March 17, 2021/InvestmentOne Report

Recently, the National Bureau of Statistics released the inflation figure for the month of February 2021 which further showed the pressure on consumer prices as the headline inflation hit a 4-year high of 17.33% from 16.47% in January 2021. In the same vein, the index rose by 1.54% on a month on month (m/m) basis, faster than 1.49% recorded in January 2021.

·         The food sub index remained the main driver of the uptick in headline inflation. The sub index rose by 21.79%y/y, the highest in over 10years, as challenges associated with food supply chain persisted. In the same vein, the index rose by 1.89% m/m faster than 1.83% recorded in January 2021.

·         The core sub index rose by 12.38%y/y in February 2021 from 11.85%y/y in January 2021 as FX related challenges remained. The index also increased by 1.21% on a month on month basis, lower than 1.26% recorded in January 2021.

·         Going forward, we believe food sub index may maintain its fast uptrend on the back of the escalating insecurity in the country as farmers vs herdsmen crisis persists. We still maintain our view on the exemption of items like rice, flour, sugar and cement from the list of liberalized items under the African Continental Free Trade Area (AfCFTA). We believe some of the benefits associated with the agreement in terms of competition, which may cause prices of these items to fall, may not be realized. This may outweigh the positive impact of the recent reopening of land borders. As such, we think prices of these items may remain sticky and by extension put pressure on headline inflation.

·         Despite the recent stability in PMS price, we think it is only a matter of time before the current PMS price is adjusted to reflect the current rally in oil prices (Brent is up 33%YTD). In line with the removal of subsidy embarked upon by the Federal Government in 2020, we expect changes in key variables that determine the PMS , Brent oil price and Exchange rate, to always warrant the need to adjust PMS price accordingly. With the recovery in Brent oil price and further depreciation of Naira at the IEFX window, we think this adjustment in PMS price is necessary to reflect the current reality in the downstream business on PMS. As such, we expect PMS prices to be adjusted accordingly as soon as the Federal Government reaches an agreement with the labour union.

·         In the same vein, with the possibility of increase in electricity tariff as well as continuous pressure in the nation’s FX market, we expect prices of the core items to increase further in the near term.

·         Overall, we expect inflation to remain high for a while before slowing down due to high base effect. On the average, we have adjusted our base case inflation expectation to around 17% (from 15%) in 2021 higher than the average of 13.20% in 2020.

·         Despite the recent increase in rates in the Fixed Income markets, we think real return may still remain negative in the near term as the FG and CBN are keen on keeping Debt service and cost of borrowing within control. Nonetheless, the continuous increase in headline inflation may force investors to demand for higher rates in the next bond and NTB auctions.

·         With the real return in FI instruments expected to remain negative, we believe investors will still be cautiously attracted to some quality names, especially those with decent dividend yields, in the equities market. While the economy is expected to return to positive growth in 2021, we are of the view that recent devaluation may attract FPI inflows into the equities market. From valuation standpoint, we believe NSE-ASI, with P/E ratio of 14.58x, is still undervalued compared to Emerging market with P/E ratio of 24.63x.  Overall, we expect investors to still buy some quality names as we await more corporate actions from some companies in the near term.