Thursday, August 13, 2015 08:25 pM / ARM Research
In today’s serialization of ARM’s core strategy document – the Nigeria Strategy Report, we dimension drivers of equity market performance in H1 2015 and outline their views on NSEASI trajectory over the rest of 2015.
Fluid economic and political factors drive heady half-year for equities
Extending bearish pattern in Q4 14, NSEASI shrank 8.4% over Q1 15 as softening economic fundamentals following oil price plunge combined with heightening political risk to drive elevated foreign and domestic aversion to naira equities. However, and in line with the general pattern for domestic markets, on the heels of the peaceful conclusion to the 2015 elections and modest improvement in oil prices, sentiment turned positive over Q2 15 (+5.4%) which helped pare YTD market weakness (-3.5%).
Parsing through index performance on a monthly basis, NSEASI opened 2015 with its widest MoM loss (-14.7%) since March 2009 in January as Brent Crude oil prices (-7.6% MoM) reached a six-year low and meshed USDNGN (-2.3% MoM) worries and fundamental concerns over corporate earnings. Sentiment darkened further in February following announcement of six-week postponement to 2015 elections which placed heavy political risk premiums on naira assets and drove NSEASI to a three year low of 27,585 points in the aftermath of the INEC announcement. Nonetheless, NSEASI recovered by end of February (+1.8% MoM), in part reflecting improving economic fundamentals on the heels of 18% MoM recovery in Brent crude and bargain hunting following the sell-offs. Equity market performance improved further in March (+5.5% MoM), led by banks, after FY 14 earnings beat broadly bearish market expectations and the USDNGN stabilized at
N198-199/$ range. The unanticipated peaceful conclusion to the 2015 general elections saw Nigerian equities record strongest monthly performance since May 2013 in April (+9.3% MoM) with biggest one-day gain of 8.3% on the day after former president Goodluck Jonathan conceded the ruling party’s defeat at the 2015 poll. Thereafter, uncertainty following the change in political leadership dominated markets over the rest of H1 2015 with lack of clarity over policy direction, in particular, swinging three-month bull run to modest bear trends over May (-1.1% MoM) and June (-2.5%). Overall, closure on the political front and a measure of stability on oil prices helped draw a line on the strong bearish sentiments towards Nigerian equities at the start of 2015.
Deteriorating fundamentals exacerbate bearish equities performance
In addition to political and macro headwinds, weak earnings outlook across NSEASI contributed to bearish market sentiment over Q1 15 before the tailwinds from the benign closure to the elections cast market attention off fundamentals during Q2 15 and towards policy trajectory of incoming Buhari government.
However, going back to disaggregate market performance by sector, our call for negative price movement by consumers, on averse investor reaction to slowing revenue growth and adverse impact on naira devaluation, largely panned out as market capitalization of food producers and brewers shed 12% and 13% respectively. For personal care manufacturers, where we saw scope for more favourable sentiment as effect of tamer oil price on margins offset impact of weaker naira, our positive call panned out with the sector positing a 12.4% gain. Nonetheless, our thesis was largely aided by movement in sector heavyweight Unilever on the heels of tender offer by its Dutch-based parent to raise ownership stake by 25pps to 75% at a 34% premium to share price as at the date of the announcement.
Upstream oil and gas (O&G) names were weighed down by fundamental concerns with net lower oil price driving weakness in Oando and Seplat. However, downstream petroleum marketers negatively surprised relative to our upbeat expectations. Our positive outlook for petroleum marketers was unhinged by 10% reduction of PMS pump price to
N87/litre in January and second USDNGN devaluation in February. Jointly, these re-inflated subsidy per litre from N0.9/litre at 2014 year end to N50.5/litre by the end of H1 15. Consequently, widened exposure to PSF receivables amid weakened fiscal ability to meet payments dampened investor sentiment over earnings outlook, leading to sell-offs. Overall, O&G sector shrank 3% and 6% over Q1 15 and Q2 15 respectively. Banks also bucked our expectations, but this time in a positive direction as strong FX income following elevated naira volatility and CBN relaxation of stringent provisioning requirements underpinned better-than-expected earnings which helped drive a recovery over March (+12%). Furthermore, CBN deferment of the Basel II/III CAR requirements to June 2016 bolstered sentiment around banks resulting in the sector clocking a 2.7% return over H1 15. Elsewhere, cement stocks buckled over Q1 15 (-18%), as concerns over impact of reduced FGN capital spending on their top-line combined with fears over inflationary impact of devaluation shocks to energy costs especially considering the dollar-priced nature of their gas supply contracts.
