Is it time to buy the dip?

Transcription

1 Special Commentary 26, January 2016 DLM RESEARCH Is it time to buy the dip? Alex Ibhade We have taken the time to pause and reflect on the negative market dynamics. In addition to what got the most attention, we pondered over the stories that would give you the most edge in 2016 as we would like to know the direction of the market in advance. In one of our daily market brief, we predicted that the start of the year will focus on crude oil price, exchange rates, and the earnings capacity of listed companies. The poor performance of domestic equities can be observed from the weekly charts maybe with increasing effects from foreign markets. In our view, the market has exhibited interplay of speculative activities and dividend yield, a trend which may remain for the most part of the year. One question we ask is is it time to buy the dip? We cannot help but postulate that entering the market at the current level allows effective estimation of value at risk (VaR) or expected short fall (ESF) on selected tickers. It s all about market risk management and capital preservation. In our examination, we note that January 2015 to date, crude oil price has declined by 45.12%, the market has lost N3.28trn, and the ASI has declined by 31.23%, triggered by redemption selling. But there is more to the market sell-off than lack of headline growth. The tendency of key investors to take advantage of the current economic challenges with a devaluation argument is one of the arguably factors that triggered the market slump. As the sell-off continues, the Nigerian Stock Exchange activated a circuit breaker to check daily equity losses as some stocks were fast declining to their nominal values. From the chart below, we note a strong correlation between crude oil prices and the equity market. Fig 1: ASI and Oil Price Movement (rebased) 60.0 Brent ASI Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Source: NSE, Euroinvestor, DLM Research Please read the Important Disclosures at the end of this report.

2 Lower oil price is taking a serious toll on the local currency, with N/USD trading at new cycle high. Taking the average of CBN, interbank, BDC, parallel, and street rates, we can say the Naira has been devalued by ~39%. Our argument is; maybe when the oil sector sneezes, the economy will be headed for total collapse and maybe a structural reform supported by strong economic policies is all we need as an economy. We support the views that devaluation is unavoidable; it s just a matter of when. We are of the view that this is imminent as the possibility of the naira rebounding appears weak due to the outlook of oil prices - if oil We cannot help but postulate that entering the market at the current level allows effective estimation of value at risk (VaR) or expected short fall (ESF) on selected tickers price will ever rebound to its multiyear highs. If we are to devalue the currency today, the devaluation would be around 5% same as oil and this would put the Naira somewhere around c.n260 c.n300. However, the key question is; after we devalue, what s next for the local currency? Nevertheless, we strongly believe devaluation alone will not solve the naira problem overnight. As we ponder over devaluation, we should also think about the significantly declining purchasing power of the naira (purchasing power parity). In our view, there are other issues at hand that needs close attention such as huge import dependence and artificial FX demand, among other considerations. From the chart below, we can say the ~39% devaluation of the Naira is as a result of artificial and overstated demand coming from BDC and the parallel markets. In addition, banks which charges rates that are almost at par with BDC rates on offshore ATM, POS and other international transactions also compounded the FX challenges. As explained in the chart below, a strong correlation exists between the movement of the N /USD currency pairing and the price of oil. Fig 2: ASI, Exchange rates and Oil Price Movement (rebased) 90.0 Brent ASI N/$-CBN N/$-INT BANK N/$-BDC N/$-STREET Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Source: NSE, CBN, Euro investor, DLM Research Major oil-rich nations are also undertaking currency devaluation. In our view, the countries under the most pressure from oil price dips are those that are already facing economic and political turmoil with limited fiscal buffers at their disposal which includes; reserve funds, and the ability to go to the international markets and raise loans. These countries will be critical to figuring when the slide will end.

3 The most dramatic example of oil-fuelled currency decline was seen in Angola, whose Kwanza has steadily fallen against the U.S. dollar by 2,765% between 2000 and 2016 due to devaluation as the drop in oil prices cut the main source of Angola s revenue and export earnings. The Russian Ruble has equally seen a steady decline largely due to its sanctions and rising strain on the country s oil-dependent economy. Hence, Russia was forced to hike its interest rate to 17% to stave off capital flight. Fig 3: Selected Countries Currency Movements (rebased) Nig. Naira Lib. Dinar EGT. Pound SA.Rand Ang. Kwanza Source: CBN, Bloomberg, DLM Research Fig 4: Selected Countries Currency Movement (rebased) Nig. Naira Rus.Ruble Tur. Lira Can. Dollar Nor. Krone Col. Peso Source: CBN, Bloomberg, DLM Research Table 2; Currencies and % devaluation (Jan 2000 Jan 2016) Country Currency FX rates FX rates % Decline Nigeria Naira % Libya Dinar % Egypt E.Pound % South Africa Rand % Angola kwanza % India Rupee % Brazil Real % Russia Ruble % Turkey Lira % Canada C. Dollar % Norway Krone % Colombia Peso %

