Originally published in Huffington Post, South Africa here
Did you know Kenyan and Tanzanian companies delivered one of the better profit margins in recent years, from a sample of large companies of 27 prominent emerging/frontier markets? We are focusing on Kenya and Tanzania because their listed data is covered by Bloomberg.
Or did you know IMF expects East Africa to see one of the highest economic growth rates — at around 9 percent compounded annual growth rate (CAGR) till 2021 — from a sample of developing market regions like BRICS, Next-11, MINT, ASEAN, etc.?
But this performance data also reveals two key challenges that are constraining the scale of investor interest in these markets versus their Asian peers. If Kenya and Tanzania want their economic story to translate into a corporate story (and an investor story), it has to reverse these two challenges.
1. Profits are too concentrated
The contribution of the largest three sectors to their profit pool was around 100 percent in each country, rendering other sectors inconsequential. They were finance, telecoms and utilities in Kenya, and finance and staples in Tanzania. Asian peers are far less concentrated. Developed markets had concentration averaging 60-70 percent.
Interestingly, telecoms and utilities in Kenya saw maximum profit growth from 2012-2016 only from Safaricom, K-Electric and K-Power, so there is concentration even at a company level. But profit growth was spread across several winners in finance (KCB, Co-op Bank, Centum, Diamond Trust, Equity Group, Stanbic, SCB, etc.). In the other sectors, only Portland Cement saw healthy profit growth. Company-level concentration was acuter in Tanzania, with only TZ Breweries, MF Bank and CRDB Bank seeing healthy profit growth.
There is a need to grow profitable companies across sectors, so that any risk to its large sectors (and companies) does not derail market performance. Kenya’s gross investment rate grew at a 10 percent CAGR for the five years till 2016, while Tanzania’s lagged at 1 percent.
IMF expects these to be 6 percent and 9 percent respectively till 2021. This would boost the share of their industry from current 17 percent and 28 percent, respectively. Moreover, it augurs well for demand for material and industrial companies. If Kenya can push its investment growth closer to GDP growth, it can add more to demand in these sectors. Furthering the expected investment rate from around 20-25 percent to around 35 percent would add a bonus.
GDP in both Kenya and Tanzania, less than the sample average of around 55-60 percent. The two countries already spend a high portion of their per-capita on private consumption, a common problem across developing countries with a similar per-capita (like Nepal, Cambodia and Bangladesh). Pushing the spending habit even further may be detrimental for savings in the long term.
As it is, their savings rate (~14 percent and ~24 percent respectively) is far less than the ~30 percent average. Diverting income from consumption to savings would not only help fund investment but also reduce over-dependence on foreign debt. Also, the good performers who are unlisted need to be listed, to reduce the gap between the real and listed economy.
2. Size has to translate into profit:
Kenya and Tanzania were amongst the smaller markets in our sample of 27, if one looks at the average profit of their large companies. In comparison to the average profit size of a Kenyan company, a Chinese company was 71 times larger, India 11 times, Indonesia 4 times, and Philippines 3 times. The average Kenyan company was 4 times larger than its Tanzanian counterpart.
The good news is that the average Kenyan company has similar average profit as Egypt or Kuwait, while Tanzania is similar to Bangladesh or Nigeria, despite the East African countries having far less GDP than these peers. So are its companies investing to scale up?
The combined equity of Kenyan companies has grown more than their profits over the past five years, indicating fresh equity has been added. The same holds true for Tanzania. At the same time, their leverage also rose, although it still remains below the sample average. But while this investment is positive, the operating leverage from these incremental assets has to kick in.
That inflow of future profitability would support the recent trend in the companies’ margins and add consistency and breadth to the profit performance of the markets. Kenya and Tanzania did not rank well in terms of their proportion of companies that delivered 10 percent+ return of earnings (ROE) in each of the five years till 2016. If the incremental size being invested now translates into incremental profits, it would help reverse this metric over the long term.
So while the world appreciates East Africa’s growth momentum, they have to reverse these two challenges so that they can evince the scale of investor interest that high-growth markets like them deserve.
* All corporate financial data sourced from Bloomberg terminal