September 1, 2011

Opportunity in Kenya: Strong Companies, Challenging Macroeconomic Picture

The East African nation of Kenya has, for many years, been one of the Continent’s strongest economies, and a hub in its region.  The country, which has a population of approximately 40 million, and a GDP of approximately $32 billion, has been growing its economy by double-digit rates over the past six years, and is expected to continue to expand at a healthy rate over the next five.  Kenya’s economy is considered the most developed in its region, and is often chosen as a starting point for multinationals looking to expand into East Africa.  In our view, there are a number of compelling opportunities for strong investment returns in Kenya’s stock exchange, however the macroeconomic overhang remains a challenge. 
Notably, Kenya’s Stock Exchange is one of the oldest in Africa, with a current market capitalization of around $12 billion, and over fifty stocks listed to trade.   The Exchange, which is the fifth largest by market capitalization in Africa, operates over an electronic platform, and is well diversified amongst a number of sectors.  However, the exchange only trades around $100 million worth of shares per month, and liquidity remains a challenge. 
Within the companies which are listed in the Nairobi Exchange we see a number of good opportunities for strong performance.  As a whole, Kenya’s listed companies are very well managed, and in many cases have high potential for growth.  In particular, on a recent trip to Africa we were impressed with a number of companies which produce cement, a necessary ingredient for infrastructure growth, as well as companies that serve the nation’s growing consumer demand.  Over the long term we believe many of these companies are trading at compelling valuations, and could be likely to perform quite well in coming years.
However, although economic growth and business performance has been strong in the past few years, we believe that in the short term the macroeconomic overhang in Kenya makes it challenging to find compelling opportunities.  On a macroeconomic level, the biggest story for Kenya’s economy in recent years has been inflation and currency depreciation.  As a country without substantial oil reserves, Kenya is a net importer of many goods, including petroleum products, food, and industrial materials.  As a result, it must maintain adequate currency reserves in order to cover the costs of goods coming into the country.  In recent years, the price of oil has risen substantially, driving up the cost of many of the products that Kenyans import and causing inflationary pressures.  This high demand for dollars in Kenya has resulted in the depreciation of the shilling against the US dollar.  For investors who are seeking opportunities in Kenya this depreciation is a particular challenge, as a gain in the stock market has the potential to be erased by exchange rate depreciation.  In fact, as you can see over the past three years the value of the Kenyan shilling (versus the US dollar) has decreased over 25%, and shares of the largest firms listed on the Nairobi Exchange are down over 30%.  

Going forward, we believe that there will be more depreciation to come for the shilling, as real interest rates remain negative, and inflationary pressure persists.  In addition, Kenya will hold elections in August of 2012, which could mean uncertainty for investors who remember the challenges of the 2007 election cycle.  Although a drop in oil prices has the potential to ameliorate some of this pressure, we think that the government will continue to raise rates in order to combat the rise in prices.  However, we also believe that the end of this cycle is getting closer, and as current yields converge with inflation, our interest in some of Kenya’s strongest businesses will continue to grow.  When this happens, we believe it would be a good entry point for some of the opportunities we find most compelling, and we will continue to watch for the right moment to invest.     
For more information about investing in Africa, please contact Nile Capital Management at (646)367-2820

We know Africa - from Cairo to Capetown.

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