africa_its time to invest in the final frontier_august 2nd 2010

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AFRICAIts Time to Invest in the Final Frontier

Market Week Pullout After a 7% Jump, Stocks Exit July With a Whimper Page M4

WhoReally Owns

Americas Debt?Page 24

August 2, 2010

ALAN ABELSON

5Beware: dangerousmonths ahead

MICHAEL SANTOLI 9

An interviewwith Mr. Market

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Coca-Cola shares:set for another pop

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Buying opportunityin Bank of America

BROKERS STOCK PICKS 20

Wedbush goes fromchump to champ

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18 B A R R O N S August 2, 2010

markets with huge potential, liberalizing policies, good capi-tal flows and undiscovered high-quality companies. And Ni-geria is one of his favorite frontier countries. He contendsthat the giant nation of about 150 million people eventuallycan fill the same leading role for Africa that Brazil hasplayed for emerging markets.

Like Brazil, Nigeria hasnt liberalized its petroleum andtelecom industries yet, and its stocks in those sectors willbenefit whenever that happens. Again like Brazil, Nigeriahas grown strongly, even though its banks curbed lendinglast year. Whenever the banks ratchet up lending, that willfurther fuel growth. (Nigerian regulators recently forcedsome banks to take bigger-than-expectedwrite-downs on loan losses. That hurt reportedearnings, but has removed a nagging issue andwill help future profits.)

Indeed, after a big drop from boom highsin early 2008, African stock marketsdespitetheir problems (see box on page 20)now of-fer the long-term investor a number of fast-growing companies with stocks that sell forabout 11 to 12 times trailing 12-month earn-ings per share as of June 30, according toS&P Indices. They look inexpensive comparedwith price/earnings ratios in most developedmarkets or even in the broad world of emerg-ing markets, where the average stock fetches15 times trailing profits.

With many economies on the continentgrowing 5% to 8% annually, according to theInternational Monetary Fund, investors canfind banks, brewers, supermarket outfits andmobile-phone companies with good prospects,

decent balance sheets and relatively low P/Es(especially compared with their growth poten-tial). Some have few rivals, provide importantconsumer services and boast profits that aregrowing faster than their homelands economy.

If the West hasnt noticed this big change,China has. With relatively little fanfare, ithas made a huge foray into Africa. Chinasrapidly rising middle class isnt just pullingitself up by the bootstraps, but also is creat-ing demand for resources from Africa. Thatshelping to raise income levels on the vastcontinent, as well.

Africas bounty of natural resources, such as oil, iron ore,gold, copper and numerous others, have brought in strongtrade flows from the Asian giant, with $88 billion in 2008 inexports and imports between the two, up 10 times from 2000

(see table on page 19). In return for those commodities, Chinais building seaports, power plants, roads and other infrastruc-ture projects, which should help sustain the growth in grossdomestic product expected in many parts of the sub-Sahara.

Africas economy is growing at a tiger-like 5% to 8% pace,versus 4% for countries like Russia and Brazil. And the IMFhas been nudging up its forecasts for Africa.

There are compelling long-term trends on the continent,says Razia Khan, the London-based head of research on Af-rica at Standard Chartered, a U.K. bank with businesses inmany emerging and frontier markets. Political stability andeconomic policy has improved. Consumption is rising, withthe working-age population expected to hit 65% of the totalpopulation in 2050, versus about 50% now. And new capital,

some from investment funds, is coming in. Africas debt andforeign-exchange markets are opening up, too, Khan adds,another encouraging sign. Over all, Africa is becoming moreaccessible to Western investment.

A key sector is banking, a necessary engine for consumerand corporate growth. Credit to the private sector in EastAfrican nations, for example, is growing at a healthy yearlyclip of 15% to 20%, notes Simon Migangala, the Dar es Sa-laam-based treasury director for CRDB Bank in Tanzania,which operates in East Africa. The global recession has hurt,but regional economies are recovering, with banking, con-struction, energy and telecommunications showing gains. It

will be much higher than expectation, he predicts of bank-ing growth.

With net-interest margins significantly higher than in therest of the world, Morland views bank stocks as one of the

best investments in the early stages of a frontier marketsgrowth. If an economy is expanding by 7% a year, for exam-ple, banking assets can grow 30% to even 100%. Businesseswe like to invest in are the same ones others are buying inChina: banks, brewers and telcos, he says.

The consumer-growth potential is huge. Africa, the sec-ond most populous continent, has close to 900 million people. While many are very poor, incomes generally are rising,thanks to globalization and Chinas hefty appetite for com-modities.

Alan Dowokpor, 44 years old, who grew up in Ghana, de-parted and then returned to Accra to head Tullow Oils drill-ing program, says that when he was a child, visitors from theU.K. used to bring a suitcase full of necessities like soap.

Now people are earning enough to afford consumer itemslike that. Making a phone call used to be a real big deal,but mobile phones have changed that. Perhaps most impor-tant, former economic emigrants, qualified, educated Ghana-ians, are coming back and that in itself says something aboutimproving opportunity.

