Spring 2016

SOUTH AFRICAN INTERVIEW: A buying opportunity, if anyone will listen

Paul ClarkPlunging commodity prices and fear of currency devaluations have led to outflows from African equity funds. It’s a shame, says Paul Clark of Ashburton, because today’s market offers a great buying opportunity. First, the bad news. Emerging market fund managers have seen something like a tenth of their asset base flow out in recent months. Paul Clark, a fund manager at Ashburton, says redemptions from his pan-African equity fund, though small, are happening on a weekly basis. The effect of these withdrawals, most of them coming from foreign investors, might be manageable if African countries had a pool of local capital to balance the outflows. But, outside South Africa, where Ashburton is based, local fund management industries are undeveloped. Plus, interest rates in many African countries are high, meaning existing capital tends to go into government bonds rather than local equities. The result is dispiriting for African equity investors. “There’s a dearth of buyers,” he says. Even South Africa, with its large and liquid capital markets, is struggling at the moment. The rand fell in value again after the country’s finance minister, Pravin Gordhan, failed to convince foreign investors in his budget on February 24 that the country could avoid its credit rating sinking to junk status. Clark, who is based in Johannesburg, seems wearily accepting of these misfortunes. South African governments have successively failed in allowing the country’s economy to reach its potential, he says, from the days of apartheid
to its current fiscal deficit. What is the best policy in these hard times? Contrary as it may sound, Clark’s suggestion is: buy more equities. Across the continent, he says, good companies are trading at prices far below their fair value. He even claims the holdings in his pan-African fund currently cost half what they’re worth. But if the valuations are so attractive, why are investors selling and not buying? CHEAP OIL
The main reason investors are shunning African equities is that commodity prices are at their lowest level in years. That matters because many of Africa’s biggest companies, from South Africa-listed mining firms to Nigerian oil and gas companies, are commodity exporters. In fact, so many are involved in commodities that African equities in general have gained the reputation of being a commodity play. With oil trading at as little as $30 a barrel recently, market wisdom says it is exactly the wrong time to buy African equities. Right? Wrong, says Clark. Although the continent’s largest stock market, the Johannesburg Stock Exchange, is populated with mining companies, elsewhere there are hundreds of attractive firms, from telecoms companies to breweries, which are not dependent on commodity prices for their profits. The continent as a whole is expected to grow more than 5% a year in the next five years, he says. A rise in commodity prices is “supportive of growth, but not necessary”. Another reason for holding back investment in Africa is perhaps more compelling: the currencies of two of the largest markets on the continent, Nigeria and Egypt, are seen to be too expensive and may have to be devalued. Indeed, Exotix Partners, an emerging markets investment firm, recently said a devaluation of the Nigerian naira by a quarter is “imminent”. Clearly, foreign investors would prefer to wait until after a devaluation before committing their money. Clark says devaluations probably are needed – however, he claims the threat of them is not in itself a reason to withhold investment. In Nigeria, a company such as Seplat Petroleum, an oil firm, is attractive in spite of a possible devaluation. Why? Because its income is all denominated in dollars. “If there’s a currency devaluation, revenues and costs are unaffected.” Meanwhile, in Egypt, Orascom Construction is an attractive choice, says Clark, because it is involved in infrastructure work in the Gulf countries, where its income is denominated in dollars. Despite the low oil price, many of these projects have not been cancelled. This is another firm that is insulated from a collapse, planned or otherwise, of its home currency. PRIVATE EQUITY
Contrary to the critics, Clark points to several positive signs in Africa that signal economic expansion and the potential for good returns. In September 2015, food maker Kellogg invested $450 million in a Lagos-based food distributor as part of a deal to expand its distribution network across West Africa. Choppies, a supermarket chain from Botswana, is expanding in Kenya, South Africa, Tanzania and Zambia. Banks and financial firms are all scrambling to gain a foothold in emerging African markets. In light of these positive signs, could there be another reason why investors have shunned African equities lately? One possibility is that private equity has swallowed up all the inflows. It is a common refrain in African investment circles that the public markets are too small and illiquid, and that the real growth is found by investing privately, either directly or through private equity funds focused on the continent. Clark agrees private equity can be attractive. Ashburton itself recently closed a private equity fund focused mainly on South Africa. However, he thinks private equity funds face challenges of their own.  For instance, the best private equity investments in Africa are thought to be among small-to-medium enterprises, many of them family businesses. “There you will find your juiciest ideas,” he says. The trouble is that deal sizes for these investments are in the region of $20 million each. Investors would prefer to do larger deals of, say, $100 million, but the large number of hopeful buyers chasing these big deals meant that “in that space, there may be some crowding out”.  Private equity investors therefore face a dilemma: pay over the odds for large deals, or accept the increased due diligence and organisation costs of investing in a multitude of smaller deals. To sum up, what should investors do? They can wait until commodity prices recover and Nigeria devalues the naira, two catalysts that would probably unleash a flood of money back into African equities. Or, if they are forward-looking, they could buy now while the market is cheap. ©2016 funds global mena

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