Delta Corporation: Future earnings hinging on the watershed 2018 election and continued focus on the economic reform agenda

Delta Corporation has long been seen as Zimbabwe`s bellwether stock, reflective of the health of the overall economy. Lately, Delta has drawn some negative, though unsurprising reportage, with one of the country`s top dailies recently reporting that the company was left with a week`s worth of raw materials for the manufacture of sparkling beverages and Super Chibuku, its popular sorghum beer offering.

Stories such as these confirm what is visible by way of a mere cursory glance on the shelves of retailers countrywide. Delta Corporation`s product supply has been greatly affected by challenges in accessing foreign currency to pay key suppliers. The company reportedly needs up to $75 million annually for raw material imports. This is the context in which Delta`s FY2017 earnings report announced last Wednesday comes under.

Stellar earnings

Delta – Zimbabwe Stock Exchange`s biggest company by market capitalisation, of over $2.5 billion – announced strong earnings bearing close semblance to what has been reported by the other companies in the market for the preceding financial year.  There was a general uplift in revenues market wide, buoyed by improved incomes trickling down to the base of the economic pyramid following favourable rainfall patterns which boosted agricultural activity last year.

Delta realised an 18% growth in revenues to $572.2 million, while Earnings before Interest and Tax (EBIT) rose to $104.7 million, a 28% growth from prior year. Resultantly, profitability improved, registering a 27% growth to $88.5 million. In terms of profitability, Delta Corporation`s performance was ahead of regional peers, achieving a Return on Equity of 17% compared to  an average of 12%. This performance however is lower than Delta`s peak performance in 2013 when it had revenues of $631.3 million and profit after tax of $104 million, its highest since dollarisation.

In many ways, 2018 mirrors 2013 in that, it is the year in which a watershed election is occurring. 2013 saw the holding of crucial elections that ended the government of national unity between MDC-T and Zanu PF through a contested election that gave Zanu Pf victory. Historically, election years are fraught with uncertainty and it is almost as if business halts in the run-up to elections, making way for the ensuing circus thrown by politicians.

Following consecutive years of formidable growth seen under the unity government, the economy began to lose bouts of steam it had garnered. For instance, in 2013 growth in aggregate demand slowed to a miserly 5% compared to 13% achieved in 2012. Total investments in the economy were a mere 14.8% of GDP in the run up to the 2013 elections.

Share Price performance

By mid-May of that year however, Delta Corporation`s share price had risen 36% to $1.35 a share. Flash forward to mid-May 2018, and the situation is somewhat similar. The whole world is anxiously waiting for the forthcoming elections and it seems major economic decisions have been put on the back burner pending the electoral outcome.

Consumer demand remains reasonably strong, sustained in part by bonus payments to civil servants that began in March with members of the Zimbabwe National Army cutting through to the whole civil service until June 2018, just before scheduled elections, when the rest of the civil service will be paid their 2017 bonuses.

Delta`s share price has risen 26% this year. This share price performance is likely to be sustained heading toward elections as the usual “flight to quality” syndrome catches up with institutional investors seeking the refuge of blue-chip counters as the country nears elections. It is worth noting that Delta itself has solid fundamentals that will continue to be a catalyst  for value. A trailing Price to Earnings ratio of 28.3, higher than the sector median of 20.3, seems to buttress this point.

Although a Price to Book ratio of 5 against peers averaging 2.2 indicates overvaluation of the stock. Delta`s appeal as a stock is nonetheless reflected by the type of foreign institutional investors it has managed to attract over the years, such as Allan Gray, Franklin Templeton and JP Morgan & Chase. However these have tried pulling out of the local market with not much success as a result of inadequate foreign currency.

Competitive advantages

No doubt, Delta corporation benefits from a considerable number of "moats" – a term made popular by Warren Buffet signifying competitive advantages that benefit major brands and companies, like distribution networks, pricing power and brand reputation. Its ability to migrate its customers upwards or downwards along its product mix is a remarkable advantage. 

Improved incomes often see consumers shifting toward the company`s premium product offerings, while during lean times, customers invariably switch to low value products. Delta witnessed an increase in volumes across the board, with premium lagers recording the highest growth of 27% compared to prior year with 1,543 million hectolitres consumed. However, in a continent where the average person drinks 10 litres of beer annually, compared to 75 litres in the United States and 66 litres in Brazil, it still has a long way to go.

Sparkling beverages were also competitive, contributing 15% growth to total volumes. Sorghum beer remains Delta`s star product with a total of 3,819 million hectolitres consumed, although overall contribution to volumes was suppressed at 9%, a trend which may be explained by the difficulties in electronic payment platforms in rural areas.

The emergence of a competition for wallet share from PepsiCo is likely not to significantly affect Delta, at least for the short term, as Delta benefits from economies of scale, wide distribution networks and improved efficiencies following its capitalisation efforts in the past. The overall beneficiary of the competition between these two will be the consumer, as is always the case when competition among producers exists.

Delta remains cash rich, with a net cash position of $236 million resulting in a liquid balance sheet. However, included in that total is $59 million worth of dividends that are yet to be repatriated as well as $46 million due to foreign suppliers. Taking out the unremitted dividends and obligations to foreign suppliers, Delta still has a Price to Cash flow ratio of 19.6, which is higher than that of regional peers at 13.4.  

Finance costs are in check, and the expectation is the business will extinguish local obligations owing to its large cash pile as well as foreign obligations as and when foreign currency allocations become available, to keep this line item flat.

The Natbrew adventure

Delta`s acquisition of Zambia`s Natbrew in January 2018 will likely present some challenges going forward due to the existential difficulties in the Zambian market. Natbrew`s operating profits have been under pressure of late, owing to competition on its Chibuku product. Natbrew remains hamstrung by years of under investment in capital, leading to frequent breakdowns of plant and equipment.

It also does not help that Zambia has a generally lax regulatory environment that sees trading of bulk and draught beer openly, when these have actually been outlawed, adding to competitive pressures on Natbrew`s products. Chibuku also faces pressure from cheap spirits that have grown to be a direct competitor for wallet share over the years. This implies Natbrew`s contribution to Delta`s bottom-line will likely take some time to be sufficiently felt, while Delta has its work cut out  for it in the Zambian market.

Delta Corporation appears overvalued when measured up against sector peers, and one would expect a correction to the stock price to take effect at some point. Prospects for the company undeniably hinge on whether the elected government after the coming elections can continue pursuing the economic reform agenda, and actually attract meaningful foreign investments into the economy to sustain demand. Foreign currency challenges will however continue to weigh on the company in the near term, compromising product supply. 

Consumer demand on the other hand should remain stable on the back of meaningful activity in the agricultural and mining sectors. The company`s superb cash generative capabilities imply a strong dividend policy  - a dividend yield of 3.5% compared to peers averaging 2.1% - will continue, especially as the company has admitted that capital expenditure initiatives have been curtailed by the shortage of foreign currency.

Delta Corporation continues to trade under cautionary due to the ongoing discussions with The Coca- Cola Company (TCCC) following its notice to Delta in 2016 signalling  its intention to terminate Delta`s bottler agreements, and it seems no significant headway has been made yet in bringing finality to this matter.