Professional Documents
Culture Documents
A RETURN TO RECOVERY
CONTENTS
Abbreviations …………………………………………………………………………………..3
Economic Outlook………………………………………………………………………………4
ReNaissance Capital does and seeks to do business with the companies covered in ReNaissance Research. As a
result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of
ReNaissance Research. Investors should consider Renaissance Research only as a single factor in making their
investment decision
Abbreviations
Economic Outlook;
The global economic recovery has been faster than predicted. The International Monetary
Fund (IMF) forecast global growth at 4.5% which is a 1% upwards revision from the October
2009 World Economic Outlook report. The recovery will be largely led by emerging and
developing economies with an estimated 6.3 % growth according to the WEO April 2010
report. Uganda’s economic growth is projected to rebound to the long-term average of 7%.
More worrisome, austerity measures in Europe sparked off by the debt crisis in Greece and
Ireland, is forcing governments to cut back on spending and yet private consumption and pri-
vate credit remain subdued. With sovereign credit coming into question coupled with a bank-
ing system riddled with bad debt, growth particularly in Europe should be slow. A recent
rebound in oil prices will fuel inflationary pressures for the local economy.
The Ugandan economy has continued to enjoy strong inter-regional trade and also trade with
China and India (who together make the 3rd most important trade block for Uganda accord-
ing to Bank of Uganda). South Sudan which forms an important trade partner, surpassing
Kenya as an export destination in 2008/09, is most likely to become an autonomous state.
Increased export earnings from Uganda going forward, will be dependent on the stability of
the new South Sudan state.
Particular challenges will be met in the foreign exchange markets (Figure 1) despite the
stability in reserves over the past year. At about five months of import cover over the year
2010, this represents a drop from a previous two year average of seven months according to
Bank of Uganda data. Portfolio inflows searching for higher yields, as the central banks
raises interests rates to control inflation, could help temporarily stabilize the foreign
exchange market. The specter of inflation and asset bubbles should however be watched as
result, leaving short term uncertainty a challenge for monetary policy.
Over the year 2010, headline inflation dropped to 4% from 13% the previous year (Uganda
Bureau of Statistics — UBOS). This was on the back of reduced fuel prices globally and
negative food inflation. A recent rebound in commodity prices (oil at USD 100 per barrel) as
a result of floods, predictions of drought and severe winters, will negatively impact inflation.
Figure 1: Exchange rate and reserve trends Figure 2:Inflation and short term rate trends
2500 8 25
7
2000 20
6
5 15
1500
4
10
1000 3
2 5
500
1
0
0 0
Jun-03
Apr-04
Jun-08
Apr-09
Nov-03
Aug-07
Nov-08
Dec-05
Oct-06
Dec-10
Jan-03
Sep-04
Feb-05
Mar-07
Jan-08
Sep-09
Feb-10
Jul-05
May-06
Jul-10
Jun-03
Nov-03
Apr-04
Aug-07
Jun-08
Nov-08
Apr-09
Dec-05
Oct-06
Dec-10
Jul-05
Jul-10
Jan-03
Sep-04
Feb-05
May-06
Mar-07
Jan-08
Feb-10
Sep-09
Inflation-Headline 91-Day
USD:UGX Reserves
The recent divergence in reserves cover of imports has translated The current trend of rising inflation in low interest rate environ-
into exchange rate volatility. Policy initiatives should strongly gear ment could indicate policy movement towards higher short term
towards building reserves to higher levels. Presently. The cover is rates. This should favor equities and short term securities, in the
at 5 months of cover which coupled with a growing import bill is short to medium term.
turning out to be insufficient.
