Nigeria has problems. But it is sorting them out, and also has plenty of natural resources and young workers. It's a buy for the brave, says James McKeigue.
When considering the next hot investment prospect, the name Nigeria doesn't immediately spring to mind. The gruesome images from recent bomb attacks and riots that left 800 people dead in the country was confirmation for most people that this is a dangerous, volatile place. The violence in the Muslim northern provinces was triggered when Goodluck Jonathan, a Christian southerner, won April's presidential elections. Yet, despite the violence, seasoned investors in Nigeria were upbeat about the elections. For them the first fair elections in 30 years are a sign that Nigeria is finally about to come good on its potential.
The deep challenges facing Nigeria
Let's be clear here. The challenges facing Africa's most populous country are massive. The most well known are probably fraud and corruption. Thanks to countless email scams the type where a prince' or fleeing oil executive wants to transfer some money into your account but just needs a small down-payment first Nigeria has an international reputation for white-collar crime. And inside the country, the situation is even worse. Anti-corruption group Transparency International ranks Nigeria a lowly 130 out of 180 countries. This sort of runaway graft affects your investments in many ways. For companies that play along, it adds to the direct cost of doing business in the country. But more morally steadfast firms may find that they lose important contracts or provoke costly disputes with local officials or partners. Transparency International estimates that 25% of African GDP is lost to corruption each year.
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And this has taken its toll on Nigeria's infrastructure. Post-independence, the country's first coup in 1966 was supposedly an attempt to stop high-level corruption. But since then large chunks of public funds have been regularly siphoned off by the political elite. This has led to a massive infrastructure gap the chasm between what the country needs, and what it actually has as key power stations, highways and airports were never built. For example, between 1999 and 2007 the government of Olusegun Obasanjo spent more than $15bn improving the power supply' with practically no improvements to show for it. As a result Nigeria, a country of almost 160 million people, has a woefully inadequate generating capacity of around 4,000 megawatts (MW). South Africa, which has just a quarter of Nigeria's population, has ten times as much capacity. The consequences are felt by every part of the economy. Large industrial groups are forced to build their own micro power stations while "fitful power means firms often pay for television ads that viewers do not get to see", says The Economist.
Sadly, the power example is repeated throughout Nigeria, and analysts highlight the lack of infrastructure as one of the key restraints holding back the country. Guy Czartoryski at CSL Stockbrokers reckons "the creaky state of the nation's infrastructure requires billions of dollars of public and private-sector investment over the next few years". Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria (CBN), has also highlighted upgrading infrastructure as a key aim.
Yet perhaps the most threatening prospect for investors is civil unrest. For more than a decade, militants in the oil-rich Niger Delta region have bombed oil installations and kidnapped staff. Jonathan, who grew up in the region, has managed to broker an uneasy peace, persuading many rebels to swap their guns for jobs and training. However, the inequalities and tensions between those who benefit from oil and those who don't continue to simmer. The north is also prone to social unrest. According to the UN, the average annual income of $718 per person in the northernmost 19 states is half the figure in the remaining 17 states, while literacy and child nutrition are poor. Far away from the oil, the thriving financial centres and the coast, the north has been neglected by successive governments, says The Economist. If Jonathan doesn't "change tack", the country will face consequences.
So why invest?
With such deep-rooted challenges why would anyone even consider investing in Nigeria? Two reasons: natural resources, and demographics.
Nigeria's young population is growing quickly and is expected to hit 258 million by 2050. That's growth of around 60% in 40 years. Moreover, Nigeria actually has the necessary resources to provide for all these extra people. Citigroup chief economist Willem Buiter is so persuaded by this potent combination of human beings and resources that he reckons Nigeria will be the world's fastest-growing economy between now and 2050. Indeed, he predicts that an average real GDP per capita growth of 6.9% per year during the next 40 years will make Nigeria the world's fifth-biggest economy.
