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A new record estimated NAV of USD 1,636 (+6.4%) reached in March, on the fund's 2-year anniversary.
 

 

AFC Uzbekistan Fund March 2021 Update

 

Dear Investors and Friends,

March 2021 marks the two-year anniversary of the launch of the AFC Uzbekistan Fund (AUF) on 29th March 2019. The fund launched with assets under management of USD 2.0 mln and ends its second year with USD 11 mln.

 

(Source: Dreamstime.com)

 

March saw a continuation of the broad, multi-month rally across the majority of the fund’s portfolio companies as the equity re-rating on the Toshkent Stock Exchange continues apace, backed by continued inflows of new investor capital from both locals and foreigners. The March NAV of the fund increased to a new all-time high, estimated at USD 1,636 (+6.4%) or +63.6% since inception.

  AFC Uzbekistan Fund valuations as of 31st March 2021:

 Estimated weighted harmonic average trailing P/E (only companies with profit):

5.45x
 Estimated weighted harmonic average P/B: 1.26x
 Estimated weighted portfolio dividend yield: 7.46%

 

Capital Markets Update

New market participants continue to wake up to the reality we have been beating the proverbial drum about for the past three years, even before the launch of the AUF, specifically that Uzbekistan is uniquely positioned with a strong balance sheet, low debt, a young and entrepreneurial population of 34 mln, diverse economy, and is geographically located at the heart of Central Asia. Unsurprisingly, the listed equity market continues to attract more local and foreign investor attention due to the continued rare combination of deep value and strong growth on offer these days.

Upon AFC's entry into Uzbekistan in mid-2018 (first through the AFC Asia Frontier Fund), the AFC Uzbekistan Fund acted as the first substantial new money to enter the equity market in nearly a decade, providing liquidity to desperate sellers who were anxious to sell their shares to the fund at gift-giving prices!

One such example, and certainly not the exception, is the Uzbek Commodity Exchange (TSE:URTS). URTS is the local equivalent of the NYMEX, COMEX and LME rolled into one, and is the fund’s third largest holding with a current weighting of about 14%.

Over the past several years, the government has required an increasing number of commodities to be traded through the exchange to promote efficiency, and more importantly transparency, in a bid to stem corruption. Cement, plastics, timber, rebar, etc. are all traded through the exchange. URTS also has a platform for government procurement where tenders for services and equipment are listed, as well as platforms for car license plates and mobile phone numbers (the latter two platforms experience strong demand as auspicious license plates and mobile phone numbers are associated with “social status” in Uzbekistan, as it is the case in many Asian countries). The government’s push to increase the number of items traded through the exchange as well as the growing demand for commodities has led URTS to continue to grow strongly.

Putting the URTS opportunity into perspective from when the AUF launched relative to today, the fund’s initial purchase of URTS shares was at a split-adjusted UZS 2,000 per share (the average price of our position is modestly higher). The share price as of 31st March 2021 is UZS 12,000 per share. Dividends per share for fiscal years 2018, 2019 and 2020 were UZS 550, UZS 830, and UZS 1,100 respectively. Thus, combined dividends per share over these three years total UZS 2,480, while the share price is up 500%.

 

(Source: Toshkent Stock Exchange, AFC Research)

 

This is the type of incredibly deep value early investors in the AUF have benefitted from. While the market has begun to more rapidly re-rate over the past several months, we still see plenty of long-term value throughout the market and continue to believe we remain in the early innings of a multi-year bull market as Uzbekistan remains largely undiscovered by international investors. Further, amid the turmoil of COVID-19 and likely future volatility in global markets, Uzbekistan is benefitting from its “frontier” status as it’s not yet highly integrated into the global economy. This means external economic shocks have but a minimal effect on the country and it should increasingly attract foreign capital as a safe haven for investors seeking growth and stability.

Back to URTS, based on unaudited 2020 financials, as of 31st March 2021, URTS trades at a P/E ratio of 9.49x, P/B of 5.52x and a dividend yield of 9.17% - still cheap in our eyes as the company experienced YoY earnings growth of 16% and return on equity of 24%.

The market capitalization of the Toshkent Stock Exchange has also grown, 21% since 2019, from USD 4.94 bln to USD 6 bln on 31st March 2021. As the onramps for investors to open accounts and become active in the market, specifically foreign investors, become easier and liquidity of listed companies increases as the privatization process advances, it’s likely that the re-rating of the broader market and deeper investor base will encourage a wave of private company IPO’s, which will transform the capital markets. AFC has witnessed this in Mongolia over the past decade, for when I lived in Ulaanbaatar in 2012, most of the listed companies were formerly state-owned enterprises. However, since 2015 there has been a mini-IPO boom with 12 IPO’s, in addition to several reverse takeovers of listed shell companies.

 

(Source: Toshkent Stock Exchange, AFC Research)

 

Toshkent Stock Exchange Index Update

As discussed last month, the Uzbekistan Composite Index (UCI) soared by 109% in February due to insurance provider Universal Sug'urta's (TSE:UNSU) share price rising 199,999% from 23rd December 2020 to 28th February 2021, highly likely a result of share price manipulation. Therefore, it was not a surprise to see UNSU's share price collapse -84% during March (from UZS 20 to UZS 3.25), leading the UCI to fall -45% (from 1,443 to 793).

Macro/COVID-19

The economic events of the past year were rather muted as the majority of the news was naturally around COVID-19. The government did a superb job of handling the initial panic of the virus overall. Uzbekistan enacted two approximately one-month-long lockdowns, one in March and the other in July 2020.

