Q4 2017 strategy - pathway in turning tide

16 October 2017 ARM Securities © 2017

ARM RESEARCHQ4 2017 Strategy - Pathway in Turning Tide

Q3 2017 Recap

ARM Securities © 2017

The Quarter in Review

16.5%

17.0%

17.5%

18.0%

18.5%

19.0%

32000

34000

36000

38000

40000

3-Jul 3-Aug 3-Sep 3-OctEquities Yield Curve - RHS

July 5CBN starts tapering marginal clearing rates at the OMO auction

July 6DMO Q3 calendar hints at softer borrowing

July 25CBN forced debit banks N471 billion via stabilization securities

MPC remained fairly hawkish

August 4FMDQ effected an adjustment to interbank USDNGN reporting to I&E window

August 9Nigeria plans to refinance $3bn worth of Treasury bills via a 3-year Eurobond

August 16August failed bond auction. Subscription to offer of 0.47x –the lowest on record

August 29Net OMO repayment of N82bn – the first time in a while

September 1Inflation declined for the sixth consecutive month

September 5Nigeria finally exits recession, albeit fragile growth

September 6CBN ceased issuance of the one-year OMO paper

September 26MPC retains policy parameters, but points to easing

September 27Successful issuance of the 7-year Sukuk bond of N100bn at rental rate of 16.47%

September 28DMO announced plans to issue $5.5bn worth of Eurobonds in Q4

Source: NSE, FMDQ, ARM Research

CRUDE OIL


Crude Oil Price Market

Crude oil market switched to a deficit (160kbpd) to drive a bull run in the commodity price.

1.2

2.0

1.0

1.7

1.0

0.3

-0.1

0.90.7

0.4

-0.2

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

90.0

92.0

94.0

96.0

98.0

100.0

Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17

Global Demand Global Supply Balance (RHS)

• Rise in demand was largely driven by growth in the OECD region (2.0% QoQ to 47.6mbpd) – Europe’s demand and the re-opening of US refinery.

• Slower than expected rise in supply hinged on further production cut by Russia (-330kbpd) and hurricane impact on increase in US shale production

• US supply came in only slightly higher relative to prior quarter (+280kbpd)

• Enough to offset the impact of a rise in OPEC’s supply, that was triggered by higher supply from previously battered members: Nigeria (+176kbpd) and Libya (+230kbpd).

• On balance, a tamer crude supply picture (relative to demand) led to a much-needed rebalancing in the crude oil market in the review period. 0.186

0.000

0.200

0.400

0.600

0.800

1.000

1.200

Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17

US Libya Nigeria

Hurricane stirs increase in est. unplanned crude oil production outages in US

Source: EIA, ARM Research

Source: EIA, ARM Research

Will crude oil ‘roller coaster’ linger? • We see scope for greater supply from US as the impact of Hurricane subsides - recent Hurricane has yielded smaller damage compared to past

storms with a sizable number of US drillers expected to resume drilling activities in the near term.

• Expected higher production from Nigeria and Libya of 120kbpd and 100kbpd respectively to moderate the impact of production cut by other OPEC members.

• Finally, expectation of further rate hike and unwinding of balance sheet by the US Fed guides to a stronger dollar and consequently lower crude oil prices.

…we resist the enticement to raise our crude oil prices forecast given recent development.

Precisely, we expect the confluence of factors to keep mean crude oil prices at a range of $45 - $50/bbl. with a base case of $50/bbl.

