cytonn monthly may 2016

Cytonn Monthly – May 2016

Executive Summary

• Fixed Income: Yields on government securities were on a downward trend during the month. Kenya’s inflation rate for the month of May came in at 5.0%, from 5.3% recorded in April and the CBK eased its monetary policy by lowering CBR by 100 bps to 10.5%. Kenya’s 2015 GDP growth came in at 5.6%;

• Equities: The equities market was on a downward trend during the month, with NASI, NSE 20 and NSE 25 declining by 1.3%, 1.0% and 1.9%, respectively compared to 6.4%% and 6.0% for the NASI and NSE 20, respectively in the same period last year. All listed banks released their Q1 results recording a weighted average core EPS growth of 12.8% compared to 5.0% for the same period last year;

• Private Equity: Real estate, financial services, and health sectors continued to witness increased private equity activity in Africa during the month as indicated by increased fundraising activities and funds deployment towards these sectors;

• Real Estate: Real estate sector continues to attract investments from both private and public sectors as the government adopts Eurocode construction standards in a bid to improve on quality of buildings and match global construction standards.

Company Updates

• Our Senior Investments Analyst, Duncan Lumwamu discussed the upcoming budget reading on KBC. Duncan Lumwamu on KBC.

• Our Senior Investments Analyst, Duncan Lumwamu also discussed the banking sector in East Africa and the latest move by KCB Group and Commercial Bank of Africa to venture into Somalia market on CNBC. Duncan Lumwamu on CNBC.

Fixed Income

Treasury bills subscriptions declined during the month of May, with overall monthly subscriptions at 132.6% compared to 186.2% in April. Yields on T-bills declined by 90 bps, 50 bps and 40 bps for the 91-day, 182-day, and 364-day bills, respectively, closing the month at 7.7%, 10.0% and 11.3%, down from 8.6%, 10.5% and 11.7%, respectively, at the end of April 2016. Yields have remained relatively low and stable on account of:

i. Eased pressure on domestic borrowing, with the government having exceeded its domestic borrowing target of Kshs 219.0 bn by over Kshs 107.3 bn and,

ii. Increased liquidity as evidenced by a 100 bps decline in the interbank rate to 3.1% at the end of May, from 4.1% in April as a result of net liquidity injection of Kshs 25.3 bn as shown below:

all values in Kshs bn, unless stated otherwise May 2016 Liquidity Position -‐ Kenya

Liquidity Injection Kshs bn Liquidity Reduction Kshs bn Term Auction Deposit Maturities 54.4 T-‐bond sales 39.6

Government Payments 102.7 Transfer from Banks -‐ Taxes 75.7 T-‐bond Redemptions 23.0 T-‐bill (Primary issues) 77.7 T-‐bill Redemptions 66.9 Term Auction Deposit 36.4 T-‐bond Interest 11.5 Reverse Repo Maturities 38.5 Reverse Repo Purchases 34.7 Total Liquidity Injection 293.2 Total Liquidity Withdrawal 267.9 Net Liquidity Injection 25.3

Source: CBK Last week, treasury bills subscription levels declined, coming in at 146.6%, compared to 230.3% the previous week. While subscription rates for the 91, 182 and 364-day T-bills remained high at 130.7%, 153.2% and 150.6%, respectively, the were lower compared to 255.3%, 175.7%, and 268.2% the previous week. Yields for the 91-day, 182-day and 364-day came in at 7.5%, 9.8% and 11.0% from 7.7%, 10.0% and 11.3% last week, respectively, with the rate of decline in yields decreasing week on week, indicating the bottoming out of interest rates at the current levels as we had highlighted in Cytonn Weekly Report #16.

The 91-day T-bill is currently trading below its 5-year average of 10.6%, having witnessed declines in the last two months. The Central Bank of Kenya (CBK) is keen on ensuring a low and stable interest rates environment, indicated by easing of the monetary policy stance of lowering the CBR by 100 bps to 10.5%. However, despite the reduction in CBR, we expect the rates to bottom out at the current levels as we close out on the current fiscal year.

Source: CBK According to Bloomberg, the yields on the 10-year and 5-year Kenyan Eurobonds closed at 8.2% and 6.6%, respectively, for the month of May up from 7.8% and 6.2% at the end of April. From peak in mid-January 2016, the yields have declined 141 bps and 221 bps for the 10 and 5-year bonds respectively, as a result of stable macroeconomic factors such as (i) 2015 GDP growth of

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91-‐Day T-‐bill rate's 5-‐yr Average

5.6%, (ii) a narrowing current account deficit to 11.4% of the GDP from 14.5% in 2015, and (iii) a stable shilling.