Of course, the fact that Nigeria has lots of resources and lots of people is nothing new. What is different, however, is that finally it seems it is ready to take advantage of them. Take the elections. Politics has long been one of Nigeria's most corrupt and lucrative industries, yet vote-rigging, corruption and intimidation were largely absent from the recent polls. A 21% increase in registered voters showed that Nigerians believed their vote counted this time. The lack of military interference is encouraging for a democracy barely a decade old and will give Nigeria's already voluble media further encouragement. If Nigeria can make inroads in reforming politics then it can start to address the bad governance, corruption and poor infrastructure that have so far stifled its potential. In time, fair elections and a free press should make politicians more accountable and improve the business environment.
An energy treasure trove
Improvements are already visible in the natural-resource sector. Nigeria is the world's ninth-largest oil producer and has the tenth-biggest reserves, but to date has squandered its inheritance. For decades much of the oil wealth has been split between foreign corporations many of whom showed little care for the environment and local people and corrupt politicians. As Buiter puts it: "Nigeria has been a classic example of the natural resource curse at work in the past, but things are beginning to improve." He points to the recent decision to create a sovereign wealth fund Nigeria was the only country in oil cartel Opec not to have one as proof that "oil revenues are managed more prudently". The fund will dedicate at least 20% of its capital to improving the country's infrastructure.
Nigeria is no slouch when it comes to gas either, with the seventh-largest reserves in the world. Until recently much of that was flared' burned without use or re-injected into oil wells. However, the government's Gas Masterplan wants to use gas to fuel new power plants. It is also boosting infrastructure so that isolated gas fields can be economically exploited. The coal industry, which faded following the discovery of oil in the mid-1950s, is also being revived as developing market demand drives up prices Nigeria has two billion tonnes of proved coal reserves. Even its agriculture sector, which has underperformed for decades, has huge potential.
Nigeria is not the only African country with bright prospects. West African neighbours such as Ghana are also enjoying growth. Indeed, consultancy McKinsey found that, in the last ten years, "economic growth accelerated" in 27 of the continent's top 30 economies. But Nigerian companies are among the best placed to benefit, with a "number of regional champions" emerging, says Buiter. "Nigeria's population and large market size may have provided the necessary scale for some firms and sectors to prosper where companies in smaller markets and countries could not."
Aliko Dangote, chairman of Dangote Cement, Nigeria's biggest company by market value, agrees. "Things are much, much better. [We] have less corrupt leaders, we are having elections I'm not saying we're 100% there, but we're getting there," he told Bloomberg.
Growth is already happening
This is not blind optimism. After stagnating for most of the 1980s and 1990s, the Nigerian economy grew by about 7.6% per year between 2003 and 2010. And, says Renaissance Capital's Olaleye Adekeye, it wasn't all down to commodities. "The oil sector has actually done very little to impact growth in recent years; for example, the oil price fall in 2008-2009 did not stop the Nigerian economy from growing 7% in 2009." The World Bank agrees, pointing out that the non-oil sector has outperformed.
Investors have also taken heart from the improved performance of institutions such as Nigeria's central bank. Under the leadership of Sanusi Lamido Sanusi, it rescued Nigeria's overleveraged banking sector during the financial crisis with a controversial but ultimately successful bail-out. A central bank initiative is also promoting infrastructure development by encouraging pension funds to invest in new projects. The governor has also called for cuts in the size of government and increased capital investment.
Guy Czartoryski at CSL Stockbrokers says such schemes show that times are changing. "The political will to implement strategic reforms was the essential ingredient missing" in the past. "The differences this time include the increased level of political awareness and the clamour for measurable development by the Nigerian people."
Perhaps the biggest vote of confidence is that Western firms such as Guinness and Unilever have been betting on the rise of the Nigerian consumer. They are investing heavily in local production. Crucially, they are not placing their hopes in the existing middle class. Rather, they think that as Nigeria's economy grows and pulls millions more people out of abject poverty, those new consumers will enter the formal economy and buy branded products such as a branded beer instead of the local moonshine. Even the infrastructure gap is an opportunity. Dangote Cement plans to invest $4bn over the next few years to boost its output. And more than 130 local and international firms have applied for roles in the soon-to-be-privatised power sector.