35.2 47.0 47.0 51.0 54.6 50.8 52.2 50.0

6.2%

25.5%

-1.2%

15.8%

-7.0%-9.3%

20.1%

-4.2%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

30.0

35.0

40.0

45.0

50.0

55.0

60.0

Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17

Mean prices ($/bbl.) % QoQ Return -RHS

42

44

46

48

50

52

54

56

58

60

40

42

44

46

48

50

52

54

56

58

60

Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17

Brent Brent Oil Futures - Dec 17

…sharp swing in sheer backwardation indicating a possible decline in crude stocks and positive for prices

Source: Bloomberg, ARM Research Source: Bloomberg, ARM Research

DOMESTIC MACRO


Aside from crude oil prices, a key issue was Nigerian oil production

Rebound in oil production

…sizable decline in crude oil production outages points tohigher production for the rest of the year

2.12.0

1.9

2.0

1.71.8

1.7

1.51.7

1.8

1.9

1.6

1.8 1.8

1.6

1.81.9

0

100

200

300

400

500

600

700

800

0.0

0.5

1.0

1.5

2.0

2.5

Jan

2016

Mar

201

6

May

201

6

Jul 2

016

Sep

2016

Nov

201

6

Jan

2017

Mar

201

7

May

201

7

Jul 2

017

Oil production (mbpd) Production Outages (kbpd) -RHS

2.2 2.162.05

1.811.61

1.76 1.81 1.84 1.89 1.96

0.0

0.5

1.0

1.5

2.0

2.5

Q3

15

Q4

15

Q1

16

Q2

16

Q31

6

Q41

6

Q1

17

Q2

17

Q3

17

Q4

17

Source: EIA, NNPC, ARM Research Source: NBS, ARM Research

• Given the relative stability in the Niger delta region coupled with the reopening of the Forcados pipeline, we expect higher oil production over the last two quarters of 2017.

• Extrapolating oil production for July using an average 28-month spread between NNPC and OPEC production data, we think production printed around 1.93mbpd in July.

• That said, we estimate Q3 and Q4 2017 crude oil production at 1.9mbpd and 2.0mbpd consecutively.

• The foregoing brings H2 17 average crude production to 1.89mbpd taking our full year crude production estimate to 1.86mbpd (+1.5% YoY).

Gross Domestic Product (GDP)

Uphill with the handbrake on

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

Q1

12Q

2 12

Q3

12Q

4 12

Q1

13Q

2 13

Q3

13Q

4 13

Q1

14Q

2 14

Q3

14Q

4 14

Q1

15Q

2 15

Q3

15Q

4 15

Q1

16Q

2 16

Q3

16Q

4 16

Q1

17Q

2 17

Oil GDP - LHS Non-Oil GDP Real GDP (RHS)

• Nigeria’s recession ended in 2nd quarter of 2017(0.5% YoY) majorly driven by growth on the oilfront (1.6% YoY) that was hinged on improved crudeproduction.

• Irrespective, optimism over the reading was weak asnon-oil GDP (91% of overall GDP) recorded aslower pace of growth (0.4% YoY) relative to theprior quarter (Q1 17: +0.7% YoY).

• Growth deceleration in non-oil led by Services,which reverted to negative growth (-0.5% YoY)coupled with further contraction in the real estate subsector.

• Weakness in non-oil GDP points to a slowerrecovery than expected.

• Given, our oil production forecast for Q3 and Q4, we now expect oil GDP of 0.7% and 1.5% YoY for Q3 and Q4 17 respectively

• For the rest of the year, we expect sustained pressures in the Services sector should leave growth at current or even lower levels.

• Improved FX liquidity should still sustain the expansion in manufacturing sector

• The end of the lean season, improved access to inputs, continued government support and cheap financing should sustain the growth in Agric.

• On balance, we now look for non-oil GDP growth of 0.4% and 0.5% YoY in Q3 and Q4 17 respectively.

• Tying our views across oil and non-oil GDP, we forecast real GDP growth for Q3 17 and Q4 17 at 1.1% and 2.0% YoY accordingly.

• On this basis, we revise our 2017 real GDP forecast slightly lower to 0.7% YoY (previous: 0.8% YoY).

Source: NBS, ARM Research

We revise our 2017 real GDP forecast slightly lower to 0.7% YoY (previous: 0.8% YoY), but…

• Tying our views across oil and non-oil GDP, we forecast real GDP growth at Q3 17 and Q4 17 of 1.1% and 2.0% YoY accordingly.

