Effects of China Volatility on Kenya, & Cytonn Weekly Report #3

By Cytonn Research Team, Jan 24, 2016

Cytonn Weekly

Executive Summary

  • Fixed Income: Yields on government securities were on an upward trend for the eighth week, indicating a rising rate environment. The Monetary Policy Committee met during the week, retaining the CBR and KBRR at 11.50% and 9.87%, respectively;
  • Equities: The market performance was on a downward trend this week, with the NASI, NSE 20, and NSE 25 indices declining 3.8%, 2.4%, and 3.3%, respectively. Uchumi shareholders approved a resolution to seek an investor to inject Kshs. 5 bn into the company;
  • Private Equity: The financial services industry and FMCG remain attractive for investment due to good returns and favourable demographics;
  • Real Estate: NCA halts construction of noncompliant buildings in Kiambu as 50,000 buildings in Nairobi face demolition over lack of construction approvals. We are collecting data from the various neighborhoods in Nairobi and the Nairobi Metropolitan satellite towns and shall be releasing research notes as we progress towards more comprehensive and thematic research reports. We have started with a research note on Kilimani. Kilimani Research
  • Focus of the Week: China?s equities market slump in 2016 sends ripples across global markets. Are we at the beginning of another global crisis?

Company Updates

  • This week, we started our Middle East road show where our Head of Private Equity Real Estate, Shiv Arora shall be meeting with leading global private equity players. We continue to build and enhance our partnerships with global and local players
  • Our Investment manager, Maurice Oduor discussed the performance of the Kenyan Banking Industry and the Kenyan economy. Maurice Oduor on CNBC Africa
  • Our Senior Investment Analyst, Duncan Lumwamu discussed performance of the shilling and the acquisition of Credit Bank by Fountain Enterprises Programme (FEP). Duncan Lumwamu on CNBC Africa
  • Informed by the rapid growth at Cytonn, we have kicked off a search for a Director of Finance & Administration. Careers at Cytonn
  • We continue to beef up the team with other on-going hires: Careers at Cytonn

Fixed Income

This week?s T-Bill subscription rate decreased from 183.8% last week to 143.0% this week, but remained high as a result of increased demand for government securities due to (i) high liquidity in the money market as a result of high T-bill maturities of Kshs 19.4 bn, and (ii) investors? appetite for short-term instruments as opposed to longer dated bonds as they anticipate upward pressures on rates. This subsequently led to the yields on T-bills continue on the upward trend, with the 91, 182 and 364-day papers coming in at 11.8%, 14.2% and 14.9%,  from 11.4%, 13.7% and 14.3%, respectively, last week.

The 2-year and the 10-year (reopened) bonds offered last week were oversubscribed with overall subscription coming in at 103.8%. The 2-year bond attracted more offers worth Kshs. 30.4 bn compared to Kshs. 5.9 bn for the 10-year (reopened) bond, as investors preferred short-term instruments due to the uncertainty of the interest rate environment and since on a risk adjusted basis the 2-year bond is very attractive compared to the 10-year. The yields for the 2-year and 10-year (reopened) bonds came in at 15.8% and 16.1%, respectively, versus our yield recommendation on our Cytonn Weekly Report #2, of between 14.0% - 14.5% for the 2-year bond and 15.0% - 15.5%. Of keynote from these bond results are:

  1. Investors are demanding a significant premium due to the uncertainty surrounding the interest rate environment, which will lead to a flat and/or inverted yield curve,
  2. The Government confirmed the uncertainty in the interest rate environment, by concentrating their borrowing to shorter duration instruments, such as the 2-year, where they accepted Kshs 30.4 bn, compared to accepting Kshs 5.9 bn in the 10-year ? a bias to shorter durations indicates that even the government is uncertain about the rate environment,
  3. All amounts borrowed in the bond offerings were used to pay off redemptions, resulting into a net borrowing of only Kshs 2.3 bn, which limits borrowing available to divert to infrastructural projects rather than recurrent expenditures, and
  4. The Government is in need of funds as evidenced by their continued acceptance of expensive money in the market; this hunger for funds may have negative economic impact due to the crowding-out of the private sector.

