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HC: Is The Supply Chain Crisis Impacting Capital Markets

  • Is The Supply Chain Crisis Impacting Capital Markets

 

Banks and investors are monitoring current supply chain imbalances closely. Capital markets are definitely impacted when the global supply chain experiences turbulence. Therefore, Capital Market suppliers like banks and investors in the Middle East and Egypt are paying close attention to how certain circumstances are impacting the global supply chain and capital markets.

 

As the world comes out of a global pandemic, we are entering into a Russia/Ukraine war that further compounds what was already a supply chain crisis. The doubling of these two worldwide occurrences has created a supply chain imbalance that hasn’t been previously observed. HC Securities & Investments is taking this moment to carefully navigate Capital Markets with our investors and clients’ best interests in mind. In this article, we will discuss exactly what is causing the supply chain crisis. As well as how Capital Markets are being impacted by it.

 

  • Global Factors & Geopolitical Issues Impacting The Supply Chain Crisis & Capital Markets

Just when COVID restrictions have begun to clear up, geopolitical conflicts like the Russia/Ukraine war offer new limitations and have caused some serious supply chain crises. Here are a few reasons why.

 

  • Port Congestion As China Increases Output

Chinese ports have been working in overdrive to first take in as many returning empty shipping containers as possible. As Chinese manufacturers ramp up production to meet increased consumer demand, the shortage of containers and surplus of goods has created massive congestion that is impacting Middle Eastern & Egyptian supply chains. Because the global supply chain and capital markets are inextricably linked, we are seeing a residual knock-on effect from port congestion that stimulates market volatility.

 

  • Spillover Impacts Global Ports Already Congested From Covid Restrictions

The Russia/Ukraine war has been raging with no sign of surrender from either side. Grain & fuel shortages around the globe are only one of the spillover effects the Middle East & Egypt are facing. Additionally, global ports where cargo has traditionally been shipped are facing extreme congestion as they try to compensate for other ports that have been closed or shut down due to the Russia/Ukraine conflict. This congestion only further bolsters supply chain imbalances that skyrocket consumer demand, and consequently inflation.

 

  • Russian Airspace Restrictions Delays Air Freight Transportation

Air transportation, especially along the Asia-Europe route has been severely altered. While air freight from China to the Middle East can avoid Russian and Ukrainian air space. The overall limitations and additional restrictions have created an environment where air freight liners are forced to prioritize certain, more important goods over others, causing shortages of goods in some areas.

 

  • Global Shortage of Truck Drivers Still Looms

Manufacturers, ports, and logistics firms were already being pushed to the edge throughout covid. This new Russia/Ukraine conflict has added an extra layer of pressure that has caused many truck drivers and port machine operators to simply quit. A global shortage of truck drivers everywhere has to be factored into the cost of goods now.

 

  • Congested Overland Rail Freight From China

Ports and rails are being pushed to the limit to keep up with consumer demand. This push to deliver has even congested overland rail freight routes coming out of China. Everyone destined for Northern European regions now have to avoid Russian rails and ship through Asia. The overall burden placed on rail operators is enormous.

 

  • Banks & Investors See Correlation Between Supply Chain Issues & Inflation

As many of the global factors and geopolitical issues listed above stimulate supply chain issues, inflation seems to tag along as an undesirable consequence. Foundational supply & demand principles dictate as consumer demand increases, manufacturers produce increased inventory to meet the demand. This in turn stimulates rises in costs, and inflation as customers are willing to pay increased costs for the products they demand.

 

Investors in the Middle East and Egypt understand this all too well and have taken a position within inflation-resistant markets. Firms like HC Securities & Investments is helping investors manage supply chain imbalances and inflation by shifting investor portfolios to more stable investments. Research shows that industries like healthcare and information technology have been somewhat resistant to the supply chain crisis and offer better stability for banks and investors.

 

 

 

HC expects the CBE to hike policy rates by 200 bps

  • HC Securities & Investment shared their expectations on the likely outcome of the MPC meeting scheduled August 18th and based on Egypt’s current situation, they expect the CBE to hike policy rates by 200 bps.

Head of macro and financials at HC, Monette Doss commented: “ The July inflation figure came in higher than our estimate of 13.0% y-o-y, and we expect it to average 14.2% over the rest of the year, well above the CBE’s inflation target of 7% (+/-2% for 4Q22). Looking at Egypt’s external accounts, we believe that pressure is accumulating on the country’s balance of payment (BoP), including (1) our FY21/22e current account deficit estimate of 4.8% of GDP, up from 4.6% a year earlier, (2) April remittances declining c7% m-o-m to USD3.1bn, (3) the banking sector’s (excluding the CBE) net foreign liability position widening to USD11.5bn in June, (4) the drop in foreign currency deposits, not included in the official reserves, to USD0.89bn in July from USD11.2bn in December, (4) net international reserves settling at USD33.1bn representing 4.71 months of imports coverage, and (5) Egypt’s external debt repayment schedule showing dues (excluding GCC deposits) of USD12.1bn over FY22/23. Against this backdrop, we believe a 200 bps interest rate hike coupled with c9% currency devaluation to EGP21.2/USD is necessary to support the currency and combat dollarization. As such, we also perceive the possibility of reintroducing high-interest rate deposits by state-owned banks to boost remittances, especially with rising GCC income levels. Assuming full currency floatation and applying Egypt’s current 1-year USD sovereign credit default swap (north of 1,400 bps) together with Egypt-US inflation differential, we believe that 12M T-bill yields could increase to 18.3%, from 16.4% currently. At this rate, Egypt’s 12M T-bills will be offering a real yield of 288 bps (given our 12M inflation estimate of 12.7% and a 15% tax rate for European and US investors) compared to a real return on the US 2-year notes of negative 265 bps (given 1-year notes yield of 3.10%, Bloomberg average 12M inflation estimate of 5.75% and assuming no taxes). That said, we expect the MPC to hike policy rates by 200 bps in its upcoming meeting.

