Superior Competitive Advantage: The key to survival in 2017

At the close of every year, we all have that moment when we think about the past year and what we would have done better. We also consider what we learned from the past year that will enable us make positive strides in the coming New Year. Resolutions, many would call them. For premier companies and others, the resolutions of the management team is to achieve more growth in the bottom line. But can they achieve this when growth forecasts look so bleak? How can they remain formidable when the macro environment is so hostile on a global level? The answers lie in the numbers. The numbers are what allow these companies to develop a strategy that can allow them to navigate the business environment of 2017. Here is how.  

Durable Competitive Advantage

Taking a leaf from Warren Buffet’s ideology of what makes a company attractive, there are lessons that premier companies in Zambia can learn from on how to remain relevant in 2017. The investment maestro seeks out companies that have durable competitive advantage. Now, TFHZPC understands that the New Year Stock Exchange (NYSE) is light years ahead of LUSE in terms of transaction volume, however, the fundamentals of business remain the same.

Over the course of the year, through our corporate intelligence investigations of companies on LUSE, we have observed there are companies that exhibit “Buffetology alignment”. These are companies that sell a unique product, service or are a low cost buyer. These 3 approaches to business fundamentals for many companies in Zambia will be key to ensure they survive the coming times.

As liquidity tightens, financial institutions will need to develop product offerings that are both unique and give customers an opportunity to differentiate the products they are offered in order to get the best value for money deal. For the food industry, economies of scale as demand for lower costing food sources will be key in ensuring growth in revenue and profits. This will be made possible through further integration of the value chain that will enable companies within that industry to be low cost buyers. For the real estate industry, product bundling may be the means of selling a unique service by players in that industry. With consumers becoming shrewder with their investments, product offerings that allow them to get the most out of the transaction will be key.

In order to achieve superior value, an inventory of resources and capabilities will have to be conducted. An assessment of the company’s assets and their time to expiry will be important when making strategic decisions that may require pursing an economies of scale approach. It is impossible to grow your production level when your equipment or animals are getting old.

Another concern is the turnover of inventory. Carrying stock will be expensive in 2017. Therefore, being able to move the goods off the shelf will be key in growing bottom line. As consumers scale back on spending, price elasticity of demand will be crucial in deciding what price movements to have in place for the products in stock.  Some companies will be tempted to drop prices in order to boost revenue growth however it will be pointless if they do not consider the low cost buyer of raw materials or component services that make the final deliverable. This is how they will be able to protect competitive advantage and increase value. 

The Macro Environment Explained

For a while now, we have brought you blogs about the fundamentals that make premier companies in Zambia special. We have talked about how the macro environment has influenced some of the success and failure of these companies. But whilst drinking a glass of wine at an exclusive pub in Lusaka, a native asked the question “this macro you keep blabbering about on your ka blog, it’s just politics affecting business!!” as he scoffed at the thought that it was only in one dimension. Putting down my glass of 2010 Merlot from the vineyards of the south of France, I endeavored to empower this entrepreneur on the macro environment. Or simply put, the marketing environment.

Know the 3 Cs

Premier companies know that it’s all about customers, company and competition. Any company that forgets any one of these Cs has no right to be in business. Yes TFHZPC said it. Understanding the external forces allows a management team to understand the various elements that affect the 3 Cs and how the course of the company can ultimately change overtime (when fortunes turn). The 3 Cs allow companies to bring visibility to what they are doing: marketing. In order to achieve this however, they must conduct market research.

Although, market research is an arduous task, it is a necessary ‘evil’. Some companies have convinced themselves that they have the ultimate product and hence do not need to do any market research (marketing myopia). Other companies have enjoyed so much power that they have extended their stranglehold to their suppliers (“Boss, will only pay you for this supply if customers buy, if they don’t sorry your goods will be a waste”). Others find themselves at odds as to whether adoption of technology is the right way to do it (think of those banks that have taken so long to bring ATMs to their customers). And finely, our favorite is the lies that customers tell. It’s often hard to tell whether a customer is telling the truth as to whether they will buy your latest offering or not. Think of the paradox of pub goers. A new place opens up and the owner of the establishment decides to put a surcharge at the door after building up the hype and “BOOM”, customers don’t show up even when they promised!  