These days, investors artificially distinguish betweenemerging and frontier markets, contends LawrenceSpeidell, chief investment officer for Frontier Market As-set Management. Africa is the most neglected frontiermarket, he avers, because its countries are a little bitpoorer and their stage of development a little behind

that of emerging markets in general. But, headds, from the standpoint of the people liv-ing in those nations and their everyday lives,the differences between them are slighter

than many believe.Speidells firm has investments in Ghana,

where the banking industry has a net-interestmargin of 8% and banking shares have rela-tively low price/earnings ratios. Ghana Com-mercial Bank (GCB.Ghana), for example, isthe largest in that country, with the longestreach, 157 branches and a stock price aroundsix times expected 2010 earnings.

His other African investments includeS ta nda rd Ch art ere d B an k Gh ana

(SCB.Ghana), which is focused on high-end cli-entele, has a 48% return on equity and tradesat a multiple around 10. Cal Bank (CAL.Ghana) is another of Speidells favorites. Smalland nimble, its the only independent bank in

his top 10. It focuses on the high-end market,targeting recent university graduates. And ithas a P/E of 6.6. (It must be noted that fron-tier-market P/Es often are based on only ahandful of profit estimates. The 10 multiplelisted for Cal Bank in the table at left, for ex-ample, is based on an analysis from only onebroker, Securities Africa in Johannesburg.)

After the frontier stock-market boomended in early 2008, African shares fell hardalong with the major global markets. Theyremain far below their highs, despite a na-scent recovery that began late last year. Ni-gerian stocks, for example, are more than

two-thirds below the highs of 2007-08, when hedge-fundmoney was pouring in, creating a bubble in which toomuch cash was chasing too few companies.

A lot of that hot money was among the first to leave

during the global crisis, observes Jenni Chamberlain, aportfolio manager at Finch Asset Management. Still, shesseeing more interest from long-term investors in Africalately. One of her favorite stocks is Sonatel (SNTS.Sene-gal), a fixed- and mobile-phone outfit that trades in Sene-gal and is 42% owned by France Telecom (FTE) and27% by the government. Its the most attractively valuedsub-Saharan telecom operator, as well as the dominantplayer in both Senegal and Mali, with a growing share inGuinea Bissau and Guinea. The company has a strong bal-ance sheet and a 10% dividend yield, Chamberlain notes.

The share-price drop across markets in Africashould entice new investors willing to look five yearsdown the road as an opportunity to pick up stocks at

Company/TickerWhereTraded Industry

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August 2, 2010 B A R R O N S 19

some of the lowest prices since 2006, when Barronslast wrote at length about frontier markets (FindingRiches on the New Frontier, Nov. 6, 2006)

Profit growth has been much higher in Africa thanin the rest of the world, mitigating some of the higherrisk there. For example, from 1995 through 2009,earnings per share advanced at a compound annualrate of 17% for the companies in the Blakeney Africaportfolio, which also includes Middle Eastern stocks.That return far outpaced the 4% to 5% average forcompanies in the Standard & Poors 500 index and the

MSCI Emerging Markets index in the same span.What would you pay for 4% to 5% annual growth? Mor-

land says maybe nine or 10 times earnings, but adds that hewould pay 25 times for 17% growth. Yet the P/E for Blak-

eneys African portfolio is about 10 times 2010 earnings.For the 10 years ended June 30, the S&P BMI frontier

stock indexs average annual total return in dollarswhich in-cludes dividends, as well as changes in share pricewas 14%,

while the S&P BMI emerging indexs was 10%. Both were farahead of the S&P 500s yearly loss of 1.5% in the period.

African equitiesnot including stocks issued by compa-nies in South Africa, which is classified an emerging mar-ketrepresent roughly 15% of the frontier indexes.

In recent months, the flow of money into frontier mar-kets has accelerated. About a $1 billion has been addedthis year, 14.5% of total frontier-fund total assets, accord-ing to EPFR Global, which tracks institutional flows.

With frontier- and emerging-market money managers

growing more enthusiastic about the continent, more oftheir cash is going into African stocks.

Many institutional investors argue that Africa is nowwhere emerging markets were 20 years agoa place inves-tors are deathly afraid of, but one that is rapidly changingand in which returns can be high.

Says John Niepold, managing partner at SQM FrontierManagement and a 20-year veteran of emerging and frontiermarkets: If you go around on the ground in Africa, as I do,youll find companies are doing well. Information isnt readilyavailable, but that also means there are market inefficienciesand the possibility for a good return. Its probably the placethat investors should consider.

Joseph Rohm, who runs the T. Rowe Price Africa &Middle East Fund (TRAMX), says South African stocks areamong his most preferred and that hes doubled his weight-

ing in African stocks to 35% of the fund since April 2009.Frontier stocks were laggards last year, so they might con-tain more bargains than emerging-market stocks, which

were on fire in 2009.Nigerian banks, for example, were trading at four to even

six times book at the top, Rohm adds, but now have forwardprice-to-book-value ratios of about one times. Although Nige-ria has 150 million people, only eight million have bank ac-counts, he says, so theres huge growth potential.

