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Tuesday, November 3,
2020 /02:34 PM / by Coronation Research / Header Image
Credit: Azer News
The Naira yields of T-bills and Federal Government of
Nigeria (FGN) bond are lower than its US dollar Eurobonds. This is highly
unusual.
FX
Last week, the foreign exchange rate markets closed
essentially flat, with the Naira depreciating by 0.05% against the US dollar to
N385.95/US$1 in the NAFEX market (also known as the I&E Window). In the
parallel, or street market, the Naira appreciated by 0.22% to close at an offer
price of N462/US$1. There is still no convergence between the two rates, though
they are still within 20% of each other. We expect this situation to continue
for some time. It seems that there is sufficient liquidity in the parallel
market to prevent the rate falling far from its current level but not enough US
dollar supply to bring the rate in line with the NAFEX rate. The result appears
to be an impasse.
Bonds & T-bills
Last week, the secondary market yield for an FGN Naira
bond with 10 years to maturity decreased by 1 basis point (bps) to 4.16%, and
at 7 years fell by 56bps to 3.44%, while at 3 years the yield declined by 55bps
to 2.63%. The annualised yield on 328-day T-bill fell by 6bps to 0.71% while
the yield on a OMO bill with similar tenure rose by 4bps to 0.82%. Following
the contraction in yields witnessed two weeks ago, the demand for instruments
in the T-bill secondary market slowed down as investors focused on the primary
market auction (PMA) that held on Wednesday. At the auction, the Central Bank
of Nigeria offered bills worth N154.3bn (US$395.6M) and stop rates across the
curve were less than 1.00%. While we doubt investors are enthusiastic about
driving rates down, liquidity seems strong enough to prevent a significant rise
over the coming weeks.
Oil
The price of Brent crude dropped by 10.32% last week
to US$37.46/bbl. The average price, year-to-date, is US$42.43/bbl, 33.79% lower
than the average of US$64.20/bbl in 2019. Oil prices dropped on the news of the
new lockdown measures imposed in countries like the USA, Germany and France.
However, such a sharp sell-off has not been observed in other commodity
markets, notably copper, iron ore and lead. This suggests that oil traders are
not only concerned with the world economic outlook but also with the resolve of
the Organization of the Petroleum Exporting Countries (OPEC) to maintain
current production cuts into next year. Among OPEC members it appears that
Kuwait, the United Arab Emirates and Iran oppose rolling over the current
schedule of production cuts. We must revise our forecast price range of between
US$40.00/bbl to US$46.00/bbl downwards to reflect the new reality.
Equities
The Nigerian Stock Exchange All-Share Index (NSE-ASI)
rose by 6.39% last week, with a gain of 13.74% year-to-date. This happened as
reported corporate earnings spurred strongly positive market sentiment,
bringing the NSE-ASI above the 30,000 mark. Last week, FCMB Group (+28.28%),
Sterling Bank (+26.43%) and Fidelity Bank (+24.26%) closed positive, while
there were no losers.
US Dollar Eurobond Yields Now Higher Than Naira Yields?
Which has the higher yield, the Federal Government of
Nigeria's (FGN) Naira-denominated debt, or its US dollar-denominated debt? After
a huge rally in the Naira T-bill and FGN bond market this year, the answer is
the US dollar-denominated debt.
Why? The answer is a simple case of the weight of
money. 23rd October 2020 marked the one-year anniversary of the closure of the
auctions of new Open Market Operations (OMO) bills of the CBN to most Nigerian
institutions. The OMO market at the time was six times the size of the T-bill
market and OMO bills and T-bills were traded as nearly-fungible instruments. As
OMO bills are redeemed, money flows through the accounts of pension funds and
other institutions into the T-bill and FGN bond markets, forcing yields down.
In the charts below we show the yields for 17
maturities of Naira-denominated T-bills and FGN Bonds from the beginning of the
year and (1 January) and from last Friday (30 October). These show the enormous
compression in yields over the past ten months. On the right-hand side are the
yields, also from last Friday, for 10 maturities of US dollar-denominated FGN
Eurobonds. The matches between maturities are not exact, but the comparison in
yields between roughly-comparable durations is revealing. Among the 10
Eurobonds the simple average yield is 3.01 percentage points (pp) higher than
the comparable Naira maturities, with a range between 1.93pp to 3.81pp.
The weight of Naira cannot reach the US bond market,
so the two markets are essentially separate. Low rates in the Naira bond market
does not mean that Naira are more valuable than US dollars.
However, from the point of view of US dollar issuers,
there is a comparison between alternative rates. The FGN, having abstained from
making a US dollar Eurobond issue in 2019 and most of 2020, would be a welcomed
issuer in our view. But Naira are simply cheaper.
For those US dollar-based offshore investors who can
buy FGN Eurobonds, the situation is as follows: the long term average yield
across maturities is in the range of 5.8%. The government does not want to
negotiate private sector debt terms (keeping Eurobonds out of debt
renegotiations) and therefore appears to be a good and committed credit. US
dollar rates above 6% look attractive, in our view.
Model Equity Portfolio
Last week the Model Equity Portfolio rose by 4.51%
compared with rise in the Nigerian Stock Exchange All-Share Index (NSEASI) of
6.39%, therefore underperforming it by 188 basis points. Year-to-date it has
gained 18.46% against a gain of 13.74% in the NSE-ASI, outperforming it by
451bps.
To underperform the index by 188bps in a week is an
unpleasant shock (in many equity markets a fund manager might hope to
outperform by that much in a year). However, it was a short week, of four
trading days as Thursday was a public holiday. Trading was volatile.
Three stocks (Fidelity Bank, Sterling Bank and FCMB
Group) rose by 24.0% or more over the four trading days. These are among the
smaller and the less-liquid bank stocks. It is difficult to accommodate moves
of this sort, unless one decides to hold an index-neutral position across a
large number of not-very-liquid stocks, a tactic which have decided not to
follow.
More significantly, Nestle Nigeria and Flour Mills of
Nigeria rose by more than 20% over the four days. These are reasonable index
weights and therefore worth thinking carefully about. We have noticed a certain
enthusiasm for Nestle Nigeria given its high profitability and return on equity
(RoE). But we doubt that its long-term sales trend is strong (especially when
we adjust it for inflation) and we have observed, in the past, that the RoE of
consumer-facing industrials can falter when sales growth is lackluster.
We shall take a close look at Flour Mills of Nigeria
and report back. We plan no model portfolio changes this week.
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