Investing in Africa and other Emerging Markets, Axel Krohne?

Axel Krohne is the head of Krohne Capital. There he is managing a fund with a focus on emerging markets. We have done their interviews with him in 2019. Now, you can find the transcript of this interview here.

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We have discussed the following topics:

Why is no India and China investing, Axel Krohne?

[00:00:07] Tilman Versch: Hello Axel. Welcome to the [00:00:09] YouTube channel. You are an emerging markets value investor, but you don’t invest in China and India. Why is that so?

[00:00:20] Axel Krohne: Thank you very much for that question. I like to prefer – I mean, I prefer investing in markets that are easier to understand. And I’ve been to China, I’ve been to India, and both of them obviously huge countries with massive populations and a lot of simultaneous competitive forces that I just can’t get a grasp on. I just feel too much of an outsider. On top of that, in China, particularly, too many frauds have been going on that I don’t trust most companies’ books and therefore I avoid them.

Return expectations

[00:01:13] Tilman Versch: In your fund, what kind of return do you expect?

[00:01:19] Axel Krohne: I don’t have expectations for the fund. However, for every individual stock that I’m buying, I expect at least to double my money and it’s not that I succeed with that all the time, but I think I have to have a few companies that do very well. A few stocks do very well in order to make up for losses. So, the stock has a 10%, 20%, and 30%, upside in my mind. I would not, I would not touch it. It’s not enough.

I don’t have expectations for the fund. However, for every individual stock that I’m buying, I expect at least to double my money and it’s not that I succeed with that all the time, but I think I have to have a few companies that do very well. A few stocks that do very well in order to make up for losses.

Is Russia investible?

[00:01:57] Tilman Versch: Let’s look a bit deeper into your fund. You are investing in countries like Russia, Nigeria, Egypt, Uganda, Ghana, and also in Asia. In some countries, Vietnam, for instance. Let’s take a look at Russia. It is a country where people say it’s not investable. What’s your opinion on it?

[00:02:20] Axel Krohne: I totally disagree. I think it is very investable. And I’ve seen many great companies marry great businesses, attractive stocks, and many of those companies are managed for the benefit of their shareholders. And that’s all the shareholders, including the minority of shareholders and they’re not run by the Kremlin. So, I like Russia at the right price.

Bank in Russia

[00:02:48] Tilman Versch: Can you name some companies in Russia that you like?

[00:02:52] Axel Krohne: Certainly, one company that comes to mind all the biggest holdings is Novorossiysk ports, trades in Russia, in Moscow quite actively, quite liquid. It’s not very investable for Germany, and Frankfurt, but it’s a port operator and MGP is a symbol and the stock’s trading at very attractive valuations. And so, the port business is a quasi-monopoly, and the stock has about north of 20% free cash flow yield, dividends year to 7%-8%, PE 6% or so. And that’s a company I would buy day in, day out, bought at a much lower valuation. But even at these appreciated prices, I think it’s still attractive. We used to own Moscow Exchange, which runs the stock exchange in Moscow Monopoly business not growing tremendously, but still a fantastic business that I like a lot.

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African banks

[00:04:00] Tilman Versch: What’s your opinion on banks in Russia?

[00:04:04] Axel Krohne: I like them. I like Sberbank. I think that’s a great business. It’s a great, highly profitable bank in terms of return on equity and the stock is cheap. We currently own a bank of some in Petersburg and the AVH fund and that’s as well and not as good of a business because the return on equity is pretty low. It’s in the high single digits, 8%-9% or so. But then you’ve got to stock trades at three times earnings, a 70% discount to book value. So, I think it’s a very attractive stock that has a lot of upsides without anything really good having to happen. It’s priced as being a major crisis, but that’s not, they just record it, record profits in the last quarter.

Why just the top banks?

[00:04:57] Tilman Versch: Let’s stay in the financial sector but go to Africa. To take a look at the financial sector here of the banks here, like banks there, too. But compared to Europe, what is the state of the banks in Africa?

[00:05:12] Axel Krohne: We own in Africa, Guaranty Bank in Nigeria, which is the number one bank there. And Nigeria has been – feels like had a recession for the last decade or so. Ever since the financial crisis when oil prices collapsed, the countries have had big oil exporters. So, things have not been going well for a long time. Despite that, Guaranty Bank has been profitable and been growing throughout this time, did not have any big losses to the oil and gas industry, did no big write-offs, a very attractive return on equities in the, I don’t know, like 30% ratio and they have 5% or 6% times earnings and pay 7% or 8% dividend yield and I like it.