• On this basis, we revise our 2017 real GDP forecast slightly lower to 0.7% YoY (previous: 0.8% YoY).

6.2%

2.8%

-1.5%

0.7%

4.0%

-2.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

2014 2015 2016 2017 Base 2017 Bull 2017 Bear

Oil GDP Non Oil GDP Real GDP


…Services sector will be the key driver of 2018’s growth fragility

7.3%

4.5%3.8%

3.2%

0.2%

-1.8% -1.1% -1.6%

1.0%

-0.5%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17

Services ICT

Slower growth in ICT + real estate contraction

• On Services, with tele density over 100%, tepid subscriber growth should continue to underpin the deceleration in telecommunications GDP.

• Consequently, ICT GDP growth should remain slack in 2018.

• The increase in crude oil production over 2017 brings a high base for oil GDP and thus guides to a slower growth.

• We a hold a pessimistic view driven by the high base in Agriculture

• On balance, we think a slower growth in the oil sector and Agriculture front holds a fragile view on overall GDP in 2018.

4.7%

3.5% 3.5% 3.5%3.1%

4.5% 4.5%4.0%

3.4%3.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17

Agric Crop Prod.

?



Current Account

Nigeria’s net creditor status diminishes again

CA surplus narrowed from $2.7bn to $1.4bn - the second consecutive QoQ contraction. Largely reflective of decline in trade surplus (goods)& sharp jumps in services and income deficits.

-833

-1,843

-123

2,262 2,276 2,110

-2000

-1000

0

1000

2000

3000

4000

-4000

-2000

0

2000

4000

6000

8000

Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17

Goods Services Income Current Transfers Current Account - RHS • Contraction in trade (goods) surplus -underpinned by FX liquidity-induced jump in imports which slightly offset milder export growth.

• Cumulative deficits across services and income segments expanded 42% QoQ to $6.1bn to nullify milder growth in current transfers and leave CA surplus 48% lower relative to Q1 17 levels.

• However, the moderation in CA balance was compensated for by a strong surge in financial accounts (over three-fold QoQ to $4.3 billion)

slower absolute reduction in foreign reserves (i.e. from debit of more than $2.9 billion in Q1 17 to just over $290 million in Q2 17).

increases in other investments (such as trade credits and loans), FPI and FDI

Capital importation into Nigeria increased by 97.3% QoQ to $1.8 billion in Q2 17 with breakdowns showing the biggest jumps in flows to the equity market. Source: CBN, ARM Research

• Our views on crude oil production and prices guides a 4.3% increase in exports to $11.3bn, relative to prior quarter.

• Sustained dollar liquidity should support import growth relative to prior quarter - +9% to $9.5bn

• Trade surplus should further contract by 15% to $1.79bn.

• Overlaying the implied goods trade surplus with target services and income deficits of $3.6 billion and $3.2

• Overall, despite the expected moderation in current account surplus—which should subsist into H1 18 in our view, projected improvement in financial account picture suggests little downside risk for the naira in the near term.

Balance of Payment to survive murky waters

-

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

3,500.00

4,000.00

Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017

Equity ($'mn) Bonds ($'mn) Money Market ($'mn)

-5.1%

-1.2%

-3.9%

-1.5%

1.0%

-2.1%

0.0%

3.4% 3.2%

1.6% 1.3% 1.1%

-6.0%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%

Q1

15

Q2

15

Q3

15

Q4

15

Q1

16

Q2

16

Q3

16

Q4

16

Q1

17

Q2

17

Q3

17e

Q4

17e

CA surplus to GDP ratio – historical and forecast

FPI flows to naira equities starts to recovered from previously battered levels

Source: CBN, NBS, ARM Research

Source: CBN, NBS, ARM Research

Exchange Rate

How has the CBN responded? • The new-found strength in the

naira reflects sustained CBN dollar injections into various FX market strata

• Foreign portfolio flows into naira assets was equally boosted by the improving fundamentals and the floating market

• Moves were seem to be geared towards a unified, floating exchange rate market.

