The AFC Uzbekistan Fund Class F shares returned +11.2% in April with a NAV of USD 1,830.25, a new all-time high, bringing the return since inception (29th March 2019) to +83.0%, while the year-to-date return stands at +36.4%. On an annualized basis, the fund returned +33.6% with a Sharpe ratio of 2.13.
The Uzbek stock market continued its broad, multi-month rally across the majority of the fund’s portfolio companies as the AFC Uzbekistan Fund experienced its twelfth straight monthly gain. The fund’s biggest holding, a cement producer, gained 41% during the month as its first quarter earnings surged 61% YoY. Beyond a great start to the first quarter earnings season, the big news during April was the reorganization of the capital markets regulator which will hopefully lead to a rapid acceleration in the privatization of state-owned enterprises and the attraction of significant new capital.
Market Update and First Quarter Earnings
As liquidity in the market is rising, albeit from a low base, and investor interest continues its growth apace, on 19th April 2021, the Toshkent Stock Exchange extended its trading hours by one hour. The market now operates from 09:30 am to 4:00 pm Monday to Friday.
First quarter earnings season has kicked off with a bang as some of our portfolio companies have reported spectacular results. Two of our holdings in the materials industry saw first quarter YoY earnings growth of 77% and 16% respectively, while two of our top cement holdings saw their earnings rocket 259% and 61% over the same period. Meanwhile, a steel producer reported 226% YoY growth. These superb results indicate to us that while some of our holdings have appreciated several hundred percent over the fund’s life, they remain far too cheap relative to their current and future growth prospects. We are therefore continuing to opportunistically accumulate shares ahead of what we believe will in due course be an influx of foreign investors who are increasingly waking up to the reality that Uzbekistan is emerging as an investment destination which should deliver strong growth for several years to come yet.
Capital Markets Development Agency Restructured
On 13th April 2021, President Mirziyoyev signed a sweeping decree “on measures for the further development of the capital market” in order to expedite the government’s goals of rapid reform by the end of 2023, and which includes having some major companies listed on the Toshkent Stock Exchange added to the MSCI Frontier Index watchlist. This is something which we believe could be a major “game-changer” since it will put Uzbekistan on the map for many foreign institutional investors.
On the same day, it was announced that the Capital Markets Development Agency (CMDA) would be dissolved. The CMDA was established in January 2019 with the purpose of acting as the capital markets regulator and overseeing their development. While a surprise to the investment community, there will be little change in relation to how this affects investors as the new regulator will continue from where the CMDA left off and hopefully move ahead at an even more rapid pace. Per the details of the presidential decree outlined below, we and most of the local investment community in Uzbekistan are very positive on this change, especially if the new regulator can execute on even a portion of its long list of goals.
The presidential decree highlights some of the lingering issues in the capital markets which need to be addressed. They include, among others:
- A low free-float among listed companies
- Low participation among institutional investors
- A high share of state-owned companies in market turnover
- A low level of financial literacy among the Uzbek population
The first three points should be quite straightforward to resolve and have been in the pipeline for several years. Uzbekistan’s capital markets face a “chicken and egg” situation whereby the government has planned to privatize vast swathes of the economy through IPO’s and SPO’s, but if not conducted in an orderly fashion, and without foreign participation, then the process will continue to be drawn out. The majority of listed companies on the Toshkent Stock Exchange have some degree of state ownership, so in order to increase their free-floats the state’s participation can easily be privatized through secondary offerings at prevailing market prices or modest discounts. This should also increase institutional participation in the market as many of these privatizations would be valued in the millions of dollars and there is unlikely to be sufficient local demand to absorb the supply of shares.
Some of the government’s more notable KPIs to transform the capital markets by 2023 include:
- Increasing the free-float on the Toshkent Stock Exchange to 5% of GDP
- Providing education on financial literacy to 40,000 local minority investors
The free-float of the Toshkent Stock Exchange is estimated at 0.4% of GDP, or less than 4% of total market capitalization of the exchange, while the current market capitalization of the exchange to GDP is 11.5%. If the free float is to equal 5% of GDP, this would equate to roughly USD 2.6 bln of equity value, or 43% of the current market capitalization of the stock exchange. Clearly, in order to achieve its goal, the government needs to expedite its privatization process of fully-state-owned enterprises as well as sell its participating stakes in already listed equities. If this can be achieved, it would be a “game-changer” for the investment landscape in Uzbekistan and create a significantly more liquid market with a much larger local and foreign investor base which we believe will help transform Uzbekistan’s capital markets into the largest in Central Asia.
