Africa's Opportunity: Betting on the Inevitable

On my first full day in Johannesburg, South Africa, I made my way over to Melrose Arch. This is a relatively new area of wide streets and sidewalks. — and the story serves as a perfect anecdote to continue our “frontier investing” discussion.

At Melrose Arch there are cafes and restaurants and stores. I was early for my meeting, so I stopped in on one of the wine shops and bought a bottle of wine. The experience was like what you would experience in any better wine store in the world — except that I got a very good South African cabernet for about $10.

I then headed over to meet with Francis Daniels, who manages the Africa Opportunity Fund. We had a good chat about investing in South Africa and greater sub-Saharan Africa. And his fund is my favorite way to play Africa…

“I look for trends that I know are going to happen,” Francis told me, “unless there is a nuclear explosion or something. Things are that inevitable. So… I like consumer finance. I like retail. I can say with confidence that eventually, blacks will have the same access to consumer products as anyone else. That’s a trend that’s unfolding now.”

The best way to see that is to look at specific companies. We looked over some of his largest holdings…

He owns African Bank, for example. It has “wonderful financial ratios,” Francis related. It has a capital base that is stocked with 20% equity (most U.S. banks never top 10%, and, hence, often get in trouble). It is also very profitable. “Blacks are underserved,” Francis goes on, “and you can command above-market rates.”

Even here, though, you can see how things have changed. Francis Daniels has owned African Bank for 10 years. In 2001, it was charging 80% interest rates. The argument then was that blacks had no credit history. But now they’ve collected the data, and competition too has done its part. Francis showed me an ad in which they now they charge 11% to finance furniture purchases. It may seem high, but remember where they started from.

“Blacks have had very little access to credit,” Francis says. “They still have very little credit. But they have been at it for only 20 years or so. Over time, it will normalize — that’s what we’re betting.”

Let’s take a look at some of his portfolio positions. Naturally, as Francis is an active manager, some of his holdings may have changed by the time you read this. You can always find the latest on his top ten in his monthly shareholder letters.

The fund’s largest position is Shoprite, the largest South African food retailer, with over 1,100 stores in 16 countries in Africa. It serves over 14 million shoppers annually. While I was on my trip, I heard this name come up at least three different times as an investment idea. And if I could recommend it, I would. But it is not easy to buy Johannesburg-listed stocks. (There is a Pink Sheets version, but it trades infrequently.)

Francis owns the shares in Zambia; it trades at half the price there even though it is the same security. This then, is another reason to buy the fund. Francis will ferret out deals you could not find on your own.

His second largest position is Sonatel. Cell phones are big in Africa. Ten years ago, there were maybe 10 million users. Today, there are 540 million cell phone users. Sonatel is a fast-growing mobile phone provider in Senegal and neighboring countries. It used to be state owned. “They had a monopoly,” Francis says, “and managed to lose money.” But today, Sonatel serves as a case study for what you can buy in Africa.

Sonatel is the second most profitable telecom in Africa. More important, it is an example of what the Africa Opportunity Fund seeks out: a company with high returns on assets at a cheap price.

He also owns bonds in Old Mutual. This is Africa’s largest life insurance company. Recently the bonds paid 16-20%, not to mention they enjoy a thick cushion of protection. In fact, the Africa Opportunity Fund focuses on its best ideas: Sonatel, Shoprite, African Bank and Old Mutual represent about half of the portfolio.

The rest of the portfolio is a smorgasbord of opportunities: a brewery, a rubber plantation, a leading media company and a stake in AICO. The latter is the controlling shareholder of Seedco, which makes seeds crucial to improving African agriculture.

In Africa, it pays to be a stock picker, because fortunes of companies and economies can diverge widely. Francis tells the story of buying Nigerian debt and making 35% during a time in which the Nigerian market fell 48%! There is also opportunity for arbitrage, or buying the same thing in a cheaper market (as Francis has done with Shoprite in Zambia).

Lots of exciting opportunities, but not the kind of thing I can tackle myself. I love the story emerging in Africa, and I hope to go back again. But it is a massive and complex opportunity best left to people who live in those markets full time.