15 3 40 43 89 90 136 -

845 871

-

500

1,000

1,500

2,000

2,500

Jan-

16

Feb-

16

Mar

-16

Apr-

16

May

-16

Jun-

16

Jul-1

6

Aug-

16

Sep-

16

Oct

-16

Nov

-16

Dec-

16

Jan-

17

Feb-

17

Mar

-17

Apr-

17

May

-17

Jun-

17

Jul-1

7

BDC sales Interbank sales

Sales to the BDCs was the game changer from the CBN alongside opening of the IEW

3,676 3,208

3,358

(1,500)

(1,000)

(500)

-

500

1,000

1,500

2,000

2,500

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000


CBN outflow ($'mn) Net CBN Flow ($'mn) -RHS

The CBN was able to meet huge dollar demand and still keep its flows positive, thanks to oil receipts

Source: CBN, ARM Research


Autonomous inflows back to the fore as FPIs buy naira assets

303

240

168

298

120

611

278

894652

493

500

555

188

473 244 542 619751

1,064

-

200

400

600

800

1,000

1,200

1,400

1,600

Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17IOC Capital Importation

NGN devaluation

Monetary Tightening FX admin policies Floating rate

Autonomous inflows – Invisibles – OTC purchases – IOCs vs. Capital Importation ($’mn)

0

1000

2000

3000

4000

5000

0

50

100

150

200

250

300

350


Autonomousoutflows ($'mn)

Net Autonomusflows ($'mn) -RHS

Net autonomous flows still sizable to offset likely shocks on the CBN net flowsSource: CBN, ARM Research


Naira resilience – new normal or fleeting reality?• From a BoP perspective, our expectation

of continued growth in the financialaccount suggest that the naira would stillhold its own in the near term despiteexpected decline in CA surplus.

• In any case, CBN’s net dollar inflow andsurging autonomous dollar supplyprovides impetus to currency marketsamidst recent pro-market initiatives (i.e.gravitation towards synchronizedexchange rate for the country).

• Farther out, currently reboundingimports could slightly dim the picture—especially from an import coverperspective

• We retain our near-term bullishness onthe USD across FX market strata and beton it trending around current levels tillthe end of H1 18.

350

360

370

380

390

Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17

NAFEX Parallel

Rates should remain at current levels with little leg-room for expansion in spread

2.0

4.0

6.0

8.0

10.0

12.0

14.0

23.0

28.0

33.0

38.0

43.0

48.0

53.0

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17

Import Cover (months) - RHS Foreign Reserves ($'billions) - LHS Threshold (months) - RHS


Source: FMDQ, ABOKI FX, ARM Research

Inflation

Inflation rate drops for the sixth consecutive month

2016 energy supply shocks/high core base

Structural setbacks - higher transportation cost/food

pressures from neighbouring West Africa

The 2017 inflation story

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Jan-

16

Feb-

16

Mar

-16

Apr-

16

May

-16

Jun-

16

Jul-1

6

Aug-

16

Sep-

16

Oct

-16

Nov

-16

Dec-

16

Jan-

17

Feb-

17

Mar

-17

Apr-

17

May

-17

Jun-

17

Jul-1

7

Aug-

17

MoM Food MoM Transport

• The deceleration in core inflation speaks to extended moderations in energy prices across the country

• However, the scale of decline, relative to our forecast, was much muted following greater than expected jump in food prices.

• In August though, the surprise clampdown in food pressures reflected the duo of delayed pass-through from naira gains as well as the impact of higher domestic production of key agricultural produce


High 2017 base implies cap to 2018 price increases

• The recent flooding disrupted harvesting inSeptember, with knock-on effect likely to keepMoM food reading ahead of trend levels, whileYoY core inflation to resume deceleration inSeptember.

