New York-based Analyst Dilip Badlani offers his thoughts on Africa, where he spent 10 days visiting Kenya and Tanzania. We have previously offered our thoughts on South Africa. Of the public markets in Africa, South Africa is the only market that is classified by the Russell Indices as an “Emerging Country”; all the other markets are classified as “Frontier Countries.”
“Space: the final frontier.” I heard that phrase often as a child because of the popularity of Star Trek. When I entered the investment business, I discovered another definition of the final frontier: the markets of many African countries. While I had a personal interest as my family has business in parts of the continent, I realized investors often dismissed Africa because of its relatively small amount of GDP, entrenched political problems, and anemic growth rates.
While the total GDP of Africa is still small—less than 3% of Global GDP1-the growth rates of several African countries have been among the fastest in the world over the past decade, thus making it increasingly relevant for today’s globally focused investor.
The Growth of Africa
From 2000-2010, six of the 10 fastest growing economies in the world were African. Buoyed by the increase in commodity prices, the economies of Angola and Nigeria were among the fastest growing in the world. Remarkably, Rwanda, a country plagued by genocide in the early ’90s and without the natural resources to benefit from higher commodity prices, also made the list. Ethiopia is another example of a country that has been able to grow despite its lack of oil resources. When I learned that Ethiopia is now the world’s tenth largest producer of livestock,2 I was struck by the contrast to the image I remember from childhood of watching Bob Geldof’s efforts to fight the devastating Ethiopian famine.
Given the significant amount of resources in Africa-10% of the world’s oil reserves, 40% of its gold, and 80-90% of the chromium and the platinum metal group-the continent has clearly benefited from an increase in commodity prices. However, resources accounted for only about one-third of the growth on the continent.3 The remaining two-thirds came from other sectors, including wholesale and retail, transportation, telecommunications, and manufacturing.
As a child, I often spent time in my father’s office as I enjoyed exploring the samples of various goods he was exporting from China to Africa. In retrospect, it has been amazing to look back on the evolution in the sophistication of products being imported into Africa. This move up the product chain may partially have been driven by an increase in the production of value-added goods produced in China. Yet credit also goes to upwardly mobile Africans who have demanded better quality products.
The African continent has seen a solid increase in its proportion of middle class citizens over the last two decades. While this increase may not be as impressive as that of China, it merits attention nonetheless. The African Development Bank states that Africa’s middle class had risen to 313 million people in 2010, 34% of the continent’s population – compared with 111 million (26%) in 1980, 151 million (27%) in 1990 and 196 million (27%) in 2000.4 While its definition of middle class may have been a little too broad – it defined middle class as people who spend the equivalent of $2-$20 a day and acknowledged that many living on $2-$4 a day are “floating” and could easily slip back into poverty. Taking these people out of the equation puts the stable middle class at 123 million, or 13% of the population.5
The developed economies of the world are currently suffering from aging populations and a lack of population growth. Africa is currently the world’s second most populous continent with a population of one billion people6 and is expected to see its population more than double by 2044.7 The fertility rate in Africa is expected to decline over this period from 4.6 children per woman in 2005-2010 to 3.0 children per woman in 2040-2045. Today’s high fertility rates in Africa can be attributed to a variety of causes, among them, poor education, limited access to or approval of birth control, and historically high mortality rates. However, in a 2008 study, the U.N. Population Division estimated that for the first time in about two decades no single African country would experience a negative population rate of growth as a result of HIV/AIDS.8 The increase in the overall size of the population will create a significant challenge in terms of available resources, but it also has the potential to provide a demographic dividend similar to that enjoyed by other economies that have seen an increasing portion of their population enter the workforce.
One of our investments at Royce is a healthcare company headquartered in South Africa. The company’s management team possesses the local knowledge to be able to operate in various countries in Africa while running manufacturing facilities that meet international standards. As there is an increase in adoption of medical drug use in Africa, this company will benefit.
Fastest-Growing Mobile Market
Walking around the streets of Nairobi, it becomes abundantly clear just how important cell phones are to an average Kenyan. I was struck by the reasonable rates for making international calls and by the quality of data coverage. The cell phone has empowered locals by putting the world at their fingertips, and I noticed some individuals with multiple phones.
Africa is indeed the fastest-growing mobile market in the world and the largest after Asia. The number of subscribers on the continent has grown almost 20% each year for the past five years, according to the GSM Association report on Africa, which expects there will be more than 735 million subscribers by the end of 2012.9, 10
The growth in the number of cell phones has created a huge opportunity to bring financial services to a previously unbanked population. Africa already has 51 mobile money systems in place. According to the providers from whom subscription data are available, there are now more than 40 million African users.11Banking through mobile phones allows for real-time transfer and the receipt of small amounts of funds at low cost. This can reduce the costs of processing and administering small loans, thereby alleviating a significant disincentive for lenders to extend credit to small enterprises.
