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 AFC Uzbekistan Fund July 2020 Update

 

Dear Investors and Friends,

Uzbekistan re-entered quarantine on 10th July, with virus cases having risen to 9,697, and it is expected to remain in place until at least 15th August. Meanwhile, the economy continues to function under this new normal and its affects have had little impact on overall earnings of the fund’s portfolio companies. In fact, many companies experienced strong year on year growth for the second quarter of 2020 and several companies announced dividends for fiscal year 2019 which translate to double-digit yields. The July NAV of the fund increased to an estimated USD 1,038 (+3.1%), according to internal calculations.

AFC Uzbekistan Fund valuations as of 31st July 2020:

Estimated weighted harmonic average trailing P/E (only companies with profit): 3.36x
Estimated weighted harmonic average P/B: 0.69x
Estimated weighted portfolio dividend yield: 6.34%

 

Operating under a second quarantine

On 10th July the government re-initiated quarantine as cases had been steadily rising from the first re-opening in late April/early May. Currently, active cases stand at 9,697. Though, unlike the quarantine in March 2020, this one could best be termed “quarantine light”, for the only parts of the economy that appear to be affected are restaurants, coffee shops, salons and select agriculture and industrial businesses.

Passenger vehicles can be on the road between 07:00 and 10:00 and 17:00 and 20:00, except on weekends, while taxis can operate all day during the week. Thus, most people still go to the office and construction sites are hives of activity, as are the bazaars (open during the week but closed on the weekend). Quarantine was expected to last only until 1st August, but it became clear to us on 10th July, after extrapolating out the rising case count, that three weeks would not be long enough to “flatten the curve”. Indeed, the government has extended the quarantine until 15th August and one should not be surprised if it is extended by an additional week.

Life continues as normal at a bazaar in central Tashkent at 15:00 on 29th July 2020

(Source: Asia Frontier Capital)

 

When considering the state of the world and that life is unlikely to regain a semblance of normalcy possibly as far into the future as the second half of 2021, we may see a bifurcated approach among countries regarding the handling of this virus. Some countries will follow the path of Brazil, Sweden and Turkey which have let the virus spread naturally, accepting the fact that it is so widespread globally that the genie cannot be put back into the proverbial bottle. In the process these countries are limiting the impact on their economies, which is still quite significant nonetheless. The other group of countries are likely to undergo a prolonged period of repeated closings and re-openings.

At present, it appears Uzbekistan has chosen the second approach, though the government appears to be attempting to keep quarantine restrictions as non-invasive as possible in order to protect the incomes and livelihoods of its citizens. The most likely reason for the country choosing this approach is in an attempt to not overwhelm the fragile and ill-equipped healthcare system. So, until the government can ensure that healthcare infrastructure is no longer at risk of being overwhelmed, this period of closings and re-opening’s is expected to continue. We would therefore expect a third quarantine period to take place sometime in October or November.  

The practicality of Uzbekistan’s Gold reserves

As many Asian Central Banks understand the value of gold and continue to increase their holdings, western Central Banks have largely done the opposite and sold large chunks of theirs in recent years. While gold is regarded by some economists and business people as an archaic relic, Uzbekistan is an important case study for why gold is so valuable for emerging economies.

The first half of 2020, like in many countries, was a challenge for Uzbekistan in relation to exports, which fell 7% year on year. Meanwhile, imports rose 3.6% due to the continued re-industrialization of the country and strong demand for animal protein, specifically beef. When excluding the country’s USD 2.12 bln in gold sales, the current account deficit stood at USD 6.52 bln. Now, accounting for the gold which was sold during the period, the current account deficit narrowed by 32.6% to USD 4.4 bln. Gold is an important commodity the government uses to decrease the current account deficit, and as global trade slows, with increasing competition for a shrinking global economic pie, Uzbekistan has a guaranteed way to make sure its current account deficit, expected to move into surplus in the mid-2020’s on the back of rising exports and a decrease in machinery imports, does not get out of hand; if it so wished it could sell enough gold today to move the country into a trade surplus. This puts Uzbekistan in a very unique position, providing strong support to the country’s finances in what will be a long road on the way back to normalcy in the global economy.  

At the end of the first half 2020, Uzbekistan’s foreign exchange reserves stood at USD 32.32 bln, of which USD 19.60 bln was gold, equivalent to 11 mln ounces (the Central Bank of Uzbekistan continually replenishes its gold reserves through purchases of physical gold in local currency from state-owned mines). As of 31st July 2020, these 11 mln ounces of gold are valued at USD 21.73 bln or 41.77% of GDP.   

Portfolio company performance

The fund’s portfolio companies showed broad performance during July, though the standouts were cement producers. Due to the first nationwide quarantine, initiated on 16th March 2020, Uzbekistan customs increased the time to clear goods at land borders where it took up to 28 days for imported cement to go through. The issue has been resolved as it now only takes 2 to 3 days to clear customs, but this bottleneck amid continued strong domestic demand led the price of PC-400 bulk cement (the most common type of cement produced in Uzbekistan) to rise from UZS 458,000 on 1st January 2020 to UZS 800,000 on 30th June, a 74.67% increase. Qizilqum Cement (QZSM), the fund’s largest holding at 33% of AUM, and the largest producer of PC-400 cement, saw its share price appreciate by 22.8% during the month. QZSM's strong performance for the month however was met with softness in some of the fund’s other holdings, merely due to low liquidity into month end, which impacted July performance by and estimated -3.6%.

QZSM had is best quarter since we first visited Uzbekistan in May 2018. Second quarter 2020 earnings per share were UZS 314.35, or a 103% increase year on year. QZSM ended the month trading at a P/E of 2.48, P/B of 0.54 and an EV/ton basis of USD 7.25 (this compares very favorably to the replacement cost of capacity of USD 110 to USD 120/ton).    

The fund also benefitted from performance in a cooking oil company (whose raw material is cotton seeds) and one of the two Kyrgyz companies the fund holds—an airport operator. The cooking oil company ended the month +27% and announced a 2019 dividend which equates to a yield of 10.2%. The Kyrgyz airport operator also announced a strong 2019 dividend which translate to a yield of 14.1%. 

For further viewing here are some interesting, relevant news links related to Uzbekistan: 

Hungary’s largest bank, OTP Bank considers entering Uzbekistan (English)

Uzbek-French company to pursue hemp production (Russian)  

Subscriptions

The next cutoff date for new subscriptions will be 25th August 2020. If you would like any assistance with the subscription process please get in touch with us at This email address is being protected from spambots. You need JavaScript enabled to view it.

Best regards,

Scott Osheroff

CIO AFC Uzbekistan Fund