Commodity supercycle and distressed assets in Africa

Commodity supercycle and distressed assets in Africa

2015 was a bad year for commodities, a market that Africa heavily relies on to grow. Here's a quick analysis illustrated by experts' quotes (Cheikh Faye, ...) to understand how deep Africa is in the commodities crisis.

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2015 was a tough year for commodities : Oil dropped 44% (lowest in 14 years), copper dropped 25% (lowest in 7 years), coffee dropped 36%, soy beans dopped 16%, natural gas dropped 30%, and the list goes on. Africa, a continent whose financial balance heavily relies on the stability of commodity prices, took a severe hit from the economic turmoil.

With profit margins getting squeezed to the max, low-profit operations dry out, go bankrupt or get shut down. Thus, the business of acquiring distressed assets is now blooming. A solid return on investment is expected from the acquisition of distressed assets in Africa’s commodities market, as the market is bound to reboot. But when exactly ?

2015 : the commodities’ crisis

Those past ten years, led among other things by China’s growth, most commodities-producing countries heavily invested in upgrading and increasing their production capabilities to meet with the growing demand. Unfortunately, in 2015, the engines went in reverse, the global demand lowered, prices fell flat, amid financial plans based on growth to reimburse recent substantial investments.

It happened to chilean copper-producer Codelco : $23 billion invested in the past recent years, 33% drop in profits in 2015, emergency financial plan deployed, the state-owned company sold $2 billion worth of bonds on the trade market to cope with its debts. Same for venezuelan PDVSA, the state-owed oil producer, whose heavy losses are shaking the country’s financial institutitons to their bones. Anglo-swiss Glencore felt the breeze : with a $30 billion debt, along with dropping prices in commodities, Glencore’s stocks lost 1/3 of their value in 2015. The company sold $10 billion of its assets to bolster its balance sheet.

The S&P GSCI is the most-commonly used index to track the value of commodities. In 2015, the S&P GSCI showed the lowest figures ever since 1999, losing a whooping 32,9% on its tracked values, with oil-based prices taking the strongest hits :

SP GSCI 2015 commodities distress

2015 will go down in history as one of the worst years ever for commodities
– Jodie Gunzberg, S&P Dow Jones Indices global head of commodities

Africa deflates

Africa is feeling the pain from this slowdown. In 2014, the IMF predicted a 7% growth in sub-saharan countries for 2015, but that number turned out to be 3,75%, and is not expected to go beyond 4,25% in 2016 (if growth shows itself). Africa holds a third of the world’s mineral resources, its economy heavily relies on the production and export of mineral assets.

In 2015, Africa has entered the era of budget cuts and currency depreciations.

In Angola, where most of the oil comes from costly ultra-deepwater fields, the days of double-digit growth charts are over, a flat 3,5% was recorded in 2015. The country’s currency took a severe punch, losing 30% of its value against the US dollar, and leading the governement to stop fuel subsidies.

The nigerian naira has depreciated by 25%, which led JP Morgan to remove the currency from its Emergeing Markets Bond Index. Nigeria, which imports its gas due to a lack of domestic refineries, is facing a gas shortage (Nigeria is Africa’s number 1 oil producer ! ) because the government cannot pay a $2 billion debt to refined oil importers. This oil shortage has an impact on all other industrial sectors, steadily paralyzing the whole economy. In Ghana, the power shortage is disrupting all other segments of the economy, and frequently making the regional news.

The zambian kwacha lost 45% of its value against the US$. Mozambique, Tanzania, South Africa and Ghana, all those countries also took a -15% depreciation against the US$ in 2015.

Countries with large amounts of corporate debt, especially in USD, will face difficulties, with rising prospects for corporate distress, weakening capital investment and growth.
– Hung Tran, executive managing director at the IIF

The failing economy is taking low-profit operations down the drain : Across Africa, Glencore closed down their loss-making mines (coal, optimum, copper) to weigh on prices. In Liberia, the Putu iron mine was closed. African Minerals shut down its iron operations in Sierra Leone. In Botswana, African Copper closed the Thakadu Mine, and Discovery Metals shut down the Boseto copper mine. Gold mines have been shut in Ivory Coast and South Africa. Those numerous shutdowns are creating a massive pool of distressed assets grieving the economy.

Cheikh Faye : “Relative value exists for those with the courage”

For analysts, commodities are in a trough between two supercycles. With deflating prices, low-profit operations are closing and up for grabs. Since the demand growth is inevitable, the market will reboot, and the distressed businesses will become profitable again. Hence the commodities’ crisis is opening grounds for new business opportunities in Africa.

Pricing will recover, that’s the intrinsic nature of cycles”, says Cheikh Faye, head of investments at Questar Holding and expert on african commodities matters, “The timing is uncertain though and no one can for sure establish a time frame“.

For those with a relative value approach and a certain tolerance for pain, there are great assets to bolt on and book handsome returns when pricing rallies.
– Cheikh Faye, head of investments at Questar Holding

Mr Faye goes on : “Regarding oil, the world consumes roughly 90 millions bpd. To meet global demand, barrels being extracted today will have to be replaced. This will lead to an inexorable spike in pricing due to capital expenditure.

Prices are not about to recover yet, Goldman Sachs predicts that the oil barrel may stale down to $20 before picking up the pace again. For minerals, Cheikh Faye fears that the future is more uncertain : “Minerals have a more complex recovery path. The previous super-cycle was driven largely by Chinese demand. Its growth story now has a different tune : Will China ever grow again at double digit speed ? Or are we witnessing a new shift to low single digit? These are the challenges for the next few years facing iron ore, coal, nickel and many growth-linked metals.

The end of the commodity supercycle has provided a window of opportunity to push ahead with the next wave of structural reforms.
– Makhtar Diop, World Bank Vice President for Africa

Along with China’s diminished glutony, pessimism has spread about the financial well-being of the middle empire, which makes it unlikely for the country to jump back into its old buying habits anytime soon. While waiting for the next supercycle, cash-rich investors are picking up the distressed assets that fall on the market’s floor by the dozen everyday. “Africa rising” will rise again, it’s only a matter of time.


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