AFRICA: Africa Offers Promising Opportunities to Local Companies
Recent Western Cape Business News
Many South African companies have expanded into Africa and are thriving in diverse sectors. Doing business in Africa provides unique challenges and many opportunities. However, it also requires a different set of skills, deep understanding of the local culture, tenacity, and creativity to adapt to local conditions. This comes from experience and local knowledge, says Ganesh Shenoy, Citadel Investment Analyst.
ECONOMIC GROWTH RATES IN AFRICA
With fewer conflicts and higher expected economic growth rates, the lure of favourable prospects in Africa has attracted capital from international and local investors.
Other factors that strengthen the investment case for Africa include the following:
The middle class (people earning between US$10 and US$50 a day) is expected to grow to 1.1 billion in 2016, which accounts for 46% of Africa’s population. As the middle class grows, so does each individual’s disposable income. This results in higher demand for durable and non- durable goods. Companies across this spectrum, including retail, telecommunications, media and healthcare are well positioned to benefit from this.
Literacy levels are improving, which provides access to jobs in semi-skilled and skilled professions that are mainly urban based. As workers move to cities to find work, the demand for housing and urban infrastructure like schools, hospitals and shopping malls increases.
A historic lack of investment in supply chain activities like procurement, distribution and warehousing, provides opportunities for logistics companies to transport finished goods and raw materials from factories and ports to warehouses and retail centres.
LOCAL COMPANIES EXPANDING INTO AFRICA
The forecast for South Africa’s economic growth is lethargic compared to its peers. Reasons for this include:
Under-investment in power and logistics infrastructure,
Poor worker productivity and unstable labour, and
A constrained consumer environment.
Companies that earn their revenue from local sources are forced to explore outside of South Africa if they want to grow. Because of the wide range of opportunities available in the rest of Africa, many local companies have expanded into Africa. However, at the same time they have found the social, economic, legal and political frameworks a challenge.
Citadel spends time and effort to understand company management and how they invest. They explore qualitative and quantitative issues and ask prudent questions.
Following this process is crucial to and just as relevant for exploring opportunities in Africa:
Does the profit on the invested capital exceed the risk-adjusted cost of capital? How conservative is management when they make decisions on levels of sustainable revenues, cost synergies and operating margins?
Is the excess return sustainable? What barriers to entry do management use to protect these excess returns? Our philosophy is based on the principle that excess returns attract new competition, which erodes this excess over time. As a result, high operating margins and returns on invested capital will revert to the long-term mean.
How does the investment benefit other businesses in the company’s portfolio? Acquisitions should preferably be in a similar line of business. If not, then we prefer to follow an alternative strategy of returning cash to shareholders rather than to diversify.
What is the level of risk associated with each investment opportunity? How sensitive is the business to political and regulatory changes and how is this included in the cost of capital? What are the exit strategies?
What price is management paying for these assets? How did they arrive at this price? Are the multiples low and is management conservative in their estimates of revenue and cost synergies? Is it a cash or share offer?
INVESTMENT OPPORTUNITIES BEYOND SOUTH AFRICA’S BORDERS
Years of under investment in Africa has created many opportunities across all sectors. The high excess returns achievable in the short term will attract local and international competition.
There are, however, certain factors that managements of companies must consider to ensure they have a happy ending to their investment story:
The increase in competition will drive down returns in the long term to a normalised level, which is the key level of returns that management must consider.
They must exercise price discipline and be prudent when investing in growth stories and chasing high returns.
They must conduct a comprehensive due diligence to identify risks and risk mitigation procedures before they invest.
If these principles are taken into account and the most prominent barriers to investing in Africa are overcome, South African companies can benefit from expanding into the rest of the Africa.
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