AFK - AFK: Best Vehicle At The Moment

Summary

• Africa’s economic growth may decline from 4.1% in 2022 to 3.8% or lower in 2023, which is well below the growth in years like 2016.
• The main reason I am hesitant about Africa is that most ETFs have a larger amount of their assets invested in banking and/or mining companies.
• I am assigning this ETF as a hold, as I may accumulate it in 2023-2024 instead of making bets on some of the ETF's constituents like Nigeria.

Overview

Africa is a difficult region for US investors to access, as there are more accessible options listed in markets like Asia, Europe, and Latin America. The VanEck Vectors Africa Index ( AFK ), which is down around 50% during the past decade, is likely one of the best vehicles for US investors to consider. The main reason I am hesitant about Africa is that most ETFs have a larger amount of their assets invested in banking and/or mining companies, and there are not many consumer pure plays. Africa will also struggle as food and energy prices remain high, and growth is still below historical norms. Valuations are not at an impressive low, and there is arguably much more value in markets like Latin America, where the risk-reward profile is much more attractive. This ETF invests in multiple countries, and I am most optimistic about Egypt, which is my favorite pick among MENA ( Middle East North Africa) equities. I am assigning this ETF as a hold, as I may accumulate it in 2023-2024 instead of making bets on some of the ETF's constituents like Nigeria or South Africa.

Africa’s Outlook

Africa’s economic growth may decline from 4.1% in 2022 to 3.8% in 2023 , which is well below the growth in years like 2016 ( above 5%). Major African equities that are a part of the MSCI frontier and emerging market indexes are not extremely cheap, given these macro and political risks that are ahead. This is one of many reasons why I prefer markets like Brazil, Chile, and Colombia, all of which trade at a discount to these African equities.

Inflation will also be a huge source of concern, as food prices rose by over 20% between 2020-2022, the most since the GFC. This is exacerbated by the fact that Africa is a net food importer, and low-income consumers have been hit hard by food and energy inflation. Inflation in Sub-Saharan Africa averaged 14.5% in 2022 , and should only decline slightly in the coming years.

Inflation has also largely impacted the mining sector, a key part of Africa’s economy. Many of the companies in this ETF are mining companies. Total mining volumes in South Africa fell by 8% due to the energy crisis in the country. South Africa’s image to foreign investors has also substantially declined due to issues in the mining industry. The mining sector contributes to around 10% of Sub-Saharan Africa’s GDP.

Some banks in Africa may be able to fare well due to growth picking up and Central banks hiking rates. The ROE of African banks dropped by 50% to 7% during 2020 and is slowly starting to bounce back.

Around 50% of Africa's population still remains unbanked, so I think this would be one of the best industries to bet on.

ETF Country Weighting

The main issue to consider with this ETF is that nearly half of the assets are invested in South Africa and Nigeria. Some of the top, high-growth economies in this region, like Kenya or Tanzania for example, represent a small % of the ETF’s assets. Since Kenya, Morocco, Tanzania, and other African frontier markets do not have listed ETFs, it is more difficult to fully access Africa when limited to US exchanges.

Within these top 10 countries, I am most bullish on Egypt, which is trading at distressed levels and has underperformed the VanEck Africa ETF during the past decade, after substantially outperforming prior to 2016.

Investors who want to bet on banks that can benefit in the region because of the large unbanked population can focus on stocks like Commercial International Bank Egypt ( OTCQX:CIBEY ) as well. This stock is still trading well below its pre-covid highs.

The Global X MSCI Nigeria ETF ( NGE ) has also substantially underperformed African equities and emerging markets during the past decade.

I have decided to hold off on Nigeria after covering the market last year , as oil production did not bounce back fast enough (still missed OPEC quotas) and the country is depleting foreign exchange reserves , which puts the country at risk.

Trends

Mobile Payments : One of the most interesting trends in Africa is how consumers can leapfrog traditional technology, in areas like banking, and embrace digital products like mobile banking . Safaricom, which is listed in Kenya and one of this ETF's top holdings, is one successful case to follow, as it has been able to capture the growth of mobile payments in Africa.

Safaricom's Mpesa Revenue

Companies like this, and other consumer themes, are spearheading growth in Africa. However, around 65% of the ETF’s assets are invested in financials, materials, and energy companies, which typically trade at a discount to the overall index. As of the end of January 2023, this ETF traded at 8.8x earnings and 1.7x book , which is reasonably valued, but not that completing because of the industries it invests in.

Tourism Recovery : Select frontier and emerging markets could stand to benefit from increased tourism arrivals. This is especially true for Egypt, which is beginning to experience a rebound in tourist arrivals. Morocco is one of the leading destinations for tourists who are traveling to Africa.

International Tourist Arrivals ( millions)

Tourism growth should benefit some of the largest countries this ETF invests in, including South Africa, Egypt, and Morocco.

ETF Final Thoughts

This ETF is one of the easiest ways to gain access to Africa, if you are willing to invest in mining/banking companies, and invest a lot in South Africa and Nigeria.

However, Africa is not very well positioned to benefit from commodities, as Nigeria's economy is still struggling, and consumers in other countries will struggle due to higher food and energy prices. Moreover, higher energy costs and political risks also reduce the appeal of some mining assets in the country.

Kenya, Tanzania, and Egypt show the most promise out of all of these markets, in my view, but they have a smaller weighting because of market cap/liquidity considerations. Egypt is the only one of these three markets with a US-listed ETF.

Some alternatives/additions to this ETF that I am considering are as follows:

1) Egypt : Egypt ETFs and Commercial International Bank Egypt.

2) South Africa : South Africa consumer ADRs if the market becomes cheaper.

For the time being, I think there is greater value in markets like Latin America, as stock markets are cheaper and more clearly positioned to benefit from higher commodity prices.

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