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HomeBusinessAnalysts Suggest Caution: Downside risks outweigh upside for non-banking Nigerian equities

Analysts Suggest Caution: Downside risks outweigh upside for non-banking Nigerian equities

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The northward momentum in Nigerian equities continued for a third consecutive month as the benchmark NGX-All Share Index (NGX-ASI) gained 5.5 percent m/m to close the month at 64,337.52 points, bringing the YTD return on the benchmark to 25.5 percent.

The rally in Nigerian equities was supported by a series of events across different sectors. Investor sentiment remains influenced by optimism around the new administration’s pro-market reforms, in addition to the impact of the earnings season.

The Oil and Gas sector was the best-performing sector for the month, gaining 20.1 percent m/m. The gains in the Oil and Gas sector were underpinned by i) the increased fuel pump price of PMS, keeping in line with the subsidy removal and providing a boost to downstream oil and gas companies; ii) the rally in oil prices (Brent gained 14.2 percent in July) and the persistent depreciation of the naira, which supported interest in upstream oil and gas businesses (as they earn in USD).

The Industrial Goods sector followed, gaining 14.2 percent m/m, broadly supported by an uptick in DANGCEM (+23.5 percent m/m) after the company announced the continuation of its share buyback program during the month.

The Banking index gained 3.8 percent as a broad-based rally across banking stocks was driven by solid H1-2023 earnings as banks recorded healthy FX revaluation gains. On the other hand, the Insurance (-5.9 percent m/m) and Consumer Goods (-4.6 percent m/m) sectors suffered losses during the month.

The selloffs in the Consumer Goods sector were triggered by huge FX losses recorded by bellwether names within the sector. Following the naira devaluation, businesses with huge FX liability exposure (payables and debt obligations) had to revalue their exposures, leading to huge FX losses given the steep devaluation.

In line with our outlook for the equities market, we have seen the bullish momentum in the equities market sustained, particularly in the banking and oil and gas sectors. However, we remain cautious and expect that the tide for the Nigerian equities market will turn from the end of Q3-2023 into Q4-2023.

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First, we expect domestic investors, who have been very bullish, to begin to reduce exposure to Nigerian equities as the reality of a lack of interest from foreign investors begins to trickle in.

The shift towards a market-determined FX policy has not led to a substantial improvement in FX liquidity, as average turnover at the I&E window since the announcement of a change in the FX regime is $110.0 million, a marginal 0.8 percent improvement on the pre-reform 2023 average of $109.1 million.

In addition, according to data from the Nigerian Exchange Group (NGX), foreign investors remained net sellers of Nigerian equities as foreign outflows (N23.0 billion) outpaced foreign inflows (N22.7 billion) in June. That said, we note the sizable increase in foreign inflows into equities for May and June.

Furthermore, we think the recent cocktail of policy actions by the Federal Government (FG), including PMS subsidy removal and exchange rate float, as well as other government agency decisions, such as an increase in education costs, is imposing devastating impacts on household consumption expenditure (which contributes 60 percent of the nation’s demand).

We expect the impacts to be fully measurable in Q3-2023 and portend a slump in aggregate economic demand with a consequent impact on the earnings of listed companies. Nevertheless, we expect Banking stocks to continue to thrive on the benefit of higher interest rates on investment securities and FX revaluation gains.

Overall, we recommend investors in non-banking stocks take advantage of the current valuation to reduce their exposures.

At best, we think the downside potential of non-banking Nigerian equities outweighs the upside potential. For context, the NGX-ASI currently trades at a PE ratio of 12.9x, a 6.5 percent premium above the long-run average PE ratio of 12.1x. As we have stated previously, we continue to retain our bullish tilt on Nigerian equities.

~FSDH Equity Research Note

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