Despite the short term uncertainty, our long term Tax revenue is expected to double within 6-10
view suggests that the Ugandan economy is years as a result of investment in the oil sector,
strongly positioned within the East African according to the same report. As a result, it is
region to benefit from a resurgence in the global expected that there will be increased investment
economy. Central to this has been capital flows in the infrastructure, energy and the resource ser-
into the local economy, the principal drivers of vices sectors of the economy. From a residual
which have been foreign direct investment, point a view the construction and banking sectors
remittances from Ugandans working abroad of the economy should benefit from overall FDI
(which have not been affected by the global eco- inflows.
nomic slow down) and credit flows. To a lesser
degree portfolio flows should make a contribu-
tion. FDI inflows according to the Uganda Investment
Authority (UIA) have experienced a CAGR of
38% from 2002-2009. The planned investments
Uganda enjoyed the third fastest growth in the for 2010, stood at USD 1.7 billion up from USD
African region after Ethiopia and Congo in 2009 1.6 billion in 2009. As such the impact of the oil
according to IMF statistics. Uganda’s nominal sector should be significant on the local econ-
GDP ranks in the top one third among 52 mem- omy; growing FDI four-fold approximately from
ber states. With the emergence of the oil sector, the current levels.
the local economy could easily get catapulted
into a middle income economy according to
Global Witness-2010 Report. (View Box 1; Page
7)
According to Bank of Uganda data, the expected We should also anticipate a rebound in private
remittances into the local economy were pro- flows in response to expected and actual higher
jected to reach USD 980.9 million in 2010 from yields both in the equity and debt markets in
USD 732 million in 2008 (34% CAGR). This developing markets as compared to developed
should cushion consumption and investments markets.
gaps within households to a larger extent. The
construction sector is positively impacted by re-
mittance inflows. Despite a persistent current account deficit, we
forecast a marginal surplus in the overall bal-
ance going forward as a result of capital flows
According to fig.3 below, Uganda’s total invest- into the economy, In the short term, uncertainty
ment (comprised of credit flows, foreign direct should remain, affecting the stability of the
investment, private inflows into the equity market local currency. Over the medium to long term
and portfolio inflows) as a proportion of GDP has the exchange rate could revert to the mid-term
been one of the fastest growing in the East Afri- average of USD:UGX 2000 as reserves
can and Sub-Saharan Africa region, a trend that is improve.
poised to continue to impact expected capital
flows into the economy.
28
26
24
22
20
18
16
14
12
10
2003 2004 2005 2006 2007 2008 2009 2010est 2011f
Since 2002, 39 deep wells have been drilled in the area, 36 of which have encountered hydrocarbons in multiple res-
ervoir intervals in the subsurface, representing a remarkable drilling success rate of over 92%. To date, 16 discoveries
of oil and/or gas have been made in the country in excellent quality reservoir sands, 11 of which have been flow
tested and some of the wells have registered cumulative flow rates of over 14,000 barrels of oil per day. The discov-
ered resources in the graben are currently estimated at over 2 billion barrels of oil equivalent in place.
The government of Uganda has contracted Foster Wheeler Energy Ltd, a UK-based firm to carry out a refinery feasi-
bility study to address, among others, the size, configuration, location, cost, financing options and markets for refined
products.
The proposed investment in the commercialization of the sector is in the region of USD 8 billion, almost 50% current
GDP. The impact on the local economy will be immense. It is estimated that government revenues should double in 6
-10 years according to the World Bank. Increased investment in infrastructure and energy should ensue as a result of
the sector.
Banking and financial institutions should build capacity to finance the derivative sectors from the oil economy. There
will be an immense need to develop a fiscal and financial institutional framework that can absorb a potential revenue
in excess of USD 30 billion over 20 years.
The oil sector is expected to contribute 15% of the country’s GDP at peak production. Credit growth and production
could slow among sectors not directly linked to the oil sector, such as agriculture which would have a negative eco-
nomic and social impact in the medium to long term. It will be incumbent upon government to utilize oil revenues to
develop infrastructure and social services, and put in place policies that avoid over concentration on one sector (oil) at
the expense of other priority sectors.
Figure 1.1: Comparison of proven reserves among Figure 1.2: Comparison of daily production
major African oil producers
The equity market maintained a strong performance over the year 2010. This was on the back
of return of capital inflows, in search of higher yield in generally undervalued companies fol-
lowing the unusually high withdrawal of investors in 2009. The returns on the equity market
should remain robust, though we should see some short term volatility as investors take
profits and as headwinds from the 2008-2009 slowdown reflect in corporate performance.
