Where will returns come from?

By Ray Chipendo, JOHANNESBURG, October 31 (The Source) – A few days ago we released our Market Outlook report on Zimbabwe with a view for 2015.  The 14 paged paper provides Emergent Research’s perspective on the future of Zimbabwean equity market.  It also shares how the last five years, post dollarization, have shaped the market and outlines what we perceive to be key drivers of returns going forward.

Great investors we have followed will let you know that forecasting the direction of Markets and economies is a futile exercise, let alone for extremely uncertain environments such as Zimbabwe. So while we itched to put a growth number out there, reason prevailed and we eventually adopted Howard Marks’ approach of “simplifying the unknowable future”. The approach applies probability ranges or distributions for specific scenarios.

We constructed three scenarios for the economy and equity market namely: Holding on the ledge (35% chance of occurring) pessimistic view of the future with economy sliding back into recession; Reasonable expectations (55%) – a prolonging of the status quo with economy growing in the region of 0-2% rate; and Growth Reloaded (15%) – happy days where the economy is pumping north of 4% growth rate.

But before I share with you the main themes in our report, something happened this week that weighed more on our optimistic scenario for the Zimbabwean economy. It is a five member UK business delegation that has been in the country for the first time in 20 years. What made the news more meaningful to me is that Turner & Townsend, my former employer, a global construction and management consulting firm, UK headquartered was part of the delegation. When I joined Turner & Townsend in 2008, the company’s Africa MD told us that in 1995 the company was making more money in Zimbabwe than any other African market including South Africa.  A replay of those days excites those that still have hope for ‘beautiful Zimbabwe’.

Major market themes for 2015!!

Back to the market outlook report – below are some of the major themes identified in report:

Polarised Market

Our report explains that if the status-quo persists or conditions worsen, we see performance of equity market becoming polarised between companies confined to the domestic market and those with export markets.

IMF’s growth forecasts for the sub-Saharan African economy stand at 5% for 2014 and 5.5% for 2015. These growth prospects are presenting strong market fundamentals for companies exporting in the region. Overall, we believe companies with firm export markets will continue on a strong growth trajectory. On the other hand companies restrained to domestic markets will be subjected to top line growth pressure reinforced by decelerating economic growth and deflation.

Valuations Reset likely for commodities and miners

In the last three years commodity and financial stocks have generally under-performed the market with the exception of a few cases such as BNC’s recent rally. Commodity price volatility and more important questions around the impact of indigenisation law have kept investors at bay. As Government tones down on the law and investors feel more comfortable we expect to see more steel and concrete going into the ground.

The RBZ’s rescue asset manager (ZAMCO) is, in our opinion, a quasi-bailout vehicle for banks.  We believe banks that will survive this phase will be in better shape and carry more confidence. With more investor confidence we expect a valuations reset moment. Most domestic banks have been trading at near bottom valuations.

Companies holding more cash now

Our research suggests that companies may be building up cash balances. Three factors might explain.  Problems in the banking sectors are tightening credit markets and making refinancing difficult. Therefore, it is better to hold on to cash than retire loans which may prove impossible to raise when needed. Secondly, companies may be forecasting tough times ahead – no better way to prepare than build cash.  Last, slowing aggregate demand combined with low production utilisation rates (37%) may be dissuading any investment into capacity.

What will drive Growth?

Three major elements drive market returns, namely earnings growth; dividends and multiples expansion (increase in P/E ratio as a result of investors willing to pay more for future earnings). Going forward what will drive market returns? We ignore dividends which are not a major element in Zimbabwe.

Earnings Growth?

The post dollarisation phase was followed by large increases in revenue among the majority of companies. Of the forty five companies that were part of our survey in 2010, 89% recorded positive revenue growth and in 2011 the ratio jumped to 91%. Corporate growth lost steam in 2013 as the number of companies boosting revenue by more than 50% plunged to zero.    In 2010 the median company registered revenue growth of 69%. The following year the figure declined to 28%; 16% in 2012; 5% in 2013 and so far this year it is 0%.  The trend is quite obvious, top line growth is now facing immense pressure. A slowing economy and deflation are to blame.

The staggering revenue growths of 2010 and 2011 were not translated into bottom line growth.   Earnings performance have been polarised since 2010. Companies with earnings growing or shrinking in the single digit range were on average 14% of the total companies between 2010 and 2013. More than a third of the companies were growing earnings at double digit and the rest, approximately half, were shrinking at double digits. As highlighted in the major themes we believe the majority of companies will continue to face earnings pressure if not contraction. A few exporters might continue on an earnings growth trajectory.

Will multiple expansion come to the rescue?

Excluding BAT, an anomaly valuation-wise, the entire market’s P/E value is approximately 11. Going forward three factors will influence the market’s valuation namely: Perceived risk; liquidity and economic prospects. Our data has shown that the dizzy performance heights reached by the stock market post dollarisation were primarily driven by a multiples’ expansion – investors being euphoric about the future of the economy and subsequently paying more for future earnings. Dollarisation and a unity government were all driving this optimism.

