2016 Outlook Nigeria · 2019. 10. 15. · A Dim Reflection Cordros Capital Research January 2016 A...

A Dim Reflection

Cordros Capital Research January 2016

A cogitatione obscurum

2016 Outlook Nigeria

Nigeria 2016 Outlook A Dim Reflection

Cordros Capital Research Jan. 2016 2

Contents

OVERVIEW 3

EQUITY RATING 5

GLOBAL ECONOMY 6

Growth – Modest and Divergent 7

Markets – Happy Start, Anxious End 7

NIGERIA 16

Economy – A Thorny Path to Growth 17

Fiscal Policy – From Transition to Change 29

Inflation – Ignore the Hype! Single-digit Still in Sight 36

Interest Rate – The Path is the Key 39

External Sector – Balance of Payment Crisis? 42

Currency – Still Seeking its True Value 44

CAPITAL MARKET 46

Equities – Sentiment Outweighs Valuation 47

Fixed Income – Yields to Remain Compressed 52

Consumer Goods – Will High Government Spending Come to the Rescue? 55

Companies 62-68

Cement – Lower Prices and Huge Government Programme vs. Weak Private Demand Outlook 69

Companies 74-76

Banking – Resilient but not Insulated 77

Companies 83-87

Contact Details 88

Disclosures 90

GLOBAL The global economy is expected to grow at 3.1% in 2015 (vs. 3.4% in 2014) – according to IMF estimates - before picking up modestly to grow at 3.4% in 2016. The lower growth in 2015 was a result of patchy recovery in developed economies, while growth in emerging and developing economies (especially oil-exporting ones) stalled. Reactions across markets in 2015 were mixed. Equities were upbeat in the first half of the year while momentum tapered in the second half.

NIGERIA

A Thorny Path to Growth

Our growth forecast for 2016 is 3.83%. The projection would have been larger were it not for our bearish outlook for the oil sector. Whilst acknowledging the resilience of the non-oil sector and remaining convinced of its ability to support growth in 2016; output from the sector is unlikely to reach its pre-2015 run rate or be robust enough to absorb the potential drag -- caused by lower oil price – from the oil sector. Fiscal Policy – From Transition to Change The assumptions driving the optimistic 2016 budget are realistic (on average) in our view. That said, we acknowledge that there are a few projections (on both income and expenditure lines) that seem ambiguous on the surface. Noteworthy, however, is that the risk of these ambiguities to the success of the entire Appropriation Bill is modest. Inflation - Ignore the Hype! Single Digit Still in Sight It is our view that it was the CBN’s inflation (CPI) target of 6-9%, and not the single-digit, that came under serious scrutiny in 2015. We see a re-occurrence in 2016, wherein we estimate the CPI to close 9.2% average (vs. 9% in 2015). Note however that overall, there appear to be more upside risks than downsides, going into the year. Interest Rate - The Path is the Key After a 6-year tightening cycle, Nigerian monetary policy rates are reversing directions. With factors weighing on Nigeria’s economic fundamentals set to remain through 2016, the monetary authorities will be compelled to be more stimulatory. An important dynamic beyond the kick-off of the easing cycle, is the progression.

Cordros Capital Research

OVERVIEW

3

Analysts

Christian Orajekwe [email protected]

Alieza Jo-Madugu

[email protected]

Hauwa Ojeifo [email protected]

Peter Moses

[email protected]

Opeyemi Ani [email protected]

Jan. 2016



External Sector - Balance of Payment Crisis? Concerns about the country’s Balance of Payments position going into 2016 are elevated. This is hinged on the likelihood that current account deficit will expand further in 2016 on the back of resumed fall in commodity prices (Nigeria’s main exports). Currency - Still Seeking its True Value In 2016, we forecast a further decline in the Naira across all major market segments, following consensus estimates for lower oil prices and further Fed tightening. In the meantime, we believe the CBN will double down on its demand management strategies. Equities - Sentiment Outweighs Valuation From valuation perspective, Nigerian equities are largely attractive (even from conservative earnings perspective) and argument in favour of a market rebound in 2016, on the back of this alone, is strong. Notwithstanding, we do know that it is unlikely that the market would stage a recovery this year. We envisage sell-offs in the first half and buy-backs in the second half. On average, the ASI would trail end-2015 levels by between 10-15%. Fixed Income - Yields to Remain Compressed Our overall view is that yields will remain compressed in 2016, with the key theme being the nature of Nigerian economic downturn. The resumption in the decline in oil prices (-17.0% YTD) further threatens Nigeria’s economic recovery and strengthens our view that the current economic slowdown - average GDP down to 3.0% in 2015 from 6.2% in 2014 - is likely to be protracted through 2016. This would have huge implications for the aggressiveness of both monetary and fiscal policymakers’ expansionary policies.

4 Jan. 2016


Source: Cordros Research estimates

Cordros Capital Research 5

EQUITY RATING

Jan. 2016

Ticker Target price

Closing Prices Return Rating

2016/17 EPS

2016/17 PE

201/17E RoAE

Mkt Cap (N'bn)

Mkt Cap (US$'mn)

Cement

CCNN 9.47 9.60 -1.32 HOLD 1.68 5.61X 17.89 12.06 60.32

DANGCEM 162.04 128.91 25.70% BUY 12.27 10.5x 28.56% 2196.69 10.98

WAPCO 118.39 80.00 47.99% BUY 8.39 9.53 19.03% 364.39 1.82

Consumer Goods

CADBURY 21.67 19.00 14.05% HOLD 0.42 45.34 0.07 35.69 0.18

DANGSUGAR 4.97 6.05 -17.85% SELL 0.99 6.11 0.20 72.60 0.36

HONYFLOUR 1.74 1.46 19.18% HOLD 0.20 7.19 0.07 11.56 0.06

FLOURMILL 40.18 18.25 120.16% BUY 1.00 26.68 0.03 47.89 0.24

NESTLE 783.48 739.99 5.88% HOLD 32.38 22.85 0.65 586.56 2.93

PZ 30.97 27.60 12.21% HOLD 1.08 19.38 0.10 83.38 0.42

UNILEVER 23.56 21.00 12.19% SELL 0.09 405.54 0.04 133.32 0.67

Banking

ACCESS 7.98 4.15 92.29% BUY 21.3 1.95x 16.23% 119.18 0.60

FBNH 4.83 3.93 22.90% BUY 0.67 5.87x 9.04% 143.94 0.72

GUARANTY 22.44 16.79 33.65% BUY 3.35 5.01x 21.70% 493.85 2.47

UBA 5.62 2.89 94.46% BUY 1.41 2.06x 15.40% 103.39 0.52

ZENITHBANK 20.26 12.61 60.67% BUY 2.69 4.23x 14.19% 429.82 2.1491



GLOBAL ECONOMY

6

Growth – Modest and Divergent 7

United States 7

Euro Area 9

Japan 10

Emerging and Developing Economies 11

Global Markets – Happy Start, Anxious End 13

Advanced 13

Emerging and Frontier 15

Jan. 2016


The global economy is expected to grow at 3.1% in 2015 (vs. 3.4% in 2014) – according to IMF estimates - before picking up modestly to grow at 3.4% in 2016. The lower growth in 2015 was a result of patchy recovery in developed economies, while growth in emerging and developing economies (especially oil-exporting ones) stalled. The weakness was broadly based on low commodity prices, fragile financing conditions across board, anticipated (albeit modest) tightening in the US monetary policy and a slowdown in China. The oil-exporting countries were hampered by weakening currencies against the backdrop of falling oil prices – due to inventory build-up, US shale discovery and OPEC’s reluctance to cut supply. UNITED STATES - Growth in the US was weak in the first quarter following harsh weather conditions and port closures. The world’s largest economy remained as falling oil prices on the back of ample global supply gave support to household purchasing power. However, drawbacks in light of (1) cutbacks in capital expenditure in the Oil and Gas sector and (2) a strengthening Dollar continued to impede trade and balance of payments. Despite strong second


Global Growth - Modest and Divergent

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Figure 1: World Output Growth Projections (%) Figure 2: Commodity Price Movement

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Source: IMF, Bloomberg


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Source: US Federal Reserve, US Bureau of Labor Statistics

and third quarters wherein the economy grew stronger than expected, the last quarter was characterised by weak exports and choppy imports as global growth was recovery came under the threat of sharp falling commodities prices. A key driver of market concerns was the Federal Reserve’s relentless stance on gradual monetary policy tightening following series of impressive economic data. One of such was the labour market, which was sturdy for most of the year – with unemployment declining to 5.1% (according to US Bureau of Labor Statistics) in August, indicating 0.4 percentage points below its February figure. Fiscal policy was broadly neutral throughout the year although inflation remained well under the target 2%. The country’s current account deficit is likely to remain wide as the real Dollar appreciation continues to foster imports and weigh on exports. In the medium term, more recovery is expected in the US, wherein lower energy prices, solid balance sheet, and a reduced fiscal haul will more than offset the pull in net imports from the strengthening currency. Overall, growth is expected to average 2.5% in 2015 and rise marginally 2.6% in 2016, according to the IMF World Economic Outlook.

8 Jan. 2016


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Figure 5: PMI Composite Figure 6: Economic Sentiment Indicator – Germany and Italy

Source: Bloomberg, CES ifo Institute, ISTAT

EURO AREA - Generally, the recovery in the Euro Area was more rapid than expected, largely underpinned by a weakening Euro, lower oil prices, record-low interest rates and improved bank credit supply conditions. Major risks to recovery however included weak corporate and private investments amid elevated corporate leverage, lingering financial market disorientation, and hampered supply-side and weak demand, most of which were predominant in the first quarter of the year. A major highlight was the Greece crisis that adversely impacted investor confidence in the entire Euro Area. Despite indications of weak construction and manufacturing for a better part of the year, lower oil prices, robust job creation and rising wages bolstered consumer spending in the United Kingdom (UK). Thus, GDP is expected to average 2.6% levels in 2015, slightly lower than in 2014, but better-than-expected in light of the global economic slowdown. The German economy is expected to finish strong in 2015 following fresh unemployment lows , healthy private consumption and increased government spending. The effects of lagging export growth and fixed investment recorded during the year were partly offset by the above stated. This is expected to remain supportive of growth in 2016. Ithe MF projects the economy to grow by 1.5% and 1.7% in 2015 and 2016 respectively.

9 Jan. 2016


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Similarly, France’s rocky start to the year, growing flat in Q2, was negated by a modest 0.3% pickup in Q3-2015. Underscoring growth was an improvement in domestic demand which more than offset external factors such as slowing China, expensive imports from the US and decelerating emerging economies. The country’s security however come under serious scrutiny following reoccurring terrorist attacks. Notwithstanding, growth is expected at 1.1% in 2015 and 1.4% in 2016, driven predominantly by the weak euro and low energy prices. Economic activities in Italy rebounded, albeit slowly, after growth stagnated in the past four years. The country made major remarks in 2015 as indicated by rising Purchasing Managers Index (PMI) – adding 1.4 points to 54.1 according to Markit - and consumer confidence peaking at a three-year high in October 2015. Unemployment, previously a major deterrent of growth, started falling (from 12.8% in 2014 to 11.8%) in September. The IMF revised the country’s growth upwards from 0.4% and 0.6% for 2015 and 2016 respectively to 0.8% and 1.3%. JAPAN - Japan’s economy - which narrowly escaped a recession in the third quarter of 2015 - was weighed down by lacklustre economic activities. Saddled on Prime Minister Shinzo Abe’s Abenomics, the country’s “three-arrow” strategy of unprecedented monetary easing, government spending and business deregulation has come under much scrutiny in recent times. Uncertainties as to whether or not the arrows may be missing their targets have come to light, underlying the persistently weak consumer spending and private sector activities.

10 Jan. 2016

Figure 7: Private Consumption Expenditure (Trillion Yen) Figure 8: Seasonally Adjusted Trade Balance (Billion Yen)


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One major challenge that the economy faced, like China, was its shrinking working population and the consequential dent on private sector growth. Whilst proponents of Abenomics believe that hefty monetary easing can spur the economy out of a two-decade long deflation, concerns on the lag in implementation of concrete reforms on labour and agriculture alongside monetary easing will continue to keep the economy at bay. Major positives however included a strong recovery in the country’s exports, strong investment and snippets of increased private consumption. The Bank of Japan (BoJ) agreed not to add to its QQE program, despite slow progress in the implementation of much needed pro-growth reforms. Going forward, Japan’s prospects remain quite healthy on the back of elevated social spending and investment in the agricultural sector. Growth is expected to strengthen mildly, consistent with a low unemployment rate, rising wages, weak Yen and low oil prices. The apex bank expects the economy to expand between 0.8% and 1.4% in fiscal year 2015, which ends in March 2016. In the subsequent fiscal year, the BoJ sees GDP growth of between 1.2% and 1.6%. EMERGING vs. FRONTIER ECONOMIES - Once upon a time, there were four emerging economic giants that were foretold to drive economic growth for the rest of the 21st century. While waning momentum has plagued the giant of them all (China) in recent years, investors see glimmers of hope in another (India). The other three – Brazil, Russia and South Africa – are currently under the threat of weakening commodity prices, and investors are not waiting around to see what happens. As anticipated, China’s economy slowed down in 2015. The country’s cooling property market – from 20% growth in 2013 to 3.5% as at 9M-2015 –pummeled its manufacturing and construction sectors. 2015 was characterized by moderate fiscal stimulus and continued monetary easing. The central bank cut reserve rates six times since November 2014 and pledged to keeping monetary policy accommodative expected in order to spur consumer spending. Going forward, the economy’s transition is expected to extend its slowing growth. We foresee further rebalancing of the economy from an export and investment-led one to an internal consumption-driven growth. With the above stated factors, coupled with the Fed rate hike, stronger Dollar, struggling frontier markets, and volatile commodities prices, China will continue to decelerate in 2016 to a more sustainable growth path. Accordingly, growth will likely reduce to 6.5% in 2016, and 6.2% in 2017.

11 Jan. 2016



India’s economy slowly outshined that of China, as optimism around the reforms and business inclination of the current administration remained supportive of growth. 2015 wasn’t entirely rosy though. The economy came under the threat of a decline in the growth of the manufacturing sector. Much of the weakness in this key driver of the economy was underscored by a squeeze in the sector’s labour market as companies cut back on capital expenditure and inventories. The central bank consequently cut interest rate – four times in 2015 – as a demonstration of a strong commitment to growth stimulation. Brazil and Russia on the other hand stumbled in 2015 on the back of major domestic and external headwinds. For the first time since 2009, Russia entered a recession in 2015 – declining 4.6% and 4.1% respectively in Q2 and Q3-2015. The country’s currency, the Ruble, shed c.30% relative to the US Dollar, on the back sharply lower oil prices and poor capital flows (owing to sanctions imposed on the country).

12 Jan. 2016

Figure 9: GDP Growth Rate (%) Figure 10: Benchmark Interest Rates

Source: World Bank


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Reactions across markets in 2015 were mixed. Equities were upbeat – on the back of monetary stimulus and modest recovery activities - in the first half of the year while momentum tapered in the second half wherein investors were met with increasing uncertainties in the global economy. ADVANCED MARKETS - Following a largely positive first half of 2015, advanced markets were largely weighed by major policy direction uncertainties and a general slowdown in business sentiments and economic activity. US indices surged on key Mergers & Acquisitions (M & A) activity in healthcare and pharmaceuticals. M & A activity hit its strongest half year in the US – in H1-2015 – since 2007.

However, bullish sentiments were short-lived following the impact of the Dollar appreciation on corporate earnings (which in turn prompted disappointing earnings), amid fragile business sentiments. Hopes of a further delay in the first interest rate hike in US (since 2006) had helped US equities in the earlier part of the year, but not for long. Investors soon fretted over the extent of the slowdown in China and emerging markets. In addition, the Fed’s anticipated monetary tightening created a sense of uncertainty in


Global Markets - Happy Start, Anxious End

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Figure 11: U.S and Regional Equities Indices

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Jan. 2016

Source: Bloomberg

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Dow Jones S&P 500 FTSE 100

MSCI Emerging MSCI Frontier EURO STOXX 50


major markets. Worries also dented prospects in the Energy, Industrial and Utilities sectors due to oil price concerns. Despite major gains in defensive consumer staple sectors and a pickup in wages, the bears outweighed, leading the S&P 500 and Dow Jones to decline 0.73% and 2.23% respectively. The Euro area markets traded sideways, with the ECB’s €1.1 trillion Quantitative Easing (QE) still remaining a cornerstone of investors’ sentiments. Following the pressure surrounding Greek’s debt situation in the first half of the year, economic data showed improvements in the second quarter. A general wave of encouraging corporate figures soon ensued in Q3-2015 as exporters reaped the benefits of the weak Euro, prompting Germany and Italy to record strong business confidence and sturdy manufacturing activity. Elsewhere, UK earnings downgrades were bettered during the results season as share prices stabilized against the backdrop of sagging oil and industrial metal prices, aided by China Construction Bank’s (CBB) move to reduce lending and deposit rates. Though energy majors disappointed, airlines picked up and exceeded expectations due to lower costs of fuel. Further revving market momentum was the decisive general election held in the United Kingdom which erased the negatives incurred during bailout and negotiations between Greece and its creditors. Japanese equities were red-hot for the most part of the 2015FY, riding on easy money as part of the QQE program of the government. The country’s equities market rose strongly for the first half of the year, with optimism driven mainly by expectations of further easing. The relative momentum however took a downturn as significant sell pressure was witnessed at the latter part of the year, erasing earlier gains. Stocks fell to 8-month lows despite an upbeat corporate result season. The market rode on economic sentiments as questions on the merits of Abenomics seemed unclear. Gains took a haircut at year end, with the Nikkei closing +9.07% in 2015FY.