In the short to medium term a rise in inflation should favor equity as compared to longer-
term fixed income instruments. As earlier mentioned, a rise in food and oil prices and the
need to contain the increased money supply during the election period, is likely to drive up
the level of inflation in 2011. We anticipate that banking stocks, which are generally more
responsive to inflation and the associated increase in treasury bill and bond interest rates, and
are therefore considered as securities that have traditionally protected against inflation,
should perform well in the short to medium term
While we view a general rise in the equity market for the year, aided by foreign flows to the
equity market in search for higher yields, the impact will not be felt across all listed stocks.
Growth in media should remain slow as competiveness picks up in 2011. Uganda Clays
faces unique business risks related to capacity expansion despite strong performance in the
real estate sector.
The previous slowdown revised valuations downwards reducing the attractiveness of the
public equity market as a viable option for firms seeking to float their shares in the stock ex-
change. With optimism in the recovery and higher PE ratios, its fair to say that the conditions
for public listings (IPOs) have improved and are likely to be more prevalent in the medium to
long term as firms get more acquainted with the pros and cons of listing.
PE (forward) 58.3
Increasing roofing substitutes threaten clay tiles as the
sole roofing material. Roofing tile contribute 50% of the com- PEG: 2.45
pany revenue and yet tiling products from alternative markets
continue to shrink the company’s roofing tile market share. This
was principally as a result of a slow response to demand over
the previous 3-7 years which allowed room for substitutes.
The price history of the company has been largely divorced Currently trading at a premium
from the performance of the company. This was mainly a of UGX 50, the counter should
function of illiquidity and speculative market activity during perform more closely to intrinsic
the 2008 share split and rights issue (Figure 4). From 2004- value going forward. The factors
2008, earnings CAGR was 8.9% against the a price CAGR of below reinforce our opinion as
98% in the same period. In 2009 and 2010 the price closed at they will hold in the medium
UGX 50. A loss was recorded in 2009. The price behavior of the term;
counter far outpaced the underlying performance of the company
during the period 2007-2008.
Massive debt assumption
has almost doubled the financial
Figure 4: Historical Price performance on the UCL counter risk of the company, placing a
strain on profitability;
UGX
300
0
The need to conclude the
investment in Kamonkoli and
the automation of the Kajjansi
plant places more emphasis on
Source: Uganda Securities Exchange (USE)
capital investment in the me-
dium term. This should have a
negative impact on cash flows
Case Scenario
ers of property. 0
2005 2006 2007 2008 2009
The housing market in Uganda had shortage esti- Source: IFC, Uganda Primary Mortgage Market Initiative
(UPMMI)
mated 522,000 in 2003 with the shortage in Kam-
pala alone at 80,000 units according to The 2002 The impressive growth in the value of mortgages has not
translated into wide scale homeownership. This largely
Uganda Population & Housing and Uganda reflects that values of single mortgages are high; a sign
National Household Survey 2002/2003. We of chronic residential shortage. Development has not
estimate that national housing demand currently ensured, reflecting the high cost of construction, which is
stands at 630,592 units and Kampala at 110,936 a stumbling block to demand for modern construction
units. This should grow between present material.
population and urbanization growth rates; 3.2%
and 5.6% respectively. However, in spite of the The expected demand in the formal sector for
strong need to fill the gap, affordability of housing can best be reflected as 200,000 units,
housing units has hampered the response from the which is about half the number of reported
demand end. The key player on the demand side NSSF subscribers. According to the 2002
has traditionally been individual private develop- report, only about 40% are able to afford tiles
ers. as an option for roofing. Our research reveals
the demand for mortgages in the formal sector
almost equals demand in the informal sector,
The growth of the mortgage sector, 30% from which places the demand for modern roofing
2005-2009 year on year, is largely in part in material at 160,000 units.
response to the funding gap (Figure 2.1). Key
players in the sector are Housing Finance Bank
(60%) followed by DFCU Bank and Stanbic There also exists strong competition from syn-
Bank that now provide the various classes of thetic products that are imported. While the
mortgage products. Nonetheless this has failed to company enjoys a monopoly in clay roofing
satisfy the market demand/shortage for tiles, the past inability to meet market demand
homeownership, primarily because of the rela- created the opportunity for alternatives. Over-
tively small number of formally employed work- all, the challenges of reaching the entire market
ers—banks’ principal targets. and strong competition offered from a mix of
alternatives implies a competitive market that
is further weighed down by affordability.