However, there has been noticeable uptick in the yields rising by approximately 42bps from last month, which may be attributable to the recent stalemate on the reconstitution of IEBC as the electioneering period approaches. The recent political bickering will have a negative impact in the Kenyan market, most importantly as the country gears for a second issue of the Eurobond, which could lead to investors demanding a premium to hold the Eurobond. Global Rating Services Firm S&P has affirmed Kenya’s credit rating at B+ for long-term debt and B for short-term debt. However, S&P has noted that there are concerns over the recent political protests and the likelihood of excessive spending on elections scheduled for August 2017 and has now issued a 33% probability of a downgrade following an uptick in political risk in the country. S&P has also noted that Kenya will attract higher interest rates when it sells a second Eurobond.

Source: Bloomberg Government is still ahead of its borrowing schedule having borrowed from the domestic market Kshs 326.3 bn for the current fiscal year against a pro-rated borrowing target of Kshs 202.8 bn. The excess borrowing from the domestic market will help plug the deficits in both foreign borrowing of Kshs 74.9 bn and tax collections of Kshs 33.9 bn, as shown below.

(all values in Kshs mn, unless stated otherwise)

2015/2016 Budget Financing

Source of Financing 2015/2016 FY Target

Pro-‐rated Target

Actual Collection Variance Possible Effect on

Interest Rates

Foreign Borrowing 401,691 371,564 296,650 (74,914) Negative

Domestic Borrowing 219,200 202,760 326,312 123,552 Positive

KRA Collections 1,254,867 1,160,752 1,126,844 (33,908) Negative

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Kenya Eurobond Yields

10-‐Year 5-‐Year

Total Funding 1,875,758 1,735,076 1,749,806 14,730 Positive

*Recalculated using 8-‐months published data

Source: Treasury/CBK

(all values in Kshs mn, unless stated otherwise) 2015/2016 Budget Financing as at December 2015

Area of Expenditure 2015/2016 FY Target Actuals Variance Possible Effect on

Interest Rates Recurrent 501,700 416,500 85,200 Positive Development 332,200 204,400 127,800 Positive Other 163,100 106,500 56,600 Positive Total Expenditure 997,000 727,400 269,600 Positive

Source: Treasury/CBK In May, the Kenya shilling strengthened by 0.3% against the dollar, closing the month at Kshs. 100.8 compared to Kshs 101.1 at the end of April. On a YTD basis, the shilling has remained steady against the dollar, appreciating by 1.4%. The performance of the Kenya shilling is attributable to (i) improved forex reserves currently at USD 7.7 bn, equivalent to 5.0 months of import cover, (ii) improved diaspora remittances, with the inflows increasing by 10.4% over the last 12 months to April 2016, to USD 1.6 bn from USD 1.5 bn in the year to April 2015, and (iii) the approved increment in the precautionary facility offered to Kenya by the IMF. We expect the shilling to remain stable during the year supported by favourable macroeconomic factors.

During the month, the government issued a 2-year FXD 2/2016/2 bond and a 9-year IFB 1/2016/9 infrastructure bond which recorded a performance rate of 269.8% with total subscriptions at Kshs 80.9 bn compared to offer amount at Kshs 30.0 bn. The government accepted Kshs 39.6 bn with a skew towards the IFB 1/2016/9 where they accepted Kshs 34.9 bn compared to Kshs 4.7 bn accepted for the FXD 2/2016/2. The average yields for the 2-year and the 9-year bonds came in at 12.5% and 13.5% respectively in line with our recommended bid range of 12.4% – 12.9% and 12.3% - 13.3% for the 2-year and the 9-year bonds, respectively: See Cytonn Weekly Report #19.

The secondary bond market activity increased during the month of May with turnover increasing by 20.9% to Kshs 46.2 bn from Kshs 38.3 bn in April. We have seen the yield curve correct marginally in the mid-tenors but remain relatively flat on the long-term bonds. Investors’ focus is shifting towards longer-dated papers as rates stabilize within the shorter end of the yield curve and are now fairly priced on a risk-adjusted basis. The NSE FTSE bond price index gained 1.5% during the month as the yields on government bonds declined.

Source: NSE During the month, the Monetary Policy Committee (MPC) lowered the Central Bank Rate (CBR) for the first time in 9 months by 100 bps to 10.5% on account of declining inflation (in May it was at 5.0% from 5.3% in April) and a stable shilling which is supported by the higher forex reserves equivalent to 5 months of import cover. In our view, despite improvements in macroeconomic environment, inherent risks persist including: (i) upward pressure on inflation in the coming months driven by excise duty, VAT on petroleum products and the rising oil prices globally, (ii) spill-over effects if the fed increases rates in June, and (iii) possible increase in the fiscal deficit due to low tax collections.