Despite the improved liquidity, the Kenya shilling was stable during the week, closing at Kshs. 102.3 to the dollar compared to Kshs. 102.4 last week. There is still considerable support for the shilling, with forex reserves standing at 4.5 months of import cover. However, the downside risk remain significant given the current account deficit and budget deficits. In the long-term, the key to stabilizing the shilling is by improving dollar receipts through manufacturing / import substitution, driving tourism, and more exports.

The monetary policy committee (MPC) met during the week and made the decision to retain the CBR and the KBRR at 11.50% and 9.87%, respectively. The decision was as a result of stable macro-economic environment since despite an increase in inflation this was largely due to one-off changes in tax and transitory El-Nino effects affecting food prices. The currency remains stable despite rate increases in the US.

The decision by the MPC to retain the CBR at 11.50% was expected but not for the KBRR. The KBRR is a function of the CBR and the 2-month moving average of the 91-day T-Bill, which brings the value at 10.76%.  We believe the CBK retained the KBRR so as to protect the consumers from higher borrowing costs, as banks would have re-priced their loans upwards. Going forward, CBK indicated that they will be re-working the formula for calculating KBRR, and also establishing enforcement mechanisms to ensure the rate is adhered to by commercial banks. We do not believe that CBK should get involved directly in the business of pricing loans as Kenya is an open market economy and CBK is not in the business of loan risk underwriting or pricing. However, this is not to say that CBK should not be concerned with the huge interest spreads in the Kenyan banking sector, they should. Their focus should be around market structure issues such as increasing competition in the banking sector by encouraging alternative products to compete with banking products, supporting small banks to compete with the big banks, opening the sector to international players ?anything to increase competition in the banking sectors, but not to get directly involved in loan pricing. But even if CBK were to get into enforcing loan pricing, Kenyan banks are very skilled at protecting their margins - the banks will find a workaround. Finally, given that government is borrowing at about 16%, a proxy for risk free rate, then loan costs of about 18 to 20%, which are premiums of 2 to 4% above government cost of borrowing, do not appear unreasonable. What we believe is unreasonable are the low rates of interests banks pay their depositors, and only the depositors can take appropriate actions by re-pricing their deposits upwards.

The Government is now slightly behind on its domestic borrowing programme target, having borrowed Kshs 121.0 bn for the current fiscal year compared to a target of about Kshs 127.8 bn, (assuming a pro-rated borrowing throughout the financial year of the budgeted Kshs 219 bn of total domestic borrowing for this year). Most of these borrowings are short-term instruments that mature within the current fiscal year and the Government will face pressure in refinancing the obligations as they mature especially in the first quarter of 2016. As a result, we maintain our view that investors should be biased towards short-term fixed income instruments given the uncertainty in the interest rate environment.


During the week, the market registered declines, with the NASI, NSE 20, and NSE 25 indices declining 3.8%, 2.4%, and 3.3%, respectively. This was on the back of declines in Safaricom, Barclays, EABL and Equity Bank that fell by 6.2%, 5.2%, 3.8% and 3.8%, respectively. On a YTD basis, the three indices are already down 6.3%, 7.3%, and 3.3%, respectively.

Equities turnover increased by 15.0% during the week to Kshs 3.3 bn from Kshs 2.8 bn the previous week. Foreign investors were net sellers, with net outflows of USD 0.4 mn, compared to net inflows of USD 102.4 mn the previous week.

The market is currently trading at a price to earnings (PE) ratio of 12.9x, versus a historical average of 13.8x, and with a dividend yield of 4.1% versus a historical average of 3.3%. The charts below indicate the historical PE and dividend yields of the market.

