By Cytonn Research Team, Apr 16, 2017
Fixed Income: T-bills were oversubscribed for the 11th consecutive week, with overall subscription coming in at 117.3%, compared to 149.5% recorded the previous week. The 182-day paper was not on offer for the 6th week in a row, as the government aims to spread maturity concentration risk across the three papers. Meanwhile, the National Treasury has ordered the tax and duty-related provisions of the Finance Bill 2017 into effect even before the Bill passes into Law;
Equities: During the week, the equities market recorded mixed trends with NASI and NSE 25 gaining 1.6% and 0.4%, respectively, while NSE 20 lost 0.1%. The High Court withdrew the Motor Insurance Underwriting Guidelines of 2009 issued by the Insurance Regulatory Authority (IRA), thus stopping IRA from setting the industry premium rate for motor segment;
Private Equity: Activity in the private equity space continues to gain traction based on investments, fund raising and exits registered during the week as, (i) Synergy Private Equity Fund achieved its 9th investment by completing its investment in Northstar Finance Services Limited, (ii) Frontier Investments Management raised USD 116.0 mn in the first close in its second fund, Frontier Energy II, and (iii) Mediterrania Capital and AfricInvest successfully exited Grupo San Jose & Lopez (SJL);
Real Estate: Kenya ranked as the third most preferred travel destination by the high net worth individuals (HNWI) in Africa in 2016, surpassing world famous Mauritius and Seychelles. The World Bank has pointed to low or informal incomes, combined with high financing costs as the key factors limiting supply of affordable housing in Kenya. Two Rivers Development Limited (TRDL), is set to issue a one -year note at a yield of 14.5%, seeking to raise Kshs 2.0 bn for its real estate projects;
Focus of the Week: Following increased incidences of claims of fraud associated with off-plan purchases in the real estate market, this week we look at off plan investments in real estate ? the processes involved, the advantages and disadvantages and the key things to look out for before purchasing real estate off plan.
T-bills were oversubscribed for the 11th consecutive week, with the overall subscription rate coming in at 117.3%, compared to 149.5% the previous week. The 182-day paper was not on auction for the 6th week in a row, a move aimed at managing maturity concentration by spreading risk across the three papers. Subscription rates for the 91 and 364-day papers came in at 127.5% and 107.1%, compared to 125.1% and 173.9% the previous week, respectively. Yields on the 91 and 364-day papers remained unchanged at 8.8% and 10.9%, respectively.
Recently, there has been upward pressure on interest rates as investors continue to demand higher yields, given the high inflation rate, currently at 10.3%. The 91-day T-bill has been the main focus, as it currently offers a negative real return of 1.5%. Despite this, the government has remained disciplined by rejecting bids that are above market. The market responded to this positively by bidding less aggressively as indicated by the high total overall acceptance rate of 81.0% compared to 78.0% at the start of February, an indication that investors are bidding within the ranges that are deemed acceptable by the Central Bank of Kenya.
This week, the Kenyan Government re-opened two bonds, FXD 3/2008/10 and FXD 1/2009/10, with effective tenors of 1.4 and 2.0 years, respectively, in a bid to raise Kshs 30.0 bn for budgetary support. In the last 3 auctions, the government has rejected expensive bids from investors, given that the domestic borrowing program is ahead of target and hence the government is under no pressure to borrow at yields above market. However, it is important to note that (i) the government has only borrowed Kshs 205.8 bn from the foreign market, which is just 44.5% of its foreign borrowing target of Kshs 462.3 bn, and (ii) the Kenya Revenue Authority (KRA) has already missed its first half of 2016/17 fiscal year revenue collection target by 3.2%, and is also expected to miss its overall revenue collection target of Kshs 1.5 tn for the current fiscal year due to depressed earnings growth by corporates. Given that (i) these bonds traded on the secondary market at yields of 12.1% and 12.6% as at 7th April, 2017 for the 1.4 year and 2.0 year bonds, respectively, and (ii) market liquidity distribution remains skewed towards the larger banks, we expect investors to bid for the bonds at yields above the secondary market yield, and we therefore recommend a bidding range of between 12.1% - 12.6% for the FXD 3/2008/10 and 12.6% - 13.1% for the FXD 1/2009/10.