Inflation for the month of May came in at 5.0%, a 27bps decline from 5.3% in April 2016 and this is the lowest since June 2013, coming in below our projection of 5.3%. See Cytonn Weekly #21. The low inflation rate was due to a higher base effect from last year despite increases in (i) Food and Non-Alcoholic drinks index (0.82%), and (ii) transport index (0.55) as a result of increases in food prices and the high cost of petrol and diesel. We expect inflation to remain within the government target annual range of 2.5% - 7.5% going forward to the end of the year.

Multilateral Trade Agreements

Kenya has signed pacts/Memoranda of Understanding (MOU) with South Korea, Russia and Turkey in the past week engaging in partnerships for mutual economic development. Kenya will partner with Russia in designing, building and operating commercial and research nuclear power reactors in a move aimed at increasing power production in Kenya. Kenya also signed three pacts with Turkey including: an MOU between Turkish Radio &Television (TRT) and KBC Television, an MOU between the Ministry of Water & Irrigation, and Yepi Merkezi, to support the implementation of the Greater Mt. Elgon-Bungoma-Busia Multipurpose Water Project and an MOU between the Turkish Standards Institute and Kenya Bureau of Standards bringing to 13 the number of bilateral agreements signed between Kenya and Turkey so far. Kenya also signed an MOU with South Korea in a USD 100 mn initiative to build a Public Research University in Konza city. The Korean Export and Import (Exim) Bank will provide the funding for the

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establishment of the Kenya Advanced Institute of Science and Technology (KAIST), the first such university outside Korea. Kenya signed other seven pacts with South Korea in areas of science and technological, industry, trade, energy and Health. The signing of these pacts signifies Kenya’s strategy to continue to boost trade between global players, while at the same time streamlining the key pillars for achievement of the Vision 2030.

The Cabinet Secretary National Treasury shall be tabling in parliament this week, the 2016/2017 budget which is estimated to come in 11.2% higher to Kshs 2.3 tn from Kshs 2.0 tn in 2015/2016. The budget is based on an expected economic growth rate of 5.8% in 2016. Below is a preliminary summary of the 2016/2017 fiscal year budget estimates published in the Budget Policy Statement:

2016/2017 Budget Estimate Summary (Kshs Bn) Expenditure Revenue

Recurrent Expenditure 850.3 KRA Collections 1,376.4 Developmental Expenditure 809.0 Appropriation in Aid 124.2 Interest Payments & Pensions 311.0 Grants 72.6 Net Lending & contingencies fund 7.1 Total Collections 1,573.2 County Allocations 284.8 Domestic Borrowing 229.6 Foreign Borrowing 459.4 Total Expenditure 2,262.2 Total Revenue 2,262.2 Deficit 689.1

Source: Treasury/Draft Budget Policy Statement 2016/2017 The total budget is estimated at Kshs 2.3 tn, with recurrent expenditure at Kshs 850.3 bn and development expenditure at Kshs 809.0 bn, representing 11.5% and 10.9% of the GDP. Key to note is that recurrent expenditure is proposed to decline to 11.5% of GDP from 12.2% in 2015/16, an indication that the government is focusing on cutting down the portion of expenditure. Development expenditure is expected to support ongoing infrastructure projects in roads, the Standard Gauge Railway, ports, energy and security.

The budget will be funded by Kshs 1.4 tn from domestic tax collection, 18.6% of GDP (18.0% of GDP in 2015), an increment which shall be achieved by broadening the tax base and improving revenue administration through simplified and modernized VAT legislation. For the 2015/2016 financial year, this is estimated to have been at Kshs 1.2 bn compared to the budgeted amount of Kshs 1.3 tn.

Budget deficit is projected to reduce to 9.3% of GDP from 10.1% of GDP, amounting to Kshs 689.1 bn. This deficit is expected to be funded by domestic borrowing of Kshs 229.6 bn and external borrowing of Kshs 459.4 bn. Moving forward, addressing revenue shortfalls is key in narrowing this gap by: (i) broadening the tax base for example having passed the Excise Duty Act, (ii) sealing the loopholes in KRA collections through digitization of processes (i-TAX), and (iii) restructuring of the KRA processes on revenue administration. The step in lowering recurrent expenditure to 11.5% is commendable, however risks abound with the high 41.5% recurrent expenditure. Nevertheless, with continued investments in development expenditure, the

economy is expected to grow and take up some of these costs. Going forward, we expect the government to be cautious on the deficit funding options, highlighted in Cytonn Weekly #21, as too much borrowing or reliance on global markets open’s up the country to international economic occurrences which could be bad for the economy. It is imperative that we be cautious on borrowing if we are to achieve the long term economic stability.

