Currency Devaluation, Where Are the Opportunities?

LAGOS, Nigeria, Capital Markets in Africa: Some African countries that are considered great investment opportunities have recently seen currency devaluations. Whilst this could be seen as a challenge for their economies, it could also create an opportunity for African manufacturers. Import substitution has been a significant part of Africa’s economic growth during the preceding decade, as seen, for example, by Nigerian based Dangote Group, currently manufacturing cement, sugar and flour. All of these items were previously imported by Nigeria even though most of the raw materials are readily available locally. So where could other opportunities lie?

As can be expected, there are numerous products that can be examined, but our process for identifying these sectors was first to look at African countries experiencing currency devaluation of more than 20% in the last 18 months, and secondly by drawing on RisCura’s Bright Africa research, which highlights the products being imported and exported by the continent. 

The first quite marked observation is the prevalence of the by-products of refining and the downstream products that are manufactured from these by-products. These include items like bitumen, PET, fertilizer, petroleum coke and synthetic rubber.

Petroleum
Refining petroleum locally or in-country refining instead of exporting oil and importing the refined product, should result in many benefits. These range from reducing the margins paid on fuel to the significant industrialisation that comes from processing the by-products into finished products. This not only negates the reliance on and need for imports, but also contributes towards employment and economic independence.
The reality is, as always, more easily said than done. In order to build new refineries, even with the increased costs of imports created by currency devaluation, there would be short-term structural disadvantages that need to be overcome. Refinery projects are highly capital intensive for a start, and there has already been strong growth in the global refining capacity. The aging and inefficient infrastructure that exists in some parts of Africa, often taking strain from repeated power outages, has made it more of a challenge to compete with global ‘super refineries’ in trading hubs and areas such as the Gulf.

Primary agriculture
Another category that relies heavily on imported products is primary agriculture. This sector includes products such as meat, milk, palm-oil, sugar and rubber. We have seen successful private equity investments in the downstream processing of these products, illustrating the growth potential in these industries, but it does have unique risks and rewards.

High cost of capital, low production yields and a long-term investment time horizon make this an industry that cannot react instantaneously to short- or even medium-term trends. It is also not an industry that has traditionally produced returns for foreign investors in line with their expectations given the perceived risks.

Data provider, BMI, predicts that growth in demand will out strip growth in supply in dairy and meat for the foreseeable future in key markets. The devaluation of currencies should therefore allow for the establishment of more primary dairy farmers, and ultimately present further downstream opportunities for investors.

The margin created by currency devaluation does, however, need to be substantial enough to overcome disadvantages including investing into land, as well as attaining equipment both for farmers and processing plants, which would require importing capital goods. The international milk markets have also been oversupplied recently with imports from China and Russia remaining subdued, and the structural subsidisation of production in Europe further contributing to a depressed price. The lack of needed infrastructure in Africa makes the route to market that much more difficult and expensive, while the commodity-like nature of milk and the concentration of processors, makes farmers a price taker, threatening margins.

This article features in the September edition of INTO AFRICA Magazine, which focuses on reviews of Africa’s economies in the first half of 2016.

Contributor’s Profile
Heleen Goussard works in RisCura’s unlisted investment advisory division primarily managing the calculation of an independent unlisted valuation, highlighting discrepancies in value and methodology, preparing all numerical information used in quarterly reports and IRR calculations for both reporting and fund raising purposes. Heleen has performed and reviewed in excess of 50 valuations at RisCura and undertaken the valuation of Infrastructure projects at both Greenfield and Brownfield stages of development. She has developed specialised skills in the valuation of Infrastructure, including renewable energy, rail concessions, and refineries. Heleen is a chartered accountant based in Cape Town.