So, and the top two or three banks, all traded similar valuations when the retail lasted, Unilever or the Nigerian, the breweries all traded 20 or 30 times earnings. And people love them. They hate the banks. And for me, I think if you believe in Nigeria, you might want to buy the consumer names you can as well by the banks, the top banks. In general, I think when investing in emerging frontier markets, I used to buy those second and third-tier banks because they are much cheaper, and I find out they are much cheaper for a reason and I think I generally stay where the market leads us.

In general, I think when investing in emerging frontier markets, I used to buy those second and third tier banks because they are much cheaper, and I find out they are much cheaper for a reason and I think I generally stay where the market lead us.

The state of stock exchanges and the investing culture in Africa

[00:06:47] Tilman Versch: What reason is this?

[00:06:50] Axel Krohne: Oh, they’re not as good. They just always stay small and shitty, and they have they’re undercapitalized. In Nigeria, for example, Skye Bank was a bank that was always cheap until it went bankrupt in Kenya. We had it where the banks got consolidated and then the smallest banks were not undercapitalized. So, it seems to be an industry where you don’t get what we wanted for being too clever just buy good, solid, great companies and then buy the market lead us. And if you can’t get the market leaders at good prices, probably don’t invest in the banks.

So, it seems to be an industry where you don’t get what we wanted for being too clever just buy good, solid, great companies and then buy the market lead us. And if you can’t get the market leaders at good prices, probably don’t invest in the banks.

Trading in developing countries, as Ghana

[00:07:28] Tilman Versch: How how’s the situation at the stock exchange for influence in Nigeria on other developing countries? Could you describe the situation there?

[00:07:39] Axel Krohne: Well, what’s been going on in Africa is the market. I mean, I started investing there 15 years ago, and it was kind of I was very early. Of the few other people who bother traveling to Botswana and meeting companies and Zambia, all those markets were barely existent, but the valuations were very attractive. So, I bought a bunch of stocks there. Had very heavy export into Africa early on, and then a lot of other people got excited about Africa and the valuations went through the roof because all the other investors I didn’t quite notice it, I thought they were too – cause I’m too smart and then came the financial crisis and the stock prices all collapsed because the stocks were bought by funds from London and New York, not by local funds. And so even though the African economies didn’t really expect any or had any recessions in those years and financial 2008, 2009 the stock markets collapsed because all the investors were sitting overseas, and the countries never recovered, or the stock exchanges never recovered.

So, we’re having right now, again, a continent that’s largely forgotten with some quite cheap stocks and very poor liquidity. I mean, me and my colleagues who invest in these crazy places that had high expectations expected those markets to develop, which has never happened.

[00:09:11] Tilman Versch: So, the valuations are still cheap there?

[00:09:13] Axel Krohne: They’re cheap. Again, if you’re selective, they’re cheap. But because of the poor liquidity for many large funds, they’re not investable. They’re all Sub–Saharan Africa, ex-South Africa. There might be only 20 companies where you can put $10 million in tomorrow. Everything else has you have to wait.

They’re cheap. Again, if you’re selective, they’re cheap. But because of the poor liquidity for many large funds, they’re not investable.

[00:09:38] Tilman Versch: How’s trading happening in like for instance Ghana or other countries?

[00:09:43] Axel Krohne: It’s getting all electronic, it’s getting a little better. It used to be not too long ago that people would sit around a table like this, meet for 30 minutes and discuss their customer orders. I got Guinness Ghana, a thousand shares on the offer. Somebody else would say, okay, I got the bid, and then they would come to an agreement.

And after that, they’d have a [00:10:14] and now it’s getting more electronic, but the volumes have not got much bigger. And for some reason how they all work the market has started to figure it out because sometimes it doesn’t make sense to me. But overall, you know, they’re not that crazy different and you can buy – I mean if you look at a brewery there and the brewery in Ghana has the same problems, the same opportunities a brewery might have in somewhere in Asia or a brewery in Germany. They’re all similar industries and it helps if you’ve been around a little bit that you understand that and you don’t need that much country knowledge.