The government is ahead of its domestic borrowing schedule, having borrowed Kshs 326.3 bn for the current fiscal year compared to a target of Kshs 202.8 bn (assuming a pro-rated borrowing throughout the financial year of Kshs 219.0 bn budgeted for the full financial year). With less than one month left to the end of the current fiscal year, the government has surpassed its local borrowing target. The additional Kshs 107.3 bn above the target will go towards plugging the tax collection deficit by KRA and the shortfall in international borrowing. Focus now is on the upcoming budget and modalities of funding it. With interest rates still coming down, but showing signs of bottoming out at the current levels, we advise investors to lock in funds in short to medium term paper for tenors between six months and one year as the rates are attractive on a risk-adjusted basis.

Equities

During the month of May, the equities market was on a downward trend with NASI, NSE 20 and NSE 25 losing 1.3%, 1.0% and 1.9%, respectively, on the back of losses in large caps led by Co-operative Bank, Barclays, KCB Group and EABL which lost 12.5%, 8.7%, 6.6% and 0.2%, respectively. During the week, the market registered a decline with the NASI, NSE 20 and NSE 25 losing 1.4%, 1.7%, and 1.8%, respectively taking the YTD performance to (1.5%), (5.9%) and (1.9%), respectively. Since the February 2015 peak, the market has been down 30.9% and 19.2% for the NSE 20 and NASI, respectively.

Equities turnover fell by 8.8% during the month to Kshs 8.9 bn from Kshs 9.8 bn in April 2016 on the back of decreased foreign investors’ activity in large cap stocks. Foreign investors were net buyers for the second month with net inflows of USD 4.3 mn, compared to net inflows of Kshs 3.5 mn witnessed in April 2016 taking advantage of the relatively lower prices. We still expect earnings growth to improve in 2016 compared to 2015 supported by a favourable macroeconomic environment despite the negative start to the year, long-term investors should gradually be taking positions in the market due to the attractive valuations.

The market is currently trading at a price to earnings ratio of 13.0x, versus a historical average of 13.8x, with a dividend yield of 4.7% versus a historical average of 3.4%. The charts below indicate the historical PE and dividend yields of the market.

Source: Bloomberg/NSE

Source: Bloomberg/NSE Barclays Bank of Kenya released Q1’2016 results

Barclays Bank of Kenya released their Q1’2016 results recording a core EPS growth of 2.6% y/y to Kshs 0.40 per share from Kshs 0.39 per share in Q1’2015, driven by an 8.4% growth in operating revenue which was outpaced by operating expenses which grew by 16.4%. Key performance indicators:

• Operating revenue grew by 8.4% to Kshs 8.0 bn from Kshs 7.4 bn in Q1’2015, supported by growth in non-interest income of 9.8% and a 5.4% growth in interest income resulting into a revenue mix of 68:32 funded to non-funded income

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NASI Dividend Yield

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• Operating expenses grew by 16.4% to Kshs 4.9 bn from Kshs 4.2 bn in Q1’2015 driven by (i) 127.3% growth in loan loss provisions to Kshs 0.8 bn from Kshs 0.4bn in Q1’2015, and (ii) a 6.4% growth in staff costs to Kshs 2.4 bn from Kshs 2.3 bn in Q1’2015. The higher growth in expenses resulted to an increase in the cost to income ratio to 61.9% from 57.7% in Q1’2015

• Customer deposits grew by 8.3% to Kshs 168.9 bn from Kshs 165.1 bn in Q1’2015, slightly lower than our growth projection of 10.0% while loan growth came in at 21.7% to Kshs 152.4 bn from Kshs 145.4 bn in Q1’2015 supported by the retail and SME business lines. Loan to deposit ratio increased to 90.2% from 80.3% in Q1’2015, higher than the industry average of 83.2%

• Yield on interest earning assets increased to 13.0% in Q1’2016 from 12.4% in Q1’2015 while the cost of funds increased to 3.0% in Q1’2016 from 2.3% in Q1’2015, highlighting the impact of high cost deposits from the high rate environment in 2015 that rolled over to the first quarter. This led to a decline in net interest margin to 10.9% from 11.6% in Q1’2015

• PAT growth came in at 3.1% to Kshs 2.2 bn from Kshs 2.1 bn in Q1’2015 in line with our projections of a 3.4% increase

