Samuel Gichohi, senior research analyst at NIC Securities

Samuel Gichohi, a senior research analyst at NIC Securities, a division of Kenya’s NIC Bank shares his views on the best bargains currently on offer at the Nairobi Stock Exchange, and how to open a brokerage account in Kenya.

The Nairobi Stock Exchange hasn’t been a great performer the past few years. Why should investors be investing in Kenya now?

The Nairobi Stock Exchange (NSE) is currently a buyer’s market, which presents foreign investors with massive bargain opportunities. This situation is a result of various factors that have converged to push stock prices to levels that are out of whack with the fundamentals on the ground. These factors include a weakening currency (which has finally begun to stabilise), escalating fuel prices, a surge in local liquidity prompted by heavy bank lending to the private sector, and food inflation caused by the region’s persistent drought. The situation was further compounded by increased political uncertainty due to the MENA crisis and the trials at the Hague of individuals suspected of instigating violence in Kenya, following the 2007 election. As a result, despite healthy turnover levels, stock prices have suffered over the last six months. Only 13 out of 48 active stocks trade above their year-end levels. But financial results for the 2010 fiscal year indicate that listed firms - especially the financial sector companies – enjoyed explosive bottom line growth. This trend continued in the first and second quarter of this year, which indicates that economic growth is still on course. Considering that a majority of stocks currently trade at P/E ratios below their respective sector P/E ratios, and that 15 of the 29 largest-cap companies offer dividend yields above 3%, there is an obvious mismatch between stock prices and company fundamentals. This is bound to correct going forward. In my view, the NSE is an ideal frontier market. It offers foreign investors exposure to the Kenyan economy, and - because many listed firms have expanded beyond Kenya’s borders - it also serves as an entry point to the regional economy. In the short term, foreign investors can capitalise by investing in the weak shilling and seek exit points as it strengthens against the US dollar.

What is your favorite Kenyan stock right now?

I have three favorites. First is Scangroup. It is East Africa’s largest advertising holding company with an 80% market share. It faces no local competition, which enhances its ability to attract and retain the region’s best talent. Being a listed company means it can also retain its top employees through stock options. In a human-capital intensive field such as advertising, this is extremely important. The company’s 2010 results were affected by costs related to its acquisition of Ogilvy East Africa, a former competitor. We expect the merger to result in cost advantages going forward. We’re also bullish on the company because competition in East Africa’s banking and telecoms industries is heating up. This will ensure higher ad-spends and thus more revenues for Scangroup. We expect annual profit growth north of 20% this year. It currently sells at a PE of 20, but we consider it undervalued because of growth opportunities.

My second pick is Equity Bank. It is the fastest-growing bank in Kenya and boasts a market share of deposits that has grown from 1.7% in 2005 to 6.2% in 2009. The deposit growth has been driven by branch expansion - particularly in Kenya’s rural areas - and by mobile phone banking. Equity Bank caters primarily to the SME and lower income segment with most loans being below Ksh.100 000. This “banking the unbanked” model has yielded impressive results, evidenced by deposit growth of 44% during the first half of this year. Equity has also done an admirable job at containing costs and maintaining the quality of its loan book. Both of these factors should lead to improved margins.

Finally, for the income investor, I like KenolKobil, a downstream oil marketer with a skillful and motivated management team. The company is focused on growing its storage capacity and distributional efficiencies, which is imperative for survival in the sub-Saharan African fuel-marketing industry. As competition increases and margins decline, the company will be able to take advantage of its scale economies. I also like that it is well diversified both geographically and in terms of its product range. The company has a heavy presence with over 400 service stations in East and central Africa as well as southern Africa. All this is backed by the additional effect of increasing property prices that could lead to significant profits when the company disposes of some of its non-core assets. The company is currently selling at a historical P/E of 10 and a half-year dividend yield of 5%. At the current price, the full year dividend yield will be approximately 10%; with profit growth, and a dividend pay-out ratio of 40-45%, the company is a cash cow.

Some Kenyan stockbrokers failed recently. Which safeguards have been put in place to protect investors and the market?

A number of market reforms have taken place recently in an effort to protect investors’ funds. They have resulted in the introduction of an automated trading system, more stringent capitalisation and disclosure requirements, the adoption of a standard stockbrokerage platform, and the eventual demutualisation of the Nairobi Stock Exchange. The minimum capitalisation requirement has resulted in most of the smaller brokerage firms being acquired by banks. Investment banks which have not reached the Ksh.250-million capital threshold have been relegated to stock brokerage status, which requires a minimum capitalisation of Ksh.50-million. The government plans to increase the investor compensation fund and investors are being educated on how to identify and report fraudulent behavior.

Read more on how to invest in Kenya's stock market.

Article provided by Investing in Africa.