I spent the last week of December in Lagos visiting our Nigerian bank holdings. As ever when traveling in this port city, one is frustrated by the slow pace of change; it is, however, ongoing and continuous. I have been traveling to Lagos for the better part of a decade now, and if one looks back, the pace of change is less frustrating and more impressive. Traffic continues to improve, with the Lekki toll road and Lekki-Ikoyi Bridge functioning and Lagos state governor Babatunde Fashola’s removal of commercial motorcyclists, popularly known as okada riders, from the road.
The economy is projected to grow by 6.5 percent over the next 12 months and could surprise to the upside. With an election in early 2015, the economy is likely to be boosted by government spending ahead of the voting. There is even talk that oil production has returned to 2.2 million barrels per day, having bottomed out at 1.9 million bpd six months ago. This growth is tangible in Lagos, with numerous real estate developments under way. Nigeria has always managed to push through significant reforms at difficult times.
The banks are in a much better position than they were a year ago, with systemic risks having subsided as a result of intervention by the Central Bank of Nigeria. Some banks are likely to experience an earnings drag, as the central bank absorbs significant liquidity during the next 12 months. The banking sector experienced a tough operating environment in 2013 because of a number of regulatory headwinds.
The Nigerian banking market is, we at Investec believe, an ideal stock-picking market, with some of the banks having balance sheets that are much better positioned than others for further regulatory changes likely in 2014. The banks are diverse in terms of strategy, capital strength and balance-sheet structure. We expect diverse performance across the sector as well. Ten years ago the Nigerian banking sector comprised 89 banks; that number presently stands at 21. We see further consolidation and have invested in banks that we believe will be long-term winners in this process. The diverse strategies range from banks that have made acquisitions (and are now in the process of restructuring to drive efficiencies) to banks that are experiencing organic growth, capitalizing on new areas of the Nigerian economy and, increasingly, more pan-African regional expansion. Banks are still cautious on consumer credit but are open to offering mobile, Internet and other non-branch-based banking.
We are not complacent and are wary of the risks of investing in Nigeria: politics ahead of an election year, the security situation in the north, a changing of the guard at the central bank and a potential devaluation of the naira. The banks are seeing new growth opportunities, however, one of which is in the power sector. A year ago the banks were very cautious with regard to lending to the industry, but this stance has since changed. Loan growth of around 20 percent is projected for Nigerian banks over the next 12 months, meaning that growth in the power industry has spillover effects for the country’s economy has a whole.
The doubling of power generation capacity in Nigeria, from roughly 3,000 megawatts to 6,000 MW, over the next three years is the most exciting development in the country in the past decade. Fifteen generation and distribution companies have recently been privatized, which will have a significant effect in reducing the cost of doing business in Nigeria as well as the operating expenditures of most of the Nigerian companies in our portfolio. For example, every bank branch runs on a diesel generator at roughly four times the cost of electricity from the grid. The banks are also actively lending to both generation and distribution companies and have become increasingly comfortable with the risks. The World Bank offers a partial guarantee payment to generation companies. Also helping reduce lending risks to the power sector are an offtake company and a specialized tariff structure.
We maintain our view that tier-1 capital banks are best placed to capitalize on this key sector, given the size of their balance sheets and their ability to take on large-scale deals without hitting for single obligors. Banks with tier-2 levels of capital, in our view, would be more likely to participate in syndicated loans. Conservative estimates of private investment in the power sector over the next three years are set at $10 billion. This new area of potential loan growth for the banking sector could further boost growth in gross domestic product by a couple of percentage points. In addition, there are a number of greenfield power plants planned for the coming decade. Challenges for these new power plants remain, such as the sourcing of long-term gas contracts; these hurdles, however, are being worked on. We see more lights being switched on in Nigeria over the next decade.
Joseph Rohm is a portfolio manager of the Africa fund at Investec Asset Management’s Cape Town office.
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