It is worth mentioning that, in its last meeting on 23 June, the Central Bank of Egypt’s (CBE) Monetary Policy Committee (MPC) decided to keep key policy rates unchanged after increasing it by 300 bps y-t-d, including 200 bps in May and 100 bps in March, concurrent with the Federal Reserve Bank’s (Fed) cumulative interest rate cuts of 225 bps y-t-d. Egypt’s annual headline inflation accelerated to 13.6% in July from 13.2% in the previous month, with monthly inflation increasing 1.3% m-o-m, compared to a decline of 0.1% m-o-m in June, according to data published by the Central Agency for Public Mobilization and Statistics (CAPMAS).

CIRA: Favorable growth dynamics

  • CIRA expansion plan implies increasing registered students and revenue at a 2022–29e CAGR of c13% and c25%, respectively, with some pressure on EBITDA due to rising OPEX

  • Planned annual CAPEX average EGP940m over the next five years  for CIRA with average debt/equity of 1.19x, on our numbers

CIRA’s expansion plan should reflect in the number of registered students growing at a 202229e CAGR of c13%, on our numbers: The company’s Badr University in Assuit (BUA) should start operations next September with six to seven science-focused faculties including physical therapy, nursing, dentistry, and biotechnology. The company plans to add two new faculties annually to reach 16 faculties by 2028e with a total capacity of 24,000 students. The company plans to start the operations of its Cairo Saxony University for Applied Sciences and Technologies (CSU) in 2024e with some four cohorts and add two annually to reach a total of 16 faculties by 2030e, with a total capacity of 32,000 students. CSU will be established under a joint venture between CIRA and Al Ahly Capital, named Al Ahly CIRA for Educational Services, in which CIRA owns 51%. CIRA will own 60% of CSU and Al Ahly Capital 40%. The company also expects to start the operations of its New Damietta university in 2025e with some four faculties and will add two annually to reach 16 faculties by 2031e with a total capacity of 24,000 students. The New Damietta university will be established under a joint venture between CIRA and El Sewedy Capital Holding, named Cairo Egypt for Education (CEE), where CIRA will own 60% of the university and El Sewedy Capital will own 40%. The company plans to increase its higher-education capacity from 25,000 students in Badr University in Cairo (BUC) in 2022 to 105,000 students in all of its universities by 2031e. We, accordingly, incorporate all universities’ expansions and account for the recent change in the university admission system by the Ministry of Higher Education. In the academic year 2020/21, the Egyptian secondary examination system was renovated, leading to a 20 pp decline in average students’ grades. The minimum grades for acceptance into private universities were not adjusted proportionally, leading to a lower number of students’ eligibility for enrollment and hence less utilization of the available seats. As a corrective action, the Supreme Council of Private Universities (SCPU) recently decided to revert to the pre-2020/2021 direct enrollment system, allowing students to apply to universities through their websites. The SCPU has also agreed to adjust the minimum grading for all faculties after the release of secondary-school grades. For K–12. The company currently owns 27 schools, 16 under the Futures brand, serving lower-middle-income families. Two schools under the British Columbia Canadian International School (BCCIS) and one under Saxony International School (SIS) are geared towards the higher-income segment, with the rest of the schools in between. In November 2021, CIRA signed a partnership with The Sovereign Fund of Egypt (TSFE) to provide high-quality, affordable education to all segments and governorates in Egypt. The partnership involves launching two new schools in the Cosmic Village with an investment cost of EGP350m, and plans to start the operations of the first one in 2024e. The company plans to add one new school annually over our 2023–29e forecast period to reach 36 schools with a total capacity of 49,000 students. The Egyptian government’s public-private partnership (PPP) program provides an upside risk to our numbers as the government is offering some 57 schools, of which the company is bidding for 12 schools. The program is under a build, own, operate, and transfer (BOOT) scheme, where the government will offer the land, while the winning company will build and operate the schools for 30 years, after which the ownership will be transferred to the government and the company will be awarded a management contract. The average annual tuition fees for these schools will approximately be EGP18,000/year, fitting well with CIRA’s Future schools brand average annual tuition fees of around EGP14,000–15,000 per student. CIRA’s management believes the program will give them access to highly scarce land in Egypt’s Delta region.

We expect revenue to grow at a 2022-29e CAGR of c25% with an average EBITDA margin of c47%: We largely maintain our K–12 revenue estimates over our forecast period but downward revise our 2022e revenue estimates by c9% as the Futures brand continues to be the main contributor to K–12 tuition revenue (c61%) as opposed to our earlier assumption of a more pronounced shift towards the high-end brands. For higher-education, we downward revise our 2022–25e revenue estimates by c9% due to a one-year delay in opening BUA in addition to lower-than-expected student registration in BUC as a result of the applied registration process, which took place in the 2020/2021 academic year. Over 2028–31e, we raise our higher-education revenue estimates by c8% to capture revenue from the New Damietta university. Based on our numbers, the K–12 and higher-education expansions imply revenue growing at a 2022–29e CAGR of c25%. We expect rising costs to reflect in K–12 OPEX 8-year CAGR of c14%, with an average EBITDA margin of c28%, down from our earlier estimate of c32%. For higher-education, we expect OPEX to increase at 2022–29e CAGR of c33%, reflecting the launch of BUA in 2023e, CSU in 2024e, and New Damietta university in 2025e. We note that universities will break-even in the third year of operations and start making profits in the fourth year. We accordingly expect the higher-education EBITDA margin to decline from c67% in 2021 to an average of c58% over our forecast period, largely unchanged from our previous estimate of c59%.

