Executive Summary

• Fixed Income: Yields on government securities continued on a downward trend for the third week. Credit rating agency Moody?s has maintained a stable outlook for Kenya citing strong economic growth prospects;
• Equities: The market was on an upward trend during the week with NASI, NSE 20 and NSE 25 gaining by 0.1% and 1.2% and 0.5% respectively. The Central Bank of Kenya has requested parliament to delay approval of the amendment bill that proposed to put a cap on lending rates at 5% above the Central Bank Rate;
• Private Equity: Kenya continues to attract global private equity players, particularly in Private Equity, Real Estate and Infrastructure developments. Finland-based NASDAQ OMX listed Taaleri Private Equity Funds increased by Kshs. 400 million (to Kshs. 2.5 billion from Kshs. 2.1 billion) its commitment to finance additional real estate projects in Kenya;
• Real Estate: Developers start focusing on redevelopment of old estates in Nairobi to maximise development potential and due to their strategic location near the CBD. Increased urbanization and growing middle class spur retail developments in Kenya;
• Focus of the Week: Cytonn Entrepreneurship Forum, a quarterly forum on entrepreneurship, will be held on February 25^th 2016 starting 6.30 PM at The Stanley. The forum, which is already full booked, will focus on what it takes to start and grow a business. For more details, please visit Cytonn Entrepreneurship Forum for details.

Company Updates

• Cytonn Investments and Finland-based NASDAQ OMX listed Taaleri Private Equity Funds are to increase by Kshs. 400 million, to a total of Kshs. 2.5 billion from Kshs. 2.1 bn, their commitment to finance additional real estate projects in Kenya. ?We are glad that in Taaleri, we do not only have a financier but also a partner who is walking the journey with us as we continue to create wealth for our clients, build safe neighbourhoods for families and create employment opportunities for Kenyans,? said Cytonn?s Chief Investments Officer Elizabeth Nkukuu. Read more here: Taaleri to increase funding commitment to Cytonn Investments
• This coming week, we will be hosting the Cytonn Entrepreneurship Forum on the 25^th of February at the Sarova Stanley. The complimentary event is sold out, to attend future events, send an email to entrepreneurs@cytonn.com. Find more details on this link: Cytonn Entrepreneurship Forum
• Our Senior Investment Analyst, Duncan Lumwamu discussed the Kenyan Treasury plans to amend income tax act to target more income taxpayers. See link on CNBC Africa: Duncan on CNBC Africa
• We continue to beef up the team with other ongoing hires

Fixed Income

Yields on treasury bills declined for the third straight week, with the 91-day, 182-day, and 364-day T-Bills down to 9.9%, 12.5% and 13.4%, respectively, compared to 10.8%, 13.3% and 13.6%, respectively, last week due to continued high liquidity in the money markets as a result of maturity of government securities of Kshs. 12.1 bn and reverse repos of Kshs 9.4 bn during the week. The subscription rate increased to 312.2% compared to 281.9% last week with investor preference still on the 182-day paper, which had a subscription rate of 468.5%, with investor expectation of a potential rate increase in the second half of the year. 

Liquidity in the money market remained high as evidenced by the interbank rate remaining low at 4.7% at the close of the week as compared to 5.2% at the close of last week. Despite the improved liquidity the shilling remained stable against the dollar closing the week at an average of 101.8 due to thin volumes and subdued activity in the dollar demand market from corporates and NGOs. The shilling is expected to be stable in the short-term due to (i) a stable dollar in the global markets, with the expectations that the Fed will slow down the rate of raising the Fed rate, and (ii) Central Bank activity to support the shilling, backed by reserves of import cover at 4.5 months, and the extension of the USD 688 mn IMF facility till March 2016.

For the month of February, the government is reopening 5 and 10-year bonds (FXD1/2015/5 and FXD1/2012/10) with a tenor of 4.4 and 6.3 years, respectively, to raise a total of Kshs. 25 bn for budgetary support. Currently, these bonds are trading at yields of 14.5% and 14.9%, respectively. Based on the current trends in yields and the historical premiums that investors usually demand for similar bonds, we expect investors to bid in the ranges of 14.5%-15.0% and 15.0%-15.5% for the 5 and 10-year bonds, respectively.