However since 2013, a slur of harmful political talk and less clarity on critical policies, such as indigenisation policy which have implications on property rights and business certainty triggered a multiples compression.  Going back to the UK business delegation, it takes these bits and pieces of optimism to drive interest in our local market and trigger a multiples expansion which will jolt up prices. This why government’s welcoming a UK business delegation should be lauded and encouraged. We have maintained that Zimbabwe’s economic problems are more policy and relationship based than structural. We have nations posting better growth figures than us despite battling with a myriad of challenges (militants killing innocent people; low literacy rates; really dilapidated infrastructure; and terrible environmental conditions).

Winning Strategies

In our opinion a winning strategy will need to satisfy our “stock grading” approach which focuses on GROWTH; VALUATION; and QUALITY.

Unless if you are aiming to have outright control of a company, buying stocks based on their valuations alone will be dangerous. Most undervalued stocks are likely to remain undervalued for extended periods of time. And the majority are under-valued on many metrics expect the most important one – free cash flow.


We place premium on quality stocks. Stocks that have little need for capital investment to maintain their earnings. Such an attribute will be desirable since raising capital is likely to become difficult in light of a banking sector burdened with high bad loans.  Quality will also come in the form of stocks that easily translate earnings into cash. Liquidity will distinguish survivors and victims.

High Returns on invested capital (ROIC) will be important as well. Post dollarisation most of the companies loaded up debt which was at interests rates in the mid-teens yet their returns on capital were in the in single digit region. Such companies were destroying value with the debt they used to recapitalise. High ROIC is a precondition.


Throughout we have emphasised the need to tap into growth in export markets.  In an environment where production utilisation is below 40%, growth is necessary to improve utilisation of plant and equipment and hence improve efficiencies. Apart from supporting earnings growth, efficient operations are important in securing markets in a competitive global economy.

For a full copy of our Market outlook report- 2015, please email your request to                               research@emergent-research.com

Ray Chipendo is Head of Research in the Johannesburg office. He can be contacted on                     ray@emergent-research.com


Zimplow- Any value left for investors

 A stock that has rapidly deteriorating fundamentals can experience a significant decline in its market value in a very short period of time as investors abandon the ‘sinking ship’ in droves.

Throw a seemingly failed corporate acquisition and an increasingly tough business environment into the mix and most certainly there will be extreme casualties as investors’ net worth plunges.

The Zimplow share price has been in a downward spiral since 2012, from a high of 30 cents to the current seven cents a share.

Why? Read on.


Zimplow Holdings, formerly, Zimplow Limited was once a corporate shining star in the unexciting business of animal-drawn implements manufacturing. Limiting its activities to this niche market, it prospered to the point of almost conquering the wider African markets. With this prosperity came a sizeable amount of cash which got management charged up and dreaming of extending its tentacles to a much more glamorous market space. Between 2009–2011, Zimplow generated $4.6 million in free cash, enough to buy back half its issued shares at current prices.

From the mega profits of their flagship operation, Mealie-Brand, Zimplow acquired 49 percent of Afritrac in 2011. This is an animal-drawn implements distributor in South Africa. It seemed reasonable as it was purported to be an entry point into the southern African markets. Following this noble acquisition came the Tractive Power Holdings (TPH) purchase from RBZ’s Finance Trust in 2012.

Zimplow was no longer a mundane business that produces ‘old technology’. In fact through TPH, it had become the largest distributor of high tech farming and mining equipment, locally. Barzem, Farmec, Northmec, Valtra and Massey Ferguson are popular brands which they now housed under one Zimplow roof with equipment such as bulldozers, combine harvesters and tractors.

Management was so upbeat and confident of their purchase that they declared Zimplow would have $100 milllion dollars in revenues by the year 2015. Revenues then were $33 million. What worried us about this assertion was that there was no mention of the word ‘profitability’. But nonetheless, this was going to be the greatest success story of Zimbabwe after Econet. Or was it?

Zimplow overstretched its means to acquire TPH. After an initial purchase of a 16 percent stake, internal resources failed to buy control of TPH. Management called on investors to provide funds through a rights issue and $11 million was raised for the acquisition of a further 57 percent. Zimplow wanted all of TPH and they were going to stop at nothing. Another $3 million was borrowed to buy out minorities and finally consummate the take-over of 100 percent control.

Happily never after

Two years later, today’s Zimplow pales in comparison to the shining star it once was as a smaller company. What management did not foresee was a slowdown in revenue growth as a result of the underperforming agricultural and construction industries along with softening mineral prices internationally. The result was a sharp decline in demand for heavy machinery, aggravated by the absence of asset purchase finance. High restructuring and finance costs diminished the profits and Zimplow had now been successfully turned from a cash compounder into a cash burner.

In the six months to June 2014, revenues of the mining and construction equipment division plunged 58 percent to $4.7 million against the prior comparable period. The farming equipment division was largely flat in terms of revenue growth. Zimplow posted its biggest loss since dollarization of $2.2million. Substantial.

The market’s reaction

Judging from the share price decline, the market did not share management’s optimism and rightfully so. The fundamentals did not support those ambitious assertions. Market capitalization for Zimplow before the acquisition was a lofty $25 million while that of TPH was $15million. Current market cap for Zimplow Holdings (combined Zimplow limited and TPH) stands at $11 million. It is this sort of excessive market behavior that drew us to look closer at the situation.

