Analysts Perspective. Nigeria in 2018. 2-3-1 Formation The global economy outperformed most predictions in 2017, and the momentum is expected to continue in 2018. Interestingly thus far, the recovery is broad-based across most advanced, emerging, and developing economies. Back home, Nigeria s economy has recovered from the recession of 2016, and is forecast to grow at its fastest pace in two years in 2018. All economic indicators point to positive direction and the sound of downside risks is barely perceptible. While we share consensus view of broadly better economic prospect, we should also mention, in Nigeria s case, the strong commodity risk factor backing the outlook. As a result, in this edition of our report on Nigeria and its markets, we discuss the outlook for 2018 in three different scenarios and specifically, the implications of each scenario. We believe this is the best course to take during recovery in a suboptimally diversified economy, with weak stabilizers. This is the year to look beneath the surface! We base the scenarios on developments that are familiar with Nigeria, and hence, consider each of them a likely occurrence. But on balance, we rank the scenarios 2-3-1 in order of likelihood. 2
Overview. GLOBAL Promising Growth Outlook Growth in 2017 and 2018 are expected to come stronger than anticipated at the end of H1-17. Led by developments in the advanced economies, the recovery is spreading to emerging markets, and outlook for developing countries is better, compared to a year ago. Equity Markets And the Bullish Run Continued Analysts Christian Orajekwe christian.orajekwe@cordros.com Peter Moses peter.moses@cordros.com Boluwatife Sorungbe boluwatife.sorungbe@cordros.com Janet Ogunkoya janet.ogunkoya@cordros.com Global equities had a bullish 2017, with markets within our coverage universe posting strong returns in both halves of the year. Unsurprisingly, activities in H2 broadly mirrored the H1 rally, as the factors which powered gains in the six months to June again played out (even stronger) over the latter half of the year. Crude Oil Market Price Rally; A Lasting Fanfare? While noting that favourable conditions for healthy oil price over 2018 exist in reasonable number, we should mention also that there is downside risk to this outlook. Worth mentioning, is our view that the hosts of factors that have supported prices to current levels are sensitive in nature and noting that there are already emerging concerns about the strength of their sustainability risk inflicting the 2014- type shock on oil-dependent countries. NIGERIA Growth What Next for Economic Recovery? Scenario 1 Real GDP grows by 4.87%. Enablers are (1) strong oil revenues amid higher crude oil price and production, (2) stronger and stable NGN exchange rate, (3) non-oil revenue benefits from a more visible tax reform and improved business climate, (4) efficient budget implementation, and (5) continued expansion in agriculture. Scenario 2 Real GDP grows by 2.63%. Enablers are (1) healthy oil prices and domestic crude production support oil earnings only below budget projection, (2) weak visibility around tax reforms constrains non-oil receipts, (3) business environment remains uncompetitive in the absence of meaningful structural reforms, and (4) aggregate demand grapples with sluggish improvement in inflation rate. Scenario 3 Real GDP growth contracts by 0.42%. Drivers are (1) oil revenue drops significantly as oil price crashes and domestic production turbulence resurfaces grinding production below 1.4mb/d, (2) non-oil revenue accretion slumps as activities across major subsectors nosedive, with sector players tussling 3
with acute foreign exchange shortage, (3) fiscal deficit widens, (4) monetary policy tightens to accommodate fiscal underperformance, ultimately crowding out private sector borrowing, (5) political tension heightens, and (6) popular reforms overtake structural reforms. Fiscal Policy Oil to the Rescue? Scenario 1 The assembly approves the budget in February, making for the signing into law in March. Revenue budget is 94% achieved. Borrowing requirements, the foreign components especially, are met as and when due. The government stretches to achieve 95% execution of the expenditure budget by the end of the budget year. Scenario 2 The assembly approves the budget in April, making for the signing into law in May. Revenue budget is 87% achieved. Borrowing requirements, the foreign components especially, are delayed, but eventually met. The government pushes for 90% execution of the expenditure budget by the end of the budget year. Scenario 3 The assembly approves