14 Jan. 2016

Figure 12: Developed Market Indices Top Six Gainers 2015 Figure 13: Developed Market Indices Top Six Losers 2015

Source: Bloomberg


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EMERGING MARKET - Emerging markets were dented massively in 2015FY following the consequences of plummeting crude oil prices (amongst other commodities) on currencies and foreign reserves against the effect of China’s lagging economy. China’s equity market was probably the most difficult conundrum for investors. The seesaw of economic data that filtered into the market only inflated worries at the fore of the global economic concerns. Though the market surged on some net positives, the declining momentum of the economy did not bode well with market sentiments. The first half of the year was characterized by significant double digit weekly gains. Investors rode on optimism on monetary stimulus by the central bank. The CSI 300 hit seven-year highs and exceeded psychological resistance levels repeatedly. Much of these were underscored by government intervention to salvage the slowing economy. Major indices soon slid on unprecedented leveraging and margin debts, coupled with downbeat economic data. Despite the government’s easing measures, coupled with its sporadic share buy-backs, the share declines eroded over 30% of the Shanghai Stock Market within a period of three weeks. Overall, China’s stocks outperformed those of the S&P 500; with the CSI 300 pulled off a 5.58% 2015 gain. Frontier markets were no better, as heavy losses in Nigeria (-17.63%) and Ghana (-11.77%), far outweighed Kenya’s gain (+20.73%). The Nigerian All-Share Index, despite rising on the success of the most decisive election in its history, shed weight on a lack of policy direction of the newly-elected administration, coupled with sticky oil prices and waning optimism in the government. Similarly, Ghana’s stock market fell on commodity-related worries and generally bleak macroeconomic reading. In the case of Kenya, investors remain optimistic as the economy remains resilient among other frontier market players.

15 Jan. 2016

Figure 14: EM Indices Six Gainers 2015 Figure 15: EM Indices Top Six Losers 2015

Source: Bloomberg


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NIGERIA

16

The Economy – A Thorny Path to Growth

Buhari’s Plan for the Oil Sector is Plausible, but Requires Time 17

Non-oil Sector Should Bounce Back, Albeit Modestly 19

Agriculture 20

Manufacturing 22

Infrastructure 23

Trade 26

Fiscal Policy – From Transition to Change

Plausible Risks 35

Difficult Government Choices 35

Inflation – Ignore the Hype! Single-digit Still in Sight 36

Interest Rate – The Path is the Key 39

Policy Harmony Beckons 39

Are Rates Set to be Lower for Longer? 40

Implications 41

External Sector – Balance of Payment Crisis? 42

Currency – Still Seeking its True Value 44

Jan. 2016


In its update on world economy in October, the IMF estimated Nigeria’s GDP growth to be 4.3% in 2016. The Federal Government forecasted a 4.37% growth, under its Medium Term Expenditure Framework (MTEF 2016-2018). Our growth forecast for this year is 3.83%. The projection would have been larger were it not for our bearish outlook for the oil sector. In November, OPEC ended its last meeting for 2015 on such controversial note that appears to have ruled out any possibility of oil price rebound in 2016 -- price of the commodity fell to near 6-year low after the meeting. Thus, whilst acknowledging the resilience of the non-oil sector and remaining convinced of its ability to support growth in 2016; output from the sector is unlikely to reach its pre-2015 run rate or be robust enough to absorb the potential drag -- caused by lower oil price – from the oil sector. Our concern is that unlike in 2008/2009 -- wherein oil price rebounded after hitting a trough -- further price contraction in 2016 is likely to delay the pace of Nigeria’s economic growth recovery. In 2015 (c.3% GDP growth), the oil sector crawled out of recession in Q3 (unsurprising) while the non-oil sector growth overwhelmingly underperformed. Aside a sharp fall in oil (43% as at H1-15) and non-oil (1% as at H1-15) revenues -- resulting to fiscal policy tightening (on infrastructure spending especially), growth came under pressure from (1) electioneering -- clouded with uncertainties that slowed down economic activities and business decisions (2) persistent insurgency activities and fuel supply shortages, and finally, (3) the change of government (at federal and state levels), post-elections.


The Economy - A Thorny Path to Growth

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Figure 16: Real GDP Growth (Output) Figure 17: Real GDP Growth (Expenditure)

Source: NBS

Jan. 2016


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Buhari’s Plans for the Oil Sector is Plausible; but Requires Time The oil sector GDP growth has been negative for four years running (see chart below). Yet, we are not optimistic of the sector in 2016. In view of further decline in crude oil price, coupled with internal challenges affecting output, we believe the question is by what magnitude, rather than if, the sector would record another negative growth in 2016 -- supporting the obvious urgency by the new administration to diversify the economy. Before crude oil prices began crashing in 2014, growth in the sector had been bedeviled by crude oil theft, pipeline vandalism, and consequent production shut-ins. Consequently, actual production continues to fall below budget. There are several stakeholders in Nigeria’s business of oil theft -- owing to the high rents that are up for grabs. Parties range from small-scale local bunkerers (who refine and sell locally) to industrial-scale operators that pump crude into larger vessels for exports. A 2015 report credited to some of the major IOCs and submitted to the Nigeria Extractive Industries Transparency Initiative (NEITI) showed about 160mbpd of crude oil valued at US$13.7 billion was lost to theft between 2009 and 2012. Buhari’s government has plans to tackle these setbacks (as part of the 2016-2018 Strategic Plan). Unfortunately, some of the measures it has proposed -- e.g the introduction of state-of-the-art surveillance systems and strengthening the capacity of

18 Jan. 2016

Figure 18: Oil Sector Real GDP Growth Figure 19: Crude Oil Production (mbpd)

Source: CBN, BoF


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security agencies -- have been deployed by previous governments, but with unsustainable results. We should expect a more confrontational intervention from PMB, may be in form of the ongoing anti-graft war. On the positive, the federal government seeks to engage the law makers to expedite action in the consideration and passage of the Petroleum Industry Bill (PIB) -- entitled Petroleum Industry Governance and Institutional Framework Bill 2015 (PIGIFB) -- which has languished in the National Assembly (NASS) for six years. Recent development on the Bill is that it has been broken down into smaller bills and several changes have been made to it, such as; (1) stripping the president of discretionary powers to allocate oil blocks (2) curtailed the power of the minister regarding board appointment and (3) splitting of NNPC into two separate entities -- the Nigeria Petroleum Assets Management Co (NPAM) and a National Oil Company (NOC -- to be operated as a fully commercial entity). The bill also creates the Nigeria Petroleum Regulatory Commission (NPRC), which will serve as the regulator for the entire industry, from licensing rounds to fuel prices. In our opinion, this is a significant move towards a speedy passage of the Bill. The fact that the Senate was actively involved in drafting the Bill (as we heard) is also a pointer to speedy passage. If successful, transparency and governance -- the prerequisites for renewed direct investments in the oil sector -- would be enhanced. That said, while we are attempted to trust the new “Change Legislators” to cooperate with PMB on this Bill, caution must be taken, bearing in mind the usual hurdles involved before receipt of legislative approvals. The Bill for instance could not be passed even when the immediate past president and the majority in the National Assembly (NASS) were of the same party. The yearly tensions over the budget (which is usually not passed into law until May) are also a case in point. Whilst acknowledging that APC (the ruling party) currently controls the NASS, the challenge is that many law makers are bound by their shared interests rather than party loyalty. One of such examples is the ongoing bickering among the ruling party members over the choice of the leadership of the National Assembly. Again, there is also report of the law makers’ reluctance to submit the NASS account to the TSA which is championed by the FG. The Non-oil Sector Should Bounce Back, Albeit Modestly We are more constructive of the non-oil sector’s outlook. This is because most of its components (some of which weigh quite strongly in the national output basket) are still operating below their potentials. The sector accounts for c.90% of the national GDP, has grown impressively pre-2015, and interestingly, reforms aimed to boost growth in the sector rank top on

19 Jan. 2016



Buhari’s agenda. The Central Bank -- via monetary policy easing -- has also played swiftly into the FG’s stimulus plan for the economy. We are convinced that a well implemented cohesion of fiscal and monetary policies would have positive implication for the non-oil sector. The first and cheap positive for growth in this sector come 2016 is that two of the primary factors that dampened output in 2015 are “extremely” unlikely to reoccur. Firstly, there would be no elections, and the unarguable slowdown they inflicted on economic activities in Q1 last year. Secondly, with the assignment of portfolios in November 2015, Buhari’s team appears ready to “get-down-to-work”. Hence, we do not expect the kind of dearth of policy actions that stalled economic decisions between June and December 2015. Growth in Key Sub-sectors Will Drive the Rebound Agriculture The MTEF gives preference to Agriculture, including agro-businesses, to drive growth in the non-oil sector. Plan is for the sector to grow by 8-15% between 2016 and 2018. This is an optimistic target, in the light of recent years growth rate.

20 Jan. 2016

Figure 20: Non-Oil Sector Real GDP Growth

Source: NBS


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Agriculture was pre-eminent before Nigeria commenced commercial crude oil production. In the 1960s and up to the early 1970s, the country was one of the world’s highest producers of palm oil, cocoa, and groundnut. However, the sector has declined in importance over the last four decades. It is dominated by smallholder and traditional farmers who use rudimentary production techniques, with resultant low yields. It has also suffered from the rampage of insurgency that has displaced thousands of farmers and others in the value chain from the North. Notwithstanding, the agric sector is currently the largest contributor to national employment (over 70%) and national output (23%).

21 Jan. 2016

Figure 21: Agriculture GDP Growth

Source: CBN, NBS

Figure 22: Agriculture vs. National GDP and Non-Oil Sector Figure 23: National Food Import Bill (N’bn)

Source: CBN

Post GDP Rebasing


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Successive governments in Nigeria have formulated several policies in attempt to promote investment and growth in the sector. But as highlighted by the International Institute of Tropical Agriculture (IITA), they lack systematic focus that shows a conscious effort to purposely prioritize the development process based on the generally identified components that constitute modern agriculture. That said, we acknowledge the immediate past administration’s Agriculture Transformation Agenda (launched in 2011) that was successful in the following areas; (1) the use of the GES scheme to engender improved quality and distribution of fertilizers and other inputs (like seedlings) and (2) the introduction of innovative financing for agriculture. The Agric Ministry alleged domestic food supply to have increased by more than 21 million tonnes since the launch of the agenda. The production capacities of rice, cocoa, cassava, maize and palm oil were strengthened during the period. The ATA, if continued, has the potential to close the gap in Nigeria’s agricultural production. Good news therefore is that the new agriculture minister, Chief Audu Ogbeh (though with lesser agric credential than the immediate past), has a good foundation on which to kick-start the journey to the sector’s ambitious 8-15% growth target. Manufacturing Manufacturing is key to Nigeria’s GDP growth. Its contribution to national output has grown consistently from c.7% in 2010 (under the rebased GDP) to c.10% in 2015. It’s also the fastest growing among the top (in contribution to output) non-oil sub-sectors. Nonetheless, the sector is faced with several challenges, the primary being systemic issues of infrastructures (power and transport especially). Similar to agriculture, manufacturing has suffered the official neglect associated with the heavy reliance on oil. Capacity utilization dropped from over 70% in the 70s to 35% in the 90s. Though utilization rate has increased quite noticeably since 2001, to 52% in 2013 (latest figure from MAN), it remains significantly shy of the figures in South Africa (c.80%), Brazil (78%) and India (96%). Discussing this sub-sector in 2016 report is imperative because history shows that it usually attracts stronger government attention post oil booms. We should therefore expect that sustained lower oil prices will likely favour local manufacturing in the long run. This is where we believe the rebasing exercise would be helpful to the new government, given that it captures a more realistic picture of the sub-sector and makes SWOT analysis much easier. Prior to rebasing, manufacturing included just three activities -- oil refining, cement and other manufacturing. Post rebasing shows a broader scale of activities, bringing activities under this non-oil category to 13.

22 Jan. 2016



Nigeria has all that it needs to return manufacturing capacity utilization to the pre-80s levels. Its key strengths, as highlighted in the Industrial Revolution Plan (NIRP 2014) are abundant natural resources (massively untapped), large market (170 million population) and abundant labour (semi-skilled, yet low paid). The NIRP also highlighted a long list of weaknesses, which if half-solved, displays great potential for future expansion. It is encouraging that shortly after taking office, President Buhari noted that Nigeria is “virtually back at ground zero as far as industrial development is concerned.” It is also encouraging that he acknowledged that reversing this will not happen overnight, but more cheering that he is willing to effect both the small and large reforms necessary, “with political will”. After a thorough evaluation process, the NIRP identified (1) agribusiness & agro allied (2) solid minerals & metals, (3) oil and gas related industry and (4) construction, light manufacturing, and services -- detailed out into specific subsectors -- as sectoral priorities. Interestingly, the DMBs have been urged by the CBN to channel the excess liquidity accruing from recent CRR reductions to these priority sectors. Infrastructure This does not appear as standalone under the NBS’ classified non-oil sector activities. Meanwhile we consider it useful in 2016 because (1) improving its status would serve as an enabler to unleash productivity across board, by reducing (or removing) structural impediments and (2) it is now under the

23 Jan. 2016

Figure 24: Manufacturing Sector

Source: NBS

Post-GDP Rebasing Pre-GDP Rebasing


Oil Refining

Cement

Food, Beverage and Tobacco

Textile, Apparel and Footwear

Wood and Wood Products

Pulp, Paper and Paper Products

Oil Refining

Cement

Other Manufacturing


supervision of a Minister (Babatunde Raji Fashola) with arguably the most reliable credential -- in terms of track record -- the ministry has had under this nascent democracy. Also worthy of note is government’s plan to spend 25% of 2016 CAPEX budget on infrastructures -- power, transportation and housing. That Nigeria’s infrastructure is in a considerably deplorable situation is a fact! Discussing how the country got here is not useful now; we would rather focus on the potentials. Under infrastructures (highlighted among the support structures and enablers for the Nigerian manufacturing sector), the NIRP placed specific emphasis on the availability of power and transportation. This is critical because power shortages and inadequate (yet dilapidated) transportation system have caused factories that used to provide employment for million Nigerians to shut down operations (by rendering them completely uncompetitive). Nigeria’s low ranking in World Bank’s ease of doing business report has been consistent over the years. Fashola has an outstanding record as the administrator of Lagos State -- the largest city in Nigeria and one of the fastest growing urban areas in Africa -- for his eight years in office (2007-2015). His reforms in infrastructures -- road construction, high performance public transport system, and environmental planning -- transformed Lagos into a mega city. In addition, being developed before the expiration of his tenure are (1) a light rail project consisting seven lines linking major population and activity centres and (2) an affordable home ownership scheme designed to reduce housing deficit in the State.

24 Jan. 2016

Figure 25: Nigeria’s Ease of Doing Business Ranking

Source: World Bank


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On Power - On power, our view is that the sector’s operational framework is much stronger -- compared to the pre-reform era -- and has been improving following the 2012 privatization. Very critical for the success of the sector is that the FGN, through the Nigerian Electricity Regulatory Commission (NERC), is strongly committed to the fulfillment of the post-privatization reforms and regulation. The resolution of outstanding labour-related challenges, the expertise of Canada’s Manitoba Hydro in transmission, the establishment of a bulk electricity purchaser (NBET) and backed by a credit enhancement scheme, the CBN’s N213billion stabilization fund and most importantly, the declaration of the Transitional Electricity Market (TEM) in February 2015 are a case in point. With TEM, market participants operate under market rules that establish an efficient, competitive, transparent and reliable market for the sale and purchase of wholesale electricity and ancillary services. It can be therefore expected that the sector would benefit from (1) the elimination of chronic payment problems and (2) improved financial discipline necessary to attract the massive investment in power supply. Power output is estimated to increase to 6,000MW in 2016, driven by (1) increase in gas supply (2) the government’s ongoing determination to expand the transmission network and (3) the adoption of a cost-reflective tariff -- an enabler for investment in various arms of the sector. Work is also very much in progress towards ensuring that revenues charged by market operators are wholly cost-reflective. In 2014 for instance, gas supply price (including transport) was increased to US$2.80 mmbtu (from US$1.80 mmbtu). This would improve investment incentive in gas supply and expectedly alleviate the ongoing chronically low availability of gas for power. At the downstream, effort in this area got a boost through the approval of a new tariff regime by NERC in December 2015. The tariff is effective from 01 February 2016. Against the old system of uniform, uncompetitive tariff, the Multi-Year Order Tariff (MYTO) varies across different classes of consumers and is reviewed semi-annually (minor) and every five years (major). Notwithstanding the progress made so far, Nigeria’s power self-sufficiency programme is still at infancy stage. Actual generation capacity (between 4,000-4,500MW) is well below the required 12,000MW. The transmission infrastructure is largely poor and distribution networks need to be expanded. Indeed, the 2010 power road map estimates that an average spend of US$10 billion investment would represent a conservative estimate of the sums that will need to be spent on the whole supply chain in order to reach the modest target of 40,000 MW by 2020. On Works - On works (road transportation in this case), the new minister -- in his inaugural presentation on the state of infrastructure -- has somewhat given guidance on priorities for 2016. As stated earlier, the 2016 budget is favourable to infrastructure spending and with respect to roads, short term

25 Jan. 2016



strategy, according to the minister, is to focus on projects that have made progress and can be quickly completed. Allocation to the works ministry was slashed to N13 billion in 2015 (from N45 billion in 2014) as part of the last administration’s resolve to prioritize capex spending. Status report shows that there are over 200 ongoing road projects (covering over 6,000km) that have been abandoned due to inadequate funding. The FG owns the lowest percentage (16) of Nigeria’s total road stock (200,000km). Notwithstanding, it is central to national development because it carries about 70% of total traffic. The insufficiency of road network and the poor condition of existing ones negatively impact manufacturing -- given the challenges faced by producers in conveying goods across the country. For instance, estimates show that it takes about 8 days average (depending on the weight of the goods and condition of the truck) for a truck moving goods to the North to make a return trip to the West. It takes about 4 days average between the West and East. Consequently, production is mostly regional-based, with only a few firms having the capacity to distribute their goods across the country. We expect a significant portion of the 2016 gross capex budget to be favourable to road construction and maintenance. We like the idea (according to the minister) of focusing first on roads that connect states, especially those that bear the heaviest traffic. Beyond 2016, we would expect emphasis to gradually shift to the implementation of National Integrated Infrastructure Master Plan (NIIMP) which was approved for implementation in September 2014 (by the Federal Executive Council) and meant for accelerated infrastructure development. The NIIMP aims to raise Nigeria’s stock of infrastructure from 20-25% of the GDP in 2014 to at least 70% by 2043, with a target investment requirement of about US$3.05 trillion (N610 trillion). The NIIMP document indicates that about US$166.1 billion (N33 trillion) is required over the next 5 years and the FG and states will provide 52% (and the rest via PPPs) of the total financing requirement during the pilot period. With the power sector largely privatized, we would expect that road and housing would attract a considerable share of the government’s budget for NIIMP. Trade Trade is the second biggest contributor (c.17%) to national output, after agriculture. So far, its growth pace has been quite impressive at 7% CAGR between 2010 and 2015, using the rebased account. Supportive of growth are a robust (and youthful) population (of over 170 million people), growing urbanization (4.7% urbanization rate), expanding middle class and consumer spending, and increasing products/brand awareness via easy access to information.

