Sustained oil price weakness combines with policy opacity to stoke market downturn

Proshare

Tuesday, February 02, 2016 12:27 PM / ARM Research

Today, we dimension drivers of equity market performance in 2015 and outline our views on NSEASI trajectory over H1 2016.

 

Nigerian equities resumed the bearish run briefly punctuated by euphoria over peaceful conclusion of the 2015 general elections in Q2 15, by posting two quarters of losses in H2 15. This resulted in  the NSEASI posting its worst performance in six years (YTD: -17.4%). Renewed market weakness over the period matches our call in our H2 15 NSR for a set of factors: further down-leg in oil prices, sustained FPI aversion to Nigerian equities in a fluid global financial market place and policy uncertainty (following the electoral victory of the opposition party at the March 2015 polls), to weigh heavily on investors’ psyche in inducing market sell-offs.  Consequently, after switching to net long positions on Nigerian equities in June, FPI have stayed net short to the NSEASI over H2 15 to the tune of N39 billion, while domestic transactions declined 53% YoY to N241 billion.

 

In terms of negative fundamental developments, evidence of deteriorating macroeconomic environment was visible in the two sets of results (Q2 and Q3 15) released over the period.  Starting with cement where slowdown in construction GDP could be seen in tame volumes reported by sector heavyweights as weak construction activity at Federal and State levels melded into cutback in capital expenditure. Similar to the cement stocks, FMCG companies also felt impact of the difficult operating environment as weak consumer purchasing power and factory downtime following bouts of power shortages in July hurt top-line.

 

Elsewhere, banking stocks grappled with deteriorating asset quality in Q2 15, with our coverage universe reporting on average 80bps YoY uptick in cost of risk with impairments, on average, more-than-doubling from 9M 2014 levels.

 

Going forward, the confluence of US rate normalization, global monetary policy divergence and depressed oil prices speaks to tamer FPI activity in the domestic markets. The foregoing shifts investor focus to developments on the home front where the emerging theme from the fiscal side is an attempt to reignite aggregate demand via Keynesian-style stimulus measure. Tying the expansionist fiscal posture with dovish monetary policy stance we see positive vibes for non-financials whilst we expect declining asset yields from downward loan pricing and depressed rates on government securities and asset quality concerns to weigh on banks over 2016.

 

Prologue


Nigerian equities resumed the bearish run briefly punctuated by euphoria over peaceful conclusion of the 2015 general elections in Q2 15, by posting two quarters of losses in H2 15. This resulted in the NSEASI posting its worst performance in six years (YTD: 17.4%). Renewed market weakness over the period matches our call in our H2 15 NSR for a set of factors: further down-leg in oil prices, sustained FPI aversion to Nigerian equities in a fluid global financial market place and policy uncertainty (following the electoral victory of the opposition party at the March 2015 polls), to weigh heavily on investor psyche in inducing market sell-offs.

 

Recasting performance on a monthly basis illustrates the impact of these drivers more clearly, starting in July when turmoil across global markets over possibility of Grexit combined with the biggest MoM drop in crude oil prices (-18%) since December 2014 in triggering fresh FPI investor anxiety. This resulted in N58 billion outflows over the month and a 9.8% MoM contraction in NSEASI.

 

While crude prices pared back declines with a 3.7% MoM gain in August, domestic equity markets closed lower as investors waited for clarity from Nigeria’s economic managers in response to the scrawny fiscal revenue profile following the collapse in oil prices. Progress on the policy direction front in September, with the submission of ministerial nominees for legislative screening, helped markets reverse the negative tide in September (+5.2% MoM) despite an abundance of negative sentiment triggers with Brent Crude posting another negative MoM performance (11%) and JP Morgan excluding Nigeria from its widely followed EM government bond indices. Nonetheless, the eventual unveiling of the cabinet nominees did not prove to be inspiring for markets as despite Brent’s 3% MoM rise in October, the NSEASI shed 6.5% over the month. Market performance resumed its lockstep dance with oil prices in November sliding 6% as Brent slid 10% over the month, a trend which has since continued in December. In sum, a rich sprinkling of negative fundamental developments and scant clarity over economic outlook amid a souring global investor sentiment to EM/Frontier market assets underpinned negative NSEASI performance over H2 2015. 