They’re all the similar industries and it helps if you’ve been around a little bit that you understand that and you don’t need that much country knowledge.

Criteria to invest in a company

[00:11:12] Tilman Versch: Interesting! What are the criteria for you to invest in the company? What does the company have to have?

[00:11:23] Axel Krohne: It has to be good and has to be cheap. What’s good? High return on equity or high cash generation along with a mean low PE ratio or cash with strong cash flow. Usually, those things come together if you just have a low PE, but the free cash flow is there, that’s a big warning sign. The price to book value. I think for many businesses, for example, is not that relevant unless maybe it’s for financial, it’s different. But what I want is high profits, and profit margins. So, businesses are not squeezed for the last penny, which pretty much excludes, for example, textile manufacturing, where whoever does those stocks for a penny less is going to get the contract from Europe, from Sahara for the next quarter. And so, knowing it guesses where they come from, whether it’s from Pakistan, Bangladesh, or how fancy the machines are unless you develop it, get the right quality for the right price. So, and it is more attractive to have a tobacco company or a cigarette company or the breweries or banking, which can be good, you know, in some of those little niche operators that happen to be good in one country, you find the stock, but you don’t find that many stocks in other countries.

It has to be good and has to be cheap. What’s good? High return on equity or high cash generation along with a mean low PE ratio or cash with strong cash flow. Usually, those things come together if you just have a low PE, but the free cash flow is there, that’s a big warning sign.

For example, this may be an advertisement company in that in Kenya, which is a WPP subsidiary called Scan Group. And, you know, that stock might be cheap. I’m not sure I don’t own it. But you can say, oh, I like advertisements. I want to find one in another country. I mean, you just can’t find one even if you look to the Czech Republic or to Norway, you might not find another listed advertisement company. So, you just have to see what’s there. And it’s all about eliminating stuff that you don’t want. So, looking for good companies and then cheap valuations, many great companies are there, but I’m looking for companies that trade with very low PE ratios and 4% or 5% or so and like high dividend payouts, dividend yields of 10% or so, get me excited.

So, you just have to see what’s there. And it’s all about eliminating stuff that you don’t want. So, looking for good companies and then cheap valuations, many great companies are there, but I’m looking for companies that trade with very low PE ratios and 4% or 5% or so and a like high dividend payouts, dividend yields of 10% or so, get me excited.

Dividends

[00:13:55] Tilman Versch: So, you look for a PE of 4% or 5% and you sell a PE of 10% or?

[00:14:00] Axel Krohne: Well, hopefully, hopefully sometimes I’ll let it run some of those out there early. Yeah.

[00:14:08] Tilman Versch: What role do dividends play in your process?

[00:14:13] Axel Krohne: I like them. A) I like just the process of collecting them and B) it shows me the cash is for real and that the companies care about their minority shareholders., sometimes. I mean, I invest in companies that don’t pay any dividends and I have the discussions with the management say you’ve got to very great business, you’ve got opportunities to expand, you’re highly profitable and I can’t grow my funds 30% for a year. But if you can grow your business, 30% for a year with don’t pay me dividends, I don’t want to if you can use it very productively, but in a lot of cases, it keeps management focused and I am some biased towards dividends, generally speaking.

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Is there a culture of buybacks?

[00:15:00] Tilman Versch: If they are a culture of buybacks and the markets you are investing?

[00:15:04] Axel Krohne: There is not. No, no. Sometimes there’s a culture of issuing new shares. I mean, giving bonus shares, doesn’t serve any purpose whatsoever. It just makes the accounting for me so complicated because you get this dilution in calculating the growth in earnings per share is a little bit complicated but share buybacks generally do not happen. And it’s probably a good thing cause in a lot of those markets, the liquidity is poor and the last thing you want is even fewer shares outstanding, even less liquidity.

Shareholder activism

[00:15:42] Tilman Versch: And the shareholder activism in this market?

[00:15:45] Axel Krohne: There is not, there’s not and I just talked with a friend of mine about Korea, where you find many good, cheap companies that have lots of cash and they don’t know what to do with it. They don’t pay dividends. They don’t buy doing buybacks. And you’d wish that there were some local activist shareholders to change that attitude, but that’s not even the Japan there’s been some across those markets. No, you vote with your feet if you don’t like what the management is doing. You sell your shares and move on.

