Executive Summary

Fixed Income: During the week, T-bills were oversubscribed for the 7^th consecutive week, and for the 2^nd week running the 182-day T-bill was not on offer. The overall subscription came in at 135.0%, compared to 131.7% recorded the previous week. The Federal Open Market Committee (FOMC) met on Wednesday 15^th March, 2017 and raised the federal funds rate to a band of 0.75% - 1.0% from 0.5% - 0.75% previously;

Equities: During the week, the equities market was on an upward trend with NASI, NSE 20 and NSE 25 gaining 3.4%, 0.7% and 2.9%, respectively. A number of companies released earning results during the week, notably Co-operative Bank, Equity Group, CIC Group and Liberty Holdings, that recorded core earnings per share growth of 8.3%, (4.6%), (83.4%) and (14.6%), respectively;

Private Equity: Maris Capital?s funding requirement for a planned investment in warehouse development in Africa will be partly funded by a consortium of investors. According to Private Equity Africa?s Annual Review Report, the overall performance in Mergers and Acquisitions? declined in the year 2016;

Real Estate: The hospitality sector continues to attract investors; during the week, Sarova Group of Hotels signed a contract to manage a Kshs 1.3 bn hotel in Nakuru.  Nigeria?s Dangote Cement, pushed back its entry into Kenya to 2021, and is set to build two plants of 1.5 mn tonnes per annum capacity each, near Nairobi and Mombasa, to serve the Kenyan local market;

Company Updates

• Our Investment Analyst, John Ndua, discussed the Equity Group?s FY?2016 earnings and the delay on the appointment of Kenya Airways Managing Director. Watch John Ndua on CNBC here
• Our Investment Analyst, Caleb Mugendi, discussed UAP Old Mutual Group FY?2016 earnings and the equities market activity. Watch Caleb Mugendi on CNBC here
• On Monday 13^th March 2017, Cytonn Real Estate, the development arm of Cytonn Investments, awarded architects for the design consultancy of its latest project, an upcoming Kshs. 15.0 billion master planned development on a 100-acre piece of land in Ruiru, Kiambu County. See Event Note
• We continually showcase real estate developments by our real estate development affiliate, Cytonn Real Estate, through weekly site visits. The site visits target both investors looking to invest in real estate directly and also to those interested in high yield investment products to familiarize themselves with how we support the high yield returns. If interested in attending the site visits, kindly register here
• We continue to see very strong interest in our Private Wealth Management training, which is at no cost, and is held bi-weekly, but is open only to pre-screened participants. To register for the training kindly use this link
• For recent news about the company, see our news section here
• We have 12 investment-ready projects, offering attractive development returns and buyer's targeted returns of around 25.0% p.a. See further details here: Summary of investment-ready projects
• To invest in any of our current or upcoming real estate projects, please visit Cytonn Real Estate
  • The Alma, which is over 55.0% sold and has delivered an annualized return of 55.0% p.a. for investors who bought off-plan. See The Alma.
  • Amara Ridge is currently 100.0% sold. See Amara Ridge
  • The Ridge Phase One is currently 20.0% sold. See The Ridge
  • Taraji Heights is currently 10.0% sold. See Taraji Heights
• Following the completion of sales for Amara Ridge, we are currently looking for land in Karen for our next development. We are also looking for 3-10 acres of land in Garden Estate, Muthaiga North, South C and Langáta. Contact us at res@cytonn.com if you have any land for sale or joint ventures in the above areas
• We continue to beef up the team with the ongoing hires: Careers at Cytonn

Fixed Income

During the week, T-bills were oversubscribed for the 7^th consecutive week, with overall subscription coming in at 135.0%, compared to 131.7% recorded the previous week, despite the withdrawal of the 182-day paper from the auction market for the 2^nd week in a row. Subscription rates for the 91 and 364-day papers came in at 75.0% and 195.0%, compared to 97.0% and 166.4% the previous week, respectively. The decline in 91-day T-bill subscription rate could be attributed to a lower real return (given that with the current inflation rate of 9.0%, and the 91-day T-bill yielding 8.7%, investors are getting a negative real return of 0.3%), and from the treasury bills results, the market average for the 91-day T-bill is 9.1% compared to the 8.7% for the accepted amounts, which is an indication that investors are demanding for higher yields on the 91-day T-bill. Yields on the 91-day and 364-day papers during the week remained unchanged, closing at 8.7% and 10.9%, respectively. The Central Bank of Kenya (CBK) has remained disciplined in stabilizing interest rates in the auction market by rejecting bids that it considers as above market, and we have seen the market respond to this, as indicated by the overall bids received acceptance rate of 80.9%, compared to 71.6% at the beginning of the year. Given the possible upward pressures on interest rates, we maintain our recommendation for investors to be biased towards short-term fixed income instruments.

According to Bloomberg, the yield on the 5-year and 10-year Eurobonds declined by 10 bps and 20 bps w/w to 4.2% and 7.1%, from 4.3% and 7.3%, respectively, the previous week. Since the mid-January 2016 peak, yields on the Kenya Eurobonds have declined by 4.6% points and 2.6% points, respectively, for the 5-year and 10-year bond due to improving macroeconomic conditions. This is an indication that Kenya remains an attractive investment destination.