 

Figure 1: NSEASI half-yearly returns


 

Weaker earnings trajectory underpins bearish sectoral performance across NSEASI

 

In terms of negative fundamental developments, perhaps the more glaring came with the release of Q2 and Q3 15 results respectively in July and October. Across the two sets of results, evidence of deteriorating macroeconomic environment was visible starting with cement where slowdown in construction GDP (Q2 15: 6.4% YoY, Q3 15: -0.11% YoY) could be seen in tame volumes reported by sector heavyweights DANGCEM (Q2 15: +1% YoY, Q3 15: -4% YoY) and LAFARGE (Q2 15: +3% YoY, Q3 15: -9% YoY). The slower revenue growth reflects weak construction activity as Federal and State governments grapple with tame crude oil receipts which melded into cutback in capital expenditure. In response to sliding volume growth, cement producers slashed prices in Q3 15 which exacerbated adverse investor sentiment with the cumulative impact of slowing volumes and weaker pricing driving 15.5% contraction in sector capitalization over the second half of 2015. Similar to the cement stocks, FMCG companies also felt impact of the difficult operating environment as weak consumer purchasing power and factory downtime following bouts of power shortages in July hurt top-line.

 

Faced with slack revenue growth, FMCGs were unable to fully transmit the higher cost environment occasioned by NGN devaluation to consumers, leading to margin pressures across the industry.  

 

Figure 2: Disaggregation of NSEASI performance by sector



Elsewhere, banking stocks grappled with deteriorating asset quality in Q2 15, with our coverage universe reporting on average 80bps YoY uptick in cost of risk with impairments, on average, more-than-doubling from 9M 2014 levels. In addition to the rise in provisions, coverage banks also responded to the declining oil price by restructuring oil and gas books to reflect the reduced cash flows under the new price environment. On the asset side of banks’ balance sheet side, the state debt - FG bond swap program drove a sector wide contraction of loan books (-1.1% YoY) over the first three quarters of 2015 (2014: +25% YoY) while on the liability portion, TSA implementation drove a 4.3% YoY cutback on deposits across the sector which translated into higher funding costs in Q3 151. As investors priced in the public sector concerns in addition to higher credit risks, banking sector market capitalization shrank 31.5% over H2 15.  

 

Last, Oil and Gas sector buckled under the weight of declining oil prices for E&P companies and delayed subsidy payments for downstream players over H2 15. On the former, the oil price contraction triggered asset write-downs leading to record losses by upstream player OANDO, while the delayed payments drove petroleum marketers to curtail fuel imports resulting in lower revenues for 9M 2015.

  

The fundamentals-driven compression in share prices over H2 15 triggered a decline in sectoral PE multiples across board: Banks (-25% to 4.5x), Oil and Gas (21% to 60.2x), Materials (-11% to 13.9x) with the exception of consumers where steeper declines in earnings, relative to price, kept multiples elevated.  

 

Figure 3: Valuation multiples across select sectors



Tame fundamental picture and policy uncertainty starves NSEASI of home and foreign support

 

Overlaying these fundamental drivers with sentiment news, we trace out investing pattern across domestic and foreign fund managers over H2 15 with foreign transactions shrinking 43% YoY to N312 billion while domestic transactions declined 53% YoY to N241 billion2. After switching to net long positions on Nigerian equities in June, FPI have stayed net short to the NSEASI over H2 15 to the tune of N39 billion (vs. H1 15: N18 billion). Post the removal of political risk from Nigerian equities which induced two months of net inflows in H1 153, FPI sentiment towards Nigerian equities soured in July on delayed clarity over fiscal policy, specifically how the new government would deal with the impact of the oil price drop, and on naira trajectory. Amid floundering oil prices (-18% MoM), release of broadly weak Q2 15 earnings across NSEASI and heightened global risk as Grexit tensions peaked, July was perhaps the month in which the worst of sentiment triggers came together, with FPI outflows climbing to a five month peak of N58.8 billion. Tracking the exit of foreign investors, domestic funds also reduced exposure in that same month with NSE data showing a 52% MoM drop to a five month low of N24 billion.  

 

Figure 4: NSEASI MoM performance and net equity flows



Though a rebound in oil prices over August should have buoyed sentiment, FPI remained net short Nigerian equities even as domestic investors stayed away. 

 

Even in September when market turned positive (+5.2% MoM), FPI remained net short (N10.8 billion) in response to renewed weakness in oil prices and JP Morgan’s expulsion of Nigeria from its bond indices. In contrast, domestic investors who perhaps had been so damaged by July’s potpourri and consequently stayed out in August despite a rebound in oil prices that month, appeared to be tempted back in September by the arrival of a ministerial list with the majority of the daily gains coming in the last week in the month. Data on PFA and Mutual Fund AUM also supports this view though the lower domestic transactions value relative to August hints at a lack of conviction. 