In addition to the largest cement plant in Uzbekistan, Qizilqum Cement (TSE: QZSM) and glass manufacturer Kvarts (TSE: KVTS), the presidential decree highlights the following companies to be privatized through 2023:
- Uzmetkombinat (a listed steel producer which is slated for an international dual listing)
- Almalyk Mining (a significant gold, silver and copper miner)
- Navoi Metallurgical Mining Kombinat (a mining conglomerate that owns the largest open-pit gold mine in the world – Muruntau)
- Uzbekistan Airways (the national airline)
- Uzbekneftegaz (the state-owned oil & gas monopoly)
- Uztransgaz (a natural gas distribution/pipeline operator)
- Halk Bank
- Agro Bank
- Microcredit Bank
- Uzagrosugurta (a top-5 insurance company with the largest branch network)
- Kurilishmashlizing (a construction machinery leasing business)
- Uzavtosanoat (state-owned auto manufacturer and producer of Chevrolet cars)
The sea change in the government’s attitude in April toward many of these companies is remarkable considering that most of them were previously regarded as strategic and therefore to remain state-owned.
In order to achieve the above targets, the government is planning to pass a new capital markets law by the end of 2021 which, among other things, is expected to improve the efficiency of conducting IPO’s and SPO’s, designating the functions of underwriters, dramatically improve broad legislation for the protection of minority investors, enhance accounting and listing requirements, the introduction of Sukuk (Islamic) bonds, permitting foreigners to invest in government bonds (currently not permitted), and perhaps most importantly, simplifying the burdensome account opening procedures for investors seeking to participate in the stock market and possibly going so far as to digitize the process.
The risks of capital markets development
While the presidential decree is very exciting and exactly what we have been anticipating, we will be watching closely to see how all of this positive news transpires as execution will be paramount.
A former and just as aggressive privatization plan was announced between 2016 and 2020 in Kazakhstan, Uzbekistan’s northern neighbour. This is what originally attracted Thomas and I to the region as Kazakhstan had planned to privatize vast swathes of the economy in order to decrease the government’s contribution of GDP from 70% to less than 50%. This included the privatization of over 900 assets and companies, including the IPO’s of KazPost, the national post office, Air Astana, the national airline, KazMunayGaz, the national oil & gas company, and Kazatomprom, the state uranium miner by 2020. However, the process could be branded a failure as it has largely been pushed back and of the four planned IPO’s, only Kazatomprom became listed. We hope Uzbekistan is able to execute more effectively on its privatization plans.
Domestic tourism as summer arrives
Summer having arrived, at least as far as the weather is concerned, with the mercury reaching as high as 34 degrees Celsius on an increasingly regular basis, I took the liberty of a free weekend to get out of Tashkent and do some sightseeing. With a dearth of tourists in country, even though there are no travel restrictions and the country remains wide open for tourism, travel companies such as our friends at Adventour have used their in-country relationships to create new tours to capitalize on the nascent but growing domestic tourism industry and prepare for the eventual return of foreign tourists. Adventour has partnered with Chateau Hamkor Wineries in Parkent region, an hour’s drive from Tashkent, where a small group and I were given a winery tour, wine tasting and concluded the day by enjoying lunch at a teahouse along a creek where we dined on a spread of shashlik, somsa and wine, which amid the heat gave us all the impetus to fall asleep. Prior to COVID-19, Chateau Hamkor exported all of its wine to China, Kazakhstan and Russia, but it has recently been focused on increasing its foothold in the domestic market.
While many people know Uzbekistan for its western desert where the Aral Sea is located, the topography of the country is widely varied. Parkent sits on a plateau in the shadow of the Tian Shan mountain range where the rolling green hills are reminiscent of the Mongolian steppe.