Currencies

[00:16:23] Tilman Versch: That’s interesting. How do you deal with currencies?

[00:16:29] Axel Krohne: As my kids say, “suck it up, buttercup”. Oh, currency risk is there. And it’s probably the biggest risk to the portfolio. It’s not the political risk. It’s not corruption. All those other things that people care about are conservative investing emerging for the market. It is about you waking up and the Ukrainian government is devalued by a third or the Khalistan or I forgot whatever their tangle or whatever it is worth much less than the morning before. And so that’s a risk that’s for real stock prices. Over time they will adjust. But you have currency depreciation especially of it when you least need it when the markets go down, that’s it for an investor, sell local stocks, and local bonds and buy back U.S. dollars. So, then the currency falls even more. And over time, markets recover, and currencies recover. And it’s a wash. You don’t lose much money long-term on currencies. You don’t make money on foreign currencies. But the problem is you lose it when you least need it. And so, when the times are good, you make even more money, which is great, but you’d rather have it so that you don’t lose as much money in the crisis, yes.

The research process

[00:17:58] Tilman Versch: Let’s go into your research process. You’re traveling a lot, going to different countries, but they’re also interesting sources where you can find information besides the company reports.

[00:18:13] Axel Krohne: No, the company reports yes. For the most part, that is it. And they can be quite, quite good and a lot of time today in the English language. And I used to – sometimes what I don’t understand the company reports, I look at to see if there’s any research report from any analysts and when I do that, I already know that I’m in trouble because if I can’t trust my own judgment if I need somebody else’s expertise, then I worry, know I’m not going to invest. And that’s even more so than when I visit the country a little bit later and I meet the analyst who is 20 years old. And it’s not that I wish to be 20 years old again, but he’s got zero business experience and zero experience as an analyst. But when you sit far away in your office in California, so all the local analysts think this and that, not realizing that the local analyst just finished high school and is really not that great of an analyst probably quite yet.

So, no, there’s no big local knowledge, outside knowledge with the annual reports. And if I don’t understand them, if I don’t understand the business, I will probably very likely not invest.

[00:19:41] Tilman Versch: On any blog series or any websites?

[00:19:45] Axel Krohne: Nope.

[00:19:47] Tilman Versch: And how big is the coverage of the companies you’re investing in? Usually?

[00:19:54] Axel Krohne: Can you specify what’s in the question?

Axel Krohne’s stock coverage

[00:19:56] Tilman Versch: Like we already talked about the analysts that are covering the companies in your market. How many analysts are covering your company? Usually.

[00:20:05] Axel Krohne: Typically, zero. Typically, zero. A lot of times I invest in companies where the locals don’t even know that they have a that the country, the company exists, especially in markets like Vietnam. It’s going to be smaller companies with zero analyst coverage. And yeah, I mean in some way in other markets where there are very few stocks, there might be one or two analysts, but it’s negligible.

The funds there, the shares are held by local pension funds many times and they never sell and so few foreign investors and they do, they own on work, and they talk to management and they either like what they hear or they don’t. And you know, you want the management is great to talk to but really if you have to do I think the research first and make sure the company is profitable and is as good just by the numbers rather than being shot by a very by a financial or the CEO who got there just because he’s the best salesman and he I mean, he has a salesman job and he charms you and you like any regards. His great vision of the future for the company of the country. But if the numbers don’t back it up, I would not invest.

Stock holding period

[00:21:25] Axel Krohne: And to how long is the usual time horizon to hold the company? How many years do you expect to do it?

[00:21:34] Axel Krohne: A few years. A few years, I’d say. After a few years, it should have done either very well or if the business has deteriorated. I sell and I’m very happy to sell very quickly if I made a mistake, if I didn’t analyze the situation correctly, or if the situation changed, I happily take my losses and move on to look for something better. I think it’s; I always believe you don’t have to make back the money the way you lost it, just go. I bought the stock at 100, not 50. I mean, that’s my problem. I don’t, the stock doesn’t care about me and is not going to go back to 100 just because I wanted to or so I’ve tried to sell it at 50 and see what’s the best opportunity with the money today.

[00:22:24] Axel Krohne: Thank you very much for that interesting interview.

[00:22:26] Axel Krohne: Thank you.

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