Foreign Investments in Africa
Although cell phones have bypassed the need for an investment in fixed-line infrastructure, there is no denying the need for major infrastructure development. I experienced first-hand one recently completed project: a smoothly paved highway that now connects Nairobi, Kenya, to Arusha, Tanzania, reducing travel time for drivers like myself. What made an even bigger impression was spotting a group of roadside construction workers that included several Chinese. I later found out that the contractor for the road was in fact a Chinese firm, China Geo-Engineering Corporation,12 just one of many businesses that have taken on infrastructure projects in Africa.
While formal statistics are difficult to gather, according to Martyn Davies, the director of the China Africa Network at the University of Pretoria, “China is probably the biggest single investor in Africa. “They are the biggest builders of infrastructure. They are the biggest lenders to Africa, and China-Africa trade has just pushed past $100 billion annually.”13 Nor is China the only Asian country to invest in Africa; there have been projects undertaken by the likes of India, Vietnam and Malaysia as well.
Over the past two decades, foreign direct investment (FDI) has increased from approximately US$9 billion in 2000 to US$18 billion in 2004 and US$88 billion in 2008.14 However, due to the global financial crisis, FDI in Africa declined to $55 billion in 2010.15 With ongoing worries about deleveraging in western economies, African leaders chose “Boosting Intra-Africa Trade” as the theme of their annual summit in January 2012.
Over the past decade, only about 10-13% of African trade was with African nations on average, while 40% of North American trade was with other North American countries, and 63% of trade by countries in Western Europe was with other Western European nations. This is not a new problem; African countries established the African Union and created various Regional Economic Communities (RECs) to try to improve growth through trade.16
Although several Chinese contractors have been successful in winning infrastructure projects on the continent, there still is a place for African contractors. One of our investments is an African contractor that specializes in road building and also owns aggregate supplies. The company has been operating in Africa for several decades and should be a beneficiary of infrastructure growth. Additionally, through its local management teams the company has been able to operate more smoothly than foreign contractors on the continent, who have often faced local resentment.
Challenges: Education, Jobs, Sustenance and Inequalities
Clearly, the opportunities for Africa are vast given its untapped resources and its sizeable young population. However, the continent still faces several challenges. Literacy rates in Africa, though showing some improvement, remain among the worst in the world.17
It also remains to be seen whether Africa will be able to leverage the potential benefits of a surging population. Job creation is just one area for concern, as unemployment rates are already at high levels in many African countries. In South Africa, for instance, currently the continent’s largest economy, the unemployment rate is 25%.18
Feeding additional mouths will also be critical in order to prevent unrest in the region. The good news is that Africa does possess significant amounts of undeveloped arable land. However, the majority of this land today lacks access and infrastructure.19 Farmers in Africa have the potential to increase their use of technology to drive growth. In the sub-Saharan region Africa in particular there are indications of yield gaps, which could be exploited with a variety of well-known practices. Cereal yields in Africa have grown little and are still at around 1.2 tons per hectare, compared to an average yield of some 3 tons per hectare in the developing world as a whole. Fertilizer consumption was only 13 kg per ha in sub-Saharan Africa in 2002, compared to 73 kg in the Middle East and North Africa, and 190 kg in East Asia and the Pacific.20
Income inequality within Africa remains a serious cause for concern. While there has been an increase in overall wealth, the level of inequality is still quite high. At the start of the 21st century, Africa had a Gini coefficient of 51%, which was the worst income distribution in the world;21 now more than a decade later, the countries on the continent still continue to rank among the worst in terms of income inequality.22 As former UN secretary general and current chair of the Africa Progress Panel, Kofi Annan, has emphasized, “We would want to see development that improves the lives of all.”23
Africa presents intriguing opportunities considering its positive demographics, rich natural resources, and untapped potential for growth. At Royce, our focus is on investing in companies with high returns on capital, strong balance sheets and good management teams. To date, we have been most successful finding companies in South Africa that meet these criteria. However, as the markets in Africa develop, we expect to find additional opportunities throughout the continent.
As the South African economy continues to mature and other, even less developed, economies begin to thrive, we will keep our attention focused on company fundamentals, corporate governance, and what we think are attractively undervalued businesses with the potential to grow in the global economy. As the bulk of Africa’s economies are frontier markets, still progressing toward the status of developing economies, the continent as a whole represents long-term opportunities that will require patience and diligence. Its resources and demographics are likely to make it well worth the wait.
5 http://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/The Middle of the Pyramid_The Middle of the Pyramid.pdf
6 ”World Population Prospects: The 2010 Revision” United Nations (Department of Economic and Social Affairs, population division)
7 ”World Population Prospects: The 2010 Revision” United Nations (Department of Economic and Social Affairs, population division)