26 Jan. 2016



Trade is segmented into wholesale and retail sales. The wholesale segment is almost entirely informal. It is robust and caters to millions of micro and small-scale retail establishments all over Nigeria and some neighbouring countries. The retail segment, while also largely conducted in informal markets, has a formal category that is rapidly growing in size and popularity. Literature on wholesale trade is scarce. This we attribute to its dominant informal nature. It is predominantly operated by locals and used to be the primary supply channel to the hitherto quiet retail segment. The latter is changing, and quite rapidly. This is because consumption pattern in Nigeria has undoubtedly witnessed a dramatic evolution in the last decade. The NBS came close to supporting this assertion through its latest available estimate which shows that employment population in the trade sector grew from 482,854 people in 2010 to 2,370,276 people in 2012. The ongoing transformation in the retail sales segment is too obvious to ignore. Though informal trading is still dominant, formal sales are capturing a growing share of the total market. The growth drivers already mentioned are the source of investor attraction. The past years witnessed significant influx of various international retail chains and shopping centres, mixed with larger indigenous outlets. These have the advantage of scale (including over the wholesalers), and leverage primarily on convenience, competitive pricing and assortments (look and feel) in winning consumer loyalty. It was reported (by the Ministry of Trade and Investment) that about N205 billion was invested in

27 Jan. 2016

Figure 26: Household Consumption Expenditure (Growth Rate)

Source: NBS


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the formal retail industry between 2012 and 2014. The first movers (dominated by South African firms) have recorded immense growth, evident in the number of outlets opened since gaining entry into the local market. Online trading is also impacting significantly on Nigeria’s retail sales sub-sector. This pattern of shopping is growing rapidly in popularity (among the young and middle-age population), especially in the urban areas. They offer consumers easy access to variety of products and at prices that are competitive with those sold in-store. Enabling the success of this industry are the boom in internet usage (at 38% penetration in 2014, from 0.1% in 2000) and the CBN’s cashless policy. From about two known names in 2012, online shopping sites have increased to more than twelve in 2015. A survey by Euromonitor shows that expenditure in Nigeria’s online stores increased from N50 billion in 2010 to N78 billion in 2012 (latest available results). The trade sector has not been spared from the trending weakness in Nigeria’s consumer purchasing power. Trading activities has also been adversely impacted by the rampage of insurgency in the North. The sector’s GDP grew by 6% in real terms in 2014 (from 7% in 2013) and growth is likely to weaken further to 5% in 2015 (after falling sharply in Q2 and Q3). We expect a slightly stronger growth in 2016 to be driven by the impact of (1) FG’s planned expansionary fiscal spending and (2) significant reduction of insurgency in the North -- on consumer demand. These should limit the impact of exchange rate pressure and higher utility bills on consumer demand.

28 Jan. 2016


The assumptions driving the optimistic 2016 budget are realistic (on average) in our view. We can argue further that even the optimism (in terms of what the FGN intends to achieve with the budget) is justified. Interestingly, the full implementation should come at no severe consequence to national fiscal position. That said, we acknowledge that there are a few projections (on both income and expenditure lines) that seem ambiguous on the surface. Noteworthy, however, is the risk of these ambiguities to the success of the entire Appropriation Bill is modest. The MTEF (2016-2018) was delivered by the Presidency to the National Assembly on December 22, 2015 and it is expected that the latter would approve the Bill for implementation into law by February 2016.


Fiscal Policy - From Transition to Change

3.

29 Jan. 2016

Figure 27: Appropriation Bill 2016

2016 Budget

Total Expenditure N6.08 trillion

FGN Revenue N3.86 trillion

Assumptions

Recurrent (non debt)

N2.35 trillion

Capex N1.85 trillion

Debt Service N1.48 trillion

Oil/oil related N0.82 trillion

Non-oil N1.45 trillion

Independent Revenue

N1.51 trillion

Oil production 2.2mbpd

Crude oil price

US$38/bbl

Exchange Rate

N197/US$

Statutory Transfer

N0.35 trillion

Fiscal Deficit N2.22 trillion

Borrowing N1.84 trillion

Recoveries N0.39 trillion

Source: BOF, 2016-2018 MTEF



The budget assumes (1) a benchmark oil price of US$38/bl (2) oil production of 2.2 million barrels per day (mb/d) and (3) an exchange rate of N197/US$. Supporting the reality in the budget assumptions are firstly, the actual average crude production of 2 mb/d achieved in nine months of 2015. Though OPEC’s estimate for the period is slightly lower (average of 1.86 mb/d), its reports (released monthly) show stronger output (average 1.93 mb/d) between September and November. Over the last five years, oil output data, from both sources, stood respectively at 2.3 mb/d and 2mb/d. Secondly, on pricing, the budget’s benchmark, though not very prudent, is attainable, considering best case oil price forecasts for 2016. That said, our view of the exchange rate is that the budget benchmark is too demanding and is only attainable under the ongoing (with Executive influence) restrictive forex management strategy. On aggregate, the spending plan is estimated at N6.08 trillion. The figure is 35% more than the amount initially appropriated for in 2015, but 20% bigger, when the supplementary budget (N575 billion) approved later in the year (for security and subsidy claims) is taken into consideration. The key highlight of the budget is the allocation of N1.6 trillion (from N722 billion in 2015) for capital expenditure. More constructive about the capex apportionment is the priority given to components that can be instrumental

30 Jan. 2016

Figure 28: Nigeria Crude Oil Production (mbpd) Figure 29: Crude Oil Price Forecast (Brent) (US$/bbl)

Source: NNPC, OPEC, Bloomberg


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to non-oil sector growth recovery -- transportation (13%), infrastructure (27%) and agriculture (3%). We had discussed earlier on the strength of the non-oil sector and the impact we believe government’s focus on high-impact and high value-added projects (such as power, integrated transport - roads, rail, air, and ports - and housing) can drive its growth. Capex allocation for defence and security (10% of total) is also a demonstration of commitment to strengthening the ongoing confrontation of insurgency activities that had plagued economic activities in the Northern region in recent years. The budget’s revenue assumptions are attainable, and with an obvious spending will, we see 2016 capex budget achieving a significant success rate (c.70%, from c.30% in 2015). Another highlight -- though controversial -- of the budget is the allocation for special interventions. We recall the APC’s promise to make monthly conditional cash transfers of NGN5,000 to the 25 million poorest and most vulnerable citizens (amounting to N1.5 trillion yearly) if elected to office. The budget however provisioned N500 billion, split between recurrent (N300 billion) and capex (N200 billion). While plausible, short term risk to this initiative lies with implementation -- owing to structural and administrative challenges that would likely be encountered. Beyond structural and administrative bottlenecks, we believe the lifespan of this initiative will be largely dependent on how long non-oil revenues and borrowings will continue covering up for lower oil revenues.

31 Jan. 2016

Figure 30: Capex Apportionment

Source: BOF


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Budget for debt service increased by 55% to N1.5 trillion. The amount includes N113.4 billion sinking fund set aside towards the retirement of maturing loans. The total debt service package represents about 24% of aggregate spending. The increase in provision for domestic debt service (by 46%, and accounts for 78% of the budget) is a function of the size of FGN debt (currently 69% of total national debt stock) and interest rates. Beyond 2016, the MTEF assumes a progressive reduction of the budget for debt service, primarily underpinned by a significant rebound (by 86%) in oil/related revenues. Gross recurrent spending package accounts for 70% of aggregate expenditure plan. The proportion of recurrent to capital spending was 72:28 in 2012, 67:33 in 2013 and 76:24 in 2014 budgets (see table below). The ratio rose to 84:16 in 2015 wherein the shock of a drastic fall in oil revenue led to a massive cut (and prioritization) of capex spending. Prudence of the current year’s budget is in the 9% reduction of non-debt recurrent expenditure budget. The budget for virtually all the expenditure heads in the non-debt recurrent category was reduced from 2015 levels. This is expected to be achieved through technology, the introduction of zero-based budgeting system, and the workings of the newly established Efficiency Unit. There are no allocations whatsoever for fuel subsidy and the Subsidy Reinvestment and Empowerment Programme (SURE-P) while support for the presidential amnesty programme in the Niger Delta technically ends in 2016.

32 Jan. 2016

Figure 31: Recurrent Expenditure to Gross Expenditure Figure 32: Capital Expenditure to Gross Expenditure

Source: CBN

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The budget for FGN retained revenue was increased by 12% (relative to 2015) to N3.9 trillion. This leaves a deficit of N2.2 trillion, representing a percentage (2.2%) of the GDP that is within the limit (3%) of fiscal responsibility. For 2017 and 2018, the MTEF assumes that (1) a near 10% p.a growth in nominal GDP and (2) improvement in revenues -- would reduce the deficit to GDP percentage to more comfortable levels (1.3% average). The deficit in 2016 is to be funded through borrowings (N1.8 trillion vs. N882 billion in 2015) and recoveries/other means (N386 billion). The borrowings will accrue almost 50:50 from the domestic (N984 billion) and foreign (N900) markets. Our view is that the domestic borrowing, 25% higher than the actual amount borrowed in 2015, is less likely to exert upward pressure on bond yields. While we do not anticipate challenges finding off takers for the foreign debt issue, we note the risk of higher borrowing costs arising from rising interest rate in the U.S and possible downgrade of Nigeria’s rating. N350 billion (out of the N386 billion stated above) is expected to accrue from recoveries -- e.g. strategic alliance contracts, NNPC/CBN and misappropriations. The balance will be flows from sales of government property, privatization, and signature bonus. Note however, that these revenues were not accounted for in 2015. Potential risk, therefore, is that

33 Jan. 2016

Figure 33: Budget Revenues Figure 34: Fiscal Deficit

Source: CBN

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2007 Fiscal Responsibility Threshold = 3%


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is that borrowings could be larger than budgeted, or spending reduced, to accommodate for shortfalls from these sources (accounting for 6% of total spending budget). The zero allocation for fines, fees and forfeitures leaves us thinking of the outcome of the financial penalties imposed on MTN and Guinness by their respective regulators in 2015. We have said earlier that the benchmark crude oil price and –by extension -- oil revenue (50% lower compared to 2015 budget) are attainable. On the other hand, we are positive on every aspect of the non-oil revenue profile, excluding the independent revenue. In order to drive revenue from the non-oil sector, changes have been made to the leadership of the revenue generating agencies including the Federal Inland Revenue Service (FIRS), Nigerian National Petroleum Corporation (NNPC), Nigerian Communications Commission (NCC), and the Nigerian Customs Service (NCS). That said, we note that the budget for independent revenue (N1.5 trillion or 25% of the aggregate spending plan) is unprecedented (see table below). Its allocation in 2015 was N489 billion, 82% of which had been achieved as at September. It is expected that the budget for this revenue item will be achieved via full implementation of the Treasury Single Account (TSA) and the remittance of operating surpluses by MDAs, as required by the Fiscal Responsibility Act.

34 Jan. 2016

Figure 35: FGN Independent Revenue

Source: BOF


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Finally on non-oil revenue, the budget is bullish on corporate (+33%) and consumption (+15%) tax collections but very conservative on customs revenue (+1%). The tax projections are based on expected improvement in collection efficiency, amidst ongoing effort to plug leakages and increase the tax base of the country. This, in our view, may also require reducing tax rates for smaller businesses, with incentives for early payment. Risk, however, is that outlook on corporate profits and national consumption is broadly to the downside. It is noteworthy that as at September 2015, collections from both corporate tax and VAT were respectively 30% and 38% below their provisional nine months budget estimates for the period. The budget speech was silent on changes to tax rates or imposition of new taxes in 2016. Our view is that with its eye on (1) fuel subsidy removal (2) increase in power tariff and (3) possible forex devaluation -- it is unlikely that the government would announce tax increase (including VAT earlier scheduled for 500bps increment mid-2015) or impose new taxes. The allocation for revenue from customs increased marginally, we assume, because of the porous borders, the effect of CBN’s forex management policies as well as the FGN stance on import substitution. We note that the ongoing efforts to curb abuse of waivers and incentives should provide support for income from this source. Plausible Budget Risks: (1) A significant shortfall in oil (should oil price crash further) and FGN independent revenues and (2) expansion of budget deficit. Difficult Government Choices: (1) Borrow more to maintain expenditure levels (2) scale back on certain commitments (e.g special intervention and capex) or (3) increase VAT rate, announce new taxes or devalue the currency to support oil revenue.

35 Jan. 2016


It is our view that it was the CBN’s inflation (CPI) target of 6-9%, and not the single-digit, that came under serious scrutiny in 2015. We see a re-occurrence in 2016, wherein we estimate the CPI to close 9.2% average (vs. 9% in 2015). In 2015, the headline index floated between 8.2% and 9.6% range. Note, that the fact that the peak for the year -- which was attained in December (primarily due to base effect, given that the monthly increase actually moderated in Q4, compared to previous quarters) -- was 40bps below the double-digit level is quite instructive. It follows therefore that the impact of the major upside risks -- notably election spending, the pass through effect of a weaker currency, domestic food supply constraint, and higher average fuel price (due to persistent supply shortages) -- had been overestimated!


Inflation - Ignore the Hype! Single Digit Still in Sight

4.

36 Jan. 2016

Figure 36: Headline Inflation Figure 37: Headline Inflation vs. Components

Source: NBS


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We conceive that both on paper and on weight, there appear to be more upside risks than downsides, going into next year. These include (1) expansionary fiscal policy and monetary policy easing (2) seeming unavoidable pressure on the exchange rate -- both the managed and parallel rates (3) higher domestic food prices -- if insurgency does not drastically reduce (4) the pass-through of higher electricity tariff, and (5) higher average fuel price -- if prolonged supply shortage reoccurs, amidst subsidy removal. No doubt, the biggest threat to single-digit inflation is the exchange rate (as discussed under currency outlook) -- with imports accounting for a significant proportion of gross domestic consumption. For food inflation especially (accounting for 51% of the CPI), persistent decrease in the volume of food imports, owing to difficulty in accessing forex, will shift pressure to local production and consequently prices. There is also chance of pressure from the proposed synergy between monetary and fiscal policies. This proposed blend, if actualized to the letter, will be the first since monetary tightening cycle began in September 2010. It can be argued that in 2015, constrained government spending (especially capex) helped keep a lid on the CPI. As at the end of H1-15 (latest data available) for instance, FGN expenditure was 51% less than the planned spending for the period. Most states of the federation were also unable to fulfill their wage obligations until the FG intervened in August via a bailout. In 2016 on the contrary, the current administration appears bullish on spending and this, it has demonstrated by increasing budgeted expenditure to N6.1 trillion (from N4.5 trillion). Theoretically, further monetary policy easing is also expected to stoke inflation. Nonetheless, we consider this a lesser evil, given our understanding of the Nigerian system. The MPC regretted (at the November 2015 meeting) the reluctance of DMBs to channel the excess liquidity that accrued from CRR reduction (in September 2015) and matured OMO bills to lending to the real sector. Consequently, the Committee loosened monetary policy beyond consensus expectation. The view shared in some commentary was that the move would encourage credit expansion (with preference for the “high risk” real sector) by DMBs (in a struggling economy), possibly reduce lending rates, and encourage public borrowing -- with a tall inflationary consequence. This, in our view, is blown out of reality! In the interim, our investigation since the decision was taken in November shows that banks are yet to lower their lending rates. This reluctance will likely persist through most part of next year -- given that the state of the economy and structural issues (especially) do not favour substantially lower interest rates, and sustained lending to the real sector. Historically, on the other hand, the charts below depict unconvincing correlation between (1) a cut in MPR and (2) bank lending rates and inflation. A 50bps reduction in MPR for instance in September 2008 had a bigger impact on inflation (up to March 2009) than a 375bps cut between April and November 2009 wherein the headline index actually moderated (from 14% to 12%). Our finding is that monetary

37 Jan. 2016



tightening has had a more direct impact on the CPI, than easing. The relationship (MPR) is almost non-existent with commercial lending rate, but very marginally direct with the prime rate. We expect a drag on inflation, in the form of (1) the moderation of prices of imported agric commodities -- notably wheat, rice, sugar and palm oil (ranking among Nigeria’s top 12 import items by value) -- helping to alleviate pressure from exchange rate (2) slow recovery of aggregate demand -- given exchange rate outlook, amidst ongoing agitation for staff retrenchment or reduction of national minimum wage by state governments (3) lower domestic food prices from increased production and distribution -- if the government delivers on promise to bring an end to insurgency and (4) base-effects. Our estimates suggest headline inflation could average 9.1% in H1-16 and 9.3% in H2-16. We expect slower increases in Q2-16 (8.9% average) and Q3-16 (9% average).

38 Jan. 2016

Figure 38: Headline Inflation vs. Money Policy Rate Figure 39: CPI vs. Prime and Commercial Lending rates

Source: CBN, NBS


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After a 6-year tightening cycle, Nigerian monetary rates are reversing directions. With factors weighing on Nigeria’s economic fundamentals set to remain through 2016, Nigeria’s monetary authorities feel compelled to be more stimulatory. An important dynamic beyond the kick-off of the easing cycle, is the progression (i.e. how much policy makers will cut rates each time, and where and when they will stop). This progression is likely to have a significant impact on investor sentiment. Policy Harmony Beckons In 2016, we expect monetary policymakers to intensify strategies implemented in 2015 used to combat the effects of shrinking oil revenues on the Nigerian economy and its external position. The monetary policymakers have demonstrated a strong desire for fiscal and monetary policy coordination. The Federal Government has been decisive in belief that an expansive approach will help “reflate” the Nigerian economy. In turn, monetary authorities have taken the lead in providing an accommodative environment. Thus, from a domestic perspective, there is policy harmony.


