Is Africa A Frontier Market Too Far?

Published in Investing on 20 January 2011

It's high growth and high risk.

With India sliding, Brazil tightening and the China bubble fit to burst, investors might have to look further afield for their emerging markets thrills in future.

Like Africa.

I suspect few Fools venture into Africa, at least not directly, but that means they missed out on a pretty rewarding 2010. So could you make a profit out of Africa now?

World Cup winner

I've just picked up on some figures from Dylan Evans, director of global investment markets at specialist South African fund manager STANLIB, showing how well African stock markets did in 2010.

South Africa was top performer, rising nearly 30% in US dollar terms, and the rest of the continent also performed pretty creditably, delivering a little over 12%.

South Africa is the continent's biggest player, with the largest, best researched and most liquid market, and this means it attracts the lion's share of inflows. With 40% of the Johannesburg Stock Exchange in natural resources, the country also cashed in on rampant global demand for commodity stocks.

I guess the World Cup might have helped a bit.

Ghana's oil jubilee

Some of the smaller countries may surprise in 2011. Like Ghana. 

It rose nearly 29% last year, just behind South Africa, and this year it will begin pumping from its Jubilee Oil Field, in which Tullow Oil (LSE: TLW) has an interest. Evans says this should transform the small economy into one of Africa's largest oil producers, and Ghana's economy is set to grow 11% this year.

That's even better than China.

And the rest...

Kenya grew 28% last year, Evans says, mostly due to its growing role as a regional economic hub for the fast-growing economies of southern Sudan, Rwanda, Uganda and Tanzania. Banks such as Equity Bank and Kenya Commercial Banks were among the market's top performers, as the country's financial services sector continues grow on the back of its rapidly expanding neighbours.

Mauritius grew 18% thanks to its thriving offshore banking sector, which boasts companies such as State Bank of Mauritius and Mauritius Commercial Bank, plus of course tourism, with growing numbers coming from China and other Asian countries.

Nigeria came fifth, with growth of 17%. An incredible 70% of its stock market is made other banks and financial services, which performed poorly, due to worries about their capital adequacy and bad debts. But the banking sector has recovered, and STANLIB now claims it is among the cheapest in Africa. If you want to invest in Nigerian banks, that is.

Lowly-rated and under-owned

African GDP is projected to grow by a massive 5.6% in 2011, according to the IMF. That compares to 4.3% in Russia, 4.1% in Brazil, 2% in the UK, and 4.2% for the world generally.

Africa isn't entirely dependent on the West and Asia for growth. It grew by more than 4% in both 2008 and 2009, when the global economy was on the brink of recession. This could work in Africa's favour by protecting it from any further turbulence in developed and emerging markets. Despite these attractions, Evans concludes that African stock markets are "relatively lowly rated and under owned".

Where's the beef?

So that's the bull case for Africa. Are you convinced? The continent is still, in large part, a play on commodities. Zambia, for example, has benefited from the strong rally in copper prices, while may also produce biofuels for China and Brazil. Zambeef has also benefited by supplying meat and dairy products to major local markets, including Nigeria.

Whether that attracts you depends on whether you think the commodity bull run has further to trot, or whether it has run out of puff.

Offshoring

There are several specialist African offshore funds to choose from, but as you might expect, performance has been highly volatile. STANLIB Africa Equity is up 14% over the past 12 months, but down 52% over three years. STANLIB South Africa Equity rose 18% over one year, but fell 26% over three years.

Similarly Investec Africa grew 29% last year and fell 18% over three years, while Imara African Opportunities is up 21% over one year and down 29% over three years. This fund also has a five-year track record, during which it returned 37%.

JPM Africa Equity, launched in May 2008, grew 33% over the past 12 months, or you could try UK-based unit trust Neptune Africa, which was launched last August.

If you prefer low-cost trackers, you might want to research iShares MSCI South Africa ETF, which has a total expense ratio of 0.74% (compared to 1.85% on Neptune Africa).

Personally, I don't feel a great urge to race into Africa. Especially with South Africa trading on a P/E of 19, and commodity prices looking toppy. For me, it could still be a frontier market too far.

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Comments

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TMFFlaneur 20 Jan 2011 , 4:51pm

I think Africa is a potentially interesting opportunity, as the last emerging market in the world. When you see how global trade has helped improve living standards in South East Asia, it could be 'interesting' for Africans, too!

