2014 Review and 2015 Outlook

1

2

3

EXECUTIVE SUMMARY

Global economic activity and trade picked up substantially within the

advanced economies towards the second half of 2013 raising hopes of a much

stronger 2014. These hopes were premised largely on waning skepticism over

the two major threats to global economic recovery at the time: the possible

breakup of the Euro-zone and the reverberating effects of the US falling off the

“fiscal cliff”. Although these two headwinds were summarily overcome early in

2014, the revival in global economic conditions remained largely unconvincing

for the rest of the year. In the major high income areas, growth in private

spending was at best tepid, as these economies began to slowly adjust to the

“hangovers” of massive balance sheet adjustments in the previous year.

Beyond the anticipated decline in oil prices, we believe the major challenge

facing the global economy in 2015 will be the task of minimizing the volatility

expected to ensue from broadly dissimilar fiscal and monetary regimes across

the advanced economies. With the Bank of Japan possibly pursuing

Quantitative Easing, the European Central Bank maintaining its aggressive

balance sheet expansion, and the US tightening stance, we see larger scale

volatility compared to 2014.

The market is moving in the direction of a possible US rate hike...

As the US economy continues its recovery, much stronger than before, the Fed is

widely expected to begin raising interest rate in mid 2015. Our analysis of seven

(7) previous US rate tightening cycles shows that rise in rate often creates

volatility and slows the pace of gains in emerging markets. Some of the impacts

of a tightening environment already occurred in 2013. While many emerging

markets now appear to be better off, having raised rates and reduced current

account deficits, some are still exposed to rate hike due to domestic economic

conditions. The last time the US Fed hinted on Quantitative Easing tapering,

global financial markets went into panic mode with emerging markets bearing

the brunt of portfolio reversals, resulting in sharp depreciations in exchange

rates. Although we expect many emerging markets to take measures to reduce

their vulnerabilities to such externalities in 2015, having learnt their lessons the

hard way, we still see a sizeable chunk of capital outflows from very volatile

frontier economies particularly those with relatively lower risk adjusted real

returns.

Are oil prices assuming a new normal?

Given the long backwardation history of oil price trading dynamics, current and

anticipated supply-demand scenarios, there is no reason to expect oil prices to

rebound sharply in the short to medium term. We see oil prices remaining

4

volatile especially in the first half of 2015 as the market digests the actions and

inactions of oil producers. Notably, the outlook for oil prices in the medium to

long term remains bleak against the background of the significant traction that

alternative energy sources as well unconventional oil production has gained in

the last decade.

Nigerian economy and financial markets may be challenged in 2015

The Nigerian economy is set to face one of the most difficult times in history as

global crude oil prices, a key anchor for fiscal strength and macroeconomic

stability, continue on a downward trajectory in 2015. The financial markets are

likely to be more challenging relative to 2014 as we expect 4 major factors to

shape the markets in 2015: 1) Post-election scenarios 2) Aggressive tightening by

the CBN, 3) Variability in foreign portfolio flows, and 4) the downward trajectory

of crude oil prices. These factors are largely expected to dictate movements in

both equity and fixed income markets albeit in different degrees during the

year. This report contains a detailed review of the market in 2014 with

projections for 2015, including expectations across different sectors; inherent

opportunities as well as strategies for navigating the market at a time like this

5

CONTENTS

Executive Summary 3

Abbreviations 7

Global Economic Review and Outlook 11

Global Economy: Quite a distance to recovery 12

United States: Turning off the stimulus tap 13

Other Advanced Economies 14

Emerging and Frontier Markets 15

Global Macro Themes for 2015 17

The BRICS 19

Africa Update and Outlook 21

South Africa: Slowly turning the corner? 22

Ghana: Growing but groaning 26

Kenya: Brighter medium term prospects 29

Oil Price Dynamics and Nigeria’s 2015 Outlook 35

Domestic Macro Trends and Outlook for 2015 43

Monetary Policy 44

Real GDP 48

Inflation Rate 50

Exchange Rate Dynamics 51

Fiscal Plan 55

Politics and 2015 Elections 59

Capital Markets Review and Outlook 61

Fixed Income Market 62

Equities Market 67

Sector Reviews and Recommendations 76

Banking Sector 77

Insurance Sector 82

Consumer Goods Sector 91

Industrial Goods Sector 97

Oil and Gas Sector 101

List of Figures and Tables 107

6

7

8

Analyst(s)

Kayode Tinuoye

Team Lead, Research

[email protected]

Office: +234-1-280 7334 Ext: 18334

Kayode Omosebi

Analyst

[email protected]

Office: +234-1-2808425 Ext: 19425

Securities Trading

[email protected]

+234-1-280-8919

Asset Management

[email protected]

+234-1-2807822

Trusteeship

[email protected]

+234-1-27157491

Investment Banking

[email protected]

Project Finance

[email protected]

Mergers & Acquisitions

[email protected]

Capital Markets

[email protected]

mailto:[email protected]









9

10

Section 1

Global Economic Review and Outlook


11

2014: The Year That Was…

Global Economy: Quite a Distance to Recovery

A strong pick-up in global activity and trade within the advanced economies

towards the second half of 2013 raised hopes of a much stronger 2014. These

hopes were premised largely on waning skepticisms over the two major threats

to global economic recovery at the time: the possible breakup of the Euro-zone

and the reverberating effects of the US falling off the “fiscal cliff”.

Although these two headwinds were summarily overcome early in 2014, the

revival in global economic conditions remained largely unconvincing. In the

three major high income areas, US, Euro Zone and Japan, the growth in private

spending was at best tepid, as these economies began to slowly adjust to the

“hangovers” of massive balance sheet adjustments in the previous year. In the

Euro-zone and the US, a significant easing following sustained fiscal

consolidation drove expectations of a recovery in demand and business

confidence.

Emerging economic data as early as April 2014 however suggested that all may

not be rosy for the global economy. In its World Economic Outlook for April,

2014, the IMF noted the improvement in global economic outlook but

maintained that output gaps largely existed especially in the advanced

economies. It was therefore of necessity that the broadly accommodative

monetary policies be sustained, even as fiscal consolidation needed to stay

within the threshold that ensured that downsides risks to global growth were

largely contained.

Monetary Policy Divergence Fuels Market Volatility

One noticeable theme in the global economy for the year was that for the first

time in a long while, the US Fed pursued broadly dissimilar monetary policy to

the ECB, a development which in our view contributed to the appreciation of

the dollar against most currencies in 2014. The search for yield continued in key

emerging markets with the attendant pressures on exchange rates especially for

countries with more open economies and weak external trade positions.

Beyond the anticipated declines in oil prices, we believe the major challenge

facing the global economy in 2015 will be the task of minimizing the volatility

expected to ensue from broadly dissimilar fiscal and monetary policy regimes

across the advanced economies. With the BOJ possibly pursuing QE, and the

ECB maintaining its aggressive balance sheet expansion, we see a larger scale

of volatility compared to 2014. That said the strong growth prospects of the US

economy should provide some comfort.

In the three major high

income areas, US, Euro Zone

and Japan, the growth in

private spending was tepid,

as these economies began

to slowly adjust to the

“hangovers” of massive

balance sheet adjustments in

2013.

The US fed policy decisions

diverged significantly from

the ECB’s, leading to strong

gains in the dollar


12

-4%

-2%

0%

2%

4%

6%

8%

2000 2002 2004 2006 2008 2010 2012 2014f 2016f

Advanced economies seem to have turned the corner but

lingering output gaps leave much ground to gain in 2015

y/y GDP growth in global and advanced economies

Advanced Economies

Emerging Economies

Global Real GDP Growth (2014-2015)

%,q/q

Q1 Q2 Q3 Q4

Advanced Economies 0.7 1.3 2.2 1.8

United States -2.1 4.6 3.5 2

Euro Area 0.9 0.1 0.5 0.8

Japan 6.0 -7.1 2.4 2.6

Emerging Economies 3.3 3.9 4.1 4

Latin America 0.2 -0.8 0.9 1.3

Emerging Europe 1.9 -0.1 -0.3 -3

Russia 0.3 1 -2 -6

Asia/Pacific 5.2 5.2 7 6.9

China 6.1 8.2 7.8 7.5

World 1.6 2.2 2.9 2.6

United States: Turning off the stimulus Tap

Economic fundamentals continue to support interest rate hike

A disappointing Q1’14 saw the US economy contract by 2.1% q/q ( Vs. a growth

of 2.6% q/q in Q4’13) as adverse weather effects and inventory overhang

constituted a drag on the economy. We believe the decline in Q1, which was

the first quarterly drop since 2009, re-enforced the vulnerability of the US

economy, and effectively places a steeper hurdle on the growth path of the

economy in the near term. The economy rebounded in Q2 with a strong 4.6%

q/q but growth slowed to 3.3% in Q3’14 (annualized 3.5%) driven by an

acceleration in private consumption spending.

Motivated by some cheery trends in economic data, the US effectively ended

its QE programme in October 2014 after a gradual cutback in debt purchase,

beginning January 2014. As a result, a huge chunk of emerging market portfolio

inflows was curtailed. Although most economic fundamentals continue to point

to the recovery of the US economy, the FED has chosen to delay interest rate

hike. We believe this is a precautionary stance taken to shield interest rate

sensitive sectors such as housing and the financial markets. While the labor

market improved significantly in Q1-Q4 ‘14, signs of a re-emergence of labor

market pressures resurfaced in Q4’14.

FED’s forward guidance points to the possibility of rates remaining at zero (0%)

through mid 2015. Nonetheless, we expect the FED to begin to raise interest rate

early in Q3 ‘15 as a sustained acceleration in private spending is expected to

spur growth while inflation remains at a comfortable sub-2% range.

Source: IMF, United Capital Research Source: IMF, United Capital Research

We believe the decline in Q1

‘14, which was the first

quarterly drop since 2009, re-

enforced the vulnerability of

the US economy.

FED’s forward guidance

points to the possibility of

rates remaining at zero (0%)

through mid 2015. economy,

and effectively places a

steeper hurdle on the growth

path of the economy in the

near term

Fig. 1


13

2.3

1.6

2.5

0.1

2.7

1.8

4.5

3.5

-2.1

4.6

3.5

2.5

3.2

-3

-2

-1

0

1

2

3

4

5

Q1'12 Q2

'12

Q3

'12

Q4

'12

Q1

'13

Q2

'13

Q3

'13

Q4

'13

Q1

'14

Q2

'14

Q3

'14

Q4

'14 F

2015F

US GDP growth to steady at 2.5% range in 2015 Fig. 2

Other Advanced Economies

Expect some volatility, but cheaper oil will support growth

We continue to expect growth to strengthen further in advanced economies in

2015 albeit at varying momentum across countries. While the US is likely to

record the strongest rebound due to robust private spending, growth in the Euro

Zone will continue to be weighed down by the legacy of socio-political crisis.

Although the recession in Europe can be placed against the backdrop of

balance sheet deleveraging, the recent crisis within the region continues to

suggest that further large capital outflow is not in any way impossible. This trend,

in our view, will be further exacerbated by the accommodative monetary

policy of the ECB expected to be sustained going into 2015.

While the big economies are expected to bounce back to positive growth

territory in 2015, the peripheral economies will continue to experience high

unemployment rates (more than 20% in some cases), with the attendant risk of

social unrest. The possibilities of flare-ups in political risks concerning the

capitalization of the ECB and the chance of further debt write-down particularly

in Greece could cause the region’s financial markets to be volatile in 2015. In

the midst of all these, the outlook for the Euro is positive. As at October 2014, the

IMF projected average growth rates of 0.8% and 1.3% for the region in 2014 and

2015 respectively. We believe this is achievable as the ECB’s recently unveiled

US q/q GDP Growth, 2012-2015(%)

Source: Bloomberg, United Capital Research

While the big economies are

expected to bounce back to

positive growth territory in

2015, the peripheral

economies will continue to

experience high

unemployment rates


14

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Canada France Germany Italy Japan Spain United

Kingdom

United

States

Euro

Area

Growth expected to be strongest in the US in 2015

Historical and Forecast GDP Growth for Advanced Economies (y/y, % )

2013

2014

2015

set of stimulus packages, which are likely to be stepped up in 2015, will continue

to support both growth and the regional currency.

In line with market expectations, growth should remain stable in Japan in 2015.

After the disruptions in the pattern of growth in Q1’14, occasioned by hike in

consumption tax, we saw a mild recovery in Q3, largely attributable to

improvement in labor market conditions. We think lower oil prices will support

growth just as the BOJ’s decision to extend and expand quantitative easing

should provide strong support for the economy. Elsewhere, growth in Canada,

Norway, and the UK are expected to be solid. The key drivers here will be

improving credit and financial market conditions as well as healthy balance

sheets.

Emerging and Frontier Markets

Attractive Prospects constrained by commodity price pressures

Emerging-market assets were under pressure in 2014 evidenced by the strength

of the US economy, which should sooner rather than later lead to higher interest

rates, and hence significant portfolio reversals. Softness in key commodity

prices, particularly oil, is adding another dimension of risk to commodity-rich

emerging market economies. In spite of the headwinds, occasioned by waning

capital flows, EMs and FMs continue to offer exciting opportunities to investors, in

our opinion. The major attractions for EM and FM’s assets in 2015 will be

continued high rates of economic growth that these regions enjoy and the

likelihood that they could be sustained due to demographic benefits as well as

In spite of the headwinds,

occasioned by waning capital

flows, EMs and FMs continue to

offer exciting opportunities to

investors, in our opinion.

The IMFs’ recently unveiled set

of stimuli which is likely to be

stepped up in 2015 should

propel the Euro Area economy

Source: IMF, United Capital Research

Fig. 3


15

prospects of exploiting vast natural resources. Across EM’s and FM’s, equity

market performance would be negatively impacted by falling oil prices and

weakening growth trends.

Importantly, in light of recent events, challenges still exist for emerging markets.

Socio-political instability in a number of regions as well as the prospects of

tightening season in the US with attendant currency weaknesses in these

economies might restrain FPIs. In fact, as early as Q1’15, we see investors

beginning to adjust to the possibility of higher US treasury yields, in anticipation

of a mid-2015 lift-off of monetary policy. However, it is critical to note that the

expected tightening in the US is on the back of improvement in economic

performance, and should ordinarily bode well for emerging and frontier

markets, via increased exports, production and trade. In addition, while the US

may be approaching a tightening phase, policy in Japan should remain very

accommodative. Recovery in advanced economies poses prospects of higher

export demand and investment flows, though weaker commodity prices will

moderate growth.

Within frontier markets, measures of economic and market reforms in a number

of key markets, among them; Vietnam, Egypt, Pakistan and Nigeria, offer the

prospects of both a stable growth and improving profitability for the corporate

sector. Concerns however exist, notably conflict in Ukraine, Iraq and Northern

Nigeria, as well as the outbreak of the Ebola virus in West Africa. Nonetheless,

we believe that many of these markets possess strong potential for long-term

growth.

60

70

80

90

100

110

120

0.8

0.9

1.0

1.1

1.2

MSCI Frontier Brent Crude

Oil price decline might pressure Frontier equities

Fig. 4


The expected tightening in the

US is on the back of

improvement in economic

performance, should ordinarily

bode well for emerging and

frontier economies.

Within frontier markets,

measures of economic and

market reform in a number of

key markets offer the

prospects of both stable

growth and improving

profitability for corporates


16

Saudi Arabia to open its stock market to foreign investors in H1’15

As the only G-20 member closed to foreign investors, Saudi Arabia’s decision to

open up its stock market has the potential to deepen financial markets in the

region. The Saudi Arabian stock market, known as the Tadawul is the Middle

East largest and most liquid market. The 167 companies currently listed on the

Tadawul have a combined market capitalization of US$531bn. The possible

effect of this is increased exposure by foreign investors to the Gulf co-operation

council region which may mean less exposure to competing frontier/emerging

region markets in 2015 and beyond. Overall, we believe that these changes to

equity market regulations in Saudi Arabia could have major ramifications, given

the size of the market.

Global Macro Themes for 2015

The market is moving in the direction of a possible US rate hike...

As stated earlier, as the US economy continues its recovery, the US fed is widely

expected to begin raising interest rate in mid 2015. Our analysis of seven (7)

previous US rate tightening cycles shows that rise in rate often creates volatility

and slows the pace of gains in the emerging markets. Some of the impacts of a

tightening environment already occurred in 2013. While many EMs now appear

to be better off, having raised rates and reduced current account deficits,

some are still exposed to rate hike due to domestic economic conditions. The

last time the US Fed hinted on QE tapering, global financial markets went into

0.8

1.0

1.2

1.4

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14

MSCI Advanced MSCI Emerging MSCI Frontier

Frontier equities outperformed others in 2014

Fig. 5

MSCI Equity Indices for Advanced and Emerging Economies, 2014(%)


Recovery in advanced

economies poses prospects of

higher export demand and

investment flows, though

weaker commodity prices will

moderate growth.

Our analysis of seven (7)

previous US rate tightening

cycles shows that rise in rate

often creates volatility and

slows the pace of gains in the

emerging markets


17

0

0.4

0.8

1.2

1.6

400

800

1200

1600 MSCI Emerging MSCI Frontier ECB Rate

panic mode. The EMs and FMs bore the brunt of portfolio reversals, resulting in

sharp depreciations in exchange rates. Although we expect many EMs to take

measures to reduce their vulnerabilities to such externalities in 2015, having

learnt their lesions the hard way, we still see a sizeable chunk of capital outflows

from very volatile emerging and frontier economies particularly those with

relatively lower risk adjusted real returns.

... but expansionary policies by BOJ and ECB will cushion the effect

In 2014, the ECB began a new asset purchase program. At its October 2 press

conference, ECB President indicated that the new program would consist of

asset-backed securities and covered bonds, and would lead to a sizable

increase in the ECB’s balance sheet. The program is scheduled to last for at

least two years with the potential to add €1trn into the Euro-zone economy.

Given these indications, there is a high probability of QE in the Euro-Zone in 2015

even as the ECB scrambles to deal with low inflation. This therefore provides

cushion to the effect of tightening and interest rate hike in the US, as QE by the

BoJ and ECB will sustain some level of funds flow into EMs and FMs. On another

note, the possible effect of the ECB’s QE could be Euro-zone banks lending

more to EMs and FMs to earn higher yields. However, it is important to note the

expected liquidity from the Euro-zone may not find easy outlets in Europe, in our

view, as bonds in the region are expensive. The German and French 2-yr note

yields dropped below zero in October 2014.

Meanwhile, the pressure for Japan to continue its asset purchase program

remains intense, especially after the sharp contraction in Q2’14 GDP and weak

production data for Q3’14. In our view, the Bank of Japan (BOJ) will be forced

to expand its balance sheet in 2015 at the same pace that it did in 2014. This

would be the equivalent of increasing the balance sheet by another 15% of the

GDP.

Expansionary regime in the Euro-zone will bode well for the EMs and FMs

There is a high probability of

QE in the Euro-Zone in 2015

even as the ECB scrambles to

deal with low inflation

The Bank of Japan (BOJ) will

be forced to expand its

balance sheet in 2015 at the

same pace that it did in 2014


Fig. 6


18

The BRICS

Geo-political and country specific risks pose major challenges

The outlook for oil prices is at the core of expectations around the economic

performances of the BRICs countries in 2015. The downward trend in global oil

prices, coupled with high inflation and currency pressures present challenges to

the Brazilian economy. Also, as global demand falls, prices of Brazil’s export

commodities (mostly iron ore and petroleum) are expected to fall, further

slowing down the economy.

China also faces demographic pressures relating to an aging working-class

population. For Russia, a major producer of oil, the increased production of

shale as an alternative energy source will continue to pressure the economy

with continued weakness in the domestic currency despite the country’s robust

foreign reserves. This is coming at a time when Russia faces sanctions from

Europe and the US, limiting Russian firms’ access to western debt markets.

Russia’s retaliation of imposing high import tariffs on Western goods has further

pushed up domestic prices, leading to higher level of inflation.

We expect the low investors’ confidence in the economy to continue to

pressure Russian stocks, further weakening the Russian Ruble. Given Putin’s

stance, which shows that he is not willing to give in to the sanctions imposed by

the West, we expect to see more sanctions on Russia, leading to higher rate of

inflation, and weakened currency, hence a slow-down in growth in 2015.

India’s successful transition in May 2014 portends better prospects for the

country’s business environment going into 2015. We already saw a 5.7% GDP

growth in Q2 ‘14 (versus 4.6% in Q1’14). We expect to see some level of

increased spending in 2015, which should translate to economic growth in India,

as long as the government continues with policies that support these

investments.

South Africa’s economy continues to face internal challenges as the GDP

contracted by 0.6% to 1% in Q1’14 from 1.6% in Q2’14. Amidst labor strikes, high

interest rate, currency pressures, rising inflation and slowing demand, we expect

further pressure on growth in the nearer term.


The outlook for oil prices is at

the core of expectations

around the economic

performances of the BRICs

countries in 2015


19

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f

BRAZIL RUSSIA INDIA CHINA SOUTH AFRICA

Amidst decreasing global demand, declining oil price,weak currencies, high imflation and

sanctions on Russia, BRICS economies may continue their gradual decline in 2015

Real GDP Growth for BRICS Economies


Fig. 7

South Africa

20

Section 2

Africa Update and Outlook

South Africa, Ghana, Kenya

South Africa

21

-8

-6

-4

-2

0

2

4

6

Q1 '09 Q3 '09 Q1 '10 Q3 '10 Q1 '11 Q3 '11 Q1 '12 Q3 '12 Q1 '13 Q3 '13 Q1 '14 Q3 '14

In spite of the recent pressure on output, long term outlook points

to a positive trend

q/q Real Growth Trend for SA (%)

South Africa: Slowly turning the corner?

For most part of 2014, labour market unrest and global macroeconomic

headwinds led to a slowdown in the South African economy. The economy

almost slid into a recession in H1’14 as the protracted strike in the mining sector

constrained industrial activities, culminating in a marginal 0.6% growth in GDP for

Q2’14 (Vs. -0.6% in Q1’14 and 3.2% in Q2’ 13). The mining and quarrying sector

witnessed a 9.4% decline in q/q output due to prolonged industrial actions

which stifled platinum production. Agriculture grew by 4.9% while transport,

storage and communication expanded by 4.0%. However, the economy

showed some signs of rebound in Q3 with a GDP growth of 1.4% albeit below

consensus estimate of 1.5%. Q3’ 14 growth was driven largely by acceleration in

the services and agricultural sectors. Growth in the mining sector rebounded to

positive territory though manufacturing output continued to fall.

With a rebased GDP (from 2005 base year to 2010), South Africa’s economy is

now 4.4% bigger than earlier estimated in 2013 with an increase in the share of

services sector and a reduction in the share of manufacturing.

Growth may continue to be challenged in 2015. We nonetheless expect a

modest recovery provided disruptions to industrial activities can be avoided.

Also, the expected alleviation of infrastructural constraints as the new power

generating capacity comes on stream should further support growth. This should

provide some scope for a rebound in export though the weaknesses in the Euro

zone which serves as the destination for most of South African exports will offset

any gains that weakening of the Rand might imply for export. The expected

normalization in monetary policy in the US also portends some downside risks for

the South African economy in 2015.