Is it true that TPH was such a bad addition to Zimplow that it wiped out half its value? Indeed at the current share price of 7 cents, the entire Zimplow company is selling at about 60 percent of its estimated liquidation value. In other words, if the company was unbundled and assets sold, investors would get 9.7 cents a share, netting a 40 percent profit. This is our margin of safety.

The investment case

Zimplow is a market leader in the animal traction business, claiming 65 percent local market share. Its diverse product offering in the heavy equipment segments is unmatched within the Zimbabwean borders. It is difficult to imagine that its fortunes are worse than other smaller players in the market.

Protracted economic stagnancy will have a telling effect on Zimplow’s fortunes. But should this be reason enough to discount the company’s assets below their net saleable value? We believe that mistaking extreme negativity as realism can create absurdities in asset valuation in much the same way as irrational exuberance can create unsustainably high valuations. This pessimism has created the unduly low price.

For one, the Zimplow balance sheet is largely made up of inventory, receivables and cash which account for about 60 percent of assets. These are current assets which management, in view of the prevailing difficulties, can control to avoid over-stocking and ensure reasonable cash flows. It is vastly dissimilar to a mining company whose greater chunk of capital is locked up in immovable assets which are illiquid for the most part. The flexibility attached to Zimplow’s balance sheet will provide room for management to take decisive action – to prevent the creditors’ book or debt from growing if the economy fails to recover timeously. As a matter of fact, efforts to this end have already been initiated at Zimplow. A $3.5 million building owned by Zimplow is reported to have found a buyer and the sale is almost complete. We expect this piecemeal liquidation of assets to be a cash buffer against losses in the short to medium term.

Secondly, a firm the size of Zimplow is unlikely to remain priced at this extremely low level without attracting a take-over bid from a bargain hunter or some sort of private equity operator. The major shareholders themselves may decide to take the company private by making an offer to minorities. This offer will not be lower than the liquidation value. In essence this is an indication that the minority stands to make a return at least equal to the margin of safety. We have seen this happen twice in 2014 with TA Holdings and Astra Industries.

Furthermore, on October 6, Tetrad which was Zimplow’s largest shareholder, sold part of its 39 percent stake in Zimplow in a special bargain sale for 9.5cents ($2.2 million) to unnamed foreign investors. Such negotiated purchases give a good indication as to the value of a company. But in this case Tetrad may have been forced to sell at the depressed price because of the pressure exerted on it to recapitalize its investment bank. It is noteworthy that even in its dire straits, Tetrad could not accept the market price of 7 cents.

Thirdly, the recently signed Russian and Chinese infrastructure deals will be a boon to Zimplow operations as and when the projects kick off. It seems overly simplistic and rather too pessimistic that the status quo in the economy will continue much further into the long term.

Is it all worth it?

Successful investing in these sorts of special situations requires strength of character and great patience. The fundamentals for Zimplow could deteriorate further in the short term before they eventually recover along with the general health of its markets and economy. It can be tough to remain resolute in the face of such circumstances.

However, the wait can prove very rewarding. We will leave you with an example: TA Holdings’ share price hovered substantially below its intrinsic value at around 5-11 cents a share for nearly 2 years between August 2012 and July 2014. In July, the largest shareholder then made an offer of 20.6 cents a share to minorities, a price that was a 275 percent premium to the ruling share price on the date of the announcement. The rest is history!

Oswell Kapotsa is a Research Analyst in Emergent Research’s Harare office and Ray Chipendo is Head of Research in the Johannesburg office.   oswell@emergent-research.com and  ray@emergent-research.com

– See more at: http://source.co.zw/2014/10/zimplow-any-value-left-for-investors/#sthash.XS9pPs2W.dpuf

Bindura Nickel – End of runway?

Missing a stock that grows at double digits in three months can be annoying. But snoozing while a company doubles in price can leave you distraught. Nothing, though, compares to Bindura Nickel Corporation’s 400 percent jump. Not in a year, but in only three months.

Before you cringe at this slip-up, we think the stock price run was just a nervous start; a long runaway still stretches ahead. BNC, we reckon, will soon be contending for a spot in the top five stocks by capitalisation.  It is already the largest mining counter by market capitalisation.

BNC has had a tough going in the last three years. Going by its numbers, the miner must have been worth $3 million on the stock market in 2012. Today, BNC’s capitalisation is $87 million and its stock price is at 7 cents.

Reading the news, it is not a difficult task telling why BNC has had the big jump, but understanding if this upward trend is sustainable is what most investors will be interested in.


BNC is the only fully integrated Nickel mining operation in Africa.  The miner owns the Shangani and Trojan nickel mines, as well as the Bindura smelter and refinery complex. BNC also owns the Hunters Road nickel deposit, which is currently in the predevelopment stage.

Following four years of stalled operations while the mine was under care and maintenance, BNC started shipping concentrates to Glencore in 2013. In the last financial year BNC delivered a total of 7,1 tonnes of Nickel concentrate to Glencore at a price of $65 million. This year the company hopes to pump up that tonnage to something north of 9,000 tonnes.

So how does BNC fare against our three ponged stock assessment approach?