Interest Rate - The Path is the Key

5.

39 Jan. 2016

Figure 40: Monetary Policy Rate

Source: CBN


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The Policy Overhaul In the face of oil price crash induced economic challenges, monetary policy gears shifted in 2015, with Nigerian apex bank broadening its scope to include economic stability, beyond the hitherto focus on price and exchange rate stability. The switch involved (1) rethinking its foreign exchange strategy by restricting forex markets and consequently prioritizing forex transactions and (2) subsequently adopting a dovish monetary stance. The decision to switch monetary strategies in 2015 was framed by monetary authorities taking the lead in monetary policy and fiscal tangency needed to combat stagflation (i.e. rising unemployment and inflation), and a negative output gap (actual output below potential output). Are Rates Set to be Lower for Longer? We expect more rate cuts in 2016, but unlike the previous easing cycle in 2009, whereby the cuts were progressive, we expect subsequent rate cuts to be less pronounced. This is because we have noticed the reduced effectiveness of the interest rate corridor approach in setting short term money market rates – the overnight rate has been trading significantly below the SDF floor since the September MPC meeting, where the CRR ratio was dropped by 600bps Consequently, we expect that monetary authorities will opt for more reserve management measures to dictate market rates in 2016.

Figure 41: Inflation and Unemployment (RHS) (2015)

Source: CBN

40 Jan. 2016


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During the year, we expect a max rate cut of 100bps in total, to 10%, with a lower bound of zero. We expect the earliest possible rate cut to come in the March MPC meeting by which time the Committee would have sufficiently evaluated the impact of November 2015 rates cut. Furthermore, we expect that rate cuts would be more symbolic (maximum of 50bps) than meaningful. For CRR, we suspect the monetary authorities will monitor money supply growth as they try to stimulate non-inflationary output growth. Consequently we envisage a further 500bps, to 15%. Implications One major implication from the CBN’s desire to keep interest rates low is that yields in the money and fixed income markets are expected to remain low. The low interest rate environment is supportive (by easing debt service pressure) of government’s expansive spending budget, 16% of which will be funded from the local debt market. Another likelihood stemming from the low interest rate environment, is increased demand management, in light of the nation’s reduced ability to retain/attract capital in the face of the onset of the Fed’s tightening cycle and low commodity prices. Overall, market volatility should also reduce without the wet blanket of low interest rates and larger volume to dampen it.

41 Jan. 2016


We are fairly concerned about the country’s Balance of Payments position going into 2016. This is hinged on the likelihood that current account deficit will expand further in 2016 on the back of resumed fall in commodity prices (Nigeria’s main exports). While imports declined (-50.3% y/y), we believe the FGN’s reluctance to devalue its currency means that we don’t expect that the value of imports will reduce sufficiently to ameliorate widening trade balance negatively impacting the Current Account. The impact of the widening CA deficit is further complicated by weak capital importation to the country, given waning international investor sentiment, driven by a combination of (1) a divergence between local and international monetary policies and (2) weak domestic output growth. The resulting external imbalance from a mounting current account deficit and shrinking capital inflows signals further pressure on the country’s foreign exchange reserves. Further bolstering our view for pressured reserves; is that a sizeable amount of the country’s trade flows pass through informal channels, implying that the country’s “Number of Months of Imports Cover” is likely to be overestimated. We expect the current account deficit to worsen in 2016 to beyond the -4.0% of GDP it recorded in Q1’15. Our forecast is premised on exports contracting much faster than imports. The outlook for commodities in general, which constitute over 90.0% of Nigeria’s exports, remains dour, given China’s weak growth outlook, the onset of the US Fed tightening cycle and the strengthening of the US Dollar. The resumed decline (-17.0% YTD) in crude oil prices (the country’s largest export) is likely to weigh on exports, especially in Q1-16, however, prices for crude oil are expected to recover somewhat as the year progresses. Consequently, we expect the decline in exports in 2016 to be muted in comparison to that of 2015 wherein the decline in crude oil prices was much sharper. Furthermore, we expect an uptick in volume of crude exports, as the FG has demonstrated over the past few months its ability to reduce production disruptions.


External Sector - Balance of Payment Crisis?

5.

42 Jan. 2016



On the other hand, we expect that the decline in imports will also be less substantial than the 50.3% recorded in 2015. Imports will be resilient in 2016, largely because of the CBN’s unrelenting dedication to defending the Naira. Whilst acknowledging the impact of the CBN’s restriction to dollar accessibility on imports, we note that the relative strength of the Naira at the official window remains supportive. Also, significant increases in FGN capital outlay as well the provision of social welfare programs, should lead to increased capital and consumption imports. Compounding concerns of a potential widening CA deficit is Nigeria’s reducing ability to attract capital. Though capital importation has been pressured since 2013, we note however, that a mixture of worsening macro’s and the CBN’s capital controls have steepened the decline since Q2’14. We expect the situation to linger, considering that portfolio inflows - which constitute a major portion of capital imports - will be discouraged following Nigeria’s divergent monetary policy and continued forex restrictions by the CBN. In particular, money market and fixed income “portfolio flows” constituting about 20% of capital imports will be hit. In Q3-15, Nigeria’s fixed income space was hit by exclusion from both the JPMorgan and Barclays Emerging Market Government Bond indices. Money market instruments are also unattractive (on risk adjusted basis) following the November MPC decision to ease monetary conditions by lowering MPR (-200bps) and CRR (-500bps). Consequently, the decision has propped system liquidity levels significantly and fuelled bullish frenzy in the money market space by domestic investors, thereby reducing the risk/reward basis for a carry trade.

Figure 42: Trade Balance (N’bn) and Current Account Balance (%) –RHS-

Source: CBN

43 Jan. 2016


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A combination of weak commodities and the US Fed’s tightening cycle has not fared well for the Nigerian domestic currency in recent times. The Naira has declined against the US Dollar for two successive years, weakening from 155/$ to 168/$ in 2014 and a further decline to 199/$ in 2015. During the period, the Naira has also experienced significant pressure in the parallel and BDC market segments, reaching record lows of 260/$. These declines have occurred in the face of the country’s weakening fundamentals - primarily the crash of crude oil prices (since 2014) which used to represent as much 90% forex receipts (2014) - putting enormous strain on the country’s reserves which declined by 15.1% in 2015 to N29.1 billion. Furthermore, the country’s ability to attract forex inflows has been constrained by (1) the implementation of the cocktail of restrictions on foreign transactions by the CBN and (2) the divergent monetary policy in the face of the US Fed’s tightening cycle which has weakened the attractiveness of the domestic portfolio investments to foreign investors.


Currency - Still Seeking its True Value

5.

44 Jan. 2016

Figure 43: Commodity-exposed Currencies (Price Movements)

Source: Bloomberg


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In 2016, we forecast a further decline in the Naira across all major market segments, following consensus estimates for lower oil prices and further Fed tightening. In the meantime, we believe the CBN will double down on its demand management strategies in the short-term. However, while the pace of reserve depletion has reduced in recent months, lower crude oil prices should translate to lower receipts and accelerated depletion of reserves in H1’16. Consequently, we believe as the reserves continue to deplete and the current account deficit begins to widen, the CBN would begin to revisit its exchange rate peg of 197/$. Unfortunately, we believe any exchange rate adjustment will be uncompetitive, given the ongoing dynamic between monetary and fiscal authorities. The fiscal authorities, spearheaded by the President, seem hesitant to endorse devaluation. Aside from fundamental drivers which may push the CBN to adjust its FX policy, we believe that the barrage of international pressure might eventually sway the CBN. For instance, given the size of external debt the FGN outlined, we believe that it is unlikely they plan to raise all from the Eurobond market rather through a combination from multilateral institutions and bilateral arrangements. Any borrowing from a multilateral institution such as the IMF will involve some agreement to revisit the current exchange rate policy. Also, Nigeria forex policy has come under opposition from other trading partners (US and EU) at the World Trade Organization (WTO). Overall, we expect that the CBN will allow a 20% downward adjustment to market rates (most likely) in the second quarter of the year. Furthermore, restrictions on FX trading and deploying of export proceeds are unlikely to be changed during this fiscal year.

45 Jan. 2016

Figure 44: Foreign Reserves and Months of Import Cover (RHS)

Source: CBN


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CAPITAL MARKET

46

Equities – Sentiment Outweighs Valuation 47

Fixed Income 52

Economic Downturn Triggers Expansionary Push 52

No Catalyst from Slowdown in the Global Economy 53

Sub-national Bonds Issuance to Remain Subdued 54

Jan. 2016


The Nigerian equities market recorded 17% loss in 2015, amid challenging times in the macroeconomic and political environment. Strip out the effect of targeted (at specific highly-capped stocks) buying frenzy in the last two sessions of the year, the All Share Index (ASI) technically shed about 23% from end-2014 level. Highlighting the bear drivers, lower oil price was instrumental to the disruptions in the macroeconomy while elections (and subsequent transition to a new, unpredictable government) fuelled the challenges in the polity. At end-2015 level, the ASI was 33% below its post-meltdown high of 43,039.45 points attained on July 09, 2014. Only 32 counters recorded price gains in the year, 87 posted declines while value of trades fell by more than 180% versus 2014. The impact on the Banking sector was much worse (for the second year running), followed by the Consumer (-17.4%) and Oil & Gas (-6.2%) sectors.


Equities - Sentiment Outweighs Valuation

1.

47 Jan. 2016

Figure 45: NSE ASI and Emerging Market Equities Figure 46: Performance of NSE Indices in 2015

Source: NSE, Bloomberg


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From a valuation perspective, Nigerian equities are largely attractive (even from conservative earnings perspective) and an argument in favour of a market rebound in 2016, on the back of this alone, is strong. The likelihood of a rebound can also be considered from the possibility of the uncertainty caused by the transition to a new government ending with 2015. Clarity on the macro front is buttressed by the fact that the economic desires of the current administration have pretty much been spelt out in both the budget and the decisions of the monetary policy authorities. On politics, election and its associated disruptions are not envisaged in the year, and it is also good news (especially for the FMCG concerns) that the military has strengthened opposition against insurgents in the North. Notwithstanding, we do know that it is unlikely that the market would stage a recovery this year. We envisage sell-offs in the first half and buy-backs in the second half. On average, the ASI would trail end-2015 levels by between 10-15%. Although we do not completely subscribe to generally shared allusion that there is a direct relationship between the equities market and the movement of crude oil price (with reference to years 1999, 2000, 2001, 2009, 2011 and post 2015 elections), we suspect that a sustained depression in the price of the commodity is capable of influencing continued skepticism among the investing public. More than the price of oil, we should expect investors (the foreign index trackers especially) to be largely driven by the outcome of government economic policies and decisions. Critical areas of interest will be (1) monetary policy - exchange and interest rates (2) economic growth recovery -- non oil sector especially, and (3) private sector performance.

48 Jan. 2016

Figure 47: Returns on NSE ASI vs. Brent Crude

Source: Bloomberg

2011 2009 2001 2000 1999

NSE ASI -16% -34% 35% 54% -7%

Brent 13% 71% -17% -5% 138%


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On economic growth, whilst reiterating our constructive position on the long term fundamentals of Nigeria, we see recovery being quite modest this year. There will definitely be gains for the economy should the government succeed in expanding spending (though subject meeting targets on oil and independent revenues), but the “magnitude and time” may not sway investors. On monetary policy, there doesn’t seem to be an end-in-sight to the ongoing patriotic style of exchange rate management. Thus, until the CBN heeds to the recommendations of the foreign institutional investors (by relaxing restriction on the currency or outright devaluation), lazy inflow of USD (down 32% in 2015) into the market will linger. Another challenge we envisage is that corporate profits may not be healthy enough to inspire investors into investing radically in 2016. Instead, we foresee a situation where investors are held back, just as in 2015, by stagnated to declining corporate earnings. Using the components of the Nigerian Stock Exchange sectoral indices (containing stocks that account for 83% of the total market) as a proxy, we observed that only the banking (grew earnings by 17.4% in nine months vs. 6.5% in 9M-2014) and the Industrial (grew earnings by 8.8% vs. -16% in 9M- 2014) sectors recorded earnings growth in 2015. It is difficult to expect a turnaround growth in 2016. Note however, that banks earnings typically lag economic downturns. Thus we envisage that investors’ skepticism of results from the sector in 2016 (which we predict to be unimpressive, on average), amidst their significant weighting on the market (19%), will likely have delusionary effect on the broader trading environment.

49 Jan. 2016

Figure 48: Capital Importation – Equity (US$’bn)

Source: CBN


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To accommodate the above highlighted challenges, we have cut earnings forecasts for almost all the stocks we cover. Interestingly, the significant depletion (between Q3-2014 to end of 2015) in the prices of most of these stocks means that despite being overly conservative with estimating our earnings, we see upside potential in some names, at current levels. Banks, brewers and cement companies offer the biggest upside, having being significantly sold off by mostly foreign portfolio investors (the historical largest holders) exiting the Nigerian market due to deteriorating economic outlook.

50 Jan. 2016

Figure 21: Profit After Tax 2015 vs. 2014 of our Coverage Universe

Banking 9M-15 9M-14 Profit/(loss) Food/HPC 9M-15 9M-14 Profit/(loss)

ACCESS 48.1 34.9 37.7% CADBURY 0.0 1.7 -98.3%

FBNH 50.2 55.6 -9.7% DANGSUGAR 9.3 9.1 2.1%

GUARANTY 74.6 66.3 12.5% **FLOURMILL 23.6 4.0 493.5%

UBA 47.7 32.9 45.2% **HONYFLOUR 0.9 1.1 -17.5%

ZENITHBANK 83.0 70.9 17.1% NESTLE 17.2 16.9 2.2%

*PZ 0.4 0.6 -32.1%

UNILEVER 0.1 1.8 -92.3%

Cement 9M-15 9M-14 Profit/(loss) Brewery 9M-15 9M-14 Profit/(loss)

ASHAKACEM 3.0 3.6 -15.3% *GUINNESS 0.4 1.5 -75.6%

CCNN 1.6 1.7 -4.8% **INTBREW 0.7 1.4 -48.2%

DANGCEM 167.1 140.7 18.7% NB 26.2 29.8 -12.2%

WAPCO 28.8 29.7 -2.8%

* 3 months

** 6 months Source: Company Accounts

Banking FY15 vs. FY14 FY15 vs. Q3-14 Food/HPC FY15 vs. FY14 FY15 vs. Q3-14

ACCESS -26.5% -46.1% CADBURY -57.1% -67.3%

FBNH -41.7% -61.7% DANGSUGAR -5.0% -27.3%

GUARANTY -27.8% -38.9% FLOURMILL -46.9% -66.4%

UBA -21.4% -48.9% HONYFLOUR -40.8% -47.6%

ZENITHBANK -23.7% -42.7% NESTLE -15.0% -21.1%

PZ 8.0% -26.6%

UNILEVER 20.8% -7.7%

Cement FY15 vs. FY14 FY15 vs. Q3-14 Brewery FY15 vs. FY14 FY15 vs. Q3-14

ASHAKACEM 14.2% -20.8% GUINNESS -28.4% -44.0%

CCNN -10.0% -37.6% INTBREW -31.6% -46.7%

DANGCEM -15.0% -23.4% NB -17.7% -22.7%

WAPCO 20.2% -23.6%

Figure 21: Share Price Performance of our Coverage Universe



In concluding this section, we highlight below, various events that are likely to impact on the market during the course of the year. By highlighting these, the expectation is that they will support investors in making informed decisions should the events occur.

