Nigerian equities are on the road to nowhere without currency reform

By David Whitehouse

Posted on Tuesday, 31 January 2023 06:00
Old Nigerian currency is seen on a carpet in a local exchange shop in the old district of Nigeria's northern city of Kano, August 24, 2017. REUTERS/Akintunde Akinleye

Frontier markets have seen an improvement in sentiment prompted by an end to China’s zero-Covid policy. But, Nigeria’s dual-currency regime and the access restrictions imposed on investors mean that Nigerian equities are missing out.

In terms of new money going into frontier markets, investor concerns about being able to access their money mean that “Nigeria is not getting a single dollar,” EFG Hermes managing director Simon Kitchen told a Nigerian Exchange briefing on 25 January. “Investment inflows into Nigeria are held back by an overvalued naira and the fact that portfolio investors can’t get their money out of their country.”

Nigerian stocks are cheap, trading on an average of 10 times 2022 earnings, Kitchen said. Yet there are also plenty of other cheap frontier markets to choose from, such as Egypt and Turkey, he noted. There is a “valuation opportunity in Nigeria, but not a unique one.”

Funds such as Blackrock’s iShares MSCI Frontier and Select EM exchange-traded fund have recently seen increased inflows, but Nigeria’s currency regime means it has missed out, Kitchen said. The fund prefers Vietnam with a weighting of about a third, compared with only 4% for Nigeria, he notes.

MSCI is considering whether Nigeria should be removed from its frontier index and has deferred a decision until June. An incoming government after elections in February still has time to prevent that. There is “a clear opportunity for a new government to change the incentives for investors and get foreign money back in the market,” which would benefit both stocks and bonds, Kitchen said.

There is a consensus that the status quo can’t endure. The Bank of America has predicted a 20% naira devaluation this year. Tajudeen Ibrahim, head of research at Chapel Hill Denham in Lagos, predicts that the naira will be devalued to above 700 to the dollar, which would mean cutting its official value by about 50%. The likely outcome is that “the rate adjusts to reality on the street”, he writes.

“It’s not enough just to devalue,” Kitchen said. “You need more policies to develop credibility.” The Nigerian Exchange states in its 2023 outlook that foreign investors are “demanding a market-reflective adjustment to the official exchange rate and a removal of fuel subsidy before considering Nigerian investments.”

Wing and a prayer

Policy uncertainty from an unfavourable starting point means corporate Nigeria can do little more than hope for the best. Guinness Nigeria, a unit of Diageo, may see its operating margin targets delayed by the anticipated devaluation, CEO John Musunga told investors on a conference call on 27 January. “Foreign exchange has been a challenge” both in terms of securing foreign currency, and of the spread between official and parallel market naira rates, Musunga said.

The company aims for an operating margin of 20% in 2024. It’s “tracking very well” towards that goal excluding currency movements, finance and strategy director Emmanuel Difom told the call. But the prospect of a currency devaluation means the goal could take another two to three years to hit, he said. Some suppliers use the parallel market as their reference rate, meaning higher cost inflation, he added.

The company’s net income for the second quarter to the end of December dropped 73%, hurt by climbing costs and reduced consumer spending power. Distribution costs were driven up by diesel prices which surged by 138% in 2022, Difom said. The current aim is “keeping the ship afloat until liquidity improves.”

Strategy at Guinness has to bend to fit Nigeria’s currency framework. About 20% of the company’s costs are in foreign currencies. Difom said he is working to reduce that, despite the fact that local supply chains are often not easily available. The company doesn’t do any currency hedging, he said, because it’s hard to find ways to do it.

The truth is that no-one is likely in the current context to supply a hedge against naira devaluation other than at exorbitant cost. Despite the fact that Guinness Nigeria has an ongoing need for foreign expertise, the company says it will be looking for projects which it can pay for in naira in coming years. “We hope and pray” that the post-election government takes a different view on policies and is more supportive of business, Musunga said.

Bottom line

Nigerian corporate profitability targets and stock-market prospects are hostages to fortune until the exchange-rate regime is fixed.

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