Why Citi is calling this East African country its most attractive frontier market


By Andrew Howell and Vineet K Kheria from Citi

Egypt, Kenya and Romania come out as most attractive Frontier Markets (FM), while Kazakhstan, Vietnam and Morocco come out least attractive. Here is what the model says about the top 3:

 Egypt leads the pack thanks to a host of supportive signals, including valuations (PE and dividend yield are low both in absolute terms and relative to the market’s history), decent earnings momentum (2019 EPS have been raised 9.3% over the past 6 months, defying the FM trend of downgrades), above-average economic growth (5.4% for 2019) and monetary factors(low real rates), only slightly offset by weak price momentum (the market has underperformed over the past 3 months).

 Kenya also looks very cheap, especially relative to its history, while other factors are mostly in line with the rest of FM. Offsetting this are weak recent price momentum and a tightening in the interbank rate in recent months.

 For the second consecutive year, Romania also makes the top 3, ranking well on valuations, earnings momentum and real interest rates,offset by macro factors (rising fiscal deficit) and very weak price momentum following the market’s December correction.

As far as the bottom 3 markets go:

1. Morocco fares worst, with stretched valuations, weak earnings momentum and imbalances (CA deficit) only slightly offset by low real rates and the recent outperformance from this traditionally defensive equity market.

2. Vietnam also ranks poorly, an outcome that is likely to be controversial among the many frontier investors who see this as a top pick for 2019. However, despite Vietnam’s strong GDP growth profile and reason able earnings momentum, its high valuations (both in absolute terms and relative to history) and weak price momentum knock it back.

3. Finally, Kazakhstan, an outperformer in 2018, ranks 3rd worst, primarily on valuations.

The most notable changes to rankings over the past year were:

 Improvement: Egypt (from 10th to 1st), Argentina (from 12th to 4th) and Bangladesh (8th to 5th)

 Deterioration: Sri Lanka (from 1st to 9th), Vietnam (7th to 11th) and Kuwait (4th to 8th) How the model works The ranking scores are calculated using normalized values of the following factors. The weight given to each is shown in parenthesis:

1. Macro growth (15%). We consider 1) Citi’s 2019 GDP growth forecast; 2) the increase in forecast 2019-20 growth over 2018 growth, and 3)the 6m trend in the 2019 consensus growth forecast.

2. Macro imbalances (10%). We consider: 1) the 2019 Citi forecast for the current account balance, both in absolute terms, relative to2018 and the absolute trend; 2) the 2019 Citi forecast for the fiscal balance,both in absolute terms and relative to 2018; and 3) the current level of international reserves as well as the YTD trend.

3. Monetary factors (10%). We consider: 1) the current level of the real interest rate (versus 12m CPI inflation); and 2) the 6 month trend in the interest rate. The usefulness of this measure is limited by the arbitrary nature of the 6m time horizon as well as the backwards-looking inflation metric.

4. Valuations (30%). Here we consider 1) 12m forward consensus PE, both of the overall market and of the financial sector only; 2)trailing PB; and 3) trailing dividend yield, all in absolute terms and relative to history.

5. Earnings momentum (20%). We consider 1) consensus earnings growth (2019-20 average); and 2) the 6m change in 12m forward earnings.

6. Price momentum (15%). Our simplest measure: the 3m performance of the MSCI $ index.

See Figure 43 through Figure 48 for the market rankings by each of the 6 factors.

How the model did in the past Overall, our ranking model was a good guide to performance in 2018, thanks largely to the poor performance of bottom-ranked Argentina. However the other two worst ranked markets, Morocco and Egypt, did not perform particularly poorly. All of the model’s top 3 picks for 2018 (Sri Lanka, Romania and Kenya) outperformed the index, though none did well in absolute terms (Romania would have, were it not for the December news flow on potential banking tax increases, negatively impacting the market’s largest stock); 2018’s top performer, Kuwait had been ranked 4th. 

One average, the top 3-ranked markets outperformed the bottom 3 by 20% in 2018, a similar relative performance to that which occurred in 2017. This follows a poor showing by the model in 2016, during which top-ranked Nigeria was a particularly weak performer.

