LBS August 2016

Monthly Economic News and Views

Presented by B.J. Rewane Financial Derivatives Company Limited

Lagos Business School

Executive Breakfast Meeting August 3, 2016

Policies Daunting, Markets Uncertain, Citizens Groaning

2

Outline

July Highlights

Global & Regional Context

Outlook for June

Policy Directions

Business Proxies & Stock Market

Political Risk Analysis

July Highlights

High Expectations & Dashed Hopes

4


Flexible exchange rate policy launched with fanfare

Naira falls modestly initially and dipped sharply lower to N316/$

Estimates for Q2 negative growth increase with consensus at -

1.5%

IMF projects full year of negative growth of -1.8% for 2016

Power output from the national grid stays at 2400MW

Court orders suspension of tariff increase

5


Government cancels Manitoba contract with Transmission

Company of Nigeria

No official reasons offered

Price of diesel skyrockets on increased demand for alternative

energy- N215/litre

Kerosene price rises stratospherically to N600 per litre

Economic activity shows signs of marginal recovery as PMI inches

up to 51.9 (FBN)

6


Oil output also up marginally to 1.52mbpd

Militant pipeline attacks in Delta are down due to a step in counter

insurgency

New spectacular attacks on gas pipelines & facilities in Ogun state

Oil price entered a bear market, down 22% in 2 months

Average oil price in July at a 2-month low of $46.51pb

0.81% lower than the Q2 average of $46.89pb

Denting the dollar inflow and external reserves of Nigeria

7


OPEC countries increase production and Saudis offer discounts

FAAC amount surges 83.2% to a high of N559bn

Attributed partially to improved tax collection and exchange

rate gains

Estimates for FAAC in August is N700bn, highest level in 30

months

Average opening position of Nigerian banks was N257.2bn

8


MPC resumed the tightening cycle, raising the MPR by 200 basis

points to 14% pa

Primarily to contain price inflation and reduce regulatory arbitrage

T/bill rates rise to record levels of 18.5% pa (364-day)

