NIGERIA IN RECESSION: COPING WITH AN ECO-
NOMIC CONTRACTION
With Nigeria’s current economic weakness, the word ‘recession’ is
on everyone's lips, but not many understand what it really means.
The general rule of the thumb is that a country is officially in a re-
cession after two consecutive quarters of negative growth. Accord-
ing to this definition, Nigeria was officially in a recession in
Q2’2016. Another school of thought states that recession begins
after a prolonged period (six months or longer) of slowing growth
and economic contraction. This period is marked by a significant
decline in aggregate demand, widespread retrenchment of busi-
ness activity and rising unemployment. Using this definition, Nige-
ria slipped into a recession in January 2016, as growth slowed in
the second half of 2015 (Chart 1). A third definition proposes that
recession also occurs when growth in a country’s economic output
is below its potential. This potential growth rate is the output level
a country would achieve if all inputs of labor and capital where fully
maximized. Accordingly, Nigeria has been in a recession since
2012, when economic output declined to suboptimal levels (Chart
2).
September 14, 2016
Volume VI, Issue 73 FINANCIAL DERIVATIVES COMPANY LIMITED
FDC ECONOMIC MONTHLY
INSIDE THIS ISSUE:
Nigeria in Recession: Coping
with an Economic Contraction
1
A Cartel in Crisis – is OPEC
Still Relevant?
7
Protectionism during a Reces-
sion: To protect or not to pro-
tect?
12
Global Perspective: Game the-
ory- Culled from the Economist
17
Macroeconomic Indicators 24
Stock Market Review 29
Equity Report: Julius Berger 34
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1 Source: NBS, FDC Think Tank
Chart 1 : Real GDP Growth Rate (%)
1
Whichever way you look at it, and regardless of economic defini-
tions and rhetoric, we are in a recession. All that matters now is
the strategies and policies implemented to bring the economy out.
The news of a recession has a psychological effect that can ulti-
mately work to lower morale and confidence, discourage invest-
ments and push a country further into recession. In such an in-
stance, investors are more willing to pull out from failing or slow
projects, managers are more willing to downsize and carry out
massive retrenchment. Understanding the increased risk of unem-
ployment, consumers reduce consumption and save more. This
leads to a reduction in aggregate demand, and reduces sales and
profitability of doing business. To avoid this chain reaction, inves-
tors, managers and consumers must prepare accordingly.
The first course of action in the wake of a recession is to develop
a financial plan. Companies should focus on managing extraneous
expenses where possible. Finance charges are bound to increase
owing to the 200 basis points (bps) hike in interest rates to 14%.
Reducing interest-bearing debt levels will significantly lower ex-
penses.
Secondly, companies should consider liquidating cash from alter-
native investments to strengthen the cash position of the busi-
ness. The Nigerian Stock Exchange All Share Index (NSE ASI) has
returned -3.64% year-to-date (YTD).3 There has been a steady
decline in Q2’16 and the announcement of the recession could
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Chart 2 : Real GDP vs Potential GDP Growth
2
2 Source: EIU 3 As of August 31, 2016
further impact stock prices and values. At N9.47 trillion, market
capitalization also declined by -3.77% YTD Companies and indi-
viduals need to consider the risks. One option might be to cash in
on investments now to be in a better position to buy them back
during the recovery.
The next consideration should be the business’ operational strat-
egy. Examples include staff, overhead, inventory and marketing
activities. Training staff in several aspects of the business could
help prevent work stoppages in the event of absenteeism or
downsizing. Businesses should also attempt to reduce overhead
costs and waste in areas like utilities, administration, and materi-
als. These areas can contribute significantly to the bottom-line. Be
careful when reviewing costs and remember: “the most powerful
leadership tool you have is your personal example”.5 If manage-
ment is deliberating cutting pay checks or increasing working
hours, it should lead by example. That way staff will not feel un-
appreciated and will maintain satisfactory levels of productivity.
Reconsidering marketing strategies as part of the operational re-
view could also be of value. Diesel prices are on the rise (figure
III). So it is important to keep logistics under control.
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Chart 3 : NSE All Share Index
4
4 NBS 5 Wooden, John. 2009. “Coach Wooden's Leadership Game Plan for Success”. McGraw Hill.
We do not suggest that businesses go into hiding by reducing
marketing. Instead, business should consider less expensive ad-
vertising channels such as social media. While good social media
still costs money, the cost of media buying and content produc-
tion can be significantly reduced.
Finally, do not forget the customer. Worsening rates of unemploy-
ment and underemployment (figure IV) mean reduced household
income. This puts a strain on disposable income to pay for goods
and services. Do not punish customers further for their lack of
funds. Instead businesses should focus on customer retention.
Acquiring new customers is more expensive then retaining old
ones and they will be harder to find in a recession. Existing cus-
tomers will remain loyal, in spite of challenges, if they feel appre-
ciated. Safeguarding the repeat business of these existing cus-
tomers will be critical in ensuring a business’ long-term stability.
Also, a satisfied customer is an essential marketing and advertis-
ing asset. Their referral will always be more valuable than a com-
pany’s marketing spending. Staff training should therefore in-
clude regular sessions on customer service delivery, as they are
the face of the company.
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Chart 4 : Avg. AGO Price
6
6 NBS
A company should never compromise on the quality of its product
or service in a bid to remain profitable. A business is more likely
to keep and acquire new customers by standing out with quality
output as others cut back to stay afloat. In the long run, quality
always thrives as customers drift to brands that offer the greatest
value for money. By the time the economy is recovering, the busi-
ness would have acquired a substantial gain in its customer base.
The ability to expect and prepare for the challenges of recession is
critical. We hope to have provided some insight into what a reces-
sion is, what should be expected, and the possible approaches
companies can take. Each company will have to figure out which
strategies work best to prepare for the storm, while we hope for
clear skies.
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7
7 NBS
A CARTEL IN CRISIS – IS OPEC STILL RELEVANT?
OPEC LOSING CONTROL
It has been nearly two years since the Organisation of Petroleum
Exporting Countries (OPEC) changed its strategy from protecting
a fair market price to recapturing market share from U.S. produc-
ers. This shift in strategy has seen member countries routinely
exceeding their production quotas with OPEC’s total production
exceeding its 30 million barrels per day (mbpd) production ceiling
by up to two mbpd.
Abandoning the quota system has come with a problem – it has
become almost impossible to re-install and enforce it. OPEC was
formed with the objective to "co-ordinate and unify petroleum
policies among Member Countries, in order to secure fair and sta-
ble prices for petroleum producers”. After two failed attempts in
the last six months to freeze output and address the lingering
oversupply in the oil market, OPEC – the once feared cartel – may
be losing its relevance.
OPEC IN DIRE STRAIGHTS
According to the Energy Information Agency (EIA), low oil prices
cut OPEC revenues by almost half in 2015 to its lowest levels in
11 years – from $753bn in 2014 to $404bn in 2015. This is pro-
jected to plunge further to $341bn as oil prices fell to as low as
$26 per barrel (pb) in the first quarter of 2016 and have averaged
just over $42pb so far in 2016 – significantly lower than the 2015
average of $53.7pb. OPEC members posted a current account
deficit of $99.6bn in 2015 – the first since 1998 – compared to a
$238.1bn surplus in 2014 and Saudi Arabia, accounting for a third
of OPEC’s earnings, saw its revenues plunge to $130bn in 2015.
from $247bn just a year before.
