Losers and gainers as Nairobi Securities Exchange hits 12-month low

NAIROBI: Depressed earnings among listed firms at the Nairobi Securities Exchange (NSE) are projected erode investor confidence in the bourse and sustain its months-long bear run.

 

Already battered by a weakening shilling and the impact of new taxation on capital gains that came into effect at the start of the year, investors have dumped stocks for alternative assets. This has driven the NSE All Share Index to its lowest levels since August 2014.

Deliberate measures taken to prop up the shilling against a strengthening dollar have resulted in a steady climb in the cost of money, represented as interest rates. This is raising the return on bank deposits, corporate debt and Government bonds.

Last week, for instance, the three-month Treasury bill was giving a return of 11.52 per cent a year, with zero risk of default.

Now, with three out of four companies reporting either a significant drop in profits or an outright plunge into loss-making territory, the flight from stocks might as well have just started.

PROFIT WARNINGS

Analysts at the Standard Investment Bank (SIB) said the dip in corporate earnings would only compound the losses reported so far among stocks of listed firms.

“While the bear run is largely corrective, the drop in profitability will cause further price dips,” said Eric Musau, a researcher at SIB.

As at Friday last week, 22 firms had either issued profit warnings or declared significant drops in the mid-year earnings season. Some, such as Kenya Airways, have booked losses in the year to March.

Further, since the NSE 20 Share Index hit its highest 2015 levels of in March, only one company — agricultural firm Sasini — has seen an increase in market capitalisation to date. The index includes firms like KCB, Safaricom, Equity Bank, British American Tobacco and East African Breweries.

Mr Musau added that the dip at the bourse has been exacerbated by global investors re-considering their exposure in emerging markets after the US raised interest rates on government securities.

The stability offered in developed markets is a huge incentive for investors, and small movements in the rates of return can cause massive re-alignments on asset allocations across the world.

But the bear run at the NSE did not just begin. It was sparked late last year in what analysts then attributed to the re-introduction of the capital gains tax, pegged at 5 per cent.

A major stand-off arose that pitted stockbrokers against the Treasury, which was looking to grab a slice of the huge profits at the exchange.

The law was reviewed in the past week, with a transaction levy of 0.3 per cent introduced after the National Assembly passed the Finance Bill 2015, with the effective date of January 1, 2016.

With the matter of capital gains tax shelved and in its place a more friendly levy, stockbrokers and investors are now caught in a complex equation of whether it is a good time to buy shares at bargain lows, or if their money would earn a more attractive return in debt instruments.

QUICK RETURNS

For a conservative investor, investing in Government securities makes a lot of economic sense, considering the return is at least 5 per cent above the prevailing inflation rate.

It might also be a good time to buy up stocks perceived to be undervalued and take advantage of the potentially big headroom for an investor with a bigger risk appetite.

Analysts often recommend a portfolio mix of stocks and debt to spread risk, but this depends on an investor’s timelines and objectives.

As it is, however, the NSE does not present opportunities for making a quick return through stock price spikes in the short term, according to Johnson Nderi, a manager at ABC Capital.

This is further compounded by the global depreciation of stocks.

But some counters have in the last week have recorded gains, such as Uchumi Supermarkets, whose stock was the star performer.

The struggling retailer has just landed a new chief executive, Julius Kipng’etich, who reports on October 1 from Equity Bank, where he is chief operating officer.

Dr Kipng’etich’s arrival is material information, especially given that he has been a successful change manager. The new executive is hoped to save the retailer from insolvency.

But generally, several listed companies are exposed to factors that may signal future price dips.

For instance, investment and insurance companies have a significant proportion of their portfolios in other listed companies, which exposes them to the drops in these firms’ earnings and devaluations.

Sunil Sanger, the managing director of Orion Advisory Services, added that the current high interest rate regime had wiped out the profitability of many companies, even though they registered an increase in revenues.

FOREIGN CURRENCIES

Firms with significant debt levels are vulnerable to increased interest rates, particularly if the loans are denominated in foreign currencies.

For instance, cement makers Bamburi and ARM have reported contrasting results, even though the fundamentals of their operations are identical.

The French-owned Bamburi nearly doubled its net profits in the half year to June because it has huge cash reserves, which earned higher interests, as well as translation gains since some of its money is held in foreign currencies.

ARM, on the other hand, recorded gains in its cement business, but these were largely wiped out by the shilling’s slump against the dollar — the currency it uses to pay its foreign debt.

Consequently, ARM booked losses, while Bamburi posted an 86 per cent jump is net profits.

But it is not all doom for investors keen on the NSE. A few firms neither suffer the problem of foreign debt nor local currency depreciation.

Cigarette maker BAT, for instance, has for the last four years benefited from its group restructuring that saw the continent’s manufacturing consolidated in the Nairobi plant.

The company, whose stock is among the priciest in the market, has more than half of its products paid for in dollars, significantly raising its revenues from translation gains alone.

Agricultural firms could also be set to gain from the weaker local currency for the same reason that their produce is paid for in dollars. However, higher input costs associated with the slump of the shilling and lower commodity prices could shave off some gains.

And while many stocks in the banking sector — which has outperformed every other industry for over 10 years — are now cheaper, Mr Sanger said the rising interest rates are likely to affect these counters.

More expensive loans tend to discourage credit uptake and result in more defaults, which could erode the sector’s profitability.

Standard Chartered Bank has, for instance, reported a 36 per cent fall in net earnings on increased provisions for defaults. More lenders are expected to face similar conditions in the second half of the year.

Ignoring the anticipated rise in defaults, higher interest rates would typically be welcome for lenders, especially because these rates almost always rise faster than both deposit and savings rates.

Central Bank’s latest statistics have the average savings rate at 1.48 per cent, the deposit rate at 6.55 per cent and the lending rate at 15.26 per cent.

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