more than half the labour force yet remains one-fourth as
productive as its counterparts around the world. One recent survey of
this huge sector concluded that part of that productivity gap can be
explained by the fact that nearly two-thirds of Africa's agricultural
land has been degraded by erosion and misused pesticides. In Ethiopia,
85 per cent of the land is damaged. Correcting this damage is therefore
critically important – agriculture contributes at least 40 per cent of
exports, 30 per cent of GDP, up to 30 per cent of foreign-exchange
earnings, and 70 to 80 per cent of employment. Get it right, and the
wider economic benefits could be huge – the UK-based Overseas
Development Institute points out that of the 30 fastest growing
agricultural economies, 17 are in SSA.

Investors have started to take notice. Cru, a small specialist fund management firm, recently launched a Malawi-based fund called Africa Invest.
The retail-orientated (and capital protected) variant of the fund can
be accessed for as little as £4,000. The fund has made an initial
investment of £2m in 2,000 hectares of land that's producing paprika
for western supermarkets. With land prices starting at £800 per hectare
(compared to £10,000 in the UK) it's relatively easy to amass large
farms that can be upgraded with new technology, mechanisation and
better production methods. According to Cru, annual returns on capital
should exceed 30 to 40 per cent.

A much larger version of this scheme is being marketed by hedge fund
Emergent. It's targeting a total return of 400 per cent over the next
five years, partly off the back of rising land values, investment in
better technology to improve productivity and the introduction of a new
form of farming called no till agriculture.

To demonstrate the potential, it's been running a trial 7,200 acre
project over the last three years that's showed an average 33 per cent
annual gain in output from soft agricultural products and a total
return of 120 per cent. Emergent points out that the return was based
on much lower historic soft commodities prices, which have nearly
doubled in recent years. This new fund believes that returns on equity
for maize should be 35 per cent a year, and 25 per cent for soybeans.

Emergent isn't the only player in the agricultural space – palm oil
companies are very active in West Africa and Lonhro has also spotted
the potential to provide capital, technology and know-how to Africa's
farming sector.


Africa's infrastructure sector faces enormous challenges. In a surprisingly candid presentation to the World Water Forum
in Mexico in March, African ministers put the total annual investment
required in their water sector alone at $20bn. Separate research from
the World Health Organisation research
indicates that $23.5bn a year would be saved by providing basic access
in SSA – 5 per cent of the region's gross domestic product.

Water is a must have, whereas electricity is often regarded as
something of a luxury. Average electricity access in SSA stands at
about 25 per cent, and the World Bank
expects 60 per cent of sub-Saharan Africans to still lack electricity
by 2020. A report by Tanzania's Economic and Social Research Foundation
calls for a doubling of generating capacity over the next 10 years,
while Nigeria, which has only a tenth of South Africa's power output
for three times the population, plans to more than double its capacity
by the end of next year.

It's not all bad news, of course – mobile phone penetration in
countries like Nigeria is already very high and growing incredibly
fast. However, it does underline the huge potential for companies and
countries that can supply this new infrastructure.

The Chinese, for example, are building a huge four-lane highway
through the Katanga province of the Democratic Republic of Congo to
reach the more developed resource infrastructure present in Zambia.
Huge new oil ports are being built around the Gulf of Guinea – Lonrho
is behind one big project in the oil-rich minnow state of Equatorial
Guinea – and opportunities in the power sector in the Republic of South
Africa are huge.

Perhaps one of the most interesting ways of playing this story is
via building materials. New roads, oil terminals and ports need an
awful lot of cement. Exotix has created an African Cement index (a
tracker fund is soon to follow) with 10 companies. One of their
favourite plays in this index is Kenya-based Bamburi Cement, which trades at 18 times earnings, has a return on equity of 25 per cent and no debt.


Guinness and SAB Miller
have been making huge profits from various parts of Africa for decades
now. For Mr Hartland Peel at Exotix, it's the great long-term value
play. "Look at where the greatest growth in consumer disposable
spending is going to go on – beer. Most companies face only one or two
competitors – that means they have a great competitive moat – and they
produce very decent cash flow," he says. Many of the leading players
have listed their shares on local exchanges, although the big western
holding company still owns a majority stake. Examples of good-quality
plays include Guinness Nigeria, which has a return on equity of 34 per
cent, an operating margin of 27 per cent and a PE ratio of 17, and
Kenya-based East African Breweries, which also trades at 17 times earnings and pays a dividend yield of 5.4 per cent.


Mobile phones are big business in Africa. Vodafone,
for example, is trying to beef up its African portfolio with a bitterly
contested takeover of a Ghanaian operation. The International
Telecommunications Union recently noted that: "Growth in Africa's
mobile sector has defied all predictions. Africa remains the region
with the highest annual growth rate in mobile subscribers." The UN
agency adds that no less than 65m new subscribers signed up in 2007.
"By the beginning of 2008, there were over a quarter of a billion
mobile subscribers in Africa and mobile penetration had risen from just
one in 50 people in 2000 to almost one-third of the population today."

World Bank officials now estimate that an astonishing $14bn has gone
into telecommunications in Africa in the past five years, with the
number of mobile telephone lines rising to 135m last year from 15.6m in
2000 – a compound annual growth rate of almost 54 per cent, compared
with 24 per cent globally. Yet this growth has only scratched the
surface – mobile penetration across the continent is still only 15 per
cent. Morgan Stanley estimates that mobile-phone penetration in SSA will rise to 42 per cent by 2012.

The latest poster boy of this sector is Kenyan firm Safaricom,
which recently floated on the local market. It boasts 10m subscribers
and in its IPO in April the government cut its stake from 60 per cent
to 35 per cent. The growing number of firms listing on local – and
international – markets has also sparked outside, particularly western,
interest as liquidity improves. Investors operating in this space think
that the next targets are likely to be Sonitel (listed in the Ivory
Coast but active throughout West Africa), Burkina Faso's Onatel (still a subsidiary of Maroc Telecom) and Mauritius Telecom.

Many western investors are also excited by Zambian operator Celtel –
big investors include Jamie Allsopp's New Star fund. It was recently
rated 'overweight' by US investment bank Morgan Stanley. According to
analyst Sean Gardiner: "Celtel Zambia is attractively valued with a
dominant 84 per cent market share" in the country. For a really
long-term bet, investors might also want to keep an eye on small
Zimbabwean operator Econet.

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