51 Jan. 2016

Figure 21: Equity Rating

Source: Company Accounts

Bullish Bearish

Significant crash in fixed income/money market yields Corporate results come out worse than expected

CBN loosens restriction and eventually devalues the NGN

Fixed income/money market yields rise to pre Q4-2015 levels

PENCOM revises investible % of PFAs equity funds to 25% Oil price crashes and stays sustainably btw $30-$25/bbl level

NSE initiatives e.g direct cash settlement, derivatives trading Stiff regulatory sanctions on quoted companies

Oil price rebounds to above 2015 average levels NSE initiative e.g approves stocks to trade below nominal value

Corporate results come out better than expected CBN's reluctance to ease restriction and devalue the NGN

Expansionary govt. spending results to bigger than expected

growth

Heightened insurgency/secession activities - Boko Haram, IPOB,

Niger Delta, Shiiite

Successful implementation of SEC's capital market master

plan

Ticker TP CP Return Rating 2016/17 EPS 2016/17 PE 2016/17E RoAE Mkt Cap (N'bn) Mkt Cap (US$'mn)

Cement

CCNN 9.47 9.60 -1.32 HOLD 1.68 5.61X 17.89 12.06 60.32

DANGCEM 162.04 128.91 25.70% BUY 12.27 10.5x 28.56% 2196.69 10.98

WAPCO 118.39 80.00 47.99% BUY 8.39 9.53 19.03% 364.39 1.82

Consumer Goods

CADBURY 21.67 19.00 14.05% HOLD 0.42 45.34 0.07 35.69 0.18

DANGSUGAR 4.97 6.05 -17.85% SELL 0.99 6.11 0.20 72.60 0.36

HONYFLOUR 1.74 1.46 19.18% HOLD 0.20 7.19 0.07 11.56 0.06

FLOURMILL 40.18 18.25 120.16% BUY 1.00 26.68 0.03 47.89 0.24

NESTLE 783.48 739.99 5.88% HOLD 32.38 22.85 0.65 586.56 2.93

PZ 30.97 27.60 12.21% HOLD 1.08 19.38 0.10 83.38 0.42

UNILEVER 23.56 21.00 12.19% SELL 0.09 405.54 0.04 133.32 0.67

Banking

ACCESS 7.98 4.15 92.29% BUY 21.3 1.95x 16.23% 119.18 0.60

FBNH 4.83 3.93 22.90% BUY 0.67 5.87x 9.04% 143.94 0.72

GUARANTY 22.44 16.79 33.65% BUY 3.35 5.01x 21.70% 493.85 2.47

UBA 5.62 2.89 94.46% BUY 1.41 2.06x 15.40% 103.39 0.52

ZENITHBANK 20.26 12.61 60.67% BUY 2.69 4.23x 14.19% 429.82 2.15


Our overall view is that yields will remain compressed in 2016, with the key theme being the nature of Nigerian economic downturn. The resumption in the decline in oil prices (-17.0% YTD) further threatens Nigeria’s economic recovery and strengthens our view that the current economic slowdown - average GDP down to 3.0% in 2015 from 6.2% in 2014 - is likely to be protracted through 2016. This should have huge implications for the aggressiveness of both monetary and fiscal policymakers’ expansionary policies. For instance, the FG’s N6.07 trillion budget aimed at reflating the Nigerian economy is set to be financed with a record 37% deficit (N2.2 trillion). The offshoot of this would be a supply boost in FGN bonds which would ordinarily push up yields. However, the monetary policymakers have also largely ensured that there is substantial liquidity within the banking system, thereby artificially increasing demand and compressing yields. The CBN cut CRR down to 20% in November 2015, from 31% earlier in the year. Notable risk is that the loosened environment may prove to be a catalyst for inflation, which reached a 3 year record high of 9.6% in December. Nonetheless, while inflation typically signals an uplift in fixed income yields, we believe only a strong upswing in inflation will attract necessary monetary policy attention. Economic Downturn Triggers Expansionary Push Nigeria’s economic growth outlook remains threatened by falling oil prices, signaling that the downturn has not lost momentum. The President Buhari led administration which resumed in May 2015, has decided to take a contrasting approach to the economic challenge by signaling expansionary ambition versus the austerity approach considered by the preceding Jonathan administration. In December 2015, President Buhari presented a N6.07 trillion budget which is expected to be financed with a record 37% deficit of N2.2 trillion (N1.8 trillion via borrowing). Specifically, the government plans to borrow N984 billion from domestic bond market, a modest increase from 2015. In January 2016, the DMO released the Q1’16 bond issuance calendar showing that the federal government plans to borrow between N240 billion and N390 billion in the first quarter. The Q1’16 calendar implies a lower run rate than the total borrowing planned for the year, with the government perhaps planning to borrow more in H2’16 (where its set to redeem N580 billion). The calendar also revealed the introduction of new 10 year and 20 year bonds.


Fixed Income - Yields to Remain Compressed

2.

52 Jan. 2016



An implication of the ambitious borrowing plan is the sizeable growth in the country’s debt service (+55%). In the 2016 budget, debt service as a portion fiscal revenue grew to 37%, significantly above international recommended criteria of 25%. The loose liquidity condition generated by the MPC and subsequent cutting of interest rates has helped alleviate FG’s borrowing costs. While broad money supply had contracted as at the last meeting, the buoyant level of market liquidity may eventually transmit to increase level of money supply and push inflation - which reached 9.6% in December (a 3 year high) – further beyond the MPC target. In the event that non-inflationary growth becomes a focus, we believe that the MPC might slowdown on its expansionary policy. No Catalyst from Slowdown in the Global Economy The resumed decline in crude oil prices has also raised spectre on the global growth outlook. Initially, it was presumed that the December US Fed rate hike would begin a tightening cycle, but recent concerns on the health of the Chinese economy (which recorded its lowest growth in 25 years in 2015) as well as weak oil and commodities prices in general are attracting greater concern for the world economy. Consequently, the IMF cut its global economic forecast. The weak commodities prices have dampened the inflation outlook in European and American economies. Overall, should the situation persist, we expect the US Fed tightening cycle to be restrained, amidst

Figure 49: FGN Outstanding Bonds Figure 50: Domestic Debt-to-GDP Ratio

Source: DMO

53 Jan. 2016


0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

20

16

20

18

20

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22

20

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10.50%

11.00%

11.50%

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12.50%

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2013 2014 2015 2016


further easing in both Japan and the Eurozone. Thus, we see less pressure for emerging and frontier (Nigeria included) economies which had seen the biggest capital withdrawals in more than 5 years. However, despite the outlook for less tightening in the US than initially expected , Nigeria is unlikely to benefit from returning capital flows given the complicated foreign exchange market regime and divergent monetary policy currently implemented by the CBN. Sub-national Bonds Issuance Likely to Remain Subdued Despite our outlook for low yield environment for 2016, it is unlikely that there will be an increase in issuance from Sub-nationals. State Governments are also facing the tough fiscal constraints challenging the FGN in the advent of the crash in oil prices. With most states lacking a diversified revenue base, they are heavily reliant on FAAC allocations. This fall in the crude oil revenue and consequently monthly budgetary allocation has placed significant pressure on state government’s purses. Unfortunately, while this presents opportunity to raise additional funds at attractive yields, it is unlikely that many will take that route after having the FGN bail them out to the tune over N640 billion in 2015. We are of the view that any potential issuance by a sub-National will be met by huge scepticism from domestic investors. Furthermore, regulatory and FGN approvals may be difficult to obtain, given the just concluded debt restructuring exercise (the bailout package). However, the few states with a reputation for fiscal prudence and diversified revenue bases (e.g. Lagos) may take the opportunity to tap the fixed income market for additional capital to boost infrastructure spending.

54 Jan. 2016

Figure 51:



Consumer Goods

1.

55 Jan. 2016

Fragility in the Macroeconomic Environment 57

Price Sensitivity Amidst Rising Costs – Pointer to Subdued Margins 57

Improved Security Situation in the North Region – How Long? 58

Finance Costs – Potential Soothing Relief from Easy Monetary Policy? 58

Consumer Stocks Aren’t Very Cheap Yet 59

Falling Commodities Prices – To Relieve Margins of Stress 60

Companies 62-68



Will High Govt. Spending Come to the Rescue? As at September 2015, the cumulative earnings of our consumer goods coverage was 19% below September 2014 levels. The earnings contraction is about 29% using the components of the NSE Consumer Index. For 2015FY, we expect the total earnings of our universe (excluding the brewers) to decline by 6% y/y (or 13% excluding FLOURMILL’s gain from disposal of ‘investment in associate’). The key driver is the significant deterioration in the macroeconomic, business, and security conditions, and the consequent adverse impact on consumer purchasing power. With unit sales volumes at flattish to declining levels, consumer goods companies struggled with (1) rising production costs (as the stronger USD fed into raw material import prices), (2) difficulty passing the costs through -- in the face of intense competition -- and ultimately, (3) pressure on margins. In term of sales, only NESTLE (5.2% y/y) and NB (10% y/y) in our universe recorded growth in 9M-15. Note, however, that both were mainly inorganic, given that NESTLE’s numbers were boosted by the inclusion of Wyeth Nutrition’s (acquired by the parent company in 2012) products to its portfolio while results from the recently acquired Consolidated Breweries (CB) boosted NB’s sales figures. As at H1-15/16, FLOURMILL’s revenue had increased by 7% while INTBREW grew top-line by 0.7%. 9M-15 gross margins for most consumer stocks under our coverage contracted during the period. Only NESTLE (131bps) and DANGSUGAR (152bps) recorded margin expansions. CADBURY (-697bps), UNILEVER (-360bps) and NB (-191bps) posted lower gross margins. As at H1-15/16, HONYFLOUR recorded a 221bps increase in gross margins while those of FLOURMILL (-30bps) and INTBREW (-184bps) compressed. GUINNESS posted a 732bps gross margin compression in Q1-15/16. 9M-15 post-tax earnings of CADBURY (-98%) and UNILEVER (-92%) were significantly below equivalent 2014 levels. In the breweries segment, GUINNESS (PAT down 76% as at Q1-15/16) and INTBREW’s (PAT down 48% at as H1-15/16) earnings suffered massive deterioration while NB’s 9M-15 PAT posted a marginal 12% decline. Excluding gains on disposal of investment, FLOURMILL’s earnings in H2-15/16 were 93% below equivalent 14/15 levels.

56 Jan. 2016

Food/HPC 9M-15 9M-14 Profit/(loss)

CADBURY 0.0 1.7 -98.3%

DANGSUGAR 9.3 9.1 2.1%

**FLOURMILL 23.6 4.0 493.5%

**HONYFLOUR 0.9 1.1 -17.5%

NESTLE 17.2 16.9 2.2%

*PZ 0.4 0.6 -32.1%

UNILEVER 0.1 1.8 -92.3%

Brewery 9M-15 9M-14 Profit/(loss)

*GUINNESS 0.4 1.5 -75.6%

**INTBREW 0.7 1.4 -48.2%

NB 26.2 29.8 -12.2%

* 3 months

** 6 months

Consumer Goods



Compared to 2015, the federal government’s spending plan for 2016 is more robust. In addition to a significant increase in the budget for investment in infrastructure, the FG has proposed a special intervention programme in form of monthly conditional cash transfers to the poorest and most vulnerable citizens. While this is a positive signal for investors in the consumer goods sector -- in view of potential recovery in aggregate demand -- our view is that overall, the macroeconomic and policy environment is still very fragile, and a recovery, if any, will have a less significant impact on the consumer goods sector. That said, we discuss, below, factors that will shape the performance of companies in 2016. Fragility in the Macroeconomic Environment Despite a huge spending plan (which also has a risk tied to crude oil prices/revenue) at the national level, we are less optimistic that aggregate demand will rebound quite strongly in 2016. Firstly, the internal finances of most state governments are still largely weak and inflows from the federation account are unlikely to significantly exceed 2015 levels. In addition, while job growth remains strong in the informal sector (though dominated by a highly price-sensitive peasant population), growth in the formal segment has continued to deteriorate, and outlook is bleak -- amidst slowing business growth and rising displacement of workers. In addition to the above, aggregate demand will remain constrained by the unrelenting pressure on the currency. Imports account for a significant proportion of aggregate household consumption expenditure and with the Naira poised for further depreciation, the inevitable pass-through impact on products prices should prolong the ongoing consumption prioritizing (and down trading) among the consuming public. Further strains on consumer wallets will emerge from the recently hiked electricity tariffs, amidst a potential increase in consumption tax (from 5% to 10%). Price Sensitivity Amidst Rising Costs – Pointer to Subdued Margins Despite depreciating by 18% (at the interbank market) in 2015, mounting pressure on Nigeria’s forex reserves (amidst falling USD inflows) suggests that the downside risk to the value of the Naira is elevated. At the unofficial market, the local currency shed about 58%. Owing to massive demand, the Central Bank (since June 2015) has been rationing USD supply in the economy -- a practice that makes it difficult for importers, including manufacturers of consumer goods, to source all the currencies required for their operations (mainly raw material inputs) at the concessional rate (N197/USD). Discussions with management of top consumer names reveals that manufacturers are only able to source not more than 50% of their total USD requirements from the Central Bank, and the balance from the unofficial market (currently at N300/US$). Excluding NESTLE and CADBURY (30% average), exposure to imported major raw materials range from about 45% to 97% across the coverage of our consumer universe. A significant potential downside pressure on the value of

57 Jan. 2016



the Naira at the unofficial market therefore suggests imminent pressure on production costs. Whilst acknowledging that commodity prices would likely soften further in 2016, the gains would be more than crowded out by a faster depreciation of the Naira. Thus, with consumers increasingly sensitive to prices, we see less room for margin recovery, as companies face difficulty passing on extra costs. Improved Security Situation in the Northern Region – How Long? The military strengthened opposition against the insurgents in the North East region and declared Boko Haram technically defeated in December 2015. The 2016 budget’s massive capex appropriation for defence and security is suggestive of the government’s commitment to ending the menace in the region. Sustained peace and consequently, the resumption of economic activities in the region will be positive for consumer companies from a sales perspective. It should also help ease the current intense competition in the South. Finance Cost – Potential Soothing Relief from Easy Monetary Policy The interest rates of our coverage companies range from 10% to 14%. As at 9M-15, the financing costs of DANGSUGAR (161% y/y), NESTLE (92% y/y), UNILEVER (101% y/y) and NB (54% y/y) have increased significantly relative to 9M-2014. As at H1-15/16, that of FLOURMILL was up 14% y/y. The primary drivers are (1) increased borrowing (short term loans and overdrafts especially) and (2) Naira depreciation (for NESTLE). As at September 2015, the proportion of short term bank loans and overdraft facilities to total borrowing ranges from 0% to 100% and from 25% to 98% respectively, for our consumer coverage universe. The CBN’s shift to an accommodative monetary policy (with the benchmark interest rate and banks’ reserve requirements reduced by 200bps and 1100bps respectively between September and November 2015) could bring reprieve -- via lower interest rates -- for consumer companies. Given the growing requirements for short term bank loans and overdraft facilities (for financing working capital needs), consumer companies are likely to benefit from rates concession. In May 2015, GUINNESS successfully sold 180-day Commercial Paper to the investing public at a discount rate of 13.31% p.a. Following the September 2015 MPC meeting, yields on shorter treasury bills and money market rates crashed to multi-year lows (3-5%) due to elevated banking sector liquidity. Consequently, in December, NB issued 182-day Commercial note at a discount rate of 8.2% p.a. Although yields began rising (very modestly) in December, they are unlikely to reach the pre-crash levels (14%). This suggests potentially lower rates on GUINNESS’ subsequent CP tranches. In addition, it is also not unlikely that in 2016, big names like UNILEVER and NESTLE could explore this window to refinance their existing facilities priced at about 13%.

58 Jan. 2016



Consumer Stocks Aren’t Very Cheap Yet While the operating performance of Nigerian consumer-focused companies have been under stress, on average, since 2012 (following the removal of the petrol subsidy, the introduction of Multi-Year tariff in the power sector and a tight monetary policy cycle), investors didn’t begin reacting rationally until 2014. Therefore in the last two years wherein sales and earnings have become much worrying (see chart below), the share prices of NSE listed consumer names have justifiably come under serious scrutiny. As such, the NSE Consumer Goods index has underperformed against the broader market between 2014 and 2015 (down by 32% vs. 31% decline recorded by the ASI) after outperforming between 2009 and 2013 (at a CAGR of 19% vs. 7% recorded by the ASI). More clearly, the P/Es of NB, GUINNESS, FLOURMILL, NESTLE and PZ have fallen from average of 34x levels in 2013 to 24x in 2015. DANGSUGAR’s P/E also declined from 10x to 7x during the same period. The exception among our coverage universe is UNILEVER (from P/E of 43x in 2013 to more than 200x in 2015) which is still strikingly expensive.

59 Jan. 2016

Figure 52: NSE All Share Index vs. Consumer Goods Index Figure 53: Growth Rate of Household Consumption Expenditure


-2%

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NSE Consumers NSE ASI -30.0%

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00

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Source: NSE, Company Reports, NBS


Falling Commodity (Agriculture and Raw Materials) Prices – To Relieve Margins of Stress Following the slowdown in global economic activity, which has subdued growth in most parts of the world, our attention has been drawn to one of the critical factors – soft commodity prices – on which the slowdown is premised. Generally, the lower commodity prices have been attributed to favourable supply conditions (despite a strong El Niño episode), low energy prices, a strong dollar, weak growth of biofuel production and high stock levels (which subsequently reflected improved crop yields during the past two seasons). Specifically, wheat prices decreased by 28.77% y/y in 2015 to US$203/mt. Also, palm oil prices came under downward pressure, shedding 24.24% y/y to US$622/mt. Cocoa prices rose marginally by 2.61% y/y to $3.14/kg while the price of raw sugar sank 18.92% y/y to $0.30/kg. On average, agricultural commodity prices are expected to remain soft in 2016. Key drivers remain the same as those of 2015 discussed above. Specifically, grains are expected to decline 3.4% and oil & meal 2.2%, while raw materials and beverages will decline by 1.1%, according to World Bank estimates. While Nigerian consumer companies (especially those significantly exposed to imports) face currency pressures, we believe the effect on cost and margins should be somewhat relieved by lower raw material input prices. This has been acknowledged by the management of some of the consumer companies in our coverage. The key risk, which may more than offset this gain, is the Naira value falling much faster than commodity prices.

60 Jan. 2016

Figure 54: Commodities Price Charts

Cocoa Wheat



Figure 55: Commodities Price Charts

61 Jan. 2016

Sugar Palm oil and Soybean oil

Maize Coffee



Nestle Nigeria Plc Modest Outlook on Margins and Earnings

With over 70% of raw material requirements locally sourced, and fuel/energy prices expected to soften in line with falling crude oil prices, we opine that NESTLE’s production costs would be reasonably protected from foreign exchange fluctuations in 2016e. That said, the prospect of margin expansion still remains narrow, as (1) the higher risk of the Naira value falling faster than commodities prices means underlying cost pressure and (2) that heightened competition, amidst subdued consumer purchasing power and limited access to the North leaves the company with little control over pricing. We expect that gross margin will average 44% in 2016e. As at 2014FY, 71% of NESTLE’s outstanding borrowings were held in USD. More borrowings were taken during 9M-15, particularly short term USD loans (accounting for about 57% of USD loans on estimate) and bank overdraft facilities. As we stated in the Consumer Sector outlook session, the challenges that Nigerian manufacturers face under the ongoing exchange rate management system is broadly underestimated. All these accounted for the 92% expansion of finance charges recorded during the period. We expect that NESTLE will continue to seek short term loans for working capital purposes. These, combined with elevated downside risk to Naira value suggest imminent pressure on earnings amidst an expected high finance charges. To minimize finance charges, the company may seek to follow the route of Nigerian Breweries Plc by issuing a Commercial Paper (to refinance borrowings) where interest rates have the potential to drop faster (depending on CBN monetary policy) than commercial banks’ rates. To Outperform Competition on Top-line – Acknowledging NESTLE’s well-diversified and household-friendly brand portfolio, we have tipped the company to outperform our FMCG category (comprising UNILEVER, PZ and CADBURY) in terms of sales revenue growth in 2016e. Also supportive of outlook on sales are the management’s commitment to investing behind key brands as well as continued efforts around route-to-market. That said, we expect growth to remain somewhat reflective of the persisting weakness in the country-wide consumption expenditure power. In addition, access to the North is still very restrained (although Nigerian military has declared the region technically safe) and competition in the South is rife. We recall that the 5% revenue growth recorded as at 9M-15 got a boost from the inclusion of Wyeth Nutrition products to existing portfolio. Thus, we expect that top-line growth will remain largely volume-driven; although the possibility of price increases (albeit marginal) outweighs discounting, in our view.