Survival Toolkit

The marketing external environment is influenced by a number of factors but for simplicity they can be categorized as Social, Technological, Economic and Political and Legal forces (STEPL or PESTL). Social demographics looks at what trends are in the environment. What is moving and shaking your customers in the moment? Technology changes are key to understanding how consumer experiences are evolving (the rise of social media through the use of smart gadgets). Economic issues evolve around your GDP, Taxes, Interest rates etc. Political and Legal are interlinked as depending on who is in charge the legal system does get a nudge. However, understanding the political landscape is vital as it can allow a company to position itself accordingly depending on how and what policies are implemented (one policy statement can bring a rise in the number of your competitors in a heartbeat).

The market research process can feel like an academic exercise, however we believe with the way the marketing environment has evolved premier companies and others will need to consider investing in it in order to remain relevant. The times are changing, companies must stay in tune or else they risk ignoring one or all of the 3 Cs. 

When Dominoes Fall – Of Demergers and Divestures

History always provides us with lessons for the future. We at TFHZPC draw our strength from our ability to use numbers to decode historical trends that can provide an indication that supports our ‘gut feel’ on how the strategic tendencies of premier companies will be shaped.

We take you back with our insight into the financials of CEC in our review of their 2015 performance. We walked you through “destruction of value on Nigerian soil due to explosive Naira”. The 11 November 2016 SENS Announcement from LUSE on them disclosed a strategic move by the group to demerge from the investment vehicle they had created in 2013 whose purpose was allow the group to explore the power sector across Sub-Saharan Africa (backed by $100m in their piggy bank). Enter Naira land and Diamonds of Sierra Leone.

We followed the macro developments on these investments and of note was the paradox of tumbling naira which possessed a credible threat to creation of value in President Buhuri’s “backyard”.

Enter SENS announcement from LUSE on 29 November 2016, CEC Plc decides to divest from diamond land. Although they argue that the country remains an attractive investment destination, we decode that the move is purely to protect shareholder value. Rightly so we might add. The rule of every finance manager is to accept all projects with a positive net present value. However, circumstances in the macro environment may lead to the NPV moving target hence an astute management team will take the decision to change course to protect value.

However, strategic decisions are not without consequences. In the case of nairaland, verbatim from the SENS report read:

“The Board has, therefore, determined an impairment of USD99,999,999 which implies that the carrying value of CEC Africa in CEC Plc books reduces from USD100 million to USD1;”

The aforementioned will certainly appear in next years published financials which we will be digesting at publication. We are still firm believers of accepting all positive NPV projects however, we also know that when the project is not a success, the numbers in the financials will show.

No Systemic Risk for Zambia’s Financial System

We have seen some of the headlines coming from popular publications and we are dismayed by the some of the social media sentiments on the stability of the financial system that supports premier companies in Zambia. For the record, we are not experts on the Zambian banking system, however, we do know what systemic risk looks like when we see it. In short, recent happenings at a known bank are not indicative of systemic risk. Far from it.

What is Systemic Risk?

Before you rush to your bank and start withdrawing your hard earned “dividends”, its important to know what systemic risk is. But wait! Why are we calling it systemic..risk? Well, the formal definition is mandatory in this situation because of the alarm that social media has raised. It’s so hostile that even the central bank had to issue a cautionary note over this matter of the banks it supervises (read it here).

We are not faced with the collapse of our financial system. Far from it. According to investopedia.com, systemic risk is the possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy. In this case we are talking about our financial system.

We have been monitoring the health of premier financial companies and we glad to note that all of them have taken (and are taking) the steps to protect shareholder value. We know this from the ratios on performance, liquidity, risk and efficiency on their recent financial statements. Our expert assessment shows that their numbers are not indicative of rocking our financial system hence BOZ is within its faculty to ‘school’ the social media novices.

So before social pundits mislead the masses, think of 2002’s Sarbanes-Oxley Act and 2008 financial crisis that was caused by systemic risk (which ultimately led to Dodd-Frank). Recall there were many exotically package financial instruments that went belly up and had the US government bailing out several big name banks. Furthermore, listen to the “macro story” as told by the Finance Minister in his latest budget speech. We envisage “quantitative easing” by way of additional liquidity being availed onto the Zambian market with fiscal policies to support them being the crucible of financial hope. In short, the outlook of many of our bank’s balance sheets over the coming months will have quite a few positive surprises. We are bullish on banking in Zambia. 

