Investment Adventures in Emerging Markets

Notes From the Nigerian Frontier

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Many frontier markets continue to stand out as particularly attractive to us right now, as a number of developed and even some established emerging markets have been experiencing a few soft GDP growth trends this year. Frontier markets are considered a subset of emerging markets, often smaller and less-developed. My travels recently took me to one of the largest frontier markets, Nigeria, where my team and I were able to see the changes taking place in the country and talk to company owners and managers about the challenges of doing business there. As we scouted for potential investment opportunities, we found some surprises too.

Nigeria boasts one of the fastest-growing economies in the world, with GDP growth rates above 6% every year since 20031. Home to more than 170 million people, it is the most populous country in Africa and the seventh most populated country in the world. The United Nations has projected its population could rise into the top three by 2050, potentially overtaking the United States2.

Unfortunately, Nigeria also has a tragic history of conflicts and power struggles, being a country that consists of more than 500 different ethnic groups. Since gaining independence in 1960, Nigeria has had eight military governments, numerous civilian-led governments and experienced a 30-month civil war. In April 2011, Goodluck Ebele Jonathan won the elections to become the country’s president. The challenges confronting Jonathan and his party today are many, including much-needed reforms, particularly in the oil and power sectors. Economic problems have magnified the ethnic and religious divisions in the country, as per capita incomes are low and there are still great disparities in income levels.

On the street in Lagos, Nigeria

The Importance of Oil – and Security

Oil exports, of great importance to the economy, have been disrupted a number of times by conflicts in the Niger Delta, where oil supplies have been a target of thieves. An amnesty program has resulted in some reduction in the incidents, but the dangers of instability remain.

Security remains an important issue for businesses in Nigeria, although it doesn’t necessarily mean danger is lurking everywhere in the country. The main security threat is regional, particularly in the northern and Niger Delta areas and mainly from Islamist militants such as the Boko Haram who target security forces, religious sites, telecommunication assets and state infrastructure. With a network of patronage, corruption is also a major problem. The good news is that Nigeria’s leaders are aware of the need to maintain a balance of power between the various regions and are working to improve the situation the best they can.

Part of the problem stems from government subsidies of refined oil products, which have led to a vast business of smuggling subsidized fuel out of the country and selling it at higher market prices. In early 2012, the government halved this subsidy and has stated an intention to remove it entirely in the near future. This should help reduce smuggling problems, in our view. Oil theft in general is a big problem in Nigeria; it has been estimated about 10% of the total oil production is stolen. Production is now running at about 2 million barrels per day (or about 700 million a year)3, which means about 70 million barrels are stolen each year.

Inflation has been another problem for businesses and consumers in Nigeria, although it has been coming down in the past decade. This year, inflation, as measured by the consumer price index, could finish at single-digit levels if near the current pace4. This is a significant improvement from the 1990s, when annual inflation rates exceeded 50%. With inflation dropping, we think Nigeria’s central bank could have more flexibility to lower its benchmark interest rate, as it has been quite high (at 12%) since the end of 2011.

The Investment Landscape

Nigeria possesses plentiful natural resources but at present is held back by a critical lack of infrastructure. Most hotels and businesses require their own gasoline or diesel electric power generators because of the unreliability of the government power system. This situation speaks to the demand in general for more power sources in emerging, and particularly frontier markets. A South Korean company recently made a much-welcomed pledge to invest US$30 billion in Nigeria’s power sector over the next ten years. In May, the World Bank and IFC also announced plans to invest about US$1 billion in the country’s energy sector. Foreign investments such as these in Nigeria’s energy sector could further support its economic growth.

Recent plans by the government to privatize the power industry have opened the door to the possibility of dramatic increases in future foreign investment. This could reduce the burden of subsidies on the government budget and spawn profitable enterprises able to pay taxes. The multibillion dollar plan includes the sale of four thermal plants, two hydropower plants and 11 electric distribution companies. If successful, the shortage of electric power and high cost of alternative electricity supply, which has hindered economic activity, should be alleviated and could result in accelerated growth over the longer term.

While most investors are keenly aware of Nigeria’s oil riches, it is important to note that Nigeria now exports 117 different commodities to 103 countries around the world. Although oil remains the dominant export, there are a number of companies in Nigeria unrelated to the oil sector where we see potential opportunities. Recently, we visited some of them, starting with a large cement company.