The Kenya Shilling depreciated by 0.4% against the dollar to close the week at Kshs 103.0 compared to Kshs 102.6 recorded the previous week, on account of heightened dollar demand from oil importers. On a year to date basis, the shilling has depreciated against the dollar by 0.5%. In recent months, we have seen the forex reserves reduce to USD 7.0 bn (equivalent to 4.6 months of import cover), from USD 7.8 bn in October 2016 (equivalent to 5.2 months of import cover). The level of forex reserves has now stabilized, an indication of the confidence of the Central Bank with the current levels of the shilling.

The Kenyan government re-opened two bonds (FXD 2/2014/5 and FXD 3/2013/5), with effective tenors of 2.2 years and 1.7 years and coupons of 11.9% and 12.0%, respectively, in a bid to raise Kshs 30.0 bn for budgetary support. Given that (i) recent bond issues in the market have witnessed investors demanding very high premiums above the secondary market yields, (ii) the government has only borrowed Kshs 123.5 bn from the foreign market against its foreign borrowing target of Kshs 462.3 bn, and (iii) the Kenya Revenue Authority (KRA) has already missed its first half of 2016/17 fiscal year revenue collection target by 3.2%, and is expected to miss its overall revenue collection target of Kshs 1.5 tn for the current fiscal year due to depressed earnings  growth by corporates, we expect these to result into an upward pressure on interest rates as the government gets under pressure to finance the budget. Similar tenor bonds are currently trading at yields of 12.8% and 12.3% for the 2.2 years and 1.7 years bonds, respectively, in the secondary market. We therefore recommend investors to bid for the bonds at a yield of between 12.8% and 13.4%, and 12.3% and 13.0% for the FXD 2/2014/5 and FXD 3/2013/5, respectively.

This week, East African Breweries Limited (EABL), released its pricing supplement for the additional Kshs 6.0 bn Medium Term Note (MTN) out of its existing Kshs 11.0 bn domestic MTN. The five-year note will be priced at a yield of 14.2%, which is a premium of 0.8% above the same tenor treasury paper that is currently trading at 13.4%. As highlighted in our Cytonn Weekly #10/2017, we maintain our view that the offer would only make sense for investors to demand a premium of at least 2.0% above the prevailing yields on a 5-year treasury bond, which translates to a minimum yield of 15.4%.

The Kenya National Bureau of Statistics (KNBS) released its January 2017 leading economic indicators with key to note is Kenya?s trade deficit, which declined by 14.6% to Kshs 853.8 bn in 2016 from Kshs 999.3 bn in 2015 on account of a 9.4% drop in the import bill to Kshs 1.4 tn from Kshs 1.6 tn in 2015. Key highlights from the report include;

• Domestic exports increased marginally by 0.5% to Kshs 500.8 bn from Kshs 498.3 bn in 2015 mainly attributed to increased volumes and prices of tea, food and beverage, which accounted for 45.5% of total exports in 2016 compared to 44.9% in 2015, the highest level in six years,
• The total value of fuel and lubricant imports declined by 12.2% to account for only 14.5% of the total import bill compared to 14.9% in 2015 indicating a notable improvement from a high of 27.1% 2011. This could be attributed to the low global oil prices in 2016,
• The value of transport equipment imports dropped by 7.0% to account for 9.8% of the total import bill compared to 16.8% in 2015 partly attributable to the stability of the shilling during the year, and
• Construction machinery equipment imports increased by 9.9% to Kshs 309.7 bn from Kshs 279.0 bn in 2015 and accounted for 21.6% of the total import bill compared to 17.8% in 2015. The increase in construction machinery equipment is partly attributable to the continued investment in the infrastructure, which is supportive of developments especially in the real estate sector.

The declining trade deficit is key in supporting the Kenyan shilling to remain within stable levels, although the currency remains exposed to external factors such as (i) the recovery of global oil prices, and (ii) weak tea and coffee prices, which are Kenya?s main exports. Going forward, the trade balance is likely to remain stable given that the import activity is likely to decline as we have observed in early 2017, due to the weakening shilling and tight liquidity in the market limiting the access of credit by traders.

The US Federal Reserve?s Open Market Committee (FOMC) met during the week, on Wednesday 15^th March, 2017 to assess the state of the US economy and agree on a path for the US monetary policy. In line with our expectations of a 25 bps increase in our Cytonn Weekly #10/2017, the Fed decided to increase federal funds rate to a band of 0.75% - 1.0%, from 0.5% - 0.75% previously: the first hike for the year 2017. The decision by the Fed to hike rates was based on:

• Economic Growth ? US economic growth remained relatively stable despite growing at a low rate of 1.6%, the lowest level since 2011 but is expected to improve to Federal Reserve?s target of 2.1% in 2017 and 2018,
• Employment - The US employment rate has improved over the last 12 months, with unemployment currently at 4.7%, as compared to 5.0% which is considered as full employment level, indicating a strengthening labor market,
• Inflation ? Core inflation has been increasing, having hit a 2-year high of 1.8% and is now just 20 bps shy of the 2.0% medium-term target, while the headline inflation was at 2.7% as at February 2017, and
• Time frame ? the committee highlighted that further delay in increasing rates could lead to a forced rapid hike in the near future, which could disrupt the financial markets and risk pushing the economy into a recession.

