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Nigerian equities record strong H1-2022 performance, is there still value in the market?

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Nigerian equities recorded a strong outing in the first half of the year as the benchmark NGX-All Share Index (NGX-ASI) gained 21.3 per cent, outperforming the MSCI Frontier Market index (-19.5 per cent in H1-2022) and MSCI Emerging Market index (-18.8 per cent in H1-2022).

The healthy performance of Nigerian equities in H1-2022 was underpinned by several factors. First, corporate earnings performance remained very strong as listed Nigerian corporates continued to defy the hostile operating conditions.

For context, the weighted average growth of Net Profit of the top 10 most capitalised stocks on the NGX (accounting for 83.4 per cent of total market capitalisation) printed at 36.3 per cent y/y in Q1-2022.

In addition, the interest rate environment was broadly accommodative for equity investors as the CBN defaulted to being interest rate defensive in H1-2022. Thus, despite implementing a 150bps hike in its benchmark policy rate, the CBN contained the direct impact on interest rates via budget support for the government, interest rate repressive policies and moral suasion of banks.

As a result, the average yield across the yield curve has declined by 21bps YTD. This accommodative yield environment provided a boost for Nigerian equities’ performance.

Analysing the performance of the different sectors of the Nigerian equities market in H1-2022 reflects the strength of solid corporate performances. The Oil & Gas sector-led gained 58.1 per cent as strong gains in oil price fed buy an interest in SEPLAT (+100 per cent YTD) while CONOIL’s (+30.9 per cent YTD) outstanding FY-2021 performance and dividend announcement drove further gains.

The Telecoms sector also delivered outstanding price appreciation following gains in AIRTEL AFRICA (+81.4 per cent YTD) and MTNN (+16.8 per cent YTD). The Industrial goods (+7.2 per cent YTD) and Consumer goods (+5.9 per cent YTD) sectors also delivered a decent outing in the first half of the year as most companies in the sector benefitted from being able to raise prices amidst the high inflation environment.

On the flip side, the Insurance (-10  per cent YTD) and Banking Sectors (-2 per cent YTD) delivered no value to investors as regulatory bottlenecks and rising competition from fintech alternatives continue to weigh.

Following the relatively strong outing for Nigerian equities in H1-2022, the question on the mind of investors is; “Is there still value in Nigerian equities?” To answer this question, we examined the current valuation of Nigerian equities relative to historical pricing and peer pricing.

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At the end of H1-2022, the NGX-ASI traded at a PE ratio of 10.5x, a 14.5 per cent discount to its five-year average and the MSCI FM. Interestingly, Nigerian equities have continued to deliver above historical average earnings growth, implying they should be trading at a premium to the five-year average PE ratio of 12.3x.

Thus, we estimate the fair pricing of Nigerian equities at 14.0x – 15.0x PE ratio, implying an c.40.0 per cent upside in value for Nigerian equities. Despite the existence of this value, concerns border around if the value will be realized amidst various headwinds including Pre-election jitters and Hawkish Monetary Policy.

The first concern for us is the hawkish monetary policy environment which historically has proved to be a concern for investors in the equities market. Since the Godwin Emefiele CBN-led Monetary Policy Committee (MPC) took office, the MPR has been raised thrice, with the benchmark NGX-ASI losing an average of 2.3 per cent within the first month of the rate hike but going on to gain 4.7 per cent and 0.5 per cent in the subsequent 3-month and 6-month period.

Thus, we establish a clear pattern of an initial negative reaction to rate hikes but the subsequent correction in the long run due to lack of immediate impact on the yield curve.

In H2-2022, we expect the MPC to maintain its newfound hawkish policy tilt in an attempt to rain in on inflation. However, we expect that the CBN will continue to contain any impact on yields, making fixed income instruments unattractive despite rising MPR, a move it successfully deployed in H1-2022.

Thus, we believe the prospects of additional rate hikes would not have a significant negative impact on equities unless the CBN finally lifts the lid on the interest rate.

Another factor to evaluate is the upcoming 2023 general elections, a critical factor for the equities market in the final six months before the election year. Taking a cue from history, in second half of a pre-election year, the NGX-ASI has lost an average of 2.9 per cent over the past five pre-election years (2002, 2006, 2010 and 2014).

Interestingly, the NGX-ASI has lost in four of such periods out of the previous five. In addition to the dismal performance of Nigerian equities during the period, investors have historically shown uneasiness during the second half of a pre-election year as foreign investors have always exited Nigerian equities aggressively with local institutional following suit.

In today’s context, foreign investors no longer play an active role in trading Nigerian equities as they control less than 25 per cent of market activities, thus we do not expect any significant selloffs from them due to current subdued presence in the Nigerian market.

Consequently, local institutional investors may have more incentive to remain in the market as long as election activities don’t turn violent.

It is however critical to examine the activities of foreign investors in H2-2022. The foreign investor activity remains subdued as the scarcity of FX continues to remain a deterrent for any form of investment.

The situation has been worsened by hawkish monetary policy by the US Fed and other Advanced Market monetary policy makers. Looking ahead to the rest of the year, foreign equity investors are likely to continue shunning Nigerian equities as the FX crunch is expected to persist (on declining crude oil production and lack of access to international debt markets) while the pre-election environment would further raise the risk premium for foreign investors.

In our view, we recommend this equity investment strategy tilt for foreign investors due to the inability to repatriate funds as well as elevated devaluation risks.

For domestic investors, we see a situation where the CBN is able to keep domestic interest rates in check despite pursuing a tighter monetary policy while pre-election activities will only trigger a broad-based market selloff if it turns broadly violent.

On the other hand, we expect Nigerian corporates (particularly FMCGs, Brewers, Upstream Oil & Gas, Oil Palm and Cement companies) to continue to deliver strong corporate earnings despite the tight operating environment.

As a result, we recommend domestic investors continue to explore opportunities in the previously highlighted sectors for capital gains in the equities market. That said, risks to this expectation are a decision by CBN to lift the lid off bond yields & treasury bills and a sudden violent turn in the 2023 elections.

~FSDH Research

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