Source: National Accounts, United Capital Research

The weakness in the Euro

Zone still portends

downside risk for the South

African economy in 2015…

Manufacturing output

continued to fall as effects of

prolonged industrial actions

lingered on the economy’s

growth path…

With the manufacturing sector in negative

territory, a strong rebound in mining is

needed for a sustainable recovery of the

broader economy

Source: National Accounts, United Capital

Research

Fig. 8

South Africa

22

7

9

11

13

Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14

Tougher Days Ahead for the Rand

USD/ZAR, 2011-2014

Exchange Rate: Economic Uncertainties Drive Rand Volatility

Intermittent emerging market sell-offs pressured the Rand significantly in 2014.

The currency lost 10.5% y/y Vs. USD as portfolio reversals heightened against the

backdrop of a cut back in US QE. Although the volatility in portfolio capital

flows into high yielding emerging markets was a key drag on the Rand in 2014,

the currency was further weakened by concerns around the strength of the

domestic economy. The exchange rate broke the ZAR11 resistance on two

occasions in 2014: February and October.

The pass-through on the price level was quite notable, as inflation rate also

broke the Reserve Bank’s target range of 3-6%. We see more pressure on the

Rand in 2015 largely on account of anticipated tightening in the US. However,

the modest growth outlook for the South African economy should support the

currency and provide cushion to shocks from portfolio reversals.

Interest Rate: The SARB Dilemma

In spite of the weak growth of the South African economy, SARB was compelled

to shelve accommodative monetary policy measures for the most part of 2014.

In a bid to control spiraling inflation, the SARB raised interest rate twice by a total

of 75bps to 5.75% as at November 2014. We think interest rates are likely to be

further increased in 2015, as we see inflation tracking above the SARB’s target.

Unless oil prices fall throughout 2015, which is very much unlikely, the expected

weakness in the Rand will continue to fuel imported inflation. This should

necessitate tighter policy measures geared towards maintaining a positive real

interest rate especially in light of the expected tightening in the US.


Portfolio reversals from emerging

markets pressured the Rand

significantly in 2015

We see more pressure on the

Rand in 2015 largely due to

expected tightening in the US

If Oil prices continue to decline

for a large part of 2015, the SARB

may delay tightening as inflation

pressure may be somewhat

muted.

Fig. 9

South Africa

23

3

4

5

6

7

Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14

I Inflation remains untamed despite successive rate hikes

S.A Inflation Rates Vs. Policy Rate (%)

Inflation Rate Policy Rate

5

7

9

11

13

15

17

19

21

Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14

Widening Valuation Gaps Relative to Emerging Market Peers

JSE Valuations Vs EMs (P/E(x))

JSE P/E

MSCI P/E

Equities Market: Stretched valuation cum macro headwinds

SA equities closed the year positive with a y/y appreciation of 7.6% in the

benchmark JSE All Share Index. Consumer goods stocks, especially food retailers

were the main outperformers while resource stocks closed the year in the

negative. Industrial and Basic materials sectors declined by 17.8% and 16.1%

respectively while financials, Consumer Services and Consumer goods sectors

returned 22.0%, 27.8% and 11.6% respectively.

The bullish run of the JSE in 2014 contrasted sharply with the backdrop of weak

macroeconomic fundamentals. Valuations now look stretched as the JSE

attained record highs especially in Q1 and Q2’14, necessitating a significant sell-

off especially in Q3-Q4 ‘14. Historically, the SA equity market has benefited from

healthy liquidity levels relative to other African bourses. We expect some more

correction in the market going into 2015, particularly if underlying macro

fundamentals do not improve significantly.

Source: SARB, Bloomberg, United Capital Research

Research


We expect further correction is

SA equities in 2015 particularly if

the underlying macroeconomic

fundamentals do not improve

Declining EM funds flows and

attendant currency pressure

were key themes that

dominated the SA fixed income

space in 2014

Fig. 10

Fig. 11

South Africa

24

7.2

7.6

8.0

8.4

8.8

9.2

Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14

Yields tapered considerably after the bearish run early in the year

SA 10yr bond yields (%)

Fixed Income: Fairly priced, Waiting on Funds Flow

Declining EM fund flows and attendant currency pressures were key factors that

shaped the SA fixed income market in 2014. Early in the year, expectations of

increasing Rand weaknesses led foreign investors to sell off on local currency

debt resulting in negative returns in the SA bond market. However, the

corporate bond segment remained quite strong given lower liquidity feeds. For

the most part of 2014, the market traded mostly sideways in spite of S&P‘s

downgrade of SA’s foreign credit rating to BBB- (one notch above sub-

investment grade). South Africa issued 3 bonds in 2014 raising a total of

US$2.2bn.

Looking ahead, we think progress on fiscal consolidation will bear on SA‘s credit

rating in the foreseeable future. With already huge current account deficit, a

further deterioration in fiscal health could feed through bond yields in 2015.

With an already huge current

account deficit, a further

deterioration in fiscal health

could feed through bond

yields in 2015


Fig. 12

Ghana

25

11.2%

19.1%

14.1%

15.9%

9.4% 9.9%

6.7%

9.5% 9.0%

10.8%

4.4%

6.4% 6.5% 5.3% 5.1% 5.5% 5.1%

0%

5%

10%

15%

20%

25% 2

01

1 Q

1

201

1 Q

2

201

1 Q

3

201

1 Q

4

201

2 Q

1

201

2 Q

2

201

2 Q

3

201

2 Q

4

201

3 Q

1

201

3 Q

2

201

3 Q

3

201

3 Q

4

201

4 Q

1

201

4 Q

2

201

4 Q

3

2014

Q4

e

2015e

Macro Headwinds Threaten GDP Outlook

Ghana y/y Real GDP Growth

Fig. 13

Ghana: Growing but groaning

The slowdown in Ghana’s economic growth, which commenced in Q3 2013,

persisted in 2014. GDP growth in Q3’14 came in at 5.1% (vs. 5.3% in Q2’14, 4.4%

in Q3’ 13 and 10.8% in Q2’13). Macroeconomic instability continues to weigh on

the real economy. The sluggish growth in GDP had earlier led to an official

revision in the country’s growth expectation to 6.9% for 2014 (Vs. 7.3% in 2013).

The country’s significant current account deficit (13.2% of GDP), driven by a

wide trade deficit of US$2.2bn and high government spending continue

portend downside risks to economic growth. However, we expect the current

account deficit to ease to 9.0% in 2015 (BoG target is 8.8%) Q4’ 14 data suggests

trade deficit have narrowed to US$495mn.

In terms of managing the level of fiscal deficits, our expectations remain slightly

bleak in the medium to long term, for 2 major reasons: 1) fiscal revenues appear

to be inert on the back of weak economic growth as well as the constraints

limiting oil production, 2) Large capital outlays needed to propel the oil and gas

sector will continue to put pressure on the current account. In 2015, we expect

growth to be anchored by agriculture largely due to higher price for cocoa, the

rehabilitation farms over the last few years, as well the distribution of fertilizers

and pesticides.

Having ramped up oil production capacity modestly, Ghana is expected to

produce around 120,000 b/d in 2015 but a significant growth in output is not

expected until 2017 when the Jubilee field, expected to double output, begins

operation. However, modest oil revenue despite falling prices is expected to

reduce fiscal deficits appreciably in 2015, giving further support to growth. Most

importantly, striking a sustainable deal with IMF will be critical to Ghana’s

macroeconomic progress and restoration of investor confidence in 2015.

Source: BOG, United Capital Research

We expect the current

account deficit to ease to

9.0% in 2015 (BoG’s target is

8.8%) as recent data suggests

trade deficit have narrowed to

US$495mn

Striking a sustainable deal with

IMF is key to Ghana’s progress

and restoration of investor

confidence in 2015.

Ghana

26

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14

Currency remains under pressure

USD/Ghana Cedi

Exchange Rate: Dollar Inflows should cushion pressure on the Cedi

Developments in the Ghanaian foreign exchange markets indicate a generally

weaker domestic currency in 2014 relative to 2013. For the first ten months of the

year, the cedi cumulatively depreciated by 31.2% against the USD in the

interbank market, compared to 7.4% in the corresponding period of previous

year. However, the currency appreciated sharply against the USD in Q3,

moderating the significant losses recorded earlier in the year. November 2014

MPC meeting showed that the country’s gross foreign reserve rose to US$6.6bn,

implying barely 3 months of import cover.

The successful issuance of a US$ 1bn Eurobond and the signing of a US$ 1.7bn

cocoa finance facility supported the Cedi during the year. We expect the

currency to depreciate further in 2015 driven by domestic macro-economic

concerns which will lead to portfolio reversals, though we see some support

from policy measures by the BoG. Also, the news flow on a potential deal with

the IMF that may be finalized in 2015 should further support the Cedi.

Fixed Income: Yields likely to remain high, reflecting domestic macro-

economic and global concerns

The country’s fixed income market is concentrated at the short end of the yield

curve and limited in terms of depth and volume when compared to Nigeria and

other frontier markets. Although the introduction of foreign participation in less

than 3-year maturities boosted foreign transactions in the market, yields remain

higher than most frontier markets in 2014.


Developments in the

Ghanaian Foreign Exchange

market in 2014 indicate a

weaker domestic currency

relative to 2013

We expect some pressure

on the currency in 2015

driven by domestic macro-

economic concerns which

will lead to substantial

portfolio reversals

The Cedi is expected to

depreciate in 2015, and FX

shortages will complicate a

market exit in the

foreseeable future

Fig. 14

Ghana

27

Looking ahead, yields will continue to remain strongly influenced by monetary

policy stance, BoG liquidity management efforts, and exchange rate

developments. The policy rate would remain high at current levels on the back

of high inflation. The Cedi is expected to depreciate in 2015, and FX shortages

will complicate a market exit in the foreseeable future. In addition, should bond

yields fall to the high or mid-teens, an increasing number of investors could take

profit.

Ghana Equities: Losing Steam

The Ghanaian equities market slowed dramatically in 2014 with the benchmark,

GSE Composite Index, gaining 5.4% for the year (Vs. 78.8% in 2013). The

unprecedented rally in 2013 has pushed valuations high to 17.9x P/E (vs. 15.5x

for comparable Frontier markets). However, we still expect a relatively modest

performance in the equities market in 2015, driven by the gradual recovery in

economic growth as well as the positive outlook for companies in the financial

services sector.

That said, we note that there is a growing concern among foreign investors on

the macroeconomic environment in Ghana, especially the rapid depreciation

of the local currency. This could adversely affect their participation in the

Ghanaian equity market in 2015. Also, the poor depth and liquidity in the market

will be a limiting factor to foreign players as there are just 36 companies listed on

the Ghana Stock Exchange; many of them are subsidiaries of multinationals

where the mother company holds the bulk of the shares. What’s more, the

biggest investor on the stock exchange, Ghana’s Social Security and National

Insurance Trust (SSNIT), the state-owned pension fund has a stake in every listed

10

15

20

25

30

May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14

Fig. 15 GHS fixed Income Instrument still offers attractive yields

Average yields on fixed income instrument in Ghana

Ex

Public Debt as a % of GDP


The rally in the market pushed

valuations high to 17.9x P/E

relative (vs.15.5x for

comparable Frontier markets

We note that there is a growing

concern among foreign

investors on the

macroeconomic environment

in Ghana, especially the rapid

depreciation of the local

currency.

Ghana

28

0

500

1,000

1,500

2,000

2,500

3,000

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Ghana Composite Stock Market Index

company and is inactive. The market may ride on this relative illiquidity to deliver

modest returns in 2015.

Kenya: Brighter medium term prospects

Kenya towed the line of Nigeria, rebasing its GDP in September 2014 by

changing its base calculation year to 2009 from 2001. This sent the East African

nation into the continent’s top 10 economies, becoming the fourth largest

economy in Sub-Saharan Africa after Nigeria, South Africa and Angola. Its GDP

post-rebasing increased to US$55.2bn in 2013 from US$44.1bn – a 25.3% jump

surpassing the government’s prediction of 20.6%; GDP per capita now stands at

US$1,245 from US$999. Agriculture, Manufacturing and the real estate sector

accounted for most of the change in the level of GDP, contributing 19.9%, 11.4%

and 5.9% respectively. The new GDP showed a growth rate of 5.7% in 2013

versus a flat growth of 4.7% under the old series.

We expect annual growth in 2014 to be tepid following the poor raining season

in H1 (GDP expanded by 5.8% in H1’14 GDP Vs. 7.1% in H1’2013). In the medium

term, the rebasing exercise is expected to provide the much needed boost to

the Kenyan economy even as the government attempts to spur economic

growth in light of the challenges facing the tourism industry. Manufacturing,

construction and services will continue to be the main drivers of growth.

Agriculture, which remains the backbone of the economy and the main

employer, is growing at a steadier pace of around 4.1%. We expect increased

Post-rebasing, Kenya’s fiscal

ratio looks better as deficit as

a % of GDP now stands at

6.0% (Vs 7.4% before

rebasing).

Kenyan Bureau of Statistics, United Capital Research

Fig. 16

Kenya

29

6.5 7.5 8.0

11.8

8.0

6.7 5.7

4.1 4.6 3.7 4.0

4.8 6.0 6.2

5.6

3.4 4.4

5.8 5.7 6.0 6.6

0

2

4

6

8

10

12

14

201

0 Q

1

201

0 Q

2

201

0 Q

3

201

0 Q

4

201

1 Q

1

201

1 Q

2

201

1 Q

3

201

1 Q

4

201

2 Q

1

201

2 Q

2

201

2 Q

3

201

2 Q

4

201

3 Q

1

201

3 Q

2

201

3 Q

3

201

3 Q

4

201

4 Q

1

201

4 Q

2

201

4 Q

3e

201

4 Q

4e

2015F

Growth path signals modest recovery

Kenya Real GDP growth ( y/y, %)

Q4'13 Q1'14 Q2'14 Q3'14

Agric. 3.2 5.7 4.5 6.2

Mining (15.8) 4.1 6.9 2.8

Manufacturing 1.3 7.9 8.4 4.5

Construction (2.8) 9.0 18.8 11.0

Services 2.1 2.3 1.8 1.7

pace of growth from the Services sector on the back of modest recovery in

tourism as well as technological-based financial inclusion.

Looking ahead, one of the biggest challenges for the Kenyan economy will be

its large fiscal deficit. Post-rebasing however, Kenya’s fiscal ratio looks better as

its deficit as a % of GDP now stands at 6.0% (Vs 7.4% before rebasing). We

expect the fiscal deficit to narrow to 5.0% levels in 2015, as recent measures

introduced by the government to reduce wage burden begin to gain traction.

However, capital spending still falls below target which might hamper growth,

as capacity constraints and corruption will continue to be major hindrances to

public investment.

Exchange Rate: KES weakens though performs better than peers

Kenyan’s shilling has been less vulnerable to external shocks compared to its

peers; KES dipped by 4.7% in 2014 to KES90.6/US$– a modest performance when

compared with the Naira, Cedi and Rand. Corporate demand has been the

major driver on the exchange rate pressure driven by growth momentum and

improved economic activity, as credit to private sector grew at an annualized

rate of 26.7% as of October 2014. Although we expect the KES to weaken in

2015, we do not see a significant decline and expect the local currency to

hover around KES 90-93 levels.

Furthermore, the country’s reserve recorded considerable accretion reaching a

record high of US$7.3 in September, 2014 representing c.4.7 months of import

cover, driven by Eurobond issuance proceeds. In spite of expected portfolio

reversal in 2015, we think the KES will hold steady relative to peer currencies, as


Sectoral Growth in Real GDP for Kenya

(%)

Although we expect the KES

to weaken in 2015, we do not

see a significant decline and

expect the local currency to

hover around KES 90-93

levels.

Kenyan Bureau of Statistics, United Capital Research Kenyan Bureau of Statistics, United Capital Research

Fig. 17

Kenya

30

84

85

86

87

88

89

90

Sept'13 Nov'13 Jan'14 Mar'14 May'14 Jul'14 Sept'14

The Kenyan Shilling was pressured in 2014 as increased importation

fuelled significant dollar demand

0

5

10

15

20

Jan

-12

Feb

-12

Ma

r-12

Ap

r-12

Ma

y-1

2

Jun

-12

Jul-12

Au

g-1

2

Se

p-1

2

Oc

t-12

No

v-1

2

De

c-1

2

Jan

-13

Feb

-13

Ma

r-13

Ap

r-13

Ma

y-1

3

Jun

-13

Jul-13

Au

g-1

3

Se

p-1

3

Oc

t-13

Inflation has been well tamed amidst broadly accommodative Policy

Rates

MPR and Headline Inflation in Kenya (y/y, %)

Inflation Policy Rate

foreign participation in Kenya’s domestic fixed income market stands at just

7.0%.

Inflation: Still in check with a benign outlook.

Inflation rate in Kenya stood within the central bank’s target corridor of 5.0% ±

250bps for most part of 2014. After temporarily breaching the upper limit of the

band in July and August, y/y CPI growth fell to 6.43% in the month of October

2014 from 6.6% in September largely due to VAT base effects and lower

electricity and fuel price pressures (in the middle of September 2014, the Energy

Regulatory Commission (ERC) announced a drop in the price of Super Petrol,

kerosene and diesel). We think the central bank will be lose on monetary policy

in H1’15 with inflation in single digits though underlying fundamentals of a huge

current account deficit will spur some weakness in KES, putting mild pressure on

inflation. Core inflation should however remain within the 5%-6% range.

In spite of expected portfolio

reversal in 2015, we think the

KES will hold steady relative to

peer currencies, as foreign

participation in Kenya’s

domestic fixed income

market stands at just 7.0%.

Inflation rate in Kenya stood

within the central bank’s

target corridor of 5.0% ±

250bps for most part of 2014.

The government has indicated

that it would seek to reduce

domestic borrowing in 2015 to

around KES101.7bn from

KES190.0bn; focusing more on

external borrowing following its

successful Eurobond issuance


Fig. 18

Fig. 19


Kenya

31

4

6

8

10

12

14

3M 6M 1YR 2YR 5YR 10YR

A combination of lower expected domestic borrowing and benign

inflation expectations should keep yields lower in 2015

Kenya Sovereign Yield Curve (%)

Fixed Income market: Yields likely to sit lower in 2015

In terms of outstanding issuance, Kenya is the fifth-largest bond market in Africa

with a total size of US$10.3bn as at October 2014. Banks held 52.5% of the total

debt holdings, followed by institutional investors (25.7%) and insurance

companies (10.2%). It has been widely speculated that Kenyan bonds may be

included in the GBI-EM index, given the foreign interest they have generated

and their critical size. We think the inclusion will eventually happen at some

point, but not in the foreseeable future. The liquidity of KES bonds is still too low

at this stage and even the outstanding size would need to increase. Kenya

raised US$2bn Eurobond in 2014, the largest African Eurobond debut so far. The

government has indicated that it would seek to reduce domestic borrowing in

2015 to around KES101.7bn from KES190.0bn; focusing more on external

borrowing following its successful Eurobond issuance. This is likely to expose

Kenya more to foreign exchange risk given the sensitivity of the KES. Overall, we

think the yield environment will be somewhat lower in 2015 as positive

inflationary expectations would necessitate sustained accommodative policy

stance.

Equities: On a bullish run

The Kenyan equities market maintained a bullish run in 2014. The market

returned 4.5%, 5.3%, 8.7% and -0.34% in Q1, Q2, Q3, and Q4 respectively,

culminating in a y/y return of 19.20%. Share price rallies in heavily weighted

stocks such as Safaricom, Kenya Commercial Bank (KCB) and Equity Bank

pushed the benchmark index north. The market also experienced increased

trading activity as investors remained bullish. The strong trading activity was

underscored by a stable currency, a generally stable macro-economic

environment and positive H1 and Q3’14 results released by listed companies.

The government has indicated

that it would seek to reduce

domestic borrowing in 2015 to

around KES101.7bn from

KES190.0bn; focusing more on

external borrowing following its

successful Eurobond issuance

Kenyan Bureau of Statistics, United Capital Research The strong trading activity was

underscored by a stable

currency, a generally stable

macro-economic environment

and positive H1 and Q3’14

results released by listed

companies

Fig. 20

Kenya

32

Given the relatively higher level of domestic participation (60% of transaction

volumes), we expect headwinds from the global financial space to have a

limited effect on the Kenyan equities market in 2015. We are positive on the

outlook of the market in 2015 expected to be buoyed by strong earnings

performance. We expect the revolution in the country’s mobile payments

industry to bode well for the banks who should continue to drive the market.

The Nairobi Stock Exchange Limited after a successful IPO (which was

oversubscribed in excess of 600%) launched a new bond trading system. The

new system will enable online trading of treasury and corporate bonds, foreign

currency bonds and improve the speed of settlement. We expect this to further

deepen the market and boost the NSE’s revenue in 2015.

80

100

120

140

160

180

Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14


Nairobi Stock Exchange on a steady bullish ride since 2013

Movement in NSE All Share Index

Given the relatively higher

level of domestic participation

(60% of transaction volumes),

we expect headwinds from the

global financial space to have

a limited effect on the Kenyan

equities market in 2015.

Fig. 21

33

6

8

10

12

14

16

Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14

SA Kenya Ghana Nigeria

Fig. 26

0.5

1.0

1.5

2.0

2.5


Kenya Ghana SA Nigeria

-24.1%

-0.1%

-25.3%

-2.7%

-5.4%

-5.2%

-34.6%

-12.1%

-40% -30% -20% -10% 0%

RAND

KES

CEDI

NAIRA

2014 2013

0

4

8

12

16

20


Kenya Ghana SA Nigeria

Fig. 23

21.0%

13.0%

5.8%

8.5%

0%

5%

10%

15%

20%

25%

GHANA NIGERIA SOUTH AFRICA KENYA

Fig. 25

8.6%

6.9%

5.6%

1.9%

0%

2%

4%

6%

8%

10%

KENYA GHANA NIGERIA SOUTH AFRICA

10 –Year Bond Yields Equity Market Indices (Rebased to 100)

Local Currency Returns: 2013, 2014 Inflation Rates: 2013-2014

Monetary Policy Rates 5-year Average Real GDP Growth

Fig. 22

Fig. 24

Fig. 27


Key Macro Variables for Select African Markets

34

Section 3

Oil Price Dynamics and Nigeria 2015 Outlook


35

80

82

84

86

88

90

92

94

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

2013

Q1

2013

Q3

2014

Q1

2014

Q3

Quarterly Trends in Global Oil Demand and Supply

Demand Supply

95

100

105

110

2010

Q1

2010

Q3

2011

Q1

2011

Q3

2012

Q1

2012

Q3

2013

Q1

2013

Q3

2014

Q1

2014

Q3

Non OPEC output has outpaced OPEC

production since 2013

OPEC and Non-OPEC share of oil production ( rebased

to 2010)

OPEC NON OPEC

Fig. 29

The Tragedy of Oil Price Slump

Tumbling oil prices was the dominant theme across the globe in the second half

of 2014. Stemming from huge supply-demand disequilibrium, Brent crude

tanked 54.2% in 2014 after reaching a year peak of $113.41d/p in June on the

heels of ISIS offensive in Iraq. Broadly, the imbalances in global oil demand and

supply in the year could be attributed to two factors: 1) the energy sufficiency

strides of the US demonstrated in the significant ramp-up of capacity in shale oil

production 2) the stickiness of Saudi Arabia’s crude oil supply in the face of

sizeable excess capacity. Perhaps, it could be argued that the moderating

force of shale oil production in a year that saw little progress in the crisis within

the oil rich Middle East, political upheavals and production stoppages in Iran

and Libya, was necessary to fill an important gap in a market with very strong

attributes of an oligopoly.