The rate hike by the Fed by 25 bps was received with mixed reactions by the market with; (i) US dollar losing by 0.5% against major global currencies to touch a five week low, (ii) the yields on the US benchmark 10-year Treasury bond increased by over 5 bps to a week high of 2.5%, and (iii) commodity prices were on a decline with oil prices on the fall, as the market expected a more bullish rate hike of more than 25 bps. However, the markets are set to normalize after absorbing the impact of the Fed rate hike. In addition to the hike during this meeting, the Fed is expected to hike the rate twice during the year given the positive economic growth expected in 2017. The US rate hikes by the Fed during the year are likely to lead to global strengthening of the US dollar, hence resulting in; (i) weakening of other currencies including the Kenya Shilling, which is likely to come under pressure especially in the short to medium term, (ii) higher debt obligations for countries with US dollar denominated debt as their debt service and debt repayments will cost more with the strengthening dollar, and (iii) a reduction in gold prices as investors? preference shift to holding dollar as oppose to gold.

The Government is ahead of its domestic borrowing for the current fiscal year having borrowed Kshs 189.7 bn against a target of Kshs 167.8 bn (assuming a pro-rated borrowing throughout the financial year of Kshs 229.6 bn budgeted for the full financial year). It is important to note, however, that the government is in the process of revising its domestic borrowing target upwards to Kshs 294.6 bn, which will take the pro-rated borrowing target to Kshs 215.3, implying that the government will fall behind its borrowing target. The government has only borrowed Kshs 123.5 bn, of the budgeted foreign borrowing, representing 26.7% of its foreign borrowing target of Kshs 462.3 bn, and given Kenya Revenue Authority (KRA) has already missed its first half of 2016/17 fiscal year revenue collection target by 3.2%, and it is expected to miss its overall revenue collection target of Kshs 1.5 tn for the current fiscal year. This creates uncertainty in the interest rate environment as the government might have to plug in the deficit by borrowing more from the domestic market, a move that may exert upward pressure on interest rates, and result in longer term papers not offering investors the best returns on a risk-adjusted basis. It is due to this that we think it is prudent for investors to be biased towards short-term fixed income instruments.

Equities

During the week, the equities market was on an upward trend with NASI, NSE 20 and NSE 25 gaining 3.4%, 0.7% and 2.9%, respectively, taking their YTD performances to (5.0%), (5.8%) and (6.4%), respectively. This week?s performance was supported by gains in select large cap stocks such as Co-op Bank, Equity Group, and Safaricom, which gained 13.3%, 6.5% and 6.2%, respectively. Since the February 2015 peak, the market has lost 45.7% and 28.7% for NSE 20 and NASI, respectively.

Equities turnover increased by 83.2% to close the week at USD 42.5 mn from USD 23.2 mn the previous week. Foreign investors turned net buyers with net inflows of USD 1.5 mn, an increase of 236.4% compared to a net outflow of USD 1.1 mn recorded the previous week, with foreign investor participation increasing slightly to 84.5%, from 82.8% recorded the previous week. Safaricom remained the top mover for the week, accounting for 46.0% of market activity. We expect the Kenyan equities market to be flat in 2017, driven by slower growth in corporate earnings, neutral investor sentiment mainly due to the forthcoming general elections and the aggressive rate hike cycle in the US, which may reduce the level of foreign investors? participation in the local equities market.

The market is currently trading at a price to earnings ratio of 10.6x, versus a historical average of 13.5x, with a dividend yield of 6.8% versus a historical average of 3.7%. The current 10.6x valuation is 27.1% above the most recent trough valuation of 8.3x experienced in December of 2011. The charts below indicate the historical P/E and dividend yields of the market.

At least 23 banks have now joined the mobile and electronic transaction service, PesaLink, since its launch last month, with the Kenya Bankers Association expressing their optimism that all the 41 commercial banks as well as micro-finance banks will eventually join the platform. PesaLink, which seeks to eliminate mediation of M-PESA and other mobile money transfer services when transferring money from one bank account to another, will allow customers to transfer up to Kshs 999,999.0 through mobile phones, giving it an edge over M-PESA platform that limits daily cash transfers to Kshs 140,000.0. Additionally, the customers using PesaLink can initiate transactions from diverse channels including the mobile phone, banks? branches, ATMs, agency banking outlets and through the internet. Using this channel, money transfer is set to be cheaper, for example, users sending Kshs 2,700 will pay Kshs 20 compared to mobile operator Safaricom?s M-PESA, which charges Kshs 55 for a similar transaction. Additionally, transfers below Kshs 500 will not pay any transaction fees. As highlighted in our Cytonn Weekly #6/2017, the PesaLink platform will (i) help to increase banks? non-funded income going forward, especially with the interest rate cap whose effects fully come this financial year, and (ii) increase financial inclusion within the country as more people will have access to more banking services on mobile and online platforms. However, whether the initiative succeeds or not is a matter of wait and see because developing a successful mobile payment platform is more dependent on innovation and technology capabilities, which M-PESA has developed over a decade, rather than just the numbers achieved by the coming together of banks.