Francis Daniels does that. He has 16 years of experience investing in Africa. He is steeped in the picky value investing tenets set out by the great Benjamin Graham in the 1930s. And the Africa Opportunity Fund, as a team, has a great track record. If you’d put $1,000 with them beginning in 2003, you’d have had nearly $6,000 by the end of 2010. That includes a pretty difficult period for most investors. More recently, over the past 12 months the fund is up 29% — not bad considering the red-hot S&P is only up 20% over that period. Finally, they eat their own cooking. About 25% of the fund’s capital is their own money.

Of note, the Africa Opportunity Fund trades in London, ticker AOF.

It’s easy to figure out the price of a London-listed stock in dollars. Pence is 1/100th of a pound. So simply divide the number by 100. Then multiply by the current pounds-to-dollars conversion rate (which you can easily find at Yahoo! Finance’s Currency Center). So using today’s price , 102/100 = 1.02. Then multiply 1.02 x 1.558 = 1.58. That means you’re paying about $1.58 for a share of this African fund. Not too shabby.

A little while back the fund’s biggest winner was Shoprite, its largest position, which rose 79%. I am, however, drawn to the discussion on one of the fund’s losers. Losers are always more instructive. In this case, it was Great Basin Gold, one of AOF’s top ten. The stock fell 67%, but the fund held bonds that lost 37%. The reason for the disappointment is one all gold investors will appreciate.

That year, Great Basin said it was going to produce 110,000 ounces of gold from its Burnstone mine. By March, that goal fell to 96,000 ounces. By June, it was down to 58,000. In July, Great Basin amended the forecast yet again to 30,000 ounces. Its actual production for the year came out to 21,989 ounces! Ah, you gotta love mining!

But the lesson Francis pulls out is a gem. He quotes from Sir Theodor Gregory’s biography of Sir Ernest Oppenheimer, the great mining magnate who founded Anglo American in South Africa:

Ernest Oppenheimer throughout his business life insisted on the necessity of liquidity, in the sense of always having available a large margin of uncommitted resources; this implied, among other things, a cautious dividend policy and large reserve funds… The supreme need of a mining house, he held, was to maintain, at all times, an adequate margin of liquidity, not only so as to be able to take advantage of new opportunities, if and when they arose, but to prevent dependence on the vagaries of the money market.

A great bit of wisdom from an old mining crow — pin that up on your wall and don’t forget it. “Great Basin Gold experienced a misfortune that forced it to breach Sir Ernest’s financing policy,” Francis writes, “a failing all too common among the mining and oil and gas exploration and development industries.” So true…

I was most fascinated by AOF’s forays into agriculture, which make up around 18% of the fund. Okomu Oil makes crude palm oil and rubber. Palm oil is an ingredient in all kinds of soaps, cosmetics, edible oils and even biodiesel. AOF was able to pick up Okomu for less than what I call its “replacement” cost (the cost it would take to replace the company and its assets.) The cost of starting a brand-new plantation comes to about $5,000 a hectare. Okomu was trading for about $3,600 a hectare. It also had a price-earnings ratio of less than 5 and pays an 18% yield.

These are the kinds of exposures that are nearly impossible for you get on your own but that you get in spades by owning AOF.

When investing in Africa, you always have to consider commodity prices. Oil, coal, rubber and many others are all volatile. As natural resources are still an important part of the story for Africa, declines in these prices have dampened stocks as well. Even so, big investments in mining projects still move ahead. I wondered what country with a small population was on the cusp of enjoying a huge windfall from natural resources.

“Mozambique,” Francis offered. “We have very modest exposure to Mozambique, but I would like to increase it a lot.”

Over the long term, Africa is rich in possibilities and deserving of a slot in your portfolio. AOF is a great way to get exposure to Africa. Francis is a friend of mine and worthy of your trust. As his annual report makes clear, he is a thoughtful money manager who follows a proven process. He has a great track record and has his own skin in the fund. The results should be good for patient investors.

Sincerely,

Chris Mayer
Original article posted on Daily Resource Hunter

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