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Team Commentary

Moody’s Downgrade 11 August 2017

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Moody’s Downgrades Namibia to Sub-Investment Grade

On Friday 11 August Moody’s Investors Service downgraded Namibia from Baa3 to Ba1, sub-investment grade. While the timing was unexpected, the downgrade was not. At the start of the year we voiced our concern that Namibia would lose its investment grade rating. We thus concur with the reasoning behind the ratings downgrade. The points raised are reflective of the facts and we trust that Namibians will view this through a constructive lens.

Moody’s statement can be found here: https://www.moodys.com/research/Moodys-Downgrades-Namibias-rating-to-Ba1-maintains-negative-outlook–PR_370993

Factors contributing to the downgrade:

1. Erosion of Namibia’s fiscal strength due to sizeable fiscal imbalances and an increasing debt burden

We agree with this point. Debt issuance over the past two years has been substantial. Debt to GDP has gone from just over 26% in June 2015 to 41.9% at present (MoF numbers). Add in the portion of the African Development Bank loan received already and this goes up further. This debt was raised partially to fund government expenditure and partially to support the external position of the country. Effectively government’s leveraged balance sheet makes it more difficult to secure further financing should it be needed in the event of any shock to the economy.

2. Limited institutional capacity to manage shocks and address long-term structural fiscal rigidities

Agree. The argument posted by Moody’s is very clear here. Examples of the erosion of fiscal strength are provided and spot on. Budget deficits in 2015/16 and 2016/17 were larger than expected due to overoptimistic revenue forecasts which did not materialise. The consumptive, recurrent portion of the budget continued to grow during these years, while the development budget shrunk. The wage bill is given as an example of this recurrent expenditure. This recurrent expenditure is very difficult to reduce in many cases and thus limits discretionary expenditure such as infrastructure projects when revenue collection is under pressure as it is now. Limited spending on necessary infrastructure projects acts as a drag on growth as pointed out by the ratings agency.

3. Risk of renewed government liquidity pressures in the coming years

Agree. Should revenue again disappoint and debt issuance increase in order to fund larger than expected deficits, we could see liquidity dry up in the same way as it did in 2016.

Thus we agree with the points made by Moody’s. Structural changes need to be made to government’s expenditure profile in order to return the public budget to a sustainable path. The minister of finance made a good point that this process will take time and that government has started and is committed to making the necessary changes.

Moody’s has to provide accurate and timely information to its clients (holders of debt – government and corporate – this includes almost everyone with a pension in Namibia) and thus has to act on what is happening in the present with a view on how this will affect the financial stability of the country and government’s ability to honour its debt obligations. The downgrade was therefore inevitable as initial efforts to drive structural changes have not been immediately evident. Indeed, the opposite has been witnessed as government has struggled to pay outstanding invoices to the private sector. The inability to pay invoices is what would have been most concerning to Moody’s as it brings into question the ability of government to honour its debt obligations. Much of these invoices have been settled as government has pointed out, but there was a substantial delay in satisfying many of these obligations, which is concerning.

We are cognisant of the fiscal measures implemented by government thus far and expect to see further commitment to these in the mid-term budget review scheduled for October. The Moody’s downgrade should not be seen as a failure of government but rather a warning to correct course after slowly straying from a sustainable path for the better part of a decade. For the man on the street the Moody’s downgrade should have little impact if the correct policy decisions are made going forward. Structural changes to the fiscal budget will not be easy to effect but are vital if Namibia is to return to a path where sustainable social and economic progress is made.

Increased Competition for Namibia Breweries in South Africa

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AB Inbev released their 2Q17 results today, reporting strong profits following the acquisition of rival beer giant SABMiller. Despite poor performance in Brazil and lacklustre results in the US, revenue grew by 5.0% with global volumes up 1.0%. Earnings before interest, taxes, depreciation and amortisation (EBITDA) rose 11.8% to US$5.35bn on an adjusted basis as strong cost cutting measures led to expansion of EBITDA margins.

Strong growth was recorded in South Africa. Revenue increased by 13.4% in 2Q17, which consisted of revenue per hectolitre growth of 2.4% and volume growth of 10.8%, while the first half of the year revenue grew 9.7%. The double-digit growth in volumes comes as quite a surprise given the weak economic climate prevailing in South Africa. According to the statement, the sound top line performance was “driven by a portfolio of brands with distinctive positioning and consistent through-the-line sales execution.”

The company noted that the launch of the premium market unit recorded promising growth, specifically in the Stella Artois and Corona brands. Corona has been gaining ground worldwide, with global growth of 16.6% and 26.2% growth excluding Mexico. According to Ricardo Tadeu, president of the new Africa zone in AB InBev, the world’s biggest brewer doesn’t have any plans to reduce its presence in any of the 31 African markets in which it now operates. They have also announced their plans to bring global beer brands such as Budweiser, Stella Artois and Corona to African markets and have also indicated their interest in brewing these brands in South Africa.

Furthermore, AB Inbev has started to invest heavily in increasing its capacity in Southern Africa, recently announcing that it was investing R2.8 billion in expansions at two of its breweries, Alrode in the south of Johannesburg and Rosslyn, outside of Pretoria. Each brewery is to receive a new 45,000 bottles per hour packaging line for returnable glass bottles, adding a total of four million hectolitres of capacity per year. The Alrode packaging line will be in production by August while Rosslyn’s will be online by October.

These developments do not bode well for Namibia Breweries who have a 25% stake in Heineken South Africa, the owner of the 4.5 million hectolitre Sedibeng brewery in Johannesburg. This brewery produces a range of premium beers including Heineken and Amstel. It also brews Windhoek and Tafel lager under licence. The increased competition, specifically in the premium market, may disrupt their plans to rapidly expand their South African market share. According to Namibia Breweries’ management, they and their associate currently hold roughly 50% of the premium beer market in South Africa, which in turn comprises around 16% of the total beer market which was estimated to be at 31.4 million hectolitres in 2014.

As mentioned our Namibia Breweries 1H17 results review, our target price is quite sensitive to the rate at which the Sedibeng brewery can increase production volume, which in turn depends on the demand created by increased market share. Details on the South African operation are limited at present, as financial information regarding the cost structures and future volumes is limited. We have thus assumed that full capacity will be reached over a five-year to six-year horizon. Given the high level of fixed cost associated with the brewery and the time it is expected to take to ramp up production, we expect to see losses in FY17 and FY18, breakeven levels of profit in FY19 and then increasing profitability thereafter. This is based heavily on management’s guidance. The South African operation will become a very large part of the business and could make up nearly half of NBS’s value once running at full capacity.

Namibia breweries’ 1H17 statements reflected strong volume growth in the last six months of 2016. Beer revenues grew by 13.9% which was driven largely by increased exports to South Africa. These volumes were largely boosted by Windhoek lager, which has gained a lot of popularity in recent years. However, it remains to be seen if the heightened exports to South Africa could be sustained in 2017 and if volumes produced in South Africa continue to grow as projected in the face of heightened competition from the AB Inbev premium brands. Namibia breweries are expected to release their FY17 results in September.