Cytonn Monthly Report – August 2015

By Cytonn Research Team, Sep 6, 2015

Cytonn Weekly

Executive Summary

  • Kenya Macroeconomic Review: Macroeconomic environment in Kenya continues to face challenges as a result of a negative operating environment;
  • Fixed Income: Yields remained high across all tenors, while the Kenya Shilling depreciated 1.3% during the month. We maintain our view that investors remain biased towards short-duration fixed income notes;
  • Equities: NASI and NSE 20 continue on a downward trend, losing 3.8% and 5.2% during the month, respectively. Given the worsening operating environment, we slightly downgraded our stance on equities from “neutral” to “neutral with a bias to negative”;
  • Private Equity: An increase in the number of PE investments in East Africa's financial sector highlights the attractiveness of the industry and deepening of the market;
  • Real Estate: The government continues to formulate and enact industry regulatory policies that will support the real estate sector.
  • Asset Allocation:
    1. Investors allocation should be focused on short-duration fixed income instruments over the remainder of 2015, as we await further clarity on the interest rate environment;
    2. We revise our view on equities to “neutral with a bias to negative”, and the equity market remains a stock pickers market;
    3. Investors should look to increase allocation to their alternative investment portfolios, which have a low correlation to the events in the public markets, and offer risk-adjusted returns above 25% p.a.
  • Company Updates:Cytonn closed a Kshs. 1.4 billion fundraising with Taaleritehdas of Finland as the anchor investor. Proceeds of the private placement to go into various real estate projects. See link: Cytonn Investments Closes Kshs. 1.4 Billion Structured Notes Fundraising

Kenya Macroeconomic Review

Economic growth has been lower than expected, as can be seen by the 4.9% p.a. economic growth in the first quarter, which led to the IMF revising downwards Kenya’s growth rate expectation to 6.0%, from 6.9% previously. Given the weak start to the year, combined with a less than conducive operating environment due to high interest rates and currency weakness, we reiterate our view, as first mentioned in our H1’2015 report, that the 7% growth projection by Treasury is highly ambitious and is not achievable. This has been brought to the forefront by the recent slower than expected earnings growth, especially in the financial services sector, highlighting that the macroeconomic environment in Kenya continues to face challenges. We are currently updating our GDP projection for this year and we shall be releasing it in the course of the month.

The Kenya Shilling continues to remain under pressure against the dollar, having depreciated by 14.5% YTD on the back of (i) global US Dollar strength as a result of the impending rate hikes by the US Federal Reserve, (ii) a worsening current account deficit, driven by increased imports for manufactured goods, while exports remain low, (iii) increased appetite by the government for dollar denominated debt which makes the countries performance highly correlated to the global market performance, and adds additional strain due to the demand to service debt, (iv) increased fiscal deficit leading to more debt uptake by the government, and (v) decline in the forex reserves hence lower ability to support the shilling. Overall, the mop-up activities by the Central Bank of Kenya (CBK) may help stabilise the currency in the short-term, but we expect it to remain under pressure.

Increased domestic borrowing by the government has led to a challenging interest rate environment, which has led to investors shying away from longer-dated securities. Government debt has been on the rise with the total Debt/GDP standing at 51.5% as of August, compared to a target of 45.0%. This increase in domestic borrowing may lead to crowding out of the private sector, leading to a decline in private sector credit to GDP, which currently stands at 32.6% as at March 2015. Due to the high demand for money by the government to finance the budget, we expect interest rates to remain high. 

Inflation rates continue to remain range bound within the CBK’s target range of 2.5% - 7.5%, with the August figure having come out at 5.8%, a drop of 79 bps from the July figure of 6.6%. We maintain our view that inflation will remain in check despite the depreciation in the currency, due to (i) CBK’s market activity to tame the weakening shilling, (ii) low global oil prices which will offer some cushion as Kenya is a net oil importer, and (iii) sufficient food stuffs in the short term due to good rainfall experienced in the second quarter.