Company Performance and Position EBIT-EBT margin variance has grown from
a conservative average of 1.4% from 2006-
The operating environment for the company still
2008 to 11.95% from 2009-2012e (Figure
posses tremendous challenge at present. Cost of
6).The interest cost represents a 10% erosion
sales grew 46.5% in 2009 particularly as a result
on profitability and constrained the ability of
of depreciation cost. Cost of sales margin should
the company to meet financial obligations.
only decline towards historical levels after 2010.
Weakened coverage ratios from cash flow gen-
In 2009, Kamonkoli made a modest 7% contribu-
erated continue to affect performance.
tion to total revenue, as the factory was only par-
tially operational in the last quarter of 2009
Overall the financial risk of the company
has doubled from the average 1.05 in 2006-
EBITDA margins in 2009 dipped to 25.3%
2008 to an average forecast of 2.57 in 2009-
from 32.2% in 2008. (Figure 5). Operating costs
2012, as measured by the degree of financial
as a proportion of revenue, has nonetheless main-
leverage. As a result of reliance on overdraft
tained a stable average margin of 25%. As a result
facilities to support working capital require-
the company should be in position to recover
ments the financing cost are set to remain high.
EBITDA margin in 2010 to 32% in light of faster
The company has since restructured its debt to
revenue growth and a return to lower cost of
longer term tenure through debt financing from
sales.
its major equity partner, NSSF.
Figure 5: EBITDA margins bottomed out in 2009 and Figure 6: EBIT-EBT margin variance should recover
should revert to historical levels of 32% in 2010 albeit very gradually.
EBITDA % of sales
% of sales
margin 35.0%
90.0% 40.0%
80.0% 30.0%
35.0%
70.0% 25.0%
30.0%
60.0% 20.0%
25.0%
50.0% 15.0%
20.0%
40.0%
15.0% 10.0%
30.0%
10.0% 5.0%
20.0%
10.0% 5.0% 0.0%
2006 2007 2008 2009 2010e 2011e 2012e
0.0% 0.0% -5.0%
2006 2007 2008 2009 2010e 2011e 2012e
-10.0%
Opex Cost Of sales EBITDA EBIT Margin EBT Margin
Source: Company Reports, ReNaissance Research estimates Source: Company Reports, ReNaissance Research estimates
The liquidity position of the company particularly Management of credit sales has been conser-
in 2009 as seen from the average ratio during the vative, a trend we hope will be maintained
period from 2006-08, worsened. going forward.
Figure 7:Working capital ratios
Level of gearing will remain almost unchanged as We have arrived at a target price of UGX
seen above from the Net Current Assets (NCA)/ 14.7 per share based on a 10-11% p.a. sus-
Equity ratio, which will be combination of two tainable growth in free cash flows to eq-
factors; 1) Increasing long term liabilities/debt uity.
which is necessary to reduce pressure from short
term liabilities, 2) Slowly growing the equity of
the company through retained earnings, which Assumptions:
could imply no dividend payments before 2012. The required return on equity of 27.9%
reflects the business risk of the company,
which we noted has doubled. This is particu-
Improvement in working capital management will
larly because of the debt assumed by the
be critical in limiting the short term strain on the
company, to which equity is subordinate;
company. Emphasis should be placed on receiv-
ables turnover that worsened from an average of
8.98 to 7.83 in 2009. Our forecast depicts a grad- Strong performance in revenues and cash
ual improvement. flows will be realized after 2012, a time we
believe that the company can sustainably
Figure 8: Working capital management estimates
perform at that level. The estimated sustain-
able growth of 11% in cash flows can be re-
2006-2008* 2009 2010e 2011e 2012e alized.
Inventory Turnover 3.33 2.58 2.32 2.36 2.45
Receivables Turnover 8.98 7.83 7.87 7.97 8.67
Discounted free cash flows to equity
Payables turnover 2.84 1.65 1.60 1.77 1.80
defined the cash flow valuation basis. This
Source: Company Reports, ReNaissance Research estimates. offers the most conservative valuation of the
* Average company’s equity given the debt position
overall.