4 A further reduction in MPR expected before mid-year. We cannot completely rule out a further rate drop despite upward inflationary pressures as headline inflation inches towards the double-digit range. High inflation increases investors uncertainty, increase risk premiums and implies lower stock market returns. The body language of the CBN suggests the likelihood of a single digit interest rate in the near term and if achieved, we anticipate it may remain for much longer, until it stimulates the economy. With the reduction in MPR, we estimate that lending rates from deposit money banks and other lending institutions would decline to c.19% - 22%. However, we note that banks and other lending institutions still maintain high lending rates of c.25% - 29%, which allows them to earn higher spreads. Fig 5: MPR: Jun-15 Source: CBN, DLM Research What has changed so much for the oil price to fall so drastically? This comes after several years of stability, though, prices recovered a few times last year, but a barrel of oil has already sunk this year to its lowest level since This may be due to a number of reasons such as; declining demand from major consumers like China, where economic growth has slackened, and a growing switch away from oil to other fuels. Second, turmoil in Iraq and Libya as the market has become increasingly sensitive to geopolitical risk. Furthermore, increasing U.S. shale-oil output which is pushing out oil imports that need to find another home. While Saudi and Algerian oil that was once sold in the United States is suddenly competing for Asian markets, and the producers are forced to drop prices. We are of the view that the decrease in oil prices will not slow oil production immediately, on the contrary, it will affects future production through decreased investment in exploration and development of new fields. In the current conditions when oil price hovered above break-even price, the response of production to price decrease may come more quickly. In our view, there may be further downside for oil price, but the bottom is not further away. Hence, production from Nigeria is gradually becoming uneconomic which may trigger imminent shutdown of some fields. The average production cost for many of the fields in Nigeria is somewhere near $29 per barrel. This includes; capital expenditure $16.20, and operational expenditure $ This is really a challenging period for the Nigerian economy. Even when the economy bounces back from multi-year lows in oil prices, can it come back from a weakened currency? The Naira has largely been viewed as petrocurrency.

5 Fig 6: Oil Price Movement (Brent), US$/barrel Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: Euro investor, DLM Research In the equity space, some value and growth stocks are fundamentally cheap. Based on our assessment, it has been a winning strategy to buy every dip or recession. Though, the problem is that dips cannot be identified until they are over. In 2016, fundamentals will be the signpost for the market, with no significant economic improvement expected till the second half of the year when some recovery is anticipated. The total market capitalization of all the listed Nigerian banks is less than the combined Market capitalization of JPMorgan Chase and Wells Fargo & Co ($375.92bn vs $456.62bn) based on data for 26th January, 2016 trade. The entire sector stocks are a strong Buy fundamentally but we would err on the side of caution for now as we remain doubts about the loan book of the banks especially oil and gas related transactions. One thing is certain; the banks will record higher NPL in their FY 2015 results. This will further weaken their asset quality going forward. Furthermore, a reduction in MPR to somewhere 9% will further squeeze yields on interest earnings assets. Though, the banks have become a dividend yield play offering above ~10% at current price levels. Hence, we conclude that selected tickers on the sector are cheap enough. Some of the banks are expected to raise fresh funds to bolster their capital adequacy ratios that are currently under pressure. Table 1: Recommendation Tickers Price P/E DiV Yield Market cap Market N'mn $mn ACCESS % 94, DIAMONDBNK % 39, ETI N/A 270, , HOLD FCMB % 20, HOLD FIDELITYBK N/A 37, NEUTRAL FBNH % 147, BUY GUARANTY % 470, , BUY STANBIC % 130, NEUTRAL SKYEBANK % 16, STERLNBANK % 47, UBA % 108, UBN N/A 93, UNITYBNK N/A 8, WEMABANK N/A 40, ZENITHBANK % 380, , BUY

