On a headline basis, the NASI returned -0.2% month on month largely weighed down by Kenya RE (-0.3%), EABL (-0.1%) as well as the banks (-0.3%). The index was mainly supported by Safaricom (+1.1%). The NASI outperformed the MSCI EFM ex ZA at 6.1% ytd compared to 4.2% ytd achieved by MSCI.
NSE is currently trading at a slight discount of 0.9% to the historical 10 year average of 11.9x.
We estimate pension funds allocation to equities dipped further to 17.1% in the month, on account of a further decline in the NASI. We believe net inflows into equities during June 2019, by pension funds, were not able to offset the decline in portfolio valuations as a result of a weaker equities market. We estimate pension fund assets have grown by 6.8% y/y to USD 12.3bn in June 2019 from USD 11.4bn in June 2018.
The KES bond curve witnessed a narrower gaps between bids and offers as bidders chased yields down due to positive sentiments on the Kenyan economy both locally and abroad. Treasury Bill auctions attracted high bid volumes due to end year government spending flooding money markets.
The 8yr T bond yielded 11.593% with a cut-off rate of 11.630%, while the 14yr T bond yielded 12.456% with a cut-off rate of 11.630%. Treasury managed to raise a total of KES 38.9bn from the auction, which offset KES 36.9bn in bond maturities.
In the twelve months of FY18/19, we estimate that Treasury has borrowed ~KES 253.1bn versus ~KES 300.5bn (down 15.8%).
E.A. Breweries EPS +56% y/y in FY19 – above expectations
Potential nationalisation of KQ – Estimated Impact on Banks
USD/KES weakens 0.7% w/w to KES 103.82
EUR/KES strengthens 0.1% w/w to KES 115.56
We estimate Kenya’s GDP to grow between 5.3% and 5.6% in 2019.
We forecast inflation to be within 5.0%-7.5% range, largely on account of food inflation.
We expect the KES to weaken between 3.0%-4.0% against the USD, to KES 104.8-105.9 on a PPP basis. We expect higher food imports and weak agricultural exports to drive the current account deficit to between 5.5% -5.8% of GDP.
We do not anticipate a reduction in the benchmark rate in FY19. We expect demand-supply dynamics to result in some tapering off in the longer end of the domestic yield curve as local institutional investors chase yields between 4 years and 10 years.
Going by our market earnings growth forecast of 10.1% and a PE re-rating of 2.5% in FY19F, we forecast the NASI to close 2019 at 158.44, representing a 6.5% potential upside, from the current level of 148.81.
Based on our fair value estimates of equities covering 75.1% of the market cap, we forecast a potential market return of 9.4%.
BUYs on E.A Breweries, KCB bank, Co-op bank, DTB bank and I&M bank
HOLDs on Safaricom, Equity bank, NIC bank.
“DIAMONDS ARE FOREVER”
We issue a Buy recommendation on Diamond Trust Bank (DTB) based on a 1 year target price of KES 264.00, representing 60.0% upside from the Rights Issue price of KES 165.00. Our positive sentiments are supported by sound balance sheet growth (3 year CAGR of 22.0% to FY16F), driven by sturdy loan book and customer deposit growth (3 year CAGR) of 22.7% and 21.4% to FY16F respectively. We expect sustained cost management meas-ures to drive stability in the cost-to-income ratio going forward, with a 3 year CTI average of 40.7% to FY16F. We expect this to translate to +12.0% y/y growth in EPS to KES 24.20 in FY14, owing to dilution from the Rights Issue. (+23.2% y/y EPS growth in FY14F, like for like comparison)
NAIROBI SECURITIES EXCHANGE
We initiate coverage on the NAIROBI SECURITIES EXCHANGE (NSE) with a BUY recommendation and a target price of KES 14.30, 50.3% above the IPO price of KES 9.50. The Nairobi Securities Exchange’s total income has recorded 5 year CAGR of 35.5% driven by increased market turnover. In last 5 years, the company has moved from a loss after tax of KES 31.8m to a profit after tax of KES 262.2m. For FY14, we forecast earnings per share to grow 5.9% y/y to KES 1.43. The growth in earnings in 2014 is likely to be subdued due to the fact that the company reported a one-off gain of KES 120.0m in 2013 from a recovery of a bad debt. In the longer term, we believe that investments in IT infrastructure and systems will facilitate the creation of new products and the launch of the derivatives market will drive income growth in a cost effective manner. The Nairobi Securities Exchange will be the second exchange in Africa (after the Johannesburg Stock Exchange) to be listed and therefore provides unique exposure to the growth in African Frontier Markets. At the issue price of KES 9.50, the NSE has a forward P/E of 6.7x, P/B of 1.2x and dividend yield of 4.5% compared to the JSE’s P/E of 15.3, P/B of 3.8x and dividend yield of 3.5%.