TransCentury is at a split-road on how it will fund a Kshs 8.1 bn dollar-denominated convertible bond that matures on March 25th 2016. The debt is more than three times the company's market capitalization of Kshs 2.4 bn. The proceeds of the bond were invested in Rift Valley Railways (RVR) but has failed to generate profits, and the company now seeks to raise the entire amount of the debt. The NSE-listed firm first aimed to raise money for the debt through a rights issue in December 2015, but a weakening of the shilling and the erosion of TransCentury's share price from Kshs 50 at the time of offer to Kshs 7 as at the close of the week, made the company abandon the plan. There are two options available for TransCentury:

  1. Seek a strategic investor who will pay off the loan amount and take over operations. In our view, this will be a positive for the firm, especially given the resignation of its CEO, Dr. Gachao Kiuna. Of Key interest to an investor, TransCentury currently has a Power Infrastructure and Engineering division (which contribute 65.0% and 35.0% of their revenue, respectively) and investments in Cable Holdings (which owns 68.4% of EA Cables) and TransCentury Mauritius Holdings of Kshs. 3.4 bn and Kshs. 3.8 bn, respectively. The Power Infrastructure Divisionis a leading manufacturer of electrical cable and transmission equipment in East, Central and Southern Africa while in the Engineering division they deal with (i) Mechanical Engineering, (ii) Civil Engineering, (iii) Logistics, (iv) Cranage & Erection Services, and (iv) Industrial Equipment. A strategic investor will (i) need to provide guidance on investment decisions, (ii) revamp management, and (iii) pay off expensive obligations that the firm holds. We view the likelihood of getting a strategic investor as extremely low given the extremely high debt levels.
  2. The other option is to default on the loan. Defaulting is far cheaper, and most likely the better option for the firm, but it will turn the bondholders into shareholders. This will be negative for any new shareholders in the company, as the company is struggling financially, and reported a loss of Kshs 1.98 bn in 2014, and Kshs 676.1 mn in the half-year to June 2015.

Uchumi Supermarkets Ltd finally received their shareholders? approval during their AGM to source for investors to inject Kshs 5 bn into the company. Uchumi plans to create an additional 1 bn shares to accommodate the new investor, which will more than double its current authorized shares of 900 mn units. They expect to use Kshs 2 bn from the funds to settle expensive bank loans and another Kshs 2 bn to pay outstanding supplier debts while the remainder of the funds will be spent to fund a turnaround plan that involves opening 1,000 mini shops and 200 express shops under a franchise model. In December they had received another Kshs 500 mn short-term loan from KCB to stock up their shelves ahead of the Christmas festivities.

This move to raise extra Kshs 5.0 bn, will in effect dilute the current shareholders by at least 62.5%, whose value stands at Kshs 3.0 bn of market capitalization. In our view:

  1. This new strategic plan to open up mini and express shops will enhance a presence for Uchumi and drive sales,
  2. This is positive for current shareholders. Despite the dilution which they will face of 62.5%, the additional Kshs 5 bn injection is vital to unlock value in the retail chain, which otherwise is running out of options to finance their strategic turnaround, and stores risk of closing if a source of finance is not secured.

We are currently reviewing the Uchumi model and we shall give a recommendation based on 2 scenarios. (i) If they get a strategic investor to inject the Kshs. 5.0 bn capital, and (ii) if they fail to get one.

We remain neutral on equities given the low earnings growth prospects for this year. The market is now purely a stock picker?s market, with few pockets of value.

all prices in Kshs unless stated




Price as at 15/01/15

Price as at 22/01/15

w/w Change

Target Price*

Dividend Yield

Upside/ (Downside)**






























Standard Chartered




































Kenya Reinsurance






















































CIC Insurance









CfC Stanbic









Jubilee Insurance









Pan Africa

















**Upside / (Downside) is adjusted for Dividend Yield

Accumulate ? Buying should be restrained and timed to happen when there are momentary dips in stock prices.

Lighten ? Investor to consider selling, timed to happen when there are price rallies

Data: Cytonn Investments


Private Equity

Fountain Enterprises Programme (FEP) is set to acquire a controlling stake of 75% in Credit Bank. The deal is valued at Kshs 4 bn, and with their book value at Kshs 1.3 bn, the transaction is being conducted at a Price to Book Value (PBV) of 4.1x, and only awaits regulatory approval from the Central Bank of Kenya. This comes on the heels of the third tier bank?s search for a strategic investor last year where FEP Holdings acquired a 5% stake at a PBV of 3.1x. Credit Bank plans to use the entire capital injection for expansion. This deal highlights:

  1. The expensive price at which FEP is looking to buy into Credit Bank, at a 4.1x book multiple, is more than twice the current market price of 1.6x price to book for banks. FEP must have badly needed a bank for strategic reasons to pay such ridiculously expensive price,
  2. Credit Bank needed a capital injection desperately, as their Total Capital to Total Risk Weighted Assets ratio is at 15.1%, only 60 bps above the 14.5% statutory requirement,
  3. Kenyan Banks are responding to the calls for more consolidation in the banking industry, which has not materialized, and,
  4. Small banks such as Credit Bank have responded by seeking strategic investors to beef up their capital base, expand their loan book and open new branches.

The West Africa Emerging Markets Growth Fund (WAEMGF) acquired a stake of more than 15% in First Atlantic Bank Ltd Ghana (FABL). First Atlantic?s total assets were 894.6 million cedi (USD 230 million) as of 2014 and the deal will enable the bank to strengthen its capital and finance its expansion strategy of opening new branches and enhancing its technology platform. The deal illustrates the attractiveness of the financial services industry in Africa majorly driven by (i) increased demand for credit from the population as well as from small and medium enterprises, (ii) room for growth due to low levels of financial services inclusion in the region, and (iii) attractive returns generated by financial services companies.

Real Estate

Nairobi City County has identified 50,000 buildings that risk being demolished as a result of lack of construction approvals. They have given the developers a one-month notice to comply or face demolition. Many of the buildings that are constructed in Nairobi are not planned for, or regulated by City Hall as they do not have construction or building permits. Noncompliance is caused by several factors, key among them being:

  1. High levies charged by City Hall such as the EIA levy which has a floor of 0.1% of project cost and no ceiling as well as the construction cost permit which is 0.5% of project cost,
  2. Time taken to get the approvals also discourages developers from applying for the permits as it can take more than a month to get a building plan approval,
  3. Bureaucracy involved in the process discourages developers from applying for the permits,
  4. Requirement to own a title deed in order to apply for and receive building permits while most people have certificates of ownership or share certificates from companies, and
  5. City Hall and the other bodies in charge of regulation such as NEMA have also not been stringent in the enforcement of these regulations.

The condition is replicated in other counties with NCA halting noncompliant construction in Kiambu after a random survey showing that only 10% of buildings under construction were compliant with the health and Service Act 2007. This increased vigilance by NCA and NEMA will result in better-planned buildings and hence safer for occupation reducing incidences of buildings collapsing. The higher costs of construction will however be passed down to buyers who will pay more for the buildings.

East Africa has been marked as one of the regions that will steer Africa?s growth. According to Deloitte?s Africa Construction Trends Report 2015, the region has seen robust infrastructural development with Kenya recording the highest number of projects, followed by Ethiopia. The report tracks projects valued over USD 50 mn, which are underway as of June each year but have not been commissioned. Transport, Energy and Power are the main infrastructural developments taking place in the region contributing to over 80% of the projects under construction. On the back of these, there shall be increased interest in land and property, as investors seek to cash in on areas with good transport network and reliable power connections. Some of these projects in Kenya include development of the East Africa Railway and the Standard Gauge Railway that will run from Mombasa to Malaba. Completion of these projects is likely to open up previously inaccessible areas. Speculative developers are likely to purchase land in these regions with a bid to construct or sell in future.

In addition to transport, energy and power, the construction sector has expanded incorporating sectors such as real estate. According to the report, Kenya and Tanzania are experiencing growth in retail, entertainment facilities, modern office parks, and hotel space developments. In Kenya, we have witnessed construction of large scale malls such as Two Rivers in Ruaka, the Hub as well as modern office parks in Karen, Riverside, Parklands and other areas in the last year. Some of the factors that have contributed to these include i) a growing middle class, ii) high yields from retail property rentals, iii) technology innovation, and iv) increased Foreign Direct Investment.