CIRA secured all the land for its planned expansions and is working on securing diverse funding sources for its CAPEX plan: The company has already secured a 40-acre land plot in Badr City for its CSU for EGP873m, paid 15% as a down payment, and the rest payable over ten years ending 2031. It also purchased a 58-acre land plot for its New Damietta university for EGP1.06bn, paid a 15% down payment, and the rest payable over ten years ending 2031. The company expects no more land additions over our forecast period. According to management guidance, we raise our 2022–26e CAPEX estimates c31% to EGP4.55bn from EGP3.46bn previously to reflect New Damietta university, which was not fully captured in our earlier estimates, rising prices of construction material and the March 2022 EGP depreciation. The company plans to allocate its 2022–26e CAPEX spending of EGP4.55bn as follows: (1) EGP1.07bn for K–12 schools, (2) EGP1.18bn for BUA, (3) EGP990m for CSU, and (4) EGP1.25bn to New Damietta University. We expect the planned CAPEX to reflect in higher debt (including land liabilities)-to-equity ratio from 1.24x in 2021 to an average of 2.11x in 2022–23e and gradually decline to 0.77x in 2026e. Recently, the company obtained an EGP348m loan from Al Ahli United Bank (AUB) at a floating rate of 1%+ corridor rate, better than its previous loan from AUB at 2.5% markup. The new AUB loan has a 2-year grace period with principal payments starting 2024. The company also secured an EGP260m loan from Qatar National Bank Al Ahli (QNBA EY) at a floating rate of 1%+ corridor rate, better than its previous loan from QNB at a 1.5% markup, including a 2-year grace period with principal payments starting in 2024e. To diversify the funding sources, the company’s board called the EGM to convene to look into starting a 3-year EGP2.0bn securitization program against future cash flows, with the first issuance expected to amount to EGP800m. On our calculations, we account for the company’s future funding needs as bank loans with an interest rate of 1% above the corridor rate, similar to recent terms of bank debt secured by the company.

HC: we expect the CBE to keep interest rates unchanged

  • HC Securities & Investment shared their expectations on the likely outcome of the MPC meeting scheduled June 23rd and based on Egypt’s current situation, they expect the CBE to keep interest rates unchanged  

Head of macro and financials at HC, Monette Doss commented: “The May inflation figure came in lower than our estimate of 14.0% y-o-y, and we expect it to average 14.4% over the rest of the year, however, well above the CBE’s inflation target of 7% (+/-2% for 4Q22). We believe inflation is largely imported and reflects some product shortages due to less domestic manufacturing and lower importation. Egypt’s PMI came in at 47.0 in May, with the data pointing to low consumer spending, falling new order volumes at the quickest pace since 2020, and reduced business input purchases and staffing. We believe that consumer and business spending is largely subdued, with much of the liquidity directed to high-yield banking deposits. As of April 2022, local currency deposits increased to c66% of GDP from the pre-pandemic level of c49% in April 2019. However, domestic credit to the private business sector remained subdued at c20% of GDP in April 2022, slightly up from c16% in April 2019, and below its pre-revolution level of c26% in April 2010. Given the current economic dynamics, we believe that further interest rate hikes will not prove effective in combating inflation and could prove self-defeating by suppressing business activity, leading to more supply shortages. We still believe that carry trade is essential for supporting Egypt’s net international reserves (NIR) given its recent decline to USD35.5bn in May from USD40.9bn in February, the drop in foreign currency deposits not included in official reserves to USD1.04bn in May from USD9.2bn in February, and the widening net foreign liability position of the banking sector to USD12.7bn in April from USD3.29bn in February. However, an overvalued EGP, as indicated by the JP Morgan real effective exchange rate index at 108 bps, the change in outlook on the Egyptian economy to negative from stable by Moody’s, the emerging markets sell-off , and subdued increase in 12M T-bills are hindering carry-trade and diluting the benefit of an interest rate hike, in our view. We note that the yield on 12M T-bills increased by only 90 bps following the 300 bps policy rate hikes, while the yield on 3M T-bills increased by 370 bps. This resulted in low coverage of the longer-term T-bill auctions, reducing the weighted average duration of issued T-bills from 22 March to 16 June to 5.5 months, from 9.8 months (from 1 January to 15 March). Given Egypt’s current 1-year USD credit default swap at 808 bps, and given the Egypt-US inflation differential, we believe interest on 12M T-bill rates should increase to the north of 16.0% to reflect the 300 bps rate hike undertaken so far, to translate to a real interest of 0.27% from -1.73% currently, before resorting to hiking rates further. That said, we expect the MPC to keep rates unchanged in its upcoming meeting.

It is worth mentioning that, in its last meeting on 19 May, the Central Bank of Egypt’s (CBE) Monetary Policy Committee (MPC) decided to increase key policy rates by 200 bps after increasing it by 100 bps in March and following the Federal Reserve Bank’s (Fed) decisions to increase the interest rate by 25 bps in March and by 50 bps in May. The Fed also said that it is likely to increase interest rate by 50-75 bps in its next meeting in July. Egypt’s annual headline inflation accelerated to 13.5% in May from 13.1% in the previous month, with monthly inflation increasing 1.1% m-o-m, compared to an increase of 3.3% m-o-m in April, according to data published by the Central Agency for Public Mobilization and Statistics (CAPMAS).