Banks were borrowing from CBN at 14% pa and lending to FGN

at 17% pa

Headline inflation jumped to 16.5% while core inflation climbed

to 15.3%

Driven by continued supply shocks and base year effects

9


Corporate performance declined across all sectors

Nestle the most pricy company on the exchange reported

sharply lower earnings

Nigerian credit ratings remained unchanged after the downgrade

by Fitch last month

Nigerian Misery Index now at an all time high of 47.7%

Threatening political stability and social cohesion

Global & Regional Context

12

FED Errs on the Side of Caution

The United States (world’s largest economy) grew by 1.2% in

Q2

Significantly lower than earlier forecasts of 2.5%

Business investments fell by 4.5% in Q1 and PMI shrank to 50.4 in June

US stocks also sank from its record high

13


The Fed Reserve decided against raising interest rates

Currently 0.25 – 0.5%

Subdued inflation expectations and global worries were major

considerations

The possibility of a rate hike increase later this year has

increased

Just as near term risks diminish

14


Political and election considerations may be a tacit consideration

An increase in interest rates, a stronger dollar and lower oil

prices are naira negative

Could trigger capital flow reversals and increased debt service

for Nigeria

The US remains one of Nigeria’s strategic trading partners

15

UK

Bank of England (BOE) meeting on August 4th

BOE cut interest rates to 0.25% from 0.5%

Making the pound weaker and British goods more competitive

16

EU Banks Pass Stress Tests

31 banks pass stress test

Banca Monte dei Paschi di Siena (BMPS) fails European Banking

Authority (EBA) stress test

RBS and Barclays showed cause for concern

Deutsche Bank and UniCredit suffered sizeable hits to their

capital buffers

Deutsche Bank is one of Nigeria’s correspondent banks

May reduce its appetite for cross border risks in SSA

17

China’s Growth in Q2 is 6.7% - on par with Q1

1.5% higher than forecasts

PMI of 49 signals a mild contraction

Shanghai Composite index rises by 0.1%

Nigeria is the 2nd largest trading partner of China in Africa

China is a big commodity cost driver

Stagnant growth in China means that global demand for oil will

slow

China

18

SSA - Economic Review

International Monetary Fund cut its global GDP growth forecast

for SSA to 3% from 3.5%

Q2 GDP growth for South Africa shows marginal improvement

Yet highlighting a weak and strained economy

Unemployment remains unabated: 26.6%

GDP outlook improved for Angola, Cote d’Ivoire and Tanzania

Cote d’Ivoire , Tanzania and Ethiopia are expected to grow the

fastest

19

SSA- Economic Review

Conflicting inflationary and policy trend in SSA

Most SSA countries use interest rates to curb inflation

COUNTRY Inflation

Trend

Current

inflation %

Monetary

policy Interest

rates%

Change in

interest rates

Policy stance

NIGERIA

16.5 14 Tightening

SOUTH AFRICA

6.3 7 Tightening

ANGOLA

31.8 16 Tightening

KENYA

6.4 10.5 Easing

GHANA

18.4 26 Tightening

Commodities Market

21

Commodity Prices Outlook

Oils prices likely to maintain downward trend as supply builds

Bearish outlook for grain prices in August due to:

Expectations of bountiful harvests

and expanding inventories

Cocoa prices to increase as West African production fails to meet

target demand

Sugar prices to remain high as increased production from Brazil &

Europe not enough to bridge deficit

22

Implications for Nigeria

Average oil price between Jan – July is now $41.86pb

Production levels yet to recover to pre-militant attack levels

Lower agric commodities prices being eroded by naira depreciation

Average decline in agric commodities was 6.83% in July

Compared to naira depreciation of 8.55%

Domestic Economy

25

Leading Economic Indicators INDICATORS

Jun’16 Jul’16 (Jun/Jul)% change Aug* Oil Markets

Spot price (avg $’pb) 49.87 46.51 -6.73 40

Production (m’bpd) 1.523 1.55* 1.77

1.62

Money Markets (End Period)

OBB (%)p.a 4.42 3.75 -0.67 6.00

O/N(%)p.a 4.83 4.25 -0.58 6.50

MPR (%)p.a 12 14 200bps 14

CPI ( %) 16.5 16.8* 0.30* 17.00

External Reserves ($’bn) 26.35 26.23 -0.45

26.0

Exchange rate (End Period)

Inter-bank (N/$) 281.33 321.66 -10.67 305-310

Parallel (N/$) 351.00 378.00 -7.14 350-370

Other

Market cap (N’trn) 10.24 9.62 -6.05 9.30-9.50

FAAC N’bn) 559.03 600.02* 3.37 620.00

FBN PMI 50.2 51 51.5

52

Vacancy Factor Index 172 172 -

175

Source: FMDQ, CBN, * FDC Forecasts

26

IMF Cuts Growth Forecast... Again

IMF cuts Nigeria’s growth forecast to -1.8%

Second cut in 6 months

First time in April, from 3.5% to 2.3%

Economic activity will be constrained by forex shortage

GDP growth is expected to bottom out in Q3 and a marginal

recovery in Q4

27

PMI- Slight Expansion

FBN & CBN’s measure of PMI show

a recovery in the manufacturing

sector

PMI expected to increase in August

Source: FBN Quest, CBN, *: FDC Forecast

44.6 50.6

54.4

46.5 48.2 50.2 51 51.5 47.2 45.5 45.9 43.7 45.8

41.9 44.1 45.6

0

10

20

30

40

50

60

FBN PMI CBN PMI

28

Oil Price Tumbles as Production Falls

Oil price drifted lower towards $42pb and has recovered to

$45pb

Expect a trading range of $41pb-$45pb in August

Domestic oil production to stay flat in August at approximately

1.5mbpd

Unofficial sources put production at slightly above 1mbpd

29

We are in a New Oil Price Regime

30

What Could Go Wrong?