Fixed Income

Treasury bill auctions continued to be undersubscribed in August, with an overall subscription rate of 55.2%, compared to 42.0% in July. The undersubscription was as a result of (i) tight liquidity in the market during the better part of the month, (ii) the uncertainty in the interest rate environment, and (iii) mop-up activities by Central Bank of Kenya (CBK) in support of the Kenya Shilling, which led interbank rates to increase significantly and touch a high of 26.3%. Yields on the 91-day paper remained flat at 11.5%, while yields on the 182-day and 364-day T-bill recorded an increase to close at 12.4% and 13.8%, from 11.9% and 13.5%, respectively, in July.

During the month, the Treasury re-opened a 2-year bond worth Kshs 20 bn to raise money for budgetary support. The bond saw a subscription rate of 97%, with yields increasing by 220 bps to 14.8%, from 12.6% in June. The average market bid rate came in at 17.0%, indicating investors are demanding higher premiums due to uncertainty in the direction of interest rates.  On average, NSE FTSE bond index lost 0.7% in the month of August and about 2.4% from January, However, in reality, with the market duration at 3.89, and yields having increased by an average of 2.5%, the bond market has lost close to 10% YTD.

The government’s borrowing programme for the current fiscal year is behind schedule; instead of net borrowing, the government has so far made a net repayment of Kshs 21.9 bn for the current fiscal year. Consequently, we expect the government to step up domestic borrowing in a bid to raise the Kshs 219 bn budgeted for the year. The stepped up domestic borrowing will further result in upward pressure on interest rates, and therefore we continue to maintain our view that investors should be biased towards short-term fixed income instruments due to the uncertainty of the rate environment.


During the month of August, NASI and NSE 20 continued on a downward trend, falling by 3.8% and 5.2%, respectively. However, foreign investors were net buyers, with inflows of Kshs 927 mn during the month. The banking sector led declines after most of them reported earnings that were below market expectations. Some of the key losers included: Standard Chartered down 13.7%, NIC Bank down 13.1%, Kenya Commercial Bank down 12.0%, Co-operative Bank down 7.6% and Barclays down 7.5%. Since their February peak, NASI and NSE 20 have declined by 19.6% and 24.1%, respectively, while the decline on a year to date basis stands at 12.3% and 18.3%, respectively.

Banks released half-year results, recording a slow-down in growth. Overall, the banking sector grew at a 6.6% rate, compared to 15.8% in 2014, with the slowdown being attributed to poor economic performance on the back of uncertainty in the interest rate environment.  On the PAT y/y growth, National Bank of Kenya (NBK) and Co-operative bank registered the highest growth of 123.0% and 32.3%, respectively. NBK’s growth was due to a robust growth in non-funded income of 227%, driven mainly by sale of property. Net Interest Income (NII) grew by 18.8%, supported by a 30.6% growth in the loan book and 6.4% increase in deposits. Co-operative Bank’s performance was driven by a 19% y/y growth in NII, to Kshs. 11.8 bn from Kshs. 9.9 bn in H1’2014. Total operating expenses declined by 4% y/y to Kshs. 9.0 bn, bringing the cost to income ratio (CIR) to 47%, from 59% in H1’2014. CfC Stanbic and Standard Chartered registered the biggest declines of 42% and 36%, respectively. CfC’s decline his was largely attributed to a decline in non-funded income (NFI), which declined by 33% y/y to Kshs. 3.3 bn thereby diluting the effect of the 2.0% increase in net interest income (NII). Standard Chartered banks results were weighed down by a 51.2% increase in loan loss provisions. NII declined a marginal 0.1% y/y, while NFI fell by 31.2% y/y on account of a one off Kshs 1.2 bn gain last year owing to the bank’s sale of property. We shall be releasing our comprehensive banking report that will provide a detailed analysis of the banking sector H1’15 performance.         

