NIGERIA IN RECESSION: COPING WITH AN ECO- · PDF fileNIGERIA IN RECESSION: COPING WITH AN ECO-NOMIC CONTRACTION ... with Iran’s insistence that there would be no restrictions to

NIGERIA IN RECESSION: COPING WITH AN ECO-

NOMIC CONTRACTION

With Nigeria’s current economic weakness, the word ‘recession’ is

on everyone's lips, but not many understand what it really means.

The general rule of the thumb is that a country is officially in a re-

cession after two consecutive quarters of negative growth. Accord-

ing to this definition, Nigeria was officially in a recession in

Q2’2016. Another school of thought states that recession begins

after a prolonged period (six months or longer) of slowing growth

and economic contraction. This period is marked by a significant

decline in aggregate demand, widespread retrenchment of busi-

ness activity and rising unemployment. Using this definition, Nige-

ria slipped into a recession in January 2016, as growth slowed in

the second half of 2015 (Chart 1). A third definition proposes that

recession also occurs when growth in a country’s economic output

is below its potential. This potential growth rate is the output level

a country would achieve if all inputs of labor and capital where fully

maximized. Accordingly, Nigeria has been in a recession since

2012, when economic output declined to suboptimal levels (Chart

2).

September 14, 2016

Volume VI, Issue 73 FINANCIAL DERIVATIVES COMPANY LIMITED

FDC ECONOMIC MONTHLY

INSIDE THIS ISSUE:

Nigeria in Recession: Coping

with an Economic Contraction

1

A Cartel in Crisis – is OPEC

Still Relevant?

7

Protectionism during a Reces-

sion: To protect or not to pro-

tect?

12

Global Perspective: Game the-

ory- Culled from the Economist

17

Macroeconomic Indicators 24

Stock Market Review 29

Equity Report: Julius Berger 34

A Financial Derivatives Company Publication

: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com

1 Source: NBS, FDC Think Tank

Chart 1 : Real GDP Growth Rate (%)

1

Whichever way you look at it, and regardless of economic defini-

tions and rhetoric, we are in a recession. All that matters now is

the strategies and policies implemented to bring the economy out.

The news of a recession has a psychological effect that can ulti-

mately work to lower morale and confidence, discourage invest-

ments and push a country further into recession. In such an in-

stance, investors are more willing to pull out from failing or slow

projects, managers are more willing to downsize and carry out

massive retrenchment. Understanding the increased risk of unem-

ployment, consumers reduce consumption and save more. This

leads to a reduction in aggregate demand, and reduces sales and

profitability of doing business. To avoid this chain reaction, inves-

tors, managers and consumers must prepare accordingly.

The first course of action in the wake of a recession is to develop

a financial plan. Companies should focus on managing extraneous

expenses where possible. Finance charges are bound to increase

owing to the 200 basis points (bps) hike in interest rates to 14%.

Reducing interest-bearing debt levels will significantly lower ex-

penses.

Secondly, companies should consider liquidating cash from alter-

native investments to strengthen the cash position of the busi-

ness. The Nigerian Stock Exchange All Share Index (NSE ASI) has

returned -3.64% year-to-date (YTD).3 There has been a steady

decline in Q2’16 and the announcement of the recession could

Page 2



Chart 2 : Real GDP vs Potential GDP Growth

2

2 Source: EIU 3 As of August 31, 2016

further impact stock prices and values. At N9.47 trillion, market

capitalization also declined by -3.77% YTD Companies and indi-

viduals need to consider the risks. One option might be to cash in

on investments now to be in a better position to buy them back

during the recovery.

The next consideration should be the business’ operational strat-

egy. Examples include staff, overhead, inventory and marketing

activities. Training staff in several aspects of the business could

help prevent work stoppages in the event of absenteeism or

downsizing. Businesses should also attempt to reduce overhead

costs and waste in areas like utilities, administration, and materi-

als. These areas can contribute significantly to the bottom-line. Be

careful when reviewing costs and remember: “the most powerful

leadership tool you have is your personal example”.5 If manage-

ment is deliberating cutting pay checks or increasing working

hours, it should lead by example. That way staff will not feel un-

appreciated and will maintain satisfactory levels of productivity.

Reconsidering marketing strategies as part of the operational re-

view could also be of value. Diesel prices are on the rise (figure

III). So it is important to keep logistics under control.

Page 3



Chart 3 : NSE All Share Index

4

4 NBS 5 Wooden, John. 2009. “Coach Wooden's Leadership Game Plan for Success”. McGraw Hill.

We do not suggest that businesses go into hiding by reducing

marketing. Instead, business should consider less expensive ad-

vertising channels such as social media. While good social media

still costs money, the cost of media buying and content produc-

tion can be significantly reduced.

Finally, do not forget the customer. Worsening rates of unemploy-

ment and underemployment (figure IV) mean reduced household

income. This puts a strain on disposable income to pay for goods

and services. Do not punish customers further for their lack of

funds. Instead businesses should focus on customer retention.

Acquiring new customers is more expensive then retaining old

ones and they will be harder to find in a recession. Existing cus-

tomers will remain loyal, in spite of challenges, if they feel appre-

ciated. Safeguarding the repeat business of these existing cus-

tomers will be critical in ensuring a business’ long-term stability.

Also, a satisfied customer is an essential marketing and advertis-

ing asset. Their referral will always be more valuable than a com-

pany’s marketing spending. Staff training should therefore in-

clude regular sessions on customer service delivery, as they are

the face of the company.

Page 4



Chart 4 : Avg. AGO Price

6

6 NBS

A company should never compromise on the quality of its product

or service in a bid to remain profitable. A business is more likely

to keep and acquire new customers by standing out with quality

output as others cut back to stay afloat. In the long run, quality

always thrives as customers drift to brands that offer the greatest

value for money. By the time the economy is recovering, the busi-

ness would have acquired a substantial gain in its customer base.

The ability to expect and prepare for the challenges of recession is

critical. We hope to have provided some insight into what a reces-

sion is, what should be expected, and the possible approaches

companies can take. Each company will have to figure out which

strategies work best to prepare for the storm, while we hope for

clear skies.

Page 5



7

7 NBS

A CARTEL IN CRISIS – IS OPEC STILL RELEVANT?

OPEC LOSING CONTROL

It has been nearly two years since the Organisation of Petroleum

Exporting Countries (OPEC) changed its strategy from protecting

a fair market price to recapturing market share from U.S. produc-

ers. This shift in strategy has seen member countries routinely

exceeding their production quotas with OPEC’s total production

exceeding its 30 million barrels per day (mbpd) production ceiling

by up to two mbpd.

Abandoning the quota system has come with a problem – it has

become almost impossible to re-install and enforce it. OPEC was

formed with the objective to "co-ordinate and unify petroleum

policies among Member Countries, in order to secure fair and sta-

ble prices for petroleum producers”. After two failed attempts in

the last six months to freeze output and address the lingering

oversupply in the oil market, OPEC – the once feared cartel – may

be losing its relevance.