The Central Bank of Kenya (CBK) is finalizing requests for licenses by two banks, Dubai Islamic Bank (DIB) Kenya and Mayfair Bank Kenya, which had received ?approval in principle? before the 2015 suspension of licensing. This statement from CBK is a step towards  lifting the moratorium on licensing of new commercial banks put in place in November 2015, 2 months after the closure of Imperial Bank over banking malpractices. Since the placement of the moratorium, foreign financial services players seeking to enter the Kenya?s banking sector had to enter through acquisitions, with Tanzania?s Bank M acquiring Oriental Commercial Bank, a pending acquisition of Fidelity Commercial Bank by Mauritius? SBM Holdings, and the recently concluded Giro Commercial Bank acquisition by I&M Holdings. Licensing applicants that meet laid down statutory criteria is positive for the market, because (i) it eliminates randomness in licensing and (ii) subjects the value of a license to market forces, rather than arbitrary regulatory actions.

Equity Group released FY?2016 results

Equity Group released FY'2016 results posting a 4.6% decline in core earnings per share (EPS) to Kshs 4.4 from Kshs 4.6 in FY'2015, attributed to a 21.8% growth in operating expenses to Kshs 39.1 bn, which outpaced a 14.2% growth in operating income. Key highlights from FY?2015 to FY?2016 include:

• Total operating revenue grew by 14.2% to Kshs 64.0 bn from Kshs 56.1 bn in FY?2015, faster than our estimate of a 5.9% growth. This was supported by a 22.5% growth in Net Interest Income, and a flat growth in Non-Funded Income of 1.3%;
• Interest Income grew by 19.3% to Kshs 51.8 bn from Kshs 43.5 bn in FY?2015, while Interest expense grew by 7.5% to Kshs 10.0 bn from Kshs 9.3 bn in FY?2015. The Net Interest Margin thus improved to 11.0% from 10.5% in FY?2015;
• Non-Funded Income (NFI) recorded a flat growth of 1.3% to Kshs 22.1 bn from Kshs 21.9 bn in FY?2015, above our expectation of a 2.4% decrease. The increase in NFI was driven by a 1.9% increase in other fees and commissions to Kshs 11.4 bn from Kshs 11.1 bn in FY?2015, and a 12.2% growth in foreign exchange trading income that came in at Kshs 3.3 bn from Kshs 2.9 bn in FY?2015. The current revenue mix stands at 65:35 funded to non-funded income from 61:39 in FY?2015;
• Total operating expenses grew by 21.8% to Kshs 39.1 bn from Kshs 32.1 bn in FY?2015 following a 173.1% y/y growth in Loan loss provision (LLP) to Kshs 6.6 bn from Kshs 2.4 bn. This was due to a pre-emptive provisioning approach adopted as a result of pressure in Micro- Enterprise and SMEs portfolio. Without LLP, operating expenses grew 9.4% to Kshs 32.4 bn from Kshs 29.7 bn registered in FY?2015. Staff costs grew by 13.0% to Kshs 11.6 bn from Kshs 10.3 bn in FY?2015;
• Cost to Income ratio deteriorated to 61.1% from 57.3% in FY?2015. Without LLP, Cost to Income ratio improved to 50.7% from 52.9% in FY?2015;
• Profit before tax increased by 4.0% to Kshs 24.9 bn from Kshs 24.0 bn in FY?2015. There was a one off increase in effective tax rate to 33.4% from 27.7% in FY?2015 as a result of the bank?s subsidiary in South Sudan, where the country experienced hyperinflation, and the bank subsequently provided for a net monetary loss charge amounting to Kshs 0.5 bn, that was nevertheless included in the tax calculation. This led to a 4.2% decline in profit after tax to Kshs 16.6 bn from Kshs 17.3 bn in FY?2015;
• Loans and advances book declined by 1.4% to Kshs 266.0 bn from Kshs 269.9 bn in FY'2015, lower than our expectations of a 10.0% expansion, due to management's decision to take a more prudent approach in lending, hence increasing the funds channeled to holdings of government securities, which offer a higher return a risk adjusted basis. Customer deposits grew by 11.6% to Kshs 337.1 bn from Kshs 302.1 bn in FY?2015, slightly lower than our expectations of a 15.1% growth. The Loan to Deposit ratio thus declined to 78.9% from 89.3% in FY'2015;
• Equity Group Kenya is currently sufficiently capitalized with a core capital to risk weighted assets ratio at 18.7%, 8.2% above the statutory requirement, with total capital to total risk weighted assets exceeding statutory requirement by 5.2% to close the period at 19.7%;
• The board recommended a final dividend of Kshs 2.0 per share, which equals a 7.2% dividend yield as at Wednesday?s closing price of Kshs 27.8.

