Full Analyst Transcript: Zimbabwe`s economic prospects in 2019

                              

Carte Blanche with Perry (CBP) recently spoke to two investment analysts with exposure and interest in the Zimbabwean economy, to find out about Zimbabwe`s investments prospects in 2019. Lloyd Mlotshwa (LM), based in Harare is the Director and Head of Sales at the IH Group, a Zimbabwean financial services boutique firm that deals with local and foreign investors. Craig Bandason (CB), based in Cape Town is a Portfolio Manager at Imara Asset Management, an independent, non-bank financial services company. Below is the full transcript of the interview:

CBP: What is your general outlook for Zimbabwe going into 2019?

LM: Our initial view is bearish at least for Q1; we believe 2018 benefitted from enhanced money supply and strong performances in primary sectors (mining & agri) – this led to excess liquidity chasing goods and services as well as forex and forex linked assets which led to strong corporate earnings for consumer companies, strong transactional fees in banking sector, elevated forex premiums and elevated asset prices including equities and naturally higher inflation. In coming year, outlook suggests reduced money supply, lower agri output and stable to weak mining output (observe production figures for 4Q18) – we see consumers coming under pressure as ‘incomes’ moderate whilst prices remain relatively high with some aspects of the economy self-dollarising; Q1 will be difficult with some relief coming from April when tobacco sales season begins.

CB: We have always taken a long-term view to Zimbabwe, preferring to look through the political noise and focusing on identifying corporate champions that can generate shareholder wealth no matter the environment.  Despite the challenges, the 1H18 corporate results are very strong and the companies in our portfolio have survived hyperinflation before and they have highly capable management teams. Key to Zimbabwe’s economic recovery is a fresh capital injection and debt forgiveness/restructuring; we believe that announcements signalling progress in this regard will be catalytic for our investments in the country. For 2019 specifically we would like to see some fiscal consolidation as well as progress with regard to the currency regime, some corporates have started officially re-dollarising (offering a discount to electronic dollars if customers pay in USD cash). Given that government is past the election hump and the ruling party controls 2/3rds majority, we hope that they can implement some of the policy reforms necessary to pave the way for debt restructuring and growth.

CBP: Which Zimbabwean economic sectors do you see performing best in the year ahead?

LM: Given higher forex retention ratios, mining should remain stable but there needs to be clear government commitment to enable miners to physically access their forex earnings and boost confidence within the sector. Banking sector likely to remain resilient through non-interest income as lack of cash continues to push transactional banking although the 2% transfer tax presents some downside risk. Telcom/fintech space likely to remain quite defensive.

CB: Again, we tend to look at a longer time horizon than one year. Currently we have a lot of exposure to fintech, which we think is highly scalable in Zimbabwe particularly because of the infrastructure backbone laid out by Econet Zimbabwe and the cash shortage in the economy. Roughly 8/10 electronic transactions are done by mobile so we see this as a huge growth space. In addition to this, we also like the food and beverages sector, especially the big players that have cost advantages, strong supplier relationships as well as established brands.

CBP: Is there sufficient scope for foreign investors to pursue Venture Capital/Private Equity as an asset class in Zimbabwe? 

LM: Bottom up we believe that opportunities are there in select businesses that have robust models, good management teams and decent market shares – however given the lack of a clear policy around forex and more pressing allocation needs given the fragility of the economy; it will be difficult to assure foreign venture capitalists/private equity managers that there are clear exit mechanisms to divest at least in the short to medium term. Interestingly there also bottlenecks in bringing in the investment at ‘fair value’ in a legal and transparent manner.

CB: Yes, there is but this is not part of our mandate so my response will be limited. By nature both, these vehicles are long term and lend themselves, more to a recovery play such as Zimbabwe. Unfortunately, though the currency issue creates a high hurdle, as investors who put their money in are not confident they will be able to get their money out when it is time to realise their returns.

CBP: The IMF has recently thrown its weight behind, the government’s Transitional Stabilization Program, albeit stressing the need for arrears clearance before any new lending prospects. On the other hand, Government has also been pushing forward with its reform agenda. In light of the above, have you witnessed any increased investor interest in Zimbabwe, and is this translating to real dollars flowing on the ground?