Barclays Bank results were in line with their strategy to diversify their customer base from corporate clients and individuals to the growing SME segment. In our view, the bank needs to adopt alternative deposit mobilization avenues such as agency banking in order to compete with other tier one banks and drive growth in the future. For more details on Barclays Bank of Kenya earnings, please see our Earnings note at: Barclays Bank Earnings Note

Listed Banks Q1’2016 Results

During the month, Kenyan listed banks released their Q1’2016 results recording an average growth in core earnings per share of 12.8% compared to 5.0% in Q1’2015. In summary, the listed banks can be categorised into four main buckets:

• The strong growth banks, with above 20% earnings per share growth: HF Group and Standard Chartered. However, it is notable that for both HF Group and Standard Chartered, growth was driven by real estate sales and forex income, respectively, which may not be sustainable in the future

• The stable growth banks, with 10% and above growth in earnings per share: Equity Group

• Anemic growth banks, with below 10% earnings per share growth: Diamond Trust Bank, Co-operative Bank, KCB Group, Barclays Bank, NIC Bank, I&M Bank and CFC Bank

• Negative growth banks: National Bank of Kenya

Below is a summary of the key metrics:

Listed Banks Q1'2016 Earnings and Growth Metrics

Bank Core EPS Growth Deposit Growth Loan Growth Net Interest Margin

Fee income to Operating Revenue

LDR

Q1'2016

Q1'2015

Q1'2016

Q1'2015

Q1'2016

Q1'2015

Q1'2016

Q1'2015

Q1'2016

Q1'2015

Q1'2016

HF Group 47.6% -‐33.7% 23.6% 15.9% 12.1% 28.0% 6.6% 6.2% 20.0% 16.7% 130.8% Stanchart 42.7% -‐28.0% 12.9% 9.2% -‐3.7% -‐10.6% 9.4% 9.2% 32.6% 24.3% 59.5% Equity Group 19.8% 10.5% 8.1% 34.6% 22.4% 34.6% 11.0% 10.7% 33.3% 42.5% 81.2% DTB Bank 9.5% 9.4% 26.1% 21.6% 24.1% 26.0% 1.8% 1.7% 20.5% 27.0% 87.2% Co-‐op Bank 7.7% 28.7% 11.9% 24.9% 16.1% 19.0% 16.9% 9.8% 33.8% 33.7% 81.7% KCB Group 6.1% 6.5% 6.6% 26.7% 16.5% 27.1% 8.5% 8.8% 26.0% 33.3% 81.7% Barclays Bank 2.6% 8.3% 8.3% 8.1% 21.7% 7.3% 10.4% 11.2% 20.7% 21.6% 90.2%

NIC Bank 0.0% -‐4.9% 14.8% 4.1% 6.1% 25.3% 8.1% 7.5% 26.8% 31.3% 101.5% I&M Bank 0.0% 0.0% 15.7% 18.3% 11.3% 21.5% 1.8% 1.7% 25.6% 25.7% 96.1% CFC Bank* 0.0% 0.0% 3.2% 17.3% 14.7% 19.5% 5.9% 5.7% 41.0% 45.0% 95.2% National Bank -‐38.4% 20.5% 16.6% 4.3% -‐5.3% 48.4% 6.8% 7.8% 24.5% 29.3% 66.7%

Weighted Average** 12.8% 5.0% 10.9% 22.2% 15.6% 21.1% 9.2% 8.3% 29.3% 32.9% 83.2%

*CFC and I&M numbers are for the bank only and not for the listed holdings entities. We have excluded them in calculation of the weighted average **Average is Market cap weighted

Source: Cytonn Research Key highlights for the results are:

• Loan growth vs deposit growth: All Tier one banks with the exception of Standard Chartered recorded higher loan book growths compared to deposit growth. However, KCB Group and Equity deposit growths were affected by currency translation as a result of South Sudanese Pound revaluations. Tier 2 banks were more aggressive in deposit mobilization with DTB, NIC, National Bank, I&M and HF Group recording double digit growths

• Increase in loan loss provisions: Banks’ profitability was affected by high levels of non-performing loans, leading to increased loan loss provisions with an average growth of 127.0% from Q1’2015. The prevailing high levels of non-performing loans are as a result of spill-over effects of the expensive cost of financing loans witnessed in the latter part of 2015. Non-performing loans have risen by 91.2% in Q1’2016 with National Bank continuing to bear the brunt of this with their negative earnings growth. The Central Bank has also stepped in to issue a directive that will see banks become more disciplined in provisioning which will see the level of provisioning remain high this year

• Exposure to South Sudan: Due to the devaluation of the South Sudanese Pound, banks that operate in the country i.e. Equity Bank, KCB Group and CFC Stanbic have lost significant value on their assets hence recording lower than expected return.