Listed insurance companies released their half-year results, registering mixed performance. While Kenya Re, Jubilee and CIC Insurance registering a y/y growth in earnings of 20.3%, 24.5% and 51.3%, respectively, the results were countered by declines of 8.9%, 32.5% and 77.7% by Liberty, Pan Africa and Britam, respectively. The declines were mainly as a result of the fair value losses on investments given the decline in the stock market and the increase in interest rates. Insurance penetration in the country also fell to 2.9% in 2014 from 3.4% in 2013, mainly as a result of GDP rebasing. With the introduction of bancassurance by several financial institutions e.g. banks, as well as agriculture insurance and micro insurance, we expect an increase in the insurance uptake in the medium-term.

Given the change in the operating environment that we have witnessed in 2015, we carried out an analysis on the various drivers of the equities market in order to re-evaluate our view on the listed equities outlook. The table below highlights the different economic drivers, and their effects on the stock market’s performance: 

Economic Drivers of Stock Market Performance

Of the 7 indicators of equities market performance tracked by Cytonn, 6 have worsened over the year, hence pointing to a gloomy equities performance expectation through year-end


Expectations at Start of 2015

YTD 2015 Experience

Medium-term Outlook

Effect on Stock Market



5.0% - 6.9% growth in 2015

(i) 4.9% growth in Q1' 2015
(ii) IMF downgrades projection to 6.5% from 6.9%

Growth to be below target


Interest rates

Low and stable

(i) CBR increased 300 bps to 11.5%

Rates to remain high given government’s heavy borrowing



Low and stable at 6.02% as at December

(i) April inflation at 7.08% (highest for year)
(ii) August inflation at 5.84%

Expected to remain relatively stable within the CBK target of 2.5% - 7.5%


Exchange rate (USD/Kshs)

Shilling to remain under pressure

(i) Shilling depreciated 14.6% against the dollar YTD

Could depreciate further given the impending rate hike in the US and Kenya’s structural weaknesses


Corporate earnings

Improve on credit expansion and a favourable macroeconomic environment

(i) Weak earnings from banking sector. Banks recorded slowest growth in 6 years of 8.3% (15.6% in 2014)
(ii) Weak shilling affected import reliant companies

Weak earnings given the high interest rates and depreciating shilling


Valuations (P/E)

Multiples to come down to historical averages as a result of earnings growth

(i) PE multiples approaching historical average

Fair/ below average given weak earnings


Investor sentiment

Positive, supported by re-allocation of funds from the Nigerian market

(i) Peaceful conclusion of Nigerian election resulting to re-allocation to other cheaper markets

Negative on the back of anticipated rate hikes in the United States


Source: Cytonn Investments

As shown in the table above, the operating environment has become more difficult for businesses to operate. While valuations are not as stretched as at the beginning of the year, (market valuation currently at 14x PE compared to 16x PE as at the beginning of the year) earnings growth is much weaker, and the operating environment continues to be unfavourable. Despite the fact that some of the above factors have already been priced into the market, as can be seen by a 13% YTD decline in NASI, we feel that the market is now purely a stock pickers’ market, with few pockets of value. As a result of this, we revise our view slightly downwards to “neutral with a negative bias” from “neutral”.

Private Equity

During the month, Abraaj Group announced the first close of its 2nd North African Fund (Abraaj North Africa Fund II) at USD 375.0 mn. Cumulatively, Abraaj has raised USD 1.4 bn for the African continent this year, a record for any PE firm investing in Africa, having raised USD 990.0 mn for its 3rd Sub Saharan Africa Fund. This fund is designed to target mid-sized businesses in Algeria, Egypt, Morocco and Tunisia that have displayed a strong growth potential and focuses on sectors such as healthcare, education, FCMG and logistics. Currently the fund has made 6 investments across its target markets with its initial investment in the North Africa Hospital Group, a healthcare company with assets in Egypt, Morocco and Tunisia. Global private equity players such as Abraaj are attracted to the African continent due to a number of factors:

  1. Positive demographics driven by rapid urbanisation and the growing middle class across the African continent;
  2. Improved governance and transparency in the business environment;
  3. Willingness of business owners on the continent to accept private capital and management expertise, increasing the number of acquirable businesses and providing a quality deal flow;
  4. Under provision of basic services such as housing, healthcare and infrastructure by local governments, and;
  5. Increased ability to exit, which is key for PE investors.