According to Bloomberg, the yields on the 5-year and 10-year Eurobonds, with 2.2 years and 7.2 years to maturity, remained relatively flat closing the week at 4.1% and 6.8%, respectively. Since the mid-January 2016 peak, yields on the Kenya Eurobonds have declined by 2.8% points and 4.7% points, respectively, for the 5-year and 10-year bonds due to improving macroeconomic conditions. The declining Eurobond yields and Standard & Poor?s (S&P) having maintained Kenya?s foreign and local currency sovereign credit ratings for the short and long term at ?B+/B?, respectively, are an indication that Kenya remains a stable and hence attractive investment destination.
The Kenya Shilling remained relatively stable against the dollar to close the week at Kshs 103.4 as was recorded the previous week, on account of increased currency inflows as the Easter holiday weekend drew nearer. On a year to date basis, the shilling has depreciated against the dollar by 0.9%. The forex reserve level currently stands at USD 8.0 bn (equivalent to 5.3 months import cover) from USD 7.0 bn (equivalent to 4.6 months import cover) recorded on 17th March 2017, largely as a result of the receipt of the Kshs 82.3 bn syndicated loan. Going forward, we expect the shilling to come under pressure from (i) global strengthening of the dollar due to the expected series of rate hikes during the year, and (ii) recovery of global oil prices. However, with the current forex reserve level, we believe the CBK will be able to support the shilling in the short term.
The World Bank has revised its outlook on Kenya?s 2017 GDP growth downwards, to 5.5% from 6.0% previously. The basis of their downward revision was (i) the slow-down in private sector credit growth that has been persistent since late 2015 and may worsen as a result of the cap on interest rates resulting in slow growth in SMEs, (ii) the prevailing drought that has affected the agricultural sector, Kenya?s biggest contributor to GDP at 19.3% of GDP as at Q3?2016, with major exports such as tea and horticultural produce being affected, and (iii) spill-over effects of the drought such as a rise in energy prices due to lower Hydro-Electric Power (HEP) production and increases in food prices due to low agricultural production; all building up to rising inflationary pressure in the country. However, the growth is still strong, above the Sub-Saharan Africa projected growth of 2.9%. In our view, we expect GDP growth for 2017 to be between 5.4% - 5.7%, supported by government spending on infrastructure and recovery of the tourism sector.
The National Treasury has ordered the tax and duty-related provisions of the Finance Bill 2017 into effect even before the Bill passes into Law. This order became effective last week and will see excise stamp fees paid on cigarettes and alcoholic beverages with more than 10.0% alcohol content increase to Kshs 2.8 per retail unit from Kshs 1.5 previously. Contrary to this, excise stamp fees on non-alcoholic beverages, mineral water and cosmetics have practically been halved, reducing to Kshs 0.6, Kshs 0.5 and Kshs 0.6 per retail unit, respectively. Keeping in mind that non-alcoholic beverages are consumed by a larger population and at a higher frequency than alcoholic beverages (above 10.0% alcohol content), the net effect of these changes would be a tax cut on beverages in general. The provisions in the Finance Bill are in line with taxation measures outlined in the National Budget for the fiscal year 2017/18 where it was proposed to increase tax on wines and spirits with alcohol content above 10.0% to Kshs 200 per liter from Kshs 175 previously. This move will likely result in alcoholic beverage manufacturers and retailers passing on the extra costs to the consumer, leading to an increase in prices of these wines and spirits. In our view, this move by the Treasury (i) will have minimal effect on inflation as alcoholic beverages, tobacco & narcotics only bear a 2.1% weighting on the Consumer Price Index? (CPI?s) and (ii) will lead to minimal increase in revenue for the exchequer as the bulk of tax collection comes from PAYE and VAT at 43.4% and 22.3%, respectively, whose changes were to increase the tax brackets hence lesser collections.