Growth Prospects

Revenue growth for commodity driven businesses is largely driven by prices. Higher international prices precede production ramp ups. Until this year, Nickel has traded very weak with prices averaging $16,000 a tonne in three years. Last year was worse, with prices averaging $14,300 a tonne. A slowly reviving global economy and, to a greater extent, moves by the Indonesian government to ban export of unprocessed Nickel have spiked the price to current levels of $18,500 a tonne.

Large investment banks including Goldman Sachs, Morgan Stanley and Citigroup have all revised their 12-month estimates to an average of $22,000 a metric ton. In any case, the long term London Metal Exchange price for Nickel has averaged $19,500 a tonne in the last five years. A reversion to mean suggests that in the long term, BNC’s revenue prospects will only get brighter.

That said, BNC made a net profit before tax of $16.4 million. All this happened on tepid Nickel prices averaging $14,300 last year. Now with prices up by 30 percent, it is not difficult to figure out why we are painting growth-prospects with bright colours.

In the last annual report, Mwana Africa, BNC’s holding company, committed to ramping up ore production from last year’s quarterly average of 149,000 tonnes to 195,000 tonnes a quarter this financial year. So far, its current first quarter’s output at 151,000 tonnes was 30 percent shy of the target. Management explains that refurbishment of underground mobile equipment was to blame.

From our analysis we estimate that total concentrate produced might not reach the originally envisaged target of 10,000 tonnes (195,000 tonnes of ore a quarter) instead we see annual total tonnage settling at 8,800 tonnes. A 23 percent jump from last year’s production. At the estimated current price of concentrate of $11,000 a tonne, (20 percent increase from last year), revenue growth is estimated to be up by 49 percent this current financial year.


BNC’s steps to revive the smelter and refinery are turning the integrated miner into a more productive and quality oriented operation.

The operation’s chairman Mr. Mpinga noted that BNC’s most significant cost was currently transport, stating that it cost the company about $1,2 million a month to truck concentrate from the mine as part of an offtake agreement. With the smelter in operation, $14,5 million will be added straight to the bottom line each year.  At a cost of $26 million to refurbish the Smelter and refinery, BNC’s transport savings will pay back the project cost in two years.

BNC’s return to profitability has reinforced its balance sheet.  Return on invested capital is currently at 58 percent and operational margins at 27 percent, signifying a quality operation.

Management has set the current financial year to focus on enhancing efficiency of operations and optimising machinery. But it is unlikely that savings from efficiency gains will reflect on the company’s bottom line this financial year. Not after BNC has paid the consultants for trimming their operations.  At least BNC will eventually emerge leaner and more efficient.

As a result of employee and government stakes in the company, BNC’s chairman asserts that the operation is considered indigenised. Resolution of indigenisation concerns gives BNC a breather. More importantly, management can concentrate on creating value for shareholders.


In October 2013, a competent person review restated proven and probable reserves to 32,975 tonnes of contained nickel. Applying the Real options valuation method, we estimate the value of the reserves at $13 million – a very conservative estimate.

Last financial year revenue was $65 million and average concentrate price per tonne was $9,120. If the price of nickel concentrate has increased in tandem with the price of nickel alloy, the former’s price should currently be hovering at around $11,000 a 20 percent jump from last year’s price.

At $11,000 a tonne and producing an estimated 8,880 tonnes, revenue from concentrates is expected to reach $96.8 million this year. Our valuation base estimate suggests a valuation of 17 cents a share, which is a 145 percent upside to the current price. It is important to note that our valuation estimate excludes revenue and savings that will be earned from a resuscitation of the smelter.

Bottom line

Expectation of a revived smelter is perhaps BNC’s biggest attraction to many investors. Yet without factoring the smelter, the miner is still an attractive stock. It seems BNC has a lot of running before it is out of breath.

Ray Chipendo is Head of Research in Emergent Research’s Johannesburg office. Oswell Kapotsa is a Research Analyst in the Harare office.  ray@emergent-research.com and oswell@emergent-research.com


Zim Stock Exchange as a broad-base strategy for Zim’s indeginisation policy

Officially recognised remittances by Zimbabwean diaspora netted US$1.8bn in 2013. The figure excludes Rand and Pulas sneaked into the country stashed under the seats of cross-border buses. Conservatively, total 2013 remittances could very well have been in the region of $2.5bn. And much of this money was for consumption purposes – to sustain families back home. At the same time, the total capitalisation of ZSE companies is nearing US$5bn. Fair to say, with a bit more confidence, Zimbabweans in the diaspora could literally own all companies on ZSE in two years’ time. How is that for an indigenisation plan!!

Divided house

Sadly, from observation and experience, most of the fiercest opponents to investing in Zimbabwe are not the foreign investors but the very Zimbabwean nationals living and working in foreign lands. Among their many gripes, the majority, in their personal capacity, have lost money back home through their own country-men and, more disappointingly, through relatives. Whether they are justified in their pessimism is beyond this post.

The tragedy turns more dreadful when you recognise that the same Zimbabwean Diaspora unconvinced about Zimbabwe is the point-man for international investors wondering if it is time to invest in Zimbabwe.  Expectedly, international investors would be reluctant to sink capital in Zimbabwe against opinions of Zimbabweans working for them – who in all fairness would be better placed to lead forays into Zimbabwe. It then follows that without winning the hearts and confidence of its nationals living abroad, Government’s overture to international investors is mostly falling on hard ground.