We maintain our ACCUMULATE recommendation on Safaricom with a Fair Value of KES 14.20, 8.1% above the current price. We estimate total return of 12.7% including our forecasted dividend of KES 0.60 for FY15F (a for-ward dividend yield of 4.6%). For FY15F, we forecast earnings to grow 31.7% y/y largely driven by growth in reve-nue on the back of additional subscribers and increased usage as costs remain stable. Safaricom’s revenue growth over the last 3 years has largely been driven by growing subscriber numbers. However, as subscriber growth be-gins to taper off and the quality and variety of products continue to rise, we believe that growth in the long term will be driven by increased usage. Safaricom trades at a forward P/E of 17.4x, EV/EBITDA of 7.2 and dividend yield of 4.6%. While this is compares unfavourably to the regional median P/E of 11.8x and EV/EBITDA of 6.3x, Sa-faricom’s M-PESA advantage and the expected growth in earnings and dividends justify the premium. Notably, Safaricom’s forward dividend yield of 4.6% is higher than the regional median of 3.3%.
Kenya is Sub- Saharan Africa’s largest tea exporter
Kenya is Sub-Saharan Africa’s leading tea exporter in addition to being among the world’s largest black tea producers. Within East Africa, Kenya is the key producer, accounting for 59.6% of total production in Africa on average over the past six years (2008-2013), well above its competitors, Uganda (8.7%), Tanzania (5.1%), Rwanda (3.6%) and Burundi (1.2%). There has been noteworthy growth in tea output, attributable to good weather as well as increase in total tea acreage, over the past decade recording a 6.3% 3 year CAGR. Total output has grown 37.2% over the past decade, from 324.0m Kgs in 2004 to 444.8m Kgs in 2014. In 2014, total tea acreage stood at 203,000 Ha (+2.2% y/y), with small holder farms at 128,600ha (+1.0% y/y) and estate farms accounting for 74,400ha (+4.3% y/y). In Kenya, tea is among the largest foreign exchange earners, accounting for 20.0% of the value of exports in 2014 equivalent to KES 94.0bn.
A Brief Look at the October-December 2014 ‘short-rains’ seasons
According to the Kenya Meteorological Department (KMD), rainfall in Kenya was near normal levels over most parts of the country during the October—December 2014 ‘short-rains’ season. However, there were certain regions of Kenya, for example areas in South Eastern Kenya, and more localised areas in Central and North Eastern regions of Kenya, which recorded depressed rainfall (i.e. >25% below long term averages).
Following on from the prolonged election cycle of 2017, the political and economic outlook for Kenya in FY18 looks considerably improved. However, issues such as bank lending interest rate caps and IFRS9’s impact on the banking sector continue to concern investors. We believe the interest rate caps, whilst not being retracted completely, will be modified in 2H18 resulting in a widening of the rate capping bands. Following the implementation of IFRS9 in FY18, although we expect some banks in the Kenyan banking sector to seek additional Tier 1 and Tier 2 capital in order to boost capital ratios, we understand the Central Bank of Kenya is currently seeking industry comments on its proposal to give banks upto five years to build capital buffers.
Economic Outlook for 2018
Stronger headline GDP growth in FY18 c. 5.3% – 5.7%, driven by a recovery of private sector confidence (post elections) and the agricultural sector (resumption of normal rainfall patterns). Expected headwinds for 2018 include the interest rate caps and slower government spending on account of fiscal concerns.
Market anticipation is that interest rate caps will be relaxed in 2019. We believe Government borrowing costs at present are artificially suppressed although government yields are trending downward due to market expectations of a reduction of the Central Bank Rate (CBR) in 1H18.
Elections completed in October 2017 – we expect political stability going forward. Opposition activities continues to pose some uncertainty, but we expect this to dissipate over 2018.
Market Performance & Outlook
- The S&P SSA Ex SA Index was up 40.9% in FY17, indicating improved performance of African indices. The Nairobi All Share Index was up 27.5% in USD terms, outperforming the Nigeria All Share Index. The NSE largely turned more expensive in 2017, despite the political and economic headwinds seen during the year.
- For the most part we think the NSE is fairly valued.
- A potential reduction of the CBR may be marginally negative for banking stocks due to an anticipated negative impact on net interest margins. The fixed income market also appears to be signalling a relaxation of interest rate caps 2019 onwards and not in 2H18.
- We believe a specific approach to stocks will yield investors positive returns. We recommend select stocks on slide 6.