the budget in June, making for the signing into law in July (vs. June in 2017). Revenue budget is 75% achieved. Country risk premium increases and naira borrowings take priority. To keep deficit within acceptable limit, expenditure is cut to 85% of budget, as was the case in oil revenue related challenging periods of 2009 and 2016. Exchange Rate More Grace from Oil? Scenario 1 The external reserve reaches USD56bn (from USD39bn). The CBN holds the Naira at NGN305, but increases flexibility in the management of FX. The naira appreciates in both the I&E and parallel markets by about 5-6% to NGN340/USD and NGN345/USD respectively. Drivers are (1) oil price of USD65-70/barrel and stable production of +2mbpd, (2) inflows from Eurobonds to fund 2018 budget deficit, and (3) strong portfolio inflows, owing to high oil earnings, compelling equities valuation, and relatively attractive FI yields. Scenario 2 The external reserve reaches USD47bn (from USD39bn). The CBN holds the line on the naira and does not increase flexibility in FX management. The naira trades between +/-2% of NGN360 and NGN363 respectively, at the I&E window. Drivers are (1) oil price of USD55-60/barrel and occasional, albeit modest cases of shortage in domestic production, (2) delayed Eurobond issues, consequently delaying impact on reserve, (3) election-induced increase in naira chasing after USD, and (4) moderate portfolio inflows, given less attractive FI (vs. 2016-2017) and equities valuation (after the 2017 bull run). Scenario 3 External reserve falls to USD30bn (from USD39bn). The current A/C balance enters negative and the CBN resorts to harmful exchange rate restrictions to stem the depletion of reserves. Pressure on oil earnings and CBN s policies force the FPIs to take to the sideline. After mush resistance, the CBN devalues by 20% to NGN363/USD. The I&E loses relevance and the parallel rate spikes to NGN497/USD. Drivers are (1) crash in oil price to USD30-35/barrel, (2) economic shock and harmful FX policies scare FPIs, and (3) suspension of external borrowings. 4
2018: Which Direction for Inflation Rate? Scenario 1 Inflation rate moderates to 9.74% in December, averaging 11.24% for the year. Enablers are (1) stronger naira exchange rate amid higher crude oil price and production, (2) stable energy prices -- electricity tariffs, and premium motor spirit (PMS) and diesel prices, (3) domestic food prices directly benefit from buoyant agriculture output, in addition to lower prices of imported food items, and (4) the apex bank keeps monetary policy tight, in its support for the FGN s activities in the local debt market. Scenario 2 Inflation rate moderates to 13.15% in December, averaging 13.15% for the year. Enablers are (1) the local currency see-saws, with gentle volatility, and ultimately stabilizes at 2017 levels amid modest-to-flattish growth in oil price and domestic production, (2) energy prices remain mostly unchanged, broadly influenced by political considerations, (3) the minimum wage discussion progresses at a slow pace, (4) the apex bank modestly lowers interest rate, and (5) domestic food prices benefit from a relatively healthy production. Scenario 3 Inflation rate rises to 18.02% in December, averaging 15.87% for the year. Drivers are (1) USD shortage resurfaces, reigniting foreign exchange crisis, as the country s external reserves come under pressure amid declining oil price and domestic production disruption, (2) energy prices go through the roof, (3) the FGN painfully raises the minimum wage bar amidst growing agitation among labour unions and in a bid to impress the electorates, and (4) increased election and campaign spending ahead of the 2019 general elections. Interest Rate 2018: What Comes After Loud Echoes of Easing? Scenario 1 Aggressive Easing: The MPC cuts MPR by 300 bps to 11.0%. Drivers are (1) crude oil prices advance, (2) zero domestic crude production turbulence, (3) NGN exchange rate stabilizes on improving external reserves, (4) government spending picks up (supported by higher federal revenue) (5) investment spend rises (following growing confidence in the broader economic landscape), (6) aggregate demand increases as inflationary conditions improve, (7) economic recovery accelerates, (8) productivity gains increase, and (9) notable success on external borrowing to augment the deficit in the budget. Scenario 2 Gradual, Modest Easing: The MPC cuts MPR by 100 bps (50 bps apiece over both halves of the year) to 13.0%. Drivers are (1) healthy crude oil earnings support steady accretion to the reserves, (2) naira remains stable, (3) inflation rate moderates slowly, (4) weak non-oil earnings pressure government expenditure, (5) private investment spending grapples with high interest rate environment, and (6) economic recovery progresses at a modest pace. Scenario 3 Further Tightening: The MPC hikes the MPR by 200 bps to 16.0%. Drivers are (1) oil price weakness blows up, (2) the external reserves face intense pressure, (3) FX crisis resurfaces, with significant LCY exchange rate depreciation, (4) supply-side induced inflation returns, and (5) output growth slows. 5