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IRAN PLAYING THE SPOILER
In addition to the dismal performance, Iran is poised for a come-
back after years of devastating economic and financial sanctions.
The Iran Nuclear Deal, effective from January 2016, reopened the
international market to, potentially, 1.5mbpd of Iranian oil as well
as the return of billions in frozen oil revenue to Iran. Iran vowed
to increase production to pre-sanction levels and has left no one
in doubt over its intentions to make good on that promise.
However, the timing of the deal could not have been worse. It
came when the global oil market had been oversupplied for over
two years owing to a surge in shale oil production by the US. Oil
prices fell from $106pb in June 2014 to current prices hovering
between the $40-50pb range. This also came at a time of growing
global economic concerns that have dampened the outlook for
global oil demand.
In February, less than a month after sanctions were lifted, a deal
to cap production was proposed. A meeting in April ended
with Iran refusing any production cut backs even after Saudi Ara-
bia, Venezuela, Qatar and OPEC non-member Russia pledged to
freeze output at January levels. In June, another meeting ended
with Iran’s insistence that there would be no restrictions to its re-
vival. In a show of defiance, Iran has said that its production lev-
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els are still below the level that it would need to attain to justify
any cooperation with OPEC.
OPEC rules require that every member must agree before any ad-
justments to output can be made. This leaves it in a situation
where Iran has to agree to a freeze or there will be no freeze.
Iran is effectively playing the role of a spoiler within OPEC and in
the global oil market.
WHAT NEXT FOR OPEC?
The 14-nation cartel is planning to meet informally at a confer-
ence in Algiers between September 26 and 28 to discuss produc-
tion levels and, of course, the recent decline in oil prices. Even
non-members like Russia will be in attendance. Desperate times
are calling for desperate measures. OPEC members are faced with
the clear and present dangers of budget shortfalls and the grow-
ing risk of civilian unrest.
But as long as Iran refuses to play along, which it most likely will
not, then OPEC meetings will be regarded by many on the outside
as nothing more than a gathering of desperate third world oil ex-
porters in competition with themselves for market share. The fi-
nancial strain as a result of lower prices has induced price cuts for
many members who are seeking to undercut the competition and
sell as much oil as possible to meet cash flow obligations. Saudi
Arabia’s quest to transition away from oil-dependence hinges on
the successful listing of the state oil company – ARAMCO. Gaining
efficiency and as much market share as possible are all part of its
preparation for the listing.
In addition, heightened tensions between the Saudi’s and the Ira-
nians make reaching any consensus on cutting production difficult
to envisage. OPEC is just another stage for both countries to en-
act their on-going battle for regional supremacy and religious su-
periority. This acrimony has fed power struggles in the Middle
East and beyond.
With members of the cartel ignoring quotas and undercutting one
another, and given that the markets barely reacted after each of
its previous two botched meetings, it is clear that OPEC will strug-
gle to be taken seriously going forward.
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DISRUPTIVE INNOVATION
If OPEC is dead, then it has been the architect of its own demise.
Cause of death: Suicide – its decision to flood the market with oil
in an attempt to squeeze out the competition failed to take into
consideration the disruptive nature of technological innovation. Its
decision to push down oil prices forced American Shale producers
to become increasingly more efficient and competitive to survive.
Innovation has driven shale oil production costs down while OPEC
production costs have remained largely the same. Many shale
producers are now globally competitive even at a lower oil price of
$40pb. With more innovation and increasingly lower costs of pro-
duction, the American oil industry is set to overtake OPEC and
snatch the title of “swing producer” from the Saudis.
At current oil prices of $40-50pb, most OPEC members are really
gasping for breath. But any production cuts to shore up prices will
be the equivalent of relinquishing market share to non-OPEC pro-
ducers and further lower OPEC’s already battered revenues. In
more ways than one, OPEC is damned if it does and damned if it
doesn’t.
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PROTECTIONISM DURING A RECESSION: TO PRO-
TECT OR NOT TO PROTECT?
In the face of a recession, Nigeria has always opted to move to-
wards being a protectionist state in an effort to curb forex de-
mand and stabilise external reserves. Over the past two years,
the government has returned to this familiar policy ground, initi-
ating a number of protectionist policies. The import restrictions on
automobiles, agricultural items and more recently the 41 items
ineligible for transactions at the official market are but a few ex-
amples. Historically, countries tend to adopt protectionist policies
during an economic downturn. Nigeria is not an exception to the
norm. However, it is not clear that this course of action is the best
course of action for Nigeria given its fundamentals. While other
countries have certainly benefited from protectionist policies they
tend to only work in specific economic contexts which support suf-
ficient local production. For an economy like Nigeria’s, that is de-
pendent on imports, protectionism can do more harm than good.
PROTECTIONISM THAT BOOSTS LOCAL PRODUCTION
LEADS TO SOUND ECONOMIES
It is no secret that the largest economies have developed with the
help of protectionist policies. At the inception of the industrial
revolution, Britain was extremely protectionist.8 In 1699, Britain
banned the imports of Irish wool and in 1700; cotton cloth from
India was banned. Ferocious tariffs were imposed on almost all
manufactured goods to protect infant industries. Britain only be-
came more open to trade in the middle of the 19th century, after
its national industries were strong enough to complete globally.
Similarly, in 1816, the US imposed a 35% tax on imported manu-
factured goods, which later increased to 50% in 1832. It main-
tained its protectionist policies until after the Second World War.
The same strategy was adopted amongst the Asian tigers. In
South Korea, foreign automobile manufacturers were barred from
operating in Korea, except in joint ventures with local business
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8 Chang, H. 2003.“Kicking Away the Ladder: The ‘Real’ History of Free Trade.” Foreign Policy in Focus: Special Report.www.personal.ceu.hu/corliss/CDST_Course_Site/Readings_old_2012_files/Ha-Joon%20Chang%20-%20Kicking%20Away%20the%20Ladder-The%20“Real”%20History%20of%20Free%20Trade.pdf
entities. Today, the South Korean automobile industry is the 5th
largest in the world measured by automobile unit production.9
PROTECTIONISM ON SHAKY FUNDAMENTALS FALLS
FLAT
However, not all countries have benefited in the same way as
these shining examples for protectionism. A century ago, Argen-
tina was ranked amongst the top 10 richest countries in the
world. In the aftermath of the Second World War, however, the
country implemented an economic system which stressed eco-
nomic self-sufficiency. By so doing, Argentina refused to partici-
pate in the expansion of international trade which followed the
Second World War. The protectionist approach steadily deterio-
rated the domestic economy and transformed a once wealthy and
fast growing nation into a quasi 'third world' country. Protectionist
policies were eventually dismantled after a substantial deteriora-
tion of economic conditions, which was one of the major factors
that begot Argentina’s economic crisis of 1999-2001.10
NIGERIA’S SHAKY FUNDAMENTALS MAKE PROTEC-
TIONISM A POOR CANDIDATE FOR POLICY REFORM
Unfortunately, Nigeria’s present economic circumstances have
more in common with Argentina than those that successfully im-
plemented protectionist policies. The majority of Nigeria’s domes-
tic needs are satisfied through imports with little or no local sub-
stitutes in place to bridge the gap if imports are eliminated. The
recent restrictions by the government have resulted in a surge in
goods and services. The price of a bag of rice has more than dou-
bled from N8,000 in 2015 to N19,000 in 2016 and basic automo-
biles are sold at luxury prices. This is largely driven by the de-
valuation of the currency coupled with the high import tariffs im-
posed on these goods. Nigeria simply does not have the infra-
structure in place to support local production.
