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Blurb

Opinion: Naira-settled OTC FX Futures and Stabilizing the Exchange Rate

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CBN Governor, naira

To stem the continued devaluation of the Naira and to breath some air of stability into the ever-volatile Naira/Dollar relationship, the Central Bank of Nigeria, CBN, introduced some far-reaching measures at different times. One of such measures was the launching of the Naira-settled OTC FX Futures Market. That “history-making” event which commenced on June 27th 2016 made the CBN “the pioneer seller of the Naira-settled OTC FX Futures contracts on the FMDQ OTC Securities Exchange (FMDQ)”.

Before the advent of the Naira-settled OTC FX Futures, various governments in Nigeria had been tinkering with the Naira exchange rate management using different policy driven methodologies at different times. In 1986, the Exchange Rate Liberalization Policy was introduced and with it, the Naira was devalued officially for the very first time, on September 26th. 1986 to be specific.

From that day till today, the Naira has been heading south. Economic and financial historians have it that Nigerian governments have tried to manage the exchange rate with the Foreign Exchange (Monitoring & Miscellaneous Provisions) (FEMM) Act of 1995, the Two-way Quote System (market making) in the inter-bank FX market in 1996 and the Wholesale Dutch Auction System (WDAS) in 2006. Unfortunately, it seems that none of those worked. It is therefore not surprising that the currency futures market has been put in place as a way to “stabilize” the Naira.

It is now almost two years since the Naira-settled OTC FX Futures market was out doored and the question is how far it has gone in stabilizing the Naira/Dollar exchange rate.Though the Naira/Dollar exchange rate continues to remain high, it is a bit comforting that the new FX currency risk exposure management instrument, (the Naira-settled OTC FX Futures), has been able to curb or curtail the speed at which the Naira depreciates relative to the Dollar. At least, for over six months the rate has remained in the N360s to the $.

When used properly, Currency Futures are a veritable instrument of managing foreign currency risk exposure. This works well when there are buyers and sellers and probably not so well when there are buyers with the CBN as the only seller. By definition, a futures contract is an agreement between two parties where one (the buyer) agrees to buy and the other, (the seller) agrees to sell a given amount of the underlying asset or subject of the contract, at an agreed price on future date.

A futures contract entails a long position by one party and a corresponding short position by another. It does look like the CBN is the seller or the short position party in the Naira-settled OTC FX futures contracts although it is not apparent who the long position parties are. By their nature, futures are zero-sum games.

Futures do not involve an initial cash flow, meaning that money does not change hands at the initiation of the contract except where commissions are charged but subsequently, it becomes apparent how much the parties to a contract will pay/receive as the price of the underlying instruments change from day to day. The method of determining the amount payable/receivable by either party is called marking to market, (the technicalities involved in mark to market calculation will not be part of this discussion).

Market Activity

It is noteworthy to point out that the Currency Futures market in Nigeria has been very active and vibrant since inception although the momentum seems to be reducing as rates converge. On the date that the market went live, it recorded $26.73 million in open interest. As at April 6, 2018, the open interest had increased to $ 3,278.43 million, an increase of 12176%. This underscores the extent of Nigeria’s dependence on and demand for the dollar, among other implications.

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The implication of this is also that, if the CBN is the only party that holds the short positions, it means that the CBN has contracted to sell $3,278.34 million to various parties over a range of period depending on the maturity dates of the contracts. However, the Naira-settled OTC FX Futures are non-deliverable, meaning that the CBN is not going to sell or deliver $3,278.34 million to the long position holders, rather, the CBN will pay them the difference between the contract price and the NIFEX/NAFEX rate as at the maturity date of each futures contract.