Supply glut aside, demand moderated considerably in 2014

According to the IEA, global oil demand has weakened since mid-2014. This

compounded the impact of a much stronger dollar compared to the trends

seen in 2013, as well as unconventional supply especially from the US. Beside the

usual seasonal factors behind demand patterns, the sluggish growth of the

global economy in 2014 also led to a slowdown in energy demand. While

demand appeared to have bottomed out during the year, having touched a 5-

year annual low, the slower-than expected recovery in Europe did little to push

deliveries especially in H2’ 2014. We posit that a mild recovery in global

economic growth in 2015 should give comfort to oil demand especially from the

OECD though the seemingly weakening of the non-OECD demand led by

marked declines in gasoline and diesel demand in both China and India is

expected to trim global oil demand. Looking farther ahead however, we think

oil demand is gradually approaching a plateau and could well be seen as a

major pressure source for hydrocarbon prices in the next decade.

Stemming from significant

supply-demand disequilibrium,

Brent crude tanked 48.3% in

2014

We posit that a mild recovery

in global economic growth in

2015 should give comfort to oil

demand especially from the

OECD

Source: EIA, United Capital Research Source: OPEC, United Capital Research

Fig. 28


36

Oil Supply War: US Vs Saudi Arabia; and the winner is...

Conspiracy theories and the quest to hold firmly to market share were at the

heart of postulations around the downward trajectory of oil prices in 2014. Saudi

Arabia, the biggest producer in OPEC, with 32.0% and c.90.1% of the Cartel’s

production volumes and excess capacity respectively, held firmly to its volumes

despite pressure from other members to cut output in order to support price.

Saudi’s motivation to defend market share in the face of declining prices did

not come as a surprise given the country’s relatively strong fiscal position as well

as its disproportionate market share in OPEC. With c. $740.4bn in excess reserves,

we estimate that Saudi still has significant cushion to accommodate oil prices as

low as $30p/b.

In its last meeting in 2014, OPEC chose to stay action as members looked to

Saudi to cut output with Gulf members having reached a consensus prior to the

meeting. The Cartel’s second option which was to convince members to stick to

production quota was also not pushed through. We note that OPEC members

have historically overshot their quota largely due to fiscal pressures arising from

deficit budgets, slow growth and high cost of alternative energy sources as well

as the need to defend fragile market shares. We think it will be more

challenging for OPEC to rein in excess production from members in 2015, as a

handful of fringe producers with huge dependence on oil had already

experienced currency devaluation, placing further pressure on their fiscal

buffers. What’s more, Saudi’s quest to hold on to market share is seen as both

politically and economically motivated, with an overweight on the former. This

could well be sustained as long as crisis in the Middle East, and Russia cum Iran

tensions persist.

Complicating the supply side dynamics was the remarkable growth witnessed in

US Shale oil production. Having increased output volumes by 1 million barrels in

2014, the US now holds largest share of global crude oil production. In fact,

“tight” oil production from shale has grown 6-fold in 5 years. The Fed has made

note of the fact that drilling activity in Shale production districts is expected to

increase steadily for the next two years, even with much lower oil prices. We

believe that the rapid growth of shale production will continue to create excess

oil. Imports from West Africa have already been edged out and we expect

further reduction from other markets in 2015.

From the foregoing, we are inclined to think that the market will have to

patiently wait for the convergence of oil prices with the production cost of most

of US shale wells. In our view, this is the only point at which oil prices can find a

support in 2015.

With c. $740.4bn in excess

reserves, we estimate that

Saudi still has significant

cushion to accommodate oil

prices as low as $30p/b.

We think it will be more

challenging for OPEC to rein in

excess production from

members in 2015.

Saudi’s quest to hold on to

market share is seen to be

both politically and

economically motivated, with

an overweight on the former


37

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016

US non-conventional oil production has increased

5-folds in the last 6 years and could yield the same

volume as crude oil as early as 2017

US Oil Production Volumes (mn b/pd)

Total Oil Production Tight Oil Crude Oil

Fig. 30

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-100

-50

0

50

100

1Q

2001

2Q

2002

3Q

2003

4Q

2004

1Q

2006

2Q

2007

3Q

2008

4Q

2009

1Q

2011

2Q

2012

3Q

2013

Saudi's output variations account for 37% of the

changes in crude oil prices

WTI and Saudi's production

Saudi Production Change WTI Price Change

Fig. 31

Are oil prices assuming a new normal?

Given the long backwardation history of oil price trading dynamics as well as

current market trends, there is no reason to expect oil prices to gain some

respite in the short to medium term. We see oil prices remaining volatile

especially in the first half of 2015 as market digests the actions and inactions of

oil producers. Our bull case scenario would be a $35-$40p/b in H1 and an

average of $55-$60p/b for 2015.

Notably, the outlook for oil prices in the medium to long term remains bleak

against the background of the significant traction that alternative energy

sources as well unconventional oil production has gained in the last decade.

Beside the US, several other countries, notably Canada, Argentina Australia e.t.c

are also on the path of shifting reliance to shale and other unconventional

resources for the majority of their oil and gas production. Argentina, with

declining production from conventional gas fields, is investing heavily in its tight

and shale gas resources; Australia with large shale gas and methane resources

looks to steadily transit away from gas production even as significant leasing

and exploration for shale gas and oil are underway in Algeria, China, Poland,

Columbia and Mexico.

Although the economic viability of producing these shale gas and shale oil rests

significantly on favourable oil prices, we think scale advantages of rapid

production build-up will improve cost effectiveness, combining with the

efficiency of the extraction of technology to render demand fairly inelastic. The

possibility that we could see some fiscal interventions in the form of price

subsidies by the US, the largest producers of shale is also a huge concern. On

Source: EIA, United Capital Research Source: EIA, United Capital Research

We see oil prices remaining

volatile especially in the first

half of 2015 as market digests

the actions and inactions of oil

producers


38

the geo-political scene however, no respite is in site as far as conflicts in the oil

producing region is concerned, with 2015 looking even more likely to be as

volatile as 2014 given recent development in the region. That said, the risk of

oversupply looks more likely to outweigh the downsides from geopolitical

tensions, in our view.

Oil

Gas

Technically

Recoverable (Billion

Barrels)

Technically

Recoverable

(Tcf)

Country

Country

Russia 75

U.S 1161

U.S. 48

China 1115

China 32

Argentina 802

Argentina 27

Algeria 707

Libya 26

Canada 573

Australia 18

Mexico 545

Venezuela 13

Australia 437

Mexico 13

South

Africa 390

Pakistan 9

Russia 285

Canada 9

Brazil 245

Others 65

Others 1535

The fall in oil prices is already taking a heavy toll on a number of countries

globally. Most oil producing Sub-Saharan and emerging economies with

external trade imbalances remain unfavorably exposed to a continuous slide in

crude oil prices. While countries who are net energy importers will continue to

benefit, via a reduction in their current account deficits (if any), net energy

exporting countries are particularly vulnerable to the extent that their balance

of payments positions can sustain them. Also, cheaper oil may impact positively

on inflation, with an indirect positive effect on economic growth in these

countries.

Relative to the size of its economy, Nigeria is the second biggest net energy

exporter in Africa after Angola. Based on spending plans for 2015, the

breakeven oil price for Nigeria is well above $100 p/b and among the highest

Top Ten Countries in Shale/Tight Oil and Gas Resources

Source: EIA

So what does cheaper oil mean for Nigeria’s macro stability?

We see oil prices remaining

volatile especially in the first

half of 2015 as market digests

the actions and inactions of oil

producers

The fiscal and monetary strain

on Nigeria remains severe,

more so with its crawling peg

exchange rate system.


39

184.0

130.7 130.5 122.7 117.5

106.0 100.6 98.0

79.7 77.3

60.0 54.0

0

20

40

60

80

100

120

140

160

180

200

Lib

ya

Ira

n

Alg

eria

Nig

eria

Ve

ne

zue

la

Sa

ud

i

Ira

q

An

go

la

Ec

ua

do

r

UA

E

Qa

tar

Ku

wa

it

OPEC Countries still require oil prices in excess of $100p/b to balance

their budgets

Break even Oil Prices Average

within the OPEC, after Algeria and Iran. This implies that the fiscal strain on

Nigeria remains severe, more so with its crawling peg exchange rate system.

As shown in figure 33 below, Nigeria falls within the quadrant of vulnerable

countries that could be severely impacted by a continuous decline in oil prices.

In fact, the country’s current account surplus, estimated at 4% of GDP could be

completely wiped out if oil prices continue to fall.

In order to correctly gauge the vulnerabilities of different countries to current oil

price shocks, we have separated the “winners” (net oil importers) from the

“losers” (net oil exporters). Oil importers are expected to save on their energy

costs while oil exporters will lose revenue. However, the final impact will depend

on the relative sizes of their economies (measured by GDP) as well as the share

of export receipts in the general government revenues of these countries. We

have assumed that fiscal buffers (i.e. external reserves) would be held constant

as most countries would lean towards a more flexible exchange rate regime in

view of current market dynamics.

We found that relative to other OPEC countries (all of whom are net exporters),

Nigeria’s vulnerability is quite low when the size of its GDP is considered. We

attribute this to the relatively strong growth in non-oil GDP witnessed over the

last decade especially the growing contribution of the services sector. However,

when placed against the backdrop of total government revenue, Nigeria’s

vulnerability rises significantly. This didn’t come as a surprise to us given the

Source: IMF, National Finance Ministries

Relative to other OPEC

countries (all of whom are net

exporters), Nigeria’s

vulnerability is quite low when

the size of its GDP is

considered

When placed against the

backdrop of total government

revenue, Nigeria’s vulnerability

rises significantly

Fig. 32


40

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

-60% -40% -20% 0% 20% 40% 60%

Net Energy Exports/GDP

Highly Vulnerable

Net Energy Exports/GDP

Highly Vulnerable

skeweness of government revenue to oil receipts. Perhaps, what is more

instructive to note is that among the Non-OPEC members, US remains one of the

least exposed largely due to the strengths and diversities of her economy, while

Saudi Arabia is modestly vulnerable, a development we can link to the recent

pressure on its fiscal expenditure. Russia on the order hand could leverage on its

massive external reserves position despite its low current account surplus (2013

est. 1.6% of GDP). The import of all these is that US and Russia are less likely to

succumb to pressure to support prices in 2015 while we might see some “ground

shifting” from Saudi Arabia when the going gets tougher sometime in the

second half of 2015, by our estimate.

Neutral

Not Vulnerable Nigeria

OPEC Members

Neutral

Vulnerable

From a balance of payments perspective, most OPEC members, including Saudi Arabia are

vulnerable to continuous declines in oil prices

Cu

rren

t Ac

co

un

t/GD

P

Source: WTO, IMF, United Capital Research

Kuwait

Saudi

Fig. 33


41

Austerity Measures: How far can they go?

In 2014, the Nigerian government introduced some austerity measures to

cushion the effect of declining oil prices on the economy. These include cut in

subsidy provisions for petrol and kerosene from N971.1bn and N250.0bn to

N458.6bn and N156.0bn respectively, introduction of surcharges on luxury goods

and a freeze on foreign travel by civil servants and government officials. We

think these measures are insufficient in light of the expected fiscal strain that a

persistent decline in oil prices portend for the Nigerian economy. We expect the

Naira to continue to be under pressure. This suggests that monetary policy

would be tighter than ever in 2015.

Domestic Macro Trends and Outlook for 2015

42

Section 4



43

0

5

10

15

20

25

2005 2006 2007 2008 2009 2010 2011 2012 2013

Monetary Policy Rates Broadly Accommodative

Select Policy Rates : Annual Averages, %

FED

ECB

Canada

SA

Brazil

India

Monetary Policy

Across the globe, central banks’ monetary policies were broadly and overly

aggressive in 2014. In a debt-ridden post crisis world, central banks continued to

expand the size of their balance sheets while adjusting short term interest rates

to zero or near zero in some cases. The multi-step unwinding of the US monetary

policy was effectively concluded with interest rates closing at zero levels at the

end of the year. As we stated earlier, the divergence in monetary policies

between the ECB and the Fed engendered a significant bout of volatility of in

asset prices and yields especially in the advanced economies with spillovers to

most emerging markets.

Nigeria: Caught in the web of emerging market portfolio reversals

In the past year, the Nigerian financial markets saw fair share of portfolio

reversals largely due to moderating impact of funds flow to emerging markets.

The US tapering of quantitative easing that effectively began in Q1, 2014

impacted liquidity in the Nigerian fixed income space, distorting valuations

across naira denominated assets. While we note that the expansionary policy

stance of the Euro-Area somewhat moderated the negative impact of these

tapering, we believe Nigeria’s ability to maintain a positive real rate

environment in 2014 remained key to retaining a healthy dose of FPIs in the

economy. Also, we think the clarity of timing and length of these monetary

adjustments especially from the Fed was critical to ensuring that market

expectations were closely linked to valuations at each point in time, helping to

minimize volatility in domestic market rates.


The multi-step unwinding of the

US monetary policy was

effectively concluded with

interest rates closing at zero

levels at the end of the year

The US tapering of quantitative

easing that effectively began

in Q1, 2014 impacted liquidity

in the Nigerian fixed income

space, distorting valuations

across naira denominated

assets

Fig. 34


44

13

0

2

4

6

8

10

12

14

Ma

r-07

Jul-0

7

No

v-0

7

Ma

r-08

Jul-0

8

No

v-0

8

Ma

r-09

Jul-0

9

No

v-0

9

Ma

r-10

Jul-1

0

No

v-1

0

Ma

r-11

Jul-1

1

No

v-1

1

Ma

r-12

Jul-1

2

No

v-1

2

Ma

r-13

Jul-1

3

No

v-1

3

Ma

r-14

Jul-1

4

No

v-1

4

CBN kept the benchmark unchanged for the most part of 2014,

resorting to administrative changes for monetary policy adjustments

Nigeria Monetary Policy Rate (MPR, %)

Domestic Monetary Conditions

Interest Rates and Money Supply: Eye on liquidity

The Nigerian monetary authority maintained a fairly tight interest rate policy in

2014 as the benchmark rate, MPR, was kept at 12% for most part of the year. The

need to keep inflation in check given the anticipated elevated spend in the

run-up to the 2015 elections was prominent in the policy discussions at the

various MPC meetings held during the year. Also, elevated system liquidity led to

a record increase in the Cash Reserve Ratio (CRR) for public sector funds from

50% to 75% at the January 2014 MPC meeting followed by an increase in the

private sector CRR from 12% to 15% in its March meeting.

The combined impacts of these aggressive policies signaled the CBN’s intention

to rein in excess liquidity in the system and curb speculative and non-core

banking activities of Nigerian banks. The suspension of the former CBN

Governor, Lamido Sanusi Lamido however “surprised” the market, leading to

considerable volatility in money market rates.

There were however two noticeable trends in the movement of monetary

aggregates (narrow and broad money) in 2014: 1) a sharp reversal in the

downward growth trend of money supply and credit growth compared to the

trend in 2013; 2) Increasing 12-month rolling correlation between money supply

and credit growth (see figure 36). We see this trend as evidencing the

effectiveness of monetary expansion in stimulating credit growth. That said, we

note the transmission could have been a lot stronger with lesser pressure on

banks’ balance sheets and a relatively more de-risked lending environment.

The combined impacts of

these aggressive policies

signaled the CBN’s intention to

rein in excess liquidity in the

system and curb speculative

and non-core banking

activities of Nigerian banks

Source: CBN, United Capital Research A much stronger transmission

mechanism could have been

achieved with lesser pressure

on banks’ balance sheet and

a more de-risked lending

environment

Fig. 35


45

0.0

0.2

0.4

0.6

0.8

1.0

1.2

-10%

-5%

0%

5%

10%

15%

20%

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14

Broad Money Supply and Credit Growth show intandem movements,

resuming an upward trend in 2014

Money Supply Growth

Credit Growth

12-month rolling correlation

4.0

6.0

8.0

10.0

12.0

14.0

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14

OMO Auctions tapered significantly in 2014 relative to 2013

CBN OMO Activities , 2013 Vs. 2014

Offer Subscription Rate

The various administrative measures employed by the CBN in 2014 meant that

there were lower volumes of OMO auctions relative to 2013. However, a more

elevated system liquidity reflected in a substantial gap between offerings and

subscription levels in H2’14 in spite of relatively flat rates at the auctions

especially towards H2. (See figure 37).

A much stronger transmission

mechanism could have been

achieved with lesser pressure

on banks’ balance sheet and

a more de-risked lending

environment

Source: CBN, United Capital Research


Fig. 36

Fig. 37


46

Outlook for Monetary Policy in 2015

Tighter still but waiting on crude oil prices

The Nigerian benchmark interest rate (MPR) closed the year at 13% with a

symmetric corridor of +-200ps as the MPC voted for a hawkish rate environment

in its last meeting of the year following persistent downward pressure on crude

oil prices. To a large extent, the trajectory of crude oil prices will shape the

monetary policy environment in 2015.

We expect a tighter interest rate regime in 2015 for 3 major reasons: 1) There are

greater downsides to inflation in the medium term given the recent devaluation

of the Naira and Nigeria’s precarious balance of payments position 2) Oil prices

are likely to fall through H1 2015 with attendant pressures on the domestic

currency; 3) A reversal to a tighter interest rate environment especially in US by

H2’ 15 will further compound the pressure on the Naira, raising the possibility of

further tightening.

It is also worth noting that the proposed fiscal spending cuts in the 2015 budget

could moderate structurally induced inflation, effectively shifting the monetary

policy anchor to exchange rate even as the recent devaluation feeds through

domestic price level as early as Q1 ‘15. We are inclined to believe that the CBN

will be even more aggressive if oil price do not find a floor early enough in 2015

and we look to see more administrative measures, increased OMO auctions as

well as more direct liquidity controls in H1 relative to 2014 levels.

The Nigerian benchmark

interest rate (MPR) closed the

year at 13% with a symmetric

corridor of +-200ps as the MPC

voted for a hawkish rate

environment in its last meeting

of the year


47

0

4,000

8,000

12,000

16,000

US

Ch

ina

Jap

an

Ge

rma

ny

Fra

nc

e

UK

Bra

zil

Ru

ssia

Ita

ly

Ind

ia

Ca

na

da

Au

stra

lia

Sp

ain

Ko

rea

Me

xic

o

Ind

on

esi

a

Ne

the

rla

nd

s

Turk

ey

Sa

ud

i Ara

bia

Sw

itze

rla

nd

Arg

en

tin

a

Sw

ed

en

Nig

eria

Po

lan

d

No

rwa

y

Be

lgiu

m

Ch

ina

Au

stria

UA

E

Tha

ilan

d

Co

lom

bia

Ira

n

So

uth

Afr

ica

De

nm

ark

Ma

laysi

a

Sin

ga

po

re

Isra

el

Ch

ile

Ho

ng

Ko

ng

Ph

ilip

pin

es

Eg

yp

t

Nig

eria

(O

ld)

Fin

lan

d

Gre

ec

e

Pa

kis

tan

Ire

lan

d

Ka

zakh

sta

n

Ira

q

Ve

ne

zue

la

Po

rtu

ga

l

Post-rebasing, Nigeria's GDP jumped 19 places to 23rd highest in the world

Top 50 Economies Globally: nominal GDP (US$ million)

Real GDP

Structurally clearer, fundamentally weakening

The rebasing of the GDP dominated discussion around Nigeria’s economy early

in 2014. With support from the IMF, World Bank and AfDB, Nigeria’s GDP was

rebased in April 2014 as the base year for the computation of GDP was

changed from 1990 to 2010. This effectively increased the size of the economy

by 89.2% to N80.2trn ($US 509.9billion) in nominal terms. A further breakdown of

the numbers showed that the services sector is not only the biggest contributor

to the GDP (with, 35.8% Vs. 20.0% in the old series), it also contributed the most

to the jump in the base year GDP numbers. We attribute this to the various

reforms that have been instituted in the Telecomms, Real Estate, Finance and

Insurance sectors over the last decade. We note that the marked difference in

the sectoral contributions to GDP post the rebasing exercise underscores the

diversification of the Nigerian economy, giving a clearer picture on the structure

of the economy, distribution and performance necessary for more effective

policy decision making.

Notably, the rebased GDP numbers have thrown up the headroom for

significant fiscal adjustments within the next couple of years. More than ever

before, it is now imperative to grow the financial sector and widen the tax net.

Although the exercise triggered “improvements” in fiscal ratios such as total

debt to GDP and fiscal deficit to GDP, it also revealed weakness and leakages

in Nigeria’s tax collection system while also highlighting the need to deepen the

financial system as indicators such as market capitalization to GDP, Credit to

GDP, M2 to GDP are now extremely poor by emerging market standards.

Source: IMF, United Capital Research

A breakdown of the numbers

showed that the services

sector is not only the biggest

contributor to the GDP (with,

35.8% versus 20.0% in the old

series), it also contributed the

most to the jump in the base

year GDP numbers

Fig. 38


48

4.5%

5.4% 5.2%

6.8% 6.2%

6.5% 6.2%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3

2014 Real GDP Growth Tracks Higher than 2013

levels

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3

Volatile growth trends from Manufacturing even as

Oil and Gas slips back into negative territory

Nigeria GDP Sectoral Growth Trends

Agriculture Manufacturing Oil and Gas Services

Fig. 40

Real GDP: Now anchored on buoyant services sector

On rebased GDP numbers, the Nigerian economy recorded quarterly growth

rates much higher than 2013 trend. Real GDP grew by 6.23% in Q3 ’14 (Vs. 5.4%

for Q3 ’13). The non-oil sector continued on its strong growth trajectory buoyed

largely by the services sector growing from 6.8% in Q2 to 7.6% in Q3 ’14 though

slowed y/y relative to Q3’ 13 (10.5%). This was largely on account of a tepid

growth from the Real Estate sector which expanded by 5.9% as at Q3, ’14

relative to Q3 ’13 (13.3%). Finance and Insurance (7.9% of the services GDP) also

slowed with a growth rate of 8.6% relative to Q3 ’13 (9.43%). The Oil and Gas

sector slipped back into negative growth territory that has been characteristic

on the sector in for the past 3 years on of account declining production due to

continued crude oil theft.

Outlook

Growth is likely to slow to below 5.0% in 2015

Tighter fiscal and monetary policies are the key downside risks we see to real

GDP growth in 2015. We do not expect a drastic reversal in government

revenue mix in the short to medium term, largely due to current heavy reliance

on oil. What’s more, government’s recurrent expenditure has historically

remained sticky, making a scale back in capital spend more likely in a bid to

prevent a ballooning of fiscal deficit. With additional currency weakness on the

horizon, the need to maintain a tight monetary policy stance will keep interest

rates high, thereby shaving 75-100bps off real GDP by our estimates. We expect

the services sector to continue to drive growth as we look to see appreciable

progress in reforms to key sectors namely agriculture and power.

