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Picking the best low-hanging fruit where few others look -- for cents on the dollar

Why stocks, not government bonds
-- even on a 15%+ yield --
are likely your best long-term wealth creation tool

Stocks vs Government bonds, which is the best wealth creation tool?

Currently in Tanzania, investing in long-term government bonds is very popular. This is due to the high yields on offer, relatively low inflation rates (sub-4%), and a government debt-to-GDP ratio that stands at under 40%. Both institutional money managers, such as pension funds and unit trusts, as well as retail investors, have been hopping on board the trend.

Retail investors, in particular, have flocked to the bond market. According to the exchange, the number of active retail investors trading bonds on the Dar es Salaam Stock Exchange (DSE) has climbed from 2,583 in 2018 to 8,058 in 2021.

At the same time, the government has shown an insatiable appetite for borrowing money to spend on its on-going, big-ticket infrastructure projects, such as the Standard Gauge Railway (SGR) and Nyerere Hydroelectric Dam, as well as its broader development agenda. So, it has been holding large bond auctions regularly.

The recent launch of 20- and 25-year government paper, to add to the previously longest-dated 15-year bonds, has been met with an avalanche of demand.

So much so, that the government has been able to sell these bonds at a slight premium to face value. This means that the effective interest rate is lower than the coupon.

How to get rates of 15%+ per annum, on safe government bonds…

Let’s work through an example. Say a 25-year government bond expiring in 2046 with a coupon rate (the annual interest paid on the face value of the bond) of 16% sees bids between 98 and 103 at auction. The government accepts all the bids at 103, meaning that the effective interest rate is 16/103 or 15.53% per annum. That’s still a great rate of return for the bond purchasers, and explains why investors have flocked to such bonds.

Hold the bond to maturity and you will be paid TZS 8,000,000 every six months for every TZS 100,000,000 of face value of bonds you own, for 25 years. And, at the end of the 25-year term, you will get back the TZS 100,000,000 face value.

Moreover, there is no withholding tax on interest earned from government bonds in Tanzania. Dividends from DSE-listed companies, on the other hand, attract a modest 5% final withholding tax.

With current historical yields on blue-chip equities traded on the DSE in the region of 6.85% (NMB Bank PLC) to 11.8% (Twiga Cement), why do I say that equities, rather than bonds are likely to be the better long-term wealth building vehicle?

Three main reasons:

    1. The power of compounding. For high-quality, well-managed companies paying out dividends to shareholders, the dividends are almost certain to grow handsomely over time.

For example, while NMB bank paid TZS 137 per share in dividends this past May, based on its 2020 earnings, the 40%+ growth in its earnings so far in 2021, means that I am projecting it will pay out between TZS 175 and TZS 200 in dividends per share next May.

And the dividend could easily keep growing 10% a year or more, on average, for the foreseeable future. So, while your government bond coupon stays at 16 per 100 of face value until maturity in 25 years’ time, the NMB dividend might have doubled two or three times over the same period.

If you were to buy NMB shares now, at TZS 2,000 per share, if the TZS 175 expected 2021 dividend doubles, doubles, and doubles again over the course of a 25-year period, which is not out of the question, you could be getting back a dividend of as much TZS 1,400 per share each year by 2046.

That’s the magic of compounding. Stocks offer it. Bonds do not.

    1. Stocks keep up with Inflation. Good companies with clear and durable competitive strengths, and a “moat” around their business which discourages competition, can raise their prices and keep pace with inflation. In other words, their earnings power and dividend-paying power both grow over time. It is not eaten away by inflation the way bond coupons are.
    1. Stocks offer capital gains. As companies grow their earnings over time, even if the stock market does not “re-rate” the multiple of earnings that investors are willing to pay for those earnings, share prices will rise. If Twiga Cement makes TZS 500 per share in earnings in 2021, and trades at a multiple of 7 times earnings, the share price will be TZS 3,500.

As those earnings perhaps double by 2031, and double again by 2046, even if the shares are still only selling for 7 times earnings, you’d have a share price of TZS 14,000.

For bonds, while it is true that they will appreciate in price on the secondary market if the overall level of interest rates falls, if you hold to maturity you will never get back more than the face value.

While having a “balanced” portfolio, with some bonds and some equities makes sense for most people, I urge all investors to keep the above in mind when weighing up the choice between government bonds and equities.

Don’t just be seduced by the lure of high government bond coupons in the short term, as in the long term their attractiveness relative to a growing stream of earnings and dividends from equities fades.

For my Tanzanian readers, government bonds are easy to purchase. For non-citizens of Tanzania, it’s trickier. You cannot invest directly. But, if you open a custody account (as a good number of my readers have), with the likes of NMB Bank (send me a note if you’d like details of who to contact), you can invest in the Tanzanian government bond market via one of the bond funds run by UTT Amis, a leading local mutual fund company.

But there are also ways to profit from stocks and bonds at the same time…

Banks in Tanzania, as my colleague Lyall Taylor in Singapore has pointed out, are like a leveraged play on government bonds in some respects.

Here’s a slide straight from NMB’s third quarter results presentation conference call I attended this week. Note the 25% year over year growth in the bank’s investments in government securities.

The DSE (as the venue for the listing and secondary trading of government bonds), as well as the Tanzanian banks, NMB and CRDB, are all companies that benefit from investments in government bonds.

They gather up low-cost deposits, where they pay a few percentage points in interest, and turn around and invest a hefty chunk of those deposits in high-interest government bonds and pocket double-digit spreads. It’s going very well for them. As I’ve written before, their earnings are rocketing.

Finally, National Investments Company Limited (NICO on the Dar es Salaam Stock Exchange), a small investment company (with a checkered history, I must warn you), is another way to get an indirect exposure to Tanzanian government bonds. Disclosure: I own over 1.2% of NICO via my Tanzanian company.

This company is also a great way to get exposure to NMB Bank, in which NICO owns a 5.3% stake, at a huge discount.

NICO’s shares trade for only TZS 290, but I estimate the value of its investment portfolio, dominated by NMB Bank shares, at north of TZS 1,100 per share. Put another way, at current market prices…

NICO’s market capitalization is just US$7.7 million but it has over US$29 million in net assets

I was at the NICO AGM last week, and I must admit I was not very impressed with management’s current lack of vision. They don’t seem to have a plan for the company, other than to buy more government bonds. But the “margin of safety,” with the stock trading at a 70%+ discount to liquidation value, is enormous. That’s why I’ve owned NICO directly for several years, and indirectly (as I do now, via my company).

It pays dividends, too. The most recent dividend of TZS 17 per share was approved at the AGM, and I am expecting that to hit my company’s bank account by December 30. They could easily be paying out much more, as a payout of 17 shillings is only about 38% of management’s projected earnings per share for 2021 of 45 shillings.

I’ll have much more to say about NICO in the future.

For now, all of the investments discussed in this article: Tanzanian government bonds, the UTT Amis Bond Fund and Liquid Fund, DSE shares, NMB shares, as well as NICO shares are very attractively priced, and worth taking a look at, in my opinion. While there is undeniably some jurisdictional risk, you get paid very handsomely to take that risk on.

To my mind, the valuation risk present in lofty developed markets is far more of a concern. But we can each make up our own minds on that. For my own capital, and for the investors who entrust me with part of their hard-earned capital, investing in Africa right now makes the most sense. So, that’s what we are doing.

Until next time,

Good Investing!

Tim Staermose
Global Value Hunter
African Lions Fund


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