It will be recalled that the first futures contract matured on July 27th, 2016, and the CBN had to pay ₦962.23m to the long position holder. For the almost two years of existence of the FX Futures market in Nigeria, 21 of such contracts have matured. Looking at the contract prices of the open trades in relation to the current exchange rate, there is indication that the CBN will be at the paying end of the contracts. According to analysis by analysts at Quantitative Financial Analytics, the total notional value of all contracts from inception to date is $11.743 billion while total matured contracts stand at $8.464 billion leaving current outstanding open interest at $3.278 billion. Out of the matured contracts, the short position holders (probably the CBN) has paid an estimated $503.8 million to the long position holders, according to the analysis.

As said before, currency futures are derivatives, and derivatives are high-risk instruments, if used properly, they are beneficial but when misused, they can lead to catastrophe. To a large extent and in most recent times, the FX currency futures market has helped in stabilizing the Naira Dollar exchange rate although the decreasing momentum arising from the convergence of rates may diminish its role in managing the currency risk exposure of Nigerians. We are watching

 

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Uchenna Ndimele is the President of Quantitative Financial Analytics Ltd. MutualfundsAfrica.com and mutualfundsnigeria.com (both Quantitative Financial Analytics company website) is a leader in supplying mutual fund information, analysis, and commentary on African mutual funds. We provide reliable fund data; and ratings information that will add value to fund managers, the media, individual investors and investment clubs.

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    Blurb

    Buy what? Dangote vs BUA Cement

    Dangote Cement has a market capitalization of N3.65 trillion, while BUA posts a N2.49 trillion capitalization, but does size win?

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    I want to review the performance of the largest quoted companies in Nigeria.

    On the Nigerian Stock Exchange, they don’t come any bigger than Dangote Cement (Dangote) and BUA Cement (BUA). Only MTNN stands with both cement companies in terms of market capitalization. Dangote and BUA are both blue-chip companies, in the same sector and both enjoy federal import protection, they also both serve a local market with huge demand for cement.

    Which is a better investment? Let us assume I have N100,000.00 (One Hundred Thousand Naira,) which should I buy? Let us review both stocks with FY 2020 results they posted. For consistency, I am going to use my trading view terminal numbers.

    READ: Dangote Cement joins MTN in the trillion-naira club, as 2020 revenue surpassed N1 trillion

    Market Capitalization

    First, we talk about capitalization, (Market cap is the number of shares issued x market value of shares ). Dangote Cement has a market capitalization of N3.65 trillion, while BUA posts a N2.49 trillion capitalization. Does size win? Dangote is bigger? Not yet!

    Market Price

    With N100,000 I can buy about 465 shares of Dangote at N215 a share and 1,360 shares of BUA at N73.50 per share. Is BUA cheaper? do we have a winner? Not quite. Let us dig deeper.

    Dangote Cement posted a Net Income figure of N276 billion, if we divide this earning by the number of issued shares which is 17 billion, we get an Earnings Per Share (EPS) of N16.14, so every share of Dangote Cement earns (not pays) the investors N16. Similarly, the Earning Per Share of BUA is N2.0

    READ: BUA Cement loses N162 billion in market value in a week

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    Thus when I buy Dangote Cement N215 per share, I am buying 16 times the earnings of Dangote. We can simplify this by simply comparing the price I pay per share of Dangote to the EPS of Dangote (Price to Earnings Ratio), thus I invest my cash of N215 to buy 16 times the earnings of Dangote, thus the Price to Earnings Ratio of Dangote is 13.31 (P/E). Using the same calculation, the price for each earnings of BUA (the P.E.) is 35.38. This means even though I am paying more cash for each share of Dangote, I am paying less to buy the earnings of Dangote, thus Dangote is cheaper than BUA.

    So our first milestone is reached, we have used the Net Income, Market Price, and Number of Issued shared to get the Earnings Per Share, we have then determined what amount of earnings we are buying to determine which stock is at a bargain.

    READ: Oba Otudeko’s stakes in Firstbank and Honeywell are worth over N10 billion

    What else?

    Let us look at the earnings that will be paid in cash. Remember, Earnings, is just the Net Income of Dangote, we as equity holders have the opportunity to share in any portion of the Net Income.