Key Metrics - 2016 RoAE (%) 65.43

RoAA (%) 21.55

EBITDA Margin(%) 25.76

EPS (N) 32.38

PE (x) 22.85

Company Data

NSE Code NESTLE

Bloomberg Code NESTLE:NL

Reuters Code NESTLE.LG

Sector CONSUMER GOODS

Market Cap. (N'bn) 586.56

Free Float (%) 36.25

HOLD Target Price (N) 783.48

Current Price (N) 733.99

Implied Return (%) 5.88

Price movement (NESTLE vs. Benchmark Indices)

Source: NSE, Bloomberg, Cordros Research

62 Jan. 2016

0.21.2


0.4

0.6

0.8

1.0

1.2

1.4

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-15

Feb

-15

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-15

Ap

r-1

5

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-15

Jul-

15

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5

Sep

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Oct

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Dec

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NESTLE ASI CONSUMER


Cadbury Nigeria Plc Fair Case for Earnings Growth

Based on our PAT forecast of N326.8 million for 2015e (representing 24% decline vs. 2014FY), we expect that this low base will help CADBURY grow net profit by about 141% in 2016e. We expect sales to recover, albeit modestly, during the year. In addition, we reckon that operational efficiency has improved in recent years following the aggressive cost control measures pursued by management of the company. Notable cost-savings drivers are (1) 100% sourcing of cocoa powder locally -- accounting for about 80% of raw material inputs -- from a 100% owned company (2) the transition from expensive LPFO to gas-powered plants across factories and (3) the modernization of processing and production plants to improve efficiency. While acknowledging challenges associated with Naira depreciation (on costs), CADBURY’s relatively low reliance on import, amidst softening USD-priced commodities, should be protective of margins in an environment of increasing consumers’ sensitivity to prices. Also supportive of earnings growth is that unlike competitors, CADBURY’s book is debt-free (NGN and USD), thus insulating the company from pressing finance charges (a common challenge among consumer companies). That said, spending on sales, marketing and distribution – which has been modest in recent years -- could skyrocket on the back of plan to aggressively step up campaigns for BOURNVITA (the proposed enhanced formular) and new products. We are Modestly Optimistic About Sales – For 2015e, we estimate that CADBURY’s sales revenue would be less than end-2014 figure by about 4%. While this implies two straight years of declining revenue, a recovery in 2016, though plausible, will be modest at 6%. Growth will be primarily on base-effect, given that 2015 (Q2 and Q3 especially) was challenging. Growth could be bigger, depending on the successful launch and market acceptability of the proposed biscuits and gums. Headwinds are (1) consumers migrating to cheaper food drinks (2) limited access to the North and (3) heightened competition in the South.


RoAA (%) 2.71


EPS (N) 0.42

PE (x) 45.34

Company Data

NSE Code CADBURY

Bloomberg Code CADBURY:NL

Reuters Code CADBURY.LG







Price movement (CADBURY vs. Benchmark Indices)


63 Jan. 2016

0.21.2


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

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-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

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Dec

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CADBURY ASI CONSUMER


Unilever Nigeria Plc Too Expensive, Even with Subdued Earnings

Despite falling consistently in three years (including 2015e, on the expectation that PAT will be lower vs. 2014FY), we expect UNILEVER’s earnings to remain unimpressive in 2016e. Key drivers are (1) subdued sales volume across the product categories (2) rising production costs from Naira depreciation and (3) increasing finance charges. Unlike NESTLE and CADBURY, UNILEVER relies heavily on imports to meet raw material requirements. Thus, weakening value of the Naira and rising production costs, amidst subdued sales volume (making it difficult to pass costs), will continue to pose headwinds for gross margin (down 360bps as at 9M-15) -- despite falling commodities prices. Besides, the use of short term commercial bank loans and overdraft facilities to augment working capital requirements is on the rise. While this has pumped-up finance charges (to all-time high in 2015e), we note that the potential of borrowing more (and hence finance costs) in 2016 is high, given subsisting pressure on cash. Modest Sales Outlook – While acknowledging UNILEVER’s diversified products portfolio and route-to-market initiatives, a continued challenging trading environment suggests that sales growth will remain subdued. Rising competition (with competitors launching new products -- e.g FLOURMILL’s spread and margarine) will continue to undermine volume growth in the previously resilient food category while competition and consumer down trading to cheaper products will prolong falling volume in the home and personal care segment. Downside Potential is Massive – At a P/E of 498x for 2016e EPS, UNILEVER ranks as one of the most overpriced stocks (alongside GUINNESS) in our coverage of consumer universe. Its price rallied by 20.8% in 2015, supported by an announcement earlier in the year of Unilever U.K’s (its parent company) plan to increase stake in the Nigerian subsidiary to 75%. Despite reducing risk-free rate and rolling forward valuation to 2016e, we still find the company’s shares significantly unattractive at current market value. Continued unimpressive earnings therefore suggest that it’s only a question of time -- most likely 2016 – before investors begin pricing UNILEVER rationally.


RoAA (%) 0.63


EPS (N) 0.09

PE (x) 405.54

Company Data

NSE Code UNILEVER

Bloomberg Code UNILEVER:NL

Reuters Code UNILEVER.LG




SELL Target Price (N) 22.06


Implied Return (%) -37.44

Price movement (UNILEVER vs. Benchmark Indices)


64 Jan. 2016

0.21.2


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0.6

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UNILEVER ASI CONSUMER


Dangote Sugar Refinery Plc Base-Effect Will Help in 2015 and Reality Will Set-in in 2016

After a base-effect (owing to massive underperformance in Q3 and Q4 2014) driven PAT growth in 2015e (+16% on our estimate), we expect DANGSUGAR’s earnings growth to reduce to more moderate level of about 0.1% in a normalized 2016. The significant fluctuation in the company’s selling prices and volume is testament of a difficult trading environment characterized by poor foreign exchange liquidity, weak consumer demand, saturated market and intense competition. We note that the fact that gains from lower raw sugar and energy prices (both valued in USD and account for about 88% of production costs) on unit costs have somewhat been offset by dwindling value of the local currency, making it difficult for DANGSUGAR’s management to exercise as much flexibility as it used to over pricing and margins. On the positive however, we acknowledge that the influence the company has over competition, in addition to its expansive distribution network, (especially in the North where sugar consumption per capita is higher), will remain an enabler of management’s volume-price management strategy. While this should guarantee some control over margins, earnings will benefit from well-contained marketing and distribution costs, amidst the likelihood that finance charges are less likely to be as high as 2015 levels -- given that short term borrowings have started moderating after significantly increasing in Q3-15. Volume to Remain Subdued - DANGSUGAR’s sales volume in nine months of 2015 was down 13% versus 9M-14. Despite aggressive price discounting, volume has remained under pressure in the last two years amidst squeeze on consumer disposable income, heightened competition in Lagos (following the entry of FLOURMILL’s Golden Sugar) and insecurity in the North (accounting for 66% of sales revenue). These factors are not likely to dissipate in the near term. On the other hand, average selling price of refined sugar in 2015 is higher than in 2014, and will likely increase further in 2016 in a bid to partly offset costs associated with currency. These altogether suggest that volume will remain subdued. Fairly Priced at Current Level – DANGSUGAR’s shares (lost 5%) outperformed both the Consumer Index and the broader market in 2015. Though the stock trades 3% above its 12-month TP of N5.33, we believe it is fairly priced at current market value – with a P/E of 4.9x for 2016e EPS of N1.13.


RoAA (%) 11.69


EPS (N) 0.99

PE (x) 6.11

Company Data

NSE Code DANGSUGAR

Bloomberg Code DANGSUGAR:NL

Reuters Code DANGSUG.LG




SELL Target Price (N) 4.97



Price movement (DANGSUGAR vs. Benchmark Indices)


65 Jan. 2016

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DANGSUGAR ASI CONSUMER


Flour Mills of Nigeria Plc Pushing Volume, Hurting Margin

We revise FLOURMILL’s 2016e PAT from N10.6 billion to N26.6 billion (vs. N8.5 billion in 2015F). Key driver is the increase in gain on the disposal of investment in associate to N23.7 billion, from N14.52 billion initially estimated. That said, we note that the first half of the 2015/16 year (with PBT ex-investment gain down by 91%) was very challenging for the company and we expect improvement in the second half to be modest. For 2017e, earnings outlook is constrained by the depreciating value of the foreign exchange to which FLOURMILL’s operation is significantly exposed to. The firm’s USD requirement for raw material imports across its businesses -- such as flour, noodles and pasta, fertilizer, sugar, animal feeds and edible oil -- ranges from 40% to 100%. More challenging, wheat -- which serves as raw material for businesses accounting for over 60% of Group gross profit -- is 100% imported. On the positive, we note that wheat prices (down by about 24% in 2015) are likely to remain soft for 2016-2017, helping to lessen the impact of currency depreciation on production costs. In our view, however, the net result of currency depreciation and falling commodities prices between 2016-2017 will be extra cost for FLOURMILL, signifying modest outlook for gross margin growth; amidst growing consumer sensitivity to prices. In addition to tight gross margin, we have increased estimates for borrowings and finance charges in 2017 -- though they are expected to sub-2016 levels. We added to borrowings because the company’s proposed N30.1 billion Rights Issue (expected to help improve the company’s debt position) currently lacks feasibility and persistent pressure on cash and cash equivalents suggests high potential for debt accumulation. As at September 2015, we estimate that a total of N45.4billion have been received from the divestment from UNICEM, consequently reducing gross debt from N188.4 billion end-2015 level to N149.7 billion. We Remain Positive of Revenue – As at H1-15/16, FLOURMILL’s revenue has increased by 7.3% through a mix of decline in the first quarter and double-digit growth in the second quarter. The increase is consistent with our 10.3% forecast for the full year. Whilst acknowledging the headwinds in the macroeconomic environment, we remain constructive of FLOURMILL’s diversified business -- wherein the Group boasts of market leading position across various categories -- and extensive distribution network. We note particularly the impact of newly launched products -- margarine and spread, breakfast cereals and snacks -- on sales revenue.


RoAA (%) 0.72


EPS (N) 1.00

PE (x) 26.68

Company Data

NSE Code FLOURMILL

Bloomberg Code FLOURMIL:NL

Reuters Code FLOURMI.LG




BUY Target Price (N) 40.18



Price movement (FLOURMILL vs. Benchmark Indices)


66 Jan. 2016

0.21.2


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FLOURMILL ASI CONSUMER


Honeywell Flour Mills Plc Losing Volume, Sustaining Margin

Compared to FLOURMILL, HONYFLOUR’s margins and earnings have shown more resilience in an obviously challenging 2015/16 year. As at first half ended September 2015, gross margin had increased by 221bps while PAT fell by 18%, from H1-14/15 level. On the contrary, sales revenue was down by 2.5% during the period, compared to FLOURMILL’s 7% growth. Management attributed the decline in sales revenue to (1) squeeze on consumer disposable income (2) loss of market share to competitors following price increases and (3) sustained heavy traffic jams at the Apapa area where the flour milling plant is located. On better gross margin, the drivers are (1) increase in prices which partly offset forex induced costs (2) stable gas -- and reduced consumption of expensive LPFO -- supply relative to 2014 and (3) increase inclusion of cassava -- from 3% to 5% -- in the flour mix. While margins have shown resilience, underlying pressure in the foreign exchange environment suggests that HONYFLOUR (whose raw material is 95% imported) is exposed to the risk of either lowering margins or losing market share. The current decision to partly pass-on extra costs to consumers, though protective of margins, appears to have increased pressure on sales, marketing and distribution costs -- owing to intense competition in the industry. Thus, as at September 2015, opex had risen by 8% and account for 14% of sales revenue (vs. 12% in H1-14/15 and 9% historical average). Aside stronger gross margin in H1-15/16, HONYFLOUR’s earnings benefited from a significant (41%) decrease in finance charges -- despite financial liabilities increasing by about N7 billion. The gain was however offset by reduction of finance income (83%), justified by the decline in cash and cash equivalents. Finance charges would likely moderate going forward as management guided that capital expenditure at the Sagamu Food Village has peaked (capex was 31% of sales in 2015) and expects spending to slowdown. The expectation therefore is that pressure on cashflow would ease, consequently reducing the need for short term borrowings (which rose consistently from N16 billion in 2013 to N31 billion in 2015). Sales Outlook is Still Strong – While currently constrained by traffic issues and competition, we remain positive of HONYFLOUR’s sales outlook. Though volume is expected to remain low in the short term, we expect it to rise in the medium term on the back of (1) fairly stable demand for flour-based foods and noodles (2) competitors adjusting their selling prices to reflect the reality of rising costs (3) new capacities coming on board -- as flour and noodles plants are currently at the peak of their utilization rates (4) ongoing government intervention to improve traffic situation at Apapa factory area.


RoAA (%) 2.20


EPS (N) 0.20

PE (x) 7.19

Company Data

NSE Code HONYFLOUR

Bloomberg Code HONYFLOU:NL

Reuters Code HONYFLO.LG







Price movement (HONYFLOUR vs. Benchmark Indices)


67 Jan. 2016

0.21.2


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HONYFLOUR ASI CONSUMER


PZ Cussons Nigeria Plc Earnings Depressed in 2016; To Recover Strongly in 2017

Following a 12% cut to our 2016 PAT estimate (to N3.8 billion), we now expect PZ to complete three straight years of earnings contraction at the end of the current financial year. The cut follows continued challenges in the sales environment, amidst subsisting cost pressure (with production cost being about 95% exposed to the USD). Management stated that whilst revenue and margins in the Branded Consumer Goods (BCG) division have been somewhat resilient (as prices were adjusted to offset the impact of the NGN devaluation), the White Goods (WG) division – largely affected by the ongoing squeeze on disposable income and consequently, difficulty passing extra costs – continues to drag. While highlighting the challenges faced by the Nigerian subsidiary in the first half of the 2015/16 year, PZ Cussons Holdings Limited UK - in its December 2015 Trading Update – guided to a likely continued deterioration in the second half, especially in the WG division. Outlook for 2017 is modestly positive. We expect revenue and PAT to grow by 7% and 12% respectively. On sales, we expect that the BCG division will remain resilient and WG subdued. In addition to contribution from the newly launched product (Cussons Baby Wipes launched in December 2015), BCG outlook is further buttressed by improving penetration to the North (currently 40% of sales, from 25% in the last two years) and the diversity of the portfolio (55% economy, 30% midstream and 15% premium brands). Outlook for WG division on the other hand is hinged on disposable income likely remaining tight, at least for most of 2016. The two divisions are exposed to cost pressures (and hence tight margins) from further weakness in the Naira/USD exchange value. Given that prices have been recently adjusted in the BCG division, we note that any extra costs from a weaker Naira may not be easily passed-on to the consumers in the short term. We also expect that management will continue to face difficulty meeting volume targets in the WG segment, talk more increasing prices. On PAT, PZ’s operating expenses have been quite conservative in recent years. Management attributed this to an active distribution model which has significantly reduced pressure on spending associated with RTM. In addition to a modest OPEX, management hinted that it expects to record nil finance charges from H2-2015/16 upwards wherein short term bank facilities will no longer be required – following improving cash position.


RoAA (%) 6.15


EPS (N) 1.08

PE (x) 19.38

Company Data

NSE Code PZ

Bloomberg Code PZ:NL

Reuters Code PZ.LG







Price movement (PZ vs. Benchmark Indices)


68 Jan. 2016

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PZ ASI CONSUMER


Cement

1.

