Investing in African equity markets today: Zimbabwe as a case study for sub-Saharan Africa

HARARE (Capital Markets in Africa) – A decade after its first disastrous flirtation with hyperinflation, Zimbabwe is once again on the economic precipice with the effects being conspicuously similar. Supermarket shelves have started to empty, some public and even private sector salaries remain unpaid, banking hall queues are getting longer and hospitals are short of basic supplies. Whilst the humanitarian state of affairs is critical we find the microeconomic structures persistently durable given that businesses continue to open their doors and survive, albeit under enormous difficulties. 

When analysing financial results of certain businesses in Zimbabwe, and comparing them to similar businesses in Nigeria (whose economy is also reeling from a substantial deterioration in aggregate demand), the Zimbabwean businesses are in many cases better off. In Nigeria, we have begun to witness the destruction of formerly impregnable competitive advantages as determined by profitability, return on invested capital and resilience of business models. By comparison, in Zimbabwe, where profitability may be trending negatively, many businesses( which survived hyperinflation) have retained their skills and chiseled business physique to survive an economic depression and continue to make profits despite the macroeconomic situation.

The rub for Zimbabwe, where the government has once again resorted to printing its own medium of exchange, meant to retain equivalence to the US dollar is that it may be the only way for it to remain competitive. This new currency, referred to as a Bond Note, is the Government’s answer to reduced liquidity of US Dollar deposits and seeks to enable the monetisation of virtual bank deposits. Virtual, because these bank deposits exist in electronic form but are almost impossible to withdraw without waiting in a daily queue to collect a maximum of 100 US Dollars per week. 

Whilst a viable solution at first glance, given that Bond Notes will be printed as part of an export incentive and limited to $200m “Bond Note Dollars”, which is estimated to be 4% of total deposits in the banking sector, it will boil down to confidence. If left unchecked without restrictions, what may seem like a perfectly sensible solution with little downside could have potentially catastrophic effects.  With limited options, the Zimbabwean government will seek out the path of least resistance. Whilst the announcement of realistic and meaningful policy is relatively inexpensive, in monetary terms, the reality is that it will be the electoral cycle which will take precedence. Economic growth projections at 1.1% of GDP appear optimistic given the state of US dollar liquidity, tax collections, and economic activity. What remains unknown is how the issuance of these notes will be viewed by the International Monetary Fund (IMF), broader multilateral funders and the international community. It would be reasonable to assume the IMF and the international community would be supportive of an initiative that seeks to promote exports and increase employment. 

The Zimbabwe Stock exchange which gained 7.45% in the final quarter of 2016, may be used as a proxy for this confidence. The fact that foreigners were sellers and locals the buyers indicates that there may not be agreement on what will happen in the future. 

In any transaction, the perspective of the buyer will be at odds to that of the seller. In this case, both buyer and seller are reacting to a loss of confidence. For the local buyers, the concern is the destruction of value as occurred during hyperinflation where the Stock exchange is viewed as a natural hedge of value whereas foreign investors are looking to realise whatever real return they can in the shortest possible order. Sadly, there is a flaw in the latter’s strategy where investors who have managed to sell shares have their currency locked in the banking system due to insufficient US dollar liquidity to complete the transaction. Similarly, dividends paid by listed businesses cannot be remitted back to the originating bank for the same reason.

As a foreign investor, real returns are critical on a continent exposed to the vagaries of global commodity prices. Foreign currency shortages in particular US Dollars are not a new phenomenon and in fact have become quite common in African economies since the Global Financial Crisis. Such investment risks are not confined to Zimbabwe, it is just the latest African example with Egypt, Angola, Mozambique and Nigeria all suffering similar fates during 2016. These macroeconomic risks affect countries around the world. Generally speaking, it helps for capital to be patient as over time liquidity shortages can be worked through and its impact reduced. This enables investors to realise real returns as opposed to merely realising performance gains through timing the ebbs and flows of market momentum. 

Successfully deploying capital in Africa or any other emerging market requires discipline. Possessing this and the other habits mentioned above improve the likelihood of identifying businesses with the fundamentals to produce sustainable returns, far greater than their cost of capital. We find similarities between such businesses and “rough diamonds” where their resilience and value is of a rare pedigree.

Unfortunately, not all of these businesses are listed on the stock exchange. Investments, therefore, require specific expertise in order to navigate the administrative structures which carry a slight difference to those traditionally used in the listed equity space. Over the last four years, there has been a noticeable increase in the investible opportunities in corporate debt and trade finance providing access to real returns in the form of US Dollar yields. Such investments allow investors to participate in individual corporate profitability whilst at the same time facilitating the natural progression of an economy by channeling capital towards the more productive sectors of the economy. As such, there has been a proliferation of buy and hold corporate debt and trade finance transactions issued and executed which have been targeting yields of between 8% and 15% per annum in US Dollars. 

Warren Buffet once suggested to the investment world that “the rear-view mirror is always clearer than the windshield.

This adage holds true within African markets where the future is unknowable and therefore is why it is the future. It is important when navigating volatile markets that any investments are channelled toward businesses that are driven by incentivised management teams with the fortitude to alter or stick to their strategy where necessary. Business models and product offerings must be appropriate to meet market demand within an industry which has sustainable barriers to entry. These are just some of the factors to be considered when investing in African markets and increase the likelihood of a successful outcome.

This article is featured in the March 2017 edition of INTO AFRICA Magazine, Africa’s Lions: Trust in Fundamentals.