A need to broaden the Indigenisation policy

But the idea is not to apportion blame, but to look for options that can move this country and the economy ahead. In the first place we should never be so polarised as to miss the greys tones where true progress can start.

The Zimbabwe Stock Exchange offers a fairly reliable and attractive platform for Diasporans to participate in the economic development of the country. With Government’s support, the indigenisation policy could be broadened and deepened to reach all citizen groups. The current law, suffering from its onerous thresholds, has its shortcomings which can be addressed by involving the stock market as a broad based empowerment tool.

For example, benefactors of the policy, including communities and staff, are unlikely to realise tangible and personal benefits in the short to medium term. Most of the share ownership schemes are long term and only materialise after several years. In general, the biggest merit of capital is in its readiness to be used to take advantage of opportunities and as collateral. In the short to medium turn share ownership schemes fail at these two tests.

Another shortcoming is a lack of reach. The policy in its current form fails to articulate how a common worker would benefit. A security guard, teacher, nurse, bus driver and even government employee finds it difficult to see how he or she can participate. Not surprisingly, many view the policy with scepticism – in fact, it is perceived as the “concentration of benefits and dispersion of cost” sort of case. Diasporans also feel excluded and believe they are only called on to put money on the ground without having a say.

It is not all doom…

It is our belief that with a government seriously lobbying the Diaspora, the economy of this country could be on its way up. It is not unreasonable to imagine that if the Diaspora is to view Zimbabwe favourably as a safe investment destination, US$5billion could be remitted to Zimbabwe every year as FDI. Seeking to be as to home as possible, some Zimbabweans in the Diaspora, including those living in Australia, US, UK and SA, are parking millions in South Africa’s property and equity markets every year. Tell them about Zimbabwe, they wince.

But it should not necessarily be so. Firstly, because the JSE has turned into a quicksand – valuations are at an all-time high. Traders and investors are anxious to see the correction. They want to get done with Doomsday as soon as possible. On the other hand, the ZSE market has the majority of stocks screaming value. And, what about concerns of a misfiring economy? Interestingly IMF and government have a growth consensus of 3.1 percent for 2014. That is for Zimbabwe. South Africa’s growth prospects for 2014 are pegged at only 1.7 percent.

ZSE is getting its act together

As with many people, some would argue that losing money in Zimbabwe is the easiest thing to do. Not so many trustworthy business people around.

Among the few subjects that revive enthusiasm and optimism on Zimbabwe’s economy are the strides being undertaken by the ZSE. Management’s actions and plans are strengthening the local exchange as a modern and credible platform for exchanging securities. Among many avenues of investing in Zimbabwe, the ZSE is positioning itself as a safe way to invest in the local economy.

Firstly, the automation of the exchange, currently underway, is paving way for online share trading which will allow individuals, including Diasporans, to trade in shares remotely. Automation, together with the new central depository system, is going to promote transparent pricing of shares and participation of small investors in trading as costs go down.

In the last few weeks, trading fees have been reduced.   The effect will be enhanced competitiveness and cost effectiveness which attracts more investors. But more interesting are the plans to demutualise the stock exchange. Attracting the investment community to invest in the exchange will attract fresh capital and make the stock market more adaptive to global trends. Lastly, the exchange’s plans to make quarterly reporting mandatory will be the biggest source of credibility. It will strengthen corporate governance and transparency of the operations of listed entities.

Broadening the reach of the indigenisation program

With this background in mind, and to broaden the indigenous policy’s reach, we propose the set-up of ZSE listed investment vehicles that issue ordinary shares to indigenous Zimbabweans. Capital raised from these proceeds can be used to buy into companies and investors seeking indigenous equity. Issued shares will only be traded among the indigenous people. These listed investment vehicles will function like any other public companies with appropriate governance and shareholder rights that allow the appointment of competent management.

The benefit to the indigenous investors is that their capital, which is sought after, will come at a premium to international investors. Because shares are tradable, an ordinary working person will be able to buy shares for as low as an investment of $50.00. With the automation of the ZSE, trading can be done online, enabling different groups including Diasporans and the ordinary man, to trade shares on smartphones and PCs. The divisibility and tradability of this ownership will enable the ordinary man to use his stock as collateral and turn it into cash if need be.

But the benefits of this model will not only accrue to the ordinary man and country as whole, it also tells the international community that Zimbabwe’s indigenous law is not extortionist but seeks to promote partnerships with international capital in a transparent way. International investors, including multinationals, would welcome co-investing with a professionally run investment vehicle where ownership is not concentrated but spread over thousands of people. It provides a sense of comfort that the motives of this investment group are aligned to theirs as well.

Most importantly, this approach will also help to convince international mining houses to list locally. For example, the Australian-listed Zimplats has in the past raised concerns of the feasibility of securing indigenous equity on the local bourse. For the mining sector, where Government’s demand for 51 percent is sticky, listed indigenous investment vehicles would help to guarantee that equity.