OPEC IN DIRE STRAIGHTS

According to the Energy Information Agency (EIA), low oil prices

cut OPEC revenues by almost half in 2015 to its lowest levels in

11 years – from $753bn in 2014 to $404bn in 2015. This is pro-

jected to plunge further to $341bn as oil prices fell to as low as

$26 per barrel (pb) in the first quarter of 2016 and have averaged

just over $42pb so far in 2016 – significantly lower than the 2015

average of $53.7pb. OPEC members posted a current account

deficit of $99.6bn in 2015 – the first since 1998 – compared to a

$238.1bn surplus in 2014 and Saudi Arabia, accounting for a third

of OPEC’s earnings, saw its revenues plunge to $130bn in 2015.

from $247bn just a year before.

Page 7



IRAN PLAYING THE SPOILER

In addition to the dismal performance, Iran is poised for a come-

back after years of devastating economic and financial sanctions.

The Iran Nuclear Deal, effective from January 2016, reopened the

international market to, potentially, 1.5mbpd of Iranian oil as well

as the return of billions in frozen oil revenue to Iran. Iran vowed

to increase production to pre-sanction levels and has left no one

in doubt over its intentions to make good on that promise.

However, the timing of the deal could not have been worse. It

came when the global oil market had been oversupplied for over

two years owing to a surge in shale oil production by the US. Oil

prices fell from $106pb in June 2014 to current prices hovering

between the $40-50pb range. This also came at a time of growing

global economic concerns that have dampened the outlook for

global oil demand.

In February, less than a month after sanctions were lifted, a deal

to cap production was proposed. A meeting in April ended

with Iran refusing any production cut backs even after Saudi Ara-

bia, Venezuela, Qatar and OPEC non-member Russia pledged to

freeze output at January levels. In June, another meeting ended

with Iran’s insistence that there would be no restrictions to its re-

vival. In a show of defiance, Iran has said that its production lev-

Page 8



els are still below the level that it would need to attain to justify

any cooperation with OPEC.

OPEC rules require that every member must agree before any ad-

justments to output can be made. This leaves it in a situation

where Iran has to agree to a freeze or there will be no freeze.

Iran is effectively playing the role of a spoiler within OPEC and in

the global oil market.

WHAT NEXT FOR OPEC?

The 14-nation cartel is planning to meet informally at a confer-

ence in Algiers between September 26 and 28 to discuss produc-

tion levels and, of course, the recent decline in oil prices. Even

non-members like Russia will be in attendance. Desperate times

are calling for desperate measures. OPEC members are faced with

the clear and present dangers of budget shortfalls and the grow-

ing risk of civilian unrest.

But as long as Iran refuses to play along, which it most likely will

not, then OPEC meetings will be regarded by many on the outside

as nothing more than a gathering of desperate third world oil ex-

porters in competition with themselves for market share. The fi-

nancial strain as a result of lower prices has induced price cuts for

many members who are seeking to undercut the competition and

sell as much oil as possible to meet cash flow obligations. Saudi

Arabia’s quest to transition away from oil-dependence hinges on

the successful listing of the state oil company – ARAMCO. Gaining

efficiency and as much market share as possible are all part of its

preparation for the listing.

In addition, heightened tensions between the Saudi’s and the Ira-

nians make reaching any consensus on cutting production difficult

to envisage. OPEC is just another stage for both countries to en-

act their on-going battle for regional supremacy and religious su-

periority. This acrimony has fed power struggles in the Middle

East and beyond.

With members of the cartel ignoring quotas and undercutting one

another, and given that the markets barely reacted after each of

its previous two botched meetings, it is clear that OPEC will strug-

gle to be taken seriously going forward.

Page 9



DISRUPTIVE INNOVATION

If OPEC is dead, then it has been the architect of its own demise.

Cause of death: Suicide – its decision to flood the market with oil

in an attempt to squeeze out the competition failed to take into

consideration the disruptive nature of technological innovation. Its

decision to push down oil prices forced American Shale producers

to become increasingly more efficient and competitive to survive.

Innovation has driven shale oil production costs down while OPEC

production costs have remained largely the same. Many shale

producers are now globally competitive even at a lower oil price of

$40pb. With more innovation and increasingly lower costs of pro-

duction, the American oil industry is set to overtake OPEC and

snatch the title of “swing producer” from the Saudis.

At current oil prices of $40-50pb, most OPEC members are really

gasping for breath. But any production cuts to shore up prices will

be the equivalent of relinquishing market share to non-OPEC pro-

ducers and further lower OPEC’s already battered revenues. In

more ways than one, OPEC is damned if it does and damned if it

doesn’t.

Page 10



PROTECTIONISM DURING A RECESSION: TO PRO-

TECT OR NOT TO PROTECT?

In the face of a recession, Nigeria has always opted to move to-

wards being a protectionist state in an effort to curb forex de-

mand and stabilise external reserves. Over the past two years,

the government has returned to this familiar policy ground, initi-

ating a number of protectionist policies. The import restrictions on

automobiles, agricultural items and more recently the 41 items

ineligible for transactions at the official market are but a few ex-

amples. Historically, countries tend to adopt protectionist policies

during an economic downturn. Nigeria is not an exception to the

norm. However, it is not clear that this course of action is the best

course of action for Nigeria given its fundamentals. While other

countries have certainly benefited from protectionist policies they

tend to only work in specific economic contexts which support suf-

ficient local production. For an economy like Nigeria’s, that is de-

pendent on imports, protectionism can do more harm than good.

PROTECTIONISM THAT BOOSTS LOCAL PRODUCTION

LEADS TO SOUND ECONOMIES

It is no secret that the largest economies have developed with the

help of protectionist policies. At the inception of the industrial

revolution, Britain was extremely protectionist.8 In 1699, Britain

banned the imports of Irish wool and in 1700; cotton cloth from

India was banned. Ferocious tariffs were imposed on almost all

manufactured goods to protect infant industries. Britain only be-

came more open to trade in the middle of the 19th century, after

its national industries were strong enough to complete globally.

Similarly, in 1816, the US imposed a 35% tax on imported manu-

factured goods, which later increased to 50% in 1832. It main-

tained its protectionist policies until after the Second World War.

The same strategy was adopted amongst the Asian tigers. In

South Korea, foreign automobile manufacturers were barred from

operating in Korea, except in joint ventures with local business

Page 12



8 Chang, H. 2003.“Kicking Away the Ladder: The ‘Real’ History of Free Trade.” Foreign Policy in Focus: Special Report.www.personal.ceu.hu/corliss/CDST_Course_Site/Readings_old_2012_files/Ha-Joon%20Chang%20-%20Kicking%20Away%20the%20Ladder-The%20“Real”%20History%20of%20Free%20Trade.pdf