The Government is ahead of its domestic borrowing for the current fiscal year, having borrowed Kshs 235.2 bn against a target of Kshs 177.6 bn (assuming a pro-rated borrowing throughout the financial year of Kshs 229.6 bn budgeted for the full financial year). The government has only borrowed Kshs 205.8 bn, of the budgeted foreign borrowing, representing 44.5% of its foreign borrowing target of Kshs 462.3 bn, and the Kenya Revenue Authority (KRA) has already missed its first half of 2016/17 fiscal year revenue collection target by 3.2%, and it is expected to miss its overall revenue collection target of Kshs 1.5 tn for the current fiscal year. Given that the government has less than 2.5 months to the close of the current fiscal year and the fact that borrowing from the foreign market is a much longer process than borrowing from the domestic market, the government is likely to use the domestic market to plug in the deficit that is likely to arise. This creates uncertainty in the interest rate environment as domestic borrowing may exert upward pressure on interest rates, and result in longer term papers not offering investors the best returns on a risk-adjusted basis. It is due to this that we think it is prudent for investors to be biased towards short-term fixed income instruments.
During the week, the equities market recorded mixed trends with NASI and NSE 25 gaining 1.6% and 0.4%, respectively, while NSE 20 lost 0.1%, taking their YTD performances to 1.3%, (2.4%) and 0.1%, respectively. This week?s performance was supported by gains in large cap stocks such as Safaricom, which gained 8.1%. Since the February 2015 peak, the market has lost 43.5% and 24.2% for NSE 20 and NASI, respectively.
Equities turnover increased by 24.9% to close the week at USD 31.1 mn from USD 24.9 mn, the previous week. Foreign investors remained net buyers with net inflows of USD 1.0 mn, compared to a net inflow of USD 0.7 mn recorded the previous week, with foreign investor participation increasing slightly to 88.1%, from 86.2% recorded the previous week. Safaricom and KCB were the top movers for the week, jointly accounting for 75% of market activity. We expect the Kenyan equities market to be flat in 2017, driven by slower growth in corporate earnings, neutral investor sentiment mainly due to the forthcoming general elections, and the aggressive rate hike cycle in the US, which may reduce the level of foreign investors? participation in the local equities market.
The market is currently trading at a price to earnings ratio of 10.8x, versus a historical average of 13.4x, with a dividend yield of 6.7% versus a historical average of 3.7%. The current 10.8x valuation is 11.3% above the most recent trough valuation of 9.7x experienced in the first week of February of 2017 and 30.1% above the previous trough valuation of 8.3x experienced in December of 2011. The charts below indicate the historical P/E and dividend yields of the market.
The High Court has withdrawn the Motor Insurance Underwriting Guidelines of 2009 issued by the Insurance Regulatory Authority (IRA), thus stopping IRA from setting the industry premium rate for motor segment. The guidelines, which were issued by IRA in 2010 on account of underperformance in the sector, pushed upwards the motor private segment premiums from a blanket-flat rate of 4.0% of the value of the car to a cap of 7.5%, with a discount of 10.0% for each year of no claim to a minimum of 4.5%. Despite the set rate, price undercutting has been ongoing in the insurance industry as a result of cut-throat competition in the business segment leading to losses in the motor class of business. This ruling will allow for insurers to charge premium rates of their own choosing, and with the introduction of the risk-based capital regime, most insurance companies have increased premium rates as they align premiums to be proportionate to the risk being insured. We view this as a good development for the industry as pricing in an open market economy is supposed to be determined by the forces of demand and supply, rather than regulatory intervention; the only exceptions that warrant regulatory intervention are public goods, such as utilities. Anytime there is external interference, such as with quotas, minimum wages or legislations; there is either excess supply or demand, which leads to a deadweight loss in the economy and ineffective allocation of resources. The court ruling comes at a time when the National Transport and Safety Authority (NTSA) is set to roll out digital driving licenses, while the IRA plans to have underwriters share customer information with Credit Reference Bureaus (CRB) to curb fraud. On implementation of these changes, insurance firms will be better placed in developing and pricing products in line with each customer?s risk profile, thus increasing profitability of the segment going forward. We hope that the trend to do away with regulatory or industry set fees will percolate its way into other areas such as legal fees, architectural fees, quantity surveying fees, and other areas that continue to set fee scales.
