Is Nigerian Equities Market Overvalued?

By Afrinvest Research

Given the challenges faced between H2:2014 and Q1:2017, investors constantly punished Nigerian equities, with sell-offs recorded across various sectors of the market.

Consequently, Nigerian equities were undervalued, in comparison to peers, presenting ample opportunities for investors to take advantage of some of the companies, which turned out impressive results despite the economic challenges.

Following the reforms in the FX market which resulted in increased FX liquidity and a restoration of investor confidence, massive gains were recorded in the market in 2017 and this has been sustained into 2018, up 12.2% (12/01/2018).

With the market now at an all-time high in terms of market capitalisation and the NSE All Share Index at a 9-year high, there are justifiable fears of overvaluation of the market which raises concerns with regards to a near term correction.

Our approach is to diagnose and probe into the fundamentals as well as technical merit of the overvaluation hypothesis.

From our analysis, average Trailing P/E and P/BV for the Nigerian equities market in the last one month as at 17/01/2018 stood at 13.1x and 1.7x, which are lower than 15.1x and 2.0x respectively for the MSCI Frontier markets index.

Looking back to the last 2-year bull market run Nigeria experienced between 2012 and 2013, the Nigerian equities market was priced at a premium to frontier markets peers in the late cycle of the run, as shown in the average P/E and P/BV multiples of the MSCI Frontier Markets index of 12.5x and 1.6x in 2013 relative to 13.5x and 2.2x of the Nigerian market in the same period.

This implies that despite the rally in the market in 2017 and early trading in 2018, current undervaluation of the Nigerian market by valuation multiples and the proven historical valuation premium Nigerian market enjoys in period of boom suggest there are more miles to clock in the market rally.

Hence, against the backdrop of improving macroeconomic conditions as well as positive outlook for corporate earnings, we believe there is a compelling case for investors to sustain interest in the Nigerian equities market as already noticed in the YTD return of 17.4% (17/01/2018).

Our Scenario Analysis in 2018

A review of our market forecast for 2017, shows that actual performance outperformed our bull case scenario, in which we projected that a contraction in the spread between the official and parallel market rates, an increase in oil production to about 2.2mb/d, oil prices between $55/b to $60/b and MPR at 14.0% will result in a 15.6% appreciation in the benchmark index.

Actual performance for 2017 (+42.3%) surpassed our forecast as investor confidence was reinvigorated following the reforms in the FX market and resilient earnings. In 2018, we envisage that market performance will be largely determined by the following factors:

1. Earnings fundamental of Corporates;
2. Stability in the FX market and other macro indicators; and
3. Funds flow dynamics to emerging and frontier markets.

Our analysis of market trend over the past 10 years, makes a case for a possible repetition of history.

As noticed in 2012 and 2013, the periods following the global economic crisis, sentiment in the local bourse strengthened which drove the ASI 35.4% and 47.2% northwards in the respective years.

In a similar situation, as the economy rebounded from the slump – 2014 to 2016 – in 2017, we expect market sentiment to wax stronger in 2018.

In our scenario analysis for the market performance in 2018, we employed a blend of relative valuation in which we benchmarked our market valuation against multiples for peers in the MSCI Frontier market index and absolute valuation based on price forecasts for our coverage universe which is about 86.0% of the entire market.

From our analysis, the Nigerian market has outperformed the MSCI index on the basis of EPS, growing at a CAGR of 12.2% between 2010 and 2017 vs. a 2.1% decline for the MSCI index in the same period.

Similarly, on a P/E basis, the Nigerian market has commanded higher pricing over the MSCI index in 6 of the 8 years under review.

Against this backdrop, we carried out scenario analysis for the performance of the All Share Index in 2018.

Our forecast for the performance of the benchmark index in 2018 is largely positive as our scenarios (bear, base, bull) all signal appreciation in the benchmark index.

On a relative valuation basis, we noted earlier that our expectations for corporate earnings in 2018 is largely optimistic on the back of improving conditions in the operating environment; hence, we assumed an EPS of N3,377.4 as our base case scenario which implies a 13.0% increase from a trailing EPS of N2,988.8 in the prior year.

Our EPS projection was based on the 7-year EPS CAGR for the All Share Index to arrive at the forecast.

For our P/E projection, we compared current pricing in the Nigerian markets against peers for which the MSCI Frontier Markets index was employed.

In order to arrive at our p/e forecast of 14.1x in the base case scenario, we analysed historical P/E multiple of the ASI relative to the MSCI Frontier Index P/E and assumed a 1.0x premium in line with historical valuation spread.

This methodology yielded an All Share Index projection of 47,620.71 points in our base case scenario, which suggests a 24.5% appreciation in the year.

On an absolute valuation basis, we have a more conservative forecast for market performance, albeit still positive.

Based on our 12-month target prices from our coverage universe of stocks – about 86.0% of market cap – relative to 2017 yearend prices, we forecast a 5.6% jump in market capitalisation, implying ASI projection of 40,384.81 points.

Finally, to make a call on market performance for 2018, we adopted a blend of both valuation methodologies. Based on the foregoing, we arrived at an ASI projection of 45,811.73 points for 2018 which is a 19.8% appreciation from 38,243.19 points in 2017.

Our bear case (+7.7% to 41,189.9 points) and bull case (+32.7% to 50,749.10 points) also follow the same trend and further buttress the consensus view of positive market performance in 2018.

Whilst we note that developments in the macro space will also determine overall market performance, we opine that barring any major shocks in the FX market, corporate fundamentals will be a key determinant of overall performance.