• Over Q4 2017, we expect MoM food inflation toprint above trend levels despite thecommencement of main harvest season

• The case for core inflation remains premised onextended deceleration in energy prices. In view ofthe foregoing, we now forecast mean headlineinflation of 16.6% over 2017 (vs. 15.6% in 2016).

• Going into 2018—the year preceding 2019 generalelections, we see little scope for substantial shockson the inflation front owing to high base effect

• The FG would have little or no motivation to towthe unpopular path of energy price

• For us, headline inflation should average 12.6%over H1 18.

• That said, increased electioneering spending—expected to commence in the latter period of H218—raises scope for some temperance in the paceof inflation deceleration towards the close of theyear.

18.7%

17.8%

17.2% 17.2%

16.3%16.1% 16.0% 16.0% 16.1% 16.0% 15.8% 15.8%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2017 Mean

-10%-5%0%5%10%15%20%25%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Jul-1

5Au

g-15

Sep-

15O

ct-1

5N

ov-1

5De

c-15

Jan-

16Fe

b-16

Mar

-16

Apr-

16M

ay-1

6Ju

n-16

Jul-1

6Au

g-16

Sep-

16O

ct-1

6N

ov-1

6De

c-16

Jan-

17Fe

b-17

Mar

-17

Apr-

17M

ay-1

7Ju

n-17

Jul-1

7Au

g-17

Food Transport Diesel -RHS

Correlation (lagged) between MoM changes in diesel prices to Transport and Food suggest a decent in both pressures in 2018

Food pressures to move from “villain” to “hero”



Monetary Policy

Is MPC at a turning point?

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

Sep-

15

Jan-

16

May

-16

Sep-

16

Jan-

17

May

-17

Inflation Rate MPR

The argument of trying to ensure positive real returns on investments supported CBN’s ongoing monetary policy tightening.

0.0%

4.0%

8.0%

12.0%

16.0%

20.0%

(1,000)

(800)

(600)

(400)

(200)

-

200

400

600

800

1,000

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17

N’ b

illio

ns Net Maturity (Issuance) Stop Rates

• The MPC has achieved something impressive -now has markets speculating on its language rather than on actual policy changes.

• This means that its forward guidance is working.

• We expect the MPC to upgrade its assessment of risks in its next meeting, which should guide to an imminent change in policy.

• Recent cessation of the one-year OMO paper and gradual reduction in clearing rates at OMO auctions suggest that the CBN is edging closer to an inflection point

Hawkish Monetary Policy

Source: NBS, CBN, ARM Research

Source: FMDQ, ARM Research

The case for CRR hike

Maturing OMO & Treasury bills Oct 2017 – Aug 2018 (N’billion)

231

801

489

640

206

591

893

259

400

747

544

221 284198

357 417

163 218314 236 273 274

0

200

400

600

800

1000

Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18

OMO Tbills

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17

N’ t

rillio

ns

N’ t

rillio

ns

CBN Outstanding OMO Required Reserve Excess Reserve - RHS

How will the CBN manage this expected liquidity in 2018, if the FG sticks to its path of financing maturing bills via Eurobond?


Source: CBN, FMDQ, ARM Research

Balance of factors guides to an accommodative stance in H1 18

• On balance, comparing the fragile growth picture withexpected downtrend in inflation and improved FXpicture because of rising dollar inflows with a subsistingCA surplus, we see more scope for the apex bank to easegradually to support the slow pace of economicrecovery.

• In the interim, we expect the CBN to assume a lessaggressive stance at its weekly OMO auctions leading tolower rates on government securities.

• Farther out, we forecast a cut in monetary policy rate(MPR) from Q2 18 and expect the MPR to be at 12% byyear-end 2018.

Hawkish Dovish

Fiscal

ARM © 201722

Federal Revenue Growth Shows Signs of Life• FG’s fiscal deficit printed at N1.828 trillion (~77% of

projected fiscal deficit estimate for 2017), largely reflectingsizable revenue shortfalls on the oil and non-oil fronts.