Marshalls East Africa is set to delist from the Nairobi Securities Exchange (NSE), following years of recording losses. Global Limited, the firm?s top shareholder with a stake of 13.9% has offered to buy out fellow minority shareholders at a 25.0% premium, at Kshs 10.8, to the six-month volume weighted average price of Kshs 8.6 as at 30th March. The buyout will open on 10th May and close on June 7, but is subject to shareholders? approval at the company?s annual general meeting scheduled for 8th May. The plan to remove the company from trading on NSE will give Marshalls greater flexibility in changing its business strategy without prejudicing shareholders, and will also reduce expenses related to maintaining a listing on the NSE, such as additional listing fees as a result of listing additional shares, and annual listing fees.
Following the release of FY?2016 earnings, a number of companies reported depressed earnings with the total number of companies that issued profit warnings in 2016 coming in at 11, compared to 14 companies in 2015, indicating a continually challenging operating environment. As a result of this, cost rationalization measures, such as laying-off of staff and closure of branches by banks continue to gather pace, with KCB Group being the latest to report laying off of 223 employees in 2016. The Group spent Kshs 186.0 mn in the staff restructuring process that brought its total employee number to 7,192 from 7,415 in 2015. This came after KCB Group had indicated that it would lay off staff to cut expenses in a bid to improve efficiency, pointing towards lower staff costs going forward.
This brings to 10 the number of banks that have announced downsizing plans since the implementation of the interest rate cap as shown in the table below.
Kenya Banking Sector Restructuring
First Community Bank
Bank of Africa
BAT Kenya also laid off 40 employees resulting in staff restructuring costs of Kshs 338.0 mn on account of redundancy. The company said it introduced new working practices in the manufacturing process, leading to a 9.0% reduction in cost of operations in 2016. BAT Kenya has seen consistent cost reduction, and with the reduction of number of employees, it may continue to record lower costs in the short term.
Below is our Equities Recommendation table. Key changes from last week include:
all prices in Kshs unless stated otherwise
Price as at 07/04/17
Price as at 13/04/17
*Target Price as per Cytonn Analyst estimates
**Upside / (Downside) is adjusted for Dividend Yield
***For full disclosure, Cytonn and/or its affiliates holds a significant stake in KCB Group, ranking as the 14th largest shareholder in the group
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
We remain "neutral with a bias to positive" for investors with short to medium-term investments horizon and are "positive" for investors with long-term investments horizon.
Synergy Private Equity Fund (SPEF), a firm that invests in high-growth companies in Nigeria, Ghana, Liberia and Sierra Leone, has achieved its 9th investment by completing its investment in Northstar Finance Services Limited (Northstar), which offers financial services products, predominately in Nigeria and Ghana. This transaction has seen SPEF add Safetrust Nigeria, Northstar Home Finance, Avance Insurance Co. Ltd and Ping Express Inc. to its portfolio. This investment will enable Northstar achieve its growth strategy and establish a leading position as the most preferred personal finance institution in West Africa. The increased investments in the financial services sector in Sub-Saharan Africa is motivated by (i) the increasing demand for credit by SME?s to cater for their business expansion needs, (ii) the growing financial inclusion in the region facilitated through alternative banking channels, (iii) increased innovation and new product development within the sector, and (iv) the growing middle class supporting an inherent increase in consumption expenditure, and an increase in the percentage of the population that will require financial services.