The proposed concept is not entirely new. In South Africa large publicly listed companies such as Sasol and MTN have created ordinary shares for BEE-compliant persons. Despite being traded on a separate trading platform, Sasol’s Inzalo and MTN’s Zakhele’s ordinary shares allow current and potential BEE shareholders to register their selling and buying orders. In turn the shares help these companies to reach their BEE ownership thresholds.

Ray Chipendo is the Research Lead at Emergent Research. He is contactable on rayc@emergentcapital.co.za, @ray_chipendo

– See more at: http://source.co.zw/2014/08/opinion-how-the-zse-could-turn-indigenisation-policy-into-a-broad-based-policy/#sthash.9Z347z46.dpuf

Cottco – Worth more Dead than Alive

By Ray Chipendo and Ngoni Mutaro, JOHANNESBURG, July 23 (The Source) –

In our recent posts we have supported, at length, an investment strategy that’s premised on buying quality and cash compounding businesses. As we explained – investing in strong and quality businesses is best suited for long term investors. But long term investing, though our preferred investment philosophy, is boring and mostly about “waiting” which is less exciting for most individuals.  The adrenaline junkie-investors would want to know if there are any especially action-packed opportunities.

Well, there are certainly “Special situations” that often trigger or follow mispricing of stocks, which creates opportunities.  As John Huber, the manager of Saber Capital Management explains, special situations create and sometimes result from cheap stocks that can be sold at a profit to a private owner. These situations include recapitalisations, mergers, acquisitions, tender offers, spinoffs and rights offerings.

In recent weeks there have been quite a number of interesting special situations involving TA holdings shares and Bindura Nickel Corporation, which led the two stocks spiralling up. Investors who had foreseen such events and taken positions must be grateful that the rest of the market pays little attention to nothing but the top ten stocks by capitalisation.

In our opinion, Cottco’s dire fall in price and the talk of a new investor sounds like one special situation. A dark mood hangs on the cotton marketer – reasonably so, as Cottco’s revenue spectacularly plunged from $129 million a year ago to $42 million this year. The market, perturbed by Cottco’s recent performance, has unjustifiably condemned the share. We say so because, according to our calculations, the company is now trading at less than its liquidation price. It is worth more as a liquidated company than when it is operating.

From a price of 6 cents a-piece beginning of January, Cottco’s share has fallen to its current price of 0.9 cents. Disposal of a stake in SeedCo; internal problems; depressed cotton prices; and problems with the inputs credit scheme are all cited as the major causes of distress.

Cottco is Southern Africa’s leading cotton buying, processing and marketing organisation. Working with many farmers in Zimbabwe, Cottco provides comprehensive agronomic and financial support at every stage of the cotton production process from planting, nurturing and harvesting the crop to processing and marketing cotton lint and cotton seed. It works with contract farmers across the country.


Based on assets and liabilities contained in the annual results released a few weeks ago, our liquidation estimates suggest that Cottco is more valuable dead than alive at its prevailing market prices. Our liquidation value estimate is 1.05c a share- this is after factoring a winding up discount on the value of Cottco’s assets and a liquidation fee too.  Notably we have discounted plant, property and equipment by 30 percent and receivables by 15 percent. Cottco’s current price of 0.9c per share suggests that if the company is liquidated, a 17 percent profit or $1.6million will be earned by shareholders on top of their investment.  As things stand, and unless the company’s prospects and operations drastically deteriorate, there is a fair downside risk protection, at least for the short term.

From experience we all know that companies do not stay below liquidation for long, somebody smart enough will find ways to profit from the situation. In our view, cautionary statements provided by the management in recent weeks may be the sign that the expected White Knight is in view.

Catalyst for a price change

In recent weeks, Cottco has issued a cautionary statement warning of current negotiations which could result in significant impact on the company. Though management has opted to remain mum, the market believes Cottco is talking to the China-Africa Development Fund. The fund is China’s largest private equity fund focusing on African investments, believed to be interested in buying a significant shareholding in Cottco Holdings Ltd through its wholly-owned subsidiary China-Africa Cotton.

On its website, the China-Africa Cotton Development Limited describes its services as contracting planting, cotton purchasing and processing in Africa. Like most Chinese investments, China is driven by a thirst for commodities. China’s vast textile industry feeds on cotton and more importantly quality cotton. Given the potential investor’s line of business, the investment is likely to be for the purpose of securing good quality cotton from Zimbabwe and supply it to China’s textile industry.

While China’s motives may be different than thought (create a permanent glut on the market to maintain keep cotton prices low), the creation of a guaranteed market would be great news to Cottco which has had to deal with a volatile commodity market. In addition to stabilising the market, the investor’s involvement will likely lead to a remodelling of Cottco as a business and not least of all, provide much needed cash for the business. If this investment is realised this could bode better days for the cotton marketer.

Bottom line

Each time a company is trading below liquidation value, there are two possibilities: Either it is a call on management to throw in the towel and wind up operations, or the market might simply be overreacting. We lean on the latter. But even so, special situations are for the bold and never for the faint hearted. There are no guarantees – it is not unusual for investors to see their hard earned money up in smoke at the end of the day. Nevertheless when investors win in special situations – often, it is in a big way.

