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The Final Frontier of Investing: Africa

By Benjamin Shepherd on July 16, 2012

Even as the global economy teeters due to weakness in Europe and slowing growth in China, Africa has proved surprisingly resilient. Foreign investors, including the Chinese government and Euro­pean multinational corporations, have been deploying capital to help develop African infrastructure in order to ensure continuous access to critical natural resources. As a result, foreign direct invest­ment (FDI) on the dark continent has grown at a compound rate of about 20 percent annually for the past five years.

Last year, I first spoke with Larry Seruma, portfolio manager of Nile Pan Africa (NAFAX), about Africa as an investment destination. The response from readers was so overwhelmingly positive that I’ve invited him back for his thoughts on the FDI explosion in Africa. Read on to learn how FDI has affected the Africa region, as well as how investors can tap into the phenomenal growth it’s driving.

Ben Shepherd: Please describe the market conditions in Africa

Larry Seruma: Market performance has been mixed so far this year, with stock markets in countries such as Ke­nya, Uganda and Tanzania produc­ing gains in the mid-teens, while other countries such as Mauritius and Morocco are down about the same amount.

Europe’s economic woes are hav­ing a negative impact on African trade. Countries whose export mar­kets rely heavily on Europe, such as Morocco and Mauritius, have suf­fered the most in terms of market performance. Economies that are dependent upon oil or other com­modities, such as Nigeria, are also facing difficulties. However, the ef­fect on Nigeria’s stock market is not as apparent because most of its oil firms aren’t listed on the local market. Better-performing African economies, such as Kenya, are driv­en more by consumption or other internal forces than commodities.

So why should investors look at Africa now? The big story is that valuations, particularly in sub-Saharan Africa, are in the single digits. And Africa’s robust gross domestic product (GDP) growth provides am­ple fundamental support for these firms. African GDP growth is aver­aging about 4 percent annually, and the International Monetary Fund forecasts that growth will double over the next 20 years. As emerging markets become key drivers of glob­al economic growth, Africa’s contribution to the world economy is projected to triple, while Asia’s con­tribution is only expected to double.

Ben: Given the current weakness in energy and other commodity prices, how serious are the headwinds Africa faces?

Larry Seruma: Right now, Africa holds about 15 percent of global oil reserves. The large, developed economies, par­ticularly the US, are trying to diver­sify their energy imports away from the Middle East. Government data shows the US anticipates that 25 percent of its oil imports will come from Africa by 2015. Meanwhile, emerging markets in Asia are still growing, and their demand for oil is coming off a low base, so they’ll be another major source of demand. The bottom line is that demand for energy commodities is still exceed­ing actual supply, especially as the emerging market economies continue to evolve.

But fear over Europe’s slowdown has created tremendous volatil­ity in the oil market. Fortunately, most of the investment in new oil discoveries in East Africa isn’t ter­ribly sensitive to the price of oil. The European oil majors are in­vesting heavily in developing these finds, which should remain economically viable unless the price of oil truly plummets.

Ben: You mentioned the US is culti­vating alternatives to the Mid­dle East for its energy imports. But does Africa have the politi­cal stability necessary to make it a reliable source of such com­modities?

Larry Seruma: You really have to analyze Africa on a country-by-country basis. The recent oil discoveries are in the more politically stable sub-Saharan region, rather than North Africa. That includes countries such as Ghana, Uganda, Tanzania, Mozam­bique and Ethiopia.

Of course, the political situation can vary widely between countries. But the Western media tend to largely focus on trouble spots such as Somalia, Chad and Sudan, which can distort one’s perception of the reality on the continent as a whole. Although there are a lot of countries in Africa that are governed by prob­lematic regimes, there are also many that are actually quite stable.

We try to avoid political risk by only focusing on those countries where we believe there is economic growth, as well as political stability founded upon the rule of law and an underlying regulatory framework.

Ben: Which countries are Africa’s major trading partners, and how will global economic weakness affect FDI?

Larry Seruma: China is one of Africa’s main trad­ing partners, with ties to countries ranging from Libya to South Africa. Its annual trade volume with the continent has grown from about $5 billion in 2000 to $170 billion last year. China is now South Africa’s largest trading partner and is also involved in countries that Western nations have avoided, as evidenced by its sizable investment in Suda­nese oil infrastructure. Beyond that, China has oil infrastructure deals in countries such as Angola and Guinea, and has invested in road and rail construction projects in Kenya.

But Europe has long been Africa’s primary trading partner, and those ties have actually strengthened be­cause the countries and firms that have longstanding relationships with Africa don’t want to cede any­thing to China. As such, they have committed serious capital to cer­tain industries. For example, both Royal Dutch Shell plc (NYSE: RDS-A) and Tullow Oil plc (OTC Markets: TUWOY) have been aggressively bidding for oil and gas assets on the Mozambique- Tanzania border. In fact, all of the European oil majors are investing heavily in Africa. So the FDI that’s going to show up over the next 10 years as a result of these deep in­vestments will be substantial.

Many US corporations are also making significant investments in Africa, including companies such as Wal-Mart Stores (NYSE: WMT), Gen­eral Electric (NYSE: GE), Cummins (NYSE: CMI), and Yum! Brands (NYSE: YUM). For example, Gener­al Electric’s restructuring included the creation of an African division, which is domiciled in Nairobi.

On the government side, China has been very effective in using its import-export bank to finance its big infrastructure projects in Afri­ca. The US government is in catch-up mode on that front, and has streamlined its import-export processes after being surprised by the growth of Chinese trade in Africa over the past decade.

Still, Africa is not decoupled from the rest of the world, and a global recession would have consequenc­es there. But Africa’s economy could enjoy some resilience due to its relationship with China. Even if China’s slowdown persists, it will still need access to basic natural resources so that it can continue developing its rural areas. Anoth­er recession could also spur large, multinational corporations to look more toward the emerging markets since consumer growth in those economies is quite strong.

Ben: Does Africa have a burgeoning middle class like other emerg­ing markets?

Larry Seruma: The high flow of FDI due to Afri­ca’s wealth of natural resources has fueled the construction of roads, ports and pipelines. The creation of this critical infrastructure has facili­tated greater links between coun­tries. That’s led to the development of regional blocks, such as the East African Committee, which has lib­eralized trade policy and loosened border controls. These new policies are fostering trade between coun­tries, while creating more regional businesses with larger markets and greater growth potential.

Africa’s rising middle class en­compasses about 300 million peo­ple, and consumer spending is estimated to reach $1.6 trillion by 2020. The easiest consumer markets to tap have been fast food restaurants. In addition to companies like Yum! Brands, there are also local brands like Mr. Bigg’s in Nigeria, which is owned by the conglomerate United Africa Company of Nigeria. I’ve spo­ken with Yum! Brand’s representa­tive in Africa to determine how KFC is performing there because it’s not itemized on its financials. He said that in Nigeria a KFC store is typi­cally profitable within about six months after opening.

Ben: Are there any companies you would recommend that are accessible to Western investors?

Larry Seruma: Tullow Oil is listed in London and has a market cap of around $16 bil­lion. Africa Oil (OTC Markets: AOIFF) is listed in Canada and has a mar­ket cap of about $2 billion. They are both oil and gas exploration com­panies that own very similar assets and are a play on the huge East Afri­can reserves that will be developed over the coming year.

Another potential play is MTN Group (OTC Markets: MTNOY), which boasts the largest mobile net­work in Africa. It operates in 21 African countries, though the bulk of its network is situated in Ghana and Nigeria.

What do you think of this article? Please post your feedback in the “comments” section below!

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