A recent report issued by Beltone Financial Holding said the stock market would benefit from the current economic reform programme, with the stock market enjoying a fruitful year with a number of planned private sector initial public offerings (IPOs), in addition to state-owned companies.
“We expect flow in the equity market to help support a positive net portfolio investment flow in FY 2017/18. A strong IPO pipeline and improved earnings—an expected average earnings per share (EPS) growth of 40% for stocks under our coverage—imply more value despite the rally,” the report noted.
According to the report, the macro scene will continue to positively reflect on the market’s performance.
“We expect the presidential election, which marks the key milestone on the political front, to ensure a stable political scene. The presidential ballots will take place on 26-28 March 2018, with the results announcement on 2 April 2018.”
The report added that there will not be a material change to the current economic cabinet, mandated with the International Monetary Fund-backed economic reform programme that ends in FY 2019/20.
“This was confirmed in the recent partial cabinet reshuffle that took place in January 2018 affirming commitment to wide structural reforms, which implies a strong upside to the investor community. A balanced and transparent communications campaign to help generate awareness on the benefits of reforms has ensured broad political and public buying for the programme. This should bode well for equities, especially with rising contribution from locals.”
Rate cuts, better macro visibility, and higher growth offers a strong upside to equities
Beltone said in its report that better visibility on the macro scene with the clear economic reform plan will remain a key elicit for driving investors’ confidence.
“Reform always carries strong upside potential for equities, as proven previously with the FY 2004/05 reform programme. We expect interest rate cuts in the first quarter of (Q1) 2018 to support market performance, particularly since most of the investors have over weighted Egypt on the fixed income side,” the report said.
A stable foreign exchange as well as reserves levels ensure abolished repatriation risks. Meanwhile, ongoing government support will create a competitive investment environment, recovery in private consumption should play a part in driving market growth,” the report added.
The interest rate cuts expected in 2018 will provide a relief for corporates with different magnitude as per their leverage ratios.
“We believe Ezz Steel will be one of the top beneficiaries from a cut in interest rates, being a highly leveraged company with a debt to equity of 4.4% and net debt to equity of 3.5%. Outstanding debt amounts to EGP 21.1bn in September 2017,” Beltone said.
Telecom operators, with their high leverage positions to cover the payment of the 4G spectrum fees in Q4 2016 apart from annual capex charges of EGP 2-3bn for regular network maintenance, should also be among the main gainers from rate cuts, namely Telecom Egypt.
Other than the debt burden, lower interest rates should support sales in the automotive sector, providing a breather to GB Auto passenger car (PC) sales.
“We believe corporates are already pricing in the anticipated increase in energy prices, with the plan well communicated since the onset of the reform programme. We see consumer goods’ companies mostly affected through their distribution and transportation costs, which comprise around 15-20% of operating costs. Discretionary products, such as cars, will likely be impacted as the rise in energy costs affects demand on PC cars in particular,” the report said.
Impact on industrial names will vary. Yet—assuming no changes to natural gas prices—steel, cables, and fertiliser industries will remain in safe territory as they use natural gas as a source of energy. Meanwhile, transportation costs barely comprise a 10% of total costs, which would likely have a trivial impact, in our view.
Improved earnings imply more value despite the rally
The report noted that the Egyptian pound’s floatation played its role in driving the market’s growth in 2017, helping Egypt surpass the majority of its major regional peers. This came despite 2017 being far from all roses, as several risks and challenges were encountered.
“Though market rallied, EGX30 in USD terms are now trading at an average of 61% discount to its 10-year high, suggesting there’s ample room for further growth. This resulted from the widening gap between the EGX30 growth in EGP and USD terms,” the report explained.
According to the report, easing inflation rates will positively reflect on demand prospects, which should accommodate the impact of the squeezed margins for corporates in 2017, translating into better earnings in 2018.
“Already, signs of recovery were seen starting Q3 2017, mainly in the consumer sector. On this backdrop, we expect more room for upgrades in stocks valuations, as anticipated economic recovery is materialising sooner than expected. We expect an average EPS growth of 40% in 2018 for stocks covered in this report. The 42% average upside for the target prices (TP) for our coverage universe implies another year of multi-rallies. We believe 2018 will be the year for attractive bottom-up growth stories,” Beltone said.
Solid IPO pipeline strengthens the value
Meanwhile, the report noted that investment climate reforms advocated rising mergers and acquisitions deals as well as a number of IPOs, a trend that will continue strongly with the government’s planned IPO programme.
“The government aims at offering shares in eight to 10 state-owned companies over the next 18 months, including at least three companies before June 2018. We believe this ambitious plan will provide a strong catalyst for the market; considered big-sized tickets, they will boost market liquidity. So far, there are serious preparations for the listing of Enppi as the first government IPO, followed by Banque du Caire” the report noted.
Moreover, the private sector has a busy solid IPO pipeline capitalising on growing investor confidence and positive sentiment towards Egypt’s story.
“Likewise, we believe merger and acquisition potential will continue to grow significantly through 2019, particularly with the deferral of the capital gain tax until mid-2020. This will provide a significant upside to specific sectors,” the report added.
Egypt is still attractively valued and under-owned
Egypt is attractively valued, trading on a 2018 price-earnings (PE) of 10.1% while offering 17.6% return on equities (ROE), compared to MSCI emerging markets of 12.9% and 11.9% respectively.
It is also under-owned with a market cap-to-GDP of 25%, off from its 2008 peak of 90.7% and compared to an average of 38% for the region.
“We note that the government aims for a 60% market cap-to-GDP in five years. Underpinned foreign buying currently stands at 18% of the market versus 40% historically, confirms our view,” Beltone said.
Meanwhile, the report noted that the upcoming energy price increase would have a minimal impact on volume recovery.
“The expected energy price hike by mid-2018 would contribute to higher transportation costs of the sectors’ corporates, which account for 10% of total cost. However, we believe producers’ cost-passing ability is likely to be undermined by depressed consumer spending power until a wage recovery fully materialises in 2019,” the report added.
Beltone said that the corporates will still favour capitalising on volume recovery. Even those companies directing their sales to international markets will be faced with weakening global demand, namely in the US and eurozone, Egypt’s key export markets.