Deadlock in talks and increased insurgency

Oil prices falling below $40pb

31

Inflation Upward Trend Sustained

Headline inflation to increase to 16.8%

Driven by supply shocks

Spike in prices of refined products

Forex scarcity and defensive buying

Higher interest rates unlikely to reduce

marginal propensity to consume

9.60

11.40

12.80 13.70

15.60 16.50 16.80

15.50

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

32

Domestic Commodities – Harvest Season

Commodity Jun’16(N) Jul’16 (N)

Garri (Yellow) 10,500 12,800

Rice (50kg) 14,000 19,000

Beans (oloyi) 16,000 18,500

Sugar 10,600 13,000

Semovita (10kg) 2,500 3,500

Tomato (Basket) 20,000 15,000-17,000

Source: FDC Think Tank

33

Domestic Commodities – Harvest Season

Harvest season notwithstanding, commodity prices remain

stubbornly high

Tomato prices, crashed 67% to N15,000

Effective curbing of pests and over cultivation

Rice, flour and sugar sharply higher on exchange rate pass

through effect

Locally produced commodities also more expensive as

substitution effect weighs in

Domestic substitutes also inching upwards

34

Energy Price Trend- Kerosene & Diesel Defy Gravity

Official price of kerosene increases by 62%

Likely to reduce the street price

0

50

100

150

200

250

300

Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16

Diesel N/l

PMS N/l

Kerosene/l

35

Impact Analysis

Growth Inflation FAAC PMI

Exchange rate

(depreciation and

scarcity)

Negative Negative Positive Negative

Falling PMS Positive Positive Neutral Negative

Surge in fuel price

(kerosene, diesel)

Negative Negative Neutral Negative

Higher MPR Negative Positive Neutral Negative

Policy Impact on Economy

38

Bold Decisions have been made…

Exchange rate

liberalization Reflect REER & correct trade imbalance

MPR rate increases Control inflation

Fuel subsidy removal Reduce fiscal and forex burden

DESIRED OUTCOMES POLICY

Note: REER means Real Economic Exchange Rates

Context

39

New Policy Sequence

40

41

Market Value (N400) vs. Economic Value (N315)

Economic prognosis suggests

the naira is undervalued by

1.26% at N314.99/$

Convergence crystallized in the

reverse direction

Market reality – IFEM rate

converging towards parallel

market rate

Conclusion: Divergence

between market realities and

economic expectations

Purchasing Power Parity

Jul-16

=N= US $ PPP ('=N=/US$)

Bottle of Coke (50cl) 120 2.65 45.28

Heineken 400 2.82 141.84

Hamburger (Johnny Rockets) 2,500 4.59 544.66

Uncle Ben's rice (S. Pkt) 1,585 3.65 434.25

Toyota Corolla 11,000,000 17300 635.84

Bottled Water (1.5ltr) 150 1.94 77.32

Big Loaf Bread 300 2.39 125.52

Irish Spring Soap (1 cake) 325 0.74 439.19

Chicken Drumsticks ( 1 kilo) 1,680 3.32 506.02

Eggs (One dozen) 510 2.55 200.00

Average PPP 314.99

Naira Price at IFEM 319

PPP (%)

Decision: Naira is Under valued -1.26%

Spot Rate (Parallel) 400

Outcome: Compared to IFEM rate of N319/$1, the Naira is undervalued by 1.26%

42

Daily Transactions in See-Saw Mode

Reduced premium between forex markets

168 198 199

330

210 230

266

377

0

50

100

150

200

250

300

350

400

Jan'15 Jul'15 Jan'16 Jul'16

Official rate Parallel Market

N42 N32

N67

N47

Spread between markets

0

20

40

60

80

100

120

140

160

Jul'25 Jul'26 Jul'27 Jul'28

48.24

7.83

144.05

23.74

Volume of Transactions Traded ($'mn)

