Egypt: What to own now? – Third-cheapest currency in EM

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renaissance-capital-logoWe welcome today’s (3 November) Central Bank of Egypt (CBE) decision to float the Egyptian pound. Our REER calculation suggests EGP11/$ as a fair value, but given the likely spike in inflation from the current 14% to perhaps closer to 20%, a rate closer to EGP13/$ looks more appropriate. EGP13/$ would give Egypt the third-cheapest currency in emerging markets (EM) on our global chief economist Charles Robertson’s REER. The move is sufficient for our equity strategist, Daniel Salter, tentatively to move his recommendation on Egypt from UW to OW; we remain selective and highlight Elsewedy Electric as our highest-conviction Egypt pick.

How could Egypt be different?

The move on the exchange rate (making it cheap on our REER measure), which we believe is likely to unlock Egypt’s IMF programme, is sufficient for us tentatively to move our recommendation on Egypt from UW to OW. Nevertheless, the equity market could be bumpy for several months: 1) as investors determine whether a clearing exchange rate has been established; 2) as previously trapped capital may choose to exit; and 3) if local investors who have been using equities as an FX hedge unwind their positions. Practically speaking, we suspect that most international investors are likely to monitor how liquidity in the FX market is delivered over the coming weeks/months, and if a two-way clearing rate is achieved, with full ability to repatriate capital without delays. Our strategy, therefore, would be to use any sell-off following today’s move up in prices to rebuild positions. We would also like to see Nigeria (UW) complete the final moves in adjusting the naira.

Elsewedy is our top Egypt pick

With our TP implying 50% upside, Elsewedy is our highest-conviction Egypt pick. At EGP13/$, our 2017E EBITDA (+36% YoY) is 16% higher than our previous estimate. This implies even more attractive dividend yields of 10% for 2016E and 12% for 2017E. Commercial International Bank Egypt (CIB) is likely to be a key beneficiary of the devaluation, as management guides for loan growth of more than 25% once the dollar shortage is mitigated. Assuming 30% loan growth for FY17/18E, we could see a 5%/9% increase in our EPS estimates, respectively. We expect an EPS CAGR of c. 30% over 2015-2018E and RoA of c. 3% over the same period, underpinned by: 1) strong revenue growth, driven by rising investment in high-yielding government securities and higher loan growth; and 2) normalisation of the cost of risk, given significant NPL coverage and the pick-up in the economy we expect.

Near-term impact on consumption negative; remain selective

Devaluation and ongoing fiscal reform will put consumers in defensive mode. Companies will find it hard to successfully pass on cost inflation without sacrificing volume, with the exceptions, in our view, to be relatively defensive names such as Cleopatra Hospital (structural growth), Eastern Tobacco (pricing flexibility) and IDH (small FX exposure, dividend and/or M&A potential), which we argue are relatively insulated from external drivers. Real estate developers could lose some investment demand owing to rising treasury yields, but real demand still looks strong, given robust sales momentum YtD; Palm Hills is our top pick in the space as we expect it to exhibit a strong turnaround. We also like Global Telecom on a strong outlook and the fact that it is immune to movements in the Egyptian pound.