Credit rating agency Moody?s maintained a stable economic outlook for Kenya, B1, in its latest sovereign rating update. This was based on the back of:

• Strong and stable economic growth prospects: This is based on expectations that (i) Kenya?s growth will remain solid supported by infrastructure spending, growth of services sector and improvement of trade balances, and (ii) the narrowing of the current account deficit to 6.7% from 9.5%, and,
• Fiscal discipline adopted by the Government to control interest rates: The Treasury in its supplementary budget plans to cut domestic borrowing by Kshs 53.3 bn from the earlier Kshs 219 bn and for the next financial year the budget deficit will drop to 6.9%. This will greatly ease the Government?s borrowing pressure as well as grow the private sector through easier access to credit, thus stimulating economic growth.

We believe the stable outlook for Kenya is advantageous for the country as it improves investor confidence and sentiments towards the country.

The government is ahead of schedule with its borrowing programme, having borrowed Kshs. 162.6 billion for the current fiscal year compared to a target of about Kshs. 141.5 billion (assuming a pro-rated borrowing throughout the financial year of Kshs. 219 billion budgeted for the full financial year). Interest rates have dropped during the week due to (i) reduced pressure on government borrowing; and (ii) high liquidity in the market. With Interest rates coming down we advise investors to lock in their funds in short to medium-term paper, as the rates are higher on a risk-adjusted basis.

Equities

During the week, the market was on an upward trend with NASI, NSE 20 and NSE 25 gaining by 0.1%, 1.2% and 0.5% respectively. This was on the back of gains in EABL, Safaricom and BAT that rose 0.4%, 0.3% and 0.3%, respectively. Safaricom and KCB were the top movers accounting for 42.4% of the trades during the week. On a YTD basis, the three indices are down 3.4%, 5.1%, and 2.8%, respectively, and from the February 2015 peak to date, NASI and NSE 20 are down 20.7% and 30.3%, respectively.

Equities turnover fell by 32% during the week to Kshs 1.9 bn from Kshs 2.8 bn the previous week. Foreign investors were net sellers for the second straight week with their participation rising to 69.6% from 66.8% last week.

The market is currently trading at a price to earnings (PE) ratio of 12.4x versus a historical average of 13.8x, and with a dividend yield of 4.2% versus a historical average of 3.3%. The charts below indicate the historical PE and dividend yields of the market.

The Central Bank of Kenya (CBK) has asked Parliament to give it time to compel banks to lower their interest rates instead of imposing caps on lending rates through the Central Bank of Kenya (Amendment) Bill 2015. The parliament had proposed to cap interest rates at 5% above the Central Bank Rate (CBR), which is currently at 11.5%. The CBK argued that the law, if passed, will encourage an informal system where banks will abandon risky loans thereby denying SMEs crucial funds to spur economic growth. In a bid to increase market transparency, the CBK recently published the lending rates of each commercial bank: Central Bank publication of average lending rates with the averages as shown;
 

The average lending rate as at Dec 2015 stood at 18.2%, which is 6.7% above the CBR. Should parliament adopt the proposal all interest rates will be capped at 16.5%, greatly reducing the net interest margins earned by commercial banks, assuming that deposit rates shall remain unchanged. Standard Chartered Bank had the highest increase in the lending rate over the 6 months but its rate still remains lower than that of I&M Bank and Equity Bank. Barclays is the only listed lender to have reduced its lending rate during the six months, mainly because of the average decline in business loans by 3.8% as the bank increasingly shifts from corporate business to target the growing SME sector.

Our view is that the increased transparency and reporting initiative by CBK is positive for the financial sector; as it will make information more available to the consumer and transparency improves market efficiency and pricing. However, we concur with CBK?s view that legislating rates will be bad for the economy. There are borrowers whose riskiness can only warrant loaning them at high rates, say 20%. The high rate compensates for their riskiness. Making it illegal not to give such a loan would reduce the amount of borrowing in the market, deny access to loans to the risky borrowers, which in turn can lead to a lot of businesses and individuals not getting access to funding to grow their businesses.

Barclays Bank of Kenya plans to start agency banking in March, which will make it the first international lender to embrace the model. This signals plans by the bank, which is largely viewed as a corporate lender to move into the retail market that is currently dominated by Equity Bank. Banks have taken up the model to boost efficiency resulting from savings associated with fixed costs of opening and maintaining a new branch. As at September last year, 17 commercial banks had contracted 39,871 agents who conducted over 193.4 mn transactions that were valued at Kshs 1 tn. With the increase in transactions processed by agents expected to continue, we view this as a positive move for the bank as it seeks to tap into the retail market. The agency-banking model, pioneered by Equity Bank, has changed the banking sector landscape and banks like Barclays have no option but to follow to get deposit growth.

