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HomeBusinessEarnings suggest the NGX All-Share is cheap ~Coronation

Earnings suggest the NGX All-Share is cheap ~Coronation

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Nigeria has lacked Foreign Portfolio Investment (FPI) in recent years, but this has not stopped a remarkable rally in the NGX Exchange All-Share Index since April 2020. One reason for this is the strength of company earnings.

Whereas it used to be FPI that drove the market, it is now the response of Nigerian investors to earnings growth.

And earnings-based valuations suggest that the NGX All-Share Index is still cheap. In the foreign exchange market last week, the exchange rate at the Investors and Exporters Window (I&E Window) appreciated by 0.08 per cent to N430.00/US$1.

Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) declined by 0.08 per cent to $39.41billion – which does not affect, in our view, the ability of the CBN to continue interventions across the various FX windows.

The CBN’s FX reserves position has been remarkably stable this year and is high by historical measures, suggesting that it will be possible to maintain these rates in the I&E Window – or rates close to them – for several months, at least. BONDS& T-BILLS Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was bearish as system liquidity remained tight.

As a result, the average benchmark yield for bonds rose 38bps to close at 11.86 per cent. Across the curve, the yields on the 3-year (+137bps to 11.39 per cent) and the 7-year (+54bps to 11.59 per cent) bonds expanded, while the yield on the 10-year bond was flat at 12.05 per cent.

At last week’s primary auction, the Debt Management Office (DMO) allotted a total of N123.84 billion.

Demand was the weakest since December 2021, as reflected by a total subscription of N142.29 billion and a bid-to-offer ratio of 0.63x (previously 2.45x). Consequently, yields across the March 2025 (+90bps to 11 per cent), April 2032 (+50bps to 13 per cent) and January 2042 (+60bps to 13.75 per cent) bonds expanded.

Our view remains that the combination of thin system liquidity and elevated Federal Government domestic borrowing will continue to drive yields upwards over the coming months. Activity in the Treasury Bill (T-Bill) secondary market was also bearish as investors continued to sell short-dated bills in the face of tight system liquidity.

Consequently, the average yield for T-bills rose by 35bps to 7.25 per cent. Conversely, the yield on the 321-day T-bill contracted by 1bp to close at 6.37 per cent.

At the primary auction, the DMO is expected to roll over N264.28 billion worth of maturing bills. Elsewhere, the average yield for secondary market OMO bills rose by 158bps to 8.94 per cent, while the yield on the 284-day OMO bill shed 1bp to 6.79 per cent.

OIL Last week, the price of Brent rebounded from the prior week’s loss, rising to as high as $107.35/bbl, its highest level since 4 July, before settling at $103.20/bbl.

The 2.02 per cent w/w gain marked Brent’s first weekly gain in six weeks. As a result, Brent is up 32.68 per cent year-to-date and has traded at an average of $104.94/bbl, 48.03 per cent higher than the average of US$70.89/bbl in 2021.

Oil prices remained volatile as the market continued to weigh up the threat of recession against tight market supply. Peak driving summer season demand in the US appeared weak.

For other downside indicators, one could point to the European Central Bank (ECB) hiking rates for the first time in many years and the anticipated outcome of the US Federal Open Market Committee (FOMC) meeting this week, in which US Fed officials have indicated the likelihood of a 75-basis points rate hike.

In this exceptional year for oil prices, however, we doubt that prices will fall lower than the $73.00/bbl set in Nigeria’s government budget. EQUITIES Last week, the NGX All-Share Index lost 0.45 per cent to settle at 51,979.92 points. Its year-to-date return fell to 21.69 per cent.

Honeywell Flour Mills (-14.55 per cent), Nigerian Breweries (-10.92 per cent) and International Breweries (-6.90 per cent) closed negative while Seplat Energy (+10.00 per cent), FBN Holdings (+2.75 per cent) and FCMB Group (+0.67 per cent) closed positive.

Performances across the NGX sub-indices were predominantly negative as the NGX Banking (-4.06 per cent), NGX Consumer Goods (-1.97 per cent), NGX Pension (-0.88 per cent), NGX-30 (-0.56 per cent), and NGX Industrial Goods (- 0.49 per cent) indices declined, while the NGX Oil & Gas (+3.80 per cent) and NGX Insurance (+1.81 per cent) indices rose. See Model Equity Portfolio on page 3.

The significant reduction in foreign investor participation on the NGX Exchange in recent years has coincided with a fall in stock valuations.

We decided to look at historical data to see whether there is a correlation between the two factors but found that it is not strong.

So why do they not correlate? There are several reasons. In 2013, there were net inflows (N20.5 billion) of Foreign Portfolio Investment (FPI) and this correlated with a rise in the valuations, in this case price-earnings (P/E) ratios, of stocks on NGX Exchange.

In 2014, 2015 and 2016 there were net outflows of FPI, but there was little correlation with equity valuations. On average, valuations rose in 2014, fell in 2015 and rose again in 2016.

What was driving this process? At the end of 2013, valuations were moderate but there was not much-earning growth in prospect in an environment of high-interest rates, so foreign investors were cautious with the equity market.

In 2014, the oil price crashed (Brent slumped 48.3 per cent y/y) and the Nigerian equity market fell, a decline that went on into 2015 and into 2016 when currency problems began to surface.

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As in 2014, the equity market in 2016 did not decline as much as earnings, making valuations rise again.

Thanks to the resolution of currency issues in August 2017, FPI rose dramatically.

Much of the incoming money went into fixed income instruments (yields were high) but a fair amount was directed at the equity market which enjoyed a significant rally (the NGX All-Share Index gained 42.3 per cent that year).

In addition, company earnings recovered strongly, and valuations tracked downwards. In 2018, valuations and net FPI dropped.

The equity rally in 2017 had been exuberant (and continued into the first month of 2018) but later tapered.

Interest rates were also low during the first part of the year, only rising from mid-year onwards, with the result that some of 2017’s foreign investors in fixed income instruments thought fit to take profits.

The process continued during 2019 with a continued bear market in equities and net outflows of FPI. By the end of 2019 and into the first quarter of 2020, equity valuations were low relative to their history. Heavy pandemic induced selloffs and increased FPI outflows compounded the issue.

While it is always difficult to put a buy recommendation on a market simply because it is cheap, the conditions were ripe for a remarkable rally in the extraordinary conditions that followed.

From the second quarter of 2020, the market recovered strongly despite the fall in earnings as domestic investors rotated into equities amid unprecedented low market interest rates.

As a result, valuations surged. Since then, foreign investors have continued to be net sellers in the equities market amid FX liquidity issues, while domestic investor participation has continued to surge amid negative inflation-adjusted fixed income yields.

However, valuations fell in 2021, as earnings recovered strongly from the pandemic-induced dip. The story has remained the same in 2022 as earnings have continued to grow.

In the long-term context, the NGX ASI is trading at 24 per cent discount to its long-term average P/E valuation.

Although market interest rates are rising, and are likely to attract a certain amount of money into Money Market and Fixed Income funds, we believe there is still potential for earnings to surprise on the upside, pushing downward pressure on valuations again. That suggests that the NGX All-Share Index is cheap.

~Coronation

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