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February 5, 2024/FSDH Research
Nigerian Equities: Local bourse storm out of the blocks in January
Heading into the year, Nigerian equities traded at a fair discount to frontier market peers and long-run average PE ratio valuation, indicating an upside of c.12% for investors to tap into. Some major investor dynamics, newly appointed FBN Holdings Chairman, Femi Otedola announced significant purchase of shares in Dangote Cement which is estimated to be around N6.0bn. This drove the share price higher by 138.5% in January to close at N763/share, contributing to the outsized gain recorded on the local bourse. In addition, we note that following the rally recorded in H2-2023, we observed significant investor interest in the Nigerian equities market in January in bid to participate in the rally, driving prices across the bourse higher. Overall, the benchmark NGX-ASI set a record monthly gain of 35.3% to close January at 101,154.46 points, after retreating from a record closing high of 104,674.67 points (set on 29-January).
Unsurprisingly, the Industrial Goods sector closed January as the best performing sector as gains in DANGCEM (+138.5% m/m) and WAPCO (+14.3% m/m) drove the index higher by 107.9% in January. The Consumer Goods index (+24.3% m/m) and the Insurance index (+21.7% m/m) followed as investor interest in BUA FOODS (+40.5% m/m), UNILEVER (+26.0% m/m), AIICO (+35.0% m/m), and NEM (+30.2% m/m) supported their performances. We note that the buying interest in UNILEVER was supported by the company’s positive operating performance after it released an impressive unaudited FY-2023 result which showed Revenue and Net profit growth of 50.7% and 91.3% respectively. Similarly, BUA Foods released solid unaudited FY-2023 results showing Revenue and Net Profit growth of 74.1% and 22.1% respectively. In the Oil & Gas sector, persistent depreciation in the Naira continued to make SEPLAT (+33.1% m/m) an attractive opportunity for Nigerian investors, driving the Oil & Gas index northwards by 20.0%. In addition, SEPLAT announced mechanical completion of its ANOH gas plant, raising optimism that the first gas from the facility will come in 2024. Noteworthy to highlight, the company communicated in its 9M-2023 numbers that it expects dividends of $30.0 million from the plant when it is fully operational using conservative assumptions on oil price, gas price, and deferments. The Banking index closed January as the lone loser as a topsy-turvy month for banking stocks saw investors book profits across the sector driving the Banking index lower by 3.4% m/m with losses in UBA (-4.9% m/m) and ZENITH (-9.2% m/m) being key drivers.
Source: Investing.com, FSDH Research
Following the strong start to 2024 for Nigerian equities, the question that needs answering for most investors: “Is there anymore upside for investors to expect through the rest of the year and what factors can be expected to drive performance?”. The first point of call will be to consider the average valuation of Nigerian equities relative to its long-run average as well as peer average. The NGX-ASI currently trades at a PE ratio of 14.9x, a 13% premium to peer average of 13.2x (includes South Africa, Brazil, Egypt, and Morocco). In addition, the NGX-ASI PE ratio of 14.9x is a 23% premium to its long-run average of 12.1x. This indicates Nigerian equities are trading at a premium to both frontier market peers as well as long-run average.
Source: Bloomberg, FSDH Research
Source: Bloomberg, FSDH Research
Another key factor that will shape the Nigerian equity market in the coming months will be the direction of the interest rate environment. We expect the interest rate environment to climb higher in the months ahead largely influenced by sustained monetary policy tightening, and elevated government borrowing. The Monetary Policy Committee (MPC) of the apex bank is expected to sit on 26th and 27th of February with policy decisions expected to focus on exchange rate stability, curtailing money supply growth, and restoring price stability. On increased money supply, the Cardoso-led CBN appears focused on curbing the excessive money supply growth witnessed in the past years. In the prior eight years, broad money supply has grown at an eight-year CAGR of 20.2% to N78.7tn in Dec-2023 from N21.7tn in Jan-2015. The surge in the naira supply has contributed to the persistent pressure on the exchange rate which has worsened in recent months with the naira down 36.8% YTD. In addition, inflationary pressures continue to rise unabated with the outlook for inflation remaining concerning following persistent food price hikes and weakening exchange rate. We expect a confluence of these factors will force the MPC to raise the Monetary Policy Rate (MPR) substantially with the potential for upward revision in the Cash Reserve Ratio (CRR) requirements. We expect these policy moves will contribute to an upward shift in the yield curve with the largest moves at the short end of the curve (a bear flattening). Substantial increase in interest rates (across NT-bills and Bonds) will make these instruments much more attractive to investors, triggering outflows from equities to the fixed income market.