Nonetheless, as earlier stated, aggregate sentiment turned positive over Q2 15 driving a recovery in multiples across the NSEASI. This was most evident in banks where the Q1 earnings boost helped drive upward rerating of price-to-earnings multiples which, on average, recovered from 4.9x in Q1 15 to close H1 15 at 6x. On the other hand, a recovery in pricing over Q2 15 despite weak underlying earnings drove consumer P/E multiples 41% higher to 39x (Q1: -3%). For oil and gas companies, despite negative price movement over H1 15 (-9%), multiples tracked higher (+51% to 76x) largely reflecting earnings compression in downs
Challenged investment landscape drivesression in transactions
A second-order implication of heightened investor edginess over NSEASI in H1 15 was the contraction in total value traded (-8.7% YoY) to
N1.05 trillion for the first 5 months, as domestic and foreign investors adopted cautious position on equities. On the heels of N101billion net short position in Q4 14, foreign investors remained averse to the equity market with net outflow of N34 billion over Q1 15. This pattern extended into Q2 15, though as in Q1 15, net short positions continued to shrink ( N4.87 billion). Delving through the numbers on a monthly basis, multi-year lows for oil price and USDNGN in January underpinned FPI outflows of N51 billion over the month (December 2014: N53 billion). The sustained negative FPI position in January combined with cutback in local investors’ activity on the bourse (domestic transactions shrank 32% MoM to N90.6 billion) to drive 15.3% MoM plunge in NSEASI. Corroborating our inferences on the influence of key drivers, a further upsurge in FPI outflows in February (+60% MoM to N81 billion) and 44% MoM reduction in domestic trading activity to N51 billion that same month, watermark the political risk that was peaking at the time.
Nonetheless, increased bargain hunting due to compelling valuations drove a 61% recovery in local transactions activity and 98% MoM reduction in foreign net short positions in March to
N2.2billion. Subsequent easing in political tensions resulted in the year’s first positive FPI net flows of N4.4 billion in April 2015. However, uncertainty on the likely policy trajectory of the new government quickly swung FPI back into negative territory with net short positions of N9.3 billion over May 2015. Overall investor activity largely tracked our thesis about heightened investor sensitivity to political and economic uncertainty on the domestic front.
Attractive alternative and limited primary market activity accentuate moderation in equity exposure
Beyond fundamental issues, continued absence of primary market activity and slew of dilutive capital raising secondary issues by banks can help investor buying appetite for NSEASI over H1 15. Indeed, elevated yield profile and renaissance of local CP-market acted to sap domestic liquidity from equities over the period. The allocation switch is evident in asset class holdings of domestic pension funds with industry wide equity share of NAV shrinking to 12% ( 2014: 15%, 2013: 15%) whilst FI holdings climbed 4pps to 65% (2014: 61%, 2013: 58%). For equity mutual funds, stock market holdings were more actively managed over February and March, with monthly movement in NAV at variance with MoM NSEASI performance suggesting caution towards NSEASI. Nonetheless with markets stabilizing post elections in April, equity mutual funds’ MoM NAV resumed tracking NSEASI in Q2 15. In sum, similar to foreign investors, domestic institutional investors moderated exposure to NSEASI over Q1 15 before subsequently dropping equities aversion stance as political tensions eased over Q2 15.
As improvement in key indices methodology flies under the radar
In addition, one market development during the period is worth noting. The NSE announced an agreement with global index provider MSCI to takeover computation of its flagship NSE 30 and NSE 50 indices, which would subsequently be referred to as MSCI NSE 30 and MSCI NSE 50 indices respectively. The initiative, which seeks to bring these indices in line with the global benchmarks for index construction by taking into account issues such as free-float, holds potential to draw a wider array of global index tracking funds to the domestic bourse. In addition, the possibility of greater investability of the index should spur development of more sophisticated instruments such as ETFs. Whilst this development holds limited near term impact, in conjunction with the amendment of minimum trading price from 50kobo to 1kobo, the initiative brings market architecture more in line with global practices which should hold positive prospects for boosting market liquidity over the medium term.
Global and domestic uncertainty cast dull clouds over equities outlook
Whilst the dark cloud of 2015 general elections has passed over, investors focus appear to be shifting to another unresolved issue on the domestic landscape: weak government revenues. Drawing inference from market movement in May and June, clarity on how the new Buhari administration and the various economic managers co-ordinate to manage the new economic reality of subdued oil prices and its ramifications for the economy should prove pivotal in market outlook for H2 15. As we established in our discussion on oil prices, softening demand growth amid sustained strength in global crude production continues to drive tempered outlook for oil prices. Thus, with no reprieve on the fundamental picture and the deferment of ministerial appointment till September 2015, investors’ sentiment could be distracted by uncertainties on the global front.
