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AFC Uzbekistan Fund October 2021 Update


Dear Investors and Friends,

October saw the commencement of third-quarter 2021 earnings season, where many of the fund’s core holdings reported strong growth yet again, benefitting from the accelerating growth in the economy, and whose share prices continued to rally on the back of good reports and more investor activity in the market. This helped the October 2021 fund NAV to increase to a new estimated all-time-high of USD 2,095.4 (+4.2%) or +109.5% since inception on 29th March 2019.

AFC Uzbekistan Fund valuations as of 31st October 2021:

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

 Estimated weighted harmonic average P/B: 1.56x
 Estimated weighted portfolio dividend yield: 5.33%


Presidential Election Concluded

Uzbekistan’s presidential election was held on 24th October 2021, where President Shavkat Mirziyoyev competed against four candidates. He won re-election by a landslide with 80.1% of the votes. With elections now behind us, President Mirziyoyev has five more years to continue, and hopefully accelerate, his reformation of the social and economic fabric of Uzbekistan, helping the country to gain what we believe is its rightful place as the largest and most influential economy in Central Asia. However, there is a lot yet to be done, and some of the more challenging reforms, including the government’s extensive privatization programme, lay ahead, which we will be watching closely.

Uzbekistan is a semi-protectionist country and there’s nothing wrong with that!

The concept of free-markets and open economies is an idea spawned post-WW II by the West and is trumpeted by the likes of the IMF and World Bank. However, while highly efficient in theory, in practice, such policies can hollow out domestic industrial sectors, as was the case with the USA in the 1990s and 2000s where manufacturing capacity shifted to Mexico and Asia to take advantage of the labour arbitrage. At the same time, such policies can inhibit younger economies from ever developing their domestic industries as they are flooded by imports from foreign competition, which already have economies of scale.

As we are all learning today, just-in-time supply chains only work when everything runs smoothly, and there are no logistical bottlenecks. This worked brilliantly since the 1990s when globalization took the world by storm. Now, however, we have been gradually (and increasingly with government responses to COVID-19) witnessing a world of rising protectionism, whether food exporters banning or slowing export permissions, or more recently, China slowing export approvals for phosphate. This trend is only set to accelerate as we witness resource shortages and rising geopolitical headwinds globally.

Believing we are in the early innings of a rising tide of nationalism/protectionism of domestic resources and industries and also of a focus on supply chain redundancies, for all of the disinflation Europe and America benefitted from by outsourcing their supply chains to Asia, this new paradigm will likely be inflationary as they seek to reconfigure their supply chains closer to home.

This scenario bodes exceptionally well for the region I have termed the “New Fertile Crescent”. This includes China, Russia, Central Asia, Iran and Turkey. The original Fertile Crescent is regarded as the cradle of modern civilization and existed at the confluence of the Euphrates and Tigris rivers in modern-day Iraq. The “New Fertile Crescent” however, encompasses countries with good demographics on average, large domestic resource bases, low debt to GDP, and more importantly, control over their supply chains accompanied by strong domestic manufacturing sectors. Thus, we believe this region is set to undergo a period of secular growth as it is less impacted by commodity-price inflation and rising protectionism, since it is already relatively protectionist and has focused on building strong domestic industries. Case in point—Uzbekistan.

In an increasingly fragmented and protectionist world, we look at the "New Fertile Crescent" region as being full of opportunities and where Uzbekistan is likely to play a big part, especially due to its domestic policies which have helped to bolster domestic industry with a focus on import substitution. During the month, I had the opportunity to visit one such beneficiary of these policies, the largest steel plant in Uzbekistan, Uzmetkombinat (TSE: UZMK).

Uzmetkombinat—one of Uzbekistan’s blue-chip companies

Uzbekistan’s business environment is evolving in the direction toward a free market but is certainly not an entirely free market, nor should it be. Having the largest industrial base of any “Soviet Satellite” during the USSR, Uzbekistan’s former and current president have been wise to focus on protecting and nurturing its domestic manufacturing sector. This certainly applies to Uzmetkombinat, currently the AFC Uzbekistan Fund’s second-largest position.


