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Uzbekistan's well-insulated economy positions it for long-term success.


AFC Uzbekistan Fund March 2022 Update


Dear Investors and Friends,

March 2022 marks the third anniversary of the AFC Uzbekistan Fund. Uzbekistan has radically changed for the better since we first visited the country in May 2018 and since the fund’s launch on 29th March 2019. The country’s future as a manufacturing hub, bolstered by strong foreign direct investments and domestic demand from the emerging middle class, coupled with economic policies that mitigate its exposure to global economic shocks, specifically in the realm of natural resources, positions Uzbekistan very favourably for continued outperformance over the coming years.

However, it is unfortunate to note that on the third anniversary of the fund, during March 2022, due to an extraordinary circumstance stemming from a corporate action in the largest holding of the AFC Uzbekistan Fund, Uzmetkombinat (TSE: UZMK), after much consideration, the directors of the AFC Umbrella Fund and AFC Umbrella Fund (non-US) decided to suspend issuing a NAV for the AFC Uzbekistan Fund and AFC Uzbekistan Fund (non-US) for March 2022 as the current market price of UZMK does not reflect reality. 


AFC Uzbekistan Fund valuations as of 28th February 2022:

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

 Estimated weighted harmonic average P/B: 1.30x
 Estimated weighted portfolio dividend yield: 5.40%


Uzmetkombinat update

As stated in the February 2022 fund update, the fund’s largest holding, steel company Uzmetkombinat (TSE: UZMK), was to hold its annual general meeting (AGM) on 15th March 2022. As state-owned enterprises (SOE’s) typically distribute 75% of their net income, we predicted there would be either a cash dividend or, more likely, an issue of new shares as the company seeks to capitalize profits as it is undergoing a significant capacity expansion and would prefer the cash to remain within the company.

Excerpt from the AFC Uzbekistan Fund February 2022 Update:

As the annual general meeting (AGM) season quickly approaches, early news is coming out that some of our portfolio companies indeed had a superb 2021. One outshining example of the value that exists among the fund’s holdings is Uzbekistan’s largest steel producer, Uzmetkombinat (TSE: UZMK). Preliminary results show that UZMK saw net income grow by 594% in 2021 to UZS 1.53 trln, up from UZS 220.2 bln in 2020.

UZMK will hold its AGM on 15th March 2022, where the main item on the agenda will be the distribution of net income. Typically, state-owned companies distribute 75% of net income, but assuming UZMK distributes only 50% this would equate to UZS 19,766 per share and thus a dividend yield of 21.9% as of 31st January 2022. This attractive potential yield caused UZMK’s share price to rally 38.8% during February and as of month end a 50% distribution of profits would translate to a yield of 15.8%, still highly attractive in an economy where inflation is under 10%!

Also on the agenda is the potential for the distribution of accumulated retained earnings in order to increase charter capital. Assuming no dividend distributions are paid and retained earnings go toward increasing charter capital, this would equate to the issuance of nine new shares for every share held. While we would prefer dividends, the company would certainly appreciate the cash to stay in the company as they have large funding requirements coming up as UZMK undergoes a capital expenditure program which will see a doubling of production to 2.5 mln tons of steel per year by 2026.

In all countries that we are aware of (except for Laos), at an AGM, if a company announces a dividend will be paid, it is normal for the ex-dividend date to be at a point after the AGM, say for example, 5 to 30 days after the AGM. However, in Uzbekistan it works differently: when an annual general meeting (AGM) of a public company is held, there is an “ex-date” which is 5 business days before the meeting where the register of shareholders closes. Legislation actually states three business days, but the Tashkent Stock Exchange operates on a T+2 settlement, meaning it takes two days for trades to settle, hence 5 days.

Later this year, when Uzbekistan’s new securities legislation is passed, Uzbekistan’s capital markets should operate in such a “normalized” manner where the ex-date for dividends and corporate actions is after the AGM. However, the existing legislation is antiquated and the following is what happened to UZMK during March 2022 that has artificially suppressed the share price, making a March 2022 NAV not representative of the true value of the fund’s holdings.