• However, our analysis points to improved revenue picture inthe subsequent two months.

• In arriving at this conclusion, we leverage on the seemingrelationship between historical FAAC and gross federationaccount revenue, with the former having accounted for ~93%of the latter over the past 18 months.

• Using this relationship and other adjustments as a basis forestimation, we arrive at cumulative retained revenue of~N1.51 trillion over the first seven months of 2017.

• FG’s expenditure remained at elevated levels going bybudget implementation of 88% between January and May2017.

• Thus, cautiously assuming same level of implementation forJune and July, we estimate FG’s fiscal deficit of N2.65trillion (or over 100% of FG’s target deficit for 2017).

• Of this lot, cumulative FG foreign and domestic borrowingshave, thus far in 2017, only covered 65% on a net basis.

0

10

20

30

40

50

60

70

80

90

Jan-17 Feb-17 Mar-17 Apr-17 May-17

Corporate Tax Customs & Excise Duties

VAT Independent Revenue

Others

Breakdown of non-oil revenue (N’ billion)


ARM © 2017 23

No cause for alarm on CBN’s financing to the FG

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0


N'tr

ilions Claims to FG FG deposit

We allay market worries on the ‘high’ CBN financing to FG. On the back of TSA, FG’s deposit to the CBN fully covers the said claims, though higher than the stipulated 5% of prior year’s revenue


ARM © 2017 24

Improving oil revenue picture trims deficit forecast• Going forward, we expect gross oil revenue to ride on both price and production momentum in the coming months.

• On the non-oil leg, we acknowledge potential pass-through from improved FX liquidity that could gradually cause import duties to track risingimports.

• That said, with the level of import activities still expected to be sizably lower than in prior years, we see scope for only limited pass-through to non-oilrevenue.

• In view of the mentioned, we project actual retained revenues to lag FG’s projection in the coming months with our base case scenario suggesting animplied fiscal deficit of N3.4 trillion in 2017E.

2017 EstimatesBudget Bear Base Bull

Oil production (mbpd) 2.20 1.50 1.85 2.20 Oil price ($/bbl.) 44.50 30.00 45.00 60.00 Exchange rate (N/$) 305.00 305.00 305.00 450.00 Oil and gas receipts (N' billion) 5,080 2,254 4,171 9,756 DeductionsJV Cash calls (N' billion) - 564 - -13% derivation (N' billion) 660 220 542 1,268 Net Oil Revenue (N' billion) 4,420 1,471 3,628 8,488 FG Share of oil revenue (N' billion) 2,144 713 1,760 4,117 FG share of non-Oil revenue (N' billion) 1,370 729 825 922

FG independent revenue (N' billion) 808 200 325 450

Other revenue (N' billion) 776 250 290 350 FG Total revenue (N' billion) 5,097 1,893 3,200 5,838 FGN Expenditure (N' billion) 7,444 5,955 6,551 7,444 Fiscal deficit (N' billion) (2,347) (4,063) (3,351) (1,606)

Source: ARM Research

CAPITAL MARKET


Fixed Income

15.0%

17.0%

19.0%

21.0%

23.0%

25.0%

3 month 6 month 9 month 1 year 2 year 5 year 7 year 10 year 20 year

31-May-17 31-Jul-17 29-Sep-17

Flattening Naira Yield CurveYields trend lower as apex bank changed front

• The CBN allowed liquidity build up into massivedemand at the PMA

• Largely reflecting the build-up in system liquidityin Q2 (Net OMO maturity of N79.8 billion vs. Netissuance of N933.4 billion in Q1 17), the CBN cutback on rates at its OMO auction in the reviewperiod.

• The CBN ceased issuance of the one-year bills atits OMO auctions which led to a downtrend inTreasury bill yields with longer term ratesdropping faster than that of shorter-terminstruments.

• FG was less aggressive with its bond issuanceeven as market favored the primary auction forshort-dated securities.