69

Volume – Single-digit Growth Awaits Nigerian Market 71

Rising Capacity; Growing Competition for Market Share 71

Pricing – Lower Propensity Not Yet Over 72

Across Board Energy Efficiency 72

Pioneer Status Incentive – Is the Holiday Over? 73

Companies 74-76

Jan. 2016



Volume = Lower Prices and Huge FGN Capex Programme vs. Weak Private Demand Outlook With sales volume down by about 3-4% in nine months of 2015, we estimate that growth will have to be at least 9.3% higher y/y in Q4-15 for the Nigerian cement market to avoid a second contraction (in supply terms) in a row (the first since 1993-1994). The primary drivers of subdued volume were (1) lower government capital expenditure (with less than 30% of its multi-year low capex budget disbursed in the first nine months) and (2) weakness in private sector demand -- as the deterioration in the macroeconomic environment bit hard on spending power. On the sideline, uncertainties around the elections in the first quarter and a prolonged national fuel supply shortage in the second quarter (which affected the distribution of cement) also impacted negatively on cement supply. This slowdown of activities was captured by the National Bureau of Statistics’ quarterly economic assessment, wherein it estimated the cement sector to have grown by 22% average between January and September, compared to 29% reported in the same period of 2014. For 2016, our view on volume is that growth would be modest, in single-digit. While the sector may be poised to benefit from the government’s expansive capex plan for the year and relatively lower cement prices, the prospect of a rebound in private sector expenditure is low, considering looming macroeconomic headwinds. Weak consumption growth expectation and

70 Jan. 2016

Figure 56: Domestic cement Output (Million tonnes) Figure 57: Cement Sub-sector GDP Growth

Source: CMAN, NBS

Cement


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rising competition (as new capacities come on board) suggest low propensity for price increases. Hence, modest volume growth and stable prices, amidst underlying cost pressures (in view of potentially weaker currency value), signal narrow room for margins expansion. Finally, the cement industry, now fully mature, may be excluded (or subjected to stricter conditions) from the pioneer incentive scheme, as the federal government seeks alternative sources of plugging its dwindling petroleum revenue. Volume – Single-Digit Growth Awaits Nigerian Market The ratio (in percentage) of government to private sector demand for cement in Nigeria ranges between 40:60 and 45:55. Given the decline in demand from the public sector (justified by weak FGN capital spending as stated above and reduced monthly budgetary allocation to states), we can argue therefore that private demand sustained the market in 2015. We see the opposite in 2016 where demand from the government is likely to salvage the sector. Our optimism is primarily embedded in the year’s budget, wherein the FGN has allocated 23% of a robust capital expenditure appropriation (N1.85 trillion) to an infrastructure ministry with significant potential for cement demand. Stability in energy supply -- given that gas has been largely available since Q3-15 while producers now have sufficient back-up in coal/LPFO -- should also be positive for the market in the year. While the prospect of a rebound in private sector expenditure is low, we think stability (and possibly further reduction) in cement prices (as competitions thicken with new capacity additions) would provide modest room for growth. That said, we expect volume to grow in single-digit y/y. Driving our conservatism are (1) low prospect for private sector expenditure rebound (2) the possibility of the FGN falling short of its infrastructure expenditure plan (on the back of significant shortfall in oil and non-oil revenue budgets) and (3) prolonged pressure on the states’ finances. Rising Capacity; Growing Competition for Market Share With UNICEM expected to onboard 2.5MT/yr capacity, installed capacity in the cement industry will rise to 43.7MT/yr by end of 2016. By end 2015, industry installed capacity was 41.2MT/yr, boosted by a 3MT/yr capacity plant commissioned by BUA Group’s Edo Cement in the third quarter of the year. At 43.7MT/yr, industry production capacity will be double domestic consumption, technically implying 50% average utilization rate, per producer. Rising capacity, amidst modest consumption growth outlook (growth is poised to trail pre-2014 10% average p.a run rate), suggests that strong competition for market share is imminent. In addition to price reduction (in September 2015), we note that producers, especially the market leaders, already offer distributors attractive rebates as part of sales promotion measures. While rivalry is already intense in the South, we expect that it will gradually shift to the North, with Edo Cement adding new capacities.

71 Jan. 2016



Pricing – Lower Propensity Not Yet Over On 03 September 2015, DANGCEM announced 18% reduction in ex-factory price of its cement to N1,330 per 50kg bag (ex-VAT). Before then, the Group had increased price by 4.3% between December 2014 (N1,563 per bag) and March 2015 (N1,630 per bag) as an interventionist measure taken (following 14% price reduction in November 2014 to N1,150 per bag) to offset the impact of a currency devaluation induced cost pressure on margins. Being the market leader, competitors (especially in the South) were compelled by DANGCEM’s latest price reduction. Over the years, Nigerian cement producers have invested massively in both capacity expansion and cost efficiency. With prices mostly upward trending, benefit has thus accrued through margin expansion. We estimate DANGCEM, WAPCO and ASHAKACEM’s EBITDA margins to have increased from 31% average in 2007 to 58% in 2015. Across Board Energy Efficiency All cement plants in Nigeria, except CCNN’s Sokoto and DANGCEM’s Gboko plants, currently benefit from production cost efficiency through high level utilization of cheaper energy sources. As at 9M-2015, coal substitution in ASHAKACEM was in the 80s, while gas utilization in WAPCO’s South-West and East plants was in mid-90s each. Gas utilization in each of DANGCEM’s Ibese and Obajana plants was in the upper 80s on average, with coal facilities serving lines 1&2 and line 3 of both plants, respectively.

72 Jan. 2016

Figure 58: Cement Prices – Nigeria (Naira/tonne)

Source: CMAN, Company Accounts, Cordros Research estimates


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DANGCEM is expected to commission (as guided by management) coal facilities at Ibese lines 3&4 and lines 1,2&4 by Q2-2016. WAPCO is also exploring alternative fuel strategy to replace gas and other fuels in kilns with new energy sources like biomass. Overall, outlook on energy supply is positive. Compared to 2015 (where supply was affected by elections, industrial strike actions and petrol scarcity), we expect less disruptions to gas supply in 2016. In addition, gas and coal prices have fallen pretty much in line with the sharp drop in crude oil prices and are expected to relieve margins of stress, amidst depreciating Naira value and tight price outlook. Pioneer Status Incentive; Is the Holiday Over? Cement companies may be heading for tough times, with an end to the Pioneer Status Incentive (PSI) in sight. Recall that the PSI grants up to 5 years tax holiday to qualified industries in Nigeria, with the aim, among others, to encourage investment in certain industries not already carried on in the country or where the existing industry is not operating at a level that is sufficient to meet the nation’s needs. Apart from income tax holiday, benefits of the pioneer exemption include tax free dividend. Nigerian cement producers are major beneficiaries of the PSI. DANGCEM for instance enjoyed tax credits (amounting to N39.6 billion) between 2010 and 2013, on the back of the PSI. The Group’s plants in Ibese and Obajana (ex 1+2) are still under pioneer status. In addition, both Lafarge Africa’s Ewekoro II plant (effective December 2011) and ASHAKACEM’s coal mine (effective January 2012) are under pioneer status until end of 2016. Consequently, the effective tax rate (ETR) of the industry was 7% average as at 9M-15, compared to 26% average for our universe of consumer goods companies. Risk to the PSI (and consequently earnings of cement companies) is that the significant drop in petroleum revenue accruing to the government as a result of dwindling oil prices has shifted focus to alternative income sources, particularly taxation. It is reported by PwC Nigeria that all new applications for pioneer status have been put on hold since 2015, as part of a process to review existing incentive regimes. In 2016, budget for FGN tax revenue was increased by about 90% of the pro-rated actual amount generated in 2015. The estimate is based on plans to expand tax base, which may include, in our view, a review or possibly more stringent adjustment of the conditions (or eligibility criteria) around the PSI.

73 Jan. 2016



Cement Company of Northern Nigeria Plc Too Many uncertainties

We have revised our TP on CCNN down to N9.47 and changed recommendation to HOLD, from BUY previously. Unlike its peers, CCNN’s capacity expansion programme is very unclear, with management consistently reluctant to provide additional details on the project. Consequently, we have excluded additional inputs from the proposed 1MTs capacity plant which management guided for a 2018 completion, hence the current valuation. CCNN’s parent company – BUA Group – commissioned a 3MTs/yr capacity cement plant in 2015 – Edo Cement – and hinted on plans to target delivery to Northern markets, in addition to South-South where it is located. This further drives our suspicion that the Group might slowdown the pace of expansion in CCNN, hence our caution on the proposed 2018 planned commissioning timeline. In addition, we have reduced capacity utilization in the latest valuation (from 95% to 90% average) in view of persistently declining volume. We project PAT to grow by 9.7% in 2015e and by a more modest 2% in 2016e. CCNN had a mixed set of results for the nine months of the 2015 financial year. Net profit was disappointing in the first half (-18%), improved in the third quarter (+144% y/y) and is expected to close higher in the fourth quarter and full year – owing to base effects of a very disappointing Q3 and Q4 2014. Meanwhile sales underperformed y/y in all quarters, and down 6.3% as at 9M-2015. The management attributed poor sales in 2015 to elections, insecurity and fuel supply challenges which affected both the company and its customers. Beyond these, we reiterate our views on shortcomings associated with the old age of the existing plants (making them prone to intermittent periods of lost productions due to repairs) and limited capacities. In addition, while the company had previously enjoyed greater influence on pricing (owing to healthy demand for cement and minimal pressure from distant competitors), the dynamics has changed in recent years (and is expected to remain so), following overall moderation of national demand and competitors (currently DANGCEM, to be potentially joined by ASHAKACEM) exploring markets to offload excess capacities. These suggest modest room for volume and margin growth. On the positive, production costs appear to have stabilized in recent years (with COS margin falling from 72% in 2012 to 64% average between 2014 and 2015) while operating expenses has reduced considerably to average 17% of revenue (from about 26% five-year average). That said, finance charges, though modest, have been on the rise.


RoAA (%) 11.84


EPS (N) 1.71

PE (x) 5.61

Company Data

NSE Code CCNN

Bloomberg Code CCNN:NL

Reuters Code CCNN.LG

Sector INDUSTRIAL GOODS






Price movement (CCNN vs. Benchmark Indices)


74 Jan. 2016

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CCNN ASI INDUSTRIAL


Dangote Cement Plc He Who Pays the Piper …

We retain our 2016e TP on Dangote Cement Plc (DANGCEM) at N162.04 and upgrade recommendation to BUY (previously HOLD). The recommendation follows the fall in DANGCEM’s share price (by 18%) since our last update in November 2015. Note that we updated valuation of the stock in November following (1) bigger-than-expected capex outlay – N251 billion in 2015e and c.N800 billion between 2016e to 2020e and (2) modest EBITDA growth outlook in Nigeria (due to uncomplimentary volume-price mix). Overall, we forecast 2016e revenue, EBITDA, EBIT and PAT growth of 10.7%, 4.6%, 3.7% and 4.2% respectively for the Group. This (compared to the much more significant growth rates expected in 2015e) suggests that outlook for the Group is modest. Changes to our forecasts could be driven by (1) larger-than-expected volumes in Nigeria - if the government delivers on its infrastructure spending plan – and offshore – if the Tanzania plant which commenced production in December 2015 performs above expectation, (2) price increase in Nigeria, and (3) material changes in capex outlay from initial forecast. Dictates the Tune - DANGCEM cut cement prices by 18% (ex-factory to N1,330 per 50kg bag ex-VAT) in September 2015 to restore the market share it lost to a major competitor at the beginning of the year. The price cut was also in response to slow demand in Nigeria, wherein industry output was heading for the second year of contraction. The move forced competitors, notably in the South West (warehousing over 40% of country capacity) to adjust prices accordingly. DANGCEM reported modest (9.7% y/y and 1.3% y/y) EBITDA and EBIT growth while PAT declined (by 19.7% y/y) in Q3-15 (three months ended 30th September). EBIT and EBITDA from the non-Nigerian operation were stronger (as volume, and thus revenue, surged, following additions to capacity) and provided adequate cover for the Nigerian component, wherein both line items declined (on the back of a volume-driven fall in revenue). Management attributed the decline in Nigerian volume primarily (although it also cited slow demand in September owed to the Muslim festivity) to subsisting macroeconomic deterioration. In addition, net profit fell in Nigeria (by 12.8% y/y), but losses increased (136.2% y/y) in the rest of Africa subsidiary, wherein net finance costs rose significantly. Management attributed the increase in Group net finance charges (by 271.1% y/y) to (1) higher borrowing cost – from 10% to 14% (2) higher average borrowing (3) the capitalization of charges relating to the new plants that commenced operation recently and (4) the reduction of investible surplus funds. We note that despite lower profit, underlying margins in Nigeria remained stable, driven by higher prices (before the cut in September) and improving energy cost-savings – via continued gas availability and the substitution of LPFO with coal. Group margins, however, have been subdued by lack of growth in Nigeria – allowing for growing share of the less efficient offshore operation in the mix.


RoAA (%) 8.45


EPS (N) 12.27

PE (x) 10.50

Company Data

NSE Code DANGCEM

Bloomberg Code DANGCEM:NL

Reuters Code DANGCEM.LG


Market Cap. (N'bn) 2,196.69

Free Float (%) 8.04




Price movement (DANGCEM vs. Benchmark Indices)


75 Jan. 2016

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DANGCEM ASI INDUSTRIAL


Lafarge Africa Plc Will Cost Savings Come to Help?

A modest outlook on volume, amidst stable to potentially lower prices in Nigeria, combined with continued deterioration in South African market, suggest low margin growth prospect for WAPCO in 2016e. Consequently, we forecast lower EBITDA margin (23.8% vs. 24.8% in 2015e) and net profit (-1.4% vs. 19.5% in 2015e) for the year. Margin from South Africa (down 500bps in 9M-15) faces pressure from unrelenting competitive trading environment. In Nigeria, the company’s South-West unit, operating at a capacity in the upper 80s (suggesting low room for volume growth) is more vulnerable to competitive pressure (from the industry leader) that threatens upside price prospect. The unit is also at the peak of its energy efficiency, thus gains from herewith is almost at the limit. ASHAKA (in the North) could benefit from the low base of 2015 (in volume terms), price stability, and continued production efficiency. However, key risks are regional volatility, the sub-optimal operation of the existing plant and potential supplies from Edo Cement. We are however more optimistic of the South-East unit which has improved significantly in terms of efficiency, and would double capacity (to 5MTs) during the year. To offset pressure on margin, WAPCO’s management (hinted at the Q32015 result conference call) plans to drive cost saving (around N7-8 billion on our estimate, between mid-July 2015 and mid-2018) through synergies. Emphasis is on operating costs covering procurements, energy (type and supply contracts) and general, administration and fixed costs. Successful implementation, with estimated cost saving of N2.97 billion in 2016e (inclusive of implementation costs), should be somewhat supportive of margin and net profit. On UNICEM – Final payment (about N27 billion) for the purchase of outstanding 7.5% stake from Flour Mills of Nigeria Plc was made on September 28, 2015. Plan is very much on track for the delivery of additional 2.5MTs capacity by end of August 2016. As at 9M-15, 44% of the company’s outstanding debt was in USD, thus resulting to N6.5 billion unrealized loss in foreign exchange. Together with the Naira facilities, WAPCO’s management hinted that it is considering the possibility of debt refinancing (leveraging on its stronger credit rating), beginning with the Naira facilities in order of priority.


RoAA (%) 11.86


EPS (N) 8.39

PE (x) 9.53

Company Data

NSE Code WAPCO

Bloomberg Code WAPCO:NL

Reuters Code WAPCO.LG







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76 Jan. 2016

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Banking 2.

77 Jan. 2016

These Banks Won’t Lend! 78

Low Yield Environment to Present Banks with Mixed Bag 79

Credit Concern Worsens as Crude Takes the Spotlight Once More 79

Regulatory Impact – Time to Loosen Grip? 81

Companies 83-87



Resilient but not Insulated Fresh off a bruising 2015, where banks proved to be resilient but not insulated from the economic uncertainty and challenges that affected the country following the sharp drop in crude oil prices, we expect a tougher test in the coming year. In 2016, banks are faced with headwinds stemming from the continued weakness in crude oil prices, the cocktail of forex restrictions (we expect more), and a transition to a low interest rate environment. We view the aforementioned factors as stiff threats to banking profitability. A combination of weak oil prices and the scarce availability of forex are likely to lead to higher impairments on Oil & Gas, Manufacturing, and General Commerce portfolios which constituted 51.6%% of total loans as at H1’15. Threat of elevated impairment provisions aside, gross earnings are also set to be pressured, on the back of our outlook for constrained loan growth, given the pro cyclical nature of banks. Furthermore, the transition to a low yield (on government securities) environment is likely to pressure earnings on investment securities, eroding the benefits (possibly lower interest expense) of increased liquidity from the reduced reserve requirement. Nevertheless, our view is that regulatory oversight this year will be less stringent than preceding years (0especially 2009 – 2014), as regulators weigh the risk of stiff enforcement on financial system stability. Overall, with banks trading below fundamental value like they did for much of 2015, our view is that current market valuations appear to be largely driven by wider macro-economic concerns. These Banks Won’t Lend! While the CBN has recently begun advocating for increased lending to target employment generating sectors, in view of ongoing macroeconomic

78 Jan. 2016

Banks


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Source: Company Reports, Cordros Research

Figure 59: Banking Performance 9M’15 vs FY’16E


challenges, we are of the position that credit growth will be subdued in 2016 -- primarily as a result of the pro cyclical nature of banks (i.e. assets quality concerns are heightened during downturns in the business cycles). This, combined with current capital adequacy requirements, will cause banks to be cautious with credit growth. Currently, the Nigerian economy is faced with headwinds from the slump in crude oil prices, which has slowed down economic growth, with unemployment and inflation both rising, amidst reduced availability of foreign currency. Thus, we expect banks to stiffen credit requirements, and reduce credit lines - for some borrowers - to exposed sectors. Also, the fall in oil prices is likely to result in economically induced business challengers (e.g bankruptcies, cash squeezes and poor returns on investmen, and companies will ultimately cut down investments and need for credit.

Low Yield Environment to Present Banks with Mixed Bag The switch to monetary easing is likely to be a mixed bag for banks. After a six-year tightening cycle, monetary policymakers have opted to take a more expansionary view, by cutting both MPR and CRR in 2015, in order to boost economic activity. Since September 2015 when the easing commenced, money market rates have diminished significantly, buttressed by the CBN’s somewhat reluctance to conduct OMO auctions. Although the Central Bank commenced OMO withdrawals in late December, our view is that the accommodative monetary condition is likely to continue through 2016. The consequent surfeit system liquidity and lower money markets rates, combined with the implementation of the Treasury Single Account (in September 2015), will likely reduce cost of funds. However, the impact is likely to be dampened, given banks’ significant exposure to foreign currency deposits (31% in Nov’15), which are likely to become more expensive.

Figure 60 Loan growth history and forecast 2014- 2016 Figure 61 Aggregate Banks’ Loan Growth Post 2009 Financial Crisis

Source: Company Reports, Cordros Research

79 Jan. 2016


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Our outlook for more expensive dollar deposits is driven by a likely persistent dollar scarcity, combined with the effects of US Fed tightening. Furthermore, we expect the lower yields to translate into slower top-line growth for banks, given their historical reliance on investment securities to generate interest income. Credit Concerns Worsen as Crude Takes the Spotlight Once More We expect NPLs and cost of risk of our coverage banks to climb by 300bps and 100bps on average respectively. Our expectation is driven by weakness in the Oil & Gas, Manufacturing, and General commerce portfolios. The Oil & Gas sector is in the spotlight once more (as in the last oil slump in 2009) after prices declined to 12 year lows in January, with growing fears that a supply glut and the strength of the US dollar may push prices even lower. While Nigerian banks are significantly exposed to the Oil & Gas sector (23.8% of total banking sector loans), the upstream segment carries the most direct threat, followed by the midstream segment. While the downstream segment is considerably less vulnerable from weaker oil prices than in 2009. In 2015, some banks restructured loans in their upstream portfolios, thereby avoiding larger credit losses. While the estimated cost of crude oil production in Nigeria is c.US$13 (WEO 2015), our discussions with the banks revealed that the break-even price projections for most facilities range from US$40 – US$50. In view of that, we believe the recent resumption in the decline of crude oil prices (-17% YTD) may trigger some financial covenants (cash flow leverage, interest coverage, and/or current ratio) especially on syndicated facilities, leading to higher level of defaults among upstream operators, thereby pushing bank NPLs higher.