Kenya Airways has signed up an American advisory firm PJT Partners to restructure its balance sheet and help it seek approximately Kshs 60 bn in long-term capital in the next six to nine months. The airline?s long and short term loans grew to Kshs 105 bn and Kshs 52 bn, respectively for the six months to September as it posted a net loss of Kshs 10.95 bn in the period. The airline has already taken a Kshs 4.2 bn bailout loan from the Treasury and another Kshs 20 bn from Afrexim Bank in order to keep its operations afloat. In our view, restructuring, financing and other turnaround strategies will help the company improve its cash flow position. However, the financial position of the company may make it difficult to raise the required funds.

We remain neutral on equities given the low earnings growth prospects for this year. The market is now purely a stock picker?s market, with few pockets of value.

Below is our equities recommendations table;

Private Equity

Taaleri a Finland-based NASDAQ OMX listed company in Partnership with Cytonn Investments have increased their commitment to finance additional real estate projects in Kenya by Kshs 400 mn, from the Kshs. 2.1 bn currently committed, to Kshs. 2.5 bn. Under the allocation increase, Taaleri will provide further development capital that will be deployed to the real estate sector through Cytonn Real Estate, the development affiliate of Cytonn Investments, whose deal pipeline now stands at Kshs 56 bn.

Cytonn Real Estate has been undertaking a number of real estate projects in Kenya, with an 85% focus towards the low to mid-income segment of the housing market. Last year, they broke ground for Amara Ridge in Karen. Looking at the returns from various asset classes over the last 5 years, research has consistently shown that real estate has delivered the highest returns and is poised to continue to do so over the next 5 to 10 years given the strong economic growth, demand for affordable housing, scarcity of high quality commercial space, and the strategic location of the Kenya as a regional hub.

Continental Reinsurance Plc, which holds a 3.5% in the Kenyan reinsurance market through their East African affiliate, has sold a 49% stake to Nigerian based Capital Alliance Private Equity IV Limited for an undisclosed amount, a private equity fund sponsored by African Capital Alliance (ACA). The acquisition dilutes Moroccan Saham?s Finances (the insurance arm of the Saham Group) which initially had a 100% stake in the company. The Lagos-based firm has operated in Kenya since 2009 and has a market share of 9.58% and 3.49% in non-life and life business respectively (based on 3Q15 figures). The move positions Continental Reinsurance favourably to bolster strategic objectives and strengthen its Pan-African foothold, expansionary plans and market positioning as the largest private Pan-African reinsurer, outside of South Africa. Continental Re has operations in 44 African countries, with its main offices in Nigeria, Kenya, Cameroon, Côte d'Ivoire, Tunisia and Gaborone.

According to the African Private Equity and Venture Capital Association (AVCA), the value of private equity deals in Africa fell to USD 2.5bn from a high of USD 8.1bn in 2014. This was due to (i) fewer deals above USD 250mn as deals below USD 250 mn remained relatively stable and (ii) challenges faced by African economies including currency devaluation, slowdown in china and a fall in commodity and oil prices. Between 2010 and 2015, West Africa attracted 25% of deal value with South Africa trailing it at 15%. In terms of sectors, telecommunications services were the most popular investment accounting for 31% of total deal values followed by utilities (16%), financials (11%) and energy (10%). Sub-sectors that saw a notable increase in PE deal values in 2015 relative to 2014 (albeit from a low base) were commercial and professional services (Industrials), health care equipment and services (Health Care) and software and services (Information Technology). In our view, the outlook for 2016 remains promising. PE investment is likely to continue to be geared towards the FMCG sectors, with infrastructure, real estate and energy also attracting a substantial interest from investors. Sub-Saharan Africa (excluding South Africa) remains the focus for PE investment in Africa.

Private equity investment in Africa, specifically East Africa continues to improve, as evidenced by the increase in the number of deals and deal volumes into the region, and the closing of various fund raising activities by funds focused on investing in Africa. With Nairobi having been ranked in the Shop Africa 2016 report by Knight Frank as the hottest retail property market outside South Africa. Infrastructure, real estate, natural resources and energy continue to be preferred by PE firms, but financial services, healthcare, education, and IT are gaining ground.