Going forward, Equity Group will thrive on (i) diversification of income streams to support the growth of non-funded income. However, given the positioning of the bank as a fee income business, we would have expected better growth in NFI. We are beginning to wonder whether the fee income initiatives, such as Equitel are bearing fruits, and (ii) the company?s plans to shelve regional expansion plans, which is prudent given the challenges faced by Kenyan banks operating in South Sudan. As discussed in our KCB Group note, regional expansion for most of the Kenyan banks sounds seductive, but has proved to be a value destroyer. For a more detailed analysis, see our Equity Group FY?2016 Earnings Note.

Co-operative Bank released FY?2016 results:

Co-operative Bank released their FY'2016 results, recording a core EPS growth of 8.3% to Kshs 2.6 from Kshs 2.4 in FY'2015, slightly higher than our expectation of a 4.1% growth. This was driven by a 16.2% growth in operating revenue that outpaced a 15.2% growth in operating expenses. It is notable that Co-operative Bank is the only bank that has reported a core EPS growth so far. Key highlights from FY?2015 to FY?2016 include:

• Total operating revenue grew by 16.2% to Kshs 42.3 bn from Kshs 36.4 bn in FY?2015, driven by a 27.1% growth in Net Interest Income (NII) to Kshs 29.5 bn from Kshs 23.2 bn in FY'2015;
• Interest income grew by 14.9% to Kshs 42.3 bn from Kshs 36.8 bn, while Interest expense declined by 6.0% to Kshs 12.8 bn from Kshs 13.6 bn in FY'2015. The Net Interest Margin thus increased to 9.9% from 8.8% in FY?2015;

• Non-Funded Income (NFI) declined 3.1% to Kshs 12.8 bn from Kshs 13.2 bn in FY'2015, driven by a 43.5% decline in forex income to Kshs 1.8 bn from Kshs 3.2 bn in FY'2015. The current revenue mix stands at 70:30 funded to non-funded income from 64:36 in FY?2015;
• Total operating expenses grew by 15.2% to Kshs 24.6 bn from Kshs 21.4 bn in FY?2015 driven by a 28.7% increase in Loan Loss Provisions to Kshs 2.6 bn from Kshs 2.0 bn and a 31.3% increase in other expenses to Kshs 8.6 bn from Kshs 6.5 bn. Without LLP, operating expenses grew 13.8% to Kshs 22.0 bn from Kshs 19.4 bn registered in FY?2015. Staff costs also increased by 5.3% to Kshs 9.4 bn from Kshs 8.9 bn in FY'2015.
• The Cost to Income ratio improved slightly to 58.3% from 58.8% in FY'2015. Without LLP, the Cost to Income ratio improved to 52.1% from 53.2% in FY'2015
• Profit before tax increased by 15.2% to Kshs 17.7 bn from Kshs 15.4 bn in FY?2015. The effective tax rate increased to 31.6% from 25.6% in FY?2015 resulting to an 8.3% increase in profit after tax to Kshs 12.7 bn from Kshs 11.7 bn in FY?2015;
• Loans and advances grew by 11.0% to Kshs 236.9 bn from Kshs 213.4 bn in FY'2015 better than our expectations of 5.2% growth. Growth was supported by increased use of alternative channels to drive loan disbursement, with 83% of Co-operative Bank?s total transactions in the year facilitated on alternative channels. Customer deposits declined by 2.0% to Kshs 260.2 bn from Kshs 265.4 bn in FY?2015, as the bank sought to shed term deposits that were expensively priced in order to manage their cost of funds downwards instead of growing their funding deposits. The Loan to Deposit ratio thus increased to 91.1% from 80.4% in FY'2015;
• Co-op Bank is currently sufficiently capitalized with a core capital to risk weighted assets ratio at 16.1%, 5.6% above the statutory requirement, with total capital to total risk weighted assets exceeding statutory requirement by 8.2% to close the period at 22.7%;
• The bank recommended payment of a first and final dividend of Kshs 0.8 per share, and recommended a bonus share of 1 share for every 5 shares held.

Going forward, we expect Co-operative Bank growth to be driven by:

• Review of the regional expansion strategy with key focus on consolidation of its regional business by optimizing performance in the existing markets while reducing the overall impact from South Sudan. Co-operative Bank will have to focus more on the much profitable and stable Kenyan business,
• Revenue diversification with expected strong growth in its subsidiaries? such as Co-op Consultancy and Insurance Agency as well as Co-op Trust Investments Limited, through the introduction of new business lines in order to grow the NFI, and
• Continued implementation of cost reduction measures through adoption of digital platform and other alternative channels of distribution for both loan disbursement and deposit mobilization. This will help the bank achieve efficiency and keep the cost to income ratio at the targeted 50.0% levels. For a more detailed analysis, see our Co-operative Bank FY?2016 Earnings Note.

Of the 6 banks that have released their FY?2016 results, all except Co-op Bank have recorded a decline in core earnings per share, with the average decline in core earnings across the banking sector at 2.3%, owing to the tough operating environment as a result of the interest rate caps and higher loan loss provision. In addition, the sector has experienced lower loan and deposit growth, with the only metric that banks have been able to protect so far being their Net Interest Margins. Key to note also is that most banks, with the exception of Co-operative Bank and Barclays banks increased their exposure to government securities. This could be attributed to the change in loan and deposits pricing framework brought about by the interest rate caps that has made most lenders increase exposure to the risk-free government as opposed to other risky borrowers. Interest rates cap was meant to improve lending to the consumer, but so far the cap has curtailed lending and it is time to review them. The remarks by President Kenyatta this week that the government intends to rectify the decline in private sector credit growth as a result of reduced lending by banks, signals the intention to review the rates cap law in some way.