Ray Chipendo is Head of Research in Emergent Research’s Johannesburg office and Ngoni Mutaro is a Research Analyst in the Harare office.    ray@emergent-research.com and ngoni@emergent-research.com


Why Agriculture stocks underperform

HARARE, July 16 (The Source) – Eight Hundred and forty million of us are going to bed hungry every day, the World Food Organisation recently told us. You would think this chilling statistic, coupled with growing demographics and rising consumption patterns, would make agriculture stocks the most sought after. But nope, investors still snub the sector. Apart from lacking the glamour of retail, telecoms and industrial sectors, the agriculture sector has some apparent flaws. We tried looking at a few structural issues that dent this sector.

Investors should not view our thoughts as bashing the sector, but rather as a checklist to pick the least tainted agro stocks.

Seasonality of production

Seasonality of agricultural production leaves most producers’ assets idle for extended periods of time. Take for example a tobacco farming operation with tilling machinery which is in the field for only two months of the year. The managers of the operation might attempt leasing the machinery to other operations in off-season times but asset utilisation rates are unlikely to come close to that of other sectors such as retail, services and mining. In practice, this suggests that on average, agriculture stocks will need more assets than most sectors to produce the same amount of profits.

One of our previous posts on Hippo Valley and OK revealed that the latter’s asset turnover was 18 times more than Hippo’s in the last financial year. As we explained- this means that for each dollar of asset, OK is producing 18 times more revenue than Hippo. As a key driver of returns on shareholder capital, low asset turnover caused by seasonality in production is found to undermine performance of agro based companies.  Inadvertently, most agro based companies adopt the mind-set of the hotel industry–obsess with jerking up asset utilisation rates.

Cash-flow mismatch

Most agro stocks get a single pay cheque a year. For the rest of the year they are working to get that pay cheque. Consider a seed producing company with one big client – Mr. Government. Mr Government only hands the seed company a cheque 60 days after receiving the consignment. But for the entire year, the seed producer has to meet cash outflows towards salaries, rents and keeping the lights on. It follows that if an ordinary business occasionally finds itself in need of an overdraft or short term loan to fill up some small working capital hole, agro businesses will have ditches to fill.

A look at balance sheets of all agro based companies on ZSE reveals capital bases bloated with short term debt raised to finance inputs and running costs. So, while service and retail businesses are fussing on how to earn the best rates on their cash, the likes of SeedCo, Padenga and Cottco are troubled with how to rationalise finance costs. The seasonal nature of agro stocks, which causes cash-flow mismatches, often results in large borrowing costs that are not common in other sectors.

High Storage Costs

Agricultural produce is mostly bulky. With long lead times associated with the sector, storage costs are often disproportionately large in the sector in that way squeezing profit margins.  Take a company such as Dairibord that mops up fresh milk from dairy farms across the country and has to store it awaiting production of various dairy products. A worse case is National Food Holdings, which similarly gathers grain from around the country, grind and mill it before selling it as mealie-meal to consumers. The holding period could extend to several months before the product is sold. With the decentralisation and fragmentation of farmers as a result of land redistribution, most agro based companies have to invest heavily in an expansive distribution footprint. Costs of maintaining such a footprint can be a sizable haircut on a company’s bottom line.

Volatility of Prices and Input Costs

Perhaps the sector’s severest blemish ought to be the commodity nature of the produce and volatility in product and input costs prices. Most agro products are commodities that fetch a uniform price world-wide. Commoditisation of most agro products has demoted the sector into an efficiency based industry. In tough times, only efficient operations that can produce the commodity at the least price possible will be the last to remain standing. In general, due to this commoditisation, most agro business cannot find scope to differentiate their products to earn super-profits hence they remain mundane investments.  But on that point, some players defy the norm. A case in point is Padenga; which has been able to differentiate its crocodile skins thereby fetching a premium on the world market.

Natural shocks such as adverse weather and pests; long product lead times and commodity trading are the largest drivers of price swings for both inputs and products. In addition to unnerving investors who are looking for some level of certainty, price volatility get in the way of management’s long term planning. Most management teams find it difficult to undertake large capital expenditure without worrying how drastic price movements could easily turn their investments into money-losing schemes.

Bottom line

The discussion above should be handy to an investor who is looking at a number of agro stocks and wondering where to put his capital. Unlike companies in other sectors most agro based stocks have posted profits in a time when most stocks have been in the red. Admittedly, the sector is not one to shoot the lights out, but there is certainly some money to be made in tilling the land and looking after animals.

About the authors
Ray Chipendo is Head of Research in Emergent Research’s Johannesburg office where Simba Chimanzi is a Research Analyst.  Their contact details are:                                  ray@emergent-research.com and simba@emergent-research.com

– See more at: http://source.co.zw/2014/07/opinion-the-curse-of-agro-stocks/#sthash.jcw5My2M.dpuf

Great investors focus on quality, you should too.

By Ray Chipendo, July 8 (The Source) – Charlie Munger, who is credited for swaying Warren Buffett’s investing philosophy towards quality businesses, had this to say about investing: It is hard for a stock to earn a much better return than its underlying business.

He argued that if the business earns 5 percent on capital over 20 years and you hold it for that 20 years, your return is unlikely to be far away from 5 percent —even if the stock was acquired at a huge discount. Conversely, if a business earns 15 percent on capital over 20 years, even if you buy it at a premium you will wind up with a great investment. Fair to say: For a long term investor the quality of a business is more important than its valuation.

