Consumer sector earnings under pressure
Although monetary and fiscal policy reforms are expected to yield results in the near to medium-term, the new policies have led to a depreciation of the local ‘RTGS’ dollar. Thus, we expect a significant drop in sales volumes and a squeeze in margins as the cost of raw material fluctuates from an unstable Zimbabwe dollar. Furthermore, corporate earnings might experience lower real run rates to FY 20, as already seen this year.
Bottom-of-the-pyramid disposable incomes have been compromised following highly inflationary policy reforms and the upward revision of fuel prices and food costs. Inflation, at 176% as at June, is at its highest post dollarization, although the economy is in a recessionary period. There has been a dislocation of real incomes with living costs as average salary increments have ranged from 30-40% amid eroding purchasing power. While salary increments bode well for consumer incomes, they do imply some forward pressure on margins as corporates absorb potentially higher costs on labour.
Rural population consumption is expected to be significantly subdued as a result of the El-Nino induced drought in the 2018/2019 cropping season, high prices of agricultural inputs and fuel in 2019, given that informal sector earnings – the greatest contributor to bottom-of-the-pyramid liquidity – largely comprise earnings of small-holder farmers, artisanal miners and informal traders.
With 90% of bank accounts in Zimbabwe having an average monthly bank balance of not more than $80, it is clear that low-value goods targeted at the low-income majority will certainly drive volumes and sales in the short-term. Thus, there has been a migration of consumption from discretionary goods to basic goods given the rising cost of living, so consumer-facing companies should target the poor. Companies that do so are likely to have a more sustainable business model that can weather current market conditions that have resulted in lower production levels.
Consumer spending to be subdued, leaning towards defensive stocks
Recent monetary and fiscal policies have had a contractionary effect on consumption, and we believe this trend will continue for the rest of 2019 and a greater part of 2020 with further reforms including a fully-fledged currency in the pipeline.
Food retail is the most significant component of the consumer sector, with more than 30% of total annual consumption expenditure, (compared with 19% in South Africa or 10% in the UK being spent on food and groceries) with staples – particularly maize meal, bread and sugar – being the most popular food items. A decline in production in the mining and agriculture sectors will dampen demand for personal consumption, while further price corrections are anticipated as the interbank remains inaccessible to most producers.
There will be a knock-on effect on corporate earnings and pressure on margins as raw materials and opex rebase faster than revenue lines. Therefore, we lean towards ‘relatively defensive’ stocks such as Econet (ECO: ZH) and Cassava (CSZL: ZH) – an attractive stand-alone asset positioned to maintain its growth trajectory. Counters such as Simbisa (SIM: ZH) and Seedco International (SCIL: ZH) provide some form of hedge through regional diversification. Producers of staples including Innscor (INN: ZH) and National Foods (NTFD: ZH) also remain in good standing, in our view given low grain yields in the 2018/19 cropping season on account of the drought, while retailers such as OK Zimbabwe (OK: ZH) are undervalued by the market at current levels.
It is not a coincidence that the mentioned stocks all hold dominant shares in their respective spaces; we believe that in this environment income statements will be distorted by the impact of inflation and exchange rate adjustments, which will naturally also affect balance sheet preservation and consequently valuation metrics. Therefore, we have a strong preference for companies with the ability to defend consumer shar, which will be a critical recovery factor when the economy eventually finds equilibrium.
The recent flight to assets such as equities as investors de-risk RTGS dollars has driven market valuations resulting in high face value multiples. On face value, our Consumer universe trades on PER of 33.45x and EV/EBITDA of 16.62x, which seem demanding. Anecdotally, current market capitalisation in nominal terms is ZWL$25.08bn, applying the current inter-bank rate of 8.9 this implies a market capitalisation of US$2.8bn. The market in real terms has not been this low since the country dollarised in 2009. Intuitively we believe that on a selective basis the market still offers some opportunities.