The executives of the cement company told us that they planned to increase local production capacity by some 9 million tons per year by 2016. To promote local production, the government gives a tax holiday of three to five years to new plants. Nigeria has plenty of high quality limestone, the main raw material for cement, in addition to relatively cheap gas to run the plants. Domestic demand for cement is growing at about 10% per year with most going to the private sector and relatively little to the public sector, which we see as an indication that infrastructure spending in Nigeria is lacking. However, this trend appears destined to change.

Visiting a Nigerian cement company

One executive at the firm told us that Nigeria was often underestimated. The biggest challenge from his perspective? A lack of effective political will and, in particular, little willingness to promote the domestic agricultural sector, since Nigeria is importing some US$1.2 billion worth of food products yearly. However, he also believed the government was generally constructive and had a good economic advisory team.

We also visited a beer producer. Executives of the firm said that the operating environment has been affected by fuel price increases and higher power prices. In addition, distribution is sometimes a problem given security challenges. However, the real problem contributing to instability was seen as high unemployment and a young and fast-growing population who want jobs. While the definition of “middle class” may not closely mirror that of highly developed countries, there is an expanding class of consumers who have growing amounts of discretionary income to spend, so food and beverage companies are hoping to benefit.

Nigeria’s reformed banking system has provided many foreigners with an attractive means to invest in the fast-growing domestic economy. The banking industry is important, not only because of the rise of microfinance, but because of the move by banks into consumer banking. Until recently, banks were mainly financing large businesses or the government through bond purchases. Following a banking crisis in 2008, the Central Bank of Nigeria (CBN) conducted an audit of the commercial banking sector. All banks that failed the audit had their CEOs replaced. The state-owned Asset Management Corporation (AMCON) was created to purchase non-performing loans and recapitalize the unhealthy banks. A recent review of the country’s banks by the IMF showed a dramatic increase in profits for the industry in 2012, while the capital adequacy ratio was above the minimum requirement of 10% and non-performing loans were below the mandated threshold of 5%5.

Executives at a Nigerian bank that we visited were quite honest about the challenges they face. They felt the market was inherently risky amid political uncertainty, a potentially volatile currency, and state interference and corruption. The good news was that the AMCON clean-up of the banking sector was now complete and bank managements were now working to meet their growth targets and become more profitable. They anticipated growth would come from lending for infrastructure projects, power and agriculture. In addition, the consumer banking market has been expanding fast. Like a number of Nigerian banks, this bank was multinational, with operations outside the country.  

Another company we visited was a leading food-focused conglomerate in Nigeria, with a range of fast food restaurants and branded food products catering to a broad section of the population. The executives echoed the security issues we heard elsewhere, particularly in the north of the country, which affected its distribution and manufacturing. Perhaps even more important from their perspective were the increased import duties and levies on wheat, impacting input costs in food manufacturing and restaurants.

In the oil sector, we visited a firm that has changed its strategy and transformed from being just a core local downstream oil marketing concern to becoming an integrated “energy group” with business lines spanning not just petroleum marketing but also the exploration and production of crude oil, international oil trading, gas and power solutions, and oil services support.

Like all our travels, these visits to Nigerian companies were important for us to see exactly what issues business owners face and how they were dealing with them. We believe the Nigerian economy and body politic should strengthen as the country moves forward with reform efforts, and we think our investment opportunities there will expand. Nigeria represents an intriguing investment destination to us, and not only because of its oil riches. Government efforts in the areas of privatization and investment in industries such as mining, agriculture, finance and manufacturing to diversify its dependence on the oil sector could help the economy in the longer term.

1. Source: The World Bank, GDP Growth (annual %), World Development Indicators.

2. Source: United Nations press release, June 30, 2013. “World populations projected to reach 9.6 billion by 2050 with most growth in developing regions, especially Africa.” 

3. Source: U.S. Energy Information Administration, August 2013.  

4. Source: National Bureau of Statistics, Nigeria, “Statistical News” (No. 520, June 2013)

5. Source: IMF Country Report No. 13/140, “Nigeria: Financial Sector Stability Assessment,” May 2013. Copyright (c) 2013. By International Monetary Fund. All Rights Reserved 

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