80 Jan. 2016


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Source: Company Accounts, Cordros Research


Another threat to bank NPLs in 2016 is the lingering forex scarcity which is plaguing Nigerian businesses. While a further devaluation of the NGN may increase the likelihood of defaults, we believe also that the current situation - whereby the CBN’s intent to preserve reserves has placed a cocktail of restrictions on forex transactions - continues to pose a large threat. On the positive, following increasing concerns about the ability of banks to meet letters of credit obligations, the CBN stated that letters of credit (LCs) would become priority transactions. Nevertheless, we foresee forex challenges as a driver of increased cost of risk in 2016. Regulatory Impact: Time to Loosen the Grip? Since the advent of the Banking Crisis in 2009, Nigerian banks have faced headwinds in the form of increased regulatory supervision. The apex bank has increased oversight on bank fees and charges, liquidity, and capital adequacy. This year, we are of the opinion that the apex bank will take a benign or subtle view towards regulatory supervision in order not to severely affect banking system profitability. One of the biggest regulatory headwinds was the implementation of stiffer capital requirements (since 2009). However, we expect pullbacks in this regard will be minimal, mainly because the risk of reducing CARs to boost lending far outweighs the benefits i.e. greater lending flexibility. Nevertheless, the CBN may postpone its implementation of the 16% CAR for systemically important banks for an additional year like it did in 2015.

81 Jan. 2016


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Furthermore, last year, the CBN retreated from implementing the “Oil & Gas Risk Mitigation Circular” it issued following the precipitous drop in oil prices in 2014. The circular, if implemented, would have had a grave impact on banks’ NPLs and CARs. Rather, in November, the apex bank instructed banks to double general provisioning to 2% from the previous 1%. In our estimations, this directive is likely to be less of an impact on bank CARs and profitability. Also with regards to fees & charges, the CBN has already begun rolling back previous decisions. For instance, it reversed decisions to scrap account maintenance fees (i.e. COT), leaving it unchanged at the N1 per mille in 2015.

82 Jan. 2016


Figure 65: Capital Adequacy Ratios

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ACCESS FBNH GUARANTY UBA ZENITHBANK

FY'14 9M'15

Source: Company Reports


Access Bank Plc Time for Tactical Retreat Perhaps

We maintain our favorable outlook on ACCESS based on (1) expectation for improvement in margins from greater amount of low cost deposits and (2) the bank’s resolute asset quality. From an NII perspective, interest expense has been a bane on earnings – expanding by 42.5% y/y in 9M’15. However, the bank has increased sales staff by three-fold in 2015 in a bid to expand its retail footprint and access a greater number of cheap deposits. The gains of this strategy are becoming evident, with cost of funds dropping to 4.5% as at September 2015 from 5.4% recorded through 9M’15. Also bolstering our outlook is the bank’s strong asset quality which withstood most macro pressures (i.e. weaker corporate profits and low consumer confidence) associated with lower oil prices in 2015. The bank has also been aggressive in this regard; providing for 196% of non-performing loans in 9M’15 compared with 114% in 9M’14. With a well diversified loan book -- only 4.8% and 8.4% of loans in the upstream and service Oil & Gas segments respectively – we remain constructive of asset quality in 2016. Additionally, we expect an improvement in cost to income ratio, after operating expenses swelled in 2015 following the aforementioned increase in retail sales staff. There were one time on-boarding expenses associated with the staff additions, which should not appear in FY’16. We expect EPS and ROE to fall to N2.13 (FY’15E: N2.70) and 16.2% (FY’15E: 21.6%) respectively. In 2015, the bank completed a capital raise of ₦41.7 billion, significantly improving CAR to 21.8% in 9M’15 from 18.1% in FY’14. Despite its strong capital buffers, our outlook on loan book growth is subdued, after ACCESS grew net loans by 39% and 16% in FY’14 and 9M’15 respectively. Our loan growth forecast also takes into account a possible devaluation of the NGN within 2016, which would cause total loans to expand because of ACCESS’ foreign currency loan book. Consequently, we expect modest growth (+9.1%) in interest income. Also, we expect non-interest income to contract by 18.1% (FY’15E: 80.8%) after it significantly expanded as a proportion of gross earnings to 68% in 9M’15 from 32% in 2013. The growth in non-interest income occurred on the back of lucrative currency swap contracts of which some matured in 2015, hence our reduced non-interest income forecast. We cut our Target Price on ACCESS to N9.44 (Previous: N10.46). Nonetheless, we maintain our BUY rating on the counter driven by its attractive market valuation.


RoAA (%) 2.45

EPS (N) 2.13

PE (x) 1.95

Company Data

NSE Code ACCESS

Bloomberg Code ACCESS:NL

Reuters Code ACCESS.LG

Sector FINANCIAL SERVICES






Price movement (ACCESS vs. Benchmark Indices)


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FBN Holdings Plc Stressed Market Valuation Drives Significant Upside

As at FY’14, FBNH had exposures to the Oil & Gas sector of c.40%. Since then, crude oil prices have fallen by over 70% while FBNH’s impairment charges surged by 250% y/y to N46.9 billion, after NPLs swelled to 4.8% (from 2.9% in December) by 9M’15. As at 9M’15, the bank’s PAT declined by 9.7% to N55.6 billion, while RoAE crashed by 450bps to 12.2%. Our outlook for earnings is broadly negative, mainly on the back of expectation for continued weakness in asset quality, amidst elevated exposure to the upstream (18%) and services (8%) segments of the Oil & Gas sector. The bank mentioned that it restructured about 9% of its loan book (primarily its Oil & Gas exposure) in 2015, however, we expect the resumed dip in oil prices will place additional pressure on these facilities. Consequently, we have increased our NPL expectation for FY’15 and FY’16E respectively to 5.5% and 7.0% respectively. Given our dampened outlook for FBNH, we forecast both PAT and RoAE to decline respectively by 50.5% and 500bps in FY’16. Our forecast incorporates outlook for increasing cost pressures and reduced gross earnings. Gross earnings expectations are hampered by lower non-interest income numbers due to lower FX trading income alongside reduced interest income on the back of shrinking loan growth (-10% FY’16). The cost pressures outlook stems mainly from our cost of risk and impairment charges outlook discussed in the above paragraph. Other cost lines are expected to ease. Operating costs are likely to fall y/y after the bank reduced headcount during 2015. Interest costs should to ease in FY’16 after spiking by 35.6% y/y in 9M’15 – the bank attributed this to the tightening measures implemented by the CBN between Q3’14 and Q3’15 which pushed its cost of funds from 3.2% in FY’14 to 4.0% in 9M’15. The onset of monetary policy easing from Q4’15 will provide some respite for FBNH in the form lower funding costs. However, a point of concern is that the bank’s declining asset quality is likely to strain an already tight CAR of 16% (just 100bps above the 15% requirements). The increasing credit risk computation, alongside the effect of a Naira devaluation (which will expand risk weighted assets), will further strain the bank’s CAR further in FY’16. Thus, we believe that FBNH will retain its low dividend pay-out ratio in order to conserve its regulatory capital. We cut our Target Price on FBNH to N4.83 (Previous: N10.46) but leave BUY rating unchanged.


RoAA (%) 0.52

EPS (N) 0.67

PE (x) 5.87

Company Data

NSE Code FBNH

Bloomberg Code FBNH:NL

Reuters Code FBNH.LG







Price movement (FBNH vs. Benchmark Indices)


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Guaranty Trust Bank Plc Gracefully Riding the Storm

We expect GUARANTY to remain the industry benchmark for efficiency and profitability in FY’16. However, we expect operations in FY’16 to be “resilient but not insulated” from the headwinds affecting Nigerian economy and the banking sector. The attendant impact of the fall in crude oil prices on the economy is likely to translate to higher NPLs in the banking sector, GUARANTY included. Notably, as of H1’15, upstream Oil & Gas constituted about 24% of total loans, most of which were performing as of then. In response to the challenging operating environment in 2015, the bank committed to increasing collective impairments by N1 billion a month and suggested that it was looking to restructure some of the upstream portfolio via tenor elongations of 1 -2 years. However, the new oil price regime of sub-US$40 per barrel is likely to push NPLs from 3.1% 9M’15 to 4.0% by FY’16E. In addition, we are also increasing our cost of risk forecast of 1.2% up from 0.65% as at 9M’15. Our forecasts take into consideration GUARANTY’s (1) exposure to the services Oil & Gas segment (+7%), where restructuring may not be the prudent option, and (2) the impact of the reduced forex availability and economy induced challenges on its credit customers. Overall, we expect a slight improvement in CIR on the back of (1) a slight reduction in interest expense (-1%) following the low interest monetary path set by monetary policymakers and (2) slow operating expense growth (+2%). We expect the bank’s EPS and ROE to decline by 5kobo and 370bps respectively to N3.35 and 21.7% in FY’16, from our FY’15 estimate. The weak profitability forecast is driven by our projection for a +44% y/y expansion in impairment charges, combined with sluggish gross earnings growth. We expect gross earnings to inch up slightly (+2% y/y) on the back of muted risk creation (+10%) without the added benefit of attractive fixed income yields to support interest income. Furthermore, we expect non-interest income to be pressured from (1) reduced credit related fees owing to muted credit creation, (2) lower card transaction fees following CBN spending limits and location based card restrictions, and (3) subdued forex trading income following CBN restrictions on two way quote trading. The bank and its peers however enjoyed some reprieve when the CBN introduced a Negotiable Account Maintainance Fees (NACMF) to replace the commission on turnover charges which were meant to be phased out in January 2016 (both fees charge customers N1 per mile). We cut our Target Price on GUARANTY to N22.62 (Previous: N33.16), however we maintain our BUY rating on the counter driven by its attractive market valuation.


RoAA (%) 3.72

EPS (N) 3.35

PE (x) 5.01

Company Data

NSE Code GUARANTY

Bloomberg Code GUARANTY:NL

Reuters Code GUARANTY.LG







Price movement (GUARANTY vs. Benchmark Indices)


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United Bank for Africa Plc Asset Quality Put to the Test

While we remain constructive of UBA in the long term -- driven by its diversified operation through pan-African presence and historically low risk profile -- we have reviewed our outlook for FY’16E downwards following the resumed descent in crude oil prices. As at 9M’15, UBA had significant exposure to the upstream sector - which accounted for more than half of its Oil & Gas exposure (21% of loan book). Although only a fraction of the upstream loans -- especially those lent to indigenous operators who are less resistant to oil price shocks -- are likely to experience significant pressure, we still expect the deterioration in that sector to negatively impact the bank’s cost of risk. Consequently, we have increased our cost of risk expectation from 0.7% in FY’15E to 1.7% in FY’16. Also, while the bank’s strong asset quality numbers are traditionally a bright spot; we are revising NPLs upwards to 3.2% (after increasing to 2.1% in 9M’15 from 1.4% in Dec’14) due to the aforementioned exposure to the upstream Oil & Gas sector. For FY’16E, we expect gross earnings and PAT to contract by 0.2% and 19.2% respectively. Our lower gross earnings forecast stems from lower loan growth outlook (+3%) -- as at Q3’15, loan book had already contracted by 12.7% q/q. Although management cited the Debt Management Office’s (DMO) exercise to restructure Nigerian State government loans (both performing and non-performing) as responsible for the decline in the loan book, we also believe that UBA was hesitant to expand its loan book during Q3’15 because of the overall uncertainty in Nigeria’s macroeconomic environment. The effect of the lower loan growth forecast is compounded by the lower interest rate environment which is likely to reduce lending rates and returns on investment securities. Furthermore, the accommodative monetary policy stance is likely to negatively affect the bank’s return on investment securities which account for c.30% of interest income on average. However, we also anticipate a slight improvement in Net Interest Margins following reduced pressure on interest expense on the back of more buoyant levels of banking system liquidity. That said, we are broadly positive on the bank’s pan-African operations (present in 18 African countries) which now account for 25% of Group revenues. However we are also circumspect of the rewards, given the associated risk of the bank’s cross border strategy, especially in 2016 where there’s an expectation of an economic slowdown across sub-Saharan Africa (the IMF cuts its forecast for SSA growth). Areas of concern with regard to UBA are East Africa and WAMZ wherein commodity producers are exposed to currency risks. We cut our Target Price on UBA to N5.62 (Previous: N8.64). Nonetheless, we maintain our BUY rating on the counter driven by its attractive market valuation.


RoAA (%) 1.74

EPS (N) 1.41

PE (x) 2.06

Company Data

NSE Code UBA

Bloomberg Code UBA:NL

Reuters Code UBA.LG







Price movement (UBA vs. Benchmark Indices)


86 Jan. 2016

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Zenith Bank Plc Strong Fundamentals but Outlook Weary

We are revising our outlook for ZENITHBANK downwards for FY’16 and consequently cutting our TP to N20.36 from N23.73. While the bank remains an attractive lender – owing to its strong balance sheet, and impressive liquidity and capital ratios – our outlook for 2016 has been hampered following persistent headwinds to the Nigerian economy. In view of higher potential risks to the Oil & Gas sector as well as higher potential defaults in the bank’s foreign currency portfolio, we are increasing our NPL and cost of risk forecasts for FY’16E. The bank showed some prudence in 2015 by increasing NPL coverage ratio to 124.4% in 9M’15 from 92.0% in FY’14. Management also communicated that it restricted some loans and placed hedges against drop in crude oil price for its Oil & Gas customers. Through 9M’15, ZENITHBANK posted strong financials, showing tremendous resilience, despite (1) the effect of a slower Nigerian economy following lower oil prices (2) tough CBN restrictions on foreign exchange accessibility and transactions which impacted the operations of the bank and its customers and (3) the uncertainty and volatility associated with an election year. We believe two major factors responsible for the impressive performance are (1) it’s prudence and conservatism which translated to lower than expected asset quality pressure and (2) it’s ability to enter transactions to take advantage of the volatility experienced during the year. Our dampened outlook for ZENITHBANK results in a 400bps drop in ROE from FY’15E of 18.8%. Aside from increased impairment charges, we expect gross earnings to contract slightly as we reduced interest and non-interest income earnings. Our non interest income forecast is driven by our expectations for reduced trading income – foreign exchange trading income fell by 44% y/y as at 9M’15 after CBN implemented forex trading restrictions in H1’15. Also, interest income is expected to moderate given the outlook for lower yields on investment securities in 2016 in comparison to 2015. As at 9M’15 - before the CBN commenced its monetary policy loosening - income from treasury bills and government bonds contributed 25% of interest income. Our loan growth outlook is a modest 10%, incorporating a potential Naira devaluation which would automatically expand FCY loan book. Consequently, we expect a 5.9% expansion of the interest income line.


RoAA (%) 2.26

EPS (N) 2.69

PE (x) 4.23

Company Data

NSE Code ZENITHBANK

Bloomberg Code ZENITHBA:NL

Reuters Code ZENITHBA.LG







Price movement (ZENITHBANK vs. Benchmark Indices)


87 Jan. 2016

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CORDROS CAPITAL LIMITED

70, Norman Williams Street

Ikoyi

Lagos

Tel: +234-1-270284-7

Fax: +234-1-4627324

Corporate Website

www.cordros.com

Bloomberg

COOS<GO>

Securities Trading

[email protected]

[email protected]

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Corporate Finance/Advisory

[email protected]

Asset Management

[email protected]


Contact Details

Jan. 2016


Fair Value Estimate

In estimating fair values for the stocks under coverage, we took into account a weighted average of projected prices derived from a blend of discounted cash flow (DCF) and relative valuation methodologies. The use of the relative valuation methodology (ies) is subject to the nature of the firm’s business and what the analyst(s) consider(s) the key value drivers from a firm specific as well as industry viewpoint. We attach the most weight to DCF valuation methodology, particularly the Free Cash Flow (FCF), Dividend Discount Model (DDM) and Residual Income Valuation Model (RIVM).

Rating Definitions

Cordros Capital uses the following rating system: BUY (OVERWEIGHT) - Over the next twelve months, we expect the stock to return at least 20% above the current market price. HOLD (NEUTRAL) - Over the next twelve months, we expect the stock to range between <-10% and <+20% from the current market price. SELL (UNDERWEIGHT) - Over the next twelve months, we expect the stock to be more than 10% below the current market price.

Cordros Capital Research 89 Jan. 2016


Analyst’s Certification and Disclaimer

The research analyst(s) whose name(s) appear(s) on the cover of this report certifies (y) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report; and (3) all analysis made by the analyst(s) were in good faith and the views expressed reflect their opinion, without undue influence or any intervention.

Important Disclosure

This document has been issued and approved by Cordros Capital (Cordros) and is based on information from various sources that we believe are reliable. However, no representation is made that it is accurate or complete. While reasonable care has been taken in preparing this document, no responsibility or liability is accepted for errors or fact or for any opinion expressed herein. This document is for information purposes only. It does not constitute any offer or solicitation to any person to enter into any trading transaction. Investments discussed in this report may not be suitable for all investors. This report is provided solely for the information of Cordros clients who are then expected to make their own investment decisions. Cordros conducts designated investment business with market counter parties and customers and this document is directed only to such persons. Cordros accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is for private circulation only and may not be reproduced, distributed or published by any recipient for any purpose without prior express consent of Cordros. Users of this report should bear in mind that investments can fluctuate in price and value. Past performance is not necessarily a guide to future performance. Cordros and/or a connected company may or may not have a relationship with any of the entities mentioned in this document for which it has received or may receive in the future fees or other compensation. Cordros is regulated by the Securities and Exchange Commission to conduct investment business in Nigeria.

Cordros Capital Research 90 Jan. 2016



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