Source: CBN, FSDH Research
Another critical focus for equity investors in the next months will be the FY-2023 earnings season combined with the Q1-2024 earnings season. Evidence from the 9M-2023 earnings cycle coupled with the unaudited results released by some consumer goods firms and banks indicates the earnings season would be fairly good. For banks, they are expected to enjoy a boost to profitability via foreign exchange gains. However, most consumer goods firms are expected to face significant profitability pressures due to foreign exchange losses as well as upward pressure on costs. Meanwhile, in line with our expectations, downstream oil & gas businesses are unlikely to enjoy the benefits of higher fuel prices due to surging costs and FX losses. However, companies in the industrial goods sector (particularly the cement producers) are likely to be bright spots due to their ability to dictate price, thus allowing them to pass through higher costs fully to the consumer. Overall, while we expect earnings growth to be strong on average, we are concerned that current prices may not justify the amount of cash distributions (in form of dividends) to shareholders. On average, Nigerian investors consider a dividend yield of >10% attractive enough to hold on to a stock upon announcing full year results, and when such expectations are not met, they tend to book profits by disposing the stocks.
Beyond FY-2023 numbers, investors will begin to price in expectations for 2024 earnings performance in their investment decisions. Our first concern on that front is the CBN’s policy guidance requiring banks to maintain a Net Open Position (NOP) that is not more than 20% short or 0% long of the bank’s shareholders’ funds. This piece of regulation restricts banks’ ability to take advantage of further downward volatility on the naira which was a major driver of profitability in 2023. That said, we note that i) banks with international subsidiaries may opt to sell their excess foreign currency positions to their international subsidiaries where they expect further weakness against the dollar ii) Q1-2024 numbers will receive a boost for the recent devaluation in January. Post-Q1, we expect to see some normalization to the earnings of Nigerian banks. For other sectors (particularly consumer & industrial goods), we are concerned that persistent weakening of consumer purchasing power and unabating inflation could weaken profitability in 2024. Furthermore, the recent devaluation of the naira in the official window will cause a number of these firms to incur further FX losses while raising the cost of purchasing raw materials. Overall, current macroeconomic evidence suggests the outlook for 2024 earnings performance is bleak.
Another factor to watch will be if recent policy decisions on exchange rate could possibly attract foreign investors back into the Nigerian equity market. First, the devaluation of the Naira to c.N1,400$ levels in January bodes well for attracting foreign investors back to Nigeria as at this level, the naira could be perceived as undervalued. In addition, the devaluation could lead to improved turnover at the official window (turnover post the devaluation has averaged $195.7mn, 72% higher than 2023’s average). Furthermore, the decision of the CBN to scrap discretionary CRR debits is expected to increase the frequency of Open Market Operations (OMO). This, combined with the possibility of a large rate hike in the upcoming February meeting which would drive OMO rates higher could be a key attraction for foreign investors. However, given FPI flows tend to come with a one-year horizon, we expect some investors to stay away due to lack of guaranteed access to liquidity when they need to repatriate imported capital. That said, should the CBN announce an aggressive upward adjustment to the MPR, we could see improve FX inflows, particularly as the naira is now trading at an attractive level to the dollar. However, the question left unanswered is if we would see some of these improved flows come to the equities market. From existing evidence, we do not expect to see a substantial improvement in FX flows to Nigerian equities for these reasons i) attractive OMO rates would likely keep FPIs focused on enjoying the carry trade opportunity on higher naira yields ii) the elevated valuation of Nigerian equities could be a deterrent to interested investors. Overall, our position is we expect foreign investors to continue to stay away from the Nigerian equities market.
Source: FMDQ, FSDH Research
Given the factor drivers discussed, we expect bearish sentiments to dominate the Nigerian equities market going forward. We particularly expect investors to begin aggressive profit booking from March (post FY-2023 earnings cycle). The possible interest rate hike at the end of February combined with the full swing of earnings season in March play perfectly into a strategy to sell equities and rotate portfolios to fixed income instruments in March. As a result, given the elevated valuation of the NGX-ASI as well as upcoming event triggers, we recommend investors increase the pace of reducing the equity exposures, retaining stocks with high conviction to deliver >10% dividend yield.
Global Equities: Optimism on global growth prospects outweigh Middle East jitters
The global equities market started 2024 on a positive note on optimism about global economic growth prospects and anticipation of more accommodative monetary policy through 2024 outweighed jitters from the ongoing middle east tensions. Consequently, the MSCI All-Country World Index (MSCI ACWI) gained 0.5% m/m in January.
