Arqaam Capital

Arqaam expects beverage firms in East Africa to outperform peers in SSA

Tuesday, June 7, 2016

Beverage companies operating in the markets of East Africa stand a better chance of surprising on the upside in the short term and showing superior performance in the long run according to a research report released by Arqaam Capital, the specialist emerging markets investment bank.


Resilient economic growth, benign fiscal positions, favorable demographic trends and structurally low consumption levels suggest that companies operating in East African markets should enjoy better growth over time and as a result stronger investor interest.


"We prefer companies with leading market shares that operate in economically resilient markets in East Africa such as Kenya and Tanzania, have leading brands in key segments with a particularly strong presence in the value/economy segments enabling them take advantage of consumer down-trading and maintain a lean cost structure and a higher share of local sourcing because imports and weak currencies put pressure on margins,' said Victor Dima, Executive Director of Equity Research at Arqaam Capital. 


"We believe that South Africa consumers will come under increasing pressure in the short term, which adds risks to the performance of beverage companies which are discretionary in nature. At the same time, South African companies are world-class diversified beverage companies, which increasingly benefit from international, including Sub Saharan, growth, which will be a differentiating factor," Victor added


According to the research report, premiumization will continue to play a significant role, but the economy segment is set to see much stronger growth in the short term. Longer-term consumer preferences are expected to continue moving sideways. This is expected to favor high-end brands, as African consumers will remain aspirational in nature, and value brands, as affordability will remain the central issue of the brewing industry in SSA. In the short term, however, the reports expects much stronger growth in value/economy brands as economically constrained consumers in SSA trade downward. 


"While not disclosed by most companies, we believe that between 40% and 60% of directs costs in sub-Saharan Africa excluding South Africa are foreign currency-denominated. At the gross level, packaging is the single largest cost structure item, representing around 75% of costs, with other raw materials representing 25% of costs, a large share of which is likely imported. While cost structure may differ from country to country, we believe that the cost contribution of the key items is not materially different."


"Our analysis shows that SSA companies are not taking advantage of lower input prices due to weakening currencies despite most input costs declining in USD terms over the last 12 months by 10-30%." Victor Dima explained


"While trading down implies risk for margins, we think that the recent margin weakness that some companies have shown is a cyclical rather than a secular phenomenon. Over time, beverage companies operating in Africa, or divisions of the international companies operating in Africa, have generated higher operating margins compared to other markets. We think that long-term margins should largely recover, and we see two factors supporting this argument, namely the oligopolistic nature of the beverage markets in SSA and the aspirational nature of African consumers, who will continue to opt for premium brands as the economic cycle turns. The mainstream segment will be the worst affected; growth in the premium and value categories is expected to continue but with value showing stronger growth." Victor Dima concluded.

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