Many Faces of Premier Companies – How To Not Be Myopic

In his famous Harvard Business Review article, Theodore Levitt told stories of how the US railway industry forgot what business they were in and were fast overtaken but road and air transportation. We have been reviewing some of the behaviors of certain premier companies and it’s clear to us that some of them chose to not be myopic.

With a macro environment that has become hostile to many companies, few Zambian companies are stepping up and making the kind of strategic adjustment that will render their businesses to run ad continuum. These are companies that have answered the quintessential question “What business are we in?” The sort of companies that have realized that growth industries are few and far between. Management teams that know that their responsibility is ensuring their companies do not suffer fateful purposes ergo realizing that if caught in a self-deceiving cycle they would render their businesses obsolete. Decision makers that realize that regulation, when in effect, must be given the seriousness that it deserves or else their business could face foreclosure. Adapt or die.  

CEC is one premier company that lives up to the bill of non-myopic. If the management team were asked, “what business are you in?”, we envisage a response that could possibly be partly shrouded in camouflage albeit protecting company strategy. However, they are an energy company with interests in telecommunication. They have been steadily working at increasing the scope of their vertical chain but at the same time, have looked at their resources and capabilities and discovered means of creating competitive advantage through resources that would traditionally condemn them to the status of a non-energy company. However, just because one is a farmer, it does not stop him from selling water if it’s in excess. The paradox of reserve capacity demands that if you are a player in a game and your resources allow you to compete in a nontraditional market, it would be folly to ignore that value creation potential that capacity gives you. This is essentially what CEC has done…is doing. On the back of its resources, it has been able to spawn off new businesses such as CEC Liquid and Hai Telecom.

As we continue to adapt to the current macro environment, entrepreneurs will need to dig deeper and assess the various resources and capabilities that they have. Bounded rationality will become a liability for anyone in business who chooses not to adapt. When the environmental pressures increase, strategy will demand self-reflection and an answer to the proverbial question: “What Business Are We In?” Ultimately, every Zambian desires to create value.      

Love Marks – The Future of Brands

Kevin Roberts, CEO of advertising company Saatchi & Saatchi, describes “Love Marks”, as a  growing phenomenon of advertising, which are destined to take over from the concept of brands. Evidently, love marks, as a brand, create loyalty beyond reason by allowing consumers to build an emotional connection that uses mystery, sensuality and intimacy. In Zambia, we have witnessed an emerging trend that points to the evolution of local brands becoming love marks. Here is some of the evidence we have observed from some of the premier companies listed on LUSE.

Zambeef has built a brand that is a house hold name. You will note that this firm deals with both sides of the consumer spectrum: cheap and premium. Through their micro outlets, such as the ones in some of the densely populated townships, they have brought food closer to the consumers. When the company faced the wrath of consumers over their importation of products that had questionable preservatives, they were quick to stop the practice and re-established the customer loyalty they had. This was evident from their performance in the following financial periods which was indicative of a bond that was strong and intimate: Love mark.

Zamefa has had customers swearing by their cables as being the most reliable. Although we had reported in an earlier blog of the 2015 financial performance that exports were the main value creator, we noted from the mid-year review that local purchases were on the increase as more and more customers trusted their quality products. What was interesting was that their brand was not ubiquitously visible, however, through an emotional connection that customers made by trusting the product over others, a strong bond was created: Love mark.

Zambia Breweries has been producing its flagship product Mosi for generations. Although the company has undergone takers and changed its face over the years, you cannot deny that consumers have remained loyal to their product Mosi. Some may recall when echoes of castle beer over taking Mosi were high, many consumers begged to continue enjoying their premier beer. There is no pub in Zambia that does not stock this beer. This is a beer that many consider as the identity of our country Zambia. A national icon perhaps but the sensual relationship that exits between Mosi and its consumers can only lead us to believe that a love mark exits.

All the companies mentioned have spent a considerable amount of money to grow their brands. In order to stay competitive, marketing campaigns for their products may be seen to become more personal. It is at this point that the firms realize that in order to sustain the sales of their products, their consumers must be faced with a loyalty dilemma before they consider buying a competitor’s product.

Evidence from financial statements suggests that goodwill is important in achieving the development of love marks. Although it is an amount that can be easily impaired when issues of reputation are raised, this is one component that must be protected by the company in order to ensure it remains relevant with its customers. Furthermore, we at TFHZPC believe that love marks are the driving force behind production drives demand. The economics of our argument is that if your product is so loved, it will have price inelasticity and sales will be driven by your production levels.     