We are collecting data from the various neighborhoods in Nairobi and the Nairobi Metropolitan satellite towns and shall be releasing research notes as we progress towards more comprehensive and thematic research reports. We have started with a research note on Kilimani;

Kilimani is one of Nairobi?s prime residential and commercial areas. The area comprises of a lot of mixed use developments and the area has a rich cultural mix given that its population consists of individuals of both local and foreign decent. Kilimani has a lot of real estate activity still going on with a host of new developments still under construction such as the FCB Mihrab, despite the high land prices in the area average at Kshs 400Mn per acre.

For Mixed Use Developments (MUD) in the Kilimani area:

  • The office component has an average of 88.7% occupancy rate and an average rental yield of 9.8%. This is similar to the general office yields in the area.
  • The retail component has an average yield of 7.5%, and the average yield for an MUD is 8.65%.
  • At an average sale price of KES 150,308 per sq. m., un-serviced apartments generate an average yield of 5.8% compared to 7.2% for serviced apartments. Hotels on the other hand generate an average yield of 7.7% at an average occupancy rate of 59%.

Given Kilimani?s relatively high land prices and increasing population density, a vertical mixed use development would be the most viable development in the region. A well thought out development mix would serve to maximize overall returns and given the current development trends, excellent architectural designs would be the ultimate pull factor in the region. Ample parking space is also necessary to serve the high traffic expected within the development. Another key point of consideration is road frontage and a development would do well with an extended high traffic frontage, most preferably along the Argwings Kodkek road.  For the comprehensive Kilimani report, see our Kilimani Report

Effects of China on the Global Financial Markets

The year 2016 has turned out to be one of the worst starts for global financial markets in at least two decades. This has been brought about by volatility in China economy and financial markets, which have led into plunging oil markets.

With regard to China, we have witnessed the following:

  • The slowdown in Chinese economic growth, which is estimated to come in at 6.5% for the year 2016 from 6.9% in 2015, and 7.3% in 2014. In addition, China is meant to be in a transitory phase, where they move from an export led economy, to one based on services, and the government will also stop interfering in markets. However, with a Chinese economy still expanding at 6.5% - 7.0% over the next 10 years, it will create an economy almost twice the size of the current one. As such, as much as investors are wary on the China market slowdown, there is still above average growth in their economy,
  •  At the start of the year, the Chinese Government devalued the Yuan by 0.5%, spreading fears across the markets that (i) China's growth potential is worse than investors think, and (ii) adding questions to China on why they are still interfering artificially with markets,
  • (iii) This led to a selloff in most global markets, with the Shanghai Composite dropping by 7% in 2 out of the 5-days trading, which led to the exchange being closed both times.

In oil markets, there has been continued decline in oil prices, with declines of nearly 20% since the start of the year, from USD 37 per barrel at the start of the year, to current prices at USD 30 per barrel. This has been brought about by:

  1. The decline in oil consumption owing to slow down in China?s industrial sector, and,
  2. The desire by members of the Organization of the Petroleum Exporting Countries (OPEC) to price out high cost shale oil producers in the US and Canada.

It is such unfolding events in the global economic environment that resulted into this foul start into the year 2016, which has had adverse effects on the stock markets, with all major indices reporting heavy losses YTD in 2016, as can be seen below:

This has made investors wonder as to whether the global dependence on China will be the start of a looming global financial crisis. In addition, the most affected economic area is the Eurozone, which depends on China as one of the largest sources for manufactured capital goods. To add to the misery for global markets, the correlation between the S&P 500 in the United States, and Stoxx 600 in Europe is now at 0.62, a very high level making it difficult for investors to diversify away from a market and avoid losses.

China?s importance to global markets?