Top picks on the frontier for 2019

Country picks As noted, our ranking model favors Egypt,Kenya and Romania. These are all markets where we see the potential for decent gains in 2019:

 Egypt. The Sisi government is pushing ahead with an ambitious package of reforms, and while the country’s 2016 IMF programme has faced some delays, the programme is likely to underpin macroeconomic stability,supported by growth in gas production and tourism. Despite the recent surge in inflation, we expect currency stability and see decent upside among financials(CIB), construction (Orascom), real estate and consumer staples (Edita,Juhayna). 

 Kenya. The Kenyan economy is on an upswing as rising business confidence, higher agricultural sector growth and rising tourist arrivals mean the official forecasts of real GDP growth of 6%+ in the coming year now look credible. Despite this, after a strong 2017, the Kenyan equity market slumped lower last year, as previous high flyer Safaricom came underpressure along with other benchmark heavyweights, amid low trading volumes. The strength of the Kenyan shilling seems to be deterring international investors;however robust FX reserves and strong capital flows into Kenya suggest to us that there is no imminent threat of a devaluation. We see 2019 as a reasonably good backdrop and are Buyers of both KCB and EABL. 

 Romania. Following a GDP growth surge of nearly 7% in 2016, Romania’s economy has been decelerating, and should grow at a more modest 3.7% in 2019. So far, a hard landing has been avoided, but a pick-up in inflation and widening twin deficits highlight the potential for macro volatility in the coming year. The equity market did well for much of 2018 but was hit hard by the news of a possible tax on banking assets in 2019; however the proposal could still be watered down, and we see the potential for a further recovery from the strong December sell-off.

Other country views:

 We concur with out Latin America strategy team who upgraded Argentina to overweight last November. While significant economic and political uncertainty remain, their analysis highlights the wisdom of investing alongside large IMF stand-by agreements, and expects performance to be driven by a strong EPS recovery. The impact of the upcoming reclassification to EMalso cannot be overlooked.

 As tempting as it is to buy back hard-hit Pakistan, one of EM’s worst-performing markets of the past couple of years, we expect a slew of ongoing challenges in 2019, including worsening relations with the west,slowing economic activity, declining FX reserves and the urgent need for an economic stabilization package, which the Imran Khan government has not yet achieved. On the positive side, the exchange rate no longer looks overvalued following a series of devaluations by the State Bank of Pakistan, and for the most part the CPEC infrastructure programs remain in place to anchor the economy. Overall, we see Pakistan as a trading market in 2019 and would be underweight.

 Nigeria is another market that struggled last year, but where the pre-conditions for a strong rebound in 2019 are lacking, in our view.While we expect a continued economic recovery this year, it should remain tepid, at just 2.4%, even as inflation remains in double digits. The higher oil price earlier in 2018 and improvement of production in the Niger Delta helped ease foreign exchange shortages, but they also have allowed the Buhari administration to delay the introduction of a more unified and coherent exchange rate policy. More recently, the sharp relapse in oil prices suggests that the functioning of the FX market could again come under pressure as reserves fall again. Presidential elections next month could bring needed policy change,particularly if opposition candidate Atiku Abubakar prevails. Valuations on the equity market looks cheap — particularly the banks — but could well remain that way without the implementation of a more coherent policy and investment framework.Underweight.

 Kuwait looks like a neutral to us. On one hand, this market’s attractiveness has declined somewhat as the market has outperformed and re-rated, while lower oil prices could present a mild headwind. On the other hand, the market could continue to be underpinned by MSCI, with an announcement on Kuwait joining EM scheduled for June. We continue to see modest upside in NBK, but struggle to see the potential for major gains aside from smaller individual stories such as Humansoft.

 The weak ranking of Vietnam in our model goes against the bullish view from many respondents to our survey. While we do not deny that Vietnam is arguably FM’s highest quality market, and a strong contender to be moved to EM within the next few years, we do see valuations as continuing to be a constraint, particularly given the potential for the economy to be affected by US-China trade tensions and a broader economic slowdown taking place in parts of Asia. Neutral.

 Among other markets, Bangladesh looks oversold, while Sri Lanka does not. Stocks in Georgia look attractive, given solid underlying economic performance.


Please enter your comment!
Please enter your name here