entities. Today, the South Korean automobile industry is the 5th

largest in the world measured by automobile unit production.9

PROTECTIONISM ON SHAKY FUNDAMENTALS FALLS

FLAT

However, not all countries have benefited in the same way as

these shining examples for protectionism. A century ago, Argen-

tina was ranked amongst the top 10 richest countries in the

world. In the aftermath of the Second World War, however, the

country implemented an economic system which stressed eco-

nomic self-sufficiency. By so doing, Argentina refused to partici-

pate in the expansion of international trade which followed the

Second World War. The protectionist approach steadily deterio-

rated the domestic economy and transformed a once wealthy and

fast growing nation into a quasi 'third world' country. Protectionist

policies were eventually dismantled after a substantial deteriora-

tion of economic conditions, which was one of the major factors

that begot Argentina’s economic crisis of 1999-2001.10

NIGERIA’S SHAKY FUNDAMENTALS MAKE PROTEC-

TIONISM A POOR CANDIDATE FOR POLICY REFORM

Unfortunately, Nigeria’s present economic circumstances have

more in common with Argentina than those that successfully im-

plemented protectionist policies. The majority of Nigeria’s domes-

tic needs are satisfied through imports with little or no local sub-

stitutes in place to bridge the gap if imports are eliminated. The

recent restrictions by the government have resulted in a surge in

goods and services. The price of a bag of rice has more than dou-

bled from N8,000 in 2015 to N19,000 in 2016 and basic automo-

biles are sold at luxury prices. This is largely driven by the de-

valuation of the currency coupled with the high import tariffs im-

posed on these goods. Nigeria simply does not have the infra-

structure in place to support local production.

Page 13



9 Wikipedia. 2016. List of countries by motor vehicle production.https://en.wikipedia.org/wiki/List_of_countries_by_motor_vehicle_production 10 Bendini, R. 2012.“Protectionism in Argentina: Old habits die hard.” European Parliament. http://www.europarl.europa.eu/RegData/etudes/briefing_note/join/2012/491424/EXPO-INTA_SP(2012)491424_EN.pdf

Nigeria’s overreliance on oil is a factor. It relies on rebounding oil

prices, not improved industries, to put it back on its feet. This was

the case in the 1980’s when the government banned the importa-

tion of rice to reduce demand pressure on external reserves. Once

oil prices recovered and the economy was back on its feet, the

government removed the import bans. It is important to note that

the ban was lifted because imports were affordable as opposed to

a more competitive domestic industry, which should be the only

justification for opening borders after having implemented protec-

tionist policies.

Today’s economic reality is no different. Domestic production does

not meet domestic demand and farmers are wary of government

promises of support, knowing they are often disregarded once oil

fundamentals improve. Lacking the necessary local production,

Nigeria’s protectionist policies instead result in supply shortages

and aberrational spikes in inflation rates. Power outages are fre-

quent, alternative energy prices are growing at a geometric pro-

gression and investors are wary of a lack of clarity on policy direc-

tion. The hope is that the pain is short lived while the Nigeria ral-

lies its local production capabilities and develops competitive in-

dustries. Unfortunately, this has yet to be the case. Presently, do-

mestic production of rice is at 2.3 million metric tons while de-

mand is at 6.3 million metric tons and Nigeria spends $1bn annu-

ally on the importation of rice. This is the trend amongst most ag-

ricultural commodities as revealed in the table below.

THE WAY FORWARD FOR NIGERIAN PROTECTIONISM

The government can protect infant industries without blocking out

international competitors. Government intervention via subsidis-

ing domestic production and imposing import restrictions to en-

Page 14

11 Federal Ministry of Agriculture and Rural Development. 2016.The Agriculture Promotion Policy (2016-2020). The Federal Government of Nigeria.http://fmard.gov.ng/wp-content/uploads/2016/03/2016-Nigeria-Agric-Sector-Policy-Roadmap_June-15-2016_Final.pdf



Demand (tons) Supply (tons)

Tomatoes 2.2 million 0.8 million

Sugar 1.7 million 0.0015 million

Wheat 4.7 million 0.06million

Oil Palm 8.0 million 4.5 million

Cocoa 3.6 million 0.25 million

11

courage infant industries is the traditional Keynesian approach.

However, modern day Keynesians are of the opinion that govern-

ment interventions need not restrict imports as such restrictions

worsen growth rather than boost it. Instead, the government

should subsidise both production and consumption of domestic

products while foreign players are left to improve quality and

standard to remain more competitive. This is a win-win situation

for all economic agents considered. The consumers have cheap

varieties to select from while the international firms and domestic

firms are able to compete on a leveled field.

In summary, protectionism during a recessionary era in an import

dependent economy will contract economic activities further

rather than stimulate, as seen in Nigeria. Economic indicators

have taken a beating due to the import restrictions and capital

controls introduced by the government. The inflation rate is at an

11-year high and external reserves are heading towards the psy-

chological level of $25bn.Trade is one of the key drivers of eco-

nomic growth. Hence, protectionism should be approached with

caution and implemented at the appropriate time to avoid retalia-

tion and public back lash.

In any case, it appears the government is likely to maintain its

stance on protectionism. External reserves are depleting to levels

that are worrisome for the economy going forward. The restriction

placed on 41 items is still in place and is not likely to be lifted in

the near term given the policy stance of the monetary authorities.

Other restrictions are seen mostly in the agricultural sector and

manufacturing sector (e.g. automobiles). Protectionist policies are

likely to remain in the short term pending a recovery in economic

activities. Unfortunately, the protectionist policies, as presently

implemented, are more likely to elongate the economic woes

rather than quicken improvements.

Page 15



GLOBAL PERSPECTIVE: GAME THEORY- CULLED

FROM THE ECONOMIST

PRISON BREAKTHROUGH

The fifth of our series on seminal economic ideas

looks at the Nash equilibrium

JOHN NASH arrived at Princeton University in 1948 to start his

PhD with a one-sentence recommendation: “He is a mathematical

genius”. He did not disappoint. Aged 19 and with just one under-

graduate economics course to his name, in his first 14 months as

a graduate he produced the work that would end up, in 1994,

winning him a Nobel prize in economics for his contribution to

game theory.

On November 16th 1949, Nash sent a note barely longer than a

page to the Proceedings of the National Academy of Sciences, in

which he laid out the concept that has since become known as the

“Nash equilibrium”. This concept describes a stable outcome that

results from people or institutions making rational choices based

on what they think others will do. In a Nash equilibrium, no one is

able to improve their own situation by changing strategy: each

person is doing as well as they possibly can, even if that does not

mean the optimal outcome for society. With a flourish of elegant

mathematics, Nash showed that every “game” with a finite num-

ber of players, each with a finite number of options to choose

from, would have at least one such equilibrium.

His insights expanded the scope of economics. In perfectly com-

petitive markets, where there are no barriers to entry and every-

one’s products are identical, no individual buyer or seller can in-

fluence the market: none need pay close attention to what the

others are up to. But most markets are not like this: the decisions

of rivals and customers matter. From auctions to labour markets,

the Nash equilibrium gave the dismal science a way to make real-

world predictions based on information about each person’s incen-

tives.

One example in particular has come to symbolise the equilibrium:

the prisoner’s dilemma. Nash used algebra and numbers to set

Page 17



out this situation in an expanded paper published in 1951, but the

version familiar to economics students is altogether more grip-

ping. (Nash’s thesis adviser, Albert Tucker, came up with it for a

talk he gave to a group of psychologists.)