UZMK’s ex-date for the AGM was on Monday 7th March 2022, and on that day, one or several shareholders thought they would be clever and sell their shares to unsuspecting buyers who thought they were getting a bargain. The sellers were gambling, effectively speculating that if they sold their shares after the ex-date and bonus shares were announced, then they would receive them, while the buyers of their shares would be paying multiples the current price after accounting for dilution. It is typical, but not part of the legislation that the ex-dividend date in Uzbekistan is often the same as the ex-date for the AGM (again, in most parts of the world at an AGM a dividend may be announced, but the ex-date is announced to be a future date). These sellers therefore aggressively sold shares, and from 4th March 2022 to 11th March 2022, the share price of UZMK fell from its March high of UZS 129,000 to UZS 51,528. On Monday 14th March 2022, the Tashkent Stock Exchange halted the shares due to the significant share price volatility, with UZMK’s shares having dropped 60% in five trading days.

At the AGM on 15th March 2022, it was decided that no cash dividend would be paid, but rather an increase in capitalization would occur, whereby 10 new shares (rather than the 9:1 we predicted in our February 2022 update) would be issued for every existing share. The caveat however was the ex-dividend date to be included in the registry for these shares was NOT 7th March 2022, but will be sometime in the near future (probably in April 2022) after the Ministry of Finance has approved the decision on the share issue.

This means the speculative sellers who drove the stock price lower, thinking they would profit handsomely, actually sold (in hindsight) shares at phenomenally cheap prices and will now have to buy shares back on the market if they wish to participate in the issue of bonus shares.

We expected that the shares of UZMK would be halted until the results of the AGM were published, but they were published on 28th March 2022 and as of 31st March 2022, trading is still halted. Therefore, we would expect the shares to begin trading in early April, and unless the ex-dividend date to receive these bonus shares is announced in short order, with the commencement of trading UZMK’s share price should trade limit up (the Tashkent Stock Exchange has a trading band of 20% per day) for several days as the share price reverts to more normal levels.  

One great piece of news however, indicating that UZMK’s business remains healthy, is that the financial results for 2021 were announced and they were superb! Earnings per share surged year-on-year 568% to UZS 33,269, while book value per share surged 85% to UZS 70,129.

Uzbekistan is well-positioned in the age of protectionism

Leading up to the COVID-19 pandemic, the world had already passed “peak globalisation” and we saw a transitioning into a new area of rising regionalisation and protectionism. We have discussed this in several prior updates but believe it is worth revisiting due to global events that prove Uzbekistan is well-positioned to handle this new world of shortages and protectionist measures that will inevitably create significant challenges for countries that are reliant on a globalised world, specifically in food and energy.

The war in Ukraine is only the latest contributor to market dislocations, as are the current energy crisis and coming global food crisis. During the heights of the COVID-19 hysteria in 2020, countries banned exports of food (Vietnam banned rice exports, Kazakhstan banned flour exports, while Russia put export duties on sunflower oil) in order to ensure ample supply for the domestic market. This certainly not free-market thinking resulting from rising energy and food prices is beginning to impact consumers' pockets. We anticipate further restrictions on the once free flow of goods, as the war in Ukraine has, directly or indirectly, led Hungary to ban grain exports, Turkey meat exports, and Russia temporarily baning grain and sugar exports, while Ukraine has followed suit as well.

The countries best positioned in this new environment are those with a high degree of control over their supply chains and self-sufficiency, while those that are not risk suffering negative economic shocks. A recent example is Sri Lanka, which has nearly run out of foreign exchange reserves and has been forced to curtail fuel imports, leading to day-long queues at petrol stations and power cuts of up to 13 hours a day.


Long term prices for Wheat, Corn and Soybeans (1998-2022)

(Source: Bloomberg)


In this age of rising protectionism and de-globalisation, Uzbekistan is very, very well positioned for not only continued economic and social stability, but also to benefit from this new environment. Having historically had aggressive protectionist policies under the country’s first President, Islam Karimov, who led the country to become the largest industrial and agricultural producer in the region, under President Mirziyoyev, many of these restrictions were relaxed, while the government still maintains semi-protectionist policies. However, the existing policies, we believe, make the country an ideal magnet for investors looking for a stable country with an ample supply of cheap commodities.