Below is a summary of the key metrics;

*Average market cap weighted

Liberty Holdings released FY?2016 results:

Liberty Holdings released their FY?2016 results posting a 14.6% decline in core earnings per share (EPS) to Kshs. 1.2 per share from Kshs. 1.4 per share, against our projection of an 8.0% increase. The decline is attributed to a 26.4% increase in net insurance benefits and claims to Kshs 4.0 bn from Kshs 3.1 bn in FY?2015, which outpaced a 9.1% increase in total revenue. Key highlights include:

• Total revenue increased by 9.1% to Kshs 9.0 bn from Kshs 8.3 bn in FY?2015, driven by a 39.2% increase in investment income to Kshs 2.6 bn from Kshs 1.8 bn and a 9.7% increase in commissions earned to Kshs 0.9 bn from Kshs 0.8 bn in FY?2015;
• Gross earned premiums grew by 2.9% to Kshs. 9.6 bn from Kshs. 9.4 bn in FY?2015. This was underpinned by (i) the group?s focus on customers with prudent underwriting and benefits management, and (ii) great synergy in their distribution networks;
• Net claims and benefits increased by 26.4% to Kshs. 4.0 bn from Kshs. 3.1 bn in FY?2015 against our projection of a 32.2% increase. This subsequently led to an increase in loss ratio to 70.9% from 56.6% in FY?2015;
• Total expenses decreased marginally by 1.5% to Kshs. 4.1 bn from Kshs. 4.2 bn vs our projections of a 2.4% increase, leading to a decrease in the expense ratio to 74.1% from 75.9% in FY?2015. The decrease was driven by a 1.9% decrease in other operating expenses to Kshs 2.9 bn from Kshs 3.0 bn in FY?2015. This led to an increase in the combined ratio to 145.0% from 132.4% in FY?2015;
• Profit before tax declined 1.2% to Kshs 0.9 bn from Kshs 1.0 bn in FY?2015, while profit after tax was down 14.7% to Kshs 0.6 bn from Kshs 0.7 bn in FY?2015 following an increase in effective tax rate to 33.3% from 22.8% in FY?2015;
• The board recommended no dividend payment on account of changes in the regulatory environment requiring an increase in the amount of capital held by insurance companies.

Going forward, Liberty's growth will be driven by diversification of their products and introduction of new and competitive products as highlighted in our Cytonn Weekly #36. Key risks remain subdued equities and bond market performance as the insurer relies heavily on investment income. For more detailed analysis on Liberty Holdings FY?2016 earnings, see our Liberty Holdings Earnings Note.

CIC Group released FY?2016 results:

CIC Group released their FY?2016 results, recording an 83.4% decline in earnings per share to Kshs 0.1 from Kshs 0.4 in FY?2015 against our projection of a 46.9% decline. This decline was attributed to a 21.6% increase in operating expenses to Kshs 4.6 bn from 3.8 bn and a 5.5% decline in total revenue to Kshs 13.1 bn from Kshs 13.8 bn. Key highlights include:

• Total revenue declined by 5.5% to Kshs 13.1 bn from Kshs 13.8 bn attributed to a 6.5% decline in net premiums to Kshs 10.0 bn from Kshs 10.7 bn in FY?2015 and a 16.3% decline in investment income to Kshs 1.3 bn from Kshs 1.5 bn in FY?2015;
• Gross written premiums rose by 7.8% to Kshs 12.3 bn from Kshs 11.4 bn mainly attributed to improved quality of business in most of the business lines;
• Investment income decreased by 16.3% to Kshs 1.3 bn from Kshs 1.5 bn as a result of the depressed NSE-listed stock prices resulting into unrealised losses of Kshs 143.0 mn;
• The loss ratio decreased to 64.5% from 67.9% due to a decline in claims and policyholders? benefits expense by 11.2% to 6.5 bn from 7.3 bn;
• Total expenses grew by 3.7% to Kshs 13.0 bn from Kshs 12.5 bn attributed to an 11.5% increase in commission expenses to Kshs. 1.5 bn from Kshs 1.4 bn, and a 21.6% increase in operating and other expenses to Kshs 4.6 bn from Kshs 3.8 bn. In addition, the insurer suffered a loss of Kshs 297.5 mn following the hyper-inflation reporting in South Sudan and also as a result of South Sudanese Pound (SSP) devaluation;
• Profit before tax declined by 91.5% to Kshs 0.1 bn from Kshs 1.3 bn, while profit after tax declined by 83.4% to Kshs 0.2 bn from Kshs 1.1 bn. This is attributed to CIC experiencing a tax credit of Kshs 73.8 mn in FY?2016;
• The board recommended a dividend payment of Kshs 0.1 per share, same as in FY?2015. This results in a payout of Kshs 0.3 bn, with Kshs 0.1 bn being financed from retained earnings.