Egypt financials: Diversified platforms support growth

  • We perceive microfinance as a major growth driver despite responsible financing regulations, while leasing lags on delayed private investment recovery

  • Strong deal pipeline and synergies with affiliated commercial banks offset lagging stock market activity, in our view

  • We increase our 12-month TP for EFG Hermes by c27% to EGP20.5/share and for CI Capital by c14% to EGP6.25/share; we maintain our OW ratings on EFG Hermes and CI Capital

We expect solid microfinance 2022–26e performance, while accounting for responsible financing regulations enforcement: Egypt’s microfinance loans increased c40% y-o-y in 2021 to EGP27.1bn, with the number of beneficiaries increasing c10% y-o-y to 3.49m individuals taking the penetration rate to 7.7%, on our calculations, from 7.1% a year earlier. The average ticket per beneficiary increased c27% y-o-y in 2021 to EGP7,748. Going forward, we expect microfinance loans to grow at a 2022–26e CAGR of c17%, well below its 2018–21 CAGR of c32%, supported by higher financial inclusion and rising inflation. We expect inflation to average 9.0% over 2022–23e, up from 5.2% in 2021, weakening the household’s purchasing power and increasing the demand for microfinance loans. On a different front, Egypt’s Financial Regulatory Authority (FRA) and the Central Bank of Egypt (CBE) recently introduced the Responsible Financing Law, which requires microfinance firms to report a sustainable rate for pricing their products. The sustainable rate formula sums up administrative expenses, loan write-off rate, the cost of external funds, the tax expense, and the required return by the microfinance company, all as a percentage of the average outstanding loan portfolio and divided by 1 minus loan write-off rate. The companies have six months to comply with the law, which became effective on 8 February. According to the law, charges and fees paid by beneficiaries should not exceed 5% of the loan’s value for micro borrowers and 1.5% for small and medium borrowers. We expect the new regulations to lead to a reshuffling in recording revenue items between interest earned, fees, and commissions. On our numbers, the all-in earned rate on EFG Hermes’ Tanmeyah’s average loan portfolios should decline from 48.5% in 2021 to 38.0% in 2026e, and for CI Capital’s Reefy should decline from 47.2% in 2021 to 38.6% in 2026e. We expect both firms to grow their loan books at a 2022–26e CAGR of c21%, increasing Tanmeyah’s market share from c14% in 2021, on our numbers, to c16% in 2026e and increasing Reefy’s market share from c6% in 2021 to c7% in 2026e. Tanmeyah’s 2021 net profit increased 2.16x y-o-y to EGP493m, c71% higher than our initial estimate of EGP288m, due to higher-than-expected fee income and lower-than-expected provisioning charges. As provisioning normalizes over our forecast period, we expect a 2022–26e net profit CAGR of c17%, implying an upward revision of c75%, on average, over our forecast period. Reefy’s 2021 net profit increased c60% y-o-y to EGP200m, c21% above our initial estimate of EGP166m on higher-than-expected loan growth. Going forward, we expect a 2022–26e net profit CAGR of c22%, implying an upward revision of c21% on average over our forecast period.

Subdued private sector participation weighs on leasing growth, and higher competition leads to lower NIMs: Even though private investments increased c41% y-o-y in 1H21 to EGP103bn, constituting c25% of total investments, it remains significantly below its pre-floatation FY14/15–FY15/16 levels where it constituted an average of 57% of total investments. In USD terms, private investments declined at a CAGR of c15% over FY15/16–FY20/21 to USD12.7bn. In 2021, the total value of leasing contracts increased c36% y-o-y to EGP79.8bn following the increase in private investments helped by lower interest rates; however, they remain subdued, in our view. Moreover, higher competition and the low-interest-rate environment led to a decline in NIMs from an average of 5.0% in 2020 to 3.5% in 2021 for companies under our coverage. Going forward, we expect leasing contracts to increase at a CAGR of c25% over our forecast period following our expected rebound in private investments. We also expect upward pressure on interest rates to support NIMs growth. EFG Leasing’s net leased portfolio increased c14% y-o-y in 2021 to EGP5.46bn, mostly in line with our initial estimate of EGP5.51bn. NIMs came in at 3.0% in 2021, on our calculations, lower than our initial estimate of 4.6%. Net profit increased c83% y-o-y to EGP101m, c44% above our earlier estimate of EGP70.3m, on lower-than-expected provisioning. We expect EFG Leasing to grow its net leased portfolio at a CAGR of c23% over our forecast period, with an average NIM of 3.4%, leading to a net profit CAGR of c20%, implying an average upward bottom line revision of c20%. CI Capital’s Corplease net leased portfolio remained unchanged y-o-y in 2021 at EGP8.44bn, after adjusting for securitizations in both years, c23% below our estimate of EGP10.9bn. NIMs came in at 4.0% in 2021, on our calculations, lower than our initial estimate of 5.0%. Despite muted portfolio growth and declining NIMs, Corplease’s net profit increased c5% y-o-y to EGP434m, c15% above our earlier estimate of EGP378m, due to some EGP35.6m in provision reversals compared to our expected provision expenses of EGP73m. We expect the company to grow its net leased portfolio at a CAGR of c26% over our forecast period, with an average NIM of 3.8%, leading to a net profit CAGR of c19%, hence, implying an average downward bottom line revision of c8%.