One other company you might want to look at on this score is Lonrho. It's an old-fashioned pan-African conglomerate, but much smaller than its notorious predecessor. And it's into some pretty new areas, such as sustainable fisheries.

No position (yet).

BarrenFluffit 20 Jan 2011 , 5:34pm

I suspect that South Africa is quite different to most of the other economies and that there is a lot of regional difference. The emphasis on rescources in investable securities suggests a low level of development generally. This was the original emerging markets story.
However wars, bad government and corruption can (and have) undone economic development too. I wouldn't want to pick one country or industry as a proxy for general development. I'd probably tuck away a small investment and give it 5-10 years to mature.

shinygoldcar 20 Jan 2011 , 6:16pm

Africa interests me, but not the resources/commodities/mining side. Revenues and incomes are far too unpredictable, and resources often seem to make things worse for the people living there not better.

I'd be more interested in telecoms, hauliers, maybe food.

drfuzz 21 Jan 2011 , 11:16am

Agree with shinygoldcar, its Africa's a sector picker's market. IMO "infrastructure" (in the very broad sense of things which keep a country running) is key, and any company which can innovate in "infrastructure" areas will do well. The classic example mobiles; fixed lines were a disaster as the copper wire would be stolen - mobiles have circumvented that problem. Let me give you a more recent example: Safaricom (Kenya - part owned by VOD) has invented something called MPESA which allows people to send money by mobile phone. Now you might think this is a crazy idea, but in a country where, despite high poverty levels, there are about 20m mobiles for a population of 35m, and banks have traditionally been reserved for the wealthy and/or traceable, MPESA has taken off and Safaricom dominates the mobile market. Equity bank (mentioned in the article) has realised that MPESA is allowing people who normally wouldn't have bank accounts to have something similar, and has started linking MPESA with their banking services, leading to an increasing market share for them. Here you are seeing innovation which circumvents long term problems (e.g. how can banks trust clients in Africa?) There are other examples of "innovation"; regional airlines have taken off (e.g. fly540 owned by aerolineas argetinas) which circumvent the traditionally long journeys between major cities - yes the flights are expensive, but yes there is demand too! Point is that any company which can find innovative solutions to long term infrastructure problems will do well. The infrastructure problems which I'll be keeping my eye on in particular are: electricity generation (there is a serious power shortage in Africa, southern Africa is very reliant on RSA - and finally renewables are really starting to take off - there are now 2 wind farms in Kenya and half a dozen planned); and water/sanitation. The latter is harder to address, but I'm wondering if companies like Veolia Environnement are worth looking at in this context.
The problem is of course, will it be african listed companies doing the necessary innovation? I've mentioned quite a few (at least partially) foreign owned companies above...

BarrenFluffit 21 Jan 2011 , 1:56pm

"will it be african listed companies doing the necessary innovation?" Is a very salient point. It may be that the profits of development appear in developed equity markets through increased demand for goods as well as via direct investment in local company's.

trf197 21 Jan 2011 , 1:59pm

I agree with the comment about infrastructure. If you are interested in a long term investment in Africa, that is un-reliant on Global commodity prices, it's hard to get away from Telecoms. Having spent quite a bit of time in West Africa, a bit of time in South Africa and a little time in East Africa it is impossible to overstate the likely significance of mobile communication in African economic development.

eipgam 21 Jan 2011 , 3:49pm

I invested a couple of years ago in New Stars Heart of Africa fund.... it was wound up (I'm still not happy about that!)...it's all about timing I suppose, as these were the sorts of growth figures I was expecting then.

sageofyork 21 Jan 2011 , 5:26pm

I have run a small portfolio of South African shares for many years. The last five years have been extremely profitable but my broker out there is now advising clients that the market may be overvalued, and I tend to agree. Emerging Market are hot now and South Africa is no exception with money flowing into what is perceived to be a relatively safe haven. It is not a place now for widows and orphans and the risk/reward is moving against new investors.

shinygoldcar 22 Jan 2011 , 6:26pm

I think I'm going to stay away for now. All the funds/ETFs are either too South Africa biased (with both the author and sageofyork saying that the market is in general overvalued) or too commodities biased (like I said earlier, too unpredictable, or volatile would be a better word) or both, and picking individual shares would be too problematic for small retail investors like me.
The idea of buying Vodafone has appeal to me though...

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