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9 Wikipedia. 2016. List of countries by motor vehicle production.https://en.wikipedia.org/wiki/List_of_countries_by_motor_vehicle_production 10 Bendini, R. 2012.“Protectionism in Argentina: Old habits die hard.” European Parliament. http://www.europarl.europa.eu/RegData/etudes/briefing_note/join/2012/491424/EXPO-INTA_SP(2012)491424_EN.pdf
Nigeria’s overreliance on oil is a factor. It relies on rebounding oil
prices, not improved industries, to put it back on its feet. This was
the case in the 1980’s when the government banned the importa-
tion of rice to reduce demand pressure on external reserves. Once
oil prices recovered and the economy was back on its feet, the
government removed the import bans. It is important to note that
the ban was lifted because imports were affordable as opposed to
a more competitive domestic industry, which should be the only
justification for opening borders after having implemented protec-
tionist policies.
Today’s economic reality is no different. Domestic production does
not meet domestic demand and farmers are wary of government
promises of support, knowing they are often disregarded once oil
fundamentals improve. Lacking the necessary local production,
Nigeria’s protectionist policies instead result in supply shortages
and aberrational spikes in inflation rates. Power outages are fre-
quent, alternative energy prices are growing at a geometric pro-
gression and investors are wary of a lack of clarity on policy direc-
tion. The hope is that the pain is short lived while the Nigeria ral-
lies its local production capabilities and develops competitive in-
dustries. Unfortunately, this has yet to be the case. Presently, do-
mestic production of rice is at 2.3 million metric tons while de-
mand is at 6.3 million metric tons and Nigeria spends $1bn annu-
ally on the importation of rice. This is the trend amongst most ag-
ricultural commodities as revealed in the table below.
THE WAY FORWARD FOR NIGERIAN PROTECTIONISM
The government can protect infant industries without blocking out
international competitors. Government intervention via subsidis-
ing domestic production and imposing import restrictions to en-
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11 Federal Ministry of Agriculture and Rural Development. 2016.The Agriculture Promotion Policy (2016-2020). The Federal Government of Nigeria.http://fmard.gov.ng/wp-content/uploads/2016/03/2016-Nigeria-Agric-Sector-Policy-Roadmap_June-15-2016_Final.pdf
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Demand (tons) Supply (tons)
Tomatoes 2.2 million 0.8 million
Sugar 1.7 million 0.0015 million
Wheat 4.7 million 0.06million
Oil Palm 8.0 million 4.5 million
Cocoa 3.6 million 0.25 million
11
courage infant industries is the traditional Keynesian approach.
However, modern day Keynesians are of the opinion that govern-
ment interventions need not restrict imports as such restrictions
worsen growth rather than boost it. Instead, the government
should subsidise both production and consumption of domestic
products while foreign players are left to improve quality and
standard to remain more competitive. This is a win-win situation
for all economic agents considered. The consumers have cheap
varieties to select from while the international firms and domestic
firms are able to compete on a leveled field.
In summary, protectionism during a recessionary era in an import
dependent economy will contract economic activities further
rather than stimulate, as seen in Nigeria. Economic indicators
have taken a beating due to the import restrictions and capital
controls introduced by the government. The inflation rate is at an
11-year high and external reserves are heading towards the psy-
chological level of $25bn.Trade is one of the key drivers of eco-
nomic growth. Hence, protectionism should be approached with
caution and implemented at the appropriate time to avoid retalia-
tion and public back lash.
In any case, it appears the government is likely to maintain its
stance on protectionism. External reserves are depleting to levels
that are worrisome for the economy going forward. The restriction
placed on 41 items is still in place and is not likely to be lifted in
the near term given the policy stance of the monetary authorities.
Other restrictions are seen mostly in the agricultural sector and
manufacturing sector (e.g. automobiles). Protectionist policies are
likely to remain in the short term pending a recovery in economic
activities. Unfortunately, the protectionist policies, as presently
implemented, are more likely to elongate the economic woes
rather than quicken improvements.
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GLOBAL PERSPECTIVE: GAME THEORY- CULLED
FROM THE ECONOMIST
PRISON BREAKTHROUGH
The fifth of our series on seminal economic ideas
looks at the Nash equilibrium
JOHN NASH arrived at Princeton University in 1948 to start his
PhD with a one-sentence recommendation: “He is a mathematical
genius”. He did not disappoint. Aged 19 and with just one under-
graduate economics course to his name, in his first 14 months as
a graduate he produced the work that would end up, in 1994,
winning him a Nobel prize in economics for his contribution to
game theory.
On November 16th 1949, Nash sent a note barely longer than a
page to the Proceedings of the National Academy of Sciences, in
which he laid out the concept that has since become known as the
“Nash equilibrium”. This concept describes a stable outcome that
results from people or institutions making rational choices based
on what they think others will do. In a Nash equilibrium, no one is
able to improve their own situation by changing strategy: each
person is doing as well as they possibly can, even if that does not
mean the optimal outcome for society. With a flourish of elegant
mathematics, Nash showed that every “game” with a finite num-
ber of players, each with a finite number of options to choose
from, would have at least one such equilibrium.
His insights expanded the scope of economics. In perfectly com-
petitive markets, where there are no barriers to entry and every-
one’s products are identical, no individual buyer or seller can in-
fluence the market: none need pay close attention to what the
others are up to. But most markets are not like this: the decisions
of rivals and customers matter. From auctions to labour markets,
the Nash equilibrium gave the dismal science a way to make real-
world predictions based on information about each person’s incen-
tives.
One example in particular has come to symbolise the equilibrium:
the prisoner’s dilemma. Nash used algebra and numbers to set
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out this situation in an expanded paper published in 1951, but the
version familiar to economics students is altogether more grip-
ping. (Nash’s thesis adviser, Albert Tucker, came up with it for a
talk he gave to a group of psychologists.)
It involves two mobsters sweating in separate prison cells, each
contemplating the same deal offered by the district attorney. If
they both confess to a bloody murder, they each face ten years in
jail. If one stays quiet while the other snitches, then the snitch
will get a reward, while the other will face a lifetime in jail. And if
both hold their tongue, then they each face a minor charge, and
only a year in the clink (see diagram).