On this wise, two events should vie for foreign interest in NSEASI over H2 15. Firstly, prospect of spillover from on-going Greek-Eurozone crisis should heighten investors’ aversion to EM/FM assets in the event of Grexit. Whilst our base case sees limited chance of Greece leaving the euro, markets are likely to be roiled by intermittent bouts of uncertainty as brinkmanship by Greece and its Euro-zone creditors push negotiations to the precipice. Secondly, as the US Federal Reserve increasingly creeps towards rate lift-off over H2 15, we see increasing possibility of global investors moderating EM/FM exposure for less risky US assets. With the country being one of the worse hit EMs from recent global shocks, FPI stance towards Nigerian assets will likely stay cautious in H2 15.
On the domestic front, akin to H1 15, bearish sentiment should continue to dim scope for resumption of primary activity on the domestic bourse with no planned listing for H2 15. Nonetheless, with a year left to raising CAR to regulatory standards, a slew of rights issues across banks among others should keep the market for seasoned issues warm over H2 15 providing more cautious approach to trading.
Beyond these negative headwinds to foreign sentiment, impact of oil price shocks should continue to reverberate across earnings outlook for the various sectors weakening appetite for NSEASI. For FMCGs, impact of macro shocks should continue to reverberate across board with weak fiscal spending, delayed salary payments across two-thirds of the states and weaker real purchasing power underpin negative topline growth. Whilst some FMCGs, flour millers and sugar refiners have sought to raise prices to pass-on devaluation shocks to input costs, the price hikes significantly tail the scale of USDNGN devaluation implying forced margin compression. Assisted by increasing spending on route-to-market to shore sales weakness we see an extension of earnings weakness (and losses) across FMCGs.
For O&G sector, depressed oil price environment over 2015 sets the stage for price induced contraction in revenue for upstream firms SEPLAT and Oando. In addition, production outlook is equally weak as difficulty in meeting JV cash calls should result in higher NPDC receivables to upstream players firming up revenue weakness. Similarly, weak fiscal position is driving increased discussion about plugging fiscal leakages which, among other possibilities, raises spectre of a roll-back in pioneer tax holidays for E&P companies.
This argument is pertinent to Oando as it seeks to obtain tax concessions on recently COP acquisition and SEPLAT whose tax holiday comes up for renewal by the end of the year. Downstream, despite intransigence by the Buhari regime towards deregulation, payment uncertainty should continue to drive weaker volumes by major petroleum marketers. Tying the weak volumes push to lower YoY PMS price following January’s cut, revenue growth across the sector should extend negative H1 15 trends. Compounding outlook is the widening impact of naira devaluation on subsidy per litre which should underpin higher PSF receivables and by extension higher financing outlay. Overall, amid limited prospects for PIB passage, negative oil price shocks should drive sector earnings lower over H2 2015.
Elsewhere, strained federal/state financial positions should continue to induce lower construction activity limiting scope for revenue increases over the rest of the year. Furthermore, higher cost of gas supply contract post NGN devaluation and erratic gas supply, which has resulted in switch to more expensive LPFO, should combine to drive margin compression. On balance, the double whammy across top-line and bottom-line retains bearish outlook for cement over H2 15.
For banks, challenged macro clime following the decline in oil price should drive moderation in loan origination over H2 15 on account of three factors. First, the tamer oil price provides a less compelling story for lending to upstream oil and gas which, by our estimates, accounted for 40% of 2014 credit growth. Second, naira softness and uncertainty over government payments should result in aversion to downstream oil and gas lending. Finally, reduced capital adequacy ratios post commencement of Basel II/III and the need to maintain buffers over regulatory thresholds amid tight forward guidance on monetary policy has resulted in several coverage banks generally guiding to single digit loan growth in 2015. Hence, we see mean sector loan growth over 2015 between 9-12% over H2 15. Whilst there has been some re-organization towards raising securities portfolio to capture higher yield environment, halving of COT charges to N1/mille and CBN curbs on FX trading should temper accrual of gains to top-line in 2015, industry-wide. In addition to the pass-through from slower top-line, the pressured macro landscape raises prospect of higher provisioning for stressed segments of the loan book: oil and gas, general commerce and consumer loan exposure to state government employees. Hence, despite attractive valuation levels, we see higher prospect of further earnings compression dampening investor appetite for bank stocks over H2 15. In all, we see the balance of factors examined and uncertainty over domestic policy direction in particular melding into broadly weak earnings outlook across the market driving scope for market downside.
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