Cashflow Summary
CFO 4,518,128 348,082 5,990,417 4,909,305
FCInv 6,560,261 5,113,755 3,994,096 3,583,227
FFCF (416,684) (2,941,376) 4,038,538 3,734,078
FCFE (757,500) (2,432,044) 1,919,249 1,945,184
Ratio Analysis
EBITDA Margin 25.3% 32.1% 31.6% 30.2%
EBIT Margin 9.2% 19.0% 21.0% 22.0%
Net Margin -4.2% 4.5% 6.9% 8.3%
ROE -3.0% 3.8% 6.8% 9.7%
ROA -1.2% 1.5% 2.7% 3.9%
Liquidity Ratio 0.52 0.66 0.83 0.92
NCL/Equity 0.85 1.00 1.05 0.97
NCL/Total Assets 0.35 0.39 0.41 0.39
Source: Company Reports, ReNaissance Research estimates. Figures in ‘000
Looking at the price behavior of the counter Figure 10 , there Key fundamental risks;
seems to be a recovery in the price that remains divorced from
The company invested
required and expected levels of growth both the company and
heavily in multi-media
the industry can sustain. (television, radio and expanded
printing capacity) Growth in
Figure 10: Historical price performance on NVL counter revenues for the media industry
have shrunk particularly as
UGX result of low advertising spend
3000 and fragmented media markets.
2500
This directly affects growth in
the company’s revenues.
2000
1500
1000 High operating costs rela-
tive to revenue generated against
500
a high capital investment, will
0 define the next earnings phase of
the company. Management is
keenly aware of the need to fo-
Period cus on cost rationalization, so as
to improve earnings;
Source: Uganda Securities Exchange (USE)
TV, 22%
Print,
Radio, 67% 11%
In an effort to capture revenue streams across the We agree that the expansion of equity base was
board, the company has made the commitment to a result of the 2008 Rights Issue. Nonetheless
expand in radio and television. These are none- the Du Pont analysis below demonstrates that
theless high capital investment venture that do not the reduction in ROE was more a result of a
translate immediately into profitability. Worse drastic change in profitability and asset effi-
still, radio remains a highly segmented sector, ciency.
with very diverse audiences.
4.50%
5.00% 3 Yr
1.53% 2007 2010 CAGR
0.00%
Cost of Sales 21,494,649.00 35,606,222.00 18%
2006 2007 2008 2009 2010
Distribution Costs 871,253.00 1,157,785.00 10%
Source: Company Reports, ReNaissance Research estimates
Administrative 5,851,996.00 10,077,477.00 20%
Management has noted that cost containment will Relative valuation compare the company
drive the strategic direction of the company while to regional multi-media companies, Nation Me-
at the same time boosting revenue by maintaining dia Group and Standard Group. The ratios
incremental investments in the most productive which in our opinion demonstrate comparable
segments of the media industry such as mass tele- circumstances are; Sales-to-Assets, Enterprise
vision and regional radio stations. Value to Sales, Price to Sales and Enterprise
Value to EBITDA;
Valuation Methodology;
Sales figures are based on FY forecasts for
most recently released HY figures Asset fig-
We have used a combination of discounted opera- ures are based on most current released figures
tions earnings after tax and relative valuation to for either company i.e. Vision Group: Decem-
reach an intrinsic value for the company. ber 2009; NMG and SG : June 2010;
Assumptions;
Reliance on NOPAT (net operating profit We combine a weight of 0.3:0.7 with a
after tax) as a valuation metric is as a result of bias for discounted NOPAT because ROE is a
high prefunded capex expenditure through the crucial metric for the performance measure-
Rights Issue. NOPAT closely reflects the return ment as literally the sole source of capital.
on equity, should the level of debt remain low.
The tax rate is 30%.
Conclusion:
Though we have a minimal discount on the relative valuation, the inclusion of ROE and PE as comparative
ratios shows that the company is trading at significant premium to its intrinsic value. We have excluded these
ratios in the relative valuation as the company grapples with a high cost environment in the value addition drive
to grow the media platform, which differentiates it from industry competition. As mentioned though, we as a
result, bias the valuation weight towards discounted earnings
The combined valuation yields a target price of UGX 292 places a significant premium vis a vis the current
trading price of UGX 550. We recommend SELL at the current level for NVL as the prevailing earnings are
expected to catch up with the company’s large asset base in the medium to the long term.