But while Nigeria might have a promising future, for UK retail investors it is not easy to pick a Nigerian winner. As Pan Kwan Yuk notes in the Financial Times's Beyondbrics blog (which covers emerging markets), Western investors have had their fingers burnt before. Last time it was Nigerian banks. "Hailed as white-hot investment opportunities during the heady days of 2006 and 2007 [they] became a byword for scandal after the credit bubble burst spectacularly in 2008." Another danger is that foreign investors will flee risk in frontier countries such as Nigeria. Buiter's advice to Nigeria is "don't be unlucky and don't blow it"; the same could well apply to people investing in it. If you are feeling brave and have some cash that you're willing to take a risk with, we look at the best ways to play Nigeria below.
The best investments to buy now
The obvious way to play Nigeria is to invest in a company listed on the Nigerian Stock Exchange (NSE). However, the downside is that transaction costs are high and it's really only open to investors with a lot of money to invest we're talking upwards of £250,000, which, in turn, means your overall portfolio would have to be very significant to be able to risk that sort of money. On the upside, the price to earnings (p/e) ratioof 16.1 is well below the four-year average of 19.9, and 26% below the average frontier market, while the average dividend yield is 5.5% against 3.5% for frontier peers.
But for most, a more realistic option is to invest in a London-listed firm with operations in Nigeria. That should offer more protection if there is a flight of capital from the NSE. One such firm is international soap maker PZ Cussons (LSE: PZC). Nigeria is the group's largest single market, and it recently invested £40m in its operations there. Its range of branded, fast-moving consumer goods should grow more popular as economic growth pulls more Nigerians out of poverty. Since we last tipped the firm as a way to play Africa in 2007, the shares have risen 90%, but they could have further to go. The firm is fairly expensive on a p/e of 18, although that is in line with its four-year trailing average.
Investors are starting to look at Nigerian banks again too. That may seem hasty; only a few years have passed since the CBN's $4bn bail-out and the spate of arrests that landed many former bank chiefs in jail. Nigerian banks also still lack the (relative) transparency of their Western counterparts, yet the central bank governor, Sanusi Lamido Sanusi, has made some significant reforms. Retail operations and riskier investment banking have been separated (something many campaigners would like to see done to Western banks), while a new credit bureau makes it easier for banks to lend to medium-sized firms.
The potential for growth is vast. According to the World Bank, businesses only obtain 1% of their financing from banks, while only five million Nigerians have bank accounts. So as the economy grows and oversight improves, banks should profit from increased local demand for financial services. One bank well placed to take advantage is Guaranty Trust Bank (LI: GTRB), which has a secondary listing in London. Guaranty has focused on corporate banking in the past, but in the last six years has made an aggressive move into retail. Aside from Nigeria it has operations in Gambia, Ghana, Liberia, Sierra Leone and the UK. It looks cheap on a forward p/e of 8.4.
As for natural resources, the sector is going through some serious changes. The petroleum industry bill, which could have a disruptive effect, is struggling through the National Assembly as vested interests and reformers battle it out. The bill looks set to punish major international producers, such as Shell and Exxon Mobile, who have already had a series of disputes with both the government and local communities. The winners will be local firms. One way to play this is via Afren (LSE: AFR). The group owns First Hydrocarbon Nigeria, an indigenous Nigerian firm. Afren has assets in other African countries, but Nigeria made up 97% of reserves and 83% of production in 2010, so it's pretty much a pure play. It also looks cheap on a forward p/e of 6.7.
Another option is to buy in via a fund. Silk Invest's African Lions fund (tel: 020-7933 8610) has Nigeria as its joint top investment, with a 22% weighting. Despite a recent slide caused by a fall in its North-African holdings, the fund is still up 30% since its launch in 2009. It is denominated in euros, and on top of the management fee, it has a performance fee of 20%, on returns above 8%.
This article was originally published in MoneyWeek magazine issue number 538 on 20 May 2011, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, subscribe to MoneyWeek magazine.
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