Real Estate

Nairobi County continues with their City redevelopment plan. KCB announced, through one of the dailies, that it has placed a bid to redevelop 3 estates in Nairobi namely; Old Ngara estate, New Ngara estate and Jeevanjee with a total estimated cost of Ksh 25 bn. The project, which is still at the proposal stage will have 40 floor apartments, and aims to be among the tallest structures in East Africa. Owing to the relatively high land prices, increasing housing deficit as well as the scarcity of development land in Nairobi, developers are focusing more on development of high-rise apartment buildings to fill the evident market gap. With most of the old residential areas have very low density housing, hence redevelopment is the only viable solution to providing badly needed affordable housing. Our recent research on Ngara indicates a 98% occupancy rate, a clear indication of the demand for housing units in the area. We also found out that the average price for housing units in the area ranges between Ksh 4 mn to 6 mn for a one-bedroom, Ksh 7 mn to 12 mn for a two-bedroom and 14 mn to 17 mn for a three-bedroom apartment. The rental yields in this market range from 5.1% to close to 10% and investors can take advantage of that.

In the last week, London-based consultancy Oxford Business Group released a report ranking Kenya as having the second most developed retail sector in Africa after South Africa. According to the report, close to 170,000 square metres of new leasable retail space came into the market in 2015. The report puts Kenya?s formal retail penetration rate as ranging from 30% to 40%, the second highest in Sub-Saharan Africa again, after South Africa whose formal penetration retail stands at approximately 60%. This has been mainly attributed to increased urbanization as well as the growing expenditure of the middle income in the country, which has been estimated to be at 67% in recent years. The demand driven retail segment has also seen increased interests from foreign players such as Game, Carrefour and Botswana based Choppies supermarket which is set to acquire Ukwala Supermarket. Kiambu, Thika, Naivasha, Nakuru and Eldoret are expected to lead in Kenya?s retail segment growth and we expect to see an influx of mixed-use developments with a large proportion of the development mix allocated to the retail segment. Given the availability of relatively cheap land, developers could opt for development of horizontal mixed-use developments as this would best serve the differentiated needs of the middle income class in these areas.

We recently did research in Kikuyu and below is the link to the research note: Kikuyu Research Note

Entrepreneurship in Kenya

This week we host the Cytonn Entrepreneurship Forum with the theme ?Starting and Thriving?. See more details at: Cytonn Entrepreneurship Forum  . For Cytonn, entrepreneurship is not some abstract theory; we are a product of entrepreneurship. Our founding team of 4 came together to form a platform that is focused on assisting investors access attractive returns in the real estate and private equity. Today the firm has created 120 jobs with employment across our 3 offices, created another 200 jobs in our on-going real estate projects, trained over 110 graduates in our internship program, we are attracting FDI into the country from global institutional investors and we are delivering high returning investment solutions to the market. Our transformative experience informed our selection of entrepreneurship development as one of the key initiatives of the Cytonn Foundation. Cytonn Entrepreneurs Forum, a quarterly engagement to development your entrepreneurs, is an initiative of the Cytonn Foundation.

Entrepreneurship is the capacity and willingness to design, develop, organize and manage a business venture along with the accompanying risks. Entrepreneurship is crucial to the growth of a country?s economy. The world?s largest economies have mainly grown as a result of a national entrepreneurial culture. An example of such a country that embraced the entrepreneurial culture is Singapore. We have picked Singapore as an example because of some similarities ? both countries gained independence at about the same time, Kenya in 1963 and Singapore in 1965, and each had total GDP of about $1 billion at independence.

Entrepreneurship received attention when Singapore suffered its first recession in 1985. An economic committee was established to chart a new direction for Singapore?s economy. It identified local entrepreneurship as an important ingredient for Singapore?s continued growth. This led to the first Small and Medium-Sized Enterprise (SME) Master Plan in 1989 that introduced an entrepreneurial infrastructure to assist SMEs to grow. In addition to entrepreneurship, Singapore has focussed on other pillars of development such as good governance, and the result is that the Singaporean economy has grown rapidly to become one of the highest GDP per capita in the world.

Singapore has grown from a GDP per capita of USD 516 at independence in 1965 to a GDP per capital of USD 55,180 today, a 106.9x times multiple and a compounded annual growth of 9.5 %. Kenya?s GDP per capita at independence was around USD 104 and today is USD 1,587, compounded annual growth of 5.2%. Had Kenya?s economic growth been similar to Singapore since independence, our GDP per capita would today be USD 10,690. A higher GDP leads to a higher standard of living. A stronger entrepreneurial culture has a direct impact in our lives, our ability to pay our bills, put food on the table, send our children school and secure our retirement.

Successful entrepreneurs have different and very unique stories but there are certain shared factors that generally affect entrepreneurs. We look at these key factors and make a judgement call as to where Kenya is and what can be done.