The first lockdown was strict with a stay-at-home order and private cars banned from the road. Following this strict period, we believe the Uzbek government took a turn toward thinking more rationally and independently, realizing that through a strict lockdown they might be able to mitigate the spread of the virus, but would destroy the economy in the process, the latter of which many Western countries are doing with unfortunate pinpoint accuracy.

Therefore, the second lockdown was centred around limiting the movement of citizens while attempting not to hinder economic activity. This meant private cars were this time not barred from the road during the mornings and evenings (effectively allowing people to get to work until 10am and return home after 5pm). As this occurred during the summertime, schools were closed, but factories, construction sites, and cafes were all open and operating normally without any restrictions.

Following the second lockdown, during the autumn school semester, many schools began operating in-person classes again, and for the most part, the population stopped wearing masks, while quarantine facilities and emergency hospitals closed. Conversation and media coverage has returned to topics around the economy, politics and social news as movie theatres are open, concerts are happening regularly, and the recent Tashkent Marathon was even held on 28th March 2021.

Privatizations

The government has been working aggressively to privatize hundreds of state assets. Though things have been moving ahead slowly due to a variety of challenges, largely around the scale of the President’s privatization agenda and the valuation metrics being used to price assets for sale.

On 12th May 2020, President Mirziyoyev signed a decree, “On the Strategy for Reforming the Banking System of the Republic of Uzbekistan for 2020-2025,” which is intended as a roadmap for the continued liberalization and privatization within the sector. The main aspects of the decree included:

  • Increasing the share of private bank’s assets in the sector from 15% to 60%; 
  • Increasing the total share of bank debt to private clients from 28% to 70%; 
  • Attracting foreign strategic investors for at least three state-owned banks; 
  • Increasing the share of non-bank lending from 0.35% to 4% of total loans. 

Six state-owned banks are slated for privatization, including Ipoteka Bank (TSE:IPTB), with 90% state ownership, SQBN (TSE:SQBN), with 90% state ownership, Aloka Bank (TSE:ALKB), with 100% state ownership, Qizhlok Qurilish Bank (TSE:KKBN), with 80% state ownership, Turon Bank (TSE:TNBN), with 97% state ownership, and Asaka Bank, with 100% state ownership. Meanwhile, the National Bank of Uzbekistan, Microcredit Bank (TSE:MCBA), and Agro Bank (TSE:AGBA) will not be privatized.  

A rumoured piece of legislation that may be announced this year could see an increase in the minimum paid-up capital of banks from UZS 100 bln (USD 9.5 mln) to UZS 500 bln (USD 48 mln) by 2025, to further strengthen the sector.

Further, at the beginning of March 2021, the government published a list of publicly listed companies slated for full privatization, including the largest consumer goods conglomerate in Uzbekistan, Toshkent Vino (TSE:TKVK), construction and bottle glass producer, Kvarts (TSE:KVTS), and industrial fabrication company, Qo'qon Mexanika (TSE:KUMZ), all three of which the fund holds.

De-Monopolization

One of the biggest challenges hindering competition in the Uzbek market has been the dominant presence of monopolies, specifically state-owned monopolies. To address this elephant in the room, during March 2021 a presidential decree was signed regarding the liberalization of the commodities markets and their de-monopolization. Specifically stating that:

From 15th June 2021, state monopolies with greater than 50% direct or indirect state ownership will lose their monopolies. This applies to monopolies in the PVC, ethanol, and silver industries.

From 1st January 2022, non-monopolist companies or companies with less than 50% state-ownership in the cement, cotton and related byproducts, and oil and gas condensate industries will no longer have price control protections, instead having their prices regulated by the market forces of supply and demand. Further yet, logistics providers which served monopolies will lose their exclusivity and will have to compete for tenders based on price and service.

Of notable interest in the decree is the planned establishment of commodity futures and derivatives trading on URTS’ exchange platform. Settlement procedures will be enhanced, enabling traders to have foreign bank accounts in order to trade with regional commodity exchanges in other countries. This will provide another long-term bullish catalyst for URTS.

Looking forward

We continue to see opportunities abound in Uzbekistan over the next several years as the economy undergoes continued liberalization and maturation, which in time should drive the capital markets into a more pronounced phase of development, on the back of accelerated state privatizations and future private sector IPO’s.

While COVID-19 has slowed the attraction of investors to Uzbekistan, it will not deter them, specifically the Chinese. The Shanghai Cooperation International Summit is planned to be held in Samarkand in 2022, with a reported 20 heads of state expected to attend. Uzbekistan’s location at the heart of Central Asia makes it a natural logistics hub, while it is also the country with the largest consumption potential due to it hosting the largest population in Central Asia. We anticipate that after the summit significant Chinese investment will pour into the country, spurring a likely prolonged period of “caffeinated” economic growth.

On the subject of caffeine and increasing investment in Uzbekistan, the country will see the grand opening of Starbucks’ flagship store in central Tashkent in 2022. Located on Taras Shevchenko, one of several “high streets” in the city, Starbucks will open in a recently renovated commercial building and be yet another global brand to enter the highly underserved consumer market that will surely attract dozens more foreign brands over the coming years as investors increasingly discover the untapped potential of Uzbekistan.

 

The planned location for Uzbekistan’s flagship Starbucks Coffee

(Source: AFC Research)