On the heels of the increase in Nigeria's equity risk premium, the third consecutive upward adjustment to the monetary policy rate, and a revision to the cash reserve ratio requirement for banks, we move to isolate the first and second-order effects on coverage companies. This report assesses the impacts of the following broad model adjustments on listed companies within our purview:
- On the heels of the increase in Nigeria's equity risk premium, the third consecutive upward adjustment to the monetary policy rate, and a revision to the cash reserve ratio requirement for banks, we move to isolate the first and second-order effects on coverage companies. This report assesses the impacts of the following broad model adjustments on listed companies within our purview:
Revision of equity risk premium to 13.7% compared to 10.1% previously. Our higher equity risk premium primarily reflects changes in political and economic risks. In particular, we look to capture rising uncertainties associated with the 2023 general elections and the potential pass-through of tighter monetary policy on growth. - Increase in risk-free rate to 14.5% from 12.5%. The new risk-free rate is obtained from a weighted average of the yield on Nigeria's 10-year sovereign bond over the last three months and our expectation for the same for the rest of the year.
- The resultant cost of equity of 28.2% vs 22.6% previously, feeding from the first two adjustments.
Given the heightened level of risk, we expect investors to demand a higher return potential on Nigerian equities to compensate for the opportunity cost of not taking advantage of the increasing allure of interest-earning investment and the time required to wait out the current and expected drags to equity valuation. In this environment, we prefer stocks with an expected 12-month total return of at least 28.2% (comprising dividend yields that are at least higher than the interest rate on the one-year T-Bill) and lower leverage. Our positions on dividend yield and leverage were structured to slightly cap the risk element in equity investment decisions, given the growing need for cautiousness.
In addition to adjusting for policy-related changes and expansion in the equity risk premium, we also highlight our expectations for Q3'22 earnings across our coverage. Specifically, we evaluate the effect of changing commodity prices and currency dynamics on companies' revenue and cost profiles. We also assessed the net impact of monetary adjustments on interest income, cost funds, and credit creation on banks' Q4'22 earnings.