It involves two mobsters sweating in separate prison cells, each

contemplating the same deal offered by the district attorney. If

they both confess to a bloody murder, they each face ten years in

jail. If one stays quiet while the other snitches, then the snitch

will get a reward, while the other will face a lifetime in jail. And if

both hold their tongue, then they each face a minor charge, and

only a year in the clink (see diagram).

There is only one Nash-equilibrium solution to the prisoner’s di-

lemma: both confess. Each is a best response to the other’s strat-

egy; since the other might have spilled the beans, snitching

avoids a lifetime in jail. The tragedy is that if only they could work

out some way of co-ordinating, they could both make themselves

better off.

The example illustrates that crowds can be foolish as well as wise;

what is best for the individual can be disastrous for the group.

This tragic outcome is all too common in the real world. Left freely

to plunder the sea, individuals will fish more than is best for the

group, depleting fish stocks. Employees competing to impress

their boss by staying longest in the office will encourage work-

Page 18



force exhaustion. Banks have an incentive to lend more rather

than sit things out when house prices shoot up.

CROWD TROUBLE

The Nash equilibrium helped economists to understand how self-

improving individuals could lead to self-harming crowds. Better

still, it helped them to tackle the problem: they just had to make

sure that every individual faced the best incentives possible. If

things still went wrong—parents failing to e their children against

measles, say—then it must be because people were not acting in

their own self-interest. In such cases, the public-policy challenge

would be one of information.

Nash’s idea had antecedents. In 1838 August Cournot, a French

economist, theorised that in a market with only two competing

companies, each would see the disadvantages of pursuing market

share by boosting output, in the form of lower prices and thinner

profit margins. Unwittingly, Cournot had stumbled across an ex-

ample of a Nash equilibrium. It made sense for each firm to set

production levels based on the strategy of its competitor; con-

sumers, however, would end up with less stuff and higher prices

than if full-blooded competition had prevailed.

Another pioneer was John von Neumann, a Hungarian mathemati-

cian. In 1928, the year Nash was born, von Neumann outlined a

first formal theory of games, showing that in two-person, zero-

sum games, there would always be an equilibrium. When Nash

shared his finding with von Neumann, by then an intellectual

demigod, the latter dismissed the result as “trivial”, seeing it as

little more than an extension of his own, earlier proof.

In fact, von Neumann’s focus on two-person, zero-sum games left

only a very narrow set of applications for his theory. Most of these

settings were military in nature. One such was the idea of mutu-

ally assured destruction, in which equilibrium is reached by arm-

ing adversaries with nuclear weapons (some have suggested that

the film character of Dr Strangelove was based on von Neumann).

None of this was particularly useful for thinking about situations—

including most types of market—in which one party’s victory does

not automatically imply the other’s defeat.

Page 19



Even so, the economics profession initially shared von Neumann’s

assessment, and largely overlooked Nash’s discovery. He threw

himself into other mathematical pursuits, but his huge promise was

undermined when in 1959 he started suffering from delusions and

paranoia. His wife had him hospitalised; upon his release, he be-

came a familiar figure around the Princeton campus, talking to him-

self and scribbling on blackboards. As he struggled with ill health,

however, his equilibrium became more and more central to the dis-

cipline. The share of economics papers citing the Nash equilibrium

has risen sevenfold since 1980, and the concept has been used to

solve a host of real-world policy problems.

One famous example was the American hospital system, which in

the 1940s was in a bad Nash equilibrium. Each individual hospital

wanted to snag the brightest medical students. With such students

particularly scarce because of the war, hospitals were forced into a

race whereby they sent out offers to promising candidates earlier

and earlier. What was best for the individual hospital was terrible

for the collective: hospitals had to hire before students had passed

all of their exams. Students hated it, too, as they had no chance to

consider competing offers.

Despite letters and resolutions from all manner of medical associa-

tions, as well as the students themselves, the problem was only

properly solved after decades of tweaks, and ultimately a 1990s de-

sign by Elliott Peranson and Alvin Roth (who later won a Nobel eco-

nomics prize of his own). Today, students submit their preferences

and are assigned to hospitals based on an algorithm that ensures

no student can change their stated preferences and be sent to a

more desirable hospital that would also be happy to take them, and

no hospital can go outside the system and nab a better employee.

The system harnesses the Nash equilibrium to be self-reinforcing:

everyone is doing the best they can based on what everyone else is

doing.

Other policy applications include the British government’s auction of

3G mobile-telecoms operating licenses in 2000. It called in game

theorists to help design the auction using some of the insights of

the Nash equilibrium, and ended up raising a cool £22.5 billion

($35.4 billion)—though some of the bidders’ shareholders were less

pleased with the outcome. Nash’s insights also help to explain why

adding a road to a transport network can make journey times

Page 20



longer on average. Self-interested drivers opting for the quickest

route do not take into account their effect of lengthening others’

journey times, and so can gum up a new shortcut. A study pub-

lished in 2008 found seven road links in London and 12 in New

York where closure could boost traffic flows.

GAME ON

The Nash equilibrium would not have attained its current status

without some refinements on the original idea. First, in plenty of

situations, there is more than one possible Nash equilibrium. Driv-

ers choose which side of the road to drive on as a best response

to the behaviour of other drivers—with very different outcomes,

depending on where they live; they stick to the left-hand side of

the road in Britain, but to the right in America. Much to the disap-

pointment of algebra-toting economists, understanding strategy

requires knowledge of social norms and habits. Nash’s theorem

alone was not enough.

A second refinement involved accounting properly for non-credible

threats. If a teenager threatens to run away from home if his

mother separates him from his mobile phone, then there is a

Nash equilibrium where she gives him the phone to retain peace

of mind. But Reinhard Selten, a German economist who shared

the 1994 Nobel prize with Nash and John Harsanyi, argued that

this is not a plausible outcome. The mother should know that her

child’s threat is empty—no matter how tragic the loss of a phone

would be, a night out on the streets would be worse. She should

just confiscate the phone, forcing her son to focus on his home-

work.

Mr Selten’s work let economists whittle down the number of pos-

sible Nash equilibria. Harsanyi addressed the fact that in many

real-life games, people are unsure of what their opponent wants.

Economists would struggle to analyze the best strategies for two

lovebirds trying to pick a mutually acceptable location for a date

with no idea of what the other prefers. By embedding each per-

son’s beliefs into the game (for example that they correctly think

the other likes pizza just as much as sushi), Harsanyi made the

problem solvable. A different problem continued to lurk. The pre-

dictive power of the Nash equilibrium relies on rational behavior.

Page 21



Yet humans often fall short of this ideal. In experiments replicat-

ing the set-up of the prisoner’s dilemma, only around half of peo-

ple chose to confess. For the economists who had been busy em-

bedding rationality (and Nash) into their models, this was prob-

lematic. What is the use of setting up good incentives, if people

do not follow their own best interests?

All was not lost. The experiments also showed that experience

made players wiser; by the tenth round only around 10% of play-

ers were refusing to confess. That taught economists to be more

cautious about applying Nash’s equilibrium. With complicated

games, or ones where they do not have a chance to learn from

mistakes, his insights may not work as well.