AfricInvest, a private equity wing of the investment financial services Group Integra, and Mediterrania, a private equity firm supporting developments in Morocco, Tunisia and Algeria, have exited Grupo San Jose & Lopez (SJL) by the sale of their 100% stake to Investec Asset Management (IAM). IAM is an asset manager based in South Africa with approximately USD 114.0 bn under its management. SJL, is a logistics and international road freight transport company that has operations in Maghreb and Europe. Mediterrania Capital and AfricInvest jointly acquired an undisclosed minority stake in SJL in June 2013 and eventually acquired the remainder in August 2015 becoming the sole owners. The acquisition of SJL is in line with Investec?s future strategy in terms of geographical expansion, service development and product offering. SJL, currently managing 11 logistics platforms in Morocco, Tunisia and Europe and delivering over 20,000 annual journeys between Europe and Morocco, will act as a link to the European and African market. With the current infrastructural developments in the region, specialized logistics and transportation are needed to transport raw materials and specialized equipment, and drive efficiency within the industry.
Frontier Investments Management, a Danish private equity firm, has raised USD 116.0 mn in the first close of its second fund, Frontier Energy II. The Fund is to finance greenfield renewable energy projects across the Sub-Sahara Africa region. The fund will be implemented in a similar way as its predecessor, a USD 63.8 mn fund, DI Frontier Market Energy and Carbon Fund, which is fully deployed in six different investments with the objective to generate 139.0 MW from the mix of geothermal, solar and hydro power projects in East Africa. Frontier Energy II is meant to achieve an Internal Rate of Return (IRR) of above 20.0% to the investor in the fund by investing between USD 3.0 mn and USD 30.0 mn, in the form of equity, debt or mezzanine, in projects that require capital ranging from USD 5.0 mn up to USD 300.0 mn. The energy market remains bullish in Sub-Saharan African states with (i) increase in energy requirements by the growing population, (ii) investor friendly regulations put in place by the industry regulators including tax exemption and import duty on material used for renewable energy plant development, and (iii) the Feed-in-Tariff that offers investors a guarantee of returns on their investments.
Private equity investments in Africa remain robust as evidenced by the increased deals and deal volumes in the region?s key sectors; financial services, energy, transport and logistics. Given (i) the high number of global investors looking to cash in on the growing middle class of Africa, (ii) the attractive valuations in frontier markets compared to global markets, (iii) better economic projections in Sub Sahara Africa compared to global markets, and (iv) the high number of exits that is evidence of the attractiveness of the region, we remain bullish on PE as an asset class in Sub-Sahara Africa.
During the week, AfrAsia Bank released their Africa Wealth Report that focused on a comprehensive review of the wealth market in Africa, including high net worth individuals (HNWI) trends, luxury trends and wealth management trends from 2006 to 2016, with projections to 2026. According to this report, HNWI are individuals with net assets of USD 1.0 mn and above. The report ranked Kenya as the third most preferred travel destination by the HNWI in Africa in 2016, surpassing world famous Mauritius and Seychelles. South Africa was the most popular African destination for the super-rich, with approximately 15,000 multimillionaires while Morocco accommodated 5,000. Kenya and Botswana were both ranked at position 3 with both hosting 4,000 multi-millionaires each. Maasai Mara and Nairobi remained the most preferred destinations for the HNWI going on holiday in Kenya, due to the safari experiences that both places offer. Mainly Cottar?s 1920s Safari Camp in Maasai Mara was the most popular safari lodge for the HNWI visiting Kenya and fifth in Africa, supported by the fact that Kenya is famous globally for the wildlife safaris and the wildebeest migration. Wildlife safari was the most popular hobby for HNWIs in Africa last year, followed by golf, cycling, art collecting, horse riding, tennis among others.