Strong market positioning coupled with a healthy advisory pipeline and existing synergies drive IB growth, in our view: Egypt’s stock market turnover increased c31% y-o-y in 2021 to EGP665bn (excluding deals), representing c87% of market capitalization from c72%, a year earlier. The turnover was mainly led by retail trades, which increased c43% y-o-y to represent c74% of total turnover, while institutional trades increased by only c4% y-o-y to constitute c26% of total turnover. With EFG Hermes’ and CI Capital’s focus on institutional trading, the two firms saw their market shares decrease to c17% in 2021 for EFG Hermes from c21% a year earlier, and to c6% for CI Capital from c8% a year earlier, on our calculation. EFG Hermes’ exposure to rebounding regional and frontier markets, and a strong Egypt market positioning reflected in increasing its brokerage revenue by c34% y-o-y in 2021 to EGP1.34bn, backed by its Egypt and regional operations, but missing our earlier estimate of EGP1.54bn by c13%. CI Capital’s brokerage revenue increased c9% y-o-y in 2021 to EGP212m, missing our earlier estimate of EGP253m by c16%. EFG Hermes’ asset management revenue increased c28% y-o-y to EGP528m, backed by local and regional operations, c55% above our initial estimate of EGP341m. CI Capital’s asset management revenue increased c66% y-o-y to EGP54.8m, however, came c13% below our estimate of EGP63m. Both firms enjoyed a strong advisory pipeline leading to a 2.08x y-o-y increase in EFG Hermes advisory fees to EGP494m, c78% above our earlier estimate of EGP278m. For CI Capital, advisory and merchant banking fees increased 10.1x y-o-y to EGP268m (of which we estimate some EGP150m as gain on the sale of Taaleem Management Services (TALM EY) shares). We expect EFG Hermes’ IB net profit to increase at a 2022–26e CAGR of c24%, implying an average upward revision of c30%, and CI Capital’s IB net profit to increase at 2022–26e CAGR of c29%, implying an average downward revision of c23%. Overall we like EFG Hermes’ exposure to regional markets and the resulting USD exposure. We believe that possible synergies with Banque Misr in terms of increasing AUMs and rapidly growing advisory business to represent an upside to our numbers for CI Capital.

EFG Hermes is developing into a universal bank with the acquisition of a 51% stake in AIB, while CI Capital acquired a c16% stake in Cleopatra Hospitals: EFG Hermes completed the acquisition of a 51.0% stake in Arab Investment Bank (AIB) at EGP2.55bn through a capital increase, which implies a 2022e P/B of 0.92x, on our numbers. Concurrently, the Sovereign Fund of Egypt (TSFE) also acquired a 25.0% stake in the bank through a capital increase. After the acquisition, the bank’s paid-in capital increased to EGP5.0bn reaching the CBE’s minimum capital requirement and achieving adequate capitalization to allow loan book expansion. The bank’s loan-to-deposit ratio reached c29% as of December 2021. We expect the bank to grow its loan book at a 2022–26e CAGR of c25% taking its L/D to c49% by 2026. We expect an average 2022–26e NIMs of 4.3%, up from an estimate of 3.1% in 2021 and we expect its ROE to increase from an estimate of 9.24% in 2021 to 16.3% by 2026e. We believe the acquisition will help the firm increase its ROE, cross-sell its different corporate and retail products and smooth its earnings volatility. We note that in February First Abu Dhabi Bank (FAB UH) submitted a non-binding offer to Egypt’s Financial Regulatory Authority (FRA) to acquire a minimum 51% stake in EFG Hermes Holding at an indicative all-cash offer price of EGP19.0/share implying a total company value of EGP18.5bn, c7% below our TP of EGP20.5/share. FAB later withdrew the offer due to global market uncertainty and volatile economic conditions. The initial offer had put the firm on a 2022e P/B and a P/E of 1.22x (adjusted for cash) and 15.7x, respectively, on our numbers. On a different front, CI Capital acquired a stake in Cleopatra Hospitals (CLHO EY) through its merchant banking operations, capitalizing on the growth potential of the healthcare sector. CI Capital and Banque Misr own MCI Capital Healthcare Partners with a 60:40 ownership split. MCI Capital acquired 26.8% stake in Cleopatra Hospitals at EGP2.09bn, implying a 2022e P/E of 15.4x. On our calculations, the company took EGP1.6bn in debt to finance the acquisition.

We increase our 12-month TP for EFG Hermes by c27% to EGP20.5/share and for CI Capital by c14% to EGP6.25/share on a mix of rolling valuations for one year, accounting for equity investments, and earnings revision. We maintain our Overweight recommendations on both stocks: We value both companies using a Sum-Of-The-Part (SOTP) valuation methodology using an excess return model for their core operations and adding excess cash and financial investments. For CI Capital, we value Taaleem using a DCF methodology. For both firms we use a cost of equity applying our forecast for 12-month T-bill yields leading to an average cost of equity of 16.9%. For EFG Hermes investment bank, our base assumption for the cost of equity is a weighted average of Egypt and the MENA region based on geographical revenue contribution leading to an average cost of equity of 12.6%. Individually, we value EFG Leasing at EGP1.08/share (c46% higher than our previous estimate) and CI Capital’s Corplease at EGP2.49/ share (c3% higher than our previous estimate) putting the businesses at a 2022e P/E multiple of 9.13x and 7.63x, respectively. For the microfinance, we value EFG’s Tanmeyah at EGP4.58/share (c66% higher than our previous estimate) and CI Capital’s Reefy at EGP1.56/share (c36% higher than our previous estimate), putting the businesses at a 2022e P/E multiples of 7.63x and 7.93x, respectively. For the investment banks, we value EFG Hermes at EGP7.69/share (c49% higher than our previous estimate) and CI Capital at EGP0.85/share (c6% below our previous estimate). For EFG Hermes, we then add the company’s excess cash position, and investment property valued at around EGP4.0bn, or EGP4.19/share (c42% lower than our previous estimate due to cash deployed to the acquisition of AIB). We value the company’s stake in AIB at EGP2.84bn, or EGP2.92/EFG Hermes share, implying a 2022e P/B multiple of 1.06x. For CI Capital, we value Taaleem at EGP0.74/CI Capital share (almost unchanged from our previous estimate) putting the business at 2022e EV/EBITDA of 12.6x. We value CI Capital’s 16% stake in Cleopatra Hospitals using the average 1Q22 market price of EGP4.79/share deducting the debt portion that we estimate at EGP960m, yielding a value of EGP0.27/share. For EFG Hermes, the NBFS platform makes up c28% of the stock’s total value, the investment bank c38%, with cash and AIB stake accounting for the remaining c35%. This sum up to a 12-month target price of EGP20.5/share, which yields a potential return of c36% on the 18 April closing price of EGP15.0/share. We therefore maintain our Overweight rating on EFG Hermes Holding. For CI Capital, the NBFS platform makes up c65% of the stock’s total equity value, the investment bank c14%, with Taaleem and equity investments accounting for the remaining c22%. This sums up to a 12-month target price of EGP6.25/share, which yields a potential return of c75% on the 18 April closing price of EGP3.58/share. We therefore maintain our Overweight rating on CI Capital. For EFG Hermes, our 12-month TP of EGP20.5/share puts the stock at a 2022e P/E multiple of 12.8x and a P/B multiple of 1.33x, while it is trading at 2022e P/E and P/B of 12.4x and 0.88x, respectively. For CI Capital, our 12-month TP of EGP6.25/share puts the stock at a 2022e P/E multiple of 9.79x and a P/B multiple of 1.65x, while it is trading at 2022e P/E and P/B multiples of 5.60x and 0.94x, respectively.

