Following a review of H1’2018, we maintain a positive outlook for the macro economic environment in Kenya, with better GDP prospects relative to 2017, supported by improved weather conditions and a conducive operating environment.
The Kenyan economy is projected to grow by 5.5% on average in 2018, according to GDP projections from 15 research houses, global agencies, and government organizations that we tracked during the half-year period, inclusive of our projection of 5.5% as at Q2’2018.

The inflation rate increased to 4.3% in June 2018 from 4.1% in May 2018 and the Monetary Policy Committee (MPC) met thrice in H1’2018. In the March 19th meeting, the MPC decided to lower the CBR to 9.5% for the first time since July 2016, noting that there was room for monetary policy easing to further support economic activity as evidenced by (i) inflation, which had eased to 4.5% in February 2018 from 4.8% in January, and (ii) increased private sector optimism as per the MPC private sector market perception survey. They later retained the CBR at 9.5% in the May 28th meeting, citing that the impact of the 50-bps reduction in March had not yet been fully transmitted to the economy, despite there being room for monetary policy easing to further support economic activity.
“We had an improvement during H1’2018 on the overall macroeconomic landscape. Of the 7 indicators we track, 5 are positive and 2 are neutral, with government borrowing being the only indicator whose outlook has changed, to positive from negative. From this, we maintain our positive outlook on the 2018 macroeconomic environment,” said Maurice Oduor, Senior Investment Manager at Cytonn.
Summary of Indicators:

  1. Government Borrowing has moved from negative at the beginning of the year to “positive”. At the beginning of the year, the government was behind it domestic borrowing target, having borrowed 75.7% of their pro-rated target at the time, and KRA was unlikely to meet its collection target due to expected suppressed corporate earnings in 2017. By the end of H1’2018, the government had surpassed its domestic borrowing target for the fiscal year 2017/18. The 2018/19 budget gave a domestic borrowing target of Kshs 271.9 bn, 8.6% lower than last fiscal year’s target, which might result in reduced pressure on domestic borrowing, with the Kenya Revenue Authority (KRA) expected to increase their revenues by 17.5% to Kshs 1.9 tn in the fiscal year 2018/19 from the estimated target of Kshs 1.7 bn in 2017/18. It is for these reasons that we turn positive from negative,


  1. Exchange Rate has remained “neutral” and we expect it to remain so for the rest of the year. The currency has remained relatively stable since the beginning of the year, hitting a high of Kshs 100.0 in April, supported by increased horticulture export inflows, the increased level of forex reserves following receipt of the Eurobond II proceeds, and the IMF extending the USD 1.5 bn standby credit and precautionary agreement,


  1. We have maintained our outlook on Interest Rates at “neutral”, and expect it to remain so throughout the year. At the beginning of the year, we expected upward pressure on interest rates as the government was behind its borrowing target, but with the interest rate cap still in place, we expected the CBK to keep rates low by rejecting bids deemed expensive in primary bond auctions. Now with the domestic borrowing target for the fiscal year 2018/19 at Kshs 271.9 bn, 8.6% lower than the 2017/18 fiscal year’s target, there may be reduced pressure on domestic borrowing. However, if the proposal by the National Treasury to repeal the interest rate cap is implemented it can result in upward pressure on interest rates, as banks would resume pricing of loans to the private sector based on their risk profiles. However, with the cap still in place, we maintain our expectation of stability in the interest rate environment,
  1. Inflation remains “positive” for 2018 with the average inflation rate for H1’2018 coming in at 4.2% compared to 9.8% in H1’2017. We project inflation to average 7.0% in 2018, down from 8.0% in 2017 and within the government target range of 2.5% – 7.5%,


  1. We are still “positive” on GDP growth in 2018, with our outlook remaining unchanged from the beginning of the year. We maintain our GDP growth projection for 2018 between 5.3% – 5.6%, higher than the growth rate of 4.9% in 2017, and in line with the 5-year historical average of 5.4%,


