Profit margin will be eroded in the manufacturing sector – Muda Yusuf
As inflation in Africa’s largest economy records its first rise in December after consecutive drops in eight months, the immediate challenge for portfolio managers and investors is a drop in Return on Investment and declining profit margin in the manufacturing sector. Meanwhile, financial pundits in the capital market have suggested that rotation of the equities portfolio from growth to value stocks will cushion the effect of the rising inflation on their investment in 2022. BAMIDELE FAMOOFO reports.
Portfolio managers and investors in Nigeria’s equities market should be ready for a difficult time if inflation, which increased from 15.40% in November to 15.63% in December 2021 continues to rise in 2022.
The immediate challenge for investment in the nation’s equities market would be that return on investment will dwindle as portfolio managers and investors would struggle to achieve real returns on investment (ROI above the prevailing inflation rate).
But financial experts have said there is a way out of the dilemma. Chidera Mbelede, stock analyst at Cordros Securities Limited, while reviewing the negative impact of rising inflation on investment in Nigeria, noted that both portfolio managers and investors might adopt the strategy of rotating their investment portfolio from growth to value stocks.
According to Mbelede, rather than investors waiting endlessly to earn dividends from their portfolio, they will need to concentrate on equities that have fundamentals and are able to appreciate in price within a limited time space to be able to achieve a desired ROI.
Also recommending a winning strategy for investors in 2022 while considering possible rise in inflation, Abdulazeez Kuranga, another financial analyst at Cordros Securities Limited, advocated that investors rotate their equities portfolio from growth to value stocks as they are poised to perform well in an inflationary environment. “Interestingly, we believe there are value stocks in the market that have the potential for capital appreciation and trade at attractive dividend yields that can compete favourably with fixed income yields over the medium term,” he added.
Muda Yusuf, Economist/Chief Executive Officer, Centre for the Promotion of Private Enterprise, noted that rising inflation will impact the productive sector negatively, as profit margin will drop due to escalation of production and operating costs of businesses.
The former Director General of the Lagos Chamber of Commerce and Industry warned that high food prices will impact adversely on citizens’ welfare and aggravate poverty.
“It will result in weak purchasing power which poses significant risk to business sustainability, price volatility which undermines investors’ confidence,” he said.
Yusuf, who attributed the latest rise in inflation to the surge in consumer spending driven by the December festivities, said exchange rate depreciation has a significant impact on headline inflation, especially the core sub index. He noted that liquidity challenges in the foreign exchange market are impacting adversely on manufacturing output while security concerns in the country which are affecting agricultural output may continue to drive food inflation higher in the months ahead.
Data from the National Bureau of Statistics released in January showed that food prices rose by 2.19% m/m (November: 1.07% m/m) – significantly above the 2021 monthly average (1.34% m/m) and the highest since May 2017 (2.54% m/m).
Thus, the prices for farm produce – both staple and cash crops have remained significantly above the five-year average and last year. Sequentially, Farm produce, (2.38% m/m vs November: 0.93% m/m) and Processed food (2.14% m/m vs November: 1.11% m/m) prices rose to a 56-month high while the imported food sub-basket rose slightly by 1bp to 1.37% m/m. On a year-on-year basis, food inflation increased by 16bps to 17.37% y/y (November: 17.21% y/y). Year-on-year, prices rose across the Farm produce (+39bps to 17.06% y/y), Processed food (+10bps to 17.46% y/y) and Imported food (+6bps to 17.34% y/y) sub-baskets.
Outlook
Experts expect the festive-induced demand to have dissipated in January 2022 in line with the winding down of the festive season. Accordingly, they expect food prices to rise, albeit slowly over the short term, because of the pre-existing structural issues amidst the high base effect from the prior year. Consequently, Cordros Securities forecast food inflation to rise by 1.52% m/m in January 2022.
On the other hand, for the core basket, the gradual depreciation of the NGN/USD rate at the parallel market has reflected recent pressures at the official window.
“Barring any significant improvements to the overall FX liquidity outlook, we expect this to mount added pressures on the prices of goods and services being produced by manufacturers accessing this window for their FX needs. In addition, we expect to see a sustained uptrend in utilities, transport and education prices given the (1) increase in gas and diesel prices and (2) additional taxes being imposed on education services based on the 2021 Finance Act. Accordingly, we expect the core inflation to rise by 1.15% m/m.”
Overall, analysts look for a m/m headline inflation of 1.36% in January, with the high base effect from the prior year translating to a y/y reading of 15.47%.
Bismarck Rewane, Chief Executive Officer, Financial Derivatives Company Limited, is of the opinion that domestic inflation will increase further in the coming months due to the imminent removal of petrol subsidy and the planting season effect amongst other factors. Rewane hopes the Monetary Policy Committee meeting that will meet this week will consider raising interest rates to curb inflation.
“This increases the chances of a tighter monetary policy stance although it is highly unlikely at this time,” he said.
“Rewane hopes the Monetary Policy Committee meeting that will meet this week will consider raising interest rates to curb inflation. This increases the chances of a tighter monetary policy stance although it is highly unlikely at this time
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Winning strategies for investors
Although inflation rate is expected to moderate in 2022FY in line with the favourable base effect from the prior year, analysis shows that the headline inflation would print 13.55% y/y by year-end, which remains stubbornly high compared to the CBN’s target band of 6.0% and 9.0%. The preceding presents a herculean task for portfolio managers and investors who look to generate returns above the inflation rate. Accordingly, we advocate that investors rotate their equities portfolio from growth to value stocks as they are poised to perform well in an inflationary environment. Interestingly, it is believed that there are value stocks in the market that have the potential for capital appreciation and trade at attractive dividend yields that can compete favourably with fixed income yields over the medium term.
In the fixed income market, Analysts at Cordros expect robust system liquidity over Q1-22. They believe that increased liquidity would be supported mainly by inflows from matured instruments (bond maturities: N605.31 billion; and OMO maturities (N1.25 trillion). However, they noted that a significant portion of the liquidity could be absorbed through the CBN’s excessive Cash Reserve Ratio (CRR) debits.
“Besides, we anticipate the DMO would frontload some of its borrowings in line with (1) historical trends and (2) robust system liquidity amidst the expectation of yield’s increase over the next three quarters. Hence, we expect yields to increase slightly in Q1-22. We also expect yields to maintain the same momentum in the subsequent quarters, underpinned by a plethora of factors, including (1) thin liquidity conditions, (2) MPC switching to a hawkish monetary policy stance, (3) increased demand for risk-adjusted returns due to the elevated political risk brought by pre-election activities, (4) uptick in inflation as high base effects wane, and (5) possible increased reliance on the domestic market to finance the 2022FY fiscal deficit.” Accordingly, Cordros’ short-term strategy for investors favours holding cash and reducing exposure to variable income fixed-income assets while preferring assets such as fixed placements.
Recommendations
Yusuf recommended measures to be taken by policy makers and the government to tackle inflation.
“To tame the current inflationary pressure, the government needs to reform the foreign exchange market to stabilise the exchange rate and reduce volatility, address forex liquidity issues through appropriate policy measures; tackle the security concerns causing disruption to agricultural activities and reduce high transportation cost,” he said.
He also called on the Central Bank of Nigeria to reduce its fiscal deficit financing to minimise incidence of high-powered money in the economy, among others.