The Nash equilibrium nonetheless boasts a central role in modern

microeconomics. Nash died in a car crash in 2015; by then his

mental health had recovered, he had resumed teaching at Prince-

ton and he had received that joint Nobel—in recognition that the

interactions of the group contributed more than any individual.

Page 22



MACROECONOMIC INDICATORS

NEGATIVE GROWTH

Nigeria’s economy contracted by 2.06% in Q2’2016. This is the

second consecutive quarter of negative growth, as Q1’2016 con-

tracted by 0.36%, and it puts the economy is officially in a reces-

sion. The non-oil sector contracted by 0.38%, and contributed

91.74% of total GDP. The oil sector contracted by 17.48%, and

contributed 8.26% of total GDP. The oil refining industry recorded

the highest growth of 49.19%, while postal and courier services

was the worst performing sector with -67.88% real growth.

INFLATION

The Consumer Price Index recorded an uptick of 17.1% in July

(year-on-year). Month-on-month, inflation increased by 0.6%.

This is the third consecutive decline in the month-on-month rate.

The Food Sub-index increased by 15.8% (year-on-year) in July,

0.5% higher than the increase recorded in June. The Imported

Food Sub-Index increased by 20.5% in July, compared to June’s

Page 24



12 Source : NBS, FDC Think Tank

Fastest Growing Sectors Real GDP Growth Rate

Oil Refining 49.19%

Water supply & Waste Management 8.46%

Agriculture 4.53%

Insurance 3.72%

Education 2.88%

Information and Communication 1.35%

Worst Performers Real GDP Growth

Manufacturing -3.36%

Accommodation & Food Services -6.39%

Fishing -6.85%

Financial Institutions -13.24%

Crude Oil & Natural Gas -17.48%

Post and Courier Services -67.88%

Chart 5: Inflation Rate (%)

12

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

M-o-M (primary axis) Y-o-Y (secondary axis)

figure of 25.1%. The Core Sub-index increased by 16.9%. This is

a 0.7% increase from June’s rates and was driven by increases in

energy and energy related prices. Meanwhile the Urban and Rural

Index increased to 18% and 15.5% respectively.

Outlook

Looking at the month-on-month rate of inflation, there has been a

decline in the pace of increase. This trend is expected to continue

next month, as August inflation is forecast to reach 17.5% (year-

on-year) which is a 0.3% month-on-month increase.

MONEY MARKET

The opening liquidity position in the money markets for the month

of August was much lower than that of July. Markets opened in

August with a liquidity position of N253.62bn long, which is a

5.05% decline from July’s opening position of N267.1bn long. The

market is estimated to have closed N15 billion long on August

31st, 94.8% lower than July’s closing position of N290bn long.

Short-term interbank rates (OBB, O/N, 30-Day) have averaged

17.21% per annum (pa) from the 1st to the 31st of August,

3.57% higher than July’s average of 13.64% pa. As at August

31st, short-term interbank rates, OBB and O/N rates were 16%

pa and 17.67% pa respectively. As of August 31st, T/bills yields

have slowly declined from their peak after the hike in MPR. As of

August 31st,yields stood at 16.68% and 19.79% for 91-day and

182-day T/bills, compared to 14.66% and 16.78% in July.

Outlook

T/Bills rates are expected to continue their downward trend as

demand for bills flattened. Likewise, OMO maturities in September

are expected to boost liquidity and push rates down.

Page 25



13 Source: CBN, FDC Think Tank

Chart 6: Interest Rates (%)

13

OIL MARKET

OIL PRICES

Oil prices (Brent) were at an average of $47.23 per barrel for the

month of August. This is a 1.83% from July’s average of $46.38

per barrel. Prices reached a peak of $50.88pb on August 19th, but

have been on a downward trend since then. The initial rise in

prices was due to optimism about the OPEC deliberation in Sep-

tember. However, the speech by the Chair of the US Federal Re-

serve, Janet Yellen, has raised expectations of an increase in in-

terest rates. This has led to a 2% appreciation of the dollar

(against the yen), and is weighing pressure on oil prices. Finally,

the US Energy Information Administration (EIA) is expected to

release data that shows an increase in crude stockpiles by

900,000 barrels to, for the week ended August 26th.

Outlook

An OPEC meeting is scheduled for September 26th – 28th. The

probability of a production freeze agreement is unknown due to

the mixed signals from policymakers and government officials. A

freeze in output will stabilize production, which has hovered at

record high levels in the last month. This will reduce the supply

glut and boost oil prices in the short to medium term.

OIL PRODUCTION

In the month of August, Nigeria’s production averaged at 1.44

mbpd.15

Outlook

The future looks bright as the Niger Delta Avengers agree to a

ceasefire and further negotiations with the federal government

and other relevant parties. The jury is out as to whether an

agreement will be reached. Meanwhile, Shell’s Forcados pipeline,

Page 26



14 Source: Bloomberg 15 Author. YEAR. “Title of ARTICLE”. Vanguard Newspaper http://www.vanguardngr.com/2016/09/nigerias-crude-oil-production-drops-130-000-bpd/

Chart 7: Oil Price ($/pb)

14

which produces about 200,000 barrels per day, is expected to re-

sume deliveries in September. Shell had stopped shipments, after

the militant attack on the pipeline in February. Over all, Nigeria’s

production is expected to reach 1.8 million barrels per day by the

year-end.

FOREX MARKET

EXCHANGE RATE

At the parallel market, the naira depreciated by 10.2% in August

to close at a record low of N420/$ on August 31th. The parallel

market averaged N398.26/$ during the month of August. This is a

8.56% decline from July’s average rate of N366.89/$. Despite

reaching a record high of N322/$, the IFEM rate closed 0.02%

higher at N316.74/$. The IATA rates appreciated by 1.1% to

N320/$ during the month. In the last week of the month, the

naira was primarily affected by the forex bottlenecks created as a

result of the CBN forex trading ban on eight banks.

Outlook

The CBN has lifted the forex trading ban on the eight banks. This

should lead to a tangible appreciation of the exchange rate across

all trading windows.

EXTERNAL RESERVES

External reserves as of August 29th were recorded at $25.46bn,

which is 3.26% lower than July’s average of $26.32bn. Year to

date, the reserves level has declined by 12.15% ($3.52bn). The

external reserves level is 26.22% below 2015’s peak of $34.51bn

and 17.58% lower than 2015’s average of $30.89bn. After de-

ducting forward commitments and arrears, the net external re-

serves level is estimated to at $19.96bn.

Page 27



16 Source: CBN, FDC Think Tank 17 Source: CBN, FDC Think Tank

Chart 8: Exchange Rate (N/$)

16

Chart 9: External Reserves ($bn)

17

Outlook

The reserves are expected to rise by $1.8bn upon the remittance

to the Treasury Single Account from the eight banks still owing

(UBA has paid debt). External reserves are subject to oil produc-

tion and price levels. Thus, the bright prospects for oil production

increases the chances of an accretion in the medium term.

Page 28


: 7739831, 7798998, 2715414; Email: [email protected]; Website: www.fdcng.com Chart 7 : Global Indices January 2016

STOCK MARKET REVIEW

The dismal H1 2016 corporate results continued to impact the

market into August. In spite of the impressive results by some

major banking tickers, including GUARANTY, ZENITHBANK, AC-

CESS and UBA, the Nigerian equities market still closed the month

red.