For more information on the listed banks’ Q1’2016 performance, see our Earnings Notes. We will be releasing a detailed analysis of the banking sector Q1’2016 performance in our Q1’2016 banking report on 13th June, 2016.

During the month, Uchumi Supermarkets faced a winding up crisis with suppliers moving to court to force the retailer to pay up on back-dated debts worth Kshs 3.6 bn. The end result of this was Uchumi proposing a debt for equity swap which will see the suppliers converting Kshs 1.8 bn of their debt to equity, a move that will result in a dilution of up to 42% as highlighted in Cytonn Weekly Report #20. The deal has since stalled with seven multinational companies among them Coca-Cola, Reckitt Benckiser and Unilever delaying the process as they seek approval from their parent firms to participate in the debt restructuring. Uchumi’s success going forward will be hinged on its ability to (i) implement its turnaround strategy, and (ii) pay off its suppliers to avoid winding up the company.

Kengen rights issue

KenGen’s planned cash call through a rights issue aimed at raising Kshs 28.8 bn began on 23rd May, 2016 with the company offering 4.4 bn new shares at Kshs 6.55 per share, a discount of 3.8% from the current market price of 6.80 per share, which will rank pari passu with the existing shares. Current shareholders have an entitlement of 2:1 and with the government as the biggest shareholder at 70%, had already expressed intention to take up their full entitlement through conversion of debt to equity. The success of the rights issue will improve the liquidity and capital structure. The company currently has short-term borrowings amounting to Kshs 9.4 bn that is due in 2016 informing our view that the proceeds of the right issue will be used to retire debt obligations and will have a minimum impact in the company’s development strategy. Kengen is a strong company with positive return potential given the capacity expansion projects as well as the diversification of revenue streams.

The Nairobi Securities Exchange (NSE) will now be able to roll out derivatives trading by the end of the year following shareholders’ approval during the AGM this week to issue 64.9 mn bonus shares worth Kshs 259.5 mn, increasing the paid up capital to Kshs 1.0 bn which is the regulatory threshold to operate a derivatives market. The derivatives market will result into deepening of the capital markets by giving investors an opportunity to hedge against currency fluctuations and also participate in alternative trading with minimal funds.

Below is our equities recommendation table. Key changes for the month include:

• Diamond Trust Bank and Equity Group have moved from “Hold” to “Accumulate” following a 6.0% and 1.3% drop in stock price respectively

all prices in Kshs unless stated EQUITY RECOMMENDATION

No. Company Price as at 29/04/16

Price as at

31/05/16

m/m Change

Target Price*

Dividend Yield

Upside/ (Downside)** Recommendation

We remain neutral on equities given the significantly low earnings growth prospects for this year. The market is now purely a stock picker’s market with few pockets of value

Private Equity

During the month, Pan African Housing Fund (PAHF), a private equity fund dedicated to residential real estate development in East and Southern Africa and managed by Phatisa, committed USD 5.1 mn of equity investment to develop a middle-income residential property in Zambia on a joint venture basis. Zambia’s residential real estate market is largely untapped, with middle-income and affordable housing showing the most growth potential in the medium term. The fund already has live development projects in Nakuru and Nairobi towns of Kenya.

International Finance Corporation (IFC), also committed USD 40 mn in equity investment in South Africa’s Growthpoint Investec African Properties Limited, a property investment holding company led by Investec Asset Management and Growthpoint Properties, to be channeled towards commercial real estate assets such as office parks, retail, industrial or logistics properties in Sub-Saharan Africa. Both developments will generate critical facilities for businesses and residential consumers that will, in turn, provide a foundation for continued rapid growth in Africa. Real estate continues to be one of the most attractive investment sectors in the region for emerging and advanced investors.

