A number of us spent the past
couple of months wondering where all the dollar in the country was hiding,
while some got down to making analysis and predictions about if and when the
CBN will give in on it’s hard stance, however, majority where left perplexed,
only imagining what a better FX Regime would mean for their investments.
Why don’t we start with a brief history,
shall we? Now, remember the global commodity price crash of 2014? I’m sure you
do. Well we can refer to this as the genesis of the whole devaluation story.
And what am I trying to say? Well a good number of Oil exporting nations were
hit hard and our dear country Nigeria wasn’t exempted.
Without overwhelming anyone with so
many technical details, let’s review how a crash in oil prices became negative
for the Nation. To begin with, Nigeria earned, and STILL EARNS over 75% of its
revenue from oil exports. Therefore, since the primary currency with which oil
is traded globally is the green back (a.k.a dollar), a fall in global oil
prices translates to less dollar receipts in the Nation’s coffers.
Ideally, just like every business,
lower revenues result in lower income or profits. The same goes if you consider
Nigeria as a company in the business of selling crude oil to other nations.
Lower oil prices mean less revenue, which in turn means fewer funds for
Government spending. Since government spending spurs economic growth, a
reduction of government’s funds can only gradually cause an overall slowdown in
macroeconomic growth.
Permit me once again to use the
company analogy. Now we know that if a company is recording lower revenues
consistently, it can most likely be linked to the following factors:
·
there is
less demand for its product
·
it is not
operating efficiently enough to meet customers’ demands with its supplies
·
high
competition amongst other market players have forced the price of the goods and
services it produces to shrink.
For the leading oil exporting
Nations especially Nigeria, factor 3 played a major role in the consistently
sharp decline seen in government’s revenue for the past two years.
At this point, I feel the need to
name our hypothetical company. Let’s settle for the name “ABC Corporation”. Now imagine the board of ABC Corp having realised
a steady and critical decline in its revenues becomes very eager to salvage the
situation. Siting the three factors previously stated, the board is restricted
to pursuing one or all of the following solutions;
· Revamp its
agency and marketing department, overhaul its product design to boost
attractiveness, and spend huge sums on advertising, all in a bid to achieve one
thing – increase product demand.
·
Fix its internal
operational issues to ensure it can supply at optimal efficient levels.
· Now this is
where it gets interesting; a third solution may be to form or join an existing
‘cartel’ amongst competing firms with the intent to drive market price upwards.
Okay, so now I have gotten the
attention of most people, let me begin to paint the same picture in the
Nigerian context.
Take Nigeria to be ABC Corporation,
with the incumbent government as the ABC board, its paramount goal being to
increase revenue. Now let’s review those three solutions again.
· Demand: China, the United States, and the European Union are the largest crude
oil importers in the world. In 2015, they consumed slightly over 30 mbpd
(million barrels per day) of crude oil and liquid fuels. Now one may wonder why
Nigeria being one of the top six global exporters of oil isn’t benefiting fully
especially with the magnitude of demand from the above mentioned big buyers.
The problem here is that while China and the EU have recently been experiencing
setbacks in their economies which hampered demand for oil, US on the other hand
(with the advent of a boom in its shale production), recently stopped importing
oil from Nigeria. In any case, countries like Saudi Arabia, Russia and Kuwait, (topping
the list of global exporters), all combined, export about 18 mbpd. All this
goes to show that Nigeria has little influence of making the demand factor work
in its favour, leaving us with just two other solutions.
· Supply: Just as ABC Corp’s board fixes its internal operational issues to boost
production and supply, recent efforts have been made by the government to fix
old refineries and build new ones. While we saw steady progress in the achievement
of the aforementioned, huge setbacks appeared in the form of sabotage, and very
recently the outright destruction of oil installations by the much talked about
‘Avengers’. These hindrances undoubtedly impacted negatively on the nation’s
volume of output. Now, the combined
effect of having a global oil market already awash with oil, weak demand for
Nigeria’s oil, as well as its thinning supply can only mean one thing – decline
in revenues. With two solutions out of the way, let us focus on a third.