Munger refers to such high return companies as quality businesses. And he reckons the best way to accrue the maximum value from quality businesses is to buy them while young. Among the very few companies on ZSE that fit the bill, is SeedCo. This Zimbabwean listed company is a Pan-African crop seed company with operations in six African countries, including Kenya and Zambia, providing seed supplies to a total of 13 African countries.

Despite debtors climbing up 23 percent to $75 million and almost half of them having to do with one troubled customer (Zimbabwean government), SeedCo is still a quality business. And, unlike other listed firms reeling under depressed margins and shrinking markets, SeedCo’s problems are somewhat different and solvable. Most of its nagging pains emanate from Government’s inability to honour payments on time – which may soon be a thing of the past as Zimbabwe’s contribution to the group’s sales continues to decline. With current contribution to group revenues sitting at 28 percent, we estimate that by year 2017 Zimbabwe’s importance in the group could be so diminished as to account for not more than 10 percent of the group’s revenue/profits. Not because Zimbabwe’s sales are expected to fall but that sales potential in the rest of Africa, notably East and West Africa, are set to easily dwarf local ones.

Over time, investing gurus have proven that buying and holding stocks well-positioned for long term growth in sales and profits is the sure way to enduring wealth. Sadly many professional investors still attempt to bet on business cycles. But judging a well-positioned stock is not easy, mainly because it is more qualitative than quantitative. It has more to do with a business’s competitive edge, management and potential of product than building predictive financial models.

So here is why SeedCo strikes us as a quality business:

Sufficient Market Potential

According to Agrow, Africa’s total seed market is estimated to be US$1.1 billion, providing enough seed to cover roughly 10 percent of the African cultivated crop area. SeedCo’s $120 million sales make the company an 11 percent market share holder of the African seed market – arguably the continent’s biggest seed company.

But what is more exciting is the growth potential of the seed market. The World Bank reports that the continent holds almost 50 percent of the world’s uncultivated land which is suited for growing food crops. Yet Sub-Saharan Africa still imports food. But the continent’s booming demographics, rapid urbanisation and heightened food security fears are driving governments, NGOs and private sector’s commitment to support food production. According to Growing Africa, food systems in Africa currently valued at $330 million may well triple to a trillion dollars by 2030 with necessary support.

SeedCo’s 120 percent growth in revenue between 2009 and 2014 is likely to be its slowest growth if the company grows with the current market. The seed company’s entry into West and East Africa’s markets may be the best move in its history. For example in Kenya, the company’s seed tonnage sales rose 25 percent last year to 4tonnes, in a market estimated to be 35 tonnes. And as the company starts selling in the Kenyan highlands, it expects sales to rise significantly. Like us, you will struggle to come across any company on ZSE with comparable growth opportunities.

Competitive Advantage

Apart from participating in a market of tremendous growth, another criterion for a quality business is its competitive advantage. A quality business needs to possess a capability that that makes it difficult for new comers and competitors to enter into the market. The seed industry is a scale business where economies of scale drastically reduce the cost of producing a unit of product. With the exception of niche crop/vegetable seed producers, most small companies struggle to compete on price with large players like SeedCo and DuPont Pioneer. Furthermore, brand loyalty is high among farmers. The risk of low yields from trying unknown and new brands can be too much to bear for farmers.

Globally, as research and development becomes a key component of the seed business, the industryis starting to resemble the pharmaceutical sector where consolidation is central. SeedCo’s cooperation with French technical partner, Vilmorin & Cie S.A, strengthens its capability to release great seed varieties that further sustain its competitive advantage. We believe the industry will eventually be dominated by a few large seed companies of which SeedCo would be one.

Management quality

If management’s stewardship is judged by how resources are allocated and the return earned then SeedCo’s management is at least doing good. We respect the way the management is managing the business’s expansion but more importantly its mitigation measures in dealing with reliance on government orders.

At the latest company’s results presentation in Harare, we asked the CEO, Morgan Nzwere, how SeedCo was responding to the company’s reliance on government seed procurement. His response outlined how the company is working towards strengthening its distribution footprint to reach farmers directly. Combined with the relative decline in Zimbabwe’s contribution to group sales, concerns around bulging short term financing and debtors may be done away with.

Sweet spot- Where Value and Quality intersect.

High quality companies are often not the cheapest companies around. But when you stumble on an under-appreciated company that is trading at low valuations and is of good quality, you have hit the “sweet–spot”. At 70 cents a share, SeedCo is trading at a Price-earnings ratio of 11.9 and Price to book of 1.42.

The legendary investor in quality companies, Philip Fisher, once advised investors not to over pay for quality companies but to wait for buying opportunities which could range from short term troubles with products and customers to general market declines. SeedCo’s share price decline by 32 percent in the last 6 months, presumably due to the same reasons, may well be Fisher’s perfect case study.

Ray Chipendo is the Research Lead at Emergent Research. He is contactable on rayc@emergentcapital.co.za, @ray_chipendo

– See more at: http://source.co.zw/2014/07/great-investors-focus-on-quality-you-should-too/#sthash.97D0omuB.dpuf