Cytonn 2015 First Half Financial Report

Executive Summary

• Global equities: Global growth faces a number of key challenges but expected to register a 3.5% growth;
• Sub-Sahara: Africa’s economies are getting more diversified and there is an expected increase in foreign direct inflows into the region;
• Kenya Economy: Good growth projections but the current account position remains a key challenge;
• Equities: The market performed dismally for the first six months and high valuations not supportive of market increases going forward;
• Fixed Income: Yields on treasury bills remain stable but expectations of rate increases still remain due to the depreciating shilling;
• Private equity: Interest in Africa as a private equity destination continues to increase as we see a number of PE funds eye the market;
• Real Estate: The sector remains an attractive investment asset class and there is increased coupling of financing and development capability as one platform, a strategy validated by the increased interest in Cytonn’s real estate project pipeline from global institutional investors.

Global Markets Review

Despite the expected slight increase in global GDP growth to 3.5% from 3.4% in 2014, there are a number of challenges facing global economic growth prospects: (i) uncertainty surrounding the timing and impact of a Federal Reserve rate hike in the US given the low inflation levels globally and mixed economic data in the US, (ii) Eurozone quantitative easing yet to take full effect on growth going forward, (iii) fear of a Greece default and a possible expulsion from the Eurozone and what that would mean to the global economy, and (iv) lower growth rates in emerging markets for example macroeconomic indicators point to China missing its 7% GDP growth target.

United States:

The US economy appears to have taken off in the second quarter of the year, driven by improved consumer confidence, spending and wage growth. In addition, the manufacturing Purchasing Managers Index (PMI) reached a four-year high in June 2015, adding a layer of diversification to the growth sectors. The housing market is showing signs of a pick-up, with new and existing home sales rising.

The stock market has been trading sideways with S&P 500 remaining relatively flat for the first half of the year, largely driven by the uncertainty of a rate hike amidst high valuations after a two-year stock market rally. The market will continue to be volatile until when there is clear direction on the rate increases.

Eurozone:

The Eurozone is on a better growth trajectory than it has been for several years thanks to the recent quantitative easing started at the beginning of this year. The banking sector is improving. Weaker Euro in addition to lower oil prices are positive contributors to higher expected growth. The main issue affecting the Eurozone is the possibility of a Greece exit given the default issues that Greece has been facing with their creditors over their bailout programme. Though the Greece situation is not news, the recent call for a referendum to vote on the proposal by the creditors has surprised many and this has led to increased political tension and market uncertainty. Analyst expects a ‘Yes’ vote supporting the creditors and this may be followed by an immediate withdrawal of market liquidity due to a potential technical default and capital controls.

The contagion effects of a Greek exit have been greatly reduced compared to previous periods. The European economy and financial system are stronger. The European Central Bank (ECB) has increased emergency liquidity assistance, allowing Greek banks to borrow more from the ECB to ensure that there was no bank run while negotiations between Greece and its creditors were being held.

China:

Despite past strong economic performance in emerging markets, going forward economic growth will start to slow down given the increasing correlation with more advanced economies. China, which consistently had above 8% in GDP growth, is expected to struggle to attain a 7% growth this year. In order to support growth, the Peoples Bank of China cut the policy rate by 25bps to 2%; this is the fourth time they have cut rates in eight months.

The Shanghai Composite index has been very volatile this year driven by an increased number of IPOs in the market: the index peaked on the 12^th of June but has lost 17.3% from that peak as at the end June, bringing the 6 months return on the index to 13.9%.

Regional Markets Review

Sub-Saharan Africa continues to grow much faster than most of the other regions; in 2015 the expected growth rate is 4.5% compared to 5.0% in 2014 as per IMF. The region expected to do much better is the East African region due to the diversified nature of its economies. There are a lot of flows into the region from new countries like China and India, and the investments are diversifying away from the traditional commodity explorations to consumer goods and services, targeting the rising middle class.

The region continues to improve its governance and political systems as can be seen by the positive government transition in Nigeria after the elections. The ease of doing business is also improving across the region and hence the increase in global companies setting shop in the region.

With the exception of the Malawian Kwacha, most of the currencies lost against the dollar due to the dollar strengthening in the international markets. Compared to previous years, foreign investor participation in the regional stock markets has been lower and in some countries like Kenya there has been negative outflow. This can be attributed to better returns expected elsewhere and the high valuations of some of the stock markets.

The region is bound to experience increased foreign direct inflows as investors divest their portfolios from low yield developed markets to the markets in Africa that offer attractive, long-term and stable returns to investors. This coupled with the increased expenditure on development initiatives should see the region’s economic growth pick up in the coming years, and we continue to view real estate and infrastructure as the biggest beneficiaries.

Kenya Macro Economic Review

As per our expectations, first quarter GDP growth was muted at 4.9%. Despite overall lower growth rate, some sectors did very well with construction, financial intermediation and electricity & water growing at 11.3%, 9.1% and 8.4%, respectively. Accommodation & food services contracted by 7.5%, which can be attributed to the insecurity situation that faced the country in the first half of the year. Given the weaker start to the year, we think that the budget for the financial year 2015/2016, which was underpinned on a 7% growth projection, is highly ambitious and might not be achievable.

The Kenya shilling has continued to lose ground against the US Dollar declining by close to 10% for the first 6 months of the year with 7.9% of that being in the second quarter. The decline can be attributed to: a strong global dollar in the international markets, the lack of clear direction from the central bank, and the continued deterioration of the current account position due to increased imports for infrastructure investments amidst declining exports. The balance of payment position has deteriorated from a surplus of Kshs 8.8 billion in the first quarter of 2014 to a deficit of KShs 14.3 billion due to a worsening current account. However there has been an increase in the net financial account supported by 13.2% increase in diaspora remittances in the first quarter and a more than double growth in the net inflows from the financial account from a surplus of KSh 75.7 billion in the first quarter of 2014 to a surplus of KSh 219.3 billion 2015. Overall, the shilling will remain under pressure but the central bank has sufficient reserves in the short term to cushion against significant volatility.

Inflation rate has increased gradually over the first half of the year from 6.0% in December to 7.0% in June. At the beginning of the year, low oil prices lead to a slight decline but with the increased global oil prices and the weakening shilling th