Source: NBS, United Capital Research

The Oil and Gas sector slipped

back into negative growth

territory that has been

characteristic on the sector in

for the past 3 years on account

declining production due to

continued crude oil theft.

Tighter fiscal and monetary

policies are the key downside

risks to GDP growth in 2015

Fig. 39

Source: NBS, CBN, United Capital Research


49

0

2

4

6

8

10

12

13,000

13,500

14,000

14,500

15,000

15,500

16,000

16,500

17,000

Core Inflation held steady despite modest increase in

Money Supply

Money Supply(Nbn) Vs. Core Inflation

Money Supply (M2) Core Inflation

Fig. 42

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

Headline Inflation stood firmly within CBN's

target range in 2014

Inflation Rate

Single digit out of the radar

In line with our expectation, headline inflation remained firmly in single digits in

2014, averaging 8.1% (Vs. 8.5% in 2013). The broad declines in global commodity

prices and relatively favourable harvest seasons helped ease pressure non-core

inflation in the year as food inflation averaged 9.5% y/y (Vs. 9.7% in 2013).

Although the conflict prone areas of the North East continued to experience

significant disruptions to farming activities, favourable main harvests was

witnessed across much of the rest of the country leading to increased inventory,

and declining staple food prices. Notably, the aggressive tightening stance of

the CBN moderated the impact of election related spend even as exchange

rate stability in the first half of the year provided cushion to domestic prices

The downside risks to inflation in 2015 include the escalations in insurgency in the

northern part of the country especially in a post election scenario given the

recent spread in the geographical reach of the Boko Haram insurgents. The

current and expected pressure on the Naira given the declines in oil prices is

another risk factor that is yet to fully crystallize, in our view. We expect to see the

full impact of the recent devaluation of the Naira from Q1‘15, even as a

possible further adjustment of the currency in the near term portends greater

downside risks to inflation in 2015. We forecast and average inflation rate of

10.5% in 2015 as we expect core inflation to average 9.5%, and food inflation

11.5%

Target Range


In line with our expectation,

headline inflation remained

firmly in single digit in 2014,

averaging 8.1% (Vs. 8.5% in

2013).

Fig. 41



50

Exchange Rate Dynamics

Battling for the “Soul” of the Naira

The Naira came under severe pressure in 2014, as the N/USD weakened by

12.6% (Vs. -2.6% in 2013) with -11.5% of the depreciation recorded in Q4’ 14

when the Naira was devalued in the Official market. Early in the year, much of

the bearish trends in the Naira were driven by reduced foreign portfolio inflows

(FPIs) as the Fed decided to cut back its bond buying programme effective Q1

2014. This was evident in a huge spike in official forex demand–supply gap

which had shot up to a 2-year high as early as January leading to 1.6%

depreciation in the currency, the highest monthly change pre-devaluation.

Domestic macroeconomic uncertainties heightened by the suspension of the

former CBN governor in February 2014 raised concerns about the fate of the

Naira. This led to sharp outflows in FPI (m-o-m, -43.3% in February). Consequently,

the Naira depreciated by 1.4% in February. However, a rebound in FPI inflows in

April especially in the equity segment lent some respite to the Naira, with an

appreciation of 2.7%, the highest monthly gain in 2014. The last quarter saw a

market-induced devaluation which coincided with tamer foreign inflows and

significant net outflows from debt and equity securities as uncertainties around

the 2015 elections heightened.

Hawkish Stance Moderates Naira Volatility

The aggressive tightening policy of the CBN as well as the various control

measures employed by the Apex bank to ease supply bottlenecks across the

various segments of the market provided minimal support for the currency in the

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

-80.0%

-40.0%

0.0%

40.0%

80.0%

120.0%

160.0%

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14

FPI Changes tracks closely in line with Naira Returns

Changes in FPIs Vs. Naira Returns

FPI Changes Naira Returns

Source:, CBN, United Capital Research

Much of the bearish trends in

the Naira were driven by

reduced foreign portfolio

inflows (FPIs) as the Fed

decided to cut back its bond

buying programme effective

Q1 2014

The aggressive tightening

policy of the CBN as well as

the various control measures

employed by the Apex bank

to ease supply bottlenecks

across the various segments of

the market provided some

support for the currency

Fig. 43


51

140

145

150

155

160

165

170

175

180

185

Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14

Administrative measures failed to substantially

close arbitrage gaps

NGN/USD Rates in 2014

Official Interbank BDC

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14

In spite of CBN's strong defense of the Naira,

demand outweighed supply by 30% in 2014 Total FX Demand Versu Total FX supply ( $US, millions)

Demand Supply

Fig. 45

face of slow accretion to external reserves, especially in Q2. Notably, the

revision in the minimum capital base for the operation of the BDC to N35mn,

from N10mn as well as the prohibition of the ownership of multiple BDCs, helped

restrict forex dealers from round tripping the Naira, with the intent to close the

arbitrage gaps in the market. However, the decision of the CBN to

simultaneously reduce weekly sales to BDCs to $US15,000 from $US15,000

created some pressure in that segment of the market, thus widening the gap

between the parallel and official rates. CBN’s late intervention in the interbank

market also supported the Naira to a large extent in 2014 even as the removal

open positions for banks in Q4 ’14 created additional support to the currency.

The Imperative of Devaluation

The CBN’s resolve to continue to defend the Naira was tested in the face of the

sharp declines external reserves as oil prices began to tank in beginning H2’14.

The reserves, which reached a 2 year low in October 2014, with an import cover

of 7.3 months based on latest available data.

One of the strongest cases for a drastic exchange rate adjustment was the

precarious state of the country’s external trade position. By Q2 ’14, current

account surprise had weakened to 1.1% of GDP (Vs. 3.6% in 2013), largely on

account of higher import bills from crude oil trade as well as increased

repatriation of profits and dividends in light of macro-economic uncertainties.

Compounding the situation was heightened speculative demand for the dollar

induced by high system liquidity. A key demand management policy

Source: FMDQ, CBN, United Capital Research

One of the strongest cases for

a drastic exchange rate

adjustment was the precarious

state of the country’s external

trade position

Aggressive tightening cum

administrative measures failed

to close arbitrage gaps in H1’

14

Fig. 44



52

0

20

40

60

80

100

120

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Jan

-13

Feb

-13

Ma

r-13

Ap

r-13

Ma

y-1

3

Jun

-13

Jul-13

Au

g-1

3

Se

p-1

3

Oc

t-13

No

v-1

3

De

c-1

3

Jan

-14

Feb

-14

Ma

r-14

Ap

r-14

Ma

y-1

4

Jun

-14

Jul-14

Au

g-1

4

Se

p-1

4

Oc

t-14

Falling Oil Prices exerting significant pressure on the naira

Average Monthly External Reserves and Brent Crude Price

External Reserves Brent

introduced by the CBN was the restriction of certain import items from being

funded at the rDAS window, a move that was intended to effectively cut

demand by more than half at the official window. Despite these restrictive

measures, demand for the greenback continued unabated as total dollar

demand was 1.3x total supply in Q3, reaching a high of 1.6x in September.

Having breached the existing target band to forex sales at the Official window

due to unabated demand, the Committee members in its last meeting for the

year, resorted to a drastic downward adjustment to the midpoint of the Official

window of the foreign exchange market from N155/US$ to N158/US$ and

widened the band around the midpoint of the exchange rate from +/-3 to +/-5

per cent.

Outlook for the Naira in 2015:

Is further devaluation on the Cards?

The key question on the minds of investors and market participants is whether

another round of devaluation might be witnessed in 2015 if the pressure on oil

prices does not abate. We estimate that from the onset of the decline in oil

prices, a 1% drop in Brent crude prices has led to 0.24% decline in gross external

reserves. Using an average monthly imports value of US$4.9bn (the mean

imports value per annum), we estimate that oil prices would need to fall to

Source: FMDQ, CBN, United Capital Research

The key question on the minds

of investors and market

participants is whether another

round of devaluation might be

witnessed in 2015 if the

pressure on oil prices does not

abate

We estimate that oil prices

would need to fall to between

$20-$25p/bd for import cover

to touch 4-4.5 months levels

compared to the

internationally accepted

standard of 3 months

Fig. 46


53

between $20-$25p/bd for import cover to touch 4-4.5 months levels compared

to the internationally accepted standard of 3 months. This brings to the fore the

robustness of Nigeria’s external reserves in containing pressure on the domestic

currency.

While the strength of the external reserves remains appreciable, the same

cannot be said about Nigeria’s trade position. Given Nigeria’s high oil import bill

placed against the backdrop of a fast depreciating Naira, the current meager

current account surplus will be wiped out in no distant time. Our view is re-

enforced by the expected increase in portfolio reversals especially as yields in

key emerging markets move in the direction of market expectation of Fed

tightening by H1’ 2015. What’s more, funds flow from Sovereign Wealth Funds

from key OPEC countries will taper as oil prices continue to recede, leading to

tighter liquidity as resultant higher rate environment in key advanced

economies becomes more attractive to yield hungry investors.

We believe that oil prices are not likely to touch levels seen at the height of the

global financial crisis (2007-2008), given the current strong performance posted

by the advanced economies compared to the era of global financial crisis.

Based on the foregoing, any further adjustment in the exchange rate in 2015

(which is likely to be lower than the 8% devaluation in 2014) will not entirely be

due to consideration of the depletion in external reserves but rather on the

shaky state of Nigeria’s trade position.

We believe that oil prices are

not likely to touch levels seen

at the height of the global

financial crisis (2007-2008),

given the current strong

performance posted by the

advanced economies

compared to the era of global

financial crisis


54

412

634

943

2,616 4,605

0

1,000

2,000

3,000

4,000

5,000

Statutory

Transfer

Capital

Expenditure

Debt Service Recurrent

Expenditure

Total

Expenditure*

Capex accounts for 9% of entire budget Outlay

Breakdown of expenditure plans for 2015 (N'bn)

Fiscal Plan 2015: Budgeting in the midst of Uncertainty

The 2015 budget is predicated on a spending plan of N4.4trn (Vs. N4.7trn in

2014), with an estimated revenue of N3.6trn (Vs N3.7trn in 2014), implying a

budget deficit of N756bn, equivalent to 0.8% 2015E GDP. The benchmark crude

oil price was set at US$65p/b, after multiple revisions on the back of the

continued downward trend in global oil prices as well as bearish outlook for the

commodity in the short to medium term. We reiterate that alternative approach

could have been a scenario based budgeting that allows the fiscal authority to

assume different benchmark prices given the uncertainty around crude oil

prices. We think some level of flexibility should have been built into the budget

to prevent recourse to the legislative arm in the event that the volatility in oil

prices heightens in 2015. Importantly, we do not think the benchmark of

$65p/bd is the bear case scenario for oil prices in 2015.

We think that the oil production benchmark is overly optimistic given the

leakages that have characterized oil production in recent times. Data from

OPEC shows that average crude oil production in 2014) stood at 1.93m bpd,

23.7% lower than the budgeted volumes in the 2014 budget. However, having

widened the band around the official exchange rate, the exchange rate

assumption of $165p/b clearly lies within the range of possible values for the

N/USD at the Official market in 2015. However, the possibility of further

devaluation before the end of the year constitutes a downside to this

assumption

2015 2014 Change

Total Federally Collectible

Revenue (N'trn) 6.90 7.50 -8.00%

Estimated Revenue 3.60 3.73 -3.49%

Total Expenditure 4.40 4.70 -6.48%

Oil Production (mbpd) 2.28 2.39 -4.60%

Benchmark Oil Price (p/b) 65.00 77.50 -16.13%

GDP growth rate 5.50% 6.75% -18.52%

Exchange Rate(N/USD) 165 160 -3.03%

Non oil Revenue(N'bn) 1.68 2.51 -33.20%

Fiscal Deficit (N'bn) 755 970 -22.16%

Fiscal Deficit (% of GDP) 0.79% 1.90% -58.42%

Domestic Borrowing (N'bn) 570.0 571.2 -0.21%

Source: Federal Ministry of Finance, United Capital Research

We think some level of

flexibility should have been

built into the budget to prevent

recourse to the legislative arm

in the event that the volatility in

oil prices heightens in 2015


Fig. 47


55

1,000

1,500

2,000

2,500

3,000

Budgeted Production volumes have historically been below target

due to persistent leakages

Nigeria Crude Oil Actual Volumes Vs. Budget

Actual Daily Oil Production (mbpd) Budgeted Production

Non-Oil Revenue: A realistic transition?

The 2015 budget is predicated on an historic shift to the non-oil sector as a

significant revenue source. This was largely anticipated given the expected

strain on petro-dollar inflows in 2015. Notably, the non-oil revenue to total

revenue is budgeted to increase to 46.7% in 2015 (Vs. 33.0% in the 2014 budget

estimates).

We note that the recent rebasing of the GDP has not only given a clearer

picture to the structure of the economy, it currently gives the fiscal authority

enough elbow room to transit from an oil dependent revenue base to a more

diversified structure, taking into consideration the increasing growth profile, post

rebasing, of previously under-estimated services sector . Historically, the strong

growth in the non-oil sector has not translated into significant non-oil revenue

accretion for the government, even if we back out the large informal sector not

integrated into the mainstream economy.

While we welcome the renewed focus on non-oil revenue streams, we estimate

that the expected revenue from these sources despite the various luxury

charges introduced will be insufficient to cover the shortfall oil revenue if we

hold the benchmark oil price constant for the entire fiscal year. More so, non-oil

revenue has been constrained by the government’s fiscal policy that has

recently tilted more in favour of import substitution, with the attendant declines

in non-oil receipts. On another note, the challenges across the non-oil revenue

Source: OPEC (Monthly Oil Market Reports), Federal Ministry of Finance, United Capital Research

The 2015 budget is predicated

on an historic shift to the non-

oil sector as a significant

revenue source

We estimate that the expected

revenue from these sources

despite the various luxury

charges introduced will be

insufficient to cover the shortfall

oil revenue

Fig. 48


56

28.7% 38.6% 40.2%

32.6% 35.2% 30.2% 32.6% 46.70%

71.3% 61.4% 59.8%

67.4% 64.8% 69.8% 67.4% 53.3%

0%

20%

40%

60%

80%

100%

2008 2009 2010 2011 2012 2013 2014* 2015e

Non Oil Revenue Targeted at 46.7% of total revenue Non -Oil Vs. Oil Revenue Split

Non Oil Oil Revenue

generating sectors have been further exacerbated by the recurring incidences

of smuggling across the borders.

Plugging the Deficits: How Plausible is a reduction in domestic borrowing?

The proposed budget is based on a deficit of N755.0bn (0.79% of GDP (Vs. 1.9%

in 2014 o) with domestic borrowing plan of N570.0bn expected to finance 75.5%

of total deficit. While the recourse to domestic borrowing as a means of

financing budget deficits can easily be regarded as the norm in Nigeria’s

budgeting cycles, we were surprised to see a reduced borrowing plan relative

to 2014 levels. Given that we expect government revenue to come in lower

than estimated in 2015, we anticipate a higher level of domestic borrowing

compared to 2014. We think the required traction in non-oil revenue growth

may be delayed beyond 2015 as the economy adjusts to a new fiscal regime,

making a reduction in borrowing unlikely. Also, we expect borrowing to be at a

much higher cost, given the uncertainties around Nigeria’s fiscal revenue

stream. The government’s recent efforts at diversifying borrowing sources to

offshore funding may also be challenged given the expected increase in

sovereign risk premiums on oil producing countries with relatively weak or

precarious balance of payments position such as Nigeria’s. These expectations

are partly reflected in the 32.4% increase in estimated debt service expense

despite a 0.21% decline in expected domestic borrowing.

Source: CBN, United Capital Research * Budgeted estimates; e= expected

The government’s recent efforts

at diversifying borrowing

sources to offshore funding may

also be challenged given the

expected increase in sovereign

risk

Fig. 49


57

419.9

358.5 334.0

257.5

156.5

84.1 71.8 59.0 52.0 47.5 39.5 39.1 30.9 27.2 26.6 23.3 20.1 18.8 15.6 13.9

9.6%

8.2% 7.7%

5.9%

3.6%

1.9% 1.6% 1.4% 1.2% 1.1% 0.9% 0.9% 0.7% 0.6% 0.6% 0.5% 0.5% 0.4% 0.4% 0.3% 0%

2%

4%

6%

8%

10%

12%

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

Edu

cation

Defen

ce

Po

lice

Health

Interio

r

NSA

You

th D

ev

Pet. R

es

SGF

Foreign

Aff

Wo

rks

Agric

Po

wer

Science &

Tech

Presid

ency

Info

rmatio

n

Justice

Tou

rism

Enviro

n

Water res.

Top Priority sectors in the 2015 budget

Total allocation ( Capital +Recurrent, N'bn )

% allocation of total spending

31.2%

35.1%

22.1% 21.7% 20.8%

32.50%

23.70%

9.00%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

2008 2009 2010 2011 2012 2013* 2014* 2015e

Capital Spending set to an historic low

Ratio of Capital to Total Expenditure

Capex Spending: The Fiscal lamb

The ratio of capital expenditure to total expenditure in the budget stands at an

all-time low, bringing to the fore the stickiness of recurrent expenditure. While

planned recurrent expenditure remained largely unchanged compared to prior

year, capex ratio declined to 9.0% of total expenditure (i.e Capex plus

Recurrent expenditure), and 13.8% of the entire spending plan. The ratio

becomes much lower if capex is adjusted for expenditure on SURE-P.

In our view, this high cost of governance is not sustainable. The lingering

infrastructure gaps in the economy calls for urgent steps to rationalize

government agencies, and drastically cut unproductive expenditure. Given this

drastic cut in capex, a resort to greater Public Private Partnerships (PPP)

arrangements as well increased privatization of government enterprises may be

the most feasible means of augmenting these significant capex shortfalls in

2015, if the projected medium term real GDP growth rate is to be achieved.

Source: CBN, United Capital Research * Budgeted estimates; e= expected


The lingering infrastructure gaps

in the economy calls for urgent

steps to rationalize government

agencies, and drastically cut

unproductive expenditure

Fig. 50

Fig. 51


58

Politics and 2015 Elections

Bracing up for a fierce contest

The political tunes of 2014 were dictated by a strong quest for power shift away

from the dominance of the ruling political party, PDP. From defections of

elected public office holders to the opposition’s surprise loss of key political

strong holds during the year, the 2015 elections stage is currently being set up

for a fiery contest. We believe it is all the more critical now for Nigeria to scale

this hurdle given the vast negative global predictions that have trailed the 2015

polls as well as the seemingly unrelenting trend of insurgency in the last 5 years.

In major emerging markets, it is now commonplace for politics and election

dynamics to form a central theme informing direct investment decisions and

even portfolio flows. Across our 2015 outlook, we emphasized the impacts that

exogenous capital flows have had and will continue to have on the Nigerian

financial markets going into 2015. We believe a successful conduct of the 2015

elections is crucial in this regard. Historically, Nigeria has enjoyed the strongest

growth in FDI inflows in election years but that growth has slowed down

significantly since the peak of 2011. In fact in the last two years: 2012 and 2013,

FDI flows declined by 20.1% and 21.3% respectively. Clearly, the nexus between

political stability and foreign investment and investor confidence cannot be

waved aside.

Defining themes for 2015 Elections: the Odds not totally in favour of PDP

On paper, the ruling party seems to have lost appreciable ground since the last

elections in 2011. With the opposition getting stronger and about to field a

personality that is arguably the strongest opposition in current day political

permutations, the elections may well be decided at the polls against an a-priori

expectation of a landslide victory characteristic of Nigerian polls in the past. This

is on the assumption that voting patterns are similar to 2011elections.

That the opposition will win more votes compared to 2011 is probably not in

doubt given the series of defections that we have seen post 2011 elections.

However, the probability that the opposition’s additional votes in 2015 elections

would be sufficient to cover the c.8.2 million votes gap in 2011 elections is at

best up in the air.

The Northern and South Western strongholds of the opposition party will be

critical to the outcome of the polls. However, wherever the pendulum swings,

we expect to see a slim margin of victory by the eventual winner. We think this

could throw up some post election resistance, and a possibility of legal tussle

that could heat up the polity. A key risk is the possibility of a run-off should

The lingering infrastructure gaps

in the economy calls for urgent

steps to rationalize government

agencies, and drastically cut

unproductive expenditure

The Northern and South Western

strongholds of the opposition

party will be critical to the

outcome of the polls


59

61.20%

32.20%

6.60%

2003

PDP ANPP Others

69.82%

18.72%

11.46%

2007

PDP ANPP Others

58.90% 31.98%

9.12%

2011

PDP CPC Others

President Jonathan fail to secure at least 25% of the votes in two-thirds of the

states.

History of Nigeria’s Presidential Election Results

Source: INEC, United Capital Research

Fig. 52

Capital Markets Review and Outlook

60

Section 5


61

80

85

90

95

100

105

110

115

120

125

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14

Performance of long term maturities diverge on heigtened uncertainties

Nigerian Bonds Index Performance for Different Maturities ( rebased to 100)

3-5yr >5 yr 3 yr

THE FIXED INCOME MARKET

FPI volatility, domestic liquidity shaped yields in 2014

To a considerable extent, the Nigerian fixed income market mirrored sentiments

that impacted emerging markets fund flow in 2014. With the US Fed’s tapering

in full gear, foreign portfolio inflows into the fixed income market receded

sharply in Q1 pressuring yields to the upside. However, the stability witnessed in

the N/USD as well as the sustained single digit inflation level ensured sizeable

amounts of FPI flow into naira fixed income assets.

On account of market expectations of higher yields during the year which was

premised partly on the anticipation of a continuous cut back in US QE after an

initial US$10bn reduction in January, the yield curve sustained its inverted slope

in Q1, with higher rates in short dated maturities. The gradual re-pricing of the

curve was however noticeable after a series of CBN liquidity mop-up exercises

which, combined with a shift in investors’ horizon to shorter term maturities

against the backdrop of political uncertainties, eventually pressured long end

yields.

Summarily, a higher level of domestic liquidity pressured fixed income yields for

most part of 2014; but increased paper issuances as well as balance sheet

sterilization via frequent CRR adjustments by the CBN created a floor for yields

during the year after temporary concerns arising from the suspension of the

erstwhile CBN Governor. While the termination of US Fed QE tapering early in Q4

pressured yields to the upside, elevated system liquidity stemming from AMCON

maturities served as liquidity boost to the market.

