Spring 2014

AFRICA FOCUS: NIGERIA - Cutting through the noise

PilonNigeria is one of the most exciting frontier markets in the world, but challenges such as an energy shortage continue to frustrate its growth. George Mitton reports. Diesel generators are a common sight in Nigeria. They range from hulking yet discreet machines that provide back-up power for banks and shopping malls, to ubiquitous home devices that cough, sputter and emit acrid smoke. Walking down the street during a power cut, it can be impossible even to make a phone call, so loud are the small machines. The noise isn’t the only annoying thing about these generators. The diesel they run on is expensive, and in a country where everyone from a backstreet metalsmith to a multinational telco relies on a generator, the economic cost is huge. Generators are expensive because, even though Nigeria has abundant oil reserves, the country has limited refining facilities, meaning most diesel fuel must be imported at a high cost. Could the expansion of Nigeria’s power grid finally put paid to the diesel generators? Or will the country still struggle to generate enough energy? These are questions investors should ask themselves before putting money into this country. First, the positive factors. Nigeria has a large population with huge numbers of people moving above the poverty line for the first time, becoming consumers of everything from beer to babies’ diapers. It has natural resources, such as oil, which are currently underexploited (Nigeria is producing way below its limit set by OPEC). On top of this, Nigeria has some of the lowest public and external debt ratios in the emerging and frontier market space. The country will soon become the second-largest constituent of the MSCI Frontier Market index, when Qatar and the UAE graduate to emerging markets. Meanwhile, its GDP is due for a sudden leap. The current GDP calculation is based on data from 1990, and it is widely believed not to reflect the reality of its economy. When the government finally releases the GDP rebasing numbers, the economy could grow from anything from 20% to 40%. It doesn’t mean Nigerians will be any wealthier than before, but the change is likely to catch the eye of international investors. Does that mean the country is due for an increase in foreign investment? Not necessarily. Like any major country, Nigeria has challenges ahead. One risk is the election scheduled for the early part of 2015, which is expected to be one of the most closely contested since the country went back to democratic government in 1999. Anticipating the election, the country’s politicians will spend much of this year politicking and canvassing votes, meaning major decisions, for instance on the long-awaited Petroleum Industry Bill, are likely to be delayed. A further concern is that the election itself may fail to go smoothly. “It doesn’t matter too much who the winner is, but if the process of getting the winner there involves a messy election, and you have political violence – one party sending their thugs to beat up people, good old-fashioned Chicago politics – that would make investors unhappy,” says Ayo Salami, chief investment officer of Duet Africa, an investment firm targeting the continent. ‘BAD BANK’
Another concern is a change in leadership at the central bank. Lamido Sanusi, who is widely credited with salvaging the country’s banking system, is due to step down as governor in 2014. Some have worried that his reforms, such as the creation of a “bad bank” to take on bad loans, and his readiness to dismiss entire bank boards and obtain corruption convictions, will wane in his absence. Others, however, say he has been such a strong force that his legacy is secure. Besides these concerns are more general problems. Corruption remains a concern in the country. Nigerian elites have not always acted in the best interests of the country as a whole, though it is worth remembering that foreign players, such as manufacturers eager to secure lucrative contracts, have aided their mismanagement. Despite these challenges, investors have plugged money into both Nigerian equities and fixed income. In general, they have been rewarded. The Nigerian Stock Exchange All Share Index rose nearly 50% last year. Bonds, especially in local currency, are offering attractive yields. Philip Southwell, chief executive of emerging and frontier market manager Exotix, says he is bullish about Nigerian assets, though there are a number of complicating factors. “We need more listings. There’s only one oil and gas play and no telcos. There’s no real agriculture play and that’s the biggest sector in the economy. There are lots of banks but they’re all pretty small. In terms of bellwethers, the only big stock is Dangote Cement, but it’s very tightly held. Having said that, we are expecting deepening of the financial markets. It’s interesting to own some banks.” OPTIMISTIC
Despite these reservations, Southwell is optimistic. He says Exotix has chosen Lagos to open its first office in Africa. The firm will be hiring staff there and building a sales and trading business in the country. “We’re putting our money where my mouth is,” says Southwell. Exotix might not be the only asset manager increasing its resources in Nigeria if current trends in the institutional space continue. According to Zin Bekkali, founder of frontier market investment firm Silk Invest, assets held by Nigerian pension funds have risen five times in five years to $20 billion. In an interview (see pages 16-17), he says that within three to five years, he expects his firm to raise more assets from institutional investors in African markets such as Nigeria than from the West. If Bekkali is right, this trend would turn conventional wisdom on its head. For years, asset managers have looked at Africa as a place to deploy assets raised elsewhere. Soon, it may become a place to send fund salesmen. If they are lucky, those visiting salesmen may soon have fewer noisy diesel generators to contend with. Nigeria plans to double its power generating capability in the next three years, which Joseph Rohm, portfolio manager at South Africa-based asset manager Investec, says is “the most exciting development in the country in the last decade”. Nigeria has privatised 15 generation and distribution companies in the hope this will aid the project. Banks are being encouraged to lend to power projects. The World Bank is involved, offering a partial guarantee payment to the generation companies. MORE LIGHTS
Rohm says conservative estimates of private investment in the power sector in the next three years are $10 billion. This is a promising area of loan growth for the banks. Although he expects challenges such as the sourcing of long-term gas contracts, he expects to see “more lights being switched on in Nigeria over the next decade and our portfolio companies benefiting from a much lower cost of doing business”. If Rohm is right, and the plans to increase Nigeria’s generating capacity proceed on schedule, the country’s reliance on diesel generators might finally ease. Good for investors and for those breathing the air on Nigeria’s streets. ©2014 funds europe

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