IFC, in its bid to continue its development in the emerging markets financial sector, has also committed investments of up to USD 25 mn in First National Bank (FNB) Zambia. This funding

1. KCB Group*** 41.5 38.8 (6.6%) 53.7 4.9% 43.5% Buy 2. Centum 44.8 41.3 (7.8%) 57.2 0.0% 38.7% Buy 3. Kenya Re 19.5 21.0 7.7% 26.7 3.5% 30.6% Buy 4. DTBK**** 200.0 188.0 (6.0%) 214.0 1.2% 15.0% Accumulate 5. NIC 37.5 38.3 2.0% 42.9 2.7% 14.8% Accumulate 6. Barclays 11.0 10.0 (8.7%) 10.3 9.7% 12.7% Accumulate 7. Equity Group 40.0 39.5 (1.3%) 41.9 4.9% 11.0% Accumulate 8. Liberty 16.0 15.5 (2.8%) 17.2 0.0% 11.0% Accumulate 9. Co-‐op Bank 19.6 17.2 (12.5%) 18.0 4.3% 9.5% Hold 10. I&M Holdings 112.0 109.0 (2.7%) 112.0 3.1% 5.9% Hold 11. StanChart*** 193.0 209.0 8.3% 207.2 6.5% 5.6% Hold 12. HF Group 21.5 19.9 (7.7%) 19.6 6.5% 5.2% Hold 13. CfC Stanbic 93.0 88.0 (5.4%) 85.4 7.2% 4.3% Lighten 14. Jubilee 470.0 473.0 0.6% 477.8 1.8% 2.8% Lighten 15. Safaricom 17.1 17.0 (0.6%) 16.6 4.2% 1.9% Lighten 16. CIC Insurance 5.3 4.8 (10.4%) 4.7 1.9% 0.9% Sell 17. Britam 13.3 14.7 10.6% 14.1 1.9% (1.8%) Sell 18. Pan Africa 46.0 40.0 (13.0%) 39.0 0.0% (2.5%) Sell 19. NBK 9.2 11.0 20.2% 8.5 0.0% (22.7%) Sell *Target Price as per Cytonn Analyst estimates **Upside / (Downside) is adjusted for Dividend Yield ***Indicates companies in which Cytonn holds shares in Accumulate – Buying should be restrained and timed to happen when there are momentary dips in stock prices. Lighten – Investor to consider selling, timed to happen when there are price rallies

will help FNB increase funding to small and medium-sized businesses in the agriculture sector in support of inclusive economic growth in the country and the region as a whole.

South African government pension fund Public Investment Corporation (PIC) increased its shareholding in Barclays Africa Group from 6.0% after being the largest buyer in a conglomerate of companies that purchased the 12.2% stake offloaded by Barclays Plc in Barclays Africa Group. The offloading of part of Barclays Plc 62.3% stake presents a good investment opportunity for private equity firms who want to own a stake in the bank, for example, Atlas Mara headed by former Barclays CEO who have already expressed interest together with the Carlyle Group to buy into Barclays. The financial services sector continues to emerge as an attractive sector for private equity investments.

The Abraaj Group has continued to express its bullish sentiments in health care investments following an investment commitment to spend up to USD 500 mn in start-up capital for a mid-tier hospital business in Africa, starting off with a 350-bed multi-specialty hospital in Lagos Nigeria in a bid to capitalize on the demand for health services from the continent’s emerging middle classes. The Abraaj Group has deployed over USD 1.0 bn in various investments in healthcare in Tunisia as well as in the larger Sub-Sahara Africa such as Lily Hospitals, Lusaka Trust Hospital, Nairobi Women’s Hospital and Vine Pharmaceuticals speaking to their bullish sentiment on the healthcare industry in Africa.

Private equity investment in Kenya continues on the upward surge, as evidenced by the increased deals in the country and the continent at large. Financial services, energy, healthcare, education, and IT continue to be the main sectors attracting private equity activity with infrastructure, real estate, and natural resources gaining ground. We remain bullish on PE as an asset class in Sub-Saharan Africa given (i) the rapidly increasing demand driven by the rising middle-income class in Africa, (ii) attractive valuations in the private sector, and (iii) better rates of return to investors with higher economic growth projections compared to global markets.

Real Estate

During the month of May, there was increased focus on design and structural integrity of buildings in the country. This was brought about by the collapse of a six-storey building in Huruma Estate in Nairobi. The collapse was blamed on the fact that the building was substandard, constructed on a swampy ground and took only 5 months to construct. As a result, the National Construction Authority launched a nationwide campaign to identify and demolish substandard buildings in the country. The government also approved the adoption of Eurocode construction standards leaving the long used British standards. This is as the Eurocode standards allow for uniformity in structural designs of buildings and civil engineering works such as geo-technical aspects and structural features, apply the most updated aspects of structural behaviour and allow for greater scope for innovation using advanced analysis technique hence giving better value for money. This adoption is aimed at curbing incidents of substandard buildings, unqualified personnel and achieving global construction standards locally.