The stability witnessed in the

N/USD as well as the sustained

single digit inflation level

ensured sizeable amounts of

FPIs flow into naira fixed income

assets

Increased paper issuances as

well as balance sheet

sterilization via frequent CRR

adjustments by the CBN created

a floor for yields during the year

Source: FMDQ, United Capital Research

Fig. 53


62

8.0%

10.0%

12.0%

14.0%

16.0%

1M 2M 3M 6M 9M 1Y 3Y 5Y 7Y 10Y 20Y

Yields rose 282 bps in 2014

Nigeria Sovereign Yield Curves: 2013 Vs. 2014

2014 2013

Q1 Q2 Q3 Q4

3M 13.2% 11.0% 11.0% 14.0%

6M 13.9% 11.0% 11.0% 14.5%

9M 14.4% 11.2% 11.2% 14.5%

1Y 15.0% 11.2% 11.6% 14.7%

3Y 13.9% 11.4% 12.0% 15.3%

5Y 13.8% 11.4% 12.1% 15.4%

7Y 13.9% 12.0% 12.3% 15.4%

10Y 13.9% 12.2% 12.4% 15.1%

20Y 13.7% 12.2% 12.4% 15.0%

Average 14.0% 11.5% 11.8% 14.9%

80

85

90

95

100

105

110

115

120

Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14

On local currency basis, Nigerian bonds outperfomed in 2014

FGN Bonds Vs. Emerging Markets Bonds ( rebased, 100)

Emerging Markets Bond Index* FGN bond Index

Nigerian fixed Income: Increasingly Attractive

On local currency basis, the Nigerian bonds market offered one of the most

attractive returns in the Frontier/emerging market space in 2014. The inclusion of

the Nigeria March 2024 bond in the GBI-EM Global Diversified Index in August

2014 provided additional momentum to Nigerian bonds in the year, with an

estimated additional inflow of around US$200m.

As a result of the increase in monthly inflows to pension funds, and less

participation by banks in the long end of the curve, pension funds investment in

fixed income securities increased significantly compared to 2013. As of Q3 ’14,

PFAs investment in FGN bonds as a portion of total stock of FGN securities stood

at 78.8% (Vs. 74.2% for Q3 ’13). Also, bond holdings as a percentage of total

Investment had reached 47.4% (Vs. 44.2% for Q3 ’13) by October.

Quarterly Trends in Yields


Source: FMDQ, Bloomberg, United Capital Research * JP Morgan Government Bond

Index Emerging Market Global

On local currency basis, the

Nigerian bonds market offered

one of the most attractive

returns in the Frontier/emerging

market space in 2014


Fig. 54

Fig. 55


63

0.00

20.00

40.00

60.00

80.00

100.00

120.00

Jan

-14

Feb

-14

Ma

r-14

Ap

r-14

Ma

y-1

4

Jun

-14

Jul-14

Au

g-1

4

Se

p-1

4

Oc

t-14

No

v-1

4

De

c-1

4

Primary Market Issuance Volumes of FGN

bonds in 2014

0

100

200

300

400

500

600

Jan

-13

Feb

-13

Ma

r-13

Ap

r-13

Ma

y-1

3

Jun

-13

Jul-13

Au

g-1

3

Se

p-1

3

Oc

t-13

No

v-1

3

De

c-1

3

Jan

-14

Feb

-14

Ma

r-14

Ap

r-14

Ma

y-1

4

Jun

-14

Jul-14

Au

g-1

4

Se

p-1

4

Oc

t-14

Volatile FPI flows in bonds and money market

instruments

Capital Importation into Bonds and Equities (US'm)

Bonds Money Markets Instruments

Primary Market Offerings: Sustained Robust Demand

The N970.0bn deficit built into the 2014 budget was financed partly with a total

of c.950bn worth of bond issuances in 2014 (Vs. N900.0bn in 2013). A significant

portion of the bond auction was concentrated in Q2, with generally reduced

marginal rates. We note that a higher level of domestic liquidity helped to

moderate the yield impact of volatile FPI inflows in 2014 as increased

participation by PFAs and inflows from AMCON maturities combined to ease

liquidity in the face of regulatory-induced reduction in fixed income holdings of

banks.

We note that in spite of the variations in system liquidity levels, there was very

little difference in the level of demand in the primary segment of the market

relative to 2013. While subscription rates average 2.1x in 2013, average

subscription level stood at 2.2x in 2014. Notably, oversubscriptions were

concentrated more in the longer tenured instruments in 2013 compared to 2014

suggesting that investors preferably took a shorter term view of the expected

socio political environment in 2015. We expect this trend to change in 2015 as

political uncertainties wane after the elections. More importantly, we believe

the yield curve is still up for further reprising especially if further exchange rate

adjustment materializes.

There were much slower activities in the State and corporate segments as

concerns over election related spending capped regulatory approvals for sub-

national bonds issuances while relatively high rate environments limited

corporate bond issuances.

Source: FMDQ , CBN, United Capital Research

A significant portion of the bond

auction was concentrated in

Q2, with generally reduced

marginal rates

We believe the yield curve is still

up for further reprising

especially if further exchange

rate adjustment materializes.


Fig. 56 Fig. 57


64

9.3%

-3.2% -5.3%

0.0%

-2.1% -4.4%

-8.4%

-4.6%

-9.6%

-4.4%

-7.2% -6.7% -6.1%

-9.2%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

FGN Bond Returns in 2014 ( Price changes only)

-

40,000

80,000

120,000

160,000

200,000


Fixed income Trading picked in Q4 on account

of bearish trends in equities

Nigeria Fixed Income Average Daily Traded Volumes

(N'bn)

FGN Bonds T-Bills

Secondary Market Trading: Vastly Improving

The FMDQ OTC trading platforms continued to enhance liquidity with robust

trading activities in 2014 compared to 2013. By Q4 2014, market turnover of

bonds and treasury bills had shot up significantly from c.1700 deals and

N314.1bn per week at the beginning of the year to c.3800 deals and N755.1bn

per week. Rates sensitivity of long term maturities was pronounced as only the

4.00 23-April-2015 showed a price appreciation of 9.3% yielding a total return of

13.3%, while the biggest price decline of -9.2% was recorded in the 10.00 23-Jul-

2030 instrument with a total return of 0.8%. (see chart 59)

Yield Outlook and Fixed Income Strategy for 2015

In summary, there were 3 major factors that shaped the Nigerian fixed income

market in 2014: 1) Aggressive tightening by the CBN, 2) Heightened volatility in

FPI inflows, and 3) the downward trajectory of crude oil prices. We expect these

factors to continue to dictate yield movements in 2015 albeit in different

degrees during the year. With respect to the first factor, more or sustained

tightening is on the cards in 2015 for reasons we have highlighted earlier in this

report. Although we do not see significant adjustments to monetary aggregates

on account of policy pronouncements early in the year, we believe market

expectations will still drive rates upward in Q1’ 15. In the last 2 years, the impact

of interest rate movements have been less pronounced the further out you go

along the yield curve. This implies that short-dated maturities tend to be more

elastic to rate changes. While this appears to be a normal trend, we believe

Source: FMDQ United Capital Research

Returns were computed as at Dec 23, 2014 Source: FMDQ, United Capital Research

The biggest price decline of -

9.2% was recorded in the 10.00

23-Jul-2030 instrument with a

total return of 0.8%.

Although we do not see

significant adjustments to

monetary aggregates on

account of policy

pronouncements early in the

year, we believe market

expectations will still drive rates

upward in Q1’ 15

Fig. 58 Fig. 59


65

6.0

8.0

10.0

12.0

14.0

16.0

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14

Bond yields peaked in December, 2014

Daily average bond yields (2013-2014, %)

effective timing is all the more imperative now given the bleak macroeconomic

outlook.

In keeping with our investment themes for 2015, we advise investors to hold less

duration in 2015 especially in Q1. Our outlook for reduced structural liquidity,

increased domestic borrowing in the face of declining oil revenue through H1

as well as expected tighter monetary policy environment continue to lend

credence to an elevated yield environment in 2015. However, historical trend

analysis suggests that yields might have peaked in Dec 2014, as expectations of

naira devaluation sparked sell-offs on fixed income instruments, pegging

average bond yield at 16.5%. That said, we think that the CBN may be nearing

the healthy limits of administrative measures with no chance of policy reversals

given current and anticipated headwinds, leaving rates adjustment very likely.

This suggests that yields could remain within sight of 2014 year end levels,

especially in H1.

Specifically, our anticipation of a successful transition on the political landscape

implies that shorter maturity preferences will wane as we move further into H1,

leaving N/USD and interest rate dynamics as key considerations for position

taking in the fixed income market. Regardless of this, cautious play will still

prevail as oil price scrambles for a support. However, beyond H1 ‘15, we expect

to see relative stability with duration risk shifting to longer-dated maturities. More

so, subject to an appreciable repricing of the yield curve, likely to be triggered

by further exchanged rate adjustment, there is the possibility of increased

participation from the PFAs compared to the currently insignificant exposure of

banks to bonds given their preference for the short end of the curve.

Overall, we expect average bond yield to sit at 14.5%-15% range in H1. Baring

major shifts in the US Fed’s policy stance; we expect the domestic monetary

policy scene to normalize in H2. Although, the market may place some pressure

on the CBN to minimize capital flight and protect already depressed Naira in

light of ensuing Fed’s tightening in H2, our anticipation of reduced FPI outflows

and stronger oil prices post election translates to a relatively lower yield

environment in H2.


In keeping with our investment

themes for 2015, we advise

investors to hold less duration in

Nigeria in 2015 especially in Q1

We envisage that the market

may place some pressure on

the CBN to minimize capital

flight and protect already

depressed Naira in light of

ensuing Fed’s tightening in H2

Fig. 60


66

25,000

30,000

35,000

40,000

45,000

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14

QE

Tapering

and the

Increase in

CRR Suspension of

the ex-CBN

Governor

GDP Rebasing

by the NBS

New CBN Governor

resumes

Ebola

Outbreak

Oil Price

Shock

Further Tightening by the

CBN, Naira Devaluation and

OPEC "no cut" decision

EQUITIES MARKET

An eventful 2014

The local bourse recorded the worst performance post market resurgence in

2012. Coming from a bullish close to 2013 (47.2% return), the equities market in

2014 was shaped by events ranging from the increase in CRR of banks;

suspension of the ex-CBN governor; weak earnings by companies; Oil price fall;

further tightening by the CBN; Naira devaluation; as well as fiscal challenges.

These headwinds dragged the NSE to close the year with a negative return of

-16.1%.

The market kicked off 2014 on a positive note on the back of robust macro-

economic fundamentals. However, CRR adjustments, QE Tapering by the Fed

and the suspension of the ex-CBN Governor shoved the positive in the market in

Q1’14, resulting in 5.3% loss in the period. Outflow of portfolio capital was largely

responsible coupled with market-distorting activities. Consequently, the All Share

Index return was negative all through the period with -1.8%, -2.5% and -2.0%

returns in January, February and March respectively. The bearish mood

witnessed in the 1st quarter rolled in the start of the 2nd quarter with a -0.7% return

Trajectory of the ASI in 2014

Equities close the year with

worst performance post market

2012 market resurgence

The market kicked off 2014 on a

positive note on the back of

robust macroeconomic

fundamentals

Fig. 61


67

-1.8% -2.5% -2.1% -0.7%

7.8%

2.4%

-0.9% -1.3% -0.8%

-8.9% -8.0%

0.3%

-12%

-8%

-4%

0%

4%

8%

12%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Monthly Returns on the NSE

-5.3%

9.6%

-3.0%

-15.9% -20%

-10%

0%

10%

20%

Q1'14 Q2'14 Q3'14 Q4'14

Quaterly Returns on the NSE

0%

20%

40%

60%

80%

100%

Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14

Foreign Vs. Domestic Participation on the NSE

Foreign % Domestic %

in April. This however was short-lived as the GDP rebasing exercise which

positioned Nigeria as the largest economy in Africa triggered a market rebound

even as the appointment of the new CBN governor, Godwin Emefiele, who

upon assumption committed to defending the local currency and achieve

price stability, gave investors a breather. In the same period, volume and value

of transactions increased by 69.3% and 213% to 6.7bn shares and N11.9bn

respectively.

Market however reversed its bullish run in Q3’14 on the back of weak sentiments

stemming from the weak H1’14 results by companies, Ebola outbreak, Oil price

shock and steep depreciation in the Naira, this led to a 3% and 15.9% decline in

the equities market in Q3’14 and Q4’14 respectively.

Foreign Players still dominate

Activities in the local bourse were largely dominated by foreign investors in 2014.

The disposition towards the equities market by foreign investors was due to the

attractiveness of the exchange when compared with other frontier markets.

Foreign participation from January to November was 58.5% as against domestic

participation of 41.5%.

The appointment of the new

CBN Governor who committed

to defending the Naira gave

investors some breather

NSE, United Capital Research NSE, United Capital Research

NSE, United Capital Research

Foreign players accounted for

58.5% of trades from January to

November, 2014

Fig. 62 Fig.

63

Fig. 64

68

392.2%

374.0%

92.5%

40.7%

39.8%

35.3%

33.5%

0% 100% 200% 300% 400% 500%

Premier Breweries

Ikeja Hotels

Beta Glass

I.H.S

Fidson

Golden Guine

Union Dicon

Small cap stocks outperformed the Market in 2014

YTD Returns of select small cap stocks in 2014

Small cap stocks defy the bearish sentiment

Small cap stocks were the best performers in 2014 with a 32.8% growth, followed

by the mid-cap stocks which were up by 23.5%. However, the large cap stocks

were down by 21.4% which shows the negative market sentiment can be largely

attributed to sell-offs in the market’s heavyweights.

Shares of small cap stocks, especially in the consumer names were the top

gainers in 2014; Small cap stocks are rarely patronized by foreign and

institutional investors for lack of liquidity, hence they were less susceptible to

capital flight and global investor sentiment. Eight (8) out of the top 10 gainers for

2014 were small cap stocks with market capitalization of less than N25.0bn.

The gains in small cap stocks can be largely attributed to strategic position

taking by investors as some of these stocks portend values especially the

Insurance and Consumer goods names. We still expect to see long-term

bargain hunting and strategic buying in these stocks in 2015 following

disappointing performance of the large cap counters.

New Listings: Relatively flat

Following the twin stellar performance of the equities market in 2012 and 2013,

the market saw two major listings in 2014 by Seplat and Caverton in April and

May respectively.

The dual listing of Seplat Petroleum Development Company Plc (Seplat) on the

NSE and the London Stock Exchange (LSE) in April 2014 marked the first IPO on

the NSE since the market crash in 2008. Seplat listed its shares on the main board


The impressive performance of

small cap stocks can be

attributed to strategic

positioning in attractive names

We still expect to see long-term

bargain hunting and strategic

buying in select small cap

stocks in 2015

Fig. 65

69

-40%

-20%

0%

20%

40%

Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14

Nigerian Equities: Market Valuations Vs Peers Nigeria

Ghana

South Africa

Egypt

Kenya

Frontier Market

EMEs

Developed

Market

at N576.0 (£2.10) per share, making it the first upstream oil and gas company

listed on the NSE. Following this, Caverton Offshore Support Group (Caverton)

listed its 3.35bn shares at N9.30 per share, adding N32bn to the total market

capitalization of the exchange.

Company Listing

Seplat Petroleum Development Company Main Board

Caverton Offshore Support Group Main Board

Omoluabi Savings & Loans Plc ASEM

Vetiva Griffin 30 (VG30) ETF

Stanbic IBTC ETF 30 ETF

Overall, the market for new listings remained relatively unimpressive in 2014 with

only five (5) new equity listings; two (2) on the main board, one (1) on the ASEM,

and two (2) ETFs. The present market sentiment which is expected to be

sustained in H1’15 does not support any market listing or IPO in 2015. Though we

expect to see capital raising exercise by listed companies, a public offer is not

expected.

Valuations: Still attractive among peers

The equities market closed the year as the 2nd worst performer among its peers

with -16.1% y/y return. Negative sentiments and macro headwinds have

depressed valuations to a 3-year low. The market closed the year with a P.E

ratio of 10.95x compared to 14.5x and 14.8x among its African peers and global

market average respectively. We see value in select stocks and find them

attractive at current prices especially for domestic investors with long-term

horizon and zero currency risk.


Bloomberg, United Capital Research

Fig. 66


The market for new listings

remained relatively unchanged in

2014 with only five (5) new equity

listings; two (2) on the main

board, one (1) on the ASEM

70

17.1 16.87

15.12 15.03 15.03

12.68

10.95

S/Africa Dev. Mkt Egypt Kenya Frontier Mkt EMEs Nigeria

Nigerian market: Too cheap to ignore

P/E Ratios of Select markets

Strides of the NSE in 2014

The NSE signed a capital markets agreement with the LSE Group (LSEG)

to strengthen cooperation and promote mutual development between

the two exchanges. The agreement also supports African companies

seeking dual listings on the Lagos and London bourses.

The NSE completed a study to assess market readiness, the infrastructure

requirements, and sequencing for the launch of risk management

products in the Nigerian capital market.

The NSE unveiled a new set of minimum operating standards for all three

(3) classes of market intermediaries in an effort to develop sustainability

and augment protection for investors and stakeholders. The deadline for

complying with the standards was December 31, 2014. The Exchange

has since announced the Minimum Standards Implementation Plan,

which kicks off with inspections of all market intermediaries in April 2015.

The NSE launched direct market access (DMA) as a first step to the

implementation of sponsored access under the West African Capital

Markets Integration (WACMI) program, thereby giving global investors

more control over final execution of their orders, as well as the ability to

exploit price and liquidity opportunities.


Fig. 67


71

7.9%

65.6% 74.7%

-16.3%

-4.5%

-50%

-10%

30%

70%

1999 2001 2003 2005 2007 2009 2011 2013 2015F

The NSE was admitted to full membership in the World Federation of

Exchanges.

The NSE, in partnership with the Convention on Business Integrity (CBI),

launched the Corporate Governance Rating System (CGRS). The CGRS

is designed to rate companies listed on the Exchange based on their

corporate governance practices, thereby improving the overall

perception of and trust in Nigeria's capital market.

The Exchange launched an on-line whistle blowing portal, X-Whistle, for

the secure and effective submission of tips and referrals regarding

violations of the rules, regulations and laws of the Nigerian capital

market by listed companies and market intermediaries.

NSE Moves to achieve Emerging market status

The NSE in 2014 took remarkable moves to deepen the market, enhance global

visibility and improve the market. The NSE’s focus from 2011 to 2013 has been on

revamping corporate governance, improving human capacity, cleansing and

restructuring the market, improving technology, product development and

advocacy for changes to policy. The management of the NSE has recently

shifted gear in 2014 with focus on driving innovation centered on increasing

global visibility for the capital market; developing a larger footprint on the

African continent and targeting emerging market status.

Equities in election years: Can history repeat itself?

The market will not be all doom

and gloom in 2015


Equities Market returns 1999 – 2015F Fig. 68


72

A trend analysis of the market direction during election in the last 15 years

revealed stellar performance by the market in 2003 and 2007, and a negative

performance in 2011. We think the impressive performance of the market in

2003 and 2007 can be traced to the relatively higher predictability of election

results in those years as the ruling party (PDP) still had a firm grip on the political

landscape with no strong opposition on a national level. However, the tide

changed from 2011 election on the back of a more robust opposition, ethnic

interest and heightened security challenges. This tide has gotten deeper as we

roll into the 2015 general elections. We therefore expect a weak sentiment in

the market for H1’15 and a better outlook for H2’15. The equities market will not

be all doom and gloom in 2015.

Expected market Returns in 2015: a closer look at our Crystal Ball

The equities market in 2015 will be shaped by key global and domestic factors,

ranging from;

Interest rate hike in the US and UK.

Falling oil prices

Exchange rate instability and possibility of further devaluation of the

Naira

Effect of falling oil prices on government finance, expenditure and

consumption and the ripple effect on company’s earnings

Effect of the CBN;s tightening stance on banks’ performance and

earnings

Pass-through effects of devaluation of cost of imports and inflation

Bearish sentiment

Attractive pricing and dividend yield

Given the dominance of foreign investors in the equities market, the impact of a

capital flight from frontier and emerging markets on the back of interest rate

hike in the US and UK will have a significant impact on the market. The

benchmark rate which have been at a low of 0.25% since 2009 coupled with

liquidity boost from Quantitative easing drove capital flows into emerging and

frontier markets. A hike in interest rate by the US Fed coupled with impressive

numbers in the US which could lead to a better performing US equities market

would lead to capital flight and also reduce inflow into Nigerian equities. The UK

which has considerable interest in the Nigerian equities market, is also expected

to raise its interest rates from 0.5% to 0.75% in Q3’15 according to the British

Chambers of Commerce. We expect this rate hike to also spur fund reversals to

the UK.

A trend analysis of the market

direction during election in the

last 15 years revealed stellar

performance by the market in

2003 and 2007, and a negative

performance in 2011


73

0

20

40

60

80

100

120

140

160

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Oc

t-03

Ap

r-04

Oc

t-04

Ap

r-05

Oc

t-05

Ap

r-06

Oc

t-06

Ap

r-07

Oc

t-07

Ap

r-08

Oc

t-08

Ap

r-09

Oc

t-09

Ap

r-10

Oc

t-10

Ap

r-11

Oc

t-11

Ap

r-12

Oc

t-12

Ap

r-13

Oc

t-13

Ap

r-14

Oc

t-14

10- year movement in ASI and Brent Crude

NGSE ASI Brent Crude

The possibility of a further devaluation in the Naira and bleak outlook for

exchange rate will weigh heavily on foreign investors’ interest in the equities

market, limiting foreign inflows.

We have anchored our forecast of the performance of the Nigerian stock

market in 2015 on the trajectory of oil prices and by extension, the Naira. Given

that we are yet to see considerable traction in domestic participation on the

bourse, we believe foreign portfolio flows will continue to dictate the direction

of the market.

In the last 10 years, 2014 had been the year with the strongest correlation

readings between Brent crude and Nigerian All Share Index after a series of

distortions occasioned by major reforms in the Nigerian banking industry. (See

chart 69 below). It is easy for us to see the likelihood of a repeat performance of

the co-movement of the ASI and global oil price in 2015, but we have also

adjusted our forecasts to reflect political uncertainties that drove equity prices in

2014. Our base case expectation for oil prices remains $55-60 p/b on average in

2015.

We have also modeled the reactionary impact of exchange rate on FPI, as well

as the expectation of a tighter monetary policy environment which will

Banking

reforms

We have anchored our forecast of

the performance of the Nigerian

stock market in 2015 on the

trajectory of oil prices and by

extension, the Naira

Bloomberg, United Capital Research

Fig. 69


74

undoubtedly impinge on the banks’ performances. The table below summarizes

our expectations for the year:

Brent Crude

( $/p/b)

Scenario ASI Market Return

First Half

1 45

27,829.72 -19.70%

2 40

26,298.78 -24.12%

3 35

24,664.76 -28.83%

4 30

22,904.27 -33.91%

Second Half

1 45

27,829.72 9.46%

2 50

29,274.55 15.14%

3 55

30,646.07 20.54%

4 60

31,954.20 25.68%

2015e returns -4.47%


75

Section 6

Sector Reviews and Recommendations

Banking Sector

76

12.13%

1.95%

8.56%

1.25%

-4.24% -4.20%

5.59% 4.50%

6.50%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Q1 2013 Q2 2013 Q3 2103 Q4 2013 Q1 2014 Q2 2014 Q3 2104 FY 2014e 2015

Deposit growth remains weak

Nigerian banks' quarterly deposit growth, 2013-2014

BANKING SECTOR

Nigerian banks: Little progress in a year of many changes

Nigerian banks have had to operate under a fast changing regulatory

environment within the last two years, with 2014 marking a strategic shift in

supervision landscape. The attendant pressure on the lenders’ earnings

generating capacity significantly shaped sentiments around banking counters

during the year, leading to heightened returns volatility relative to 2013. The

year started with the guidelines by the banks to comply with the full Basel II

approach. This incited a flurry of capital raising exercises and dented the

prospects of dividend payment by the banks. The numerous policy

pronouncements during the year was capped with the bold tightening move

by the CBN via the hike in Cash Reserve Ratio (CRR) on private sector deposit to

20% and an 100bps increase in MPR to 13% in the last quarter of the year.

