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When Thomas and I first visited Uzbekistan in May 2018, the once-in-a-generation valuations of the majority of listed equities made it abundantly clear that they couldn’t get much cheaper. The country, and its equity market in particular, had been “left for dead” by foreign investors following the global financial crisis of 2009, while local investors preferred bank term deposits which at the time paid annualized interest rates of up to 22% in local currency terms.
To quote Jim Rogers who famously said, “I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up”, AFC and a fellow frontier markets investor from Taiwan were the first foreign institutional investors to re-enter the market in 2018 and build large positions in “blue-chip” equities. Regarded as “crazy” by some of our local contacts for acquiring shares in listed companies, and in some cases willing to buy large blocks of shares at prices they deemed “expensive”, we were gifted the opportunity of ample weak hands willing to sell their shares to us at “deal of the decade” prices. We were comfortable paying what appeared to be high prices at the time in order to build our initial positions, knowing that as local and foreign investors caught on to what we saw, the stampede to acquire shares would drive prices higher; we wanted to be positioned to benefit from this and thus positioning early was imperative. Several of the fund’s current holdings, at the time had up to 70% of their market capitalization in cash with zero debt and were growing their earnings by several hundred percent per annum; some even hosted dividend yields as high as 50%. While share prices have certainly risen and dividend yields have compressed, for the majority of the fund’s positions, they have merely gone from being “unreasonably cheap” to “deeply undervalued”, meaning there should be several more years of upside ahead.
Phase II approaches
As “Phase I” of our thesis continues to unfold, we believe “Phase II” is approaching as large and high-quality state-owned enterprises gradually advance toward privatization through the stock market.
When speaking with investors we are often asked what percentage of listed companies are wholly privately owned. The answer is very few, since Uzbekistan, until 2016 was a centrally planned economy with the State heavily involved. Since the fall of the Soviet Union, and subsequent launch of the Tashkent Stock Exchange on 8th April 1994, state-owned enterprises have been partially privatized through the exchange, which today hosts 144 companies and a market capitalization of USD 5 bln. Historically, listed equity valuations have been so cheap (attractive for us) that private companies were unwilling to sell equity through the exchange. Rather, they have opted for private equity investment in order to obtain higher valuations; this is the opposite of what typically happens around the world as listed companies usually trade at higher valuations due to their liquidity premium.
Once the initial re-rating phase of existing listed companies further matures, we expect to start seeing high quality state-owned enterprises IPO and/or be privatized through the stock market (Phase II of our thesis). The liquidity and market participation generated by these privatizations and higher valuations should in due course trigger Phase III of our thesis which is for private companies to pursue IPO’s. Listing costs on the Tashkent Stock Exchange are very affordable and it will provide companies with a straight forward avenue for financing, relative to private equity or debt financing from banks which often come with restrictive conditions.
Back to Phase II, before private companies aggressively participate in the market, several large state-owned companies in the commodities sector are expected to IPO which should transform the capital markets of Uzbekistan by attracting new institutional capital, as well as dramatically increasing the market capitalization and liquidity of the exchange. In mid-November, one of the most notable (and highest quality) state-owned enterprises finalized its consolidated IFRS reports which were audited by Ernst & Young. The company has also retained KPMG for pre-IPO analysis before a planned IPO in 2023. The company is Olmaliq Kon-Metallurgiya Kombinati (TSE: AGMK), a large mining company producing copper, zinc, molybdenum, gold and silver. AGMK also accounts for 90% and 20% of Uzbekistan’s respective silver and gold production. Scheduled for privatization in 2023 through an international IPO and secondary offering of existing shares though the Tashkent Stock Exchange, while the company’s valuation has not been publicly disclosed, it is expected to be several billion dollars which would nearly double the current market capitalization of the exchange. Several other such companies (including Navoi Metallurgical Mining Kombinati which operates the largest open-pit gold mine in the world—Muruntau) are scheduled for similar privatization towards the middle of the decade and should help to accelerate foreign investor attention to the very attractive and highly diversified economy of Uzbekistan.
Portfolio companies report strong third quarter earnings growth
Projected to grow 0.7% in 2020 with growth rebounding to 5% in 2021, according to the IMF, while large portions of the global economy are unfortunately being subjected to varying degrees of government-mandated restrictions, in Uzbekistan it very much feels like January 2020. COVID-19 is certainly an issue in Uzbekistan, though it appears the government has accepted the fact that the virus can’t be stopped through quarantines (of which there were two earlier this year) and has opted to instead open the economy rather than smother it. The decision by the Mirziyoyev administration can be clearly felt, as stated in previous monthly updates, construction sites are buzzing, schools are all back in session, foreign tourists are welcomed, cafes, restaurants and pubs are open and there is no “social distancing”. This response by the government, one of the best in the region, is likely what has translated into a very positive third quarter earnings season, with many of the fund’s holdings having reported superb results.
The below table shows several of the AFC Uzbekistan Fund’s holdings and their earnings growth on a trailing twelve months basis and for the third quarter year-over-year. Valuations for the majority of the portfolio remain far too cheap. Continued growth expectations will be supported by the further liberalization and diversification of the economy, rising foreign direct investments, exports and improved purchasing power among the local population.
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