·
Price: Unlike ABC Corp seeking to form or join a ‘cartel’, Nigeria already
belongs to one called ‘OPEC’. Unfortunately, OPEC has displayed apparent
anti-competitive cartel behaviour through the organization's agreements about
oil production and price levels. What do I mean by this? Well, it’s simple, logically
speaking, cartels work to fix prices in their favour, sometimes propping up
prices by limiting supplies. However, for fear of losing its market share to U.S
Shale producers, OPEC instead let prices decline enough (by not capping its
supplies) to begin curbing investment in new shale wells. This technique ended
up being counterproductive for both OPEC and Non-OPEC members, and countries
like Venezuela, Brazil and Nigeria have suffered huge economic setbacks on account
of it. So now, we see that Nigeria has no influence on the price factor as
well.
With Nigeria running out of
possible solutions on shoring up its dollar earnings from oil exports, the next
best thing or should I say the inevitable last resort, was to consider
devaluing its currency, and indeed, from 2014 to date, we saw the Nigerian
Interbank Naira/Dollar rate fall from N156/$ to N199/$ to eventually settle
recently at N281/$ levels.
While there have been many
arguments for and against devaluing the naira, I will settle just for
highlighting the effect of the naira devaluation on our dollar earnings and
reserves. So, to put it simply, from a N156/$ rate to a N281/$ rate, the nation
stands to get more naira (upon conversion) for each dollar earned. Technically
speaking, with the devaluation, there is more naira for the government to spend
against its shrinking dollar receipts.
Now let’s bring ourselves back to
the main question - what’s in it for your portfolio? Without dwelling so much
on the negative impacts of a valuation, one key concern for many is that
devaluation in most cases may lead to a higher inflation rate, and if this is
so, then the major objective for any investor will be to earn positive real
returns on all investments. This means being able to earn returns above the
inflation rate. Once this is not achieved, your disposable income shrinks (not
in nominal terms) as you spend more naira per unit item purchased or consumed.
Research has recently proven that
equity investors earn higher returns (in the long term) than Investors in other
asset classes. The caveat here is that only those with moderate to high risk
appetites end up telling a good story about their experiences in the equities
space. In any case, the trick is to invest in fundamentally sound companies. If
you are as psychic as I am, then you may agree that the next question for many
will be “how do I tell what companies are fundamentally sound?” The answer lies
in looking out for companies that exhibit the following qualities; sound
corporate governance practices, transparency, quality, and timeliness of
financial reporting, quality of earnings and cash flow, history of profit
retention for funding future growth, and so on.
Having all these at the back of
your mind, the next big thing is to choose your stocks, and if you still feel
you are not ready, you can consult your financial planner or adviser for help.
For those who however decide to grow their investments in equities, without
going all out to make stock recommendations on this write up, I will
nevertheless leave you with the following tips on sectors likely to benefit
from the recent devaluation.
Like I mentioned earlier, there
have been many arguments for and against the devaluation. This has also applied
to companies. For companies that had huge dollar denominated debt before the
devaluation, the devaluation can only mean an increase in its debt, putting
further strains on its debt financing. In such cases, such an organisation may
suffer a few setbacks in its business operations and most times will opt for a
restructuring of its loans. The flip side will apply to companies that earned
dollar denominated revenues (either because they have business operations
abroad, or sales from local business transactions warrant earnings in foreign
currency) before the devaluation. In this case, such organisations will see a
nominal increase in revenues, and if they are able to manage their operations
efficiently, such spikes in revenues may lead to better earnings for both
companies falling into this category and investors in such companies.
It doesn’t really matter what side
of the debate you are on – for or against – what matters at this point is your
ability to utilise and make the best out of the opportunity herein. So go out
there and make profitable investment decisions.
See you again.