• Overall, the outcome of these events underpinneda 98bps contraction in the yield curve to 17.47%over Q3 17 against expectation.

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17

Avg OMO rate Avg T-Bill rate



• In our monetary policy forecast, we expect the CBN to assume a less aggressive stance at its OMO windows to continue to driverates lower in the near term.

• On the strength of the mentioned, we expect T-bill yields to decline to sub 18% levels in Q4 2017, with a sizable decline (100-150bps) in H1 2018.

• At the longer end of the curve, as noted in the fiscal review, we have a base case scenario suggesting an implied fiscal deficit ofN3.4 trillion in 2017E

• Consequently, we assume a fiscal deficit of N1.6 trillion for the second half of the year.

• Excluding N724billion issued in Q3 2017 (Net T-bill issuances: N318billion, Bond Issuance: N406billion), the FG would need toborrow circa. N900billion over the rest of this year.

• Given the foregoing, we adopt a successful Eurobond issuance of $2.5billion, translating to N900billion to fully cover ourproposed borrowings by the FG and displacing the need for domestic borrowings.

• We go on to provide a further N450billion (Q4 17 Bond issuance: N300billion and Net T-bills issuances: N150billion).

• On balance, this would mean moderated domestic borrowings for the remainder of the year and, by extension, sustained yielddowntrend at the long end.

• Tying it all together, we see a subsisting downtrend in the level and slope of the naira yield curve over the next six months withdovish monetary policy, lower domestic borrowings, and perhaps some form of coordination with monetary policy to easefinancing costs to drive yields lower.

Rates sensitivity and waning inflation meld into dovish yield outlook

Fixed Income Strategy

• While we expect a downtrend in the level and slope of the naira yield curve over the next six months, we think beyond the first halfof 2018 comes a looming risk that can volte-face our call – political risk gearing towards the election.

• First off, increased electioneering spending—expected to commence in the latter period of H2 18—raises scope for sometemperance in the pace of inflation deceleration towards the close of the year.

• Secondly, a possible desperation by the FG to fulfil its earlier mandate will moderate earlier sensitivity towards borrowing cost

• Also, uncertainty gearing towards election may keep foreign investors jittery, moderate inflows and stir capital flight, thus pushingyields up. Consequently, naira would likely come under pressure.

• Having framed our outlook, we see merits in positioning bond portfolios towards the long end of the curve but slightly loweringposition at the very long-end.

• We are not completely in favor of going all-out long-end because that would mean higher volatility as our H2 2018 call plays out.

• Basically, we recommend a staggered approach to building duration with emphasis on mid-tenured bonds on the downward slope ofthe naira curve in a bid to ‘run-down the curve’ as dovish influences kick into gear over H1 2018.

• Overall, our strategy calls for investors to position bond portfolios with an eye on flexibility ahead of what promises to be a roller-coaster 15 months for debt markets.

Go long but be mindful of duration risk

H1 18 –downtrend in

yields

H2 18 –Political

risk

Duration risk

Equities

• NSE ASI posted an 8.3% QoQ gain in Q3 17 largely reflecting strong market performance in July (+8.5% MoM) which more than offsetweaknesses in August and September.

• Food sub-sector (+29.7% QoQ) had the greatest impact on the equity bourse in the quarter accounting for 49.7% of the uptrend in the NSEASI with banking (+7.95% QoQ), cement (+3.6% QoQ) and brewer’s stocks (+7.6% QoQ) following closely contributing 32.3%, 14.3%and 13.0% respectively.

• Irrespective of the recent rallies, Nigeria’s equity bourse remains cheaper relative to some Africa climes given its P/E of 13.2x vs. 17.9x forJSE top 40, 14.5x for LUSEIDX, and 13.2x for MXEE (Bloomberg Emerging markets, Europe, Middle East, and Africa Index).