There is only one Nash-equilibrium solution to the prisoner’s di-
lemma: both confess. Each is a best response to the other’s strat-
egy; since the other might have spilled the beans, snitching
avoids a lifetime in jail. The tragedy is that if only they could work
out some way of co-ordinating, they could both make themselves
better off.
The example illustrates that crowds can be foolish as well as wise;
what is best for the individual can be disastrous for the group.
This tragic outcome is all too common in the real world. Left freely
to plunder the sea, individuals will fish more than is best for the
group, depleting fish stocks. Employees competing to impress
their boss by staying longest in the office will encourage work-
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force exhaustion. Banks have an incentive to lend more rather
than sit things out when house prices shoot up.
CROWD TROUBLE
The Nash equilibrium helped economists to understand how self-
improving individuals could lead to self-harming crowds. Better
still, it helped them to tackle the problem: they just had to make
sure that every individual faced the best incentives possible. If
things still went wrong—parents failing to e their children against
measles, say—then it must be because people were not acting in
their own self-interest. In such cases, the public-policy challenge
would be one of information.
Nash’s idea had antecedents. In 1838 August Cournot, a French
economist, theorised that in a market with only two competing
companies, each would see the disadvantages of pursuing market
share by boosting output, in the form of lower prices and thinner
profit margins. Unwittingly, Cournot had stumbled across an ex-
ample of a Nash equilibrium. It made sense for each firm to set
production levels based on the strategy of its competitor; con-
sumers, however, would end up with less stuff and higher prices
than if full-blooded competition had prevailed.
Another pioneer was John von Neumann, a Hungarian mathemati-
cian. In 1928, the year Nash was born, von Neumann outlined a
first formal theory of games, showing that in two-person, zero-
sum games, there would always be an equilibrium. When Nash
shared his finding with von Neumann, by then an intellectual
demigod, the latter dismissed the result as “trivial”, seeing it as
little more than an extension of his own, earlier proof.
In fact, von Neumann’s focus on two-person, zero-sum games left
only a very narrow set of applications for his theory. Most of these
settings were military in nature. One such was the idea of mutu-
ally assured destruction, in which equilibrium is reached by arm-
ing adversaries with nuclear weapons (some have suggested that
the film character of Dr Strangelove was based on von Neumann).
None of this was particularly useful for thinking about situations—
including most types of market—in which one party’s victory does
not automatically imply the other’s defeat.
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Even so, the economics profession initially shared von Neumann’s
assessment, and largely overlooked Nash’s discovery. He threw
himself into other mathematical pursuits, but his huge promise was
undermined when in 1959 he started suffering from delusions and
paranoia. His wife had him hospitalised; upon his release, he be-
came a familiar figure around the Princeton campus, talking to him-
self and scribbling on blackboards. As he struggled with ill health,
however, his equilibrium became more and more central to the dis-
cipline. The share of economics papers citing the Nash equilibrium
has risen sevenfold since 1980, and the concept has been used to
solve a host of real-world policy problems.
One famous example was the American hospital system, which in
the 1940s was in a bad Nash equilibrium. Each individual hospital
wanted to snag the brightest medical students. With such students
particularly scarce because of the war, hospitals were forced into a
race whereby they sent out offers to promising candidates earlier
and earlier. What was best for the individual hospital was terrible
for the collective: hospitals had to hire before students had passed
all of their exams. Students hated it, too, as they had no chance to
consider competing offers.
Despite letters and resolutions from all manner of medical associa-
tions, as well as the students themselves, the problem was only
properly solved after decades of tweaks, and ultimately a 1990s de-
sign by Elliott Peranson and Alvin Roth (who later won a Nobel eco-
nomics prize of his own). Today, students submit their preferences
and are assigned to hospitals based on an algorithm that ensures
no student can change their stated preferences and be sent to a
more desirable hospital that would also be happy to take them, and
no hospital can go outside the system and nab a better employee.
The system harnesses the Nash equilibrium to be self-reinforcing:
everyone is doing the best they can based on what everyone else is
doing.
Other policy applications include the British government’s auction of
3G mobile-telecoms operating licenses in 2000. It called in game
theorists to help design the auction using some of the insights of
the Nash equilibrium, and ended up raising a cool £22.5 billion
($35.4 billion)—though some of the bidders’ shareholders were less
pleased with the outcome. Nash’s insights also help to explain why
adding a road to a transport network can make journey times
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longer on average. Self-interested drivers opting for the quickest
route do not take into account their effect of lengthening others’
journey times, and so can gum up a new shortcut. A study pub-
lished in 2008 found seven road links in London and 12 in New
York where closure could boost traffic flows.
GAME ON
The Nash equilibrium would not have attained its current status
without some refinements on the original idea. First, in plenty of
situations, there is more than one possible Nash equilibrium. Driv-
ers choose which side of the road to drive on as a best response
to the behaviour of other drivers—with very different outcomes,
depending on where they live; they stick to the left-hand side of
the road in Britain, but to the right in America. Much to the disap-
pointment of algebra-toting economists, understanding strategy
requires knowledge of social norms and habits. Nash’s theorem
alone was not enough.
A second refinement involved accounting properly for non-credible
threats. If a teenager threatens to run away from home if his
mother separates him from his mobile phone, then there is a
Nash equilibrium where she gives him the phone to retain peace
of mind. But Reinhard Selten, a German economist who shared
the 1994 Nobel prize with Nash and John Harsanyi, argued that
this is not a plausible outcome. The mother should know that her
child’s threat is empty—no matter how tragic the loss of a phone
would be, a night out on the streets would be worse. She should
just confiscate the phone, forcing her son to focus on his home-
work.
Mr Selten’s work let economists whittle down the number of pos-
sible Nash equilibria. Harsanyi addressed the fact that in many
real-life games, people are unsure of what their opponent wants.
Economists would struggle to analyze the best strategies for two
lovebirds trying to pick a mutually acceptable location for a date
with no idea of what the other prefers. By embedding each per-
son’s beliefs into the game (for example that they correctly think
the other likes pizza just as much as sushi), Harsanyi made the
problem solvable. A different problem continued to lurk. The pre-
dictive power of the Nash equilibrium relies on rational behavior.
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Yet humans often fall short of this ideal. In experiments replicat-
ing the set-up of the prisoner’s dilemma, only around half of peo-
ple chose to confess. For the economists who had been busy em-
bedding rationality (and Nash) into their models, this was prob-
lematic. What is the use of setting up good incentives, if people
do not follow their own best interests?
All was not lost. The experiments also showed that experience
made players wiser; by the tenth round only around 10% of play-
ers were refusing to confess. That taught economists to be more
cautious about applying Nash’s equilibrium. With complicated
games, or ones where they do not have a chance to learn from
mistakes, his insights may not work as well.
The Nash equilibrium nonetheless boasts a central role in modern
microeconomics. Nash died in a car crash in 2015; by then his
mental health had recovered, he had resumed teaching at Prince-
ton and he had received that joint Nobel—in recognition that the
interactions of the group contributed more than any individual.
