Equity prices in emerging markets suppressed last year

Emerging markets equity prices have been suppressed since the beginning of 2022 as investors price in global headwinds including inflation, and the reaction of central banks thereof.

Emerging equity markets saw the worst calendar year since 2008 as they fell by 20% in USD terms during the year 2022.

In the region, the Nairobi All Share Index (NASI) saw a 23% annual decline in 2022, touching its 20-year low in June 2022, while the Uganda All Share Index (USE-ASI) touched its ten-year low in the same month. Both, the NASI and the USE-ASI are down 0.6% and 0.04% since the beginning of the year 2023.

The Tanzania Share Index (TSI) saw a 9.1% positive return during the year 2022, while the index is already 4.1% up since the beginning of the year 2023.

Despite a positive return of the TSI during the period, a combined Price to Earnings (PE) ratio of the eight most traded counters on the DSE is now half that of 2017 and has been consecutively dropping for the last four years, from 10.14x in February 2019 to 6.04x in February 2023.

PE ratio measures the price of a company relative to its earnings. The eight selected stocks include CRDB, NMB, DSE, Twiga Cement, Swissport, NICOL, TOL Gases and TCCIA Investment Co. Ltd.

Price suppression results from a substantial foreign outflow from stock markets in emerging economies as foreign investors shy away from elevated risks in these markets mostly due to central banks raising policy rates to contain inflation.

According to Financial Times, the year 2022 saw the longest foreign outflow streak from emerging markets, in history. Tanzania saw the foreign purchase of equities drop to 49% of the total turnover compared to the historical average above 85%.

Foreign purchase for January 2023 was 14% of the turnover, compared to 78% in January 2022 while foreign sales intensified from 41% to 69% during the same period.

Central banks, globally, began raising interest rates at the beginning of the year 2022, to hammer the inflation that followed Russia’s invasion of Ukraine.

According to Reuters, the U.S Federal Reserve hiked its policy rate by 225bps during the year 2022, while apart from Japan, all other central banks controlling the 10 most traded currencies globally, rose their policy rates by a total of 2,700bps in 54 rate hikes during the year 2022, making this the fastest and biggest scale of monetary policy tightening in the last two decades.

Raising interest rates triggers a series of economic headwinds especially in emerging markets, including sluggish economic growth due to suppressed consumption power, the elevated cost of borrowing especially for emerging economies which already have low debt service coverage ratio, and currency instability from the mass outflow of global investors fetching safer fixed returns in developed economies.

Also, raising interest rates directly affects the discount rate which is an integral part of the equities valuation process. A discount rate (weighted average cost of capital (WACC), almost similar to the internal rate of return (IRR), measures the minimum risk adjusted rate of return accepted by providers of debt and equity. The discount rate accounts for the risk of the respective country, market, and the specific stock being valued.

The most commonly used source of global discount rates, Damodaran Online, reviewed risk premiums upwards as a result of 2022 global developments. For instance, the published country risk premium for Tanzania was reviewed from 5.44% in January 2022 to 9.49% in November.

The same for the equity risk premium which went up from 9.68% to 15.43% during a similar time frame. The upward review does not identify either specific risks or features for Tanzania, but collectively for emerging economies.
The review was identical to a number of countries including Kenya, Uganda, Rwanda, Egypt, Gambia, Costa Rica, Cameroon, and many more, despite the risks and economic environment in these countries being far apart.

The collective upward revision of the discount rate does not reflect Tanzania’s specific development of the business environment and prospects of corporate earnings in Tanzania in the medium term, including the 53% banking sector annual profit growth in 2022.

Banking sector profit has grown almost nine times in the last five years, from TZS 134bln in 2018 to TZS 1.16trn in 2022, while credit growth to the private sector reached a seven-year high in quarter three of 2022. Yet, the two largest banks, controlling about 40% of banking assets, are both trading at below 4.2x PE ratio.

Moreover, the World Bank projects the GDP growth of Tanzania to be twice that of the world in the next two years while Moody’s upgraded its rating for Tanzania from ‘Stable’ to ‘Positive’.

Tanzania has well-diversified sources of foreign inflows while the Tanzanian Shilling has barely depreciated by an annual average of 0.3% over the last four years. The country has the lowest inflation in the region and one of the lowest in the world, thanks to favourable climatic conditions for agriculture, and food sufficiency within the country.

With these developments, evident in the 2022 growth of corporate earnings, Tanzanian listed equities are low hanging fruits for an investor with a keen eye. Foreign investors are bound to return chasing higher returns in emerging markets after the global economy settles. U.S. inflation has been falling for seven straight months up to January 2023, while most central banks indicate a slower tightening pace.

The return of net foreign inflows shall most likely result in a climb of indices and PE ratios. The silver lining for local investors is the opportunity to invest now when markets are undervalued since the discount rate and pricing of equities are highly influenced by emerging markets’ collective risks rather than specific features of the Tanzanian economy.

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