MPC – How the 5th Force Continues to Reign

On 16^th November 2016, the central bank governor Denny Kalyalya announced the decisions of the monetary policy committee (MPC). This quarterly announcement sets the tone of how the money in the country will “behave” over the coming months. With the budget recently announced by the finance minister, financial institutions listened with intent on how they will navigate the macro forces that would be presented. On this occasion, we can only imagine the relief that came when the announcement was made that the policy rate would be maintained at 15.5%. One of the reasons for this was an improved inflation rate of 12.5% (down from the early 20s).

With inflation heading south for Christmas (towards single digit), it’s understandable why the governor is bullish on the economic outlook. This is seen through the signal of reducing restrictions on money flow by removing restrictions on banks’ access to the Overnight Lending Facility (OLF). Furthermore, the central bank will allow the banks’ automatic conversion of intra-day credit to overnight loans on the OLF and extend the banks’ compliance to statutory reserve requirements from daily to the weekly average (according to the policy statement).

This move echoes the finance minister’s statement in the budget speech where he indicated support for the financial system to get more cash into circulation. This is good news for premier banks such as Standard Chartered, Invest Trust and Cavmont (all listed on LUSE) as this will certainly influence their competitive strategies for the coming year. With the consumer in mind, these banks will certainly be looking for ways to bring products to market at a good price. We will not speculate that interest rates will fall as the reserve rate and OLF (both influence loan interest rates) have been maintained at 15.5% and 25% respectively. However, with more liquidity available, this may get the banks thinking of how to extract more value from the surplus cash available.

Although the recent increase in fuel may impact the inflation rate in the medium term, there is confidence from the central bank that single digit inflation is attainable by year end. Premier companies will be keen to see how this plays out as they look to closing out the year with less inventory on their balance sheets. With the year almost at a close, surges in pricing may have a negative effect on revenue growth as more consumer products become elastic.  

Whatever the case, we see a change in tide for monetary policy going forward. The New Year should be meet with capital budgeting strategies that can take advantage of this change. We all need cheaper money to survive in the game. 

Industrial Development Corporation – The Road to IPO

Tucked away in Lusaka South Multi-Facility Economic Zone is an entity that is poised to set the Lusaka Stock Exchange alight. When President E. Lungu made the statement to parliament on the significance of the IDC and its mandate to take companies to Initial Public Offering (IPO) or listing, TFHZPC got really excited about the prospects of analyzing future premier companies on LUSE.

But the question is, “How do we get these State Owned Enterprises (SOEs)” to IPO. We will not speculate on the timeline of such an endeavor but we will provide some pointers on some of the signals future investors need to look out for if they intend to further diversify their portfolios. 

The Turn Around

Before any company can consider going to IPO it must look at the health status of its books. The numbers on the present and previous years have to be assessed whether or not the company has had good earnings. If the earnings have been negative, a turnaround will have to be put in place. This can come in many forms (some unpopular) but the most common include a review of the management team, staff levels, leverage, customer relations, supply chain management, working capital management and cost management.  Strengths and weakness in the aforementioned give the turnaround team an idea what it will take to make the company profitable again. More often than not, it’s always expected that a time frame to profitability will be put in place and the aim is to get an income statement that has positive earnings three years in row.

Valuation

With steady cash flows, an unquoted SOE can easily be valued using net present value or discounted cash flow. What these methods basically do is they look at the revenue potential of the prospective company over a specified period of time and allow for the determination (calculation) of the company’s theoretical value. Comes in handy for stock brokers to determine what share price the company will list at.

Underwriting

The process of taking an SOE to IPO is an expensive and meticulous one. The banks with investment divisions will be keen to land the contracts to help with the process of taking these companies to IPO. The banks will be responsible to handling the intricacies of the process with regulatory departments such as the Securities and Exchange Commission (SEC) and also engaging with possible investors. Eventually, a document known as the final prospectus is produced which is the go to document for all that want to know about the company and why it’s listing. In addition, details of the share price would have also be determined by the underwriter.

What Value is there in Listing?