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MACROECONOMIC INDICATORS
NEGATIVE GROWTH
Nigeria’s economy contracted by 2.06% in Q2’2016. This is the
second consecutive quarter of negative growth, as Q1’2016 con-
tracted by 0.36%, and it puts the economy is officially in a reces-
sion. The non-oil sector contracted by 0.38%, and contributed
91.74% of total GDP. The oil sector contracted by 17.48%, and
contributed 8.26% of total GDP. The oil refining industry recorded
the highest growth of 49.19%, while postal and courier services
was the worst performing sector with -67.88% real growth.
INFLATION
The Consumer Price Index recorded an uptick of 17.1% in July
(year-on-year). Month-on-month, inflation increased by 0.6%.
This is the third consecutive decline in the month-on-month rate.
The Food Sub-index increased by 15.8% (year-on-year) in July,
0.5% higher than the increase recorded in June. The Imported
Food Sub-Index increased by 20.5% in July, compared to June’s
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12 Source : NBS, FDC Think Tank
Fastest Growing Sectors Real GDP Growth Rate
Oil Refining 49.19%
Water supply & Waste Management 8.46%
Agriculture 4.53%
Insurance 3.72%
Education 2.88%
Information and Communication 1.35%
Worst Performers Real GDP Growth
Manufacturing -3.36%
Accommodation & Food Services -6.39%
Fishing -6.85%
Financial Institutions -13.24%
Crude Oil & Natural Gas -17.48%
Post and Courier Services -67.88%
Chart 5: Inflation Rate (%)
12
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
M-o-M (primary axis) Y-o-Y (secondary axis)
figure of 25.1%. The Core Sub-index increased by 16.9%. This is
a 0.7% increase from June’s rates and was driven by increases in
energy and energy related prices. Meanwhile the Urban and Rural
Index increased to 18% and 15.5% respectively.
Outlook
Looking at the month-on-month rate of inflation, there has been a
decline in the pace of increase. This trend is expected to continue
next month, as August inflation is forecast to reach 17.5% (year-
on-year) which is a 0.3% month-on-month increase.
MONEY MARKET
The opening liquidity position in the money markets for the month
of August was much lower than that of July. Markets opened in
August with a liquidity position of N253.62bn long, which is a
5.05% decline from July’s opening position of N267.1bn long. The
market is estimated to have closed N15 billion long on August
31st, 94.8% lower than July’s closing position of N290bn long.
Short-term interbank rates (OBB, O/N, 30-Day) have averaged
17.21% per annum (pa) from the 1st to the 31st of August,
3.57% higher than July’s average of 13.64% pa. As at August
31st, short-term interbank rates, OBB and O/N rates were 16%
pa and 17.67% pa respectively. As of August 31st, T/bills yields
have slowly declined from their peak after the hike in MPR. As of
August 31st,yields stood at 16.68% and 19.79% for 91-day and
182-day T/bills, compared to 14.66% and 16.78% in July.
Outlook
T/Bills rates are expected to continue their downward trend as
demand for bills flattened. Likewise, OMO maturities in September
are expected to boost liquidity and push rates down.
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13 Source: CBN, FDC Think Tank
Chart 6: Interest Rates (%)
13
OIL MARKET
OIL PRICES
Oil prices (Brent) were at an average of $47.23 per barrel for the
month of August. This is a 1.83% from July’s average of $46.38
per barrel. Prices reached a peak of $50.88pb on August 19th, but
have been on a downward trend since then. The initial rise in
prices was due to optimism about the OPEC deliberation in Sep-
tember. However, the speech by the Chair of the US Federal Re-
serve, Janet Yellen, has raised expectations of an increase in in-
terest rates. This has led to a 2% appreciation of the dollar
(against the yen), and is weighing pressure on oil prices. Finally,
the US Energy Information Administration (EIA) is expected to
release data that shows an increase in crude stockpiles by
900,000 barrels to, for the week ended August 26th.
Outlook
An OPEC meeting is scheduled for September 26th – 28th. The
probability of a production freeze agreement is unknown due to
the mixed signals from policymakers and government officials. A
freeze in output will stabilize production, which has hovered at
record high levels in the last month. This will reduce the supply
glut and boost oil prices in the short to medium term.
OIL PRODUCTION
In the month of August, Nigeria’s production averaged at 1.44
mbpd.15
Outlook
The future looks bright as the Niger Delta Avengers agree to a
ceasefire and further negotiations with the federal government
and other relevant parties. The jury is out as to whether an
agreement will be reached. Meanwhile, Shell’s Forcados pipeline,
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14 Source: Bloomberg 15 Author. YEAR. “Title of ARTICLE”. Vanguard Newspaper http://www.vanguardngr.com/2016/09/nigerias-crude-oil-production-drops-130-000-bpd/
Chart 7: Oil Price ($/pb)
14
which produces about 200,000 barrels per day, is expected to re-
sume deliveries in September. Shell had stopped shipments, after
the militant attack on the pipeline in February. Over all, Nigeria’s
production is expected to reach 1.8 million barrels per day by the
year-end.
FOREX MARKET
EXCHANGE RATE
At the parallel market, the naira depreciated by 10.2% in August
to close at a record low of N420/$ on August 31th. The parallel
market averaged N398.26/$ during the month of August. This is a
8.56% decline from July’s average rate of N366.89/$. Despite
reaching a record high of N322/$, the IFEM rate closed 0.02%
higher at N316.74/$. The IATA rates appreciated by 1.1% to
N320/$ during the month. In the last week of the month, the
naira was primarily affected by the forex bottlenecks created as a
result of the CBN forex trading ban on eight banks.
Outlook
The CBN has lifted the forex trading ban on the eight banks. This
should lead to a tangible appreciation of the exchange rate across
all trading windows.
EXTERNAL RESERVES
External reserves as of August 29th were recorded at $25.46bn,
which is 3.26% lower than July’s average of $26.32bn. Year to
date, the reserves level has declined by 12.15% ($3.52bn). The
external reserves level is 26.22% below 2015’s peak of $34.51bn
and 17.58% lower than 2015’s average of $30.89bn. After de-
ducting forward commitments and arrears, the net external re-
serves level is estimated to at $19.96bn.
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16 Source: CBN, FDC Think Tank 17 Source: CBN, FDC Think Tank
Chart 8: Exchange Rate (N/$)
16
Chart 9: External Reserves ($bn)
17
Outlook
The reserves are expected to rise by $1.8bn upon the remittance
to the Treasury Single Account from the eight banks still owing
(UBA has paid debt). External reserves are subject to oil produc-
tion and price levels. Thus, the bright prospects for oil production
increases the chances of an accretion in the medium term.
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STOCK MARKET REVIEW
The dismal H1 2016 corporate results continued to impact the
market into August. In spite of the impressive results by some
major banking tickers, including GUARANTY, ZENITHBANK, AC-
CESS and UBA, the Nigerian equities market still closed the month
red.
The NSE ASI declined by 1.47% to close the month at 27,599.03
from the 28,009.93 points recorded in July. Market capitalization
closed at N9.48trn, having lost N141.12bn in the review period.