Although short term earnings visibility appears distorted for Nigerian lenders, we

continue to expect that the resilience of the sector in the face of numerous

opportunities in the economy will lead to modest growth in deposits and risk

assets in the medium to long term.

Navigating the rough patch of rate hikes

As at H1’14, Nigerian banks had already adjusted to the CRR hike in the

public/private sector deposit, especially the tier 2 banks which showed more

resilience. Banks aggressively drove their retail deposit strategy which helped in

stabilizing Net Interest Margin (NIMs), though cost of funds inched up by 20bps

to 4% in this period. However, we expect that the 500bps hike in CRR on private

Banks’ Financials, United Capital Research

Although short term earnings

visibility appears distorted for

Nigerian lenders, we continue to

believe in the resilience of the

sector

Banks that have grown non-

interest income contribution to

total earnings will be less

impacted by the hike in CRR

Fig. 70

Banking Sector

77

sector deposit to 20.0% will put the banks in a tough operating environment in

2015 having sterilized an additional N450.0bn of banks’ deposit liabilities which

implies a cumulative debit of c.N4.3trn with the CBN. This in our opinion will

hamper the income generating capacity of the banks and also dip liquidity

ratio to about 36%-38% level, further affecting banks’ capacity to create risk

assets. We expect an 8.1% decline in bank’s gross earnings going into H1’15.

Loan Growth should moderate to 10% in 2015

We have cut our 2015 loan growth forecast for our coverage banks from 15% to

10% (versus 12.8% as at Q3’ ’14), to reflect the recent rate hike and the possibility

of further tightening in 2015. We however expect the current capital injections

from Eurobond and Rights Issues to continue to drive loan growth across our

coverage banks as lending opportunities continue to unfold post 2015 elections.

We expect loan growth in FY’14 to remain largely flat at Q3’14 levels even as we

expect to see a rise in cost of funds across the board though with less impact in

the Tier 1 names due to economies of scale and access to less expensive

deposit. The rise in Cost of funds and the idle cash with the CBN will continue to

pressure NIMs in 2015.

2015 Earnings on a Quandary

Higher liquidity constraint and lower loan growth will pressure earnings of the

banks as assets reduce. The impact is expected to be most felt by the Tier 1

names due to the volume of deposit to be sterilized but a few of them with

sufficient liquidity cushion should be less impacted. Also, banks that have shown

20% 22%

18% 17%

15%

29%

18% 18% 17.30% 16.20%

0%

5%

10%

15%

20%

25%

30%

35%

Q4 2012 Q1 2013 Q2 2013 Q3 2103 Q4 2013 Q1 2014 Q2 2014 Q3 2104 FY 2014e 2015

Earnings remain pressured on higher funding costs

Nigerian banks' annualised ROEs, 2013-2015e


We have cut our 2015 loan

growth forecast for our

coverage banks from 15% to

10% (versus 12.8% as at Q3’ ’14),

The 500bps hike in CRR on

private sector deposit to 20%

will put the banks in a tough

operating environment in 2015

Fig. 71

Banking Sector

78

0.98%

5.45% 5.56%

8.78%

4.12%

2.26%

6.01% 6.00%

9.80%

0%

2%

4%

6%

8%

10%

12%

Q1 2013 Q2 2013 Q3 2103 Q4 2013 Q1 2014 Q2 2014 Q3 2104 FY 2014e 2015

Loan growth to remain muted at FY '14

Nigerian banks' quarterly loan growth, 2013-2014

strong growth in non-interest income contribution to total earnings will be less hit

by the hike in CRR. We have therefore revised our coverage banks’ gross

earnings growth forecast for FY’15 to 12% driven by a weak loan growth, higher

cost of funds and strain on margins. We also cut our dividend payout

expectations across our coverage as we expect the banks will retain more

earnings to manage liquidity in the face of the tight monetary stance.

Oil Price Declines: Measured impact on currency obligations

Nigerian banks’ total exposure to the oil and gas sector has averaged 23.1% in

the last four years (Vs. 13.2% between 2007 and 2011). With a high oil price

regime and rising indigenous participation in IOCs’ divestment activities,

Nigerian banks have shown increasing appetite for financing oil and gas

projects especially those in the upstream segment. In the last two years,

exposures have peaked to 24.0% of industry risk asset portfolio. We think the

recent declines in oil prices have taken a huge bite off banks’ ability to grow

loan books in 2015, as most oil and gas projects especially upstream, which

often accounts for more than half of banks’ total oil and gas exposure, become

unprofitable at sub-$70p/b oil prices.

On another note, existing significant FCY asset liability mismatch will necessitate

restructuring and repricing which could come at an additional cost to the banks

with a negative impact on margins. A quick look at our coverage names (see

chart 73 below) reveals that FBN, Fidelity, FCMB, Stanbic, Skye Bank and

Guaranty have net FCY funding gaps that are quite significant relative to their

shareholders funds. This also exposes their NIMs to further currency devaluation

within the year.



We also cut dividend payout as

we expect the banks will retain

more earnings to manage

liquidity in the face of the tight

monetary stance

Nigerian banks’ total exposure

to the oil and gas sector has

averaged 23.1% in the last four

years (Vs. 13.2% between 2007

and 2011).


Fig. 72

Banking Sector

79

53.4% 47.5% 30.8%

50.4% 45.9% 46.0% 52.1% 57.8% 55.7% 45.2% 52.7%

46.6% 52.5% 69.2%

49.6% 54.1% 54.0% 47.9% 42.2% 44.3% 54.8% 47.3%

0%

20%

40%

60%

80%

100%

FirstBank Zenith UBA GTBank Access Diamond Skye Fidelity FCMB Sterling Stanbic

Nigerian banks have significant net FCY funding liabilities

FCY Exposures (Assets Vs. liabilities)

FCY loans FCY Deposits

-51.7% -46.0%

-39.8% -39.5% -32.8% -32.5% -31.3%

-24.1% -21.3%

-11.7% -6.8%

1.6%

14.7%

26.5%

-60%

-40%

-20%

0%

20%

40%

YTD Performances of Nigerian banking stocks, 2014

Also, the persistent fall in oil prices which is expected to be sustained in H1’15

may result in reluctance by foreign banks to extend credit lines to Nigerian

banks; Credit lines by foreign banks to Nigerian banks have always been

strongly correlated with oil prices. Banks will therefore be faced with the

challenge of managing short term foreign currency obligations.

Market Performance and Outlook

The sector ended the year with only two stocks trading higher relative to their

respective closing prices in 2013, as persistent regulatory guidelines and policies

instigated negative sentiment towards the banks. The banking sector returned -

33.3% in 2014 with the biggest loss in ACCESS (-31.3%) while STANBIC (26.5%), ETI

(14.7%) and STERLNBANK (1.6%) were the only three stocks to close the year

positive. We anticipate more policies will be instituted to regulate operations,

whilst we also envisage the relaxation of some to offset the expected

restrictions. As such our expectations for the sector in 2015 are tempered,

though we estimate that downside risks are overpriced, creating significant long

term opportunities at current prices.

The sector ended the year with

only two stocks trading higher

relative to their respective

closing prices in 2013

Fig. 73

Fig. 74


Banking Sector

80

0.6

0.8

1.0

1.2


Sector Performance Vs ASI

Banking Index NSE ASI

Sector Coverage Names: BANKING

Name Mkt Cap (NGN) Liquidty

Price*

ACCESS 6.75 154,459.7 136,083,754.1 1.05 1.67 6.4 4.0 0.59 0.58 17.6 17.4 9.92 47% BUY

GUARANTY 26.07 767,270.8 508,974,884.8 2.97 2.42 8.8 10.8 2.27 2.24 26.9 26.4 30.29 16% HOLD

FBN 9.00 293,688.8 286,421,448.5 1.93 1.82 4.7 4.9 0.60 0.60 14.4 15.7 13.59 51% BUY

ZENITH 19.00 596,533.4 426,801,533.5 2.96 2.41 6.4 7.9 1.14 1.07 19.2 18.2 26.70 41% BUY

ETI 18.0 406,135.7 144,575,187.4 1.82 2.50 9.9 7.2 1.12 1.10 19.4 15.3 23.11 28% BUY

SKYE 2.80 37,014.1 22,137,868.0 1.08 0.90 2.6 3.1 0.32 0.32 13.0 11.7 3.90 39% BUY

FCMB 2.66 52,675.2 47,965,661.8 0.88 0.77 3.0 3.5 0.35 0.34 11.8 12.5 3.07 15% HOLD

DIAMOND 5.42 78,455.8 78,667,870.0 1.98 1.49 2.7 3.6 0.51 0.51 17.2 17.5 6.24 15% HOLD

FIDELITY 1.69 48,967.4 22,222,530.6 0.27 0.39 6.2 4.4 0.29 0.29 4.8 7.9 2.11 25% BUY

STERLING 2.42 52,254.6 33,527,880.3 0.48 0.44 5.1 5.5 0.80 0.78 18.1 15.5 1.91 -21% SELL

STANBIC 28.0 280,000.0 62,245,340.6 3.00 2.69 9.3 10.4 2.65 2.61 21.0 26.7 24.10 -14% SELL

* Prices as at Dec 31, 2014

Million Trailing 2014e

Daily Val.

Traded Trailing

Upside/

Downside Rating

EPS

Target

Price2014e2014e Current 2014e Current

P/BVP/E (x) ROE (%)

Recommendations

Fig. 75



Insurance Sector

81

414.8

87.6 76.3 56.5

10.9 34.3 30.1 21.7

0%

3%

6%

9%

0

90

180

270

360

450

Namibia Morocco Tunisia Angola Nigeria Algeria Kenya Egypt

Nigeria's Insurance Penetration one of the lowest globally

Insurance pentration and density in select African Counties

Density (LHS) Pentration (RHS)

INSURANCE SECTOR

The Untapped Gold Mine

Nigeria remains a huge potential market for insurance business in Africa. The

under penetration story is glaringly a strong investment case for the country’s

largely undeveloped risk market. By sheer demographic advantages and

current economic size, Nigeria can undoubtedly be described as holding the

biggest potential in insurance business in Africa.

In spite of lingering challenges, the Nigerian Insurance Industry has witnessed

appreciable progress in the last decade most of which was regulation driven as

market participants are yet to fully exploit the inherent potential in the industry,

in our view, however, opportunities still abound in this space. Our core

investment case for the sector is that growth will continue to be driven by

Nigeria’s attractive demographics, government reforms and increase in

business activities in the country. We continue to believe this sector portends a

wide array of opportunities given the very low insurance penetration rate

compared to other countries.

Industry Growth: Riding on Reform Initiatives

In the face of challenges facing the industry, past and current reforms by

NAICOM have given hope, as the sector begins a bumpy ride to a positive

change. Various initiatives by NAICOM and hunger for increased market share

by insurance companies pegged the industry gross premium at N105.5bn in

Q3’14, implying c.6% increase from N99.6bn posted in Q3’13. In the same vein,

PAT rose by c.40% to N14.7bn from N10.5bn recorded in corresponding period of

previous year just as return on equity (ROE) and return on asset (ROA) surged,

SwissRe, United Capital Research

Various initiatives by NAICOM

and hunger for market share by

insurance companies pegged

the industry gross premium at

N105.5bn in Q3’14

By sheer demographic

advantages and current

economic size, Nigeria can be

undoubtedly described as

holding the biggest potential in

insurance business in Africa.

Fig. 76

Insurance Sector

82

albeit marginally by 1.6% and 0.7% y/y respectively. According to NAICOM, an

annual growth of 17% in gross premium earned was recorded between 2009

and 2013 even as the industry regulator expects this to double within 3–5 years.

Much as we believe the industry has huge potential for growth, we are not

overly optimistic in the short term, given that the sector was unable to achieve

the target of N1trn set by NAICOM between 2008 and 2012 (achieved N234bn)

in its Market Development and Restructuring Initiative (MDRI) project. Also, our

discussions with industry players revealed that the N6trn objective by 2020

appears bullish and unrealistic. Notwithstanding, we expect the sector’s growth

trajectory to expand in the coming years, a position governed by the various

actions of the players to expand their balance sheet size through mergers and

acquisitions and rights issue. This will avail them the opportunity to underwrite

“big ticket” transactions as insurers cannot expose more than 5% of their net

assets (shareholders’ fund) to such transactions as required by the guideline on

Oil and Gas insurance by NAICOM. This said, the recent risk-based supervision

by NAICOM which was developed to ensure that insurance companies only

underwrite insurance contracts which their assets can support will make

insurance companies to further expand their balance sheet.

Weak Demand for Insurance: Public Apathy or Public Poverty?

Fundamentally, the demand for Insurance as an economic product thrives on

the purchasing power of the consumer. While opportunities for premium

expansion on the corporate side rests significantly on domestic economic size,

life insurance products and to a sizeable extent, general insurance is

strategically linked to an individual’s living standards. In our view, the perception

of insurance by Nigerians is distorted by their economic power.

A panel review of per capita incomes stacked against insurance premiums

across emerging markets suggests that there is a strong positive correlation

between per capita income and gross premium incomes across countries (see

chart 77)

Based on the foregoing, we argue that there is little evidence to support the

notion that there is public apathy towards insurance services; rather we believe

the low standard of living and longstanding income inequality remain key drags

for the industry.

We argue that there is little

evidence to support the notion

that there is public apathy

towards insurance services

According to NAICOM, an

annual growth of 17% in gross

premium earned was recorded

between 2009 and 2013 even as

the industry regulator expects

this to double within 3–5 years

Insurance Sector

83

United Kingdom

France Germany

Italy

Netherlands

Brazil

Spain

India

South Africa

Russia Mexico

Indonesia

Argentina Turkey

Morocco

Nigeria

Egypt

Kenya

Algeria

Angola

Namibia Tunisia Mauritius

R² = 0.7123

-

10,000

20,000

30,000

40,000

50,000

60,000

- 50,000 100,000 150,000 200,000 250,000 300,000 350,000

Per capita income shows high correlation with Insurance Penetration

Gross Premium Income and Per capital income of select countries

The “Rising” Middle Class: Can they come to the rescue?

Anecdotal evidence suggests that there is a bourgeoning middle class in

Nigeria and indeed, the broader emerging market space, with the potential to

foster economic growth across different sectors and push the weak demand for

insurance products. By nature, the middle class is seen as a predominantly

young active population with upward mobility in income, consumption, and

purchasing power. We note that there has been a consistent upward trajectory

in real per capita income (PCI) in Nigeria. Although statistics on income

distribution is limited, the upward swing in income per head can be a lagging

indicator of middle income growth. That said, it is pertinent to find a nexus

between middle income expansion and demand for insurance services in

Nigeria. Nigeria’s geographical advantage of fewer records of natural disasters

coupled with her citizens’ subconscious mindset of optimism makes a case for

close linkage between PCI and GPI difficult to accept, at least from a time

series perspective.

We believe the expansion in middle class creates opportunities for highly

innovative insurers to take advantage of changing lifestyle, consumption

patterns and social dynamics of a new generation of spenders. We believe that

to capture a substantial share of this insurable market, innovation and

Nigeria

Premium (US$m)

PCI ($)

IMF, Swiss Re, United Capital Research

We believe the expansion in

middle class creates

opportunities for highly

innovative insurers

Fig. 77

Insurance Sector

84

adaptability will be very critical. However, Nigerian insurers are offering too little

in this regard.

NAICOM: Pushing the frontiers of market expansion…

National Insurance Commission (NAICOM) which was established in 1997 with

the responsibility of regulating and supervising Insurance business in Nigeria has

made some remarkable contributions to shaping the Insurance industry.

However, the regulator’s intent to solidify the sector’s configuration has led to

new regulatory measures such as recapitalization regulation, and premium

expansion programs via the Market Development and Restructuring Initiatives

(MDRI) and the “No Premium No Cover” policy as well as the adoption of IFRS

reporting style and guidelines on Micro and takaful Insurance.

In 2014, the Regulator continued the enforcement of the No Premium No Cover

policy which commenced in 2013, stating that no valid Insurance contract can

exist without the receipt of an Insurance premium. Prior to enforcement of this

premium, Insurers were holding a large chunk of receivables in their balance

sheet, increasing the credit risk of Insurers and of their capacity to meet

obligation coupled with inability to invest these premium and generate income.

The enforcement of this policy has helped boost profitability of Insurers and the

confidence of the public. It has also helped in managing cash flows, thereby

improving balance sheet quality. We estimate that the enforcement of this

policy boosted insurers’ premium generation by 10-15% in 2014.

…but bargaining power is still in the hands of the brokers

About 90% of corporate business for Insurance companies is generated by

brokers/agents, and with over 2400 brokers/agents servicing 48 Insurers and 2 re-

insurers, it is not surprising to see the brokers/agents having a strong bargaining

power. Given the nature of Insurance in Nigeria, where demand for Insurance is

driven marginally by corporate entities relative to private individuals, the

brokers/agents hold a strong force in the Industry. This unhealthy dominance

leads to late remittance and sometimes non-remittance of premium.

Consolidation, M&A’s expected in the Short to medium term

The rich fundamentals of the Nigerian industry continue to endear it to foreign

investors who are looking for exposure to Nigeria’s massive growth markets and

a profitable haven for investible funds in Africa and other emerging economies.

The capital requirement of entry into the Insurance business (N2bn, N3bn, N5bn

and N10bn for life, non-life, composite and re-insurance respectively) makes it

easy for foreign players to gain entry into the Industry though NAICOM’s current

We estimate that the

enforcement of the No Premium

No Cover policy boosted

insurers’ premium generation by

10-12% in 2014.

The rich fundamentals of the

Nigerian industry continue to

endear it to foreign investors

who are looking for exposure to

Nigeria’s massive growth

markets

Insurance Sector

85

AIICO

8.5%

Custodian

and Allied

4.6%

Leadway

11.0%

Mansard

4.6%

IGI

4.9%

Market Share of Top 5 Players, 2013

N18.4bn

N10.1bn

N24.1bn

N10.0bn N10.6bn

0

10

20

30

AIICO Custodian

and Allied

Leadway Mansard IGI

Gross Premium of top 5 market players, 2013

policy does not issue fresh Insurance license to any interested party. We believe

that Merger & Acquisition is the only way foreign players or other interested

parties can play in the industry.

A number of foreign players have made entry into the Industry via acquisition; 5

foreign Insurance companies currently own significant stake in local insurers.

Sanlam Emerging Markets acquired 35% stake in FBN Life Insurance

AXA Insurance Plc acquired 77% ownership stake in Mansard Insurance

Plc.

New India Assurance has 51% stake in Prestige Assurance.

Old Mutual owns 70% in Oceanic Life (Old Mutual Life)

Greenoaks Global acquired 92.8% in Union Assurance

Others who have expressed interest are Prudential Plc, Liberty Holdings,

among others.

Local Insurers have also embarked on consolidation and M&A’s in recent times

in an attempt to increase market share. The more recent merger and

acquisition in this space was between Custodian and Allied Insurance Plc and

Crusader Nigeria Plc, as well FBN Life Assurance 100% acquisition of Oasis

Insurance Plc. Similarly, Universal Insurance Plc and African Alliance Plc have

expressed their intent to merge and form a new entity – Universal Insurance Plc.

Market Structure: The Big 5 control 34% of the market

The Industry remains fragmented, as no Insurer holds above 12% of market

share. The top 5 Insurance players control 34% of the market with the largest

Insurer, Leadway Assurance holding 11% of the market. The top 5 players in the

industry (measured by GPI) are local players save for AIICO insurance which has

a substantial foreign ownership.

NIA, United Capital Research NIA, United Capital Research

A number of foreign players

have made entry into the

insurance industry via

acquisition

Fig. 78 Fig. 79

Insurance Sector

86

Motor Insurance to remain a major driver of premium income

We believe that for a long time to come, motor insurance will continue to

account for the biggest share of premium income in the industry. The

compulsory third party insurance enforced by the NAICOM and government

enforcement agencies will continually support premium generation by Insurers.

Also, the increase in the volume of comprehensive insurance policies by

corporate and individuals have been significant in recent years. Looking ahead,

the consumer lease financing and the automotive policy by the federal

government portends opportunities for growth in the Motor insurance segment.

We however note that the market still expects significant improvement in claims

settlements.

Gross Premium Income of Insurers By Class of Business

N'000

Class of Business 2006 2007 2008 2009 2010

Fire 9,817 10,383 15,618 16,536 19,293

as % of total premiums 11.90% 10.30% 10.40% 9.20% 10.40%

Motor 17,108 25,220 38,118 45,215 42,039


General accident 11,945 16,191 22,536 23,912 28,592


Marine and Aviation 7,841 11,256 17,231 16,728 20,097


Workmen's compensation 924 984 720 1,704 903


Oil and Gas 14,907 12,981 17,403 31,577 26,092


Miscellaneous 5,393 7,822 9,137 8,982 8,945


Others 1,612 - - - -

as % of total premiums 2.00% - - - -

Life 12,743 15,783 29,328 34,292 39,761


Total 82,289 100,620 150,090 179,941 185,730

NIA, United Capital Research

Insurance Sector

87

Industry Outlook: 2014 and beyond

Opportunities abound in the Insurance Industry

Our outlook for the industry is positive in the medium to long term. We believe

there are opportunities yet untapped for growth as penetration rate is expected

to inch higher in the next 4 years. Should penetration rate meet the average

emerging market rate of 2.7% in 2019, gross premiums should rise to a high of

N2.9trn (US$17.6bn) over this period. In our view, the possible drivers of this

growth are:

Credit Facilities: The recent influx of consumer and retail credit and the

prospect for more growth in that space given the growing number of

working and middle class Nigerians as well as the drive by banks and

other finance institutions to penetrate this space, will help support the

Insurance sector. Typically insurance products accompany some

consumer loans such as mortgage and car loan.

Nigeria’s Attractive Demography: The high rate of urbanization and the

rising middle class portends prospects for the Insurance Industry. This

effect of this will be high demand for Insurable products like car, home,

personal items, as well as Life Insurance.

Regulation and Enforcement: NAICOM’ efforts at boosting confidence in

the sector and supporting growth via regulatory policies will continue to

shape the sector. The regulator has also shown its drive to grow the

insurance sector by enacting new laws and ensuring stricter

enforcement of existing ones. We expect to see more policies and

support from NAICOM in the future to support sector growth.