    Dangote in 2020 paid out from earnings N272.69 billion as dividends, this translates to about N16 per share or in terms of returns 7.44%. We get this Dividend Yield return by comparing the dividend paid to the market price per share (D/P). BUA also in 2020 paid out N59.26 billion as dividends from earnings, this translates to a dividend yield of 2.81%.

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    So, if I invested N100,000 in shares of Dangote Cement, I would earn a cash return of 7.44%, if I did the same with BUA I would earn a cash return of 2.81%.

    READ: Jumia: In search of the elusive break-even sales

    Let us go a bit deeper…

    When you buy a stock, you are buying into the earnings and cash flow. Dangote Cement in 2020 earned N276 billion and paid N272 billion as dividends meaning they retained about N3 billion for that FY while generating over N248b in Free Cash Flow. Similarly, BUA earned a net N71.52 billion, paid out N59 billion in dividends, retained N19 billion but posted a negative Free Cash Flow of (N95.49 billion). Should BUA cement have simply used that cash to finance working capital rather than paying it as dividends? Perhaps. Let us speak more of Cash flow.

    Cash retained is cash not paid to you the investor. You have to ask how well your company is utilizing that cash retained. Should it all be paid out as dividends? Or retained in the company to fund expansion and growth?

    READ: Three things Nigerians can learn from Warren Buffet’s latest letter

    Look at it this way, if Federal Government Bonds were offering a Yield of 15% and we see that Dangote is offering a yield of 7.44%, then as shareholders you should demand that Dangote pays more cash to you to allow you to invest in FGN bonds because you get a higher return (at lower risk). The point is any company retaining cash or paying cash at a lower yield than the market is hurting the investors, who are missing the opportunity of investing higher elsewhere.

    Let us score both company managers by how well they have managed the revenues and capital of the companies

     

     Return on Assets %Return on Equity %Return on Invested Capital %EBITA Margin %Net Margin %Debt to AssetsLong Term Debt to Assets
    Dangote Cement14.6231.2126.9244.0424.310.240.08
    BUA Cement11.1519.1215.3541.8732.030.360.23
    FY 2020

    Across the board, the management of Dangote Cement has done a better job when compared to BUA Cement in managing the assets of the company. Dangote Return on invested capital is higher with a much lower recourse to debt and of course a higher FCF number.

    Overall, on Earning, Returns and Efficiency, it appears Dangote Cement posts better fundamentals…

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    Do follow @FinPlanKaluAja1

    This is not investment advice, this is not a recommendation to buy or sell. Past performance is not a guarantee of future performance. Speak with your adviser before investing. Equity is risky.

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    Blurb

    Is something fishy going on at Custodian Plc?

    Custodian stock hit a year high just as it announced a Convertible Loan Instrument set to be approved at its AGM.

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    Custodian Investment Plc. announces board meeting and closed period, Custodian Investment Plc. announces board meeting and closed period

    Custodian Plc, one of the largest insurance companies in Nigeria is currently trading at a new year high of N7.10 and is up 21% year to date. Nairametrics Blurb team has in recent days noticed an upsurge in its share price especially since the company announced its AGM.

    As we pen this article, about 2.9 million units have exchanged hand at a share price of N7.

    The stock is included in the Pension Index and by some measure quite illiquid. It is also one of the stocks recommended in our Premium Service Stock Select Newsletter thus the need for further introspection.

    READ: Buy what? GTBank vs Zenith Bank

    Custodian Investment AGM

    Typically, when companies announce AGMs we are keenly curious as this is where decisions that can ultimately affect shareholders (especially smaller retail investors) are approved.

    In its recent filings, the company stated as follows in item 10.