 

Indeed, the ultimate release of specific ministerial names did little to sustain market confidence which soon ebbed outright with release of weak Q3 15 earnings in October. Consequently, FPI remained net short (N3.1 billion) with inflows sliding to the lowest (N25.5 billion) since NSE began reporting monthly data while domestic investors also moderated exposures (-13% MoM to N52.6 billion).  

 

Over H2 15, the dour macroeconomic underpin combined with poor visibility on economic policy to drive net short FPI positions and reduced exposure to the domestic market by local investors.    

 

Bearish market and shrinking liquidity keeps primary market dry

 

A fall-out of the reduced interest in Nigerian equities from domestic and offshore investors was the resulting slide in average daily volume (-13% YoY to 316 million shares) and value traded (-27% YoY to N3.14 billion) over H2 15. Beyond leaving the market susceptible to further downtrend, the shrinking market depth and declining valuations made it difficult to raise equity or to list companies. For evidence, while H2 15 witnessed announcement of seasoned offerings, none of the proclamations came into effect as declining prices dampened optimism to follow through {Both FMNL (N30billion) and UACN (N4.8 billion) announced rights issue plans but did not undertake the plan}.

 

Figure 6: Mean monthly volume and value traded



As regulatory bodies ramp up push to bring market standards in line with best practice

 

Perhaps as a reflection of the depressed market performance, the NSE did not go ahead with the downward adjustment in par value from N0.50 to N0.01 per share.

 

Nonetheless, in another effort at aligning equity market architecture to global standards, the Exchange together with the Central Securities Clearing System (CSCS) announced plans to commence a post-trade allocation service to enable fair allocation of securities for pooled transactions to various client accounts by December 1, 2015. Previously this process was done at the discretion of the brokers which left the system open to unfair practices for pooled trades.  

 

Among other developments aimed at improving market standards, the SEC, under its three point agenda (direct settlement of investors, smart trading and full dematerialization of the capital market) commenced enrolment for e-dividend payments in September 2015. Leveraging on the BVN initiative and seeking to curb the problem of rising unclaimed dividends, the scheme seeks to register investors on an online portal (e-dmms) managed by SEC to co-ordinate direct dividend payments on investment holdings. In addition, the SEC set January 2016 as the commencement date for the direct cash settlement, whereby sales proceeds on trades executed by brokers are directly wired into customers’ accounts.  

 

In line with the uptick in activity by SEC, the NSE released draft guidelines to amend listing company rules which require financial audits before dividend announcements and raised sanctions for delayed results releases. The new rules are largely in response to the furore following the delayed release by OANDO of its 2014 results and infraction committed during the period by making payouts from reserves.

  

In a related development, the NSE also introduced a new index called the premium board designed to track the performance of “large cap, liquid stocks of firms with excellent corporate governance and sustainable business models”.

 

To qualify for inclusion, firms are required to, by the date of application to the board, achieve: 

1. Market capitalization that is equal to or in excess of N200 billion. 

2. Minimum free float requirement of 20% of its issued share capital; or b. the value of its free float is equal to or above N40 billion

3. Minimum rating of 70% under The Exchange’s Corporate Governance Rating System (CGRS).  

 

Following the announcement, the NSE named ZENITH, FBNH and DANGCEM as the only three firms to be admitted upon commencement of the Premium Board in August 2015. Going by the first two criteria alone, several other firms (see table 11 below) also qualify, implying future inclusion over the near term.  

 

Table 1: NSE Premium board: current and potential members



Can impact of stimulatory domestic policy offset effect of bearish FPI stance on NSEASI?

 

Similar to 2015, events across the global landscape and the impact of domestic policy responses to these developments form the basis for our equities outlook. On the global front, the lift-off in US interest rates in December 2015, in a manner similar to the decision to start of tapering, and guidance to 100bps increase over 2016 raises the opportunity costs for investing outside the US economy. In addition, amid rising monetary policy divergence, the upbeat growth picture for DM renders the economic case for FPI activity in EM/frontier markets less compelling. Exacerbating the case for Nigeria is the bearish base case for oil prices over 2016, which expands prospects for higher BoP and fiscal deficits.   

 

The foregoing shifts investor focus to developments on the home front where the emerging theme from the fiscal side is an attempt to reignite aggregate demand via Keynesian-style stimulus measures. While the government has since announced a N6 trillion expenditure outlay with projected deficit of N2.2trillion, uncertainty remains over how the budget will be financed. The efficacy of the budget itself in stimulating aggregate demand holds import for various sectors of the market starting with FMCGs. The ‘welfarish’ twist to recurrent spending with the planned primary school feeding and unemployment package should provide upside to consumption demand.

