LISTED COMPANIES - NOT SO BLUE AFTER ALL

The last week has been indeed a very important one for not only investors, but equally for policy makers in gauging the direction ofthe economy. Most listed companies and banks in general have been publishing their results which, to a large extent, have been impressive. The adage that ‘size does not matter, what matters is how you use it’ has been put to test once again, and indeed some ‘seemingly’ big institutions such as ZB Holdings and PG have failed to use their perceived size to generate positive earnings for investors with full year losses of $2.6 and $9.2 million respectively.

Among the banking stocks, CBZ Holdings, with a remarkable trading P/E of 6x, is one of the most attractive counters on the market after it bagged $22million in profits in 2010. The market capitalization levels of companies on the ZSE continue to show interesting valuation aspects, with highly geared companies getting the lowest confidence. Interfresh, after having made a profit of $3.7 million, albeit heavy reliance on revaluation gains amounting to $7.3 million, is trading at a market cap of $1.5 million! Where on earth would one find such a cheap stock whose market cap is half its annual profit? Shouldn’t Interfresh be the most attractive counters onthe ZSE? A closer look at its balance sheet reveals a worrying debt component in excess of $5 million. Indeed the market has been discounting such stocks that do not exhibit strong positive cash flows that can potentially extinguish debts that are sitting on their balance sheet. And equally important, its revaluations at $7.3 million versus a loss from operations at $2 million point to a very long road ahead of Interfresh towards return to real profitability backed by positive cash flows.

Therefore, considering the very slim possibility that Interfresh will declare a dividend in the next three or so years, investors will find it hard to see value in the stock, and indeed its market cap at $1.5 million is probably a very true reflection of the value of the company. PG Industries is one such listed company that has equally suffocated under the debt burden and inefficiencies since dollarisation and has, expectedly, lost the keys to open the doors to profitability, churning a massive $9.2 million loss in 2010. Having struggled with a debt that had ballooned to $10 million just before its right issue in December2010, PG’s subsequent proceeds from the $11.2 million right issues had very little impact in changing its falling fortunes. Unusually high losses typically put struggling companies’ going concern in serious doubt, and surely the market does not wish to see another Gulliver,Redstar or Bindura in PG. PG has failed to re-align operations tosatisfy the modesty and efficiency that is called for in a stable environment with low operating margins, and resultantly it has not managed to steer clear of trouble.

And a fragile cash-flow position and unsustainable operating costs have haunted it for long. The market will not, however, give PG the proverbial nine lives of a cat and unlike the Zim-dollar environment, the losses that PG is making are real and it has to move quickly to plug the leakages. Its shareholders, having recently capitalized it, inadequately though, may not be having the same appetite and ability to inject more money to fund an unviable business model.

And the local lenders, having burnt their fingers in PGs before (such as BancAbc), will likely want to keep their distance from such a big company whose magnitude of losses are enough to bring down a couple of small banks in town. Therefore the future of PG rests with the ability of the board to demonstrate above-usual leadership skills by learning two key aspects on managing a business in a stable environment - keeping costs down and optimizing debt.

The advent of dollarisation has brought in very low inflation (nowbelow 4%), liquidity crunch, real costs of doing business and thinoperating margins. Some of the weaknesses of business models that survived under hyper-inflation where costs were subsidized have now been exposed. Common blame has now been on the inaccessibility and high cost of capital, but the bottom line remains that no more subsidies exist in this economy for poor business models and the time has come for managers to take full responsibility for running their businesses. The tragedies of PG Industries, Redstar, Gulliver and Steelnet, among other listed companies, show that indeed some business models need to change or perish. Unlike in 2006-2008 era when borrowing was the most lucrative activityon any company’s balance sheet, the costs of borrowing in the dollarized environment are real and many companies, including listed ones, have lost the ‘blue chip’ status.

Indeed bankers and creditors who will lend goods and services without security to listed companies just on the strength of it being listed may learn the hard way that all that sounds, looks and smells blue is not blue after all. Banks therefore have to remain very vigilant in such circumstances to ensure that they do not carry the burden of economic losses via exposure to high non-performing loans of inefficient companies. Zimbabwe corporate environment is navigating through a very important phase of creative destruction, and banks, for their very important intermediation role that keeps credit flowing to facilitate trade, need to remain vigilant and safeguard their capital.

BARCLAYS BANK – NONSENSICAL ARROGANCE, COSTLY ALOOFNESS

Good signs of progress

The reporting season is upon us and there is little doubt that the economy has turned around the corner, at least for companies that are managing to navigate through debt traps and keeping costs down. The impressive results coming out of Innscor, Dairibord, Cafca and Truworths, among others, reveal a growing impressive profitability path. These are clear signals of domestic demand improving at are markable pace although the numbers are not reflecting clearly in theGDP growth figures that remain somewhat depressed. The Innscor Africa’s goods train, whose coaches are representative ofthe broader FMCG segment of the economy, has notched a massive 22%increase in revenue for the six months to $255m, a very clear andbroad sign that indeed domestic demand is strengthening.

Inasmuch asgovernment coffers are showing a gloomy picture, at least for now considering treasury revenue for the first two months of 2011 has fallen below the target by about 40%, the broader economy-wide risksare tapering-off. By growing its pre-tax profit 2.3 times more thanthe corresponding growth in revenue in 2010, Innscor has exhibited significant cost containment measures, and indeed the continued expansion and refurbishments should bolster earnings significantly inthe future considering the consumer purchasing power that is increasing at a sustainable pace. However, considering the significant cash that Innscor generates, the group should actively optimize the same and reduce the temptation to grow the debt exposure that compromises future earnings and liquidity.