Going forward, CIC Group?s growth will be driven by (i) strategic partnerships with various banks and other alternative channels to enhance market penetration, such as the partnership with Co-operative bank to offer bancassurance services, and (ii) increase in its equities and property investments portfolio through its asset management subsidiary to grow the investment income. The key risks remain their exposure in South Sudan, which may continue to erode shareholders? value. For more detailed analysis on CIC Group FY?2016 earnings, see our CIC Group Earnings Note.

Below is our Equities Recommendation table. Key changes from last week include;

• BAT has been placed under review following the release of its FY?2016 earnings. We will be meeting with management to discuss the FY?2016 results and the business strategy going forward in order to update our valuation,
• Equity Group moved to an ?accumulate? recommendation, with an upside of 16.6% from a ?buy? recommendation with an upside of 23.6%, following a 6.5% w/w price increase,
• Co-op Bank moved to a ?lighten? recommendation, with an upside of 3.3% from an ?accumulate? recommendation with an upside of 16.0%, following a 13.3% w/w price increase,
• CIC Group and Liberty Holdings has been placed under review following the announcement of weak earnings growth,
• This week we re-introduce Safaricom to our recommendation list with an updated valuation after meeting with management. We do not expect the findings of the dominance report to impact the firm as even the Communications Authority of Kenya (CA) is against recommendation to split Safaricom?s non-telecom business lines from its telecom business lines. Management also dispelled such a move citing that this would only be warranted in a case where there was abuse of dominance. Going forward, we expect M-PESA and data to remain the main revenue drivers for Safaricom. Safaricom has successfully completed the pilot test phase of the M-PESA linked debit card, which will further make it more convenient for M-PESA customers to carry out transactions on the M-PESA platform. We upgrade our recommendation from a ?sell? with a target price of Kshs 16.6 to an ?accumulate? with a target price of Kshs 19.8.

We remain "neutral with a bias to positive" for investors with short to medium-term investments horizon and are "positive" for investors with long-term investments horizon

Private Equity

Maris Capital, a Mauritian investment holding company with interests in real estate property, mining and agriculture, has received support from other investors through funding of its investment vehicle Africa Logistic Properties (ALP). The USD 70.0 mn investment vehicle, which is looking to invest in developing and managing grade A warehouses in sub-Saharan Africa, will receive the greater share of its funding requirements from an investor consortium that will jointly contribute USD 48.0 mn, which is 68.5% of the planned investment. The consortium is made up of CDC, the UK?s development finance institution, IFC, a member of the Word Bank Group, Maris Capital and Mbuyu Capital Partners, an Appointed Representative of Privium Fund Management (UK) Limited, each contributing USD 25.0 mn, USD 10.0 mn, USD 8.0 mn and USD 5.0 mn respectively. In our view, investments in development of Grade A warehousing is a well thought out opportunity as it is supported by (i) an increase in demand for quality warehousing in sub Saharan Africa, as occupiers currently paying USD 4.2 per square meter per month for prime logistic space in Nairobi are ready to pay up to USD 6.0 per square meter per month for space of similar standards and quality as warehousing space in South Africa or Eastern Europe, and (ii) attractive yields and return on investment from warehouse development, with total returns of 10.4% and 11.1% in Mombasa road and Industrial Area respectively, according to the Cytonn Warehouse Research Note.

Dutch PE firm DOB Equity targets to double its Kenyan investment portfolio this year. The fund is scouting for investment opportunities in Kenya where it already has stakes in eight ventures across sectors such as retail, agribusiness, education, and energy. The East Africa-focused fund typically invests between Kshs 27.3 mn and Kshs 218.0 mn in mid-sized firms for a minority stake ranging from 25.0% to 49.0%. DOB Equity expects to make at least three new investments in 2017 and follow-on deals in existing portfolio companies which include the pay-as-you-go solar provider M-Kopa, solar lighting and appliances firm Barefoot Power, low-cost chain of schools Bridge International Academies, Lake Victoria ferry operator Globology Ltd, Twiga Foods, solar micro grid company PowerGen and their latest investment of an undisclosed amount in Countryside Dairy. The continued interest in Kenya by Private Equity firms indicates a positive performance outlook for the sector this year, which is supported by (i) attractive valuations in the private sector, and (ii) strong economic growth projections, compared to global markets.

Private Equity Africa released their Private Equity Annual Review report for 2016, highlighting an overall year-on-year drop in both Mergers & Acquisitions? (M&As) deal volumes and deal values across the region. As per the report, there were a total of 754 reported M&As, valued at USD 25.8 bn compared to about 830 deals valued at USD 56.0 bn in 2015, a 0.1% and 117.1% decrease in volume and deal value respectively. The decrease can be attributed to reduced attractiveness of commodity reliant African countries, such as  Nigeria, which felt the impact of falling commodity prices. Of the 754 total deals reported, 308 came from South Africa while Kenya ranked 4^th with 40 deals. Egypt and Nigeria ranked second and third, with 89 and 46 deals respectively. More than half of these deals were in the technology, retail sector and consumer goods sectors. However, 2017 is expected to be a better year for Africa?s private equity sector as we expect improved performance which will be supported by (i) optimism on the performance of oil and commodity prices, and (ii) continued growth of the middle class and their need for goods and services, an example being the shift from cash to electronic means of payment in the financial services sector.