We expect growth of the tourism sector to continue, hence attracting more tourists due to the following factors;
This week, World Bank released the Kenya Economic Update 2017 report that highlighted the need for investment in housing, which will create jobs, improve economic growth and strengthen the country?s financial services sector. This is can be achieved by unlocking the residential housing market through the development of the housing finance market that can provide a wide range of employment opportunities through the construction sector and related industries as evidenced in countries such as Colombia, India, and South Africa. For example, in Colombia it is estimated that 5 jobs are added for every USD 10,000 spent on house construction. The key take outs from this report were;
The World Bank report went further into analyzing the key constraints that are limiting supply of affordable houses in Kenya as;
We remain skeptical on achieving affordable housing in Kenya unless the government provides a conducive environment for both financiers and developers by;
Two Rivers Development Limited (TRDL) is set to issue a one -year note at a yield of 14.5%, to raise Ksh2.0 bn to fund its real estate projects. The note will be guaranteed by Centum Investments, which owns 58.0% of TRDL. The funds will be channeled towards financing the construction of the remaining piece of land for other developments such as apartments and office suites. At the same time, TRDL announced its plans to sell 11 plots of land during the year at a minimum disposal value of Kshs 5.0 bn to repay the Kshs 2.0 bn short-term debt and build infrastructure on the remaining land. The land set for sale are five residential plots for Kshs 2.5 bn, three mixed use plots at Kshs 1.4 bn, two mixed retail plots at Kshs 1.2 bn and Kshs 57.0 mn from the disposal of a plot meant for construction of the five-star hotel.
Financing has proved to be a key constraint to many developers with many developments stalling due to cash withdrawal by financiers or lack of project financiers. Our view is that developers should have a team focusing on project finance structuring. The financing should be structured in various forms of debts and equity that complement each other to avoid projects from stalling or sale of project assets that lead to concept changes and likely loss of investor money, confidence or both.
We expect continued investment in the hospitality sector as the sector attracts increased numbers of tourists driven by improved security, infrastructure and tourism products and remain neutral on focus on affordable housing by developers until government provides incentives to developers to curb high costs translating to high prices.
Over the last couple of weeks, we have witnessed a number of property buyers coming to the fore claiming to have been swindled by developers over off plan real estate purchases. This week we thus seek to demystify off plan investment in real estate. We start by introducing off plan investments in real estate, the processes involved, the potential gains and risks. We then cover briefly the two most recent cases in the dailies of Simple Homes and Gakuyo, and conclude by advising buyers on what they should look out for when purchasing property off plan.
Off plan investment refers to the purchase of property before completion, generally driven by the high price of real estate and the long time taken to deliver units, given low supply of real estate units despite the increasing prices. The buyer hence buys the property off the plan or design stage of the development. It has become increasingly popular as the prices of the property sold are much lower than market, and can be up to 50.0% less than the price of a completed house.
The process of purchasing a property off plan begins with the signing of three documents, (i) the Reservation Form, (ii) the Letter of Offer and, (iii) the Sale Agreement, where a developer promises to deliver a parcel of land, a house or land package to a buyer at an agreed price at a future date, subject to the developer obtaining all necessary approvals in respect of the development from the relevant authorities and satisfying any conditions necessary to finalize the development. In most cases, the buyer must pay the developer a deposit upon signing the contract, with the balance of the purchase price due at the settlement date, or via a specific payment plan.
The victims in the above scams would have saved themselves millions of shillings had they done some very basic due diligence, before parting with their money. We recommend the following:
The buyer should ensure that the developer is a registered company in the country of operation. He/she should also know who the directors of the company are, how they have delivered in previous projects if they have any, to gauge their workmanship, delivery to promise, timelines and proof that they are actually developers. This will prevent one from investing with a brief case company run by fraudsters.
For the project, the buyer ought to establish the following facts:
The buyer should hire a conveyancing lawyer to review all contracts signed and ensure they are all above par and he or she is not defrauded in any way or exposed to unnecessary risk
In the current market due to the high land and construction costs as well as interest rates, house prices are generally high. Hence if a developer offers a house at a price that is very low by market standards and not achievable under normal circumstances, and it is the only company offering such, then one should be cautious and evaluate them fully as it is probably a scam to lure unsuspecting buyers desperate to acquire a home.
Purchasing off plan is a great way of investing in real estate and hence the buyers should not be deterred by the few cases of unethical developers as they will miss out on not only a dream home but also a lucrative investment opportunity with the highest returns of up to 25% p.a. He/she needs to understand what they are getting into, conduct a background check on the developer, consult their lawyers and invest.
For more on sharp real estate investments visit Cytonn Solutions.
Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only, and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.