Innovative Solutions and Micro Insurance: Given the poor penetration of

insurance products relative to the population, we expect insurers to

come up with increasingly novel ways to grab a share of the vastly

untapped market. We expect insurers to leverage on technology in their

bid to increase insurance penetration and make the insurance

experience more convenient for the customer. Examples of such

innovative solutions include MTN 'Y'ello cover' in collaboration with

Mansard Insurance, Airtel's 'Padi 4 Life' in collaboration with FBN Life

Assurance as well as the development of mobile insurance apps for

quick and convenient insurance transactions

Should penetration rate meet

the average emerging market

rate of 2.7% in 2019, gross

premiums should high N2.9trn

(US$17.6bn) over this period

Insurance Sector

88

Insurance co. OPEX Margin Net Margin Underwriting Margin Claims Ratio Expense ratio Reinsurance Rate Return on Invst. Assets Investment Assets/Total Assets Current Ratio Net working Capital Ratio

AIICO 47.7% 4.1% 15.0% 37.2% 47.7% 21.8% 9.4% 65.5% 1188.8% 336.6%

ARM Life 131.9% -109.3% -46.0% 141.8% 131.9% 15.3% 11.9% 52.6% 136.0% 71.6%

CHI 63.5% -7.7 41.2% 25.3% 63.5% 38.1% 7.0% 41.9% 167.0% 102.6%

Continental Reinsurance 43.0% 13.1% 12.6% 46.9% 43.0% 11.2% 11.8% 54.8% 200.4% 50.0%

Cornerstone 48.9% 32.0% 32.2% 43.1% 48.9% 41.9% 9.1% 58.1% 164.4% 51.4%

Custodian 26.8% 42.8% 127.7% 53.8% 26.8% 55.2% 17.6% 50.1% 144.2% 64.7%

Equity 70.6% -13.6% 50.7% 29.7% 70.6% 21.4% 7.2% 24.5% 156.3% 55.0%

FBN Life 46.4% 11.8% 23.5% 16.9% 46.4% 5.8% 11.6% 94.0% 299.9% 116.3%

Guinea 74.0% 4.1% 101.5% 33.2% 74.0% 9.5% 0.0% 38.2% 296.0% 249.3%

KBL 46.7% 7.3% 17.7% 30.9% 46.7% 20.0% 5.4% 54.7% 251.8% 198.5%

Lasaco 54.0% 7.6% 38.9% 52.1% 54.0% 32.4% 8.6% 42.6% 149.1% 48.0%

Law Union 63.9% 16.4% 56.1% 25.2% 63.9% 21.6% 9.0% 42.4% 169.2% 67.8%

Leadway 19.2% 21.4% 40.0% 48.3% 19.2% 42.8% 5.4% 64.0% 114.6% 28.2%

Linkage 65.3% 26.1% 11.5% 40.7% 65.3% 25.6% 9.0% 87.6% 936.4% 111.9%

Mansard 97.6% 27.8% 32.5% 46.8% 97.6% 39.8% 1.8% 57.6% 184.3% 45.3%

Mutual Benefits 92.0% 8.3% 37.7% 41.8% 92.0% 12.4% 6.9% 51.8% 96.4% 15.0%

NEM 52.3% 5.3% 24.7% 41.4% 52.3% 4.7% 10.6% 64.6% 151.2% 77.3%

Niger 64.6% 6.5% 49.3% 38.6% 64.6% 9.3% 7.5% 25.3% 59.8% 30.5%

Oasis 7.4% -6.9% 60.9% 13.1% 7.4% 17.8% 10.1% 44.7% 305.2% 111.6%

Prestige 43.1% -5.2% -5.9% 65.6% 43.1% 63.0% 4.4% 38.8% 165.2% 55.1%

Regency 42.5% 18.6% 54.1% 27.9% 42.5% 26.9% 7.4% 55.2% 255.6% 142.3%

Royal Exchange 52.6% 15.3% 17.1% 47.3% 52.6% 27.1% 7.4% 26.5% 123.3% 23.9%

STACO 75.5% 9.1% 43.1% 59.8% 75.5% 13.5% 6.1% 29.7% 80.6% 46.1%

Standard Alliance 67.5% -28.5% 32.5% 34.6% 67.5% 18.1% 10.3% 37.0% 195.9% 11.2%

STI 36.5% 8.1% 43.7% 40.7% 36.5% 42.1% 8.6% 34.0% 137.5% 42.6%

UBAMET 57.7% 24.6% -16.4% 62.6% 57.7% 9.8% 12.0% 92.3% 216.8% 54.9%

WAPIC 96.3% -7.8% -4.0% 80.1% 96.3% 28.8% 11.3% 60.3% 330.6% 132.8%

Sector Performance and Returns Expectations

The sector returned 17.6% in 2014 (Vs. 40.5% in 2013) despite generally bearish

sentiments in the Nigerian equities market in the year. The sector’s performance

was boosted by the contribution by it’s the most capitalized stocks, Custody

Insurance and MANSARD as they returned 74.0% and 30.6% respectively. Their

performances were however not unconnected to the business combinations

they witnessed during the year. Notwithstanding the sector’s positive return

performance in 2014, c.67% (20 out of 30 listed companies) of insurance

counters still closed the year at their nominal values reflecting investors’ weak

appetite for insurance counters regardless of the impressive fundamentals of a

few of them. However, we are of the opinion that even if the upside potential

from insurance stocks look unattractive relative to other sectors from absolute

stance, low volatility of returns remains a valid investment case.

Company filings, United Capital Research

Operating statistics of Select Insurance Companies

Insurance Sector

89

74.0%

30.6%

-17.1% -16.7% -13.3% -10.7% -7.4% -5.7% -3.6%

-40%

-20%

0%

20%

40%

60%

80%

CUSTODYINS MANSARD CONTINSURE PRESTIGE NEM CORNERST INTENEGINS ROYALEX AIICO

Return performance of selected insurance stocks in 2014

0.6

0.8

1.0

1.2


Nigeria Insurance Sector Vs. NSE ASI

Insurance Index NSE ASI

Sector Coverage Names: INSURANCE


Price

MANSARD 3.05 30,500.0 27,435,435.6 0.14 0.17 22.0 18.2 2.04 1.97 10.2% 10.8% 2.43 -20% SELL

CUSTODIAN 3.62 21,762.9 12,723,845.9 0.78 0.82 4.6 4.4 1.01 0.93 19.9% 21.2% 5.21 44% BUY

Continental Re 0.99 10,269.0 8,672,983.4 0.17 0.20 5.8 4.9 0.67 0.64 11.8% 13.0% 1.30 22% BUY


RatingCurrent 2014e Current 2014e

EPS P/E (x) P/BV ROE (%)

Upside/

Downside

Target

Price2014eMillion

Daily Val.

Traded Trailing 2014e Trailing



Recommendations

Fig. 80

Fig. 81


90

0

5,000

10,000

15,000

20,000

25,000

0

5,000

10,000

15,000

20,000

Q2

2010

Q3

2010

Q4

2010

Q1

2011

Q2

2011

Q3

2011

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

Q4

2013

Q1

2014

Consumer Spending in Nigeria; pressured in 2014

Quarterly Aggregate Consumption Expenditure in Nigeria,

2010-2014

Consumer spend( N'bn) Disposable Income

North East

6%

North

Central

13%

North

West

12%

South East

14% South

South

18%

South

West

37%

Geographic Distribution of consumption

spending in Nigeria

CONSUMER GOODS SECTOR

Attractive demographics clogged by operating challenges

The consumer goods sector in Nigeria has been thriving on the back of the

country’s huge mass market and macroeconomic stability. But consumption

expenditure has been slowing. According to the NBS, average household

income spent on food consumption is estimated at 64.7% of the total

expenditure. However, recent pressure on the consumer wallet continues to

reflect in dwindling consumer spend in Nigeria as aggregate consumption

expenditure declined by 0.3% and 11.0% in Q3 ’13 and Q1 ’14 respectively even

as the major consumer names continue to face distribution challenges arising

from security threats in Northern Nigeria, including obstacles along export

routes.

Food and Beverage Sector: Keeping pace with rising demand

The consumption pattern of Nigerians has been historically skewed towards

food compared to non-food item as c.36.0% of Nigeria’s GDP is driven by food

consumption expenditure. Having recorded population-induced growth over

the last 10years, players are now ramping up CAPEX in order to shore up

capacity on the back of growing demand and market. We estimate that the

flour milling subsector in particular has shored up capacity considerably from

22,000MT/day in 2012 to about 25,000MT/day presently. The sugar refining

capacity have also increased significantly from 2.170MMTp/a to 2.920MMTp/a.

Source: NBS, United Capital Research Source: Euro monitor, United Capital Research

Consumption expenditure has

slowed significantly since 2013

Players in the Food and Beverage

sector are ramping up capacity

to meet increasing demand

Fig. 82 Fig. 83

Consumer Goods Sector

91

0.0%

4.0%

8.0%

12.0%

16.0%

2007 2008 2009 2010 2011 2012 2013 2014e 2015f

Strong Growth in Food and Beverage Sector

Food and Beverage Sector Revenue Growth 2007-2015f

Food and Beverage Sector: Cost and Profitability Metrics

2007 2008 2009 2010 2011 2012 2013 2014e 2015f

Cost to Sales 74.7% 76.0% 72.6% 75.0% 77.1% 76.5% 75.4% 74.4% 74.1%

OPEX Margin 10.1% 8.6% 9.4% 10.3% 10.2% 11.0% 11.8% 11.4% 11.2%

EBIT Margin 12.5% 12.5% 14.7% 12.5% 10.5% 10.7% 11.3% 12.6% 13.1%

EBITDA Margin 11.2% 14.3% 14.2% 14.4% 10.9% 11.7% 10.7% 11.3% 12.8%

Net Margin 8.9% 8.5% 9.2% 7.3% 6.5% 7.1% 7.4% 7.6% 8.6%

ROE 25.7% 26.3% 27.4% 22.7% 19.0% 21.0% 22.4% 22.9% 25.4%

ROA 12.2% 11.6% 12.1% 9.5% 7.8% 8.4% 8.7% 8.7% 9.8%

Leverage 2.1x 2.3x 2.4x 2.4x 2.5x 2.5x 2.6x 2.6x 2.6x

Asset Turnover 1.4x 1.4x 1.3x 1.3x 1.2x 1.2x 1.2x 1.1x 1.1x

Companies’ Financials, United Capital Research

Nestle and other players have hinted on plans to invest heavily in boosting its

capacity, Nestle plans to invest N100bn over the next 10yrs to expand capacity

to meet the growing demand for its product in the region.

Elevated Cost Structure remains a serious challenge

The volatile prices of agricultural inputs especially wheat prices remains a serious

challenge for players in this space. Wheat prices globally are usually very

volatile and highly susceptible to internal price movements. These inputs

account for the bulk of flour millers’ revenue (c.90% of turnover). Although

cocoa is locally sourced, prices vary in line with international movement. Players

however enter into some form of futures contract of up to 3 months with

suppliers to hedge against price volatility. However, the recent devaluation of

the Naira coupled with raise in the MPR to 13% will continue to affect

companies in this sector especially those who largely import their raw materials.

Also, cost of borrowing due to interest rate hike and tight liquidity will pose a

major challenge to profitability.


The volatile prices of agricultural

inputs especially wheat prices

remains a serious challenge for

players in this sector. Fig. 84


92

Lager

58% Stout

15%

Malt

27%

Segment Distribution of Nigerian Brewery

Market

0

100

200

300

400

500

Breweries sector revenue trend, 2000

-2015e

Brewery Sector: Changing drinking patterns...

The Brewery sector accounts for about 45.3% of the beverage market in Nigeria,

however, the recent decline in discretionary spend has been most noticeable in

this space. The beer sector grew by 3.0% in 2012 and declined by 2.1% in 2013. A

breakdown of the brewery market indicates that of the total beer consumption

in Nigeria, Lager beer has the largest market share of 58.3%, stout has 27.2% and

Malt has 14.5%. We think the brewery sector is witnessing an historic shift in

drinking patterns, a development that is hitting hard on the premium brands.

We believe that the next stage in the industry life cycle will see shrinkage in

market shares for players in this segment, forcing many players to play at the

low end.

…continue to prompt acquisitions and inorganic growth strides

The two (2) major players, Nigerian Breweries (NB) and Guinness control about

90% of the industry market share having seen significant investments in capacity

and product chains to penetrate the vast changing beer market landscape.

Heineken NV which owns majority stake in NB, Consolidated Breweries and

Champion Breweries control c. 71.0 % of the market while Diageo owns majority

stake in Guinness controls 27.0% of the market. Heineken NV recently

concluded its merger of Consolidated Breweries and NB to exist as NB with a

wide product portfolio in the premium and value segment of the market. SAB

Miller (SABM) a more recent entrant to the brewery market has had a growing

and significant stake in the industry and has built up its capacity to about

1.8mhl, which includes Pabod Breweries in Port-Harcourt, International Breweries

in Ilesa and Onitsha.

The entry of SABM has put a threat to future dominance of NB and Guinness.

SABM acquired international Breweries in Jan 2012 and has made other

acquisition since then which includes Intafact Beverage in Onitsha and Voltic

Nigeria Ltd in Lagos. The company recently invested US100mn to penetrate

effectively and aggressively in the Nigerian market through strategic regional

approach.

Company filings, United Capital Research Heineken, United Capital Research

We think the brewery sector is

witnessing an historic shift in

drinking patterns, a

development that is hitting hard

on the premium brands

The two (2) major players,

Nigerian Breweries (NB) and

Guinness control about 90% of

the industry market share

Fig. 85 Fig. 86


93

FMCG sector: Striving hard to push sales

The FMCG players, many of whom are net manufacturers, continue to feel the

pinch of tighter credit flows and high operating costs in an era of cautious bank

lending and lingering infrastructural bottlenecks. Given the ongoing distribution

challenges, exercabated by volatile security situation, the route to market for

these players have been rather tortuous. This has been further complicated by

wholesalers’ difficulties in obtaining credits to fund working capital position,

reflecting in pressured liquidity positions for key players.

NESTLE has particularly done well in the face of rising competition from imported

substitutes with largely volume driven growth buoyed by efficient supply chain

management. Also, its highly domesticated input sources have stabilized cost of

production and margins offsetting the impact of increased promotional spend.

PZ on the other hand has struggled to hold on to market share in the face of stiff

competition. Management has frequently attributed the recent weak earnings

performance to security challenges in the North, but we believe wider industry

headwinds from heightened domestic and external competitive pressures are

largely responsible for its continued underperformance especially in the HPC

segment.

Global Brand Subsidiaries Installed Capacity (mhl)

Heineken NV

Nigerian Breweries 15.4

Consolidated Breweries 3.7

Champion Breweries 0.5

Diageo Guinness Nigeria Plc 5.5

SABMILER

International Breweries 1.8

Pabd Breweries Ltd

N/A Intafact Beverages Ltd.

Voltic Nigeria Ltd.

Global Brewers in Nigeria

Heineken, United Capital Research

The FMCG players, many of

whom are net manufacturers,

continue to feel the pinch of

tighter credit flows and high

operating costs

Given the ongoing distribution

challenges, exercabated by

volatile security situation, the

route to market for FMCG

players have been rather

tortuous


94

131.7%

33.49%

-1.5% -5.7% -15.69%

-28.8% -32.2% -33.5% -35.7% -45.7% -49.25% -50.44% -55.6%

-100%

-50%

0%

50%

100%

150%

Returns Performances of Selected consumers, YTD 2014

Sector Outlook for 2015 and Beyond

The expectation of a decline in consumer spending in 2015 largely on the back

of recent devaluation of the Naira, as well as lingering security threats remain

key downside risks to the sector in 2015. We estimate that aggregate consumer

spend for 2014 at 65.1% of national disposable income down from 70.1% as at

Q1, 2014, suggesting increased deleveraging by the Nigerian consumer. We

expect to see a shift to necessity as a result as spending and credit conditions

tighten. We would therefore look to pitch our tent with the defensive names in

the sector. That said, we believe new product offerings, product innovation and

capacity expansion will drive the sector’s revenue this year. While we do not

expect a quick recovery in consumer spend in 2015 due to lingering macro

headwinds as well as overall decline in government spending, we continue to

believe Nigeria will remain an increasingly attractive frontier consumer market in

the medium to long term on account of positive developments in

demographics, rapid urbanization and robust growth outlook.

Market Analysis and Returns Expectation

The sector under-performed the market in 2014, returning -17.9% compared to

the market return of -16.1%. The poor performance of the sector was largely

driven by losses of large cap stocks like FLOURMILL (-50.4%), PZ (-35.7%),

UNILEVER (-33.5%), GUINNESS (-28.7%) and NESTLE (-15.7%). The poor sentiment

was swept across all stocks in the sector save for 7UP and UNIONDICON which

appreciated 131.6% and 33.5% y/y respectively.

We estimate that aggregate

consumer spend for 2014 at

65.1% of national disposable

income down from 70.1% as at

Q1, 2014


Fig. 87


95

0.6

1.0

1.4


Consumer Goods Sector Vs. NSE ASI

Consumer Goods Index NSE ASI

Sector Coverage Names: CONSUMER GOODS


Price*

7UP 165.40 105,953.6 40,152,026.8 10.55 8.52 15.7 19.4 5.82 5.18 24.8% 26.7% 167.37 1% HOLD

CADBURY 40.00 75,128.1 15,073,468.1 2.02 1.29 19.8 31.0 6.64 6.40 19.5% 20.7% 25.65 -36% SELL

DANGFLOUR 4.55 22,750.0 6,626,629.8 -1.68 -0.69 nm nm 2.00 2.87 nm nm 5.10 12% HOLD

DANGSUGAR 6.35 76,200.0 20,739,555.6 0.86 0.88 7.4 7.2 1.56 1.55 21.8% 21.6% 11.79 86% BUY

FLOURMILLS 39.2 102,870.1 38,618,336.7 1.31 1.87 29.9 21.0 1.13 1.11 3.7% 5.3% 30.97 -21% SELL

HONEYWELL 3.46 27,438.5 7,377,412.5 0.54 0.35 6.4 10.0 1.26 1.21 10.1% 12.1% 5.72 65% BUY

NASCON 6.22 16,479.5 7,933,747.6 1.26 1.18 4.9 5.3 2.71 2.45 34.5% 46.5% 8.61 38% BUY

NESTLE 1011.75 801,970.0 237,986,191.1 33.76 29.65 30.0 34.1 23.96 22.80 70.7% 66.8% 904.21 -11% SELL

PZ 23.80 367,449.6 25,555,553.3 2.25 1.41 10.6 16.9 1.34 1.33 7.2% 7.9% 29.43 24% BUY

UNILEVER 35.80 135,442.0 39,198,255.7 1.55 0.64 23.1 55.8 3.05 3.01 6.3% 5.4% 28.03 -22% SELL




Upside/

Downside

Target

Price2014eMillion

Daily Val.


INDUSTRIAL GOODS S


Sector Coverage Names: BREWERIES


Price*

GUINNESS 168.15 253,215.1 62,137,269.5 6.31 6.94 26.7 24.2 5.62 5.60 21.1% 23.1% 229.08 36% BUY

NB 165.30 1,250,115.0 387,952,590.2 6.10 5.26 27.1 31.4 11.55 11.33 36.7% 36.1% 173.67 5% HOLD




Upside/

Downside

Target

Price2014eMillion

Daily Val.



Fig. 88



96

CEMENT SECTOR

A fast changing competitive landscape

The dynamics of the Nigerian cement industry is rapidly changing. We have

observed that in the last 2 years, attention has shifted from capacity and

distribution linkages to pricing and quality. The demand drivers for the sector

however remain unchanged - individual home owners given the long delays in

large scale infrastructural projects. The history of strong domestic demand versus

capacity constraints is now giving way for efficiency and strong market power

with players seeking to leverage on scale to improve efficiency. The cement

market grew by 1.3% to 16.2MT in Q3’14, largely driven by a growing building

and construction market as well as a robust economy. Furthermore, total

installed capacity increased by 9MMTp/a while capacity utilization stood at 85%

as companies in this sector have geared towards gas supply and other

alternative power measures. Dangote Cement maintained its dominance of the

Nigerian cement market in 2014, though its ambitious pan African expansion

plans were slower than earlier anticipated.

Lafarge Consolidation: Standing up to the giant

In a bid to measure up to the competitive pressures from Dangote, Lafarge

worldwide concluded the consolidation of its Nigerian and South African

operations into one entity in 2014. The combined entity known as Lafarge Africa,

now has a market capitalization of N486bn (US$3 billion) and will be listed on the

Nigerian Stock Exchange, becoming the 6th largest company by market

capitalization. The transaction involved the transfer of Lafarge S.A.'s interests in

Lafarge South Africa Holdings (LSAH), UniCem, Ashaka Cement and Atlas

Cement to Lafarge WAPCO. Consequently, the enlarged entity Lafarge Africa

now owns 100.0% of LSAH, 58.6% of Ashaka Cement, 100.0% of Atlas Cement

and an indirect holding of 35.0% in UniCem. Lafarge Africa now has a

combined capacity of c.12MMTp/a in Nigeria and South Africa and with a

5.5MMTp/a capacity expansion already underway in UniCem and Ashaka

Cement.

LAFARGE WAPCO LAFARGE AFRICA

Subsidiary Wapco Wapco, Ashakacem, Unicem, Lafarge SA,

Installed Capacity 4.5MMT 12MMT

Market Presence South-West South-West,North-East, South Africa

Company Disclosures, United Capital Research

In the last 2 years, attention has

shifted from capacity and

distribution linkages to pricing

and quality

Lafarge Worldwide consolidated

its Nigerian and South African

operations into one entity in

2014

Industrial Goods Sector

97

Two Dominant players still face fierce competition

The consolidation of the shares and businesses of Lafarge group in South Africa

and Nigeria into one entity, Lafarge Africa Plc, has led to a more intense

competition in the cement industry. While Dangote Cement controls 64% of the

market, Lafarge Africa currently controls 33% of the market. The Intense

competition among these two manufacturers is leading to stable and lower

prices amid increased capacity by the firms as they position to meet

burgeoning demand. The competition has gotten fierce with price as one of the

weapons most commonly deployed. The biggest player in the industry, Dangote

Cement Plc, announced on November 2, 2014 that it had pegged the price of

its 32.5 cement grade at N1,000 per 50kg bag, while it noted that the higher 42.5

grade would sell for N1,150 per bag. The new prices, exclusive of the VAT,

represent about 40% discount on the prevailing market prices of the product,

which was selling for N1, 700 across the country, irrespective of the grade.

New cement standard: Raising the bar on quality

The Standard Organization of Nigeria (SON) following allegations of poor

cement quality and the increased incidence of building collapse, proposed the

adoption of a new cement standard 42.5 grade, hence limiting the previously

used 32.5 grade to plastering. Based on the new standard, only the 42.5 grade

can be used for block making, thus necessitating a major shift to production of

the new and better quality grade. A direct implication of the new standard on

cement producers is the increase in cost of producing 42.5 grade as the

cement mix requires a higher and purer amount of clinker thus impacting

negatively on raw material and power costs. Dangote Cement had recently

launched its 42.5R cement grade, though Lafarge Wapco was the first producer

of the 42.5 grade (CEM II 42.5N) but failed to take first mover advantage

through proper advertisement and product visibility.