This leaves tremendous room for the banking sector to absorb Recommendation BUY
credit risk overall. Target Price (UGX) 956
Current Price (UGX) 800
2 Year High 1160
Customer demand deposits define the source of funding for the 2 Year Low 275
Shares in issue (000) 400,000
sector which has generally reduced the cost of funds (that stood Market Cap (UGX 000,000) 176,000
at 3.62% at the end of 2009 compared 3.33% in Kenya). Deposit Float (UGX 000,000) 35,200
gathering and retention will be a major concern for new entrants Float (USD 000) 16,000
and established banks respectively. Overall shrinking interest Float (%) 20
margins and asset issues of lower asset quality should arise from PE (forward) 16.43
the competitive environment.
Risks:
UGX Billions
9,000.00
8,000.00
7,000.00
Quality of credit has
6,000.00 declined in the recent past and
5,000.00 yet if the sector is to grow
4,000.00 strongly it must expand to non-
3,000.00 traditional models of banking;
2,000.00
1,000.00
- Cost of funds is set to rise
FY04 FY05 FY06 FY07 FY08 FY09
as banks seek longer term funds
Deposits Loans and Advances Assets through time deposits or more
expensive demand deposits.
Source: BOU This will impact on profitability;
The case for expansion is further compounded by a largely
unlevered sector (Figure 19), which depends on low cost funds Competition for deposits on
in the form of deposits to fund liabilities. In comparison to the liabilities will undermine equity
Kenyan economy shows that the Ugandan banks still have room bases and ability to lend and
to boost credit as a percentage of assets and at the same time thus future growth
gather deposits so as to reduce cost of funds.
Retail banking has become more competitive. Figure 21: Low penetration indicating that a huge
Banks with large branch networks, wider plat- quantity of economic output is informally financed...
forms and product ranges are likely to be more
profitable. The extension of branches as well as
14% Private Sector Credit/GDP
more efficient operations such as ATM’s and 12.3%
11.5%
internet banking should define the next invest- 12%
0%
2001/2 2002/3 2003/4 2004/5 2005/6 2006/7 2007/8 2008/9
Business banking tailored to the informal and
Source: BOU, ReNaissance Research
SME sectors is also a huge growth area. The
credit profile as at June 2009, depicts a lion share
of total advances to a single sector, trade, which
defines the major economic activity of the SME Figure 22: The deposit base, that is largely short term
sector. At 20.6% of total advances to the private also has room to grow
sector it comes second to personal loans and other
services (Figure 20).
30.0%
25.9%
Deposits/GDP
25.0%
21.9%
While these growth figures and opportunity show
20.0% 17.8%
great promise, the level of penetration in the 15.7% 15.9% 16.4%
Figure 23: Asset share for selected top banks as at 2009 Figure 24: Deposit share for the top banks as at 2009
CERUDEB 7% CERUDEB 8%
Crane 7% Crane 7%
DFCU 7% DFCU 5%
Baroda 5%
Baroda 4%
Figure 25: Loan and Advance share of the top banks as at Figure 26:Wide margins between deposits and lending
2009 rates
25
0% 5% 10% 15% 20% 25% 30%
20
Stanbic 25%
Standard Chartered 15% 15
Barclays 12% 10
CERUDEB 9% 5
Crane 6%
0
Jun-07
Jun-09
Jun-04
Jun-05
Jun-06
Jun-08
Sep-04
Mar-05
Sep-05
Sep-06
Mar-07
Sep-07
Sep-08
Mar-04
Mar-06
Mar-08
Mar-09
Dec-05
Dec-07
Dec-04
Dec-06
Dec-08
DFCU 4%
Baroda 4%
Demand Deposits Time Deposits Lending Rates
The competitive structure further hinders the While the opportunity to expand the sector exists,
level of penetration of the sector. The top three our view is that the traditional banks will be bent
banks controlled 50% of the market as at end of on attracting deposits through increasing customer
2009 (Figure 23-25). They have the largest plat- convenience through services like ATM’s, inter-
forms (branches and ATM’s) to attract and retain net banking and mobile banking
customer deposits.