The NSE ASI declined by 1.47% to close the month at 27,599.03

from the 28,009.93 points recorded in July. Market capitalization

closed at N9.48trn, having lost N141.12bn in the review period.

Even as the CBN continued to adopt several measures to entice

foreign portfolio investors, the year-to-date return on the ASI re-

mained negative at 3.64%.

The CBN again flexed its regulator muscle by suspending nine

banks from participating in the foreign exchange market. The sus-

pended banks had failed to remit a total of $2.334bn, being the

dollar deposits of the Nigerian National Petroleum Corporation

(NNPC)/Nigerian Liquefied Natural Gas (NLNG) Company, into the

federal government’s Treasury Single Account (TSA).

Activity on the bourse was mostly negative as the 23 trading days

resulted in 11 days of gains against 12 days of losses. Daily

changes, representing volatility on the ASI, ranged between -

1.80% and 0.84% in the month.

Page 29



Chart 10 : NSE ASI August 2016

18

70,000,000

120,000,000

170,000,000

220,000,000

270,000,000

320,000,000

370,000,000

420,000,000

27,000.00

27,200.00

27,400.00

27,600.00

27,800.00

28,000.00

Daily Volume Traded NSE ASI

18 Source: NSE, FSDH, FDC Think Tank

Page 30

Market activity for the month increased by 24.48% to N56.12bn

from the N45.08bn reported in the month of June. The average

daily turnover for the period was N2.55bn, 1.59% above the year-

to-date daily average of N2.51bn.

Market breadth was negative at 0.33x in the review period as 18

stocks advanced against 55 stocks that declined while 108 stocks

remained unchanged. The best performing stocks include TOTAL

33.23%, AIRSERVICE 17.65%, PRESCO 16.60%, ETERNA 17.02%

and UNILEVER 14.72%.

Top price losers for the month were DIAMONDBNK (33.96%),

CHAMPION (29.51%), FIDELITY (27.64%), FCMB (27.14%) and

STERLNBNK (25.60%).

All the sectoral indices closed negative except the oil and gas sec-

tor which increased by 2.35%. This can be attributed to the better

than expected Q2’14 corporate earnings of Total Nigeria Plc.

Revenues and profit after tax for the period were up by 65% and

212% respectively. The financial services sector led the losers as

banking and insurance respectively lost 2.79% and 2.56% from

declines in the share prices of many ‘big cap’ stocks in the sector.

The 4.44% decline in DANGCEM and 22.54% loss recorded in CAP

resulted in the 1.98% decline in the industrial goods sector.



TOP 5 GAINERS

Company Aug-16 Jul-16 % Change Absolute Change

TOTAL NIGERIA PLC. 240.00 181.50 32.23% 58.50

AIRLINE SERVICES AND LOGISTICS PLC 2.00 1.70 17.65% 0.30

PRESCO PLC 45.30 38.85 16.60% 6.45

ETERNA PLC. 2.74 2.35 16.60% 0.39

UNILEVER NIGERIA PLC. 39.00 34.65 12.55% 4.35

TOP 5 LOSERS

Company Aug-16 Jul-16 % Change Absolute Change

DIAMOND BANK PLC 1.05 1.59 -33.96% -0.54

CHAMPION BREW. PLC. 2.58 3.66 -29.51% -1.08

FIDELITY BANK PLC 0.89 1.23 -27.64% -0.34

FCMB GROUP PLC 1.02 1.40 -27.14% -0.38

STERLING BANK PLC. 0.93 1.25 -25.60% -0.32

Global stocks posted another monthly advance with exception to

Nigerian and Kenyan equities indices. The 10.47% decline re-

corded by the Kenyan Index is attributable to the recent attempt

by the government to encourage borrowing by placing a 4% ceil-

ing above the Central Bank of Kenya’s 10.47% policy rate. This

will have a domino effect on the stock market, as the Central

Bank’s decision may be met with resistance by commercial banks

who may be unwilling to extend new credit lines to companies.

This resistance will affect working capital and sales. We expect to

see a further decline in the share prices of listed companies.

Source: NSE, Bloomberg, MSCI, FDC

Page 31



Chart 11 : Sectors in August 2016

19

-1.08%

-2.56%

-2.79%

2.35%

-0.24%

-0.71%

-3.00% -2.00% -1.00% 0.00% 1.00% 2.00%

NSE 30

INSURANCE

BANKING

OIL&GAS

CONSUMER GOODS

INDUSTRIAL GOODS

Chart 12 : Global Indices August 2016

20 -9.00%

-7.00%

-5.00%

-3.00%

-1.00%

1.00%

3.00%

5.00%

7.00%

19 Source: NSE, FDC Think Tank 20 Source: NSE, Bloomberg, MSCI, FDC Think Tank

Outlook

The pessimistic sentiment of investors is expected to linger in the

month of September as worse than expected economic data re-

cently released by the Nigerian Bureau of Statistics (NBS) paints a

gloomier picture of the business environment.

However, the outcome of the proposed OPEC meeting, where a

decision as to whether or not to freeze oil output will be made,

may lead to a recovery in international oil prices. This may in turn

boost government revenue. In addition to the recent cease-fire by

the Niger Delta Avengers (NDA), we expect a ramp up in the na-

tion’s daily oil production.

The bimonthly meeting of the monetary policy committee (MPC) is

scheduled to hold this month. The policy makers might decide to

retain status quo on key policy rates to give an allowance for the

effect of the last rate increase to kick in. On the other hand, it is

more likely that the MPC will vote to reduce MPR as the need to

reflate the economy heightens as the country is now officially in a

recession.

Page 32



EQUITY REPORT: JULIUS BERGER

Analyst Recommendation: SELL

Recommendation Period: 365 days

Industry: Construction/Materials

Market Capitalization: N63.87

Current Price: N48.39

Target Price: N39.74

The government has pledged to bridge the country’s infrastruc-

tural deficit and improve capital expenditure. In doing so, the con-

struction industry has been singled out as a significant beneficiary

of these investments. Analysts generally regard Julius Berger best

positioned to take advantage of this opportunity. It’s the country’s

leading construction company and has an outstanding delivery

record. However, the company’s disappointing H1’2016 result in-

dicates a sub-par performance. Revenue declined by 39% year

over year (YOY) from N77.8bn in H1’15 to N47.8bn. Net income

decreased by 94% from N2.26bn to N136mn during the same pe-

riod.

The significant reduction in revenue can be attributed to the pro-

tracted delay in the passage of the 2016 budget, resulting in

fewer available capital projects from the government. The release

of budgeted capital expenditure funds has been curtailed by lower

than expected revenue due to low oil production and prices. With

Nigeria facing a recession and weak economic prospects, brand

loyalty and high quality delivery may no longer be valuable attrib-

utes. Julius Berger’s earnings declined largely due to foreign ex-

change (forex) related charges which led to a decline in profitabil-

ity. This trend may persist due to a fluctuating and depreciating

naira (since the currency was floated). Foreign investment has

been scarce resulting in a limited inflow of US dollars and a weak-

ened exchange rate.

