Cytonn Weekly Update #10 with a focus on Kenya's Infrastructure Bond

By Cytonn Research Team, Mar 13, 2015

Cytonn Weekly

Executive Summary

  • Fixed Income: Notwithstanding the strong interest from investors, yields on government securities remained unchanged. The Kenya Shilling weakened during the week but strong interest in the Government Infrastructure Bond is expected to further support the Kenya shilling. 
  • Equities: The NASI fell marginally, mainly attributed to a downturn in Insurance medical business that registered losses last year, pulling down listed medical insurance underwriters.
  • Real Estate: The global property market is projected to grow at 11% and with a weakening Shilling and insecurity and political concerns curbed, we expect to see early gains in the Kenyan real estate sector.
  • Private Equity: Falling interest rates and a buoyant economy in Kenya pose an opportunity for global PE firms, which face both increasing interest rates in the US and a slowing economy in Eurozone and China.
  • Focus of the week: 12-year government infrastructure bond to be auctioned on 25th March with expectations of high participation given the yield of 11% offered. The roll-overs from the maturing two-year bond worth Kshs 19.96 billion are also expected to boost uptake.
  • New Developments at Cytonn: In an effort to fulfill its Real Estate Investments Strategy, Cytonn has completed the formation and staffing of its development affiliate, Cytonn Real Estate, which is focused on Real Estate Services, Project Management and Development Management. This is pursuant to our revised strategy of owning the entire real estate value chain from site acquisition, development and exits; and effectively reducing overreliance on other third party developers.

Weekly rates for our Cash Management Solutions Private Placements

Date Currency 3 Months 6 Months 12 Months
March 16, 2015 KES 12% 13% 14%
USD 5% 5% 5%

Fixed Income Update

Despite minimal changes in the yields, government securities issued during the week received oversubscriptions. The yields stood at 8.5% for the 91-day paper and 10.4% and 10.6% for the 182-day and 364-day papers respectively while the subscriptions were at 281% for the 91-day T-bill and 253% and 226% for the 182-day and 364-day T-bills were respectively.  Looking at the absolute amounts that investors were looking to invest in each Treasury bill, it is clear that they are still skewed towards longer dated securities meaning that they could be expecting rates to ease in the short term. 

The Kenya Shilling weakened slightly against the USD to close at 91.7 from last week?s close of 91.2 on the back of a global Dollar rally on expectation that the Fed will hike interest rates sooner than expected. 

The European Central Bank?s government bond-buying program, aimed at stimulating the Eurozone economy, has driven European bond yields to record lows and, in some cases, deeper into negative territory.  The effects have also been felt in the US Treasury market whose yields declined as a result of an increase in demand fuelled by the search for better yields as well as the strengthening Dollar.

In the coming week, we expect more foreign inflows into the country as investors prepare to invest in the government bond on 25th March. This coupled with the release of the US retail market data that showed a decline in retail sales of 0.6% may, in our opinion, pause the Dollar rally to further support the Shilling.

Equity Market Update

The NASI lost 0.3% as the Insurance sector weighed down on performance. CIC Insurance fell 17.1% as it recorded a 110% increase in losses to Kshs 620 million from its medical insurance business. Kenya?s medical insurance class recorded an underwriting loss of Kshs 437 million citing higher medical claims, healthcare costs and fraud. This doesn?t bode well for the industry, especially for CIC with medical insurance contributing close to 25% of its business. Given the company reported a 16.6% y/y decrease in Earnings per Share, we thus expect the stock to underperform.

Equity bank posted a 27.8% increase in profit to a record Kshs 17.15 billion making it the most profitable Kenyan bank. Increased lending, higher transaction income and a one-off Kshs 1 billion gain from divesting its stake in Housing Finance boosted its net profit. Customer deposits and loans grew more than 25% y/y leading to an 11% increase in its Net Interest Income thereby meeting market expectations. With the bank diversifying into other revenue streams including communications through its Equitel sim card and targeting insurance through its healthcare centers Equity Afia, we see this as a factor that will drive earnings in the future.

