The AFC Uzbekistan Fund Class F shares returned +1.3% in February with a NAV of USD 1,985.07, bringing the return since inception (29th March 2019) to +98.5%, while the year-to-date return stands at −1.2%. On an annualized basis, the fund returned +26.5% p.a. with a Sharpe ratio of 1.77.
February saw some excellent preliminary earnings news from the fund’s largest holding, Uzmetkombinat, which propelled the share price 38.8% higher during the month. Otherwise, it was business as usual in Uzbekistan, with Ukraine having a minimal potential negative effect on the country, which we discuss further below.
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:
|Estimated weighted portfolio dividend yield:
Russia invades Ukraine – implications for Uzbekistan
As Russia launched a full-scale invasion of Ukraine during the month, we have received a few questions on any potential collateral damage that could be done to Uzbekistan and its economy. For the time being, the three biggest risks to Uzbekistan are the depreciation of the Russian ruble, sanctioning of Russian banks which do business in Uzbekistan, and the potential for remittance inflows from overseas Uzbeks working in Russia to slow for a period of time.
Russia is Uzbekistan’s largest trading partner and the Uzbek som typically devalues when the Ruble does (as does the Kazakh tenge). The most recent example of this happening was during the height of Covid hysteria in March 2020 when spot oil prices went negative. However, so far, the UZS has been stable, most likely due to intervention by the Central Bank of Uzbekistan, not related to the Ukraine situation but rather due to the government’s continued focus on maintaining price stability in a bid to decrease inflation and keep it below 10%. We always watch the FX situation closely and will continue monitoring the situation as usual.
In our view, the bigger risk is Russian banks doing big business in Uzbekistan. With VTB Bank, Sberbank, and Sovcombank being sanctioned by the U.S. Treasury, some of the Uzbek state-owned enterprises that have borrowed from these, and other Russian banks, may seek to repay these loans and pursue re-financing elsewhere in order to avoid any issues that U.S. sanctions on these financial institutions could bring. In relation to the banks, as there are several million Uzbek citizens living abroad, many of whom are migratory labour remitting portions of their salaries back to Uzbekistan, for those living in Russia it could become more of a challenge to remit earnings back home. However, this would likely only be a temporary issue as other banks can be used, and Uzbeks are resourceful to say the least so we don’t see a potential drop in remittances as being long-lasting.
Aside from these three risks, we don’t see any significant change in Uzbekistan’s growth prospects as the economy continues to hum along, as does the economic liberalisation.
Capital markets 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 outstanding 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.
As the global economy has entered what we believe is a new era post-COVID, transitioning from globalisation to de-globalisation and ensuing regionalisation, and as we are in the early innings of what is shaping up to be a prolonged global energy crisis, big steel producers like China are likely to continue curtailing excess production which was once destined for export in order to save precious energy resources. Such policies (which one could positively spin as “ESG” but are really a result of energy shortages) are liable to keep steel prices elevated for an extended period. This makes UZMK an ideal investment as it is a defacto monopoly in Uzbekistan, and once the company completes its capacity expansion in the middle of the decade it can pursue regional market share as well.
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.
On 31st December 2021 it was announced that an 86.9% stake in the fund’s largest holding, Qizilqum Cement (TSE: QZSM) would be privatized. Uzbek securities legislation states that when more than 50% of the equity of a company changes hands, the buyer is obligated to announce a general offer. In the case of QZSM, the deal was registered on 4th February 2022 and the day’s closing price was UZS 5,197. Therefore, the new owner must announce a tender offer to purchase shares held by minority investors at a price of UZS 5,197. However, during the month some shareholders decided to sell their shares under this guaranteed offer price and we scooped up many shares as low as UZS 4,200 per share, making the fund effectively risk-free money. The inefficiency and lack of liquidity in the stock market of course can be a double-edged sword, but we well understand the state of the market and are happy to exploit such inefficiencies, for as the market develops there will be fewer such opportunities.
At the end of February 2022, the fund was invested in 28 names and held 8.6% in cash. The portfolio was allocated to Uzbekistan (91.35%) and Kyrgyzstan (0.03%). The sectors with the largest allocation of assets were materials (50.9%) and financials (24.3%). The fund's estimated weighted harmonic average trailing 12 months P/E ratio (only companies with profit) was 5.70x, the estimated weighted harmonic average P/B ratio was 1.30x, and the estimated weighted average portfolio dividend yield was 5.40%.