Even as the CBN continued to adopt several measures to entice
foreign portfolio investors, the year-to-date return on the ASI re-
mained negative at 3.64%.
The CBN again flexed its regulator muscle by suspending nine
banks from participating in the foreign exchange market. The sus-
pended banks had failed to remit a total of $2.334bn, being the
dollar deposits of the Nigerian National Petroleum Corporation
(NNPC)/Nigerian Liquefied Natural Gas (NLNG) Company, into the
federal government’s Treasury Single Account (TSA).
Activity on the bourse was mostly negative as the 23 trading days
resulted in 11 days of gains against 12 days of losses. Daily
changes, representing volatility on the ASI, ranged between -
1.80% and 0.84% in the month.
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Chart 10 : NSE ASI August 2016
18
70,000,000
120,000,000
170,000,000
220,000,000
270,000,000
320,000,000
370,000,000
420,000,000
27,000.00
27,200.00
27,400.00
27,600.00
27,800.00
28,000.00
Daily Volume Traded NSE ASI
18 Source: NSE, FSDH, FDC Think Tank
Page 30
Market activity for the month increased by 24.48% to N56.12bn
from the N45.08bn reported in the month of June. The average
daily turnover for the period was N2.55bn, 1.59% above the year-
to-date daily average of N2.51bn.
Market breadth was negative at 0.33x in the review period as 18
stocks advanced against 55 stocks that declined while 108 stocks
remained unchanged. The best performing stocks include TOTAL
33.23%, AIRSERVICE 17.65%, PRESCO 16.60%, ETERNA 17.02%
and UNILEVER 14.72%.
Top price losers for the month were DIAMONDBNK (33.96%),
CHAMPION (29.51%), FIDELITY (27.64%), FCMB (27.14%) and
STERLNBNK (25.60%).
All the sectoral indices closed negative except the oil and gas sec-
tor which increased by 2.35%. This can be attributed to the better
than expected Q2’14 corporate earnings of Total Nigeria Plc.
Revenues and profit after tax for the period were up by 65% and
212% respectively. The financial services sector led the losers as
banking and insurance respectively lost 2.79% and 2.56% from
declines in the share prices of many ‘big cap’ stocks in the sector.
The 4.44% decline in DANGCEM and 22.54% loss recorded in CAP
resulted in the 1.98% decline in the industrial goods sector.
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TOP 5 GAINERS
Company Aug-16 Jul-16 % Change Absolute Change
TOTAL NIGERIA PLC. 240.00 181.50 32.23% 58.50
AIRLINE SERVICES AND LOGISTICS PLC 2.00 1.70 17.65% 0.30
PRESCO PLC 45.30 38.85 16.60% 6.45
ETERNA PLC. 2.74 2.35 16.60% 0.39
UNILEVER NIGERIA PLC. 39.00 34.65 12.55% 4.35
TOP 5 LOSERS
Company Aug-16 Jul-16 % Change Absolute Change
DIAMOND BANK PLC 1.05 1.59 -33.96% -0.54
CHAMPION BREW. PLC. 2.58 3.66 -29.51% -1.08
FIDELITY BANK PLC 0.89 1.23 -27.64% -0.34
FCMB GROUP PLC 1.02 1.40 -27.14% -0.38
STERLING BANK PLC. 0.93 1.25 -25.60% -0.32
Global stocks posted another monthly advance with exception to
Nigerian and Kenyan equities indices. The 10.47% decline re-
corded by the Kenyan Index is attributable to the recent attempt
by the government to encourage borrowing by placing a 4% ceil-
ing above the Central Bank of Kenya’s 10.47% policy rate. This
will have a domino effect on the stock market, as the Central
Bank’s decision may be met with resistance by commercial banks
who may be unwilling to extend new credit lines to companies.
This resistance will affect working capital and sales. We expect to
see a further decline in the share prices of listed companies.
Source: NSE, Bloomberg, MSCI, FDC
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Chart 11 : Sectors in August 2016
19
-1.08%
-2.56%
-2.79%
2.35%
-0.24%
-0.71%
-3.00% -2.00% -1.00% 0.00% 1.00% 2.00%
NSE 30
INSURANCE
BANKING
OIL&GAS
CONSUMER GOODS
INDUSTRIAL GOODS
Chart 12 : Global Indices August 2016
20 -9.00%
-7.00%
-5.00%
-3.00%
-1.00%
1.00%
3.00%
5.00%
7.00%
19 Source: NSE, FDC Think Tank 20 Source: NSE, Bloomberg, MSCI, FDC Think Tank
Outlook
The pessimistic sentiment of investors is expected to linger in the
month of September as worse than expected economic data re-
cently released by the Nigerian Bureau of Statistics (NBS) paints a
gloomier picture of the business environment.
However, the outcome of the proposed OPEC meeting, where a
decision as to whether or not to freeze oil output will be made,
may lead to a recovery in international oil prices. This may in turn
boost government revenue. In addition to the recent cease-fire by
the Niger Delta Avengers (NDA), we expect a ramp up in the na-
tion’s daily oil production.
The bimonthly meeting of the monetary policy committee (MPC) is
scheduled to hold this month. The policy makers might decide to
retain status quo on key policy rates to give an allowance for the
effect of the last rate increase to kick in. On the other hand, it is
more likely that the MPC will vote to reduce MPR as the need to
reflate the economy heightens as the country is now officially in a
recession.
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EQUITY REPORT: JULIUS BERGER
Analyst Recommendation: SELL
Recommendation Period: 365 days
Industry: Construction/Materials
Market Capitalization: N63.87
Current Price: N48.39
Target Price: N39.74
The government has pledged to bridge the country’s infrastruc-
tural deficit and improve capital expenditure. In doing so, the con-
struction industry has been singled out as a significant beneficiary
of these investments. Analysts generally regard Julius Berger best
positioned to take advantage of this opportunity. It’s the country’s
leading construction company and has an outstanding delivery
record. However, the company’s disappointing H1’2016 result in-
dicates a sub-par performance. Revenue declined by 39% year
over year (YOY) from N77.8bn in H1’15 to N47.8bn. Net income
decreased by 94% from N2.26bn to N136mn during the same pe-
riod.
The significant reduction in revenue can be attributed to the pro-
tracted delay in the passage of the 2016 budget, resulting in
fewer available capital projects from the government. The release
of budgeted capital expenditure funds has been curtailed by lower
than expected revenue due to low oil production and prices. With
Nigeria facing a recession and weak economic prospects, brand
loyalty and high quality delivery may no longer be valuable attrib-
utes. Julius Berger’s earnings declined largely due to foreign ex-
change (forex) related charges which led to a decline in profitabil-
ity. This trend may persist due to a fluctuating and depreciating
naira (since the currency was floated). Foreign investment has
been scarce resulting in a limited inflow of US dollars and a weak-
ened exchange rate.