1. Economic Factors: The main economic factors to consider are capital, labour, raw materials and markets. Of these factors, the two areas where we believe we have the greatest challenges in Kenya are capital and labour.
   1. Capital remains a challenge to most entrepreneurs because there is a specific way to engage and access investors, who want to see a business plan, a viable strategy, a strong management team and the ultimate exit plan to return their capital. The way to address this is to have relevant training on how to package a story for investors. Entrepreneurs also need to train on how to access alternative capital beyond bank debt and listed equities. Given globalization, entrepreneurs can access capital from anywhere in the globe, and some cases, it can be easier to find capital from venture and private equity investors in say, London, New York, Helsinke, etc, than in Nairobi.
   2. With regard to labour, Kenya has a very rigorous education system that produces numerate and literate graduates. However, the curriculum could improve on areas like problem solving, initiative, articulating and navigating ideas to execution. We need to produce graduates who are not looking for employment mainly for what they can get out of a company, but mainly for what they can create and share in the success.
2. Cultural & Social Factors: How we view entrepreneurs effects the number of people who pursue entrepreneurship. We believe that Kenya has two norms around entrepreneurship, one positive and another one negative
   1. On the positive side, we celebrate entrepreneurial achievements and success stories such as MPesa, Seven Seas Technology, The Nairobi Women?s Hospitals, the iHub, Craft Silicion, just to name a few, all initiatives that were started by individuals and teams to meet unique needs and they have created both wealth and impact on the formal and upper segment of the society. In the informal and lower segment of society, we also celebrate small businesses, commonly called jua kali.
   2. On the negative side, we also celebrate such as tenderprenuership and get rich quick schemes through corruption and this influences many young talented individual to seek shortcuts.
3. Political Environment & Government: Government has a huge potential to spur or deter entrepreneurial development. Stable government, reasonable taxation, reduced corruption, ease of doing business, rule of law and independent judiciary are key to a thriving entrepreneurial environment. Through entities and initiatives such as Kenya Invest, Chamber of Commerce, and Vision 2030, the environment is supportive of entrepreneurial development, but we to need address corruption in government agencies and ministries, greatly improve ease of doing business and make the judicial process more efficient.
4. Entrepreneurial Skill Set and Orientation: Despite all the above, the success of the venture ultimately depends on the entrepreneur and the entrepreneurial spirit. The ability to pick a spot in the market that is underserved, put in place the right strategy, picking the right partners and team, putting in the requisite hard work and recovering from the inevitable setbacks is the key ingredient to entrepreneurship.

As part of the developing world, Kenya stands to gain a lot by embracing a culture of entrepreneurship. It is this realization that has seen an increase in the emphasis placed on entrepreneurship, which is now part of the Kenyan education curriculum. The government has introduced efficient business registration platforms; and technological infrastructure is being upgraded, all in the aim to improve the ease of doing business and support the entrepreneurship culture that is at the heart of the Kenyan spirit. Yet a lot remains to be done.

The biggest issues we think need to be addressed are:

1. Corruption - this is a major hindrance to entrepreneurship as it alters the level playing field where entrepreneurship thrives. It also increases the level of risk, discourages foreign investors, discourages genuine entrepreneurs, and has a negative impact on innovation
2. Education & Support Environment - the Kenyan education system which is a hindrance in the sense that it is not effective in impacting competitive skills making our labour market fairly uncompetitive. An SME master plan, similar to what Singapore had, can do a lot in terms of supporting entrepreneurs and developing the necessary skills.
3. Competiveness - the global marketplace is ever changing and increasingly competitive thus making it difficult for Kenyan entrepreneurs to fully reap the benefits of entrepreneurship and attain global competitiveness. Infrastructure, cost of power, ease of doing business, Internet connectivity and cost, licensing, etc., all affect competitiveness.

We understand and live the challenges that entrepreneurs face especially in getting mentors to guide them. As wealth managers, we interact with successful entrepreneurs on a day-to-day basis and this has given us important insights that we want to pass on to those who most need it. More importantly, we want young and upcoming entrepreneurs to network by creating a platform where successful entrepreneurs can share the secrets for their success and at the same time interact in a peer environment to sharpen their entrepreneurial skills. In summary, entrepreneurship is the centre-piece of Cytonn?s CSR.

The theme for the February forum is ?Starting and Thriving?. This forum will bring together a panel of distinguished entrepreneurs with the goal of sharing their perspectives on what it takes to start and grow a business successfully. We shall be holding the Forum on the 25^th of this month and hope that the Cytonn Entrepreneurs Forum, will contribute to developing and assisting more entrepreneurs in Kenya and the region.