As has been the trend for the year so far, the real estate sector continued attracting investments buoyed by the high returns and demand for real estate products. Key projects that were launched or broke ground in the month of May include:

i. Life Style Properties that announced plans to develop 120 residential units in Tatu City Masterplan

ii. Kenya Women Holding that broke ground on a Mall in Nakuru iii. Several Public Private Partnerships were announced including an ambitious Kshs 300bn

project by the Nairobi County Government to redevelop several old estates iv. Express Kenya broke ground on a 15.8-acre residential project in industrial area

encompassing 1500 units and a shopping mall

The capital intensive nature of the real estate sector has had some developers struggling to meet their investment objectives. Home Africa for instance, released their annual 2015 financial reports posting a 62.2% drop in revenue from Kshs 687.3 Mn to Kshs 259.8 against an 18.7% increase in operating expenses from Kshs 294.8 mn in 2014 to Kshs 349.9 mn in 2015. Kamuthi Housing Cooperative faced a risk of losing 4.0 bn worth of properties due to unpaid debts. The two companies cited poor sales as the key reason behind their financial woes. These financing problems can be attributed to inappropriate financing structures relying heavily on presales hence limiting liquidity during the construction period when the uptake is slower than estimated, inadequate research to inform on market gaps, the rate of market uptake and poor governance. The government also had to bail out the Lake Basin Development Authority to prevent it from losing its headquarters and a mall in the complex. The authority defaulted on a Kshs 2.5bn loan owed to Cooperative Bank that had been used to finance the development.

During the week, Letshego a Botswana-based mortgage lender announced that it has set aside Kshs 16 bn to be used to lend money to the low-income earners in the Kenyan economy in the short-term. The fund will lend mortgages for houses costing as low as Kshs 1.5 mn to a maximum of Kshs 10 mn. In total, the financier aims to loan Kshs 27.5 bn by 2020 in Kenya. This is a positive development in the industry as this population segment has been underserved with the current mortgage market focusing on the upper middle to high-end clientele. If adopted by other fanciers as well, it will lead to an increase in the demand for houses in this segment of the population and developers could be able to exit faster.

Gakuyo Real Estate a Thika-based real estate developer broke ground on a 2.5 billion housing project in Kenol Kabati Area in Muranga County. The development will consist of 2,280 housing units sitting on a 300-acre parcel of land to be developed in phases. The target market is the lower middle class with the house prices ranging from Kshs 3.0 mn for a two-bedroom house to Kshs 3.5 mn for a three-bedroom unit. The developer is partnering with their sister company Ekeza Sacco to finance the project. Ekeza is also offering loans to members at 1% p.a. to purchase the houses. Individuals also have an option of purchasing eighth-acre plots and developing them with loans from the Sacco. Currently, the high-end residential sector has the highest investments constituting 80% of the total developments, this market has however slowed down with an annual growth rate of 1.5% in 2015 down from 2.2% in 2013 according to Knight Frank’s report on cities. The tastes and preference of this clientele have also grown more specific making it increasingly harder to satisfy this client. This has had developers shifting focus to the

lower end segment of the market. Other factors also making investment in the lower end residential segment of the market attractive include:

i. The middle to low-income form the largest part of the population and hence offer a large untapped market for residential developments leading to increased demand

ii. High returns the average rental yield for the lower end of the market averages at 6.7% compared to an average rental yield of 4.4% in the high end residential segment

iii. Economies of scale; unlike the exclusivity sought by the high end client, it is possible to develop en mass for this market and duplicate hence earning a developer economies of scale

iv. Improved access to finance in the recent years, housing cooperatives and Saccos have begun increasingly engaging in financing real estate for their members offering loans for as low as 5% while the current market lending rate can go as high as 21%. They also provide development finance

v. Rising disposable incomes as the people in the low end segment graduate to the middle class

vi. Alternative building technology have provided developers with a slightly cheaper method of construction which is also time saving as a standard three-bedroom bungalow can be constructed in three weeks thus saving on financing costs. Though in its nascent stage, the trend is picking especially in Nairobi’s Satellite Towns such as Athi River and Kitengela

To tap into this market a developer ought to come up with creative financing options such as zero deposit plans or instalment payments over a short period of time while the houses are occupied paid just like monthly rental payments. A developer however has to carry out proper market research and due diligence and sort out financing before venturing into this market to avoid pitfalls such as low uptake or signing up non-credit worthy buyers hence making losses.

The outlook for real estate remains positive especially for residential developments for low income earners. Government support has also been improving through infrastructure development and most recently linking of the government agencies enabling the citizens to publicly access information on title documents. Financing however still remains a headache for developers as high financing costs and poor structuring has some developers losing out on the high returns being earned in the sector.

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes

cytonn monthly may 2016

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