By Cytonn Research Team, May 24, 2015
Treasury bills were undersubscribed for the third straight week, registering a 41.1% subscription rate and yields remained relatively unchanged. There was a 162.8% subscription rate for the re-opened 2 and 10-year bonds as investors sought to lock in better yields in the primary bond market. The rates increased marginally to 11.9% and 13.0% for the 2-year and 10 year, respectively. As pointed out in our Weekly Cytonn report #19 last week, investors are keeping short on duration as can be seen by the 2-year paper receiving 3 times the amount of bids of the 10-year, at Kshs 24.3 bn versus Kshs 8.3 bn, respectively.
As highlighted in the gazette notice, the government remains under pressure to finance the budget, as both the net domestic borrowing and the revenue collection are below target by Kshs 88 bn and Kshs 250 bn, respectively, as at the end of April.
Centum and Chase bank are in the market looking to raise corporate bonds. Chase Bank is looking to raise Kshs 10 bn at 13.1% p.a. (Kshs 5bn in the first tranche) in a 7-year bond, while Centum is looking to raise Kshs 6 bn at 13.0% p.a. in a 5-year bond. Given that (i) corporate bonds are usually held at book value by investors and not marked to market, and (ii) lack of similar reinvestment options, investors will find the bonds attractive investment opportunities. However, given that both are offering about 150 basis points above similar tenured government bonds, we don?t think 150 basis points premium to government securities is a sufficient compensation for corporate credit risk.
The shilling continued its downward trend against the dollar, closing at 96.8, representing a drop of 0.4% during the week. The rate of decline is marginal compared to the previous weeks given the Central Banks activity in the market. The Central Bank however has adequate forex reserves amounting to 4.4 months of import cover and a Kshs 64.0 bn ($673.7 mn) IMF facility that it can use to stem the shilling?s decline.
Given the governments financing shortfall and the uncertainty in the shilling, we see interest rates edging up in the short term and hence remain biased towards shorter duration investments.
During the week, NASI and NSE 20 continued their losing streak, with NASI declining 1.7% and NSE 20 declining 2.1%, as foreign investors continued being net sellers.
In Q1?2015, banks recorded a 2.7% quarter over quarter increase in pre-tax profits to Kshs 37.3 bn on the back of a 3.0% increase in deposits to Kshs 2.4 tn and a 3.6% rise in loans to Kshs 2.0 tn, as per a report by the Central Bank. However, non-performing loans rose 9.4% to Kshs 117.2 bn, with the real estate, building and construction sector contributing to the increase of poor quality loans. Going forward, banks will have to improve efficiency in order to retain profit margins, as the sector matures, growth rates in deposits and loans slows, and net-interest margins begin to tighten.
After a successful turn-around in their earnings over the last 2 years, from a loss of Kshs 6.2 bn in 2012 to a profit of Kshs 1.0 bn in 2014, KenolKobil is looking to expand further and diversify its revenue streams. This week they signed a local lubricants manufacturing and distributorship deal with British Petroleum (BP) for its Castrol branded lubricants, and will jointly set up a Kshs 1.4 bn factory in Mombasa for the production of the lubricants. The deal will enable the firm to focus on high margin business segments, since lubricant prices are not controlled by the Energy Regulatory Commission, as well as a reduction in the import duty paid by the firm from 25.0% to 10.0% for the inputs required. In our view, this presents an upside potential for future earnings through revenue diversification and higher margins.
The stock market continues to be largely driven by corporate announcements. We remain neutral on equities, given stretched valuations and relatively lower earnings growth prospects. We are of the view that active money managers will be able to derive returns through prudent stock picking.
Globally in 2014, there was an increase in mergers & acquisitions in the insurance sectors as companies sought to get more efficient in their operations and improve growth through economies of scale. In Kenya however we have seen an increase in strategic investments by insurance companies seeking to grow their business: Old Mutual?s purchase of UAP and Pan-Africa?s purchase of General Accident.
In order to strengthen the sector, the Insurance Regulatory Authority increased the capital requirements for insurance companies and also limited individual ownership to 25%. With insurance penetrations at 3.0% in Kenya and the region, the insurance sector remains attractive.
Tilisi Developments Ltd launched a 400-acre master planned real-estate development in Kiambu that will have more than 3,200 houses and a logistics park providing warehousing facilities. While the plan allows for individuals to construct housing units, the developers will provide security and core infrastructure such as water, power supply, roads, drainage, street lighting and perimeter walls. Similarly, Shelter Afrique, a housing finance institution, has struck a Kshs 2.6 bn finance deal with property firm Kingspride to construct 440 middle-income housing units in Ruaka and Kiambu towns targeting the expanding middle-class and taking advantage of the infrastructure upgrades such as the Northern bypass, which has opened up these areas for development.
These transactions continue to support our view that demand for planned community developments with amenities and enhanced security will continue given rapid urbanization. The demand will increase both at the affordable to mid-income housing segment and in the high-end segments. The increased investment in infrastructure development, such as the Northern and Eastern bypass in Nairobi, has opened up investments opportunities in areas such as Karen and Ruaka, which are now more accessible for households looking to move away from congested city areas such as Westlands, Upper Hill and Eastlands.
In our Cytonn Weekly report #18, we spoke about how investors typically invest in well-known and liquid asset classes such as money markets, equities and fixed income, collectively referred to as ?traditional investments? or ?public markets?. There exists an alternative to these traditional investments in private equity, real estate and structured products. Last week, in our Cytonn Weekly report #19, we demystified structured products, and this week we explain real estate investments.
While relatively illiquid and more complex, alternative investments are essential to an investment portfolio for 2 reasons: First, they offer higher returns. Second, the returns are more stable and uncorrelated to more volatile returns such as equities. For example locally, real estate has registered the highest returns over the last 5 years, at 24% p.a., as compared to traditional markets, as can be seen in the graph below.
There are two ways to access real estate in any market:
Depending on the investors? investment needs, risk/return profile, time horizon and liquidity needs, there are a number of investment options available. Such investments are:
We believe that developments that involve land owners as JV partners to contribute land, professional money managers to raise development finance, and institutional developers to develop is an innovative approach that will have profound effects to the Kenyan economy by: