Investing Specialists

Africa: Rising Incomes, Changing Tastes

Jeffrey Stafford, CFA

What the world eats influences industries from seeds and fertilizers to packaging and soft drinks. With consumption in developed nations largely stagnant, emerging markets are the critical growth driver. Diets will continue to improve as emerging economies climb the income ladder, but how much potential remains?

We expect sub-Saharan Africa, as well as India, to play starring roles in the emerging-market diets growth story, helping to overturn what has been a China-centric narrative. In this article, we focus on Africa. Although we expect caloric gains in India in the next decade to exceed China's impressive growth of the past decade, the outlook is even better for sub-Saharan Africa, where we expect caloric gains to increase by nearly the total caloric intake of the United States. Why do we view sub-Saharan Africa as fertile ground for diet growth?

Income
Income is the main driver of caloric intake among emerging economies. But beyond GDP of roughly $15,000 per capita, calories tend to plateau at 3,100 to 3,500 kilocalories (kcal). Emerging countries occupy different positions on the income-calorie curve, implying dissimilar growth potential. With average caloric intake approaching that of rich countries, China's high growth days are behind it. The same is true of Brazil. By contrast, sub-Saharan Africa, India, and most of Southeast Asia are likely to see robust caloric intake gains in the decade to come.

Age
Because the young and the old require fewer calories, age composition matters to caloric intake. By 2022, rapidly aging China will have an average caloric requirement on par with Japan today, while younger African, Indian, and Southeast Asian populations portend an age-based lift to caloric intake in the next decade (Exhibit 1).

Population
Fertility rates in sub-Saharan Africa are quite high relative to the rest of the world; the U.N. forecast of medium fertility rates pegs cumulative population growth at 33% from 2011 to 2022. Combined with our outlook for per-capita caloric intake growth, total daily calories consumed in sub-Saharan Africa would grow by 942 billion kcal, or 45%. This is by far the greatest increase of any region we reviewed and roughly on par with the total caloric intake of the United States or that of Germany, France, the U.K., and Italy combined.

These are meaningful increases that will have significant consequences for global food and agriculture markets.

Where Sub-Saharan Africa Is Today
At about 2,440 kcal per capita per day, sub-Saharan Africa sits at the low end of the food development curve, but the region has made solid gains over the past couple of decades. Caloric intake growth was basically stagnant from 1960 to the late 1980s, with average daily intake per capita of just over 2,000 kcal. Since then, food intake has accelerated, growing at a cumulative 17% from 1990 to 2011, comparable to Brazil (20.8%), China (22.2%), and Indonesia (16%).

That's despite sub-Saharan Africa's GDP growth over the same period significantly trailing these other regions. Cumulative GDP growth per capita clocked in at 31.5% for the region from 1990 to 2011 compared with 43.1% for Brazil, a whopping 573.9% for China, and 96.5% for Indonesia.

This apparent disconnect between sub-Saharan Africa's rate of dietary improvement and its economic advancement is a function of the fact that while food consumption rises with income, it rises most strongly at the lowest income levels. Sub-Saharan Africa consists of 50 countries, including some of the poorest in the world. GDP per capita for the region was $3,171 in 2012 compared with a world average of $13,539. Another relatively poor country, India, comes in at $5,050 per capita, nearly 60% higher.1

As one would expect, people in sub-Saharan Africa spend a big chunk of their incomes on food. A United Nations paper2 in 2012 found that 19 countries in the region spent on average 64% of their expenditures on food. By contrast, Americans spend 6.6% on food, according to the U.S. Department of Agriculture. Even India spends only 25% of total consumption expenditures on food.

Also, richer households in sub-Saharan Africa spend a smaller percentage of their incomes on food; highest-income quintile households spent 53.4% of income on food, while lowest-income quintile households spent 69.9%. With such low income levels, the region would seem primed for big gains in caloric intake if the economies of sub-Saharan Africa can grow at a fast clip and people have more money to spend on food.

That's a big if, however. Over the past decade, sub-Saharan Africa's GDP per capita has expanded at a compounded annual growth rate of 3.2%, considerably slower than other emerging regions such as China (9.9%) and India (6.3%). Further, the International Monetary Fund predicts sub-Saharan Africa's per capita GDP growth rate to decelerate over the next seven years at an annualized rate of 2.7%.

Although economic growth may decelerate, we think sub-Saharan Africa can match its recent growth rate in calories per capita through our forecast period, as the region has proved in the past that its diets can improve in the face of substandard economic growth.

Nigeria Serves as a Benchmark
Wealthier countries within sub-Saharan Africa, South Africa and Nigeria, offer glimpses into the possible dietary future of the region's poorer nations. With GDP per capita more than three times the region average, South Africa has the highest daily caloric supply in sub-Saharan Africa at just more than 3,000 kcal per capita. Excluding South Africa, the average for the region is about 2,425 kcal.

Because South Africa has its own unique history and development story, we believe Nigeria is a better benchmark for other sub-Saharan African countries. With a daily caloric intake of 2,724 kcal per capita in 2011, we think Nigeria represents what the region's caloric intake will look like in 2022, which we forecast to be 2,674 kcal.

Within Nigeria, there is a strong relationship between total household expenditures and food expenditures, as one would expect in a relatively poor country. Poorer states in Nigeria with lower total household expenditures (and thus likely lower incomes) spend less on food. In richer states, food expenditures increase steadily, but there does seem to be some of the topping-off effect (as we see globally), as total annual expenditure per capita reaches NGN 250,000 to NGN 300,000 (roughly $1,525 to $1,850).

If we apply the IMF's Nigeria growth forecast of GDP per capita to per capita household expenditure growth, the average Nigerian will go from spending about NGN 172,700 per year in 2010 to NGN 197,500 in 2022. We estimate that this would imply per-capita food spending of about NGN 127,000 per year, for cumulative increases in total and food expenditures of 14.3% and 13.8%, respectively.

Food Production Is Key
In our view, the drivers of caloric intake in sub-Saharan Africa are unique. According to the International Food Policy Research Institute, agriculture is the primary livelihood for about 65% of Africans and represents 30% to 40% of the continent's GDP. Because subsistence farming is so important to a wide population of Africans, caloric intake in the region depends more heavily on food production than in other more developed areas. Farmers in Iowa don't eat substantially less3 when there's a poor harvest in the state, but poor farmers in sub-Saharan Africa often do. For many living on the continent, food is a source of both nutrition and income. For this reason, food production--a function of yield and area harvested--is important to consider when projecting the region's diets.

Since 1990, food production per capita and caloric supply per capita have grown more or less in tandem. A sizable portion of the gains in food production per capita has come from cassava, a drought-resistant root. Since 1980, production of cassava has grown at a compound annual rate of 3.6%.

Future crop production gains will depend on a number of factors. First, gains in real income outside of agriculture would probably help spur investment in agriculture in the region. Farmers need better seeds, more fertilizer, broader irrigation, larger farms, better infrastructure, and more mechanization to begin catching up to the rest of the world's yields.

These inputs do not come cheaply, and investments, both domestic and foreign, will probably be needed to stimulate growth. (China is among the countries that have shown interest in developing agriculture lands on the continent.) These investments are hard to predict, though, which leads to a high degree of uncertainty in our caloric forecast.

But of all the emerging markets, sub-Saharan Africa is the only region that can expect a strong age tailwind on caloric intake through 2050. The region's median age in 2010 of 18.1 was also the lowest of any major geographic region in the world.

Although other factors were certainly at play, caloric supply per capita in sub-Saharan Africa began to pick up markedly right around the time that the tailwind from the age effect took hold toward the end of the 1980s (Exhibit 2 ). After flattening out somewhat in recent years, the age effect should accelerate over the next couple of decades, probably offsetting some of the headwinds from a projected deceleration in economic growth in the region.

Ghana or Uganda
We think higher incomes, age-based tailwinds, and improvements in farming techniques will continue to drive caloric intake in sub-Saharan Africa higher. We expect per-capita caloric intake to rise by 232 kcal, the greatest increase of any emerging market. That said, our forecast has a high degree of variability. In addition to the uncertainties regarding farming improvements, another main driver of this variability is the substantially different historical outcomes among countries in the region.

A bull case would involve countries following a path similar to Ghana, which has made substantial progress on the caloric intake front over the past decade. From 2000 to 2011, Ghana's caloric supply per capita grew at a compounded rate of 1.6%, the most robust rate of the largest populations in sub-Saharan Africa. Ghana achieved strong caloric growth despite an annual GDP per-capita growth rate that mirrored some of its neighbors'. In our opinion, Ghana has been successful in raising caloric intake because of specific events in the country. Agricultural reforms have made private investment in the sector more plentiful, and an increased budget for agricultural research has led to solid gains in crop yields.

A bear-case scenario would have more countries in the region follow the path of Uganda and Tanzania. The two nations have made considerable progress in GDP per capita in recent decades (both are similar to Ghana's GDP growth rate), but their caloric supplies per capita have languished comparatively. Uganda, and Tanzania only posted annual caloric supply per capita growth of 0.1% and 0.7%, respectively.

Other downside risks to our forecast include a reduction in foreign aid to the region, violent conflicts or disease that drag down income growth, and a lack of funding to the agriculture sector by governments.

Overall, we expect an annual caloric-intake growth rate of 0.8% from 2011 to 2022 compared with 0.8% from 2000 to 2011. And therein lies the story of the region's food consumption potential: Sub-Saharan Africa's pull on calorie demand will be magnified by rapid population growth.

Investors Should Not Ignore Region
Stocks with direct exposure to the caloric-intake story in sub-Saharan Africa are few and far between, but this is an area that investors with a long-term strategy should not ignore. As the economies in the region continue to develop, we think Africa will show up as an important market in the investor presentations of more and more companies connected to the agricultural complex. In the meantime, investors might want to consider companies that have heavier exposure to emerging markets other than Africa (Exhibit 3). All these firm have economic moats.

 Mead Johnson MJN
Mead Johnson is best positioned to take advantage of China's continued diet upgrade. It has significant exposure to the infant nutrition category, which is a competitively advantaged segment given that parents tend to be highly loyal to brands when it comes to products for children.

 Mondelez (MDLZ)
Mondelez focuses on confectionery, and it enjoys proportionately greater exposure to India than other global players (other than  Unilever (UL)). It has staked out strong positions in sub-Saharan Africa and is poised to benefit from dietary tailwinds.

 Monsanto MON
Advanced seed technologies will be necessary to boost crop yields. Monsanto, along with DuPont DD, has already staked out seed-industry claims in South America, a region that has benefited from China's appetite for soybeans. Additionally, the company is starting to make inroads through joint ventures in the Chinese seed market. Although insignificant currently, we think sub-Saharan Africa represents a substantial market opportunity for seed companies further down the road.

 Nestle (NSRGY)
Among the global consumer firms we cover, Nestle offers the broadest exposure to emerging-market diets. Nestle is the largest packaged food firm in the world, with a vast product portfolio that includes beverages, dairy products, infant nutrition, and confectionery. Nestle's extensive history in several emerging markets, including sub-Saharan Africa, and nuanced understanding of customers and routes to market enhance its competitive position. The firm is positioned to take advantage of a growing middle class but also serve a more constrained consumer base. Its Popularly Positioned Products strategy, according to the company, offers a similar quality and nutritional profile as its core product base, but at more affordable prices. Within Africa, Nestle's products include coffee, ice cream, and cooking aids.

PotashCorp (POT)
If the world is to meet the growing dietary demands of emerging markets, crop yields will need to improve. That will require significantly more fertilizer. Potash Corporation of Saskatchewan sells fertilizer around the globe, with exposure to both emerging markets and the developed-market bread-baskets that feed them. Capacity expansions position the firm to meet rising demand. PotashCorp's low costs afford it a competitive edge over peers in this structurally attractive industry.

 Rexam REXMY
Brazil and China are key markets for several food and beverage packaging companies, including Rexam. Although these countries have already made substantial gains in caloric intake, we think there is room for further growth in high-value food items as diet composition shifts in these nations. We expect strong growth in single-serve beverages and a general shift from glass to metal packaging.

 SABMiller PLC SAB
SABMiller has the greatest exposure to China, given a joint venture with China Resources Enterprises, where we anticipate the largest growth in absolute volumetric terms. However, we think Africa is the jewel in SABMiller's crown. Being the first mover in South Africa and other markets has created a distribution and cost advantage that new entrants will find difficult to overcome if they want to compete in the value segment.

 Yum Brands (YUM)
Our outlook for Chinese restaurant spending (up 161% over the next 10 years) suggests that the Yum Brands growth story is far from over. Although China gets much of the focus as the company's largest operating profit contributor, we expect emerging economies such as India, Indonesia, Malaysia, Vietnam, the Philippines, and several African markets to become vital drivers of long-term free cash flow.

Endnotes

1. Because of cultural differences, India actually eats fewer calories per person than residents of sub-Saharan Africa despite markedly lower incomes.

2. Chauvin, Mulangu, and Porto, "Food Production and Consumption Trends in Sub-Saharan Africa: Prospects for the Transformation of the Agricultural Sector," 2012

3. They may decrease food purchases marginally because of potentially higher food prices.

This article originally appeared in the December/January 2015 issue of Morningstar magazine.

This article is based on an excerpt from the September 2014 Morningstar Basic Materials Observer. To learn more about Morningstar's Institutional Equity Research, call 312-696-6869.

Jeffrey Stafford, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.