6 Consumer goods need to get cheaper. In view of the challenging business environment, we are of the view that consumer goods stocks are still expensive when you consider negative growth, declining earnings, weak cash flow, margin compression, weak FX supply, changing consumer taste and weakening consumer spending on the back of dampened disposable income. If the current fiscal situation deteriorates further, this will further weaken the earnings capacity of companies in the sector. Hence, it is likely the players in the sector will adopt a new dividend pay-out policy in order to keep the current level of investments Cement stocks are cheap enough. Cement stocks are relatively cheap at the current level. The cement sector is closely related to both the economic cycle and economic developments. The main driver of cement consumption is spending on infrastructure, construction and real estate projects. The Nigerian government announced plans to build 200,000 affordable residential units over the next 4 years targeting low income earners which will be supported by the World Bank with a total investment cost of $300 billion. This will be supplemented by private real estate investors. In addition, as per the 2016 Budget Proposal, a considerable portion (30%) of the budget will be directed to capital projects. Hence, we believe transmission into Cement sales is almost immediate. We believe that the reconstruction of the North-East zone devastated by Boko Haram and potential expansion projects of ports would also create opportunities for cement demand in the medium to long term. We favour Dangote Cement for its high production capacity, low cost/ton as well as high gross profit, EBIT and EBITDA margins. We believe the stock is currently trading at a lower P/E compare to regional peers. Dangote Cement is expected to benefit significantly from the infrastructural spending expected from the 2016 Budget. The company is making a $14bn investment in a refinery and fertilizer and hence maybe be substantial buyers of its own cement. We err on the side of caution for the oil & gas sector. The oil industry, with its history of booms and busts, is in its deepest downturn. This is expected to cause earnings decline for companies that have made record profits. We believe this is already happening. One possible scenario for the sector is that production is no longer economical at the current level while the sector has become riskier. If the current situation deteriorates, it is likely the players in the sector will adopt a new dividend pay-out policy in order to keep the current level of investments.

7 Equity research methodology employed in this report Views documented in this equity research report stem from conclusions reached through the use of multiple valuation methodologies, industry-wide knowledge, company specific information and our near to medium term expectations of industry and company performance, as well as market outlook. Our forecasts are based on a combination of top down and bottom up analysis, alongside historical trends in industry and company financials. Where appropriate, we factored in available forecasts and business direction provided by company management. This equity research report qualifies as an initiation research report on the company whose stock has been analysed, hence the level and depth of details documented herein. Further updates on this company, or its stock, or both, will be communicated to investors via brief research notes or earnings-flash s, as occasion demands. Our recommendation is slightly biased towards value investing. Therefore, our investment rank gauge a customized scale we use to judge how well a firm under coverage has performed is determined using major value parameters as well as relevant ratios and multiples computed with figures from the company s most recent financials. The investment rank or grade given to a company is an alphabet which falls in the set {A+, A, B, C+, C, D, E, F}, where Grade A+ means the company has done excellently well on all fronts that form the basis of our consideration, and has a strongly positive performance outlook. Grade A means the company s performance is of high quality, but can be made better. Outlook for the company is positive. Grade B means the company performed marginally above average, at least relative to its peers, but faltered on some fronts. Outlook is weakly positive. Grade C+ means the company s performance is exactly average; outlook is neither positive nor negative. Grades C and D indicate that dwindling performance is the company s fate at the current time. Outlook for the company is mildly negative. Grades E and F mean the company is headed for towards jeopardy, which might impair its ability to continue as a going concern. Outlook for the company in this case is alarmingly negative. The variables used to arrive at the company s investment rank cover a wide range of measures which characterize liquidity, operational efficiency, profitability, profitability margins, growth, economic profitability, gearing, relative valuation ratios, capital structure and management performance. Our investment recommendation is underpinned by the upside or downside potential of a stock under coverage. This potential is estimated by comparing the stock s current market price to its price target and fair value, on a percentage increase or decrease basis as summarized below: Deviation from current price Recommendation >30% STRONG BUY 10% to <30% BUY -10% to < 10% HOLD <-10% SELL Source: DLM Research In our analysis, we distinguish between fair value and price target. Fair value is our opinion of the actual fundamental worth of a stock, irrespective of what the market thinks of the stock or what investors are willing to pay for it. Value investors purchase stocks way below their fair values, while income investors might purchase stocks at their fair values at the very maximum. Price target, on the other hand, is the estimated price we opine the stock will trade in the near to medium term. It is the price that, if realized, could result in the best investment returns, given prevailing market conditions. It gives an idea of the price other investors might be willing to pay for a stock regardless of its actual worth. We employ fair value, price target or both to determine a stock s upside or downside potential. A BUY recommendation directly means what it says; purchase the stock according to your wallet and appetite for risk. A SELL recommendation prompts investors to exit their positions in the stock, as the analyst believes the stock is not worth investors time and capital commitment. A HOLD recommendation generally tells investors to do nothing; if you have not bought the stock, do not buy it and if you have bought it, do not sell it.

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