    That the Board of Directors of the Company be and is hereby authorised to:

    (a) raise the Naira equivalent of up to $15,000,000.00 (Fifteen Million US Dollars), as additional capital through a convertible loan instrument;

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    (b) convert the loan in the Naira equivalent of up to $15,000,000.00 (Fifteen Million US Dollars) into shares in the Company (the “Conversion Shares”) at a conversion price, being the higher of N6 per share or the 12-month historical average daily share price of the Company derived from the Daily Official List of The Nigerian Stock Exchange (for the period ending on March 23, 2021), subject to adjustment upon the occurrence of certain adjustment events;

    (c) allot the Converted Shares to the Lender upon the exercise by the Lender of its right to convert the Loan into shares in the Company, subject to applicable law; and

    (d) take steps necessary or reasonably desirable to give effect to the foregoing resolutions and for effecting any transactions pursuant thereto, including the appointment of professional advisers, and the obtention of relevant regulatory approvals.

    READ: Notore Chemicals is swimming in debts – company to access equity market in Q2 2021

    What this means?

    In simple English, the directors of Custodian are seeking the approval of its shareholders to borrow $15 million (N6.1 billion) in convertible loan instrument.

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    A convertible loan instrument is simply a loan that you can convert into shares if the lender so wishes. The share price for conversion are predetermined and in this case, they stated N6 per share or the 12-month historical average daily share price of the company’s stock.

    If the lender does decide to convert the loans to shares at the current share price of N6 per share, it means about 1 billion shares will be offered to the lender, an equivalent of 17.4% of the total outstanding shares of the company. This loan is in effect, a potential dilution of existing shareholders of the company if it is approved at the AGM.

    So why is the company seeking a convertible loan or even diluting its shareholders?

    READ: Gains on quoted investment stocks rescued Custodian Investment Plc from loss in Q3 2020

    Fishing around for why

    Typically when a company decides to raise money via a convertible loan instrument, they are looking for lower interest rates, debt that avoids the burden of periodic repayment, and/or looking to delay when the actual equity is issued. There are also tax considerations at play but not as significant as the ones mentioned above.

    Except, Custodian is looking to purchase another asset, after it bought UPDC, we do not understand why it will be looking to raise capital huge enough to dilute existing shareholders. It also did not explain why it is seeking to raise the said capital in its AGM Notice, a slight departure from the norm in cases like this.

    • Custodian is also highly capitalized with a Net Asset of about N46 billion and a balance sheet size of N176.1 billion (after the acquisition of UPDC) as of 2020.
    • Suffice to add that the company recently paid shareholders about N2.6 billion in dividends, making us wonder why it is seeking to dilute shareholders when it could have just ploughed that amount to its capital raising needs.
    • In fact, the dividends paid in 2020 was just 21% of profits, meaning it had retained about N10 billion in profits made during the year. Again, why does it need N6.1 billion in loans?
    • Custodian also has a thriving insurance business which fetched it about N58 billion in gross premium income out of which N32 billion was from non-life. Again, why does it need N6.1 billion on convertible loans?
    • The company currently carries a debt of about N5.5 billion which was inherited from its acquisition of UPDC. The debt is mostly a bond issued at an interest rate of 16% per annum and due for full liquidation in 2023.
    • There is no rush to pay down this debt.

    READ: NPF Microfinance vs C&I Leasing: A tale of two rights offer

    What then?

    We are lost as to why the company is looking to raise this capital and can only now think of two reasons. Firstly, could it be the existing shareholders looking to tighten their stake in the company? Custodian’s majority shareholders are Gratitude Capital Limited and Mikeade Investments Limited with 22.48% and 15.72% respectively.

    • The company CEO Oluwole Oshin represents Gratitude Capital while Business Mogul Micheal Ade (Elizade) owns Mikeade Investments Limited. Could it be either of these two investors looking to up their stakes?
    • There could also be a reason for this back door approach. About 74.5% of the company is owned by just 20 shareholders so it is clear that increasing majority stake will be difficult to achieve.
    • The other reason is perhaps an institutional investor looking to acquire a significant stake in the company through the backdoor. Is this plausible?

    READ: Investors react to Fidelity’s bond listing, as it gains N1.74 billion

    Well, these are speculations that only Cusdotian can confirm. We hope they do so as soon as possible.

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