Our take on the CBE’s interest rate decision, EGP movement and newly introduced CDs

The Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) has decided in a special meeting today to raise the key policy rates by 100 bps, it announced in a release. The Egyptian pound devalued to EGP18.22/USD, according to Bloomberg. Banque Misr and the National Bank of Egypt offered one-year certificates of deposits (CDs) at an interest rate of 18%, according to banking sector data. (CBE, Bloomberg, Banking sector data)

HC’s comment: Overall, we are positive on the CBEs today’s decisions, including the 100 bps increase in policy rates, the EGP devaluation by more than c10%, and public banks offering one-year CDs at an interest rate of 18%,  as they are a better reflection of the economic fundamentals and hence remove distortions that negatively affect economic activity. Although the decisions could negatively impact consumer demand in the short term, they will potentially contain inflation, stop dollarization, attract foreign portfolio investments, enhance foreign currency supply with a positive spillover effect on economic activity, compared to a standstill that could occur due to foreign currency shortages. We see the stock market reacting positively to the move; however, the 18% CDs could, to an extent, compete with investment in the Egyptian stock market; but, we still expect the stock market to rebound from current levels as it was heavily oversold. We expect a rate increase of 150 bps throughout 2022 but we now believe that it could occur faster than we previously expected. The high-yielding CDs will serve different purposes, such as partially containing inflationary pressures, supporting households’ disposable incomes in light of the EGP devaluation, and stopping dollarization. We also believe that the combination of EGP devaluation along with higher interest rates will result in a rebound in Egypt’s carry trade and help finance Egypt’s external funding needs. We believe that carry trade could rebound at a yield of 14.2%-14.5% for 12M T-bills, implying a real return of around c1% on our calculations. This will make Egypt more competitive in the carry trade market compared to Turkey, with its Bloomberg 2022e inflation estimate at c44% and its recent 1-year note offering a yield of c22%. The EGP devaluation to a rate of EGP18.22/USD, exceeded our estimate of EGP16.70/USD by 8.34%. Over the coming months, we believe that the exchange rate will be flow-driven and could show some appreciation depending on the rebound in carry trade.

HC expects the CBE to increase interest rates by 0.5-0.75 bps

  • HC Securities & Investment shared their expectations on the likely outcome of the MPC meeting scheduled March 24th and based on Egypt’s current situation, they expect the CBE to increase interest rates by 0.5-0.75 bps

Head of macro and financials at HC, Monette Doss commented: “We raise our 2022e inflation estimate to 11.5% from 7.2% previously on increasing international prices of wheat and oil and our expectation of less importation of consumer goods that could lead to some supply shortages. Our calculations are based on Bloomberg 2022 consensus wheat price estimate of USD1,086/bushel, c53% higher than its 2021 average price of USD712/bushel and consensus Brent price estimate of USD91.7/barrel, c55/% above its 2021 average of USD59/barrel. We also expect new regulations requiring letters of credit (LCs) for most imported goods to ultimately result in less importation of consumer goods, possibly leading to some supply shortages and imposing some inflationary pressures. On a different front, our calculations suggest that carry-trade currently requires a 12M T-bill rate of 14.8% (162 bps higher than the latest auction) based on; (1) Egypt’s current 1-year USD credit default swap of 560 bps, (2) Bloomberg 2022 consensus estimate for the Federal Reserve rate at 1.55%, and (3) Egypt-USA 2022 inflation differential of 544 bps (given our Egypt 2022e inflation estimate of 11.5% and Bloomberg USA 2022 inflation estimate of 6.1%). We believe that carry trade is key at the moment to support Egypt’s net international reserves (NIR), more so with the banking sector’s net foreign liability (NFL) position widening to USD11.5bn in January and possibly worsening further as net foreign portfolio outflows reached USD2.3bn since the beginning of the Russia-Ukraine war. That said, we expect the MPC to increase interest rates by 0.5-0.75 bps in its upcoming meeting.

It is worth mentioning that, in its last meeting on 3 February, the Central Bank of Egypt’s (CBE) Monetary Policy Committee (MPC) decided to keep rates unchanged for the tenth consecutive time. Egypt’s annual headline inflation came in at 8.8% in February, with monthly inflation increasing 1.6% m-o-m, compared to an increase of 0.9% m-o-m in January, according to data published by the Central Agency for Public Mobilization and Statistics (CAPMAS).