  1. Our outlook on Investor Sentiment remains “positive” for the rest of the year given (i) the now settling operating environment following the elections in 2017, (ii) the expectation that long-term investors will enter the market seeking to take advantage of the valuations which are still historically low, and (iii) expectations of a relatively stable shilling. We still expect investor sentiment to continue improving in 2018, and,


  1. Security has been maintained at “positive” for 2018. Kenya now has direct flights to and from the USA, and the USA lifted its travel warning for Kenya, placing it in the 2nd highest tier of its new 4-level advisory program, indicating positive sentiments on security from the international community. We expect security to be maintained as so, especially given that the elections are now concluded, and the government has settled into office.

FIXED INCOME REVIEW: During the first half of 2018, T-bills auctions recorded an oversubscription, with the average subscriptions level coming in at 142.6% compared to 263.2% in H1’2017. Overall average subscriptions for the 91, 182, and 364-day papers in H1’2018 came in at 105.6%, 122.3% and 177.7%, respectively, from 154.0%, 184.5% and 131.2%, in a similar period in 2017. Yields on T-bills declined by 40 bps, 90 bps and 70 bps in H1’2018, closing at 7.7%, 9.7%, and 10.5%, from 8.1%, 10.6%, and 11.2% recorded at the end of 2017, for the 91, 182, and 364-day papers, respectively. This was mainly due to the Central Bank of Kenya’s (CBK’s) efforts to keep rates low by rejecting expensive bids in the auction market.
“Rates in the fixed income market have remained stable, and had been on a declining trend towards the tail end of the fiscal year 2017/18, as the government rejected expensive bids as it has been under no pressure to borrow. The government is however likely to remain behind its borrowing target for the better part of the first half of the 2018/19 fiscal year as per historical data. The newly released 2018/19 budget gives a domestic borrowing target of Kshs 271.9 bn, 8.6% lower than the recently concluded fiscal year’s target, which may result in reduced pressure on domestic borrowing.” said Stephanie Onchwati, Investment Analyst – Macros and Fixed Income at Cytonn. “However, the National Treasury has proposed to repeal the interest rate cap, which if repealed can result in upward pressure on interest rates, as banks would resume pricing of loans to the private sector based on their risk profiles. However, with the cap still in place, we maintain our expectation of stability in the interest rate environment. With the expectation of a relatively stable interest rate environment, our view is that investors should be biased towards medium to long-term fixed income instruments,” added Stephanie.
 EQUITIES REVIEW: During H1’2018, the Kenyan equities market recorded mixed performance, with NASI and NSE 25 gaining 1.8% and 2.4% respectively, while NSE 20 declined by 11.5%. Kenyan listed banks released their FY’2017 and Q1’2018 results, recording a 1.0% decline in core EPS and a 14.4% increase, respectively in the two periods, compared to a growth of 4.4% in FY’2016 and an 8.6% decline in Q1’2017.
“We are “NEUTRAL” on equities for investors with a short-term investment horizon since the market has rallied and brought the market P/E slightly above its historical average,” said Caleb Mugendi, a Senior Investment Analyst – Equities at Cytonn. “However, pockets of value still exist, with a number of undervalued sectors like Financial Services, which provide an attractive entry point for long-term investors, and with expectations of higher corporate earnings this year, we are “POSITIVE” for investors with a long-term investment horizon,” said Caleb.
 REAL ESTATE REVIEW: H1’2018 performance of the real estate sector in Kenya improved slightly, with sectors such as office, retail and industrial registering a marginal increase in yields of between 0.1% points and 0.7% points, to 9.3%, 9.7% and 6.1% from 9.2%, 9.6% and 5.4%, respectively. The performance was bolstered by (i) continued demand for investment property from multinational individuals and the growing middle class, (ii) Government efforts towards enabling the environment for developers through key statutory reforms such as the National Land Use Policy, and (iii) continued infrastructural improvements in the country.
However, the sector continued to face challenges such as: (i) limited access to financing, with private sector credit growth coming in at 2.8% as at April 2018 compared to a 5-year average of 14.0% for the period 2013 to 2018, due to strict underwriting standards, (ii) high land costs, especially in Nairobi and its metropolis, with land prices appreciating by a 6-year CAGR of 17.4% for the period 2011-2017, and (iii) an oversupply in selected sectors such as office, as per KNBS data; the aggregate value of building approvals in Nairobi came in at Kshs 60.1 bn for the period January to March 2018, which is 2.1% lower than the value of approvals for the same period in 2017, which was Kshs 61.7 bn. 59.8% of the approvals were in the residential sector, indicating that investors are more focussed on the residential sector than the oversupplied office sector.
“We remain optimistic about the positive performance of the real estate sector driven by positive demographic trends such as rapid urbanization that currently stands at 4.4% against a global average of 2.1%, a rapid population growth rate of 2.6% against a global average of 1.2%, sustained infrastructural development with the government set to build 10,000 kms of road networks in the next 5-years which will open up areas for real estate development, government initiatives on affordable housing, and a better operating environment due to political calm after the end of the extended election period, as well as sustained investor appetite,” said Nancy Murule, Cytonn’s Senior Research Analyst – Real Estate.
In terms of sectorial performance;

