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The final frontier: African stocks blip brighter on the radar

13 Aug 2009

By Sherif Mahmoud Salem, co-fund manager for Invest AD’s Emerging Africa Fund

Haunted by images of famine, disease and warfare, and dogged by a reputation for corruption, sub-Saharan Africa is the final frontier for international investors. But as a manager of a fund that invests in the region, I see change that could help unleash global capital to fuel development of the continent's undoubted potential.

Foreign direct investment from China and the Gulf is helping build much-needed infrastructure, governments are spending income from natural resources and commodities more wisely, macro-economic management is improving, and talented Africans are returning from the West to bolster corporate governance.

For investors, taking advantage of these positive trends is still tricky. Stock exchanges are young, skewed towards a few industries, and illiquid - although here too, I see improvements, with initial public offerings (IPOs) likely to deepen equity markets in coming years.

However, the prospects are bright for companies that can harness international capital to fund growth.

Sub-Saharan Africa produces nearly half of the world's chromium, diamonds, and platinum, nearly a third of its gold, and analysts believe the region holds huge undiscovered oil reserves. And thanks to better tax collection and government spending, these riches are finally filtering through to other areas of the economy and promoting stability.

While inflation has dropped to an average of 10-15 per cent from a dizzying 50 per cent in the mid-1990s, the region's gross domestic product (GDP) grew an average of 5 per cent in the decade to 2005, and should notch up 1.5 per cent growth this year even as the global economy contracts.

Nigeria, expected to post 2.5 per cent GDP growth this year and 4.4 per cent in 2010, is a notable success story. The country is the world's seventh largest producer of oil, with an average of 2 million barrels per day, but as part of efforts to attract foreign investment, the government has tried to promote economic diversification into other areas.

It has made progress in privatising firms in the steel, petrochemical and mining sectors, a new central bank governor is bent on raising standards of corporate governance and transparency, and a bank consolidation programme has prompted 89 relatively weak lenders to merge into 24 well-capitalised banks.

Although non-performing loans have climbed because many Nigerian banks funded stock purchases before the global financial crisis sparked a sell-off, the sector's valuation of 5.8 times forecast 2009 earnings shows the kind of value on offer in African stocks.

Mauritius has also transformed thanks to a bold economic reform programme launched in 2005. The country has built an information technology industry, with thriving business processing outsourcing centres, and a financial services industry, to complement traditional income from tourism, textiles and sugar. Mauritius now comes top in Africa and 24th globally in the World Bank's rankings for the ease of doing business.

So what is stopping foreign capital flooding into these markets?

A lack of stock market liquidity hampers the ability for a large investor to exit a stock easily, and without affecting pricing, and a shortage of variety hinders proper diversification.

The Nigerian Stock Exchange was the fourth largest in Africa as of the end of 2008, with a market capitalisation of $47 billion (Dh172 billion). Although turnover was up a quarter from the previous year, daily turnover was on average just $81 million, compared to a daily average of nearly $575 million on United Arab Emirates exchanges.

And the financial sector accounts for nearly two thirds of Nigeria's market capitalisation. Kenya gives better diversification, with financials making up about a third of capitalisation, utilities a quarter and the consumer sector a fifth. But total market capitalisation of the Kenyan bourse is only $9.1 billion and turnover averages about $1 million a day.

Because of the lack of depth in markets, I prefer a "bottom-up" approach to investing - examining companies, rather than a "top-down" method where countries and sectors are judged before stocks. And because research is scarce, this means digging deep on companies and talking frequently to management.

But such visits give a much better view than reading an analyst's report. For example, I have been amazed by the calibre of management I have met in Nigeria. I feel a reverse brain drain is unfolding, with highly educated Nigerians leaving Wall Street and Canary Wharf to return to their native country to work and live.

And you can really get to know a company. On my last trip I visited Dangote Sugar Refinery, which has a near 90 per cent share of Nigeria's white sugar market, to learn about how its proximity to Lagos port had eased its plans for expansion into West African countries.

Given their immaturity, African equity markets are probably still not for the faint-hearted. But the risks that have traditionally deterred investors are certainly reducing, and with the right investment approach, the returns are more promising than ever.

The views and opinions contained herein are those of Sherif Mahmoud Salem, co-fund manager for the ADIC Emerging Africa Fund, and do not necessarily represent Invest AD's house-view. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.