In arriving at the valuation of Julius Berger, we analyzed the com-

pany’s strategic positioning as the trusted infrastructural partner,

prevailing macroeconomic conditions, the huge infrastructural

deficit, foreign exchange risk, high interest rate environment and

the growing interest in public private partnerships (PPP). Despite

the fact that Julius Berger stands to benefit from the govern-

Page 34



ment’s desire to upgrade Nigeria’s infrastructural footprint, the

unfavorable macroeconomic milieu and fiscal challenges limit its

profitability and ability to add value to its shareholders. Accord-

ingly, we believe that Julius Berger is overvalued, and therefore

recommend a SELL as we do not foresee a significant upside in its

share price in the near to medium term.

CONSTRUCTION INDUSTRY STRUGGLING WITH HIGH

OPERATING COSTS AND POOR FEDERAL INVESTMENT

Julius Berger’s performance and earnings prospects have been

severely affected by the tough macroeconomic terrain. The high

interest rate environment, with the monetary policy rate at 14%,

has led to an increase in financing costs. This rise in benchmark

rates has been driven by an increasing inflation rate; it currently

sits at 16.5%, the highest in 11 years.

The decline in crude oil production, following unrest in the Niger

Delta, has reduced government revenue. This has led to lower

government spending on capital projects, directly affecting the

construction industry. The forex revenue in the external reserves

declined to N25.7 billion, the lowest in about 10 years. The impact

on the external reserves and the lack of dollar inflow from foreign

investors have led to a depreciation of the naira and increased

operating costs. Given the bleak economic condition, the con-

struction industry is struggling to survive.

STRATEGIC POSITIONING WITH THE GOVERNMENT

IS BOTH STRENGTH AND A WEAKNESS

If it were simply a matter of company performance, Julius Berger

is strategically positioned to be the preferred partner of the Nige-

rian government. Its laudable reputation, extensive product port-

folio and solid brand make it the first choice construction company

in Nigeria.

Since its pioneer project (Eko Bridge construction) in 1965, Julius

Berger Plc has become the giant of the Nigerian construction in-

dustry and has played an integral role in Nigeria’s infrastructural

development story. It is a company whose name is synonymous

Page 35



with quality and trust as it has built several landmark projects in

Nigeria, such as the Lekki-Ikoyi Link Bridge, Central Bank of Nige-

ria head office and the National Assembly. The growing public pri-

vate partnership (PPP) provides more opportunity for Julius Ber-

ger to build on its experience with the Nigerian government in se-

curing more high-profile projects

Julius Berger’s expertise is in executing complex works requiring

the highest level of technical expertise and Nigeria-specific

knowhow. Its business is supported by vertically integrated opera-

tions, which augment efficient and timely project execution. The

company’s subsidiaries include: Julius Berger International GmbH;

Julius Berger Services Nigeria Ltd; Julius Berger Medical Services

Ltd; Julius Berger Free Zone Enterprise; Abumet Nigeria Limited;

and, Prime Tech Design and Engineering Nigeria Ltd. The com-

pany’s competitors include reputable companies such as Reynolds

Construction Company (RCC), Setraco Nigeria Limited, Brunelli

Construction Company, Arab Contractors and Dantata & Sawoe

Construction Company Nigeria Limited. Julius Berger’s reputation

for exceptional quality places it as a market leader in the con-

struction industry.

The company’s growth through the years reflects this foundation.

However, it also reflects its significant exposure to public projects

and its resulting over-concentration risk. As a result, the massive

delays in federal government spending are wreaking havoc on its

past success, as can be seen by the decline in its financial state-

ment below.



Page 36

Income Statement for Julius Berger PlcN'000 2011 2012 2013 2014 2015

Revenue 169,413,371 201,565,276 212,737,291 196,808,632 133,807,574

Cost of Sales (135,789,354) (156,726,348) (161,134,675) (146,313,712) (100,473,106)

Gross Profit 33,624,017 44,838,928 51,602,616 50,494,920 33,334,468

Marketing and distribution expenses (94,636) (153,661) (111,209) (116,879) (75,140)

Administrative expenses (22,820,461) (31,704,992) (32,624,772) (31,497,145) (21,445,734)

Operating Profit 10,708,920 12,980,275 18,866,635 18,880,896 11,813,594

Investment Income 99,303 838,767 19,949 405,811 139,763

Other gains and losses 1,072,482 1,232,358 295,816 (170,361) 695,388

Finance cost (1,947,558) (2,709,908) (2,961,864) (5,981,450) (6,148,772)

Profit Before Tax 9,933,147 12,341,492 16,220,536 13,134,896 6,499,973

Income tax expense (5,521,149) (4,328,798) (8,367,196) (4,894,917) (4,059,833)

Profit After Tax 4,411,998 8,012,694 7,853,340 8,239,979 2,440,140

JULIUS BERGER MANAGEMENT STRONG BUT UNABLE

TO STEM THE BLEEDING

The company’s board and executive management team under-

stands the local business environment. They bring a wealth of ex-

perience that has helped propel the company to past successes.

The board of directors is led by Mr. Mutiu Sunmonu, Commander

of the Order of the Niger. He has been a board member of Julius

Berger since 2016 and was appointed Chairman in April 2016. He

previously worked as the Managing Director at Shell Petroleum De-

velopment Company and was the Country Chairman at Shell Com-

panies Nigeria. He is also the Chairman of the Board at Imperial

Homes Mortgage Limited. The management of Julius Berger is

made up of accomplished individuals led by Engineer, Wolfgang



Page 37

Balance Sheet for Julius Berger PlcN'000 2011 2012 2013 2014 2015

Property, Plant and Equipment 55,421,778 57,079,027 67,995,915 68,369,671 58,376,513

Goodwill - 4,634,422 4,842,708 4,606,412 5,041,184

Other intangible assets - 127,935 118,297 77,402 32,712

Investment property - - 780,177 2,648,412 2,546,436

Trade and other receivables 161,554 1,706,067 1,469,591 2,334,764 844,122

Tax receivable 12,458,367 25,957,783 31,075,595 35,060,509 21,039,915

Deferred tax assets 3,362,383 3,017,036 7,468,271 8,041,407 10,087,301

Other financial assets - 4,125,734 - - -

Non-current assets 71,404,082 96,648,004 113,750,554 121,138,577 97,968,183

Inventories 11,061,851 10,710,071 11,432,482 12,111,830 11,110,116

Amounts due from customers and other contracts 7,587,091 5,544,984 20,898,658 29,122,120 27,228,427

Trade and other receivables 46,230,007 41,582,008 52,245,757 63,425,208 88,634,246

Tax receivable 23,425,928 13,089,156 7,430,849 5,575,112 5,292,205

Cash and cash equivalents 11,827,635 10,731,468 20,475,649 23,473,159 13,360,038

Assets classified as held for sale 711,495 728,473 1,027,308 1,199,775 1,493,055

Current assets 100,844,007 82,386,160 113,510,703 134,907,204 147,118,087

Total Assets 172,248,089 179,034,164 227,261,257 256,045,781 245,086,270

Share capital 600,000 600,000 600,000 660,000 660,000

Share premium 425,440 425,440 425,440 425,440 425,440

Foreign currency translation reserve - 222,992 687,896 919,411 419,755

Retained earnings 8,684,026 13,774,577 18,863,052 23,420,332 22,729,580

Equity attributable to owners of the company 9,709,466 15,023,009 20,576,388 25,425,183 24,234,775