HC: About Egypt macro, overdue private sector engagement

  • In its latest report, HC shared their outlook about Egypt’s macro economy in 2022 addressing the main GDP growth drivers and expectations on the EGP and interest rates.

  • We see tourism and government spending as the main GDP growth drivers. We expect building up inflationary pressures, and moderate EGP depreciation supported by a possible 100-150 bps rate hike in 2022
  • Current account deficit to narrow while debt repayment schedule necessitates seeking additional external funding, in our view
  • We expect the budget deficit to slightly widen to 7.5% of GDP in FY21/22e, with the banking sector financing the bulk of the deficit 

Head of macro and financials at HC, Monette Doss commented: “We see tourism and government spending as the main GDP growth drivers in FY21/22e, which we estimate at 5.4%. We expect building up inflationary pressures to lead to moderate EGP depreciation and a possible 100-150 bps rate hike in 2022: According to official announcements, tourism receipts recovered to pre-COVID-19 levels during 2021 implying a 5.50x y-o-y growth in 1H21/22 to USD9.83bn. We accordingly believe that tourism was the major contributor to 1Q21/22 GDP growth of 9.80% y-o-y due to favorable base effect. On another front, government investments increased c14% y-o-y in FY20/21 to EGP560bn to constitute c74% of total investments, up from c62% a year earlier. Private investments showed broad-based recovery in 4Q20/21, growing by 14.0x y-o-y to EGP66.3bn, just below its pre-COVID-19 level of EGP68.4bn in 4Q18/19. We believe that government megaprojects mostly backed private investments in 4Q20/21. Going forward, we expect the government to remain focused on developing Egypt’s physical and human capital, with the Egyptian Village development project being at its core focus currently. To acquire the necessary funding from different international organizations, we expect the government to also focus on Environmental, Social, and Governance (ESG) projects while seeking further private sector engagement, as evidenced by The Sovereign Fund of Egypt’s (TSFE) investment mandate. As such, we expect more investments with higher private sector participation in water desalination, agritech, fintech, and green manufacturing. Our estimates filter through to a GDP growth of 5.4% in FY21/22e, up from 3.3% a year earlier. In 2022e, we expect inflation to increase 2 pp y-o-y to 7.2%, reflecting high global inflation, global supply bottlenecks, rising gasoline prices and the possibility of further reduction of local food subsidies. Applying a real effective exchange rate model, we expect the EGP to show an average annual depreciation of c3% over the next two years. Despite inflation being in line with the Central Bank of Egypt’s (CBE) target range and Egypt offering high real interest rates, we expect the CBE to hike policy rates by 100-150 bps in 2022 to support the EGP considering Egypt’s high foreign funding needs.”

“Current account deficit to narrow while debt repayment schedule necessitates seeking additional external funding in 2H21/22e, in our view: Egypt’s trade deficit increased from 10.0% of GDP in FY19/20 to 10.4% in FY20/21, as non-oil imports outpaced exports growth. On our calculations, we expect Egypt’s trade deficit to slightly increase to 10.5% of GDP in FY21/22e and to narrow to 10.0% in the following year as we account for higher prices of raw material imports, higher imports of intermediate and investment goods on higher expected economic activity. We expect Egypt’s tourism receipts to increase 2.19x y-o-y in FY21/22 and worker remittances to maintain momentum on growing Gulf economies. Hence, we expect Egypt’s current account deficit to narrow from 4.6% of GDP in FY20/21 to 3.6% in FY21/22e and 2.8% in FY22/23. In FY21/22e, Egypt is due to repay some short-term external debt of USD13.8bn, long-term external debt of USD15.7bn, and maturing deposits to gulf countries of USD11.3bn that we expect to be rolled over. We believe that the banking sector, mainly public banks, financed the bulk of Egypt’s short-term external debt repayment during 1H21/22 worth USD7.92bn in addition to funding foreign portfolio outflows from government T-bills of USD3.40bn during October and November. This resulted in the banking sector (excluding the CBE) reversing from a net foreign asset (NFA) position of USD1.73bn in June to a net foreign liability (NFL) position of USD10.0bn in December. We believe that by December 2021, the government had already secured USD10.0bn of the external funding necessary for FY21/22e. To satisfy its obligations while maintaining net international reserves (NIR) stable in 2H21/22e, we expect the government to seek additional external funding worth USD15.5bn. On our calculations, the government’s external debt should reach c26% of GDP in FY21/22e and c24% in FY22/23e. At these levels, public debt held by non-residents would exceed the IMF’s lower early-warning threshold of 15%; however, it remains below its upper early warning benchmark of 45%. Also, our estimates for external funding needs for FY21/22e and FY22/23e represent c7% of GDP and c4%, respectively. Accordingly, we expect Egypt’s external financing requirements to be just above the IMF’s lower early warning threshold of 5% of GDP in FY21/22e and drop below it in FY22/23e.” Added Doss

“We expect the budget deficit to slightly widen to 7.5% of GDP in FY21/22e, with the banking sector financing the bulk of the deficit: We expect government revenue to increase c10% y-o-y capped by slow business activity. On the other hand, we expect government spending to increase c11% y-o-y to EGP1.75trn in FY21/22e, assuming a stable effective interest on total domestic debt at c12%. Hence, we expect the debt service cost to increase c11% y-o-y in FY21/22e to EGP644bn (c37% of total government spending) and c10% y-o-y in FY22/23e to EGP701bn (c36% of total government spending). Recent official announcements suggested that the government will contain its subsidy bill through a few possible approaches. In this regard, the government increased the selling price of subsidized edible oil by c19% in October 2021, increased the price of subsidized sugar by c24% in December 2021, announced in December 2021 that newly married men will not be entitled to family ration cards, and has put a ceiling in October 2021 on the quantities of subsidized allowance per beneficiary. We expect these measures to offset the increase in rising commodity prices partially. Accordingly, we estimate an increase in subsidies and social benefits of c6% annually over the next two years to EGP281bn in FY21/22e and EGP300bn in FY22/23e. On our numbers, the government’s budget deficit should slightly widen from 7.4% of GDP in FY20/21 to 7.5% in FY21/22e and decline to 6.4% of GDP in the year after. We believe that Egypt’s banking sector can finance up to c51% of the government budget deficit over the next two years without experiencing a significant tightening in interbank liquidity. We expect the government’s net domestic debt to decline from c82% of GDP in FY20/21e to c80% in FY21/22e and c77% in FY22/23e.” Monette Doss concluded