LM: It is certainly welcome to see more positive sentiment toward Zimbabwe within the DFI space – we did initially see increased enquiries shortly after elections, I would say that has tapered down significantly since then. Sadly there is a gap between the expected pace of reform along with extent of reform and current pace and extent of reform; as an example whilst it is understandably difficult to implement meaningful currency reform over-night – maintaining a veneer rate masking what seems to be a true rate creates polarity that limits investor appetite and naturally caps the flow of investment dollars. Austerity will require strong leadership from the front and the extent to which government commits to such programs will be closely observed and interpreted either increasing confidence in the reform agenda or reducing it.

CB: We have been invested in Zimbabwe for a long time now, through hyperinflation, recession, depression, deflation and now the more recent hyperinflation cycle. Our underlying companies have done extremely well to protect shareholder value and grow throughout the period. Real dollars in the form of portfolio flows will only come in once the backlog of USD portfolio outflows gets cleared.

CBP: Just how big of an impact, will the removal of Zimbabwean domiciled constituents from the S&P African Indices have on portfolio investments into Zimbabwe?

LM: Very significant, a large sub-set of portfolio investors, especially GEM funds, will likely be unable to invest in Zimbabwe as that removal shines a bright light on our risk profile.

CB: As much as many investors track the S&P African indices very few can fully replicate it for various reasons. The impact is obviously negative from a coverage point of view but the funds that are actually replicating the index to hold Zimbabwe aren’t that many, the currency issues were well flagged prior to removing Zimbabwean constituents.

CBP: Official data shows inflationary pressures heightening, with the November inflation increasing to 31.01%. Other observers have noted though, that these figures are significantly watered down. In your experience, are foreign investors dependent on official government data and how are the inflationary pressures likely to affect investments?

LM: Whilst government data is important, investors local and foreign will typically use other resources to sense-check the stats. I think an important starting point in analyzing the inflation data is understanding what comprises the basket of goods being measured; bear in mind that the prices of staples like mealie-meal and cooking oil haven’t moved as aggressively as more discretionary goods given a strong agri season and government subsidies. Components like rent have been declining over the last 2 years although that may change going into 2019. Inflation will certainly threaten real returns particularly in fixed income given where rates currently are, rental yields will similarly be threatened. Equities might be the more preferable space on a relative basis; however, valuations appear to have already over-run in many names, so one would have to quite selective.

CB: We do not rely on the inflation data but it is something we track. Our real insights come from internal inflation measures from the companies we invest in. Equities is an asset class that outperforms during periods of inflation so for domestic investors it is not surprising that the market performed well in 2018 in Zimbabwe digital dollars. However, we use the Old Mutual Implied Rate to value our portfolio, currently we are valuing Zimbabwe at 20c to the USD. For inflation to come down government needs to stop creating electronic dollars through monetary financing of the budget deficit via overdraft from the RBZ. We are hearing that government has stopped issuance of treasuries, a step in the right direction.

CBP: There has been extensive debate on the country’s currency regime. In your opinion, what is the best currency regime for the country going forward?

LM: There is no easy path to currency reform and I don’t want to claim to have the intricate answers but my view is that we have to quickly begin a journey to some form of devaluation, which implies liberalizing the rate – naturally there will be some short to medium term pain but ultimately there is already an acceptance of this particularly in the corporate sector. Foreign currency allocation should to a wide extent revert to the commercial banking sector as we increase forex retention ratios for exporters allowing a greater pool of currency that can be matched to importers at a market-determined premium but managed within the private sector as a start.

CB: Our view is that the Zimbabwean currency should be officially devalued to match the reality on the ground and the quasi currencies of Ecocash, bond and RTGS. Another alternative is to join the Rand monetary area, a major trading partner and a currency that closer reflects the economy

CBP: Lastly, is Zimbabwe that bad as an investment jurisdiction compared to other sub-Saharan Africa peers, and do foreign reports mirror what is obtaining on the ground?

CB: The question is framed – “really that bad” assumes that its bad and it is now a measure of relative “badness”. We believe in the African investment opportunity. Africa is a patchwork of different countries pushing and pulling in different directions. Our view is that we prefer to build a portfolio where the countries have a low correlation to each other, in that sense, Zimbabwe is interesting because it has its own dynamic and therefore is an attractive source of return that is unrelated to the globe and some of the other opportunities in the region. To answer your question more anecdotally – Zimbabwean management teams are brilliant but the policymaking is poor. However, with the cabinet in place from September it is too early to tell what the new team will do.  We believe that Zimbabwe has its highest chance of a positive outcome simply because it is willing to engage the international community, only time will tell how sincere their efforts are.