Tuesday, March 01, 2016 10:15 AM / Afrinvest
One key theme that has come up in our analysis and valuation of companies is the tougher operating environment which is consequent on the weak macroeconomic backdrop.
Slowing GDP growth has been a major headwind on sales of manufacturing companies and risk assets creation by banks. Elevated inflationary pressures and FX shortages have driven-up costs whilst uncertain direction of fiscal and monetary policy have together worsened the risk landscape and impaired market valuation of assets.
We forecast GDP growth to rebound to 3.5% in 2016 (from estimated 3.0% in 2015), largely hinged on expectation of fiscal stimulus and inflationary pressure forecast to hit double digit. FX supply constraint will also remain a challenge in 2016 given the negative sentiments deterring autonomous FX inflow and bearish outlook for oil prices.
These mutually reinforcing factors will combine to pressure revenue, earnings and margins across sectors and remain a drag on market sentiments.
Revised Valuation Assumptions
Our risk free rate assumption is lower at 9.3% due to the easy monetary policy but this is not the true reflection of the risk landscape nor inflation expectation; thus we have raised our equity risk premium and inflation assumptions to 11.4% and 10.1% respectively. Current prices for the purpose of this report are prices as at 12th February, 2016.
Our Top Picks across Sectors
We have a Buy rating on most of the Banking stocks but our top picks in the sector are GUARANTY, UBA and ZENITH due to their rich ROE, lower Cost Profile and relatively heathier balance sheet which are positive driver of earnings and sentiment.
We believe Tier-1 banks will continue to deliver superior earnings performance (relative to Tier-2) and are better equipped to weather the storm in light of the current challenges, we maintain that investors underweight on Tier-2 banks in favour of Tier-1 banks.
We believe most of the banking tickers have already been heavily discounted for projected weaker forward earnings to a point that positive earnings surprises in 2016 will have massive positive knock-on impacts on pricing. Our Tier-2 coverage have higher upsides but we advocate selective and cautious positioning with a keen eye on sentiment drivers.
Our valuation suggests that the sector’s return based on our valuation coverage over the next 12 months will remain likely negative (-12.6%); yet, we believe there are still opportunities in specific stocks in the sector. We are however cautioned by the weak sentiments and recent exit of most foreign portfolio investors from the market. Nonetheless, we believe sector pricing over a long term horizon presents a fantastic opportunity for discerning investors.
Our top picks include Nestle, NB, Flourmill and DangSugar given their continuous investment in capacity and expansion, leadership of their respective segments and investor sentiments towards these stocks. In addition, the stocks are so selected given their relative defensiveness as blue chip stocks relative to other stocks within the sector.
As the struggle for market share continues in the industry and margins contract, we favour companies with strong volumes growth potential and cost leaders with capacity to grow EPS and justify our earnings based valuation multiple. Industry price and cost leader, Dangote Cement is best positioned for this with over 60.0%of Nigeria’s market share and increased exposure to other regions in Africa with strong earnings potential.
Hence, our top pick is Dangcem with 25.5% upside to our 12-Month value target of N183.92 while we have placed a “HOLD” on WAPCO (TP: N81.78) and CCNN (TP: N9.58). WAPCO’s shares outperformed the industry in 2015 as the market had initially underestimated the impact of the price cut in Nigeria on forward earnings. The stock has consequently converged towards our value target.
We have an Overweight outlook on the sector as we expect it to outperform the benchmark index by 19.0% to 25.0% based on our bullish outlook for DANGCEM and positive outlook for sector dividend.
We expect gross premium growth to stay positive in 2016, albeit modest given constraints in the system. While macroeconomic challenges remain a critical concern, demographic attractiveness and low insurance penetration rate in Nigeria accentuates the compelling growth potential of the sector.
We see further merger and acquisition activity (as witnessed in recent years) driving performance in the sector. Meanwhile, tighter regulatory activities which has brought about the implementation of “No Premium No Cover” rule, the launching of the Micro Insurance Scheme and the Takaful Insurance as well as the recent claims payment guidelines is expected to strengthen recent gains observed in the sector.
We have a Buy rating on AIICO and CONTINSURE, an Accumulate on MANSARD and a HOLD on CUSTODYINS.
Oil and Gas
Since the fall in global oil prices, investor sentiments towards oil and gas stocks have been largely dampened due to the blue outlook. Following this, downstream Nigerian oil companies suffered immediate massive sell-offs. However, our analysis of the companies within our coverage (downstream) indicates that bottom line declines have been against foreign exchange illiquidity and subsidy delays.
Going forward, with technical removal of subsidy through the price modulation template and diversification strategies of some, we expect an improvement in company returns.
Against the colossal sell-off in OANDO following the release of its FY: 2014 results, we believe the stock has bottomed out and our fundamental analysis gives a ‘BUY’ rating.
Similarly, we have placed a “BUY” rating on CONOIL while TOTAL and MOBIL are rated “ACCUMULATE” and “REDUCE” respectively. Due to the sentiments FO enjoys, it currently trades at a significant premium to its peers, based on fundamentals, Forte Oil is rated a “SELL”.
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