In arriving at the valuation of Julius Berger, we analyzed the com-
pany’s strategic positioning as the trusted infrastructural partner,
prevailing macroeconomic conditions, the huge infrastructural
deficit, foreign exchange risk, high interest rate environment and
the growing interest in public private partnerships (PPP). Despite
the fact that Julius Berger stands to benefit from the govern-
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ment’s desire to upgrade Nigeria’s infrastructural footprint, the
unfavorable macroeconomic milieu and fiscal challenges limit its
profitability and ability to add value to its shareholders. Accord-
ingly, we believe that Julius Berger is overvalued, and therefore
recommend a SELL as we do not foresee a significant upside in its
share price in the near to medium term.
CONSTRUCTION INDUSTRY STRUGGLING WITH HIGH
OPERATING COSTS AND POOR FEDERAL INVESTMENT
Julius Berger’s performance and earnings prospects have been
severely affected by the tough macroeconomic terrain. The high
interest rate environment, with the monetary policy rate at 14%,
has led to an increase in financing costs. This rise in benchmark
rates has been driven by an increasing inflation rate; it currently
sits at 16.5%, the highest in 11 years.
The decline in crude oil production, following unrest in the Niger
Delta, has reduced government revenue. This has led to lower
government spending on capital projects, directly affecting the
construction industry. The forex revenue in the external reserves
declined to N25.7 billion, the lowest in about 10 years. The impact
on the external reserves and the lack of dollar inflow from foreign
investors have led to a depreciation of the naira and increased
operating costs. Given the bleak economic condition, the con-
struction industry is struggling to survive.
STRATEGIC POSITIONING WITH THE GOVERNMENT
IS BOTH STRENGTH AND A WEAKNESS
If it were simply a matter of company performance, Julius Berger
is strategically positioned to be the preferred partner of the Nige-
rian government. Its laudable reputation, extensive product port-
folio and solid brand make it the first choice construction company
in Nigeria.
Since its pioneer project (Eko Bridge construction) in 1965, Julius
Berger Plc has become the giant of the Nigerian construction in-
dustry and has played an integral role in Nigeria’s infrastructural
development story. It is a company whose name is synonymous
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with quality and trust as it has built several landmark projects in
Nigeria, such as the Lekki-Ikoyi Link Bridge, Central Bank of Nige-
ria head office and the National Assembly. The growing public pri-
vate partnership (PPP) provides more opportunity for Julius Ber-
ger to build on its experience with the Nigerian government in se-
curing more high-profile projects
Julius Berger’s expertise is in executing complex works requiring
the highest level of technical expertise and Nigeria-specific
knowhow. Its business is supported by vertically integrated opera-
tions, which augment efficient and timely project execution. The
company’s subsidiaries include: Julius Berger International GmbH;
Julius Berger Services Nigeria Ltd; Julius Berger Medical Services
Ltd; Julius Berger Free Zone Enterprise; Abumet Nigeria Limited;
and, Prime Tech Design and Engineering Nigeria Ltd. The com-
pany’s competitors include reputable companies such as Reynolds
Construction Company (RCC), Setraco Nigeria Limited, Brunelli
Construction Company, Arab Contractors and Dantata & Sawoe
Construction Company Nigeria Limited. Julius Berger’s reputation
for exceptional quality places it as a market leader in the con-
struction industry.
The company’s growth through the years reflects this foundation.
However, it also reflects its significant exposure to public projects
and its resulting over-concentration risk. As a result, the massive
delays in federal government spending are wreaking havoc on its
past success, as can be seen by the decline in its financial state-
ment below.
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Page 36
Income Statement for Julius Berger PlcN'000 2011 2012 2013 2014 2015
Revenue 169,413,371 201,565,276 212,737,291 196,808,632 133,807,574
Cost of Sales (135,789,354) (156,726,348) (161,134,675) (146,313,712) (100,473,106)
Gross Profit 33,624,017 44,838,928 51,602,616 50,494,920 33,334,468
Marketing and distribution expenses (94,636) (153,661) (111,209) (116,879) (75,140)
Administrative expenses (22,820,461) (31,704,992) (32,624,772) (31,497,145) (21,445,734)
Operating Profit 10,708,920 12,980,275 18,866,635 18,880,896 11,813,594
Investment Income 99,303 838,767 19,949 405,811 139,763
Other gains and losses 1,072,482 1,232,358 295,816 (170,361) 695,388
Finance cost (1,947,558) (2,709,908) (2,961,864) (5,981,450) (6,148,772)
Profit Before Tax 9,933,147 12,341,492 16,220,536 13,134,896 6,499,973
Income tax expense (5,521,149) (4,328,798) (8,367,196) (4,894,917) (4,059,833)
Profit After Tax 4,411,998 8,012,694 7,853,340 8,239,979 2,440,140
JULIUS BERGER MANAGEMENT STRONG BUT UNABLE
TO STEM THE BLEEDING
The company’s board and executive management team under-
stands the local business environment. They bring a wealth of ex-
perience that has helped propel the company to past successes.
The board of directors is led by Mr. Mutiu Sunmonu, Commander
of the Order of the Niger. He has been a board member of Julius
Berger since 2016 and was appointed Chairman in April 2016. He
previously worked as the Managing Director at Shell Petroleum De-
velopment Company and was the Country Chairman at Shell Com-
panies Nigeria. He is also the Chairman of the Board at Imperial
Homes Mortgage Limited. The management of Julius Berger is
made up of accomplished individuals led by Engineer, Wolfgang
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Page 37
Balance Sheet for Julius Berger PlcN'000 2011 2012 2013 2014 2015
Property, Plant and Equipment 55,421,778 57,079,027 67,995,915 68,369,671 58,376,513
Goodwill - 4,634,422 4,842,708 4,606,412 5,041,184
Other intangible assets - 127,935 118,297 77,402 32,712
Investment property - - 780,177 2,648,412 2,546,436
Trade and other receivables 161,554 1,706,067 1,469,591 2,334,764 844,122
Tax receivable 12,458,367 25,957,783 31,075,595 35,060,509 21,039,915
Deferred tax assets 3,362,383 3,017,036 7,468,271 8,041,407 10,087,301
Other financial assets - 4,125,734 - - -
Non-current assets 71,404,082 96,648,004 113,750,554 121,138,577 97,968,183
Inventories 11,061,851 10,710,071 11,432,482 12,111,830 11,110,116
Amounts due from customers and other contracts 7,587,091 5,544,984 20,898,658 29,122,120 27,228,427
Trade and other receivables 46,230,007 41,582,008 52,245,757 63,425,208 88,634,246
Tax receivable 23,425,928 13,089,156 7,430,849 5,575,112 5,292,205
Cash and cash equivalents 11,827,635 10,731,468 20,475,649 23,473,159 13,360,038
Assets classified as held for sale 711,495 728,473 1,027,308 1,199,775 1,493,055
Current assets 100,844,007 82,386,160 113,510,703 134,907,204 147,118,087
Total Assets 172,248,089 179,034,164 227,261,257 256,045,781 245,086,270
Share capital 600,000 600,000 600,000 660,000 660,000
Share premium 425,440 425,440 425,440 425,440 425,440
Foreign currency translation reserve - 222,992 687,896 919,411 419,755
Retained earnings 8,684,026 13,774,577 18,863,052 23,420,332 22,729,580
Equity attributable to owners of the company 9,709,466 15,023,009 20,576,388 25,425,183 24,234,775
Non-controlling interest 36,759 121,171 458,040 670,660 57,180
Total Equity 9,746,225 15,144,180 21,034,428 26,095,843 24,291,955
Borrowings - - 6,435,141 3,201,710 -
Retirement benefit liabilities - 1,656,643 2,033,004 1,996,506 1,853,781
Deferred tax liabilities 5,440,300 5,666,877 12,336,676 13,220,121 12,989,322
Amount due to customers under contracts 94,097,474 86,487,144 80,214,852 93,690,330 106,971,355
Provisions - 1,268,007 - 2,135,994 404,308
Non-current liabilites 99,537,774 95,078,671 101,019,673 114,244,661 122,218,766
Amount due to customers under contracts 13,658,887 18,863,122 46,472,088 35,188,722 32,912,602
Trade and other payables 19,310,108 33,121,063 34,016,585 42,138,848 34,596,825
Borrowings 16,038,018 8,208,260 19,279,413 34,809,060 24,807,936
Current tax payable 3,482,077 3,551,109 5,314,810 3,473,353 6,106,748
Retirement benefit liabilities 10,475,000 5,067,759 124,260 95,294 151,438
Current liabilites 62,964,090 68,811,313 105,207,156 115,705,277 98,575,549
Total liabilites 162,501,864 163,889,984 206,226,829 229,949,938 220,794,315
Total equity and liabilites 172,248,089 179,034,164 227,261,257 256,045,781 245,086,270
Goetsch, who has been with the company since 1991. He was
previously on the Board of Directors and Managing Director at the
company in 2007 and was reinstated in July 2016. Mr. Wolfgang
Kollermann is the Financial Director and has been with the com-
pany since 2000, occupying several positions. He is the Chairman
of Julius Berger Medical Services Ltd and is a Member of the
Board of many of its subsidiaries.