In global markets, the Nikkei 225 rose yet again setting a new 15 year high to close at 19,254 points. The weaker Yen currently at 121 to the Dollar has helped the index, with Japanese exporters rallying on the expectation of better earnings from overseas shipments priced in Dollars. With the Dollar likely to continue strengthening, we expect earnings momentum to actualize and the index to hit 20,000 in the short term.

Global Real Estate Update

The global real estate market was resilient in 2014 as debt and equity volumes crossing borders grew in search of diversity. Despite the jitters in emerging markets with rising insecurity from Islamic militia groups Al-Shabaab and Boko Haram, the lack of opportunities and demand for higher yields drove global investors into these markets.

The US was back again as top in property trading in 2014 for the first time since 2009, contributing to 32% of all global property trading and having grown by 16% to USD 390 billion. The sector weighting shifted with a 28% drop in land sales while offices and hospitality saw the strongest increase followed closely by retail and industrial use.

As we move into 2015, demand for and allocation to real estate is bound to increase on the back of increasing global liquidity. High volatility in other asset classes is likely to push global investors towards real estate, which is a low volatility asset class. According to the International Investment Atlas 2015 report, an 11% rise is expected in global volumes with a marginal drop in yields. In Kenya, as we see political and security concerns reined and an IMF buffer loan in place, the East African powerhouse is set for early gains in this sector. With the Shilling weakening against the greenback, real estate investments are even cheaper to make for the Kenyan Diaspora in the US.

Global Private Equity Update

The market-opening initiatives and recent peaceful political transition across Asia as seen from new leaders like Xi Jinping in China, Narendra Modi in India and Joko Widodo in Indonesia, lays a stable regulatory  foundation core to executing PE deals and making Asia an attractive investment destination. 

Globally, PE firms face inflated target prices on the back of growing competition and abnormally low interest rates. In the US, deals valuation is close to 10X EBITDA. High purchase prices puts pressure on PE firms to achieve their hurdle rates and one way to counter this challenge is to increase leverage on these deals. Leverage levels in the US have gone to over 6X EBITDA, which is what the multiple was just before the global financial crisis. But this leverage levels are sustainable as long as interest rates remain low, but with rates likely to go up as the Fed plans to tighten the monetary policy, interest rates will hike. This puts the highly leveraged deals at risk, exacerbated by a slowing global economy.

Global PE firms are already highly leveraged, like those in the US, and those facing a slowing economy, like those in the Eurozone, will find the declining interest rates in Kenya and a buoyant economy a sweet opportunity for high returns.

The Government of Kenya will issue a 12-year, 11% coupon amortized bond on the 25th of March 2015. This shall be the tenth infrastructure bond to be issued since 2009 when the Government first issued such a bond. The Government?s issuance of infrastructure bonds can be linked to Vision 2030, adopted in June 2008, under which the government aims to transform Kenya into a "newly industrializing, middle-income? country. One way of achieving the objective is through improved infrastructure, hence the increased expenditure on infrastructure.

There is a high appetite for infrastructure bonds in the market as signaled by oversubscriptions in all previous issues. This could be because of the high yields offered and the tax savings that accrue to the investor given that the bond is tax exempt. Additionally, the bonds are usually amortized, that is, the principal is repaid in parts over the bond?s tenure, hence reducing the risk of default. 

Kenya?s bond market is characterized by high turnover, and is therefore liquid. In 2014 the turnover stood at Kshs 506 billion compared to Kshs 452.5 billion recorded in 2013, representing an 11.8% increase. The good performance is expected to continue in 2015 as evidenced by a 19% increase in bond turnover in the first two months of the year as compared to a similar period in 2014.

We expect high participation levels from both local and foreign investors at the auction with the bidding closer to the 11% coupon rate. Moreover, there will be increased liquidity given a 20 billion maturity of a two year bond issued in 2013.


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