  1. In Residential – The opportunity in the residential sector, is mainly in apartments, in areas such as Kilimani and Ngong’ Road, which had the highest returns to investors with annual returns of 14.4% and 11.8%, respectively, while for detached units, Ruiru and Lower Kabete areas recorded the best annual returns at 11.7% and 10.7%, respectively. The sector also presents an opportunity in affordable housing boosted by (i) government initiatives, such as affordable housing being part of the “Big 4 Agenda”, and (ii) an available market, given the shortage of housing units that stands at 2.0 mn units, with an effective annual shortfall of 200,000 units that is mainly concentrated in the lower middle and low-income segments,


  1. In Commercial Office – The pockets of value in the sector remain to be; (i) Grade A offices which are in short supply, accounting for just 24.0% of the office space supply in the market and have attractive returns with average rental yields of 9.8%, compared to a market average of 9.3%, and (ii) Serviced offices which have low supply, with a market share of just 0.4% and high returns, with average rental yields of 13.4% compared to a market average of 9.3%,


  1. In Retail – The opportunity in the retail sector is in suburban malls in areas with low supply, such as county government headquarters that are increasingly witnessing an increase in population as a result of devolution,


  1. In Industrial – The sector presents a market niche driven by (i) low supply of industrial parks, (ii) improved infrastructure that has opened up areas such as Ruiru and Athi River as well as counties for development of industrial parks, and (iii) government support, given that the government has included manufacturing among the Big Four Pillars of focus,


  1. In Hospitality – The sector continues to be attractive driven by increased demand from both local and international guests, with the number of international arrivals at the 2 main airports (JKIA and Mombasa International) increasing by 5.8% to 236,273 persons during the period between January and March 2018 from 223,327 persons during the same period in 2017, according to Kenya National Bureau of Statistics. The opportunity in the sector is in (i) serviced apartments, which recorded high average occupancy rates of 72.1% compared to 50.6% for hotels in Nairobi in 2017, and (ii) 4-star hotels which recorded a high occupancy of 56.5% and Revenue Per Available Room (RevPAR) of Kshs 6,872 in 2017, compared to the market average of 50.6% and Kshs 5,937, respectively, and,


  1. In Listed Real Estate – We retain a negative outlook of the sector, mainly due to market structures and poor market sentiment. However, attempts by key real estate industry players in the region, such as East Africa Forum for Structured Products (EAFSP), to improve the market sentiment on REITs and other alternative investments, and the need for capital by developers are expected to drive uptake of the REITs and hence performance of listed real estate.


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