CAPITAL MARKET Equities After the Bull Comes Another Bull? Scenario 1 Equities return excess of 40%. Drivers are (1) higher than expected economic growth, (2) better-than-expected corporate earnings growth that eases valuation concerns, (3) strong portfolio inflows to historical high, (4) favourabe regulation, (5) M&A activities, and (6) significantly low FI yields. Scenario 2 Equities deliver 10-15% return. Drivers are (1) moderate economic growth, as widely expected, (2) stable to modest growth in corporate earnings (valuation concerns linger), (3) modest improvement in FPI flows, amidst growing opportunities across developed and EM/FM markets, and (4) lower than expected moderation of FI yields. Scenario 3 Equities deliver 20-25% negative return. Drivers are (1) economic and political shock, (2) very poor corporate earnings (which escalates valuation concerns), (3) MSCI delists Nigeria from its index, and (4) FPIs fly to safety. Fixed Income Which Path for Yields In 2018? Scenario 1 Significantly Lower Yields: Average T-bills yield on the 91, 182, and 364-day bills falls to 9.07%, 11.14%, and 12.03% respectively while average bond yield on the 5, 10, and 20-year bonds drops to 13.04%, 13.40%, and 14.0% respectively. Drivers are (1) global crude oil market rebalances, (2) domestic crude production rises, (3) naira exchange rate strengthens, (4) speedy decline in inflation, (5) the monetary authority switches its gear to an accommodative monetary policy stance, (6) increased foreign investors participation, (7) JPMorgan Chase & Co. readmits Nigeria into its local-currency emerging-market bond indexes, (8) political activities progress at a peaceful pace, (9) the FGN succeeds with its planned debt management strategy, and (10) the DMO, on behalf of the FGN, introduces additional alternative instruments. Scenario 2 Marginally Lower Yields: Average T-bills yield on the 91, 182, and 364-day bills drops to 11.68%, 13.02%, and 13.40% respectively while average bond yield on the 5, 10, and 20-year bonds closes at 15.64%, 15.70%, and 16.31% respectively. Drivers are (1) oil price and production closely trail 2017 average, (2) NGN exchange rate steadies at 2017 levels, (3) inflation rate sustains moderation, albeit at a slow pace, (4) economic recovery advances at a modest pace, (5) the MPC gradually eases interest rate, (6) the race for the 2019 general election advances without a major outbreak of crisis, and (7) FGN s debt management strategy grapples with CBN s frequent OMO auction Scenario 3 Higher Yields: Average T-bills yield on the 91, 182, and 364-day bills rises to 13.50%, 15.57%, and 15.92% respectively while average bond yield on the 5, 10, and 20-year bonds expands to 16.24%, 16.40%, and 18.16% respectively. Drivers are (1) oil price weakness resurfaces and deepens, (2) crude oil production drops significantly, mirroring 2016 levels, (3) the NGN exchange rate depreciates materially across the various markets, (4) inflation rate goes out of hand, (5) the apex bank commences aggressive OMO auction (including special auctions for DMBs) to stifle the financial system of naira liquidity, (6) the volume of treasury bills 6
offered at the CBN s bi-monthly NTB auction increases to both mop up liquidity and fund fiscal deficit, (7) foreign investor appetite weakens, (8) the political climate gets heated up as the race for the 2019 general election intensifies, (9) monetary policy tightens further, and (10) the FGN jettisons its planned debt management strategy amid increasing difficulty in securing external funding. SECTORS Consumer Goods An Impressive 2017 Sets Tone for 2018 Catalysts Improvement in consumer spending: From likely faster growth in economic activities, reduced inflationary pressure, election spending, and the proposed increase in national minimum wage, the outlook for consumption demand is positive in 2018. Low interest rate and deleveraged balance sheet: Both the debt repayments in 2017 and declining interest rates, suggest potentially lower finance charges in 2018, and consequently, a catalyst for earnings. Foreign exchange stability: By easing the pressure on margins and financing costs (USD components), including on consumer spending (through inflation), the stability of the naira followings months of intense fluctuation, is among the positively changed story of the Nigerian consumer goods companies. Impressive 2017 beams more light on consumer goods stocks in 2018: The strong earnings growth and share price gains recorded in 2018 should encourage investors to increase focus on consumer goods stocks which are historically regarded as defensive amidst a broadly bullish equities outlook. Risks External pressure: This relates to the strength of domestic macro recovery, naira exchange rate, and inflation. Nigeria s economy is forecast to recover only modestly in 2018 and its less-optimally diversified structure renders the recovery, including consumer spending, significantly vulnerable to unexpected shocks. Competition: Already, both the attractive profits reported by the established players and the improved access to the USD have encouraged a gradual return of the smaller players (mostly importers) to business. The risk of the established companies we cover losing market share to competition in 2018 is consequently high. Policy issues: This relates to the inflationary consequences of possible increase in energy price on consumption demand, especially vis-à-vis non-essentials. Valuation issues: In our view, the strong run of stocks prices in 2017 suggests limited upside potential for our coverage universe, even after revising our estimates upward following the July-September results and rolling forward valuation coming into 2018. 7
Cement 2018: Volume and Energy-led Growth Catalysts Supportive macroeconomic environment: From likely faster growth in economic activities and better government revenue prospect, the outlook for cement consumption, in private and public sectors, is positive in 2018. Energy diversification: We are convinced by the commitments of the sector operators to energy diversification, the benefits of which include positive transmission to margins (through lower production costs) and the reduction of energy supply risk. Foreign exchange stability: By easing the pressure on margins and financing costs (for LAFARGE), including on consumer spending (through inflation), the stability of the naira followings months of intense fluctuation, is positive for the Nigerian cement companies. Risks Price cuts: Cement companies are more likely to reduce prices in 2018 than increase them. We consider this a risk because of the impact higher prices have had on sector revenue over the last one year especially External issues: This relates to the strength of the domestic macro recovery, government revenue expectations, and naira exchange rate, amidst the risk of unexpected oil revenue shock. Drag from overseas operations: From intense competition to low prices, underperforming infrastructure sectors (e.g. South Africa), overcapacity, energy (e.g. Tanzania), and generally, economic growth challenges, the journey outside Nigeria should remain challenging for Nigerian cement companies. Agriculture Sustained Relevance on Direct Government Support Catalysts Supportive macroeconomic environment: While output growth will still lag pre-oil crash levels, our view is that, the level of activities, particularly across major non-oil subsectors, will be beneficial to oil palm producers even as manufacturers seek a volume-led growth. Energy diversification: We believe producers will continue to derive the gains of energy diversification, including positive transmission to margin (through lower production costs) and the reduction of energy supply risk. Expansion drive: While it is clear that most expansion plans, particularly those related to fresh cultivation, require medium-to-longer term duration for visible impact given the long gestation period of the cultivated crops, we look for 2018-specific plans impacting positively on the performance of agriculture producers. 8
Risks Policy reversal: Two major policies are worth mentioning here: (1) the CBN s exclusion of importers of palm oil related products from its official FX window and (2) the 35% import tariff imposed on CPO imported from non-ecowas countries. Unfavourable weather condition: Agricultural activities are subject to weather conditions. For oil palm producers, in particular, excessive rainfall and/or high temperature are inimical to production and yield. Security threat: OKOMUOIL and PRESCO s operations (including plantations) are largely domiciled in the Niger Delta region of the country, where issues of security apprehension are common. 9