China is the world?s largest economy by population, with 1.4 bn people, the second largest economy by Gross Domestic Product (GDP) at USD 10.4 tn compared to 17.4 tn in the US and has the second largest equities market capitalization after the US, at USD 5.8 tn, compared to USD 16.8 tn in the US. Despite this, China is still considered an emerging market. However, China?s importance to the global economy is not little by any standard, especially towards global growth. A recent report by the IMF estimated that for a 1% decrease in China?s investment growth could reduce global growth by 0.1%, 5 times greater than in 2000, showing the increased global dependence on China.

China has been the engine of global growth since the last global financial crisis of 2008, growing at above 7.5% for the last 7 years. However, last year, the growth slowed to 6.9%, owing to China?s shift towards a more services led economy pegged on consumption from its export-based economy. This slower expected growth is putting a strain on the leadership of the country, that is trying to cut production capacity that currently exceeds demand as a result of credit driven over-investment in the past decade, while still ensuring the minimum growth of 6.5% required to achieving a well off society by 2020. In addition, Chinese industrial sector is the largest global consumer of commodities and raw materials hence a slowdown in growth dampens worldwide demand, putting further pressure on the price of commodities, including oil and copper. 

Can the situation be rectified?

Despite renowned analysts such as Larry Summers, and hedge fund manager George Soros stating that we are headed for a repeat of the 2008 financial crisis, all is not lost as the contagion effect of China is yet to spread full-blown to other markets. The Chinese government has already put in place a number of policy tools aimed at curtailing the market turbulence, including the abolishment of the 7% circuit breaker on the CSI 300, the main equity index, and extending the short sale ban on large shareholders of companies to discourage speculation.

In addition, Chinese policy makers can implement demand-boosting policies. These include i) cut the Reserve Requirement Ratio from the current 18% for large banks to ensure adequate liquidity in the money market, and (ii) cutting the Central Bank Rate from the current 4.35% to boost growth organically and support the services sector.

What about the effect on Kenya?

For the year 2016, a lot of growth is expected in Sub-Saharan Africa but more so in East Africa. In 2016, SSA is expected to grow at 4.4%, while East Africa is expected to grow at 6.1%, highlighting the importance of the region towards Africa?s growth.


2016e Growth (%)

East Africa only


Sub-Saharan Africa without South Africa


Sub-Saharan Africa (SSA) as a whole


Sub-Saharan Africa without East Africa



Kenya, being part of the global financial system is also not completely oblivious to the happenings in China. This is due to the following factors:

  1. Given that China is one of Kenya?s largest trading partners, a slowdown in China will affect the bilateral trade between the 2 countries.
  2. The extra-perceived risk of emerging markets will also reduce global investor appetite for securities in frontier markets like Kenya.
  3. With Kenya?s Eurobond debt, increased infrastructure spending, a large though declining current account deficit at 6.9%, coupled with little focus on export policies, Kenya is quite exposed to external shocks such as the current China induced global markets volatility.
  4. Though Kenya?s debt to GDP ratio is not unsustainable at 54%, the country?s foreign debt service is high as a percentage of exports, given interest payments of USD 182 mn in the Eurobond debt. Any additional borrowings will be expensive given the yield on the Kenyan Eurobond is currently approaching 10%, way above the 6.6% at the time of issue.

In summary, Kenya is now very exposed to external shocks such as the recent China induced global markets volatility. External shocks are disruptive to stable and sustainable growth, and yet stable and sustainable growth over long periods of time is necessary to change standards of living in any country. In order to ensure stable and sustainable growth, Kenya should increase its preparedness for external shocks. Given increasing dependence of foreign borrowings, including the existing Eurobond, we are now very exposed to external markets financial conditions, which are currently difficult. The precautionary IMF standby facility of Kshs 688 mn is not sufficient to weather external shocks. We need to focus on a whole lot of other avenues such as (i) spurring domestic demand, (ii) improving the ease of doing business so as to attract more FDI, (iii) focussing on export driven manufacturing, (iv) fiscal discipline by reducing spending and rationalizing infrastructure spending and investments, (v) reducing public finances mismanagement and corruption. All these actions will improve the country?s flexibility to react to external markets shocks.

Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.