Once the SOEs are listed on the stock exchange, this will offer government an opportunity to either exit or retain a minimal stake whilst at the same time allowing Zambians to now participate in the ownership of these newly promoted premier companies through their ownership of shares. Although the share certificates may not be enough for the owner to have a seat on the board, there is eligibility to dividends as well as value growth as these companies become more profitable. We envisage pension funds and high net worth individuals will take this opportunity to invest in the newly promoted premier companies. These will certainly open up new avenues of value creation that many investors will be longing for. 

The 2017 Budget in a Nut Shell

Every time a Finance Minister takes to the stand and presents the coming year’s budget, CEOs, entrepreneurs and Finance Managers alike listen with keen interest on what the macroeconomic environment will be like for their businesses in the coming year. Hon.  Felix Mutati last week Friday 11^th November 2016, presented Zambia’s budget to the house of parliament. This was the most anticipated budget as many stakeholders were keen on understanding how in the era of deficit and courting IMF, Zambia would navigate the coming year.

We at TFHZPC will not go into the details of the entire speech but we shall provide some highlights that may need to be taken note of by premier companies listed on LUSE. With the financial statements in mind, here is our perspective of what industry should expect.

Taxes

With the upward increase in PAYE’s upper band from 35% to 37.5%, there will be movement on SGA on the income statement as admin costs rise marginally. Increases in tax on airtime, beer and cigarettes will impact Airtel, Zambrew, National Breweries and BAT respectively earnings are reduced in tune with the increase in tax. Economies of scale will be the strategy to employ as these companies will seek to grow their revenues from increased units of sale of offset the tax jab.

The Top Line

With K5.7 billion allocated to the medical industry, we envisage insurance firms may consider tapping into this opportunity of increasing their revenue in terms of premiums. We noted in earlier blogs that part of Madison and Prima Reassurance’s strategy was to grow their subscriber base. When money enters the medical industry, it presents a unique opportunity for players in that game. This could be translated into more affordable options for their clients in terms of where they access medical services inadvertently leading to less pay outs from insurance companies for subsidized services.

In addition, government’s plan of diversification to cash crops such as cotton, cashew nuts, soya beans, cassava and rice will have Zambeef thinking seriously about these products. Revenue grow is from scale therefore, looking at their present strategy of growth through acquisition, if the numbers are right, the board may consider a trade buy of an established player as they company consolidates its foothold in the agriculture industry.  

Liquidation of Local Debt

Standard Chartered, Cavmont and Invest Trust will be keenly looking at government’s decision to liquidate local debt. This implies more local currency in circulation. This may stimulate banks to offer new services that will seek to increase their interest income on the income statement. When this happens, their balance sheets will see growth in assets that will boast their positions with the central bank. A possible benefit to consumers may be reduction in interest rates as the liquidity crunch would have been lifted. This will be as a result of intense competition as banks try to figure out what to do with all that money.

Zambeef and ZamSugar: Chronicles of Financing Deals

In today’s challenging and diverse Marco environment, the modern Chief Financial Officer (CFO) or Finance Manager (FM) of a company must be knowledgeable in some of the most complex instruments at his his/her disposal in order to meet the demands of his/her company’s financing and investment needs. Corporate finance is a key activity in the management and success of a commercial enterprise and the CFO / FM is its custodian. Their task is twofold: look after their company’s investment story and ensure that it’s adequately financed. How difficult can that be? They are only long term decisions, by which we mean that the cash flow implications of the decisions last for at least a year, right? It is more complex than you know.

When a company looks at growing its revenue stream, it is faced with two choices: either to grow organically or go to market and purchase a company that already has a revenue stream it can add on to its own. The former and latter preposition is what Zambeef and ZamSugar (respectively) ventured into when you look at their significant transactions for 2016.

Rule Number 1: Accept All Projects with a Positive NPV

In ZamSugar’s case, using a combination of its own liquid assets ($20m) and funds from a syndicated financing agreement ($60m) they were able to raise the $80m they needed to invest in the Product Alignment and Refinery Project (PAAR) which was officially commissioned by His Excellency, the President of the Republic of Zambia, Mr Edgar Chagwa Lungu, at the Mazabuka-based Nakambala factory on 6^th July 2016. At the onset, the CFO is given the mandate to justify such an investment. There are many methods that are available to his team that may include Net Present Value (NPV), Internal Rate of Return (IRR), Hurdle Rate or Payback. NPV and IRR are the two most popular among CFOs. But what is quintessential about these methods is the consideration of the time value of money (A kwacha today is worth more than a kwacha tomorrow). This underpins their justification to the board that the investment the company makes will not only grow the company’s revenues but also increase the firm’s value in the long run. In short, the investment is a strategic decision with long term consequences.