A site visit to Uzmetkombinat- Uzbekistan’s largest steel plant

(Source: AFC Research)


UZMK has an annual production capacity of 1mln tons of steel, produced using electric arc furnaces to melt scrap steel, collected in Uzbekistan, as well as imported crude steel from Russia and Kazakhstan. The company benefits from its monopoly position in the collection of scrap steel in Uzbekistan, while the country officially bans exports of any scrap. This gives UZMK a competitive advantage in purchasing scrap at a price it sets and one which is well below international scrap steel rates. As the government of Uzbekistan imposes an import duty on steel products, steel prices in the country are higher than abroad, thus allowing UZMK to benefit from significant margin when selling its steel locally—a core focus of the company as Uzbekistan remains a net importer of steel, mainly from China, Russia, Iran and Kazakhstan.

With steel demand continuing to rise in Uzbekistan, UZMK is currently undergoing a EUR 600 mln capacity expansion which will see steel production increase from 1mln tons per year to 2.5mln tons per year by 2026, subsequently cutting steel imports and further cementing UZMK’s grasp on the local steel market.

Touring Uzmetkombinat’s factory

(Source: AFC Research)


The formation of steel billets 

(Source: AFC Research)


UZMK’s expansion consists of modernization of its current German production lines, which will increase capacity by 300k tons per year, the construction of a 1mln ton per year hot rolled coil line (this is already underway) and the purchase of a small steel factory in a nearby city with annual production capacity of 200k tons per year. This expansion will use mostly Italian equipment, contrary to the common stereotype that such a company in such a frontier market would default to Russian or Chinese equipment. The capital for this project will come from various sources—a locally syndicated loan for USD 100mln and several other loans from international banks at favourable rates, while a portion of the project will be financed from cash on hand.


Hot rolled coil prices have risen sharply in 2021

(Source: Bloomberg)


One of the risks with such a project is the large debt UZMK will be taking on. However, while the company may cut its dividend for a year or two, the medium-term outlook is very bright. For example, a downstream steel plant, the Tashkent Metallurgical Plant, located on the outskirts of Uzbekistan’s capital, Tashkent, is currently importing roughly one mln tons per year of hot rolled coil. Once UZMK has completed its new production line, expected in 2023, it has a guaranteed buyer as UZMK will be able to undercut imported hot rolled coil courtesy of Uzbekistan’s import duties, thereby rendering Russian steel uncompetitive.

UZMK has returned over 1,100% from our initial investment in the company, before dividends, and we remain upbeat due to its monopolistic position and benefitting from Uzbekistan’s focus on import substitution. This has led trailing-twelve months earnings to soar 547% YoY, while book value per share has surged 62% YoY. Compared to most similar companies recycling scrap steel abroad, UZMK has a strong moat as it controls its raw materials costs, while foreign companies are subject to paying market price for scrap steel. The company ended October trading at a P/E of 4.01x, P/B of 1.79x and hosts a dividend yield of 3.34%.  

Going forward, while steel prices will surely not rise the way they have over the past year, we believe a transition is occurring where China, the world’s largest steel producer, is struggling with energy shortages and pollution curbs, thereby eliminating many tax rebates on exported steel to engineer an end to overproduction. This should bolster international steel prices over the coming years and put UZMK in an enviable position as it moves yet closer to bringing its new capacity additions online.

Lastly, as UZMK puts the finishing touches on its capacity expansion and accelerates its debt repayments, this should coincide with an international dual listing, likely on the London Stock Exchange, in 2024 or 2025 which will provide foreign investors exposure to one of the most attractive blue-chips in Uzbekistan today.

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

President Mirziyoyev wins re-election with landslide

Uzbekistan's economy bouncing back strongly with upward GDP revision from World Bank

IMF expects Uzbekistan's economy to grow faster

Uzbekistan works with India to move goods through Iran's Chabahar port                         

AFC Uzbekistan Fund Marketing Information as of the end of September 2021