Profitable Banks, a good economy

The banking sector, which is the barometer of the broader economy, isyet to publish most of its results but Barclays Bank Zimbabwe hasalready opened the fair with dismal performance, posting a loss of$1.4 million for the full year to December 2010. BancABC’s local operations have realized a modest $3.6 million profit over the same period, a significant turnaround from the losses of 2009. And indeed the share price rose 18.6% soon after the results announcement, a showof confidence in the banking group. Cabs Building Society, on the other hand, has exhibited important efficiencies in the six months to December 2010, needing only $6million to run its very huge branch network, a very important and practical case study for other banks to learn from. Barclays struggled with operating expenses at $33 million in 2010. For the six month,Cabs went on to make an all important $5.5m after tax profit(excluding property revaluation gain). The decent profits coming outof banks are good indications of moderating risks and that signal better times ahead for the economy. This will generally translate to cheaper, longer and flexible credit becoming available.

Across the border, South African Banks, sitting on deposits of $359.8 billion asof December 2010 and loans of $306.1 billion, have equally improved on their profitability. ABSA, the biggest bank, made an operating profitof $1.3 billion for 2010. Barclays Bank Zimbabwe somewhat exudes significant elements of itsglobal DNA. The Barclays Bank Group has generally been the conservative type, having been one of the few banks that did not receive government bailout funds in the UK at the height of the financial crisis in 2008. But it has however remained largely profitable, and for 2010, Barclay’s Plc pre-tax profit rose 30% to £6billion. Barclays Bank Zimbabwe has however taken conservatism to theextent that has not only frustrated investors, but has equally seenits deposit market share plummet significantly to as low as 7% in 2010 from as high as 15% in June of 2006. These figures reveal market confidence that continues to slip from its palms and indeed, with its aloofness, Barclays is gravitating towards the pool of the small banks in town, the tag it rightfully deserves. But does size really matterin banking? Indeed it does given the narrowing net interest margins and surely bigger banks are better placed to make decent profits than smaller ones.

Managing banks in difficult economic times is not an easy task considering the need to safeguard liquidity and solvency whilst at the same time contending with an expectant economy looking for easy and cheap credit. At a time most of the banks are increasing credit facilities to customers to assist the economy that is desperately in need of credit, Barclays Bank Zimbabwe has rather decided to remain very conservative. The preamble to its 2010 financial statements is fraught with glaring contradictions that probably seek to pacify investors that are tired of the same old justifications for poor performance. Although claiming to be negotiating the ‘environment with minimal adverse impact to customers, employees and shareholders’, the very figures in the financial statements flatly refute these assertions. Its loan to deposit ratio, at a paltry 23%, is the lowest in the market that averages 65%. Banks generally keep more cash toward the end of the year as a strategy to ensure that their credit rating levels are favourable from the liquidity perspective, and Barclays seems to have embraced the idea wrongly, if at all it was the intention. It is not surprising therefore that, after having failed to adjudicate credit risks appropriately and ending up sitting on piles of cash under the guise of safeguarding liquidity, Barclays Bank Zimbabwe has failed to identify the road to profitability, posting aloss of $1.4 million for the 2010 full year. Worse still, this isafter it had received $6.5 million in restructuring assistance for the retrenchment of 206 employees from Barclays Plc.

Does it not cross the ‘minds’ of Barclays Bank Zimbabwe, listed for that matter, that levying bank charges of $19 million vis-à-visinterest income of a paltry $4 million is a sign of excessive risk-averse behavior, being insensitive and more importantly failing the vital intermediation role that the banks are supposed to play? Comparatively, BancABC Zimbabwe’s interest income, at $16 million, is decently much higher than its non-funded income at $10.7 million and when compared to Barclays’ income structure, Barclays leaves a lot tobe desired.

Barclays needs to learn the importance of keeping its costs down so that even when it decides to toe the line of a conservative lending approach, it would not inadvertently incline heavily towards non-funded income as the main income source to remain afloat. Of course Barclays bank will not probably be the only bank that will show excessive dependence on non-funded income. But the fact that it purposefully keeps its lending too low (the lowest in thesector) puts itself in the path of well deserved criticism. Indeed it would be disastrous for the economy as a whole if CBZ and BancABC, among other big banks in the market, had the same mentality of conservative lending as Barclays’.When a bank the size of Barclays is so scared to lend, hallucinating bad debts stalking it from every corner, the logical conclusion therefore becomes that the ‘robust risk management framework’ that the bank so claims to have is either non-existent or incorrectly specified. Is this not the same bank that saddled its balance sheet with non-performing 2-year special TBs back then in 2006 and 2007 when it consistently failed to apply its excess liquidity to good use and the RBZ would wipe the same and lock it up for 2-years? And indeed ithas been losing market share, moving toward the middle-tier banks but more worrying still, not understanding how to make profit. In its results publication, Barclays Bank Zimbabwe also bemoans the‘slower than initially anticipated’ economic recovery.

By deciding to be very conservative in its lending, the bank is indeed amplifying the same economic risks its running away from – the act of a bank entangled in an inextricable web of self delusion. The individual decisions of a bank the size and stature of Barclays have a big impact on the perception and quantification of country risk. Lines of credit usually come through banks. Therefore when banks such as Barclays are very conservative in lending locally, continuing to be wary of risks in the economy, only courageous foreign investors will take the bold step to see the opportunities and proceed to establish lines of credit for the country.

And Barclays therefore does not only become a pain to investors holding on to its stocks, but equally to a local banking sector whose fortunes on lines of credit become mis-interpreted by foreign investors who may naturally incline toward Barclays’ exaggerated negative view of the economy. After all has been said, the income structure and lending attitude of Barclays Bank seriously compromises its role in the banking sector and being a big bank, Barclays may need to take very important lessons from equally big and profitable listed banks such as CBZ and BancABC and meet the expectations of investors and the economy as a whole.