Private equity investment activity in Africa has continued to improve, as evidenced by consistent investor interest in the continent. Preference this was skewed towards the Real Estate sector. We remain bullish on PE as an asset class in Sub-Saharan Africa given (i) the abundance of global capital looking for investment opportunities in Africa, (ii) attractive valuations in the private sector, and (iii) strong economic growth projections, compared to global markets

Real Estate

The hospitality sector in Kenya continues to attract investors as they tap into the demand for accommodation brought about by increased tourism, leisure and business travel. This was evidenced this week with the Sarova Group of Hotels signing a contract to manage a Kshs 1.3 bn hotel in Nakuru. The hotel named Sarova Woodlands, is set to open to the public in May 2017. It will consist of approximately 146 rooms and conference facilities among other key amenities. Sarova Woodlands hotel will mainly target business and leisure travelers who are the key contributors to the performance of hospitality sector. This is supported by the fact that;

• The number of both the local and international delegates have been increasing steadily over the past 5 years at 3.3% and 20.9%, respectively, according to the KNBS 2016 Economic survey,
• Holiday travelers accounted for 72.0% of international arrivals while business travelers accounted for 11.0% multinational conferences in 2015, and
• SMEs, county governments and businesses are boosting hospitality as both local and international delegates create demand for conference facilities. Local conferences increased in 2015 by 4.0% to a total of 3,199 according to the KNBS 2016 Economic survey

The hotel is expected to offer quality services in accordance to the standards of the Sarova brand that is ranked as 4 - star by the Kenya Tourism board in 2016.  We are of the view that the hotel is likely to record high returns as it serves the high hotel demand in Nakuru. This is also supported by;

• Devolution that has resulted in increased demand for conference facilities, seminar venues and meeting places for County Governments and their committees, and
• Government efforts to improve the hospitality sector. For example, the government waived visa fee for children less than 16 years in 2016 applicable to all nationalities, in an effort to position Kenya as a family holiday destination among others

4 - star hotels in Kenya recorded the second-best returns at a 44% measured by total revenue per room as a percentage of the average daily rate (TREVPar/ADR) as shown below,

Source: Cytonn Research

In terms of regional performance, Nakuru recorded occupancy rates of 29% and TRevPar of 81 USD, compared to market average of 33% for occupancy and TRevPar of 98 USD as shown on the table below in 2016;

 Source: Cytonn Research

Still focusing on hospitality sector, during the week, Kenya Wildlife Service (KWS) announced the completion of the Northern tourism circuit connecting with that of the Coast. The programme, was funded by the French Government and it involved initiation of community-based projects in Isiolo, Tana River, Garissa, Kitui, Tharaka-Nithi and Meru national reserves at a cost of Kshs 56.0 mn. The programme majorly aimed at;

• Rehabilitation of game reserves in Northern Kenya and the Meru National Park,
• Conservation of biodiversity of the protected areas and the peripheral zones occupied by human beings, and
• Improving infrastructure such as construction of 14.0 km access road linking Murera and Maua in Meru County, security and welfare of the communities living around the parks.

This move by the KWS will see improved performance in tourism sector especially focusing on safaris. According to Cytonn research, safari product recorded high TRevPAR averaging at USD 125 and occupancy of 30% in comparison to other products such as beaches at TRevPAR averaging at USD 57 and occupancy of 29%. However, the tourism sector continues to face challenges such as terrorism, mainly in northern Kenya and hence will lower the number of both local and international tourists in these areas. We therefore remain neutral on the performance of the Northern region until government solves the issues on terrorism and banditry.

The construction sector continues to attract foreign investors into Kenya as they try to tap into the demand for construction materials. Cement consumption went up by 9.9% in 2015, driven by increased developments in infrastructure and real estate. This is evidenced by Nigeria?s Dangote intentions to put up a cement factory in Kenya. This was initially scheduled for 2018, however, they have pushed the entry into Kenya to 2021. The company is set to build two plants of 1.5 million tonnes per annum capacity each, near Nairobi and Mombasa, to serve the Kenyan local market. Dangote Cement is however exporting cement to Kenya from its Ethiopian plant at a price approximately 20% lower than the locally manufactured brands. This has thus led competition that has seen local companies decline in sales citing competition from the cement being imported. With the impact, already being witnessed before the setup of the factory, we expect once the factory is operational to witness the following outcomes:

• Stiff competition among cement production companies, which will lead to price wars hence decrease in cement prices that will translate into decreased construction cost,
• Increased innovation and productivity, in pursuit of product differentiation due to increase in number of cement companies in Kenya, with 6 players currently operating in the market, and
• Increased production in construction sector that will translate into increased Real estate and construction contribution to Kenyan GDP

We expect increased activities in real estate sector mainly focused on infrastructure developments by the government as well as in the hospitality sector as they take advantage of improving legal environment and increased supply of construction materials by both local and foreign companies.