Rule Number 2: Always have the shareholders’ interests in mind

In Zambeef’s case, they used a fantastic instrument called put options granted to Rainbow Farms Investments Proprietary Limited in 2013 as part of the Zam Chick Limited and Zamhatch Limited joint ventures entered into with RCL Foods. A put option (or simply put) is an option to sell assets at an agreed price on or before a particular date. What makes this deal even more exciting for a CFO is that he/she now has to present a case to the board where issues of how financing of this “put” shall be made. In their case, Zambeef had the option of dilution of shares by raising money through share offers which would have upset shareholders. In this particular case, the put was financed using cash from part of the proceeds from the US$65 million investment from CDC Group PLC. Not only does this deal preserve shareholder value, it ensures that that the company is able to continue financing its operations without being heavily dented by a large outlay of cash. Prudence is a virtual possessed by the most talented of CFOs.  

Respect One Two Three

In Zambia, we are big on numbers. Whether its vote tallies in the last general election, to the amount we are currently paying for fuel to the general perception of how much money it will take to develop our country. But ever wonder why some numbers are often taken for granted when looking at the bigger picture when creating value? Why success is only measured on the top line whilst the middle park is ignored? But wait. Not everyone has the privilege of being enrolled at institutions that teach interpretation of financial numbers nor are many alumni of such. A problem no doubt but not a complete train smash.

We at TFHZPC address this argument to the startup entrepreneur. The one with the big idea who wants to take it to the next level. The blogs we have given you so far tell the story from 3 core financial statements: The Balance Sheet (What a company owns, owes and its value), The Cash flow statement (How you are spending your money) and Income statement (What cash is coming in and going out).

What a company owns, owes and its value

When you enter a market as a game, the new player must take stock of what he believes will generate revenue for his / her grand idea. We believe they call them assets!! These money spinners are what keeps your business in the game. However, there is a small matter of paying for the privilege of money spinning. The liabilities you owe: be it to the bank, loan shark, relative that gave you an endowment. Subtracting these aforementioned two gives you your worth. Do not cheat yourself: you are not worth that invoice you cashed in. Do the math and know the worth of your business.

How you are spending your money

So you have accessed some cash. That’s financing. The moment you decide to purchase a printing press for your company, that’s an investment. When you have to do your tamanga, those lunch meetings to score the deal, fuel for your jeep or printing of business paraphernalia, that’s operational costs.

What cash is coming in and going out

What many often pay attention to mostly is the money coming in and out of their company. Accounting for revenue and what it costs to make those sales gives you an indication of whether you making good of those items that are in the balance sheet. Our blog ubiquitously mentions EBITDA. This is where we calculate it! (Can we retire now? Not just yetJ)

When 3 become one

We believe when in doubt, look at the numbers. Very challenging times ahead. The macro forces have not yet settled.  However, we excited to see what premier companies will be up to in these 3 statements when final year results are announced in 2017. With strategy at the center, we believe the 3 financial statements have the capacity to show light to any business owner who pays attention to them. The sort of light that makes managers make decides to opt for just in time (JIT) when it comes to handling inventory. The sort of decisions that marketing managers make when they are looking at increasing their company’s product visibility without hurting the bottom-line. The sort of decisions that make corporate finance managers seek alternative forms of financing of the numerous projects a company may wish to undertake to continue generating value. The sort of decisions that human resource managers will make that will bring the most out of their employees boasting return on labour (kwacha generated per employee). The sort of decisions shareholders will make when they take management teams to task to forego dividends in the interest of growing their businesses and retaining competitive advantage. The trinity of financial statements have the power to change the course of any business. We are certain that companies that will report healthier earnings at the close of our current financial year would have looked at the nuances in the numbers and extracted value from their businesses.    

The Anatomy of Zambeef’s Half Year Review

“Doctor TFHZPC, we have a Zambian patient at reception who would like to see you. His symptoms include desire for aggressive growth through expansion by micro outlets. He currently exhibits growth through acquisitions. His desire for value is unabated.” – Nurse

“I have been looking at your file patient ‘Z’. You have not been doing too badly