BlackRock Frontiers, managed by Sam Vecht (pictured) and Emily Fletcher, has announced its interim report for the six months ended 31 March 2016. During the period, the trust provided an NAV total return of -0.1% and share price total return of 0.1%, thereby outperforming the MSCI Frontier markets index which returned -2.2% but underperforming the MSCI Emerging Markets Index returned 6.4% (all in US dollar terms). Sterling depreciation during the period had a noticeable impact on the trust’s sterling total returns; the trust returned 5.2% and 5.4% for NAV and share price respectively which compares against 3.1% for the MSCI Frontier Markets index and 12.1% for the MSCI Emerging Markets Index. The period saw the trust’s life extended for a further five years, £15m raised via a c-share issue and 5.9m tendered shares (4% of issued share capital) successfully placed in the secondary market. The board has declared an interim dividend of USc 2.6 per share (the Company’s revenue return amounted to 2.33 cents per share – down from 2.54 cents for the prior year).
Previously, the trust has paid out approximately a third of its revenues at the interim stage and the balance in the form of a final dividend. However the Board has decided to rebalance the split between interim and final dividends to better reflect the timing of the underlying income earned by the trust. As at 12 May 2016, the trust had accrued current year revenue earnings of USc 2.65 per share and, reflecting this, the Board has declared an interim dividend of USc 2.60 per share (2015: 2.40 cents per share). The Board says that it anticipates that the total dividends declared by the trust, for the full year to 30 September 2016, will be broadly in-line with last year’s full year dividends of USc 6.55 cents, despite currency headwinds and portfolio allocation changes away from countries such as Nigeria, where historically dividend yields have been high.
In terms of performance, the managers say that the largest relative contribution to performance came from the trust’s significant underweight portfolio exposure to Nigeria. The managers say that whilst they have a long-term positive view of the country, the decline in oil prices and the reluctance of monetary authorities to allow the currency to adjust has placed pressure on the economy. Performance of the stock market has reflected this economic deterioration, with the MSCI Nigerian index falling by 23.0% over this period. Within the portfolio, exposure to Nigeria has been reduced to less than 1% of the portfolio.
The managers report that stock selection within Pakistan was a key source of alpha and that whilst the headline performance of the market wasn’t exceptional, with the index falling by 1.3% over the period, the portfolio benefited from holdings in a number of stocks which have outperformed the market including Hub Power company, DG Khan Cement and Engro Foods. The share price of Engro Foods, a domestic milk producer, rose following the announcement that Friesland Campina had entered negotiations to acquire the company.
The managers say that the trust also benefitted from individual stock drivers such as Caribbean telecom operator, Cable and Wireless Communication (CWC), Estonian ferry operator, Tallink, and Frontier market bottling franchise, Coca-Cola Icecek. Liberty Global announced a take-over of CWC, as they moved towards consolidating their position across the Americas region. The trust exited its position, which had been bought in 2012, following the announcement of the deal at a price which the managers say was around double the initial purchase price. The managers comment that Tallink performed well after announcing strong results for the fourth quarter of 2015 (the company reported growth in revenues and strong free cash flow generation with a tail wind from the lower oil price). Icecek has operations in Frontier markets such as Pakistan, Iraq and the CIS and across the Middle East and North African region. The company is reportedly the highest-growth bottler across the Coca Cola franchise universe with some of the lowest market penetration figures, which the managers say means that it has good long-term potential. They also comment that falls in raw material prices (including sugar) had a positive impact on margins in 2015, which, combined with its growth profile, was recognised by investors as an attractive proposition. The largest detractor from performance was Sri Lanka where the index fell by 15.6% over the period. The managers say that investors became increasingly concerned about the extent of the fiscal deficit and the lack of coherence in the budget for 2016.
In terms of portfolio activity, the managers increased the trust’s positions in Argentina, both prior to and following the election of President Macri, which they say was in line with their expectation of a shift towards economic normalisation in the country. Positions were also increased in Kazakhstan, Kenya and Romania. In Kazakhstan, the KazMunaiGas position was increased on the belief that the company is undervalued as it is trading at a significant discount to the value of net cash on its balance sheet. In Kenya, a position in Equity Bank was initiated. The managers say that they believe that having a market share of current account customers of more than 50%, gives the bank’s deposit franchise a sustainable funding advantage in a country which is heavily reliant on external funding sources. In Romania, a position was added in a utility, Electrica, which the managers say generates a sustainable real return from its assets resulting in a dividend yield above 7%. They also say that, with cash representing more than 70% of its market cap, they believe that the company is well positioned to make accretive acquisitions.
Early during 2016, the managers used the opportunity presented by, what they saw as, temporary market weakness to add to a number of positions and increase the net exposure of the portfolio. These included the Pakistan cement company, DG Khan, which is the third largest cement company in Pakistan by local market share (11%). The managers believe that company is set to benefit from increased housebuilding and government infrastructure projects in the north of the country. Bancolombia, a Colombian bank with operations across Central America, was added to the portfolio. The managers say that the stock is trading at much cheaper valuations than its historical levels, a result of enduring margin compression and a credit cycle, prompted by the fall in the oil price driving the currency down and interest rates up. The managers now see the economic situation stabilising and believe Bancolombia will be a key beneficiary as a result. Another new addition to the portfolio was Centamin, a gold mining company with operations in Egypt. The managers say that the company is ramping up production to record levels as its underground expansion has come into full operation. With expansion capital expenditure now complete and a long mine life ahead, the managers believe that the company is well-placed to generate free cashflow and has a strong balance sheet with no debt.
In terms of divestitures, the trust continued to reduce exposure to Nigeria on the back of the managers strongly held views that the currency needs to devalue substantially from current levels. The managers also took the decision to exit Iraqi oil stocks during the period. They say that these holdings had suffered as a result of the low oil price and the realisation that despite being low cost producers, the regional Kurdish Government and Iraqi government are highly geared to the oil price.
In terms of outlook, the managers say that frontier markets are currently trading around the lowest valuation levels (as measured by price/earnings ratio), that they have seen during the life of the Company, and therefore they believe that Frontier Markets continue to present an attractive investment opportunity.
BlackRock Frontiers benefits from sterling weakness BRIF