Among big stocks, Rohm likes Africa-related play Tul-low Oil (TUWLY), a growing U.K.-based energy-explora-tion company with significant assets in Uganda, Ghanaand other parts of the continent. Among local stocks,Rohms fund holds Safaricom (SAFCOM.Kenya), an in-novative Kenyan mobile-phone outfit with one of the mostsuccessful mobile- banking applications; Guaranty Trust

Bank (GUARANTY.Nigeria) and Standard Bank Group(SBK.South Africa).Another fan is Timothy Drinkall, whose Morgan Stanley

Frontier Emerging Markets Fund (FFD) is overweight Af-rica. He notes that frontier-market valuations are trading ata big discount to emerging markets, instead of the premiumseen during the boom. And he adds that frontier marketsshow lower correlations with developed-market moves.

Emerging markets rallied 75% in 2009, but the stock mar-ket in Nigeria, one of his favorite investment areas, fell 33%in dollar terms, and Kenya rose only 5%. In Kenya, he says,the underlying profit growth potential is more than 15%.There he holds East African Breweries (EABL.Kenya) andEquity Bank (EQBNK.Kenya). The latter has the most ac-counts in Kenya and is expanding in Uganda.

Another stock worth a look is Letshego (LET-SHEGO.Botswana). Its a growing payday lender, with rela-tively low credit risk, a P/E multiple around 10 and a return

on equity of 27%, says Nick Padgett, whose Frontaura GlobalFrontier fund has been increasing its weighting in Africanstocks. Another of his holdings, CRDB Bank (CRDB.Tanza-nia) is one of the largest banking institutions in its home coun-try. It sports a P/E of five, a price-to-book ratio of 1.1 and apotential for a double-digit net interest margin.

Sub-Saharan Africa is far more attractive than its mediastereotype would lead one to believe. Yes, poverty and vio-lence are still huge problems in some parts of the continent.But, increasingly, the miseries of lands like Zimbabwe aremore the exception than the rule. Africa isnt an easy placeto invest in. But the patient are likely to be rewarded for

venturing into what for many is the last overlooked invest-ment frontier.

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HOW DAUNTING ARE THE INVESTMENT RISKS IN

Africa? The political dangers have lessenedsignificantly in the past five to 10 years, but,as with all frontier markets, they havent

disappeared. The overall trend in political stability andcoherence is positive, says Philippe de Pontet, a Wash-ington-based analyst at political risk consultancy Eur-asia Group. There are 10 to 15 countries seeing im-proved macroeconomic policy, a movement toward

consolidating democracy and better political gover-nance, he avers. Progress can backslide, but in coun-tries like Ghana, Senegal, Liberia, Sierra Leone andeven Nigeria, for a sustained period of time now,things are trending the right way, he asserts.

One of the most important changes has come fromgovernments interfering much less in their nationaleconomies compared with 15 years ago, a big spur togrowth, notes Miles Morland, chairman of DevelopmentPartners International. In the 2010 Heritage Founda-tion country rankings of economic freedom, Mauritiusis listed higher than the Netherlands; Botswana aheadof Belgium; and Nigeria ahead of each of the BRICsBrazil, Russia, India and China.

Politics aside, the stock-market values of many com-panies trading in places like Nairobi and Lagos are of-ten small. Indeed, the total market cap of the main sub-

Saharan stock markets together, according to S&P In-dices, was about $62 billion at the end of 2009, less thanMcDonalds market cap. And some economies dependheavily on one commodity, as Zambia does on copper.

And Africas exposure to the Middle Kingdom has a po-tential short-term downside: Should Chinas economy

weaken sharply, it could hurt the continent.The shares in many of the 18 sub-Saharan frontier

stock markets outside emerging-market South Africaare illiquid, though the situation is improving. Accordingto broker Securities Africa, trading volume in Nigeriaand Kenya, the two biggest African frontier markets,average $24 million and $4 million per day, respectively,

well above their 2009 means but below the 2008 highs ofnearly $70 million for Nigeria and $5 million for Kenya.

Institutional investors typically have the where-withal to invest in Africa, but it isnt easy for individualsthere. There could be expensive trading fees or stock-

certificate custody issues, and traditional sell-side ana-lyst coverage is thin. While there are many exceptions,transparency and governance arent up to Westernstandards, though improving.

There are straightforward, if less direct, ways forthe individual investor looking to play the Africa cardin U.S. markets, either through South African stocksthat trade herelike mobile-phone service providerMTN Group (MTNOY) and supermarket companyShoprite Holdings (SRHGY), which are expanding insub-Saharan Africaor frontier-market mutual fundsand a South African stock-market ETF (see table onpage 18). V. J. R.

A Decade of Improvement

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Sizing Up the Real RisksOf Investing in Africa

africa_its time to invest in the final frontier_august 2nd 2010

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