• However, equity investing opportunities look more attractive in Egypt (EGX 30 P/E: 13.1x)

Equities set to maintain upbeat momentum

-100%-80%-60%-40%-20%

0%20%40%60%80%

100%

Q1

13

Q2

13

Q3

13

Q4

13

Q1

14

Q2

14

Q3

14

Q4

14

Q1

15

Q2

15

Q3

15

Q4

15

Q1

16

Q2

16

Q3

16

Q4

16

Q1

17

Q2

17

Q3

17

CEMENT BANKING BREWERSFOOD PERSONAL CARE OIL& GASINSURANCE REAL ESTATE CONSTRUCTION

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep

-15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-1

6

Sep

-16

Nov

-16

Jan-

17

Mar

-17

May

-17

Jul-1

7

Sep

-17

NGSE EGX30 JSE Top 40 LUSEIDX

Historical P/E ratios NGSE vs. African peersAttribution analysis of quarterly sectoral performance

Source: NSE, ARM Research Source: Bloomberg, ARM Research

• We retain our view that the trajectory of crude oil prices, domestic macro recovery, FX liquidity, fiscal policies, and pension reformswill continue to dictate the performance of the equity market.

• Nonetheless, domestic macro appears set to extend its positive momentum going into 2018 with recent PMI numbers providingearliest indications of sustained resurgence.

• Beyond this, continued rise in crude export proceeds leaves the nation’s reserves well above the $30 billion mark with CBN’s cashflow position also providing positive re-assurances that the apex bank’s FX market interventions across strata is not yet done anddusted.

• With alternative yield-paying investment outlets such as treasuries set to become relatively unattractive, we expect domestic investorsto pay greater attention to equities

• On balance, we see improved economic fundamentals and gradual recovery as potential drivers of a bull outlook in the comingmonths.

Equities to ride domestic and foreign excitements.

Thank you

ARM Securities© 2017

ARM Securities

Research 234 (1) 2701653 [email protected]

Institutional Sales & Trading 234 (1) 448 8833 [email protected]

Customer Service 234 (1) 4488282 [email protected]

Copyright © 2017 ARM Securities Limited (“ARM”).

All rights reserved. Unauthorised use, reproduction, distribution, or disclosure of this document is strictly prohibited.

This material has been issued by ARM Securities Limited, a member of the Asset & Resource Management (“ARM”) Group, and a Company regulated by the Nigerian Securities & Exchange Commission. The analyst(s) primarily responsible for preparing this research report, in whole or in part, certifies that with respect to each security or issuer covered; all the views expressed accurately reflect his/her personal views about the subject securities and issuers and no part of his/her compensation was, is, or will be, directly or indirectly, related to the inclusion of specific recommendations or views in the report.

This research report is based on information from sources that ARM and its analysts believe to be reliable. Neither ARM nor any of its research analysts, nor any member of the ARM Group, gives any representation or warranty, express or implied, or undertaking of any kind or assumes responsibility or liability of any kind with respect to the accuracy or completeness of the information set out in this report or any third party’s use (or the results of such use) of such information. This report is provided solely for informational purposes and is not to be construed as providing advice, recommendations, or endorsements of any kind whatsoever. The investments and strategies discussed here may not be suitable for all investors; counsel of investment advisor should be obtained with regards to such investments and or strategies. This research report is not a replacement for advice from an accountant, lawyer, personal finance advisor or other category of investment advisor. The investments discussed in this report may oscillate in price or value. Opinions and information provided are made as of the date of the report issue and are subject to change without notice. This research report is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Reference herein to any specific security or financial instrument does not necessarily constitute or imply its endorsement or recommendation by ARM, its directors, officers, employees, or designated agents. Members of ARM may act as broker, advisor, or lender, or make a market in any investments or issuers referenced in this report. Further information on any of the securities discussed herein may be obtained upon request to ARM. By accepting this document, you agree to be bound by the foregoing limitations.

Date post:	22-Jan-2018
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Q4 2017 strategy - pathway in turning tide

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