 

Whilst this should benefit FMCGs, per our budget review we expect the impact might not materialize soon even as our views on naira weakness suggests margin pressures as companies struggle to transmit FX induced pressures on import costs to customers. However, some form of relief appears on the horizon for highly geared companies as low rate environment translates to tamer interest expense pressures in 20166. Nonetheless, the delayed feed-through of the stimulus and FX pressures on margins should temper gains from interest expense leaving bottom-line broadly subdued over 2016 for FMCGs. 

 

For cement stocks, the appointment of erstwhile Lagos state governor, who gained a reputation for sizable infrastructure uplift in Nigeria’s financial capital, and announcement of a N2 trillion capital expenditure budget should buoy optimism about construction activity at the Federal level which should translate into volume growth for players in the cement sector. Nonetheless, details of the 2016 capital budget focus on road construction, which tips the scales in favour of asphalt, implying that expansionary capital spending might not directly impact the cement sector. Whilst an expanding non-Nigerian footprint has raised prospects for topline support, the lower share in total revenues and pressured macro climate across Africa dim scope for expanding offshore divisions to offset weakness on the Nigerian leg. The weak topline picture melds into gross margin weakness stemming from FX induced pressures on dollar exposures on gas contracts and gypsum imports  Incidentally, ~70% of loans across the cement sector are inter-company or on concessionary terms, which narrows scope for any sizable savings from lower interest costs. Overall, sector outlook remains broadly muted over 2016. 

 

For downstream oil and gas companies, the increased prospect of the end to the PSF scheme puts sector outlook at an inflection point over 2016. First, deregulation allows players within the sector with deeper access to capital and logistics infrastructure to push greater volumes without uncertainty over payment delays.

 

Furthermore, recently announced moves to review the present PMS template with a view to switched fixed naira margins to a more flexible arrangement, with prospect for upward adjustment in trade margins, should buoy margin outlook.

 

In addition, interest expense which has averaged 34% of PBT annually since start of delayed payment saga in 2012 (pre-2012: 12%) should moderate with the disappearance of subsidy at current oil price levels. This should remove the need for borrowing that is typically necessitated by delayed government reimbursement, with the emerging low rate environment providing additional down-leg in finance costs. In summary, the stronger revenue and margin outlook combine with savings on finance charges in driving broadly positive earnings outlook for petroleum marketers. On the other hand, for the upstream O&G sector, continued downdraft in oil prices, which are set to approach the breakeven range for Nigerian oil fields, broadly speaks to a dour earnings outlook.

 

Furthermore, following expiration of the three-year tax concession for sector heavyweight SEPLAT, prospects for the supplementary two-year renewal appear weak given the depressed state of fiscal revenues.   

 

In contrast to the broadly positive vibes dovish monetary policy gives non-financials, for banks, the reverse is the case as benefits of tamer funding costs are likely to be more-than-offset by declining asset yields from downward loan pricing and depressed rates on government securities. Compounding this is the marked contraction in loan book over 2015, which implies that banks would have to raise loan volumes to raise interest income. Nonetheless, as the macro environment remains weak we see modest loan growth largely driven by various on-lending initiatives whose impact on interest income is, however, tempered by the lower rates. Furthermore, financial performance should be negatively impacted with onset of zero COT and persisting asset quality issues which should heighten over 2016 as the combination of weaker oil prices and impact of CBN FX measures drive deterioration in risk assets to upstream Oil & Gas, general commerce and manufacturing. Thus, banks are more likely to struggle to grow earnings over 2016.

 

Related News from ARM’s Nigeria Strategy Report

1.       Monetary strokes normalise yield curve - The case for a lower treasury yield curve

2.      Monetary Policy: Rewriting the Past

3.      Inflation rises from 8.2% in January to 9.6% in December 2015; Inflationary Pressure Likely in 2016

4.      Another low payout from December 2015 revenues by FAAC

5.      Renewed oil price descent swings trade balance deeper into deficit

6.      Nigeria's GDP growth stuck in the slow lane

7.      Petroleum sector reforms lead revamped drive for new policy direction

8.     Fiscal Imbalance Persists on Soft Oil Price - fiscal deficit to be much higher than budget

9.      New Government's Progress Threatened by Headwinds

10.  Soft commodities resume bearish trend but has an inflection point been found?

11.   FPI flows exit Emerging Market dance floor

12.  Oil scrapes even lower down the barrel

13.  Escalating challenges drive Africa's growth lower

14.  Uneven global growth driving divergent policy agenda - 2016 Outlook  

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