We anticipate downward pressure on lending rates Another possible and very likely scenario is
as yields, particularly on time deposits, increase, the consistent rise of the risk appetite in the
shrinking net interest margins. The Ugandan sector. In the expansion of retail and SME
banking sector has comparatively higher rates in credit, the sector is likely to face worsening
the region and competition from particularly Ken- performance of loans. The banking sector has
yan and Nigerian banks should be a major factor quite an impressive latitude on risk, an industry
in shrinking net interest margins (Figure 27) capital adequacy
Figure 27: Comparative rate spread (Tier 1 & 2) ratio at 21.05% against a BOU
Uganda Kenya Nigeria requirement of 12%. However the provision
Deposit Rate 2.35 3.59 4.63 for non-performing loans (NPL’s) has shown a
recent upward surge, even among the more es-
Lending Rate 20.14 13.87 15.74
tablished banks
Source: Central Bank Data (respective countries)
2010 was characterized by very low treasury bill Increasing provisions quarter-on quarter in
interest rates. The results of banks with significant 2009 is evidence of generally falling asset
funds in this asset class, which did not respond by quality. The ratio of NPL/Gross loans stood at
increasing loans & advances, are likely to be ad- 4.1% in 2007, then reverted downwards to
versely affected. The 2011 inflation outlook is 2.1% in 2008 before closing 2009 at 4.2%. The
expected to revert to double digit percentages in Kenyan economy in the same period moved
view of the high oil prices, over 17% devaluation from 10.5% to 9.0% and then 7.8% as at end of
of the UGX to the USD and increased liquidity in 2009, according to Central Bank of Kenya
the economy following the election period. Bank data. This has been on the back of credit to
of Uganda is therefore very likely to react by sig- retail and SME sectors. Increasing provisioning
nificantly increasing treasury bill interest rates in will, in the long term, affect the NIM.
order to mop up the excess liquidity and control
inflation and further devaluation of the UGX,
which will now greatly favour banks with signifi- We are however particularly attracted to the
cant exposure to treasury bills. overall conservatism in the sector. Capital ade-
quacy ratios represent a wide margin through
which the banks can and should take on more
In the medium term, the profile of funding re- risk. The change in the asset mix for the sector,
mains very attractive, deposits represent 78% of from risk free government securities to more
the sector liabilities of which demand deposits are risky asset classes (loans) will proceed with
approximately 70%. This placed the cost of de- caution.
posits to an average of 3.62% in 2009 which
compares reasonably with Kenya at 3.3%.
However as interest rate risk rises, other sources
of funds like debt and equity should come into
play
The bank has the largest platform through which to serve and reach customers of different categories.
Stanbic Bank Through ATM’s alone the bank can provide the greatest outreach through card services that greatly reduce
Target Price: UGX 238 operating costs and are a huge growth center for the banking industry;
HOLD
Weakness:
The bank has to move out of traditional and comfortable sectors of asset growth, i.e. government treasuries
and corporate lending. Retail credit and SME lending are fast becoming the mantra of the sector’s expan-
sion yet remain more risky banking areas;
Strengths:
Impressive branch expansion and deposit growth for the bank have been key to the growth of the bank and
establishing its brand in the industry;
Investment in the new IT system should give the bank the opportunity has increased efficiencies across
banking operations and enabled the bank initiate new products and services;
DFCU Bank The bank should continue to achieve an ROE of 26.8% upwards which is higher than industry average of
Target Price: UGX 928 18.9% in 2009. Sustainable growth in earnings should remain an impressive 16% over the short to medium;
HOLD
Weaknesses:
The bank has a high cost of funds at 5.7% against an industry average of 3.6% in 2009. The bank has made
an extensive investment in branches to reach more deposits as confirmed by management;
The bank has no regional footprint, and should have challenges taking advantage of opportunities in cross
border transactions
Strengths:
This has been a largely ignored bank in the equity market despite impressive ROE at 24% upwards and an
impressive sustainable growth in earnings at 17%. This is comparable to its peers is asset size such as
DFCU Bank;
Bank of Baroda There is a move to replicate rural banking models as in India, so as to extend reach and boost customer
Target Price: UGX 965 deposit bases. These are expensive ventures but a step in the right direction for long term growth;
ACCUMULATE
Customer niche among the SME or the Business banking segment. This is mainly characterized by trade
finance (largest private credit center) that the bigger banks are just getting the hung of;
Weaknesses:
Conservativeness of management; Baroda ranked second on capital adequacy in 2009 with a ratio of
32.5%;
High cost of funds at 5.4% implies extensive effort to collect deposits, which will prove costly.