Gas Supply Challenges: Energy efficiency still at risk

Cement producers struggled with inadequate gas supply in 2014, which was

exacerbated by the increased demand for gas by the recently privatized

power generating companies. This disruption affected cement production with

local producers having to resort to more expensive sources of fuel - Low Pour

Fuel Oil (LPFO). With the increased demand for gas putting a strain on the

existing system and the expected addition of new capacities, the gas situation

may get worse in 2015. However, some players are already opting for other fuels

like coal which is cheaper than LPFO. For example, Dangote Cement is

planning to switch to coal, even as the company disclosed that significant

The intense competition among

players is expected to lead to

stable and lower prices

With the increased demand for

gas putting a strain on the

existing system and the

expected addition of new

capacities, the gas situation

may get worse in 2015


98

progress has been made in completing the coal mill with order already placed

for the import of coal consignments. Although coal is more expensive than gas

at the moment, the price of gas is expected to converge to the price of coal

based on the planned increases in gas price, as conveyed in the Gas Master

Plan.

Market Performance and outlook

The Industrial goods sector closed the year with a negative return of -10.4%

despite the year-end rally witnessed in this space. BERGER and ASHAKACEM

were the only stocks that closed in the green with a return of 12.5% and 4.3%

respectively. The sector’s heavyweights, DANGCEM and WAPCO, closed the

year with a negative return of -8.7% and -28.1% respectively, driven by poor

earnings growth on the back of high production cost.

We see medium to long term potential upside in this sector, especially within the

cement space as we recognize the strength of the underlying market

opportunity. Therefore we will be bullish on companies with strong, and in some

instances, spare production capacity, which we think will remain a long term

strategic advantage for players. More importantly, we will favour companies

with stable sources of gas supply to power operations.

Notably, our expectation of reduced government spending will cap volume

uptake for players in 2015. What’s more, the fall in discretionary income will

reduce demand from individual home owners who remain the key drivers of

demand, with further pressure on revenue growth of cement producers. The

lingering gas supply constraints has exposed players to the vagaries of

exchange rate as the major input, clinker, which requires over 90.0% of total

production energy requirements, has been the hardest hit. By and large, we

expect a modest slow down in earnings for players in the cement sector, largely

due to elevated and erratic energy costs as well as reduction in volumes.

Current valuations however still portend long term opportunities, on our

estimates.

We see medium to long term

potential upside in this sector,

especially within the cement

space as we recognize the

strength of the underlying

market opportunity

On our estimates, current

valuations portend significant

long term opportunities


99

0.6

1.0

1.4


Industrial Goods Sector Vs NSE ASI

Industrial Goods Index NSE ASI

Sector Coverage Names: INDUSTRIALS


Price*

DANGCEM 200.00 3,408,101.5 270,217,159.9 16.86 10.95 11.9 18.3 5.97 5.90 32.7% 32.3% 168.84 -16% SELL

WAPCO 80.50 354,536.2 113,046,293.7 8.98 9.61 9.0 8.4 2.04 1.97 24.3% 23.6% 91.69 14% BUY


Million

Daily Val.



Upside/

Downside

Target

Price2014e RatingCurrent 2014e Current 2014e

12.90%

4.3%

-8.7% -11.6%

-22.6%

-29.1% -30.0%

-40%

-30%

-20%

-10%

0%

10%

20%

BERGER ASHAKACEM DANGCEM CCNN CAP PORTPAINT WAPCO

Returns Performances of Select Industrial Goods Players




Fig. 89

Fig. 90


100

298 266

174 157 150

102 98 93

48 44 37

0

100

200

300

400

Ve

ne

zue

la

Sa

ud

i Ara

bia

Ca

na

da

Iran

Iraq

Ku

wa

it

UA

E

Ru

ssia

Libya

USA

Nig

eria

Nigeria has the 2nd Largest crude oil deposit in Africa

World’s 2013 oil reserves (Bn bbls)

OIL AND GAS SECTOR

Nigerian Hydrocarbon: robust reserves, little exploration

According to BP statistical review 2014, Nigeria had about 37.2bn barrels of

proven crude oil reserves as of end of 2013 – the 2nd largest deposit in Africa,

after Libya. Proven oil reserves estimates have however been inactive over the

past few years with exploration activities at their lowest levels. The long delay in

the passage of the PIB, oil theft and pipeline vandalism continue to play a major

role in the low exploration of hydrocarbon, especially in the onshore.

.

Production leakages and theft: Here to stay?

According to the Nigerian Extractive Industries Transparency Initiative (NEITI),

Nigeria lost over 136mn barrels of crude oil estimated at US$10.9bn through

pilfering and sabotage from 2009 to 2011, while 10mn barrels valued at

US$94mn were also lost to pipeline vandalism in the downstream sector within

the same period.

Oil theft, pipeline vandalism and other security challenge led to significant

volatility in oil production and heightened exploration risks in 2014, with

production volume falling below the long term average of 2m bp/d. We believe

that operational risks will continue to grow in Nigeria’s oil and gas sector over

the next few years as long as these bottlenecks are not effectively removed. In

addition, the low level of transparency in oil revenue, local tensions and


Exploration activities have been

at their lowest levels in the last

few years

We believe that operational

risks will continue to grow in

Nigeria’s oil and gas sector over

the next few years

Fig. 91

Oil and Gas Sector

101

1

2

3

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Nigeria Oil Production trend 2009 – 2014 (Mn bbls)

negative environmental impacts of oil exploration will remain key risks to

investment in the sector, constituting a clog on the realization of the country’s

aspiration to increase production to 4mnbp/d by 2020

World Energy in 2014: The Great Shale Revolution

One of the most astonishing transformations in the history of the global

economy has taken place almost overnight in the oil industry. From an output

low of 5mnbp/d in 2008, the least since 1946, US oil production skyrocketed to

8.864mnbp/d in September 2014, the most in nearly 30 years. This incredible 77%

surge in only 6years was generated by the recent technology development of

hydraulic fracturing in natural gas production from shale formation in the US.

This development has influenced not only energy dependence in the US but

also global energy prices. The US has vast reserves of shale formation, which

often extend our conventional natural oil and gas basins, but are generally

deeper and more difficult to exploit. The implication of the vast improvement in

US shale production is a drop in import from Nigeria. According to US

Department of Energy, Nigeria did not export any barrel of crude to US refiners

in July 2014, ending over 4 decades of exports.

BP, United Capital Research

Nigeria did not import any

barrel of crude to US refiners in

July 2014, ending over 4

decades of exports.

Fig. 92

Oil and Gas Sector

102

3.0

4.5

6.0

7.5

9.0

10.5

2010 2011 2012 2013 2014

US crude oil production has witnessed significant growth in the last 4

years US Oil Production 2010 – 2014 (Mn bbls)

Delayed PIB meets increased propensity to divest

The delay in the passage of the PIB has continued to stall huge investment in the

oil industry, placing a cap on industry capacity and reserves. In 2014, Shell

Petroleum Development Company (SPDC) had to put on hold investment

decisions on two key offshore oil and gas projects estimated at US$30bn

pending the passage of the PIB. Major Oil and Gas projects affected by the PIB

include the Trans-Sahara gas pipeline project, the Olokola Liquefied Natural Gas

(OKLNG) project, Brass LNG project and Russian Gazprom US$25bn gas project,

and the US$12bn Bonga South West Aparo development.

A number of IOCs divested their upstream assets in response to the high level of

oil theft, pipeline vandalism, operational and security challenges in the Niger

Delta as well as elevated cost of doing business in Nigeria. Chevron sold some

of its oil blocks in shallow waters while SPDC, Total and ConocoPhillips have

earlier sold their Interests. Given that IOCs account for more than 70% of

Nigerian daily crude production, these divestments continued to command

interest from different stakeholders in the Nigerian Oil and Gas industry.

The divestment programme by the IOCs has significantly changed the Oil & Gas

industry dynamics in Nigeria, providing opportunities for smaller players. The

demand from smaller players for divested onshore blocks is likely to remain high

as new divestments may prove attractive plays for Nigerian companies to gain

access to viable oil discoveries located onshore, in swamp land or in shallow

waters, and achieve material increases in scale. We expect the IOCs to

continue with the process of divesting oil blocks in 2015, albeit at a slower pace

than 2014, particularly those located onshore and in shallow waters. In an effort

The delayed passage of the PIB

has capped industry capacity

and reserves

The divestment programme by

the IOCs has significantly

changed the Oil & Gas industry

dynamics in Nigeria, providing

opportunities for smaller players

BP, United Capital Research

Fig. 93

103

to rationalise portfolios and achieve economies of scale, most of the large

international oil companies have shifted their operational focus gradually to

larger discoveries, often taking them further offshore and in deeper water

ranges where they still possess technological and capital advantages over

domestic oil companies.

Stalled Privatization of Refineries: Posing a Challenge for Growth

Nigeria’s grossly inadequate refining capacity continued to stifle growth in the

oil and gas industry in 2014. The Bureau of Public Enterprises (BPE) and the

Ministry of Petroleum Resources had earlier indicated plans to sell the existing

four (4) refineries, with a combined capacity of 445,000bp/d, with an average

capacity utilization of 31% once the PIB is passed. While a number of private

Company Disclosures, United Capital Research

Oil and Gas Sector

104

firms have indicated interest to build and operate their own refineries, the

uncertainty regarding the deregulation of the downstream sector and delayed

passage of the PIB have put a halt to these plans except for the US$9bn

Dangote Refinery/Petro-chemical/Fertilizer complex which aims to start with an

initial refining capacity of 400,000bp/d.

Sector Outlook for 2015 and Beyond

According to the OPEC, global demand for crude in 2015 is expected to fall to

the lowest level in more than a decade and far below current output. OPEC

forecast demand for the group’s oil will drop to 28.9mnbp/d in 2015, down

280,000bp/d from its previous expectation and over 1mnbp/d less than it is

currently producing. Poor outlook for crude oil demand driven by weaker

outlook for growth in Europe and Asia will continue to pressure oil price demand

in the face of higher supply growth from shale and other non-OPEC sources. The

expectation of a continuous decline in oil price will pressure counters of players

largely exposed to the upstream segment of the industry while downstream

players are likely to benefit from a possible deregulation of the sector. That said,

we believe the passage of the PIB and a visible progress around the gas master

plan will constitute significant lifelines for the sector in 2015. With the largest

holding of proven natural gas reserves in Africa, we believe that the gas

segment has the potential to drive Nigeria’s energy sector through the gas to

power framework in the medium to long term, provided infrastructural rigidities

and poor domestic pricing inhibiting the monetization of the sector can be

effectively addressed.

Market Performance and Returns Expectations

Thanks to a bullish run in FO and MOBIL of 133.2% and 33.2% respectively, the Oil

and Gas sector was able to defy the general bearish market sentiment closing

the year with a positive return of 7.5%. However stocks in the basket like

CONOIL, ETERNA, OANDO, TOTAL, JAPAULOIL and MRS still closed in the

negative, shedding 43.9%, 33.9%, 33.6%, 16.2%, 7.4% and 2.3% respectively

We think the current price of stocks in this space offer opportunity for bargain

hunting, as we are constrained to take a position that most counters have

bottomed out. However, valuation suggest that FO is over-valued, though we

do not rule out a possibility of further rally, a decision justified by its year high

price of N259.94 prior to the start of the general market bearish sentiments.

Hence, it is not unlikely it exceeds this year high in 2015. In sum, we expect the

According to the OPEC, global

demand for crude in 2015 is

expected to fall to the lowest

level in more than a decade

and far below current output

Poor outlook for crude oil

demand driven by weaker

outlook for growth in Europe and

Asia will continue to pressure oil

price demand in the face of

higher supply growth from shale

and other non-OPEC sources

Oil and Gas Sector

105

0.4

0.8

1.2

1.6


Oil and Gas Sector Vs. NSE ASI

Oil & Gas Index NSE ASI

Sector Coverage Names: OIL AND GAS


Price*

OANDO 15.68 142,447.9 138,759,029.9 nm 1.61 nm 18.1 0.04 0.04 7.1% 6.9% 24.33 55% BUY

SEPLAT 390.00 215,791.0 125,352,178.4 98.84 85.19 3.9 4.6 0.99 0.94 21.7% 20.5% 411.15 5% HOLD

CONOIL 38.11 26,446.5 6,198,450.2 3.47 2.74 11.0 13.9 1.58 1.54 11.4% 11.1% 28.40 -25% SELL

MOBIL 158.00 56,974.1 11,966,332.1 19.21 22.17 8.2 7.1 4.26 3.94 59.8% 55.3% 229.62 45% BUY

TOTAL 142.5 48,381.9 11,783,466.5 13.91 10.40 10.2 13.7 3.77 3.66 27.5% 26.7% 111.08 -22% SELL

FORTE OIL 227.90 246,196.0 63,985,352.5 5.75 4.90 39.6 46.5 20.30 22.81 43.7% 49.1% 103.19 -55% SELL




Upside/

Downside

Target

Price2014eMillion

Daily Val.


33.2%

4.8%

-2.3% -7.4% -16.2%

-33.6% -33.9% -35.6%

-43.9% -50%

-10%

30%

70%

MOBIL UNIONVENT MRS JAPAULOIL TOTAL OANDO ETERNA SEPLAT CONOIL

Returns Performance of Select Oil and Gas Stocks, YTD 2014

oil and gas sector to post a modest base case return of 5.56% in 2015. However,

we preach cautious trading given the sector’s high volatility.


Fig. 94

Fig. 95


Oil and Gas Sector

106

LIST OF FIGURES AND TABLE

Figure Title

1 y/y GDP growth in global and advanced economies

2 US GDP growth

3 Historical and Forecast GDP Growth for Advanced Economies

4 Oil Price

5 MSCI Equity Indices for Advanced and Emerging Economies 2014 (%)

6 Expansionary Regime in the Euro zone

7 Real GDP Growth for BRICS Economies

8 q/q Real Growth Trend for SA (%)

9 USD/ZAR, 2011-2014

10 SA Inflation Rates Vs. Policy Rate (%)

11 JSE Valuations Vs. Ems [P/E (x)]

12 SA 10yr bond yields

13 Ghana y/y Real GDP Growth

14 Ghana Cedi/USD

15 Average Yields on fixed income instruments in Ghana

16 Ghana Composite Stock Market Index

17 Kenya Real GDP Growth (y/y, %)

18 Kenyan Shilling

19 MPR and Headline Inflation in Kenya (y/y, %)

20 Kenyan Sovereign Yield Curve

21 Movement in NSE All Share Index

22 Local Currency Returns 2013, 2014

23 Inflation Rates: 2013-2014

24 5-year Real GDP Growth

25 Monetary Policy Rates

26 10-year Bond Yields

27 Equity Market Indices (Rebased to 100)

28 Quarterly Trends in Global Oil Demand and Supply

29 OPEC and on- share of oil production (rebased to 2010)

30 US Oil Production Volumes (m b/pd)

31 WTI and SAUDI's Production

32 Break-even Oil Prices

33 Vulnerability of OPEC members to Oil Prices

34 Select Policy Rates: Annual Averages , %

35 Nigeria Monetary Policy Rate (MPR, %)

36 Broad Money Supply and Credit Growth

37 CBN OMO Activities, 2013 Vs. 2014

38 Top 50 Economies Globally: Nominal GDP (US$ million)

39 Real GDP Growth Rate

40 Nigeria GDP Sectoral Growth Trends

41 Headline Inflation

42 Money Supply (N’bn) Vs. Core Inflation

43 Changes in FPIs Vs. Naira Returns

44 N/USD Rates in 2014

45 Total FX Demand versus total FX supply

46 Average month External Reserves and Brent Crude Price

47 Breakdown of expenditure plans for 2015 (N'bn)

48 Nigeria Crude Oil Actual Volumes Vs. Budget

49 Non-Oil Vs. Oil Revenue Split

50 35.1% Ratio of capital to Total Expenditure

107

51 Top Priority sectors in the 2015 budget

52 Nigerian Bonds Index Performance for Different Maturities ( rebased to 100)

53 FGN Bonds Vs. Emerging Markets Bonds ( rebased, 100)

54 Nigeria Sovereign Yield Curves: 2013 Vs. 2014

55 Primary Market Issuance Volumes of FGN bonds in 2014

56 Capital Importation into Bonds and Equities (US'm)

57 Nigeria Fixed Income Average Daily Traded Volumes (N'bn)

58 FGN Bond Returns in 2014 ( Price changes only

59 Daily average bond yields (2013-2014, %)

60 Equities Market, An Eventful 2014

61 Equities Market

62 Equities Market

63 Equities Market

64 Equities Market

65 Global Equities Markets

66 Global Equities Markets

67 Nigerian banks' quarterly loan growth, 2013-2014

68 Nigerian banks' annualized ROEs, 2013-2015e

69 Nigerian banks' quarterly loan growth, 2013-2014

70 FCY Exposures (Deposits Vs. liabilities)

71 YTD Performances of Nigerian banking stocks, 2014

72 YTD Performances of Nigerian banking stocks, 2014

73 Insurance penetration and density in select African Counties

74 Gross Premium Income and Per capital income of select countries

75 Market Share of Top 5 Players, 2013

76 Gross Premium of top 5 market players, 2013

77 Return performance of selected insurance stocks in 2014

78 Nigeria Insurance Sector Vs. ASI

79 Quarterly Aggregate Consumption Expenditure in Nigeria, 2010-2014

80 Geographic Distribution of consumption spending in Nigeria

81 Food and Beverage Sector Revenue Growth 2007-2015f

82 Breweries sector revenue trends, 2000-2015e

83 Segment Distribution of Nigerian Brewery Market

84 Returns Performances of Selected consumers, YTD 2014

85 Consumer Goods Sector Vs. NSE

86 Returns Performances of Select Industrial Goods Players

87 Industrial Goods Sector Vs ASI

88 World’s 2013 oil reserves (Bn bbls)

89 Nigeria Oil Production trend 2009 – 2014 (Mn bbls)

90 US Oil Production 2010 – 2014 (Mn bbls)

91 Returns Performance of Select Oil and Gas Stocks, YTD 2014

92 Oil and Sector Vs. ASI

108

INVESTMENT RATINGS AND CRITERIA

United Capital Research adopts a 3-tier recommendation system for assets under our coverage:

Buy, Hold and Sell. These generic ratings are defined below;

Buy: Based on our valuation and subjective view (if any), the total return upside on the stock’s

current price is greater than our estimated cost of equity.

Hold: Based on our valuation and subjective view (if any), the total return upside on the stock’s

current price is less than the cost of equity, however, the expected total return on the stock is

greater than or equal to the Standing Deposit Facility rate of the Central Bank of Nigeria (which is

currently MPR – 200bps; i.e 11%). We consider this as the minimum return that may deserve our

holding of a risk asset, like equity.

Sell: Based on our valuation and subjective view (if any), the total return upside on the stock’s

current price is less than the Standing Deposit Facility rate of the Central Bank of Nigeria (which is

currently MPR – 200bps; i.e. 11%). We consider this as the minimum return that may deserve our

holding of a risk asset, like equity, especially as we consider the average 4.5% total transaction cost

for an average retail investor.

NR*: Please note that in addition to our three rating heads, we indicate stocks that we do not rate

with NR; meaning Not-Rated. We may not rate a stock due to investment banking relationships,

other sources of conflict of interests and other reasons which may from time to time prevent us from

issuing a rating on the shares (or other instruments) of a company.

Please note that we sometimes give concessional rating on stocks, which may be informed by

technical factors and market sentiments.

Current Stock Rating Dispersion and Relationship

Conflict of Interest: It is the policy of United Capital Plc and all its subsidiaries/affiliates (thereafter

collectively referred to as “UCP”) that research analysts may not be involved in activities that

suggest that they are representing the interests of UCP in a way likely to appear to be inconsistent

with providing independent investment research. In addition, research analysts’ reporting lines are

structured so as to avoid any conflict of interests. Precisely, research analysts are not subject to the

supervision or control of anyone in UCP’s Investment Banking or Sales and Trading departments.

However, such sales and trading departments may trade, as principal, on the basis of the research

analyst’s published research. Therefore, the proprietary interests of those Sales and Trading

departments may conflict with your interests as clients. Overall, the Group protects clients from

probable conflicts of interest that may arise in the course of its business relationships.

109

Analyst Certification

The research analysts who prepared this report certify as follows:

1. That all of the views expressed in this report articulate the research analyst(s) independent

views/opinions regarding the companies, securities, industries or markets discussed in this report.

2. That the research analyst(s) compensation or remuneration is in no way connected (either directly

or indirectly) to the specific recommendations, estimates or opinions expressed in this report.

Other Disclosures

United Capital Plc or any of its affiliates (thereafter collectively referred to as “UCP”) may have

financial or beneficial interest in securities or related investments discussed in this report, potentially

giving rise to a conflict of interest which could affect the objectivity of this report. Material interests

which UCP may have in companies or securities discussed in this report are disclosed:

UCP may own shares of the company/subject covered in this research report.

UCP does or may seek to do business with the company/subject of this research report

may be or may seek to be a market maker for the company which is the subject of this research

report

UCP or any of its officers may be or may seek to be a director in the company(ies) covered in this

research report

UCP may be likely recipient of financial or other material benefits from the

company/subject of this research report.

Company Disclosure

Dangote Cement Plc h

Dangote Flour Plc h

Dangote Sugar Plc h

Diamond Bank Plc h

FirstBank Holdings Nigeria Plc h

Guaranty Trust Bank Plc h

Guinness Nigeria Plc h

PZ Nigeria Plc h

Disclosure keys

a. The analyst holds personal positions (directly or indirectly) in one or more of the stocks covered in

this report

b. The analyst(s) responsible for this report (whose name(s) appear(s) on the front page of this report is

a Board member, Officer or Director of the Company or has influence on the company’s operating

decision directly or through proxy arrangements

c. UCP is a market maker in the publicly traded equities of the Company

d. UCP has been lead arranger or co-lead arranger over the past 12 months of any offer of securities

of the Company

e. UCP beneficially own 1% or more of the equity securities of the Company

f. UCP holds a major interest in the debt of the Company

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g. UCP has received compensation for investment banking activities from the Company within the last

12 months

h. UCP intends to seek, or anticipates compensation for investment banking services from the

Company in the next 6 months

i. The content of this research report has been communicated with the Company, following

which this research report has been materially amended before its distribution

j. The Company is a client of UCP

k. The Company owns more than 5% of the issued share capital of UCP

Disclaimer

United Capital Plc Research (UCP) notes are prepared with due care and diligence based on

publicly available information as well as analysts’ knowledge and opinion on the markets and

companies covered; albeit UCP neither guarantees its accuracy nor completeness as the sole

investment guidance for the readership. Therefore, neither UCP nor any of its associate or subsidiary

companies and employees thereof can be held responsible for any loss suffered from the reliance

on this report as it is not an offer to buy or sell securities herein discussed. Please note this report is a

proprietary work of UCP and should not be reproduced (in any form) without the prior written

consent of UCP Management. UCP is registered with the Securities and Exchange Commission and

its subsidiary, United Capital Securities Limited is a dealing member of the Nigerian Stock Exchange.

For enquiries, contact United Capital Plc, 12th Floor, UBA House, 57 Marina, Lagos. ©United Capital

Plc 2014.*

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Documents

2014 Review and 2015 Outlook