HC expects the CBE to keep interest rates unchanged

  • HC Securities & Investment shared their expectations on the likely outcome of the MPC meeting scheduled February 3rd and based on Egypt’s current situation, they expect the CBE to keep interest rates unchanged.

Head of macro and financials at HC, Monette Doss commented: “Egypt’s inflation remains largely contained towards the lower end of the CBE target range of 7% (+/-2%) for 4Q22. We, however, expect inflation to average 7.0% in 1Q22, as we expect a pick up in food and gasoline prices reflecting global inflationary pressures. We continue to believe that carry trade is essential for supporting Egypt’s net international reserves (NIR). More so as demonstrated by the net foreign liability (NFL) position of the Egyptian banking sector (excluding the CBE), which increased to USD7.12bn in November from USD USD4.8bn in the previous month. Accordingly, we perceive continued pressure to maintain the current levels of Egyptian treasuries interest rate. Currently, Egyptian treasuries offer a real return of c4% (given 12M T-bill rate of 13.2%, taxes for US and EU investors of 15%, and our 2022e inflation forecast of 7.2%). Even though the US Federal Reserve might start increasing interest rates in March, US 2-year notes are expected to offer a negative real return of -2.2% given Bloomberg consensus estimates of 2022 2-year notes rate of 1.4% and average US inflation of 3.6% over 2022-23. Currently, Turkey offers a real return of 3.8% on our calculations (based on its 2-year note rate of 22.6%, zero taxes on Turkish treasuries, and Bloomberg inflation consensus estimates of 18.8% on average over 2022-23). We note that Egypt’s credit default swap (CDS) is currently at 550 bps, just above Turkey’s CDS of 527 bps. Accordingly, we believe that Egypt’s carry trade remains attractive at the current levels, and with inflation remaining within the CBE’s target range, we expect the CBE to maintain rates unchanged in its upcoming meeting.

It is worth mentioning that, in its last meeting on 16 December, the Central Bank of Egypt’s (CBE) Monetary Policy Committee (MPC) decided to keep rates unchanged for the ninth consecutive time. Egypt’s annual headline inflation came in at 5.9% in December, with monthly inflation decreasing 0.1% m-o-m, reversing an increase of 0.1% in November, according to data published by the Central Agency for Public Mobilization and Statistics (CAPMAS).

The Global Green Economy in 2022

Egypt & Africa now have a new responsibility for the Green Economy in 2022. Looming climate change and international negotiations over the global problem have sparked a “Green Transition” in Africa & Egypt. The United Nations IPCC, an intergovernmental panel on climate change, has recently updated its reports to state that globally, we must reach a net-zero CO2 emissions level by 2050 to begin reversing the impacts of global warming. For this reason, the green economy has seen a new surge of funding and interest in Q1 of 2022. Contact an HC Securities & Investment experts to discuss how the Green Economy of 2022 can impact your portfolio.

  • The IPCC Net Zero Emissions Goal Stimulates Innovation & Green Investment

A Task Force established by the IPCC has concluded that immediate action must be taken. That mandate has kickstarted a transition towards a new wave of green innovation. Anytime innovation is involved, lenders aren’t too far behind. Financial activities surrounding profitable green initiatives are on the rise. Emerging nations in Africa are now at the top of the list for securing funding and technology from large financial institutions. This renewed investment into the green transition has sparked interest from many banks and investment firms from around the globe. 2022 is sure to see a great deal of financial activity in the green sector from emerging nations.

  • The Growing Market For GSS Bonds

Green, social and sustainable bonds are a new trend across the globe. Many nations have issued them and the market is growing. A total of 16 nations currently issue GSS bonds, however only 1 exists in africa. Nigeria is shaping up to be a central location for investment firms, banks and private investors looking to support state-run green initiatives. As 2022 brings a transition into a net zero emissions plan, GSS bonds could provide a new source of financing for Egypt and countries in Africa.

  •  The New Assault On Fossil Fuel Subsidies

Fossil fuel subsidies have been known to promote excessive energy consumption. When energy prices are low thanks to government subsidies, both private and public organizations over consume. Fossil fuel subsidies are necessary in some places, however when they are used inefficiently it can cause some serious problems. 2022 has already shown a trend of correcting old, out of touch fossil fuel policies. Consequently, removing energy subsidies frees up additional capital to fund the green transition. We can expect this year to bring the removal of more fuel subsidies in Africa and Egypt and major investment in new green initiatives.

  • A Rapid Green Transition Is Coming

One thing is for certain, a transition is on the horizon. Egypt and Africa along with the rest of the world is on a rapid transition to a net-zero emissions point. To get there, we are seeing huge investment and initiatives from intergovernmental organizations around the globe. Smart investors and savvy entrepreneurs can potentially take advantage of this green transition to earn great returns. As Egypt and Africa become larger players on the international stage, all eyes are watching. Heading into 2022, the GDP of Africa & Egypt is on the rise. Similarly, the amount of investment being diverted into green projects is on the same trajectory. But can we reach net-zero emissions by 2050? Only time will tell.