An example of Uzbekistan’s semi-protectionist measures is the country’s rich natural gas resources. Produced domestically, the country is able to sell gas at below market prices to local industry and retail consumers, enabling the large petrochemical industry to generate healthy margins on exports, while providing raw materials to the domestic market at attractive prices. Fertiliser specifically is a hot global topic at present due to the major input being natural gas, which has become prohibitively expensive in many parts of the world, specifically in Europe, where several fertiliser plants have shuttered.

In Uzbekistan, the fertiliser urea sells for USD 300 per ton compared with USD 930 per ton on the international market. While raw urea cannot be exported (with the aim of supplying cheap fertiliser to the domestic market as well as forcing the industry to add value to it before exporting), Uzbekistan’s farmers win, as well as the country as a whole, with value-added exports being much more valuable in dollar terms. Such policies have been one reason that announced foreign direct investments (FDI) reached USD 8.6 bln in 2021, a 30% increase over 2020.


International Urea – fertiliser - pricing

(Source: Bloomberg)


To support this trend, it was announced in March that Uzbekistan plans to increase natural gas production to 66.1 bln cubic meters by 2030, up from 53.6 bln cubic meters in 2021, and that the increased production will be kept within the country to satisfy retail and industrial demand.

These types of semi-protectionist policies will continue to help insulate the Uzbek economy from external shocks, attract growing FDI, and help the Central Bank of Uzbekistan (CBU) achieve its inflation targets. The CBU had a 2021 inflation target of 10%, but exceeded it, with inflation reaching 9.98% in December 2021. 2022 will be interesting to watch with the CBU inflation target of 9% (February 2022 inflation reached 9.7%).

One of the CBU’s tools to contain inflation is of course the central bank policy rate. In an attempt to stabilise the Uzbek som after the selloff in the Russian Ruble during March 2022, on 17th March 2022 the CBU raised the central bank policy rate from 14% to 17%. This policy action helped make the Uzbek som the best performing currency in the region year-to-date, down only 2.2%.

While the sharp policy rate increase and modest depreciation are not atypical in frontier markets, to put this in perspective, Uzbekistan has real interest rates of 7.2%. This compares very favourably to the USA and EU which both have negative real rates of 7.4% and 5.65% respectively, as a result of out-of-control inflation.


Central Asian currencies and Russian Ruble versus USD year-to-date

(Source: Bloomberg)


Boycott of Uzbek cotton ends

The world’s 7th largest cotton producer, Uzbekistan’s textile industry has long suffered due to a boycott by the International Coalition Cotton Campaign (ICCC) since 2009 due to large-scale forced and child labour. This prevented many western fashion brands from sourcing textiles from Uzbekistan, as 331 brands including C&A, Gap, H&M, Levi Strauss, Tesco, and Walmart refused Uzbek cotton.

Once President Mirziyoyev came to power, he became focused on eradicating forced and child labour in the industry. He finally succeeded and on 1st March 2022, the International Labor Organization recognised that Uzbekistan had managed to completely eliminate forced and child labour from the cotton industry in 2021. This was followed on 10th March 2022 by the ICCC calling an end to the boycott, thus paving the way for Uzbekistan’s textile industry to kick into high gear. Having already contributed USD 3 bln (18%) to Uzbekistan’s exports in 2021, we believe we are on the cusp of significant growth in the sector, which will not only boost exports but also increase employment and therefore consumption as the middle class grows, sustaining indirect demand for the goods and services the fund’s portfolio companies sell.


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

Uzbekistan vows to remain open for foreign business, attracts millions in investments

Work on USD 5 bln Pakistan - Afghan - Uzbekistan railway kicks off

Uzbekistan plans to increase gas production but not exports

Uzbek cotton boycott ends

AFC Uzbekistan Fund Marketing Information as of the end of February 2022