In the US equity market, all the major equity indices ended the first week of the year in the red as investors were unmoved by profits following nine consecutive weeks of gains from 2023. Rising yields in the treasury market combined with tensions in the Middle East (which investors worried would impact oil prices and the global supply chain with a consequent negative impact for inflation) gave investors further impetus to reduce their equity exposures triggering a poor start to the year. However, sentiments rebounded through the month with major equity indices recording three weeks of consecutive gains for the rest of the month. Despite the higher-than-expected inflation print for December (headline inflation rose 3.4% y/y and 0.3% m/m), investors took comfort in the fact that several components of the basket were in deflation with higher demand for food in December likely the driver of higher food prices in the headline basket (core inflation was down to 3.9% in Dec-2023 from 4.0% in Nov-2023). Furthermore, the Fed’s preferred gauge of inflation, the Personal Consumption Expenditure index (PCE) fell to 2.6% in January. Positive news on the economic growth front further boosted optimism as data from the US Commerce Department showed that the US economy grew at an annualized rate of 3.3% in Q4-2023, faster than economist’s expectation of 2.0%, albeit slower than the 4.9% recorded in Q3-2023. The strong rate of growth in Q4-2023 showed investors that the US economy remains very resilient as consumer spending remained strong while government spending recovered reinforcing belief that prosperous times await the US economy in 2024 particularly as the US Fed begins to cut rates during the year. While the outcome of the US Fed meeting where the monetary policy setting committee opted to maintain status quo attempted to derail markets (with Jerome Powell seemingly pushing against rate cuts starting from March and highlighting the need to see a definite pathway for inflation to fall back within target), a positive start to the Q4-2023 earnings season roused investors, keeping sentiments positive. Overall, the tech-heavy NASDAQ 100 (+1.9% m/m), S&P 500 (+1.7% m/m), and DJIA (+1.2% m/m) all closed the month positive while the small-cap Russell 2000 (-3.9% m/m) closed in the red.
Source: Investing.com, FSDH Research
European markets started 2024 mostly in buoyant mode as the pan-European STOXX 600 gained 1.4% m/m in January. Despite the seemingly positive start to the year, January kicked off on a bearish note for European equities as optimism on the European Central Bank (ECB) commencing rate cuts in March waned while Euro Area inflation data showed inflation picked up in December, rising to 2.9% from 2.4% in Nov-2023. The negative inflation data fueled the suspicion that the ECB will prolong its hawkish policy stance. European equities received a major boost after the ECB opted to leave rates unchanged in its January meeting while providing a somewhat dovish outlook on future policy decisions. Furthermore, the ECB President, Christine Lagarde noted in an interview that interest rates in the Eurozone are likely to have peaked barring any supply-side shocks with a more positive outlook on inflation. Despite the positives on monetary policy direction, growth outturns in Germany in which preliminary estimates indicate the German economy contracted by 0.3% in 2023, concerned investors. Overall, key indices in France (CAC 40) and Germany (DAX) gained 1.5% and 0.9% respectively in January. In the UK, concerning data on economic growth (economy grew 0.3% m/m in Nov-2023 but three-month average output contraction of 0.2% raised recession concerns) and inflation (Dec-2023 inflation rose to 4.0% for the first time in 10 months) swayed investors causing negative sentiments to persist as the FTSE 100 lost 1.3% m/m.
The general landscape for the US equity market continues to remain positive, particularly after a fairly bullish start to the month. Looking ahead, we continue to see further opportunities for long term investors to reap the benefits of retaining exposure to the US equity market. First, the biggest driver of the US equity market performance in the next months will be the monetary policy pathway of the US Federal Open Market Committee (FOMC). In line with our expectations from last year, we expect the FOMC to begin its expansionary monetary policy cycle at its June/July meeting. Contrary to prior consensus expectation of March, the US Fed’s chairman’s speech at the January FOMC meeting indicated the committee will not cut rates too fast, waiting for strong evidence of a pathway towards stable inflation. As a result, consensus expectation is now that the Fed will begin cutting interest rates from May with a 93.8% probability (34.2% probability of a 50bps cut and 59.6% probability of a 25bps cut) according to the CME Fed Watch Tool. The CME Fed Watch Tool predicts a 62% probability of maintaining the status quo at the May meeting. Overall, we think it is a matter of “when” and not “if” the FOMC will adopt a dovish policy stance in the coming months as long as there are no supply side shocks. This bodes positively for the US equities market.
Complementing monetary policy expectations, the US economy continues to remain resilient. As highlighted earlier, the US economy grew at an annualized rate of 3.3% in Q4-2024, shrugging off concerns around the impact of rate hikes. The economy continues to rely on a strong consumer base as consumption spending strengthens (which is upheld by strong wage growth, increasing personal income, and record low unemployment rates). Expectations are that as the FOMC begins its expansionary monetary policy cycle in 2024, business investment will also improve, contributing further to an already resilient economy. We think this bodes well for corporate earnings performance in 2024.
Overall, we remain bullish on US equities. We also expect the bullish sentiments to be broad based and could be particularly favourable for small-cap stocks that have been under the cush in the past weeks. For context, the Russell 2000 index (a benchmark for small-cap stocks) currently trades at a PE ratio discount of 20.7% to its long-run average. This sets a potential opportunity for small cap stocks to outperform in a period of economic expansion and lower interest rate expectations. That said, we also expect companies with a solid history in the technology sector and companies in the Dow Jones Industrial Average to perform admirable amidst our economic expectations. As a result, we recommend a diverse portfolio across the cap tiers of the US equity markets while investors with higher risk appetite can construct portfolios with a bias for the small-cap factor.
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