Non-controlling interest 36,759 121,171 458,040 670,660 57,180

Total Equity 9,746,225 15,144,180 21,034,428 26,095,843 24,291,955

Borrowings - - 6,435,141 3,201,710 -

Retirement benefit liabilities - 1,656,643 2,033,004 1,996,506 1,853,781

Deferred tax liabilities 5,440,300 5,666,877 12,336,676 13,220,121 12,989,322

Amount due to customers under contracts 94,097,474 86,487,144 80,214,852 93,690,330 106,971,355

Provisions - 1,268,007 - 2,135,994 404,308

Non-current liabilites 99,537,774 95,078,671 101,019,673 114,244,661 122,218,766

Amount due to customers under contracts 13,658,887 18,863,122 46,472,088 35,188,722 32,912,602

Trade and other payables 19,310,108 33,121,063 34,016,585 42,138,848 34,596,825

Borrowings 16,038,018 8,208,260 19,279,413 34,809,060 24,807,936

Current tax payable 3,482,077 3,551,109 5,314,810 3,473,353 6,106,748

Retirement benefit liabilities 10,475,000 5,067,759 124,260 95,294 151,438

Current liabilites 62,964,090 68,811,313 105,207,156 115,705,277 98,575,549

Total liabilites 162,501,864 163,889,984 206,226,829 229,949,938 220,794,315

Total equity and liabilites 172,248,089 179,034,164 227,261,257 256,045,781 245,086,270

Goetsch, who has been with the company since 1991. He was

previously on the Board of Directors and Managing Director at the

company in 2007 and was reinstated in July 2016. Mr. Wolfgang

Kollermann is the Financial Director and has been with the com-

pany since 2000, occupying several positions. He is the Chairman

of Julius Berger Medical Services Ltd and is a Member of the

Board of many of its subsidiaries.

To cope with the challenging macroeconomic conditions the team

has made drastic decisions, such as the 39% downsizing of its

staff. However, management has been unable to improve upon

2015’s unimpressive financial result given the impact of the plum-

meting economy.

Bulls Say:

Renowned reputation and superior brand value due to consis-

tent high quality delivery

Deep knowledge of the Nigerian construction and infrastructural

environment

Federal government is committed to addressing Nigeria’s infra-

structural gap as reflected by the increased percentage of capi-

tal expenditure in the budget

Few strong and reliable competitors

High barrier to entry as huge investment outlay is required

Increasing public-private partnerships (PPPs)

Bears Say:

Rising finance costs due to high interest rate environment

Forex rate risks could potentially erode earnings

Government delay in approval of and payment for capital pro-

jects

Declining government revenue as a result of oil production

slowdown following relentless insurgency and volatile prices

Significant exposure to public projects could result in concentra-

tion risk



Page 38

RISKS AND OUTLOOK: GOOD OPPORTUNITIES BUT LIT-

TLE UPSIDE

Julius Berger faces market and concentration risks. Market risks in-

clude currency uncertainty, an adverse economic landscape, inter-

est rate increases and rising operating costs. The vacillating forex

market could result in high finance charges, which could cripple

earnings if not properly managed. The adverse economic environ-

ment has also led to a decline in demand for construction services

from both the public and private sectors. High interest rates and

depreciation of the naira can also lead to higher financing and oper-

ating costs. Concentration risk is a huge concern for the company

because most of its projects are federal and state government con-

tracts.

Though these risks pose immense challenges on the company’s out-

look, Julius Berger has devised a practical risk management struc-

ture. The company manages forex exposures by utilizing forward

forex contracts. The company’s foreign debt is repayable on de-

mand with its carrying amount reflecting the fair value and expo-

sure to interest risk as of the reporting date. Concentration risk is

managed through forward funding where achievable.

Nevertheless, the persistent macroeconomic headwinds still pose a

huge challenge. The decline in demand for construction services,

increasing interest rate and high forex charges threaten the com-

pany’s ability to improve shareholder value. Thus, Julius Berger is a

company with the paradox of good opportunities but little upside

and we must recommend a SELL.

APPENDIX - VALUATION

We derived our valuation for Julius Berger Plc by using the Dis-

counted Cash Flow (DCF) methodology. Our fair value estimate for

Julius Berger Plc is N39.74, which is a 17.1% downside on the cur-

rent price of its share as of August 23 2016. The discount rate

(weighted average cost of capital (WACC)) of 17.0% is derived us-

ing a 14.94% risk free rate (the yield for the 5 year Federal Gov-

ernment of Nigeria (FGN) Bond issued on July 2016), a beta of

1.24, an after-tax cost of debt of 11.7%, and a market risk pre-

mium of 6%. The long term cash flow growth rate to perpetuity cal-

culated is 4.1%.

Page 39



Important Notice

This document is issued by Financial Derivatives Company. It is for information purposes only. It does not constitute any offer, recommendation or solicitation to any person to enter

into any transaction or adopt any hedging, trading or investment strategy, nor does it constitute any prediction of likely future movements in rates or prices or any representation that

any such future movements will not exceed those shown in any illustration. All rates and figures appearing are for illustrative purposes. You are advised to make your own independ-

ent judgment with respect to any matter contained herein.

© 2016. “This publication is for private circulation only. Any other use or publication without the prior express consent of Financial Derivatives Company Limited is prohibited.”

Taking into account Julius Berger’s latest financial results, increas-

ing inability of the government and private clients to finance new

projects the prevailing macroeconomic conditions and a disappoint-

ing H1 2016 result, we forecast a two-year revenue compound an-

nual growth rate of 8.1%.

JULIUS BERGER VALUATION USING DISCOUNTED

CASH FLOW DCF

Page 40



DCF Valuation for Julius Berger PlcN'000 2016E 2017E 2018E

EBIT 9,474,992 10,230,546 10,488,688

Less: Taxes (4,414,988) (4,767,047) (4,887,332)

EBIAT 5,060,004 5,463,498 5,601,356

Plus: Depreciation Expense 10,372,544 10,292,369 9,544,671

Less: CAPEX (8,089,859) (7,163,344) (6,920,739)

Less: Change in working capital 25,930,761 (964,317) (2,528,623)

Free Cash Flow (FCF) 33,273,450 7,628,206 5,696,665

WACC 16.5% 16.5% 16.5%

Present Value (PV) of FCF 28,570,570 5,624,249 3,606,483

Terminal value @ perpetual growth rate (2018) 2016 2017 2018

Terminal value as of 2018

Present value of terminal value 26,097,529

DCF Calculation Valuation

PV of explicit period 37,801,302

PV of terminal value 26,097,529

Enterprise Value 63,898,831

+ Cash 13,360,038

- Borrowings (24,807,936)

Equity Value 52,450,933

Share price 39.74

Shares outstanding ('000) 1,320,000

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