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CardinalStone Research: Rising liquidity levels could drive more flows into equities

Equities market may be set for a first gain in three years in 2020

Monthly data spanning January 2014 to January 2020 suggests thatcn  Nigeria’s equity market had a 73.4percent correlation (R square of 53.9percent) with global crude oil price.

The market is also impacted by flow of capital, policy changes, corporate restructurings and the pace of liquidity build up, in our view. Aided by improved oil price outlook, we believe changes in the last three drivers could lead the All Share Index (ASI) to a second positive return in six years in 2020.

Notably, the U.S. Energy Information Administration expects global Brent price to slightly improve to $64.83 per barrel in 2020 (versus $64.36 in 2019) on expected increase in refinery runs and slight improvement in oil demand outlook.

The mild improvement in oil price expectation is, however, unlikely to persuade foreign providers of capital to significantly come into Nigerian equities in 2020; year-to-date (YTD) net foreign portfolio outflow stood at N84.5 billion as at November 2019).

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However, domestic investors are more likely to take advantage of equity opportunities due to the second order effect of the exclusion of domestic non-bank institutions and individuals from OMO activities. Specifically, the policy tweak could continue to result in the re-allocation of some maturing OMO bills to other investment options such as equities, as real yield on fixed income investments become increasingly negative. Thus, although the fundamentals may not be compelling enough to attract foreign portfolio investors (FPIs), a bourgeoning system liquidity could provide support for equities in the coming year.

There could be selected opportunities in some equity names

We believe 2020 could be characterized by major transactions such as acquisitions, recapitalization, and potential listings. We also see legroom for significant balance sheet optimisation and policy-induced uplifts from cost reflective tariff and stricter border enforcements.

On acquisitions, Seplat may have set the tone with the completion of the acquisition of Eland Oil & Gas Plc (Eland), via cash and new borrowings, in December 2019, with Transcorp also expected to finalise the acquisition of Afam in H1’20. In addition to these, 2020 is also likely to be characterised by business consolidation in the insurance industry as companies race to meet the December 31, 2020 recapitalisation deadline.

The new CBN policy restricting domestic non-bank institutions and individuals from participating in OMO market activities is also likely to cascade to some redirection of liquidity to some of these names. Considering expected weighty maturities and the negative real yield environment in the money market (and some bond tenors), investors may seek out opportunities in alternative asset classes, including equities. This view is supported by the inability of the shallow treasury bills market (N2.7 trillion outstanding as at H1’19, according to Debt Management Office) to absorb the impending liquidity injections.

Indeed, the. We highlight that a conservative increase in allocation to equities of 100 – 150bps by PFAs could amount to circa N84.6 billion – N126.9 billion flows, which represents a potential 2percent to 2.9percent of the free float market capitalization of stocks in the Pension Index (or circa 1.1percent to 1.7percent of the free float market capitalization of the entire market).

Although our assumed allocation increases constitute only small fractions of free float market capitalisation, a concentration of demand activities in a few counters may drive rallies in select names.

In line with the largely cautious stance of Nigeria’s PFAs, our recent engagements reveal that a few of them have been placing funds in money markets (that is fixed deposits) in the hope that the apex bank would reverse the OMO ban rather than go into equities. We believe that this tactic may break if the CBN fails to upturn its decision, while banks reprice interest rates on deposits lower as liquidity builds up.

Elsewhere, the apex bank and the FG look likely achieve reduced interest expense pressure and lower cost of borrowing with this OMO policy. In addition, given that it is also an anomaly for nonbank institutions to participate in OMO transactions, the CBN is likely to retain its new policy in the near term and liquidity build up could have some positive pass-through to select equity names in coming months.

 

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