To cope with the challenging macroeconomic conditions the team
has made drastic decisions, such as the 39% downsizing of its
staff. However, management has been unable to improve upon
2015’s unimpressive financial result given the impact of the plum-
meting economy.
Bulls Say:
Renowned reputation and superior brand value due to consis-
tent high quality delivery
Deep knowledge of the Nigerian construction and infrastructural
environment
Federal government is committed to addressing Nigeria’s infra-
structural gap as reflected by the increased percentage of capi-
tal expenditure in the budget
Few strong and reliable competitors
High barrier to entry as huge investment outlay is required
Increasing public-private partnerships (PPPs)
Bears Say:
Rising finance costs due to high interest rate environment
Forex rate risks could potentially erode earnings
Government delay in approval of and payment for capital pro-
jects
Declining government revenue as a result of oil production
slowdown following relentless insurgency and volatile prices
Significant exposure to public projects could result in concentra-
tion risk
A Financial Derivatives Company Publication
: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com
Page 38
RISKS AND OUTLOOK: GOOD OPPORTUNITIES BUT LIT-
TLE UPSIDE
Julius Berger faces market and concentration risks. Market risks in-
clude currency uncertainty, an adverse economic landscape, inter-
est rate increases and rising operating costs. The vacillating forex
market could result in high finance charges, which could cripple
earnings if not properly managed. The adverse economic environ-
ment has also led to a decline in demand for construction services
from both the public and private sectors. High interest rates and
depreciation of the naira can also lead to higher financing and oper-
ating costs. Concentration risk is a huge concern for the company
because most of its projects are federal and state government con-
tracts.
Though these risks pose immense challenges on the company’s out-
look, Julius Berger has devised a practical risk management struc-
ture. The company manages forex exposures by utilizing forward
forex contracts. The company’s foreign debt is repayable on de-
mand with its carrying amount reflecting the fair value and expo-
sure to interest risk as of the reporting date. Concentration risk is
managed through forward funding where achievable.
Nevertheless, the persistent macroeconomic headwinds still pose a
huge challenge. The decline in demand for construction services,
increasing interest rate and high forex charges threaten the com-
pany’s ability to improve shareholder value. Thus, Julius Berger is a
company with the paradox of good opportunities but little upside
and we must recommend a SELL.
APPENDIX - VALUATION
We derived our valuation for Julius Berger Plc by using the Dis-
counted Cash Flow (DCF) methodology. Our fair value estimate for
Julius Berger Plc is N39.74, which is a 17.1% downside on the cur-
rent price of its share as of August 23 2016. The discount rate
(weighted average cost of capital (WACC)) of 17.0% is derived us-
ing a 14.94% risk free rate (the yield for the 5 year Federal Gov-
ernment of Nigeria (FGN) Bond issued on July 2016), a beta of
1.24, an after-tax cost of debt of 11.7%, and a market risk pre-
mium of 6%. The long term cash flow growth rate to perpetuity cal-
culated is 4.1%.
Page 39
A Financial Derivatives Company Publication
: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com
Important Notice
This document is issued by Financial Derivatives Company. It is for information purposes only. It does not constitute any offer, recommendation or solicitation to any person to enter
into any transaction or adopt any hedging, trading or investment strategy, nor does it constitute any prediction of likely future movements in rates or prices or any representation that
any such future movements will not exceed those shown in any illustration. All rates and figures appearing are for illustrative purposes. You are advised to make your own independ-
ent judgment with respect to any matter contained herein.
© 2016. “This publication is for private circulation only. Any other use or publication without the prior express consent of Financial Derivatives Company Limited is prohibited.”
Taking into account Julius Berger’s latest financial results, increas-
ing inability of the government and private clients to finance new
projects the prevailing macroeconomic conditions and a disappoint-
ing H1 2016 result, we forecast a two-year revenue compound an-
nual growth rate of 8.1%.
JULIUS BERGER VALUATION USING DISCOUNTED
CASH FLOW DCF
Page 40
A Financial Derivatives Company Publication
: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com
DCF Valuation for Julius Berger PlcN'000 2016E 2017E 2018E
EBIT 9,474,992 10,230,546 10,488,688
Less: Taxes (4,414,988) (4,767,047) (4,887,332)
EBIAT 5,060,004 5,463,498 5,601,356
Plus: Depreciation Expense 10,372,544 10,292,369 9,544,671
Less: CAPEX (8,089,859) (7,163,344) (6,920,739)
Less: Change in working capital 25,930,761 (964,317) (2,528,623)
Free Cash Flow (FCF) 33,273,450 7,628,206 5,696,665
WACC 16.5% 16.5% 16.5%
Present Value (PV) of FCF 28,570,570 5,624,249 3,606,483
Terminal value @ perpetual growth rate (2018) 2016 2017 2018
Terminal value as of 2018
Present value of terminal value 26,097,529
DCF Calculation Valuation
PV of explicit period 37,801,302
PV of terminal value 26,097,529
Enterprise Value 63,898,831
+ Cash 13,360,038
- Borrowings (24,807,936)
Equity Value 52,450,933
Share price 39.74
Shares outstanding ('000) 1,320,000
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