1 Green, 7 Amber & 8 Red

44

Consumers are Struggling

Business Proxies

48

FAAC Up at an 18-Month High

FAAC to be shared in August is projected to

rise to N700bn

As a result of increased exchange rate gains

Reached highest level in 18 months

N559.03bn in July from N305.12bn in June

Government is better positioned to intervene

Pending N90 billion bailout to states

Only available to states who meet criteria (tax

review, debt ratio

49

More Ships in Lagos

Ships awaiting berth increased to 45 in July

Higher international trade activity, forex availability and settlement of

backlogs

Ships awaiting berth expected to increase to 50

Boosted by budget implementation, flexible exchange rate

0

100

200

300

400

0 10 20 30 40 50 60 70

Feb

-15

Ma

r-1

5

Ap

r-1

5

May-1

5

Jun-

15

Jul-

15

Aug

-15

Sep

-15

Oct

-15

Nov-

15

Dec-

15

Jan-

16

Feb

-16

Ma

r-1

6

Ap

r-1

6

May-1

6

Jun-

16

Jul-

16

Ships Awaiting Berth

Parallel Rate (N/$)

Ships Awaiting Berth

50

Power Output

1592.25

2753.6

4544.75

4382.2

0.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

3500.00

4000.00

4500.00

5000.00

0.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

3500.00

4000.00

4500.00

Power Output (Monthly Average)

Constrained Ouput Monthly Average

Power Output (MW) Average power output is constrained

Output yet to recover to pre-avenger

attack levels

Generation and output subject to

militant attacks and speed of repairs

Source: NERC

51

Domestic Retail Industry

Knock-on effect of forex policy seen in prices of imported items

Substitution to cheaper/local brands expected

Lower real income likely to reduce traffic in retail stores

Shelves are expected to thin out more due to higher import

cost

Stock Market

Market Expectation Up, Corporate Earnings Down

54

NSEASI July 2016 - Highlight

Nigerian stocks market tumbled by 5.36% to

close at 28,009.93 points

Bringing YTD return of the index to (2.21%)

Market capitalization closed at N9.62trn for the

month of July

Representing a 5.36% decreased from N10.16trn

The bourse average daily turnover decreased by

29.9% to N2.5bn from N3.54bn

26,000

27,000

28,000

29,000

30,000

NSE ASI

55

NSEASI July 2016 - Highlight

The average daily volume traded (ADVT) decreased by 21.7% to

273.9bn

The selloff that occurred in the first three weeks of the month of

July brought to light four key issues:

The flight to safety as yields on government securities surge upwards

FX illiquidity

Unimpressive corporate earnings result

Short term over board on economic indicators

Market PE ratio now 9.3x

56

ScottFree BC 30

ScottFree Index

BC30 index lost 3.98% in June

The SFNG Blue-Chip 30 Index (USD) was

down 14.24% while the SFNG Blue-Chip Index

(EUR) was down 15.59% for the month of July

30 day volatility in July was at 17.52% (down

from 40.61% in June)

1 year return of -21.52%

Trailing P/E 6.67x

57

H1’16 Corporate Earnings

H1’16 earnings season commenced

As of July 29th, about 49.7% of all NSEASI companies have

reported Q2’16 earnings

Stock prices reflective of perceived ability to deliver future

returns

Short term overboard on economic indicators

Results were disappointing but overall in-line with market

expectation

58

H1’16 Corporate Earnings

H1’16 Pre-Tax Profit down by 53.4% from N377.2bn, Earnings

up by 6.67% from N2.04trn

Banks’ H1’16 was disappointing:

Gross earning marginally increased 0.3% from N694.3bn and pre tax

profit declined by 19.1% from N122.3bn

Sector P/E – 7.26x

NSE Banking declined by 2.64% for the month of July

Banks

Gross earnings declined marginally by 0.2%

to N273.4bn from N273.9bn

Net interest income up by 8.85% from

N110.3bn to N120.1bn

Net impairment charge spiked to N32.9bn

from N17.8bn

Representing 84.8% increase

Pre-tax profit down by 32.31% to N41.6bn

from N61.4bn

P/E ratio 3.16

Share price N12.74

Gross earnings declined by 1.24% to

N268.45bn from N271.8bn

Net interest income down by 5.01%

from N132.7bn to N126.1bn

Net impairment charge spiked to


Representing 209.6% increase

Pre-tax profit down by 11.9% to


P/E ratio 11.18

Share Price N3.33

ECOBANK FBNH

61

Oil and Gas Downstream

Revenues rose 29.9% y-o-y to N145billion

Petroleum products and lubricant segments

grew by 29.2% and 35% respectively

PMS price increase by 67.6% to N145

attributable factor

Gross margin improved to 15.74% from

11.36%

Pre-tax profit increased by 198.58% to

N12.9bn

Profit margin improved to 8.8% from 3.86%

Declared interim dividends of N3 per share

payable in September 2016

P/E ratio 15.22

Share Price N181.5

Revenue up by 52.9% to N50.3bn

Reflective of PMS price increase in the

month of May’16 hike from N97 to

N145

Gross margin and profit margin were

flat at 81% and 12.9% respectively

Selling and administrative expense in

aggregate rose by 20.6% from N4.9bn

to N4.1bn


N12.9bn

P/E ratio 11.23

Share Price N162

TOTAL MOBIL

62

Agriculture

Revenue up 51.2% to N7.54bn

Local sales accounts for 89.7% of revenue

as against 81.9% for prior year

Finance cost reduce by 32.4% to

N164.7mn

Still enjoying its five (5) years moratorium

by Socfinaf S.A and single digit interest rate

from FGN



H1’16 profit margin 51.8% compared to

prior year of 42.8%

P/E ratio 8.36

Share price N33.66

Revenue up 60.5% to N7.52bn

Gross margin increased to 63.3%

Finance cost reduce by 5.62% to

N303.3mn


N4.12bn

H1’16 profit margin 54.8% compared to

prior year of 33.3%

P/E ratio 16.7

Share price N38.85

OKOMU OIL PRESCO

63

64

Outlook

Record rates at T/bill auction of 18.5% (364-day) is crowding

out equities

PFAs are scrambling for T/Bills

Retail investors and mutual funds also shorting equities

Weak earnings in Q2

Real Estate Industry

66

Real Estate Update

The vacancy factor index remains high at 172

The LVFIX is a lagging indicator - yet to respond to recent policy

changes

0.36% Q1 contraction in GDP still affecting the vacancy rates today

Expectations of a further 1.5% contraction in GDP is likely to push

the index up

67

Real Estate Update

In many areas in Lagos, rents have remained very high despite

the supply glut

Vacancy rates of commercial properties have remained stable

Dollar denominated rents becoming less prevalent

In dollar terms, rents are sharply lower

68

Real Estate Update

The increase in inflation rate to 16.5% is likely to reduce future

demand for housing

Individuals will face budget constraints

Will increase the number of rental defaults in the market

Real returns in the stock market have been negative

Real estate as an asset class still offers positive returns

Investors will rather divert funds to such markets

69

Outlook

Demand for housing is expected to shrink due to lower

disposable income

We expect a move from prime areas to more affordable housing

(mainland areas)

We expect to see new developments coming into the market

Positive changes in the sector are expected from 2017 onwards

As we see demand growing through expatriates coming into the

country

Aviation Sector-Dollar Backlog

Once Bitten, Twice Shy

72

Global Aviation Performance

Global airline share prices dropped by 11.6%

YTD decline of 21%, the worst since 2008 recession

Terrorist attacks increase negative sentiments to airline stocks

Q1 net post-tax profits are 25% higher than Q1’2015

Average global yield down by 9% YTD

Premium fares are the buffer for airline profitability

73

Global Aviation Market

Passenger and freight capacity increasing

African carriers have grown AFTK by 23% Y-o-Y

Passenger load factor is trending at record highs

74

Domestic Aviation Update - IATA Fares Go Up

Domestic carriers want to increase fares by 45%

Naira weakness leading to higher operating costs

IATA rate of exchange now flexible

Dollar scarcity still a fundamental problem

Backlog beginning to creep up again

After 9 months of using N200/$, it is currently at N312/$

75

Domestic Aviation Update

Jet A1 fuel spikes 100% to N240 per litre from 2015

Maintenance costs have skyrocketed

Flight delays and cancellations continue

Pilot and cabin crew training costs are all in dollars

76

Factors affecting the Domestic Aviation Market

Weaker naira and declining purchasing power

Nigerians are cutting back on international travel

Current connectivity within Africa is poor

State govts facing fiscal imbalance are slashing travel costs

77

Domestic Aviation Outlook

Ethiopian airlines offers the best deals

Lagos-Newark via Lome on a dreamliner for N400,000

Time and cost efficient deal in style

Qatar airways is next amongst Naira stretchers

78

Domestic Aviation Outlook

Load factors to the US picking up gradually

Nigerians are now cutting back on travel

Expect another round of capacity cuts into Lagos and Abuja

Fares will stagnate as devaluation eats deep into disposable

income

79

Implications

Delayed and cancelled flights will affect business activity and

connectivity

Revenue loss for many airline companies

Risk on flight safety

Capacity and frequency into Lagos and Abuja will be cut

Political Update

82

Political Update

Buhari finally starts making appointments to APC loyalists

Sharing of spoils helps consolidate power base

Poor economic performance is eating into Buhari’s favourability

Opponents are too weak to take political advantage

PDP in total disarray

83

Political Update

Lack of strong opposition is encouraging militancy

Political opponents are exploiting the economically frustrated

and disgruntled

Dismantling of rent-structure and war on corruption has

weakened the political class

Incumbency a major advantage but turnout very low in bye

elections

84

Political Update

Most elections are inconclusive at first count due to complicity

Senate & House leadership are all embattled

Edo State election likely to favour incumbent

But the State has always been electorally unpredictable

Militancy in the Niger Delta will continue to be a nuisance

Intelligence force and constructive engagement will be used

simultaneously

Outlook For August

86

Outlook for August

CBN will meet its August forward delivery

Reducing volatility in the spot market to N305-330 trading range

Narrowing the premium with the parallel market to 15%

CBN will increase OMO activities forcing T/Bill yields to above

17% p.a.

87

Outlook for August

FGN will accelerate its dollar debt issuance and budget support

facilities from multilaterals

Oil production will remain flat at 1.5mbpd

Amnesty payments will not ameliorate the attacks

Will increase the squabbles between the groups

88

Outlook for August

The administration will become more responsive to public

sentiment

Nigerians will alter spending patterns drastically in response to

challenges

89

Long Term Outlook

90

Corporate Humour

Life is one long process of

getting tired – Samuel Butler

Reality is the leading cause of stress for

those in touch with it – Jane Wagner

91 Corporate Humour

Time is a great teacher, but it

kills all its students – Hector

Berlioz

Happiness is an agreeable

sensation arising from

contemplating the misery of

others – Ambrose Bierce

92 Corporate Humour

Nobody cares if you are

miserable, so you might as well be

happy

A woman’s best beauty aid is a

near-sighted man

93 Corporate Humour

Resentment is like drinking

poison and waiting for the

other person to die.

The abdomen is a cavity

containing the organs of

indigestion – Evan Esa

94 Corporate Humour

Rome is like a man who keeps

himself by showing visitors the corpse

of his grandmother

Bismarck J. Rewane, MD/CEO Financial Derivatives Company Ltd.

Lagos, Nigeria 01-7739889

© 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.”

Economy & Finance

LBS August 2016