On the East African front, there continues to be increased interest in the financial services sector which is attracting more private equity investments as evidenced by several deals during the month. For instance, Mauritian fund manager, Axis, acquired ApexAfrica Capital, a Kenyan stockbroker, for Kshs 470 mn, making it one of the highest valued acquisitions of a market intermediary in East Africa. Premfin Capital, a Mauritius-based financial services firm owned by a group of Kenyan investors, acquired two microfinance companies, Gatsby Microfinance in Uganda and Fanikiwa Microfinance in Tanzania. The acquisitions sought to broaden Premfin’s investment portfolio and accelerate the company’s growth.

During the month we also saw the National Social Security Fund (NSSF) buy 5.5% stake in Equity bank from Helios Investment Partners in a deal estimated at Kshs 9.7 bn. This highlighted the fund's increasing interest in Kenya's banking sector, having earlier invested in National Bank, Kenya Commercial Bank and Housing Finance for stakes of 48.1%, 6.1% and 2.2%, respectively. The emergence of financial sector as a target for PE investors in East Africa is driven by:

  1. A rapidly growing, and entrepreneurial, population seeking access to credit to finance growing ventures;
  2. Low financial services inclusion in the region with Kenya leading at 77% while Uganda and Tanzania, are at 43% and 35%, respectively;
  3. Increasing ease of exit in the financial services sector, most recently witnessed by Helios’ full exit of Equity Bank.

Given (i) the abundance of global capital looking for opportunities in Africa, (ii) the attractive valuations in private markets compared to public markets, and (iii) better economic growth in Sub Saharan Africa as compared to global markets, we remain bullish on PE activity in financial services, retail and FMCG, services, and manufacturing sectors.

Real Estate

During the month there was a lot of focus on government actions centered on formulation and enactment of policies that directly affect the real estate industry. One of the bills enacted into law in the course of the month was the Nairobi City County Regularisation of Development bill which stipulates that all unauthorised buildings will be eligible for demolition regardless of whether they are under construction or have been completed. The new law defines unauthorised buildings as those that have been constructed on river, road or rail reserve land and those that have been constructed without prior approval from City Hall. The owners of such buildings have been granted a six month window to come forward and seek fresh permits. Structurally sound buildings will be approved while those with minor defects will have to be altered according to the recommendations of the vetting team that will be put in place to inspect the building plans. Those who will be seeking to regularise their properties will be charged the same amounts as if they were applying for a development permit before construction.

As highlighted in our Cytonn Report #34, the Physical Planning Bill and Finance Bill will boost the construction industry in Kenya, as they set key reforms, which will make it more cost effective to undertake developments and improve construction efficiency, respectively. In our view, such reforms are market shaping and stimulating policies. To delve further, policy interventions fall under four categories, namely (i) market shaping, (ii) market regulating, (iii) market stimulating, and (iv) capacity building policies. In contrast to the Physical Planning Bill and the Finance Bill, the NCC Regularisation of Development Act comes out as a strong market regulating policy. The act will be of great benefit by:

  1. Helping to curb incidences of building collapse, and;
  2. Prompting the public to engage the services of qualified, registered, technical consultants to design and construct their buildings.

Though it is clear that the bill was specifically formulated to regulate development in Nairobi, we hold the opinion that these efforts should also permeate to the counties since majority of developments in the counties are unauthorised. We also maintain that for the government to achieve measurable and sustainable results, it needs to focus more on building the necessary capacity and providing the required tools and resources to ensure that the laws are enforced.

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.