In response to a highly uncertain business environment the his- The fundamental drivers of growth
torical price performance on the counter had long moved down- are;
wards in 2008-2009 (Figure 29) Intense investor aversion to a
non-dividend payment regime, coupled with thin liquidity (only Increased productivity in the
10% free float) was principally the cause. This has only recently leaf processing unit as replace-
reverser in 2010 to a high of UGX 1740. ments of machinery was
achieved in 2009. We are confi-
dent that going forward the com-
Figure 29: Historical Price performance to-date pany should achieve upwards of
20 million Kgs of leaf sales,
which is necessary to maintain
2000 operational profitability;
1800
1600
1400
1200
Stronger relationships with
1000 farmers through farm inputs and
800 guaranteed tobacco market
600 should ensure a consistent sup-
400
200
ply of quality leaf. Management
0 has shown willingness to
30-Dec-07 30-Dec-08 30-Dec-09 30-Dec-10 strengthen these relationships;
Both segments have an equal importance in terms While cigarette distribution has the potential
of revenue contribution to the company (Figure for high growth, particularly among newer
30) . The ratio has averaged 52:48 over the last 5 brands, the company has no control over excise
years in favor of cigarette distribution. Thus reve- duty and yet distributions costs will remain a
nue performance on both fronts is critical for the challenge. This operating cost environment im-
business model to remain sustainable. plies a lower margin segment. The distribution
segments is also challenged by illicit trade that
shrinks market share.
Figure 30: Revenue contribution as a percentage of total
70.0%
In our estimation, leaf exports should be a
57.7%
highly profitable segment though single period
60.0% 55.8% 55.5% 55.9%
47.9%
52.1% effects could imply a loss making period for
50.0%
42.3%
44.2% 44.5% 44.1% the company. Cigarette distribution is a more
40.0% stable operating segment, though on its own,
30.0% the company cannot remain profitable in the
20.0% long term.
10.0%
Net Sales/
PE PBV ROE Div Yield Assets EV/Net Sales P/Net Sales EV/EBITDA
BAT Uganda 10.7 9.90 92.8% 4.0% 0.65 1.09 0.76 5.57
BAT Kenya 13.8 4.37 31.6% 7.2% 1.05 1.99 1.84 8.04
Discount/Premium -22.7% 126.8% -65.9% 79.7% 60.9% -45.3% -58.5% -30.8% 5.5%
Conclusion
Despite operating in a high business risk environment, we are of the opinion that the company offers underly-
ing value over the long term. This is the view we hold in light of the restructuring process that commenced in
2007. Management has delivered on the strategic plans and is set for a more predictable performance going
forward.
However the recent price behavior in the equity market and low liquidity on the counter with a float of just
under 10%, has introduced risk for investors in the company.
Overall we recommend LIGHTEN for BAT Uganda
The short term (12 months) target for the price on the counter
stands at UGX 84, with a blend of target PBV and an average of
PE for comparables in the region. Over the shorter term per-
formance should remain stagnant though material changes in the
overall economy should boost growth for the insurance sector.
The company nonetheless has unique risks that can only be miti-
gated through increased competitiveness. In spite of the
potential upside from the current price, we recommend
ACCUMULATE.
PE Target 84
PBV Target 83
Average 84
IMPORTANT INFORMATION
\While all reasonable care has been taken to ensure the accuracy of the information contained herein, ReNaissance Capital accepts no re-
sponsibility for the inaccuracy nor incompleteness of any information nor for any recommendation or forecasts. ReNaissance Capital shall
not be responsible for any losses incurred on any investments arising from the recommendation , forecast or other information herein con-
tained. The contents of this publication should not be construed as an express or implied promise, guarantee or implication by ReNaissance
Capital or its Directors and Officers that one will profit from the strategies herein, or one’s losses in connection therewith can or will be lim-
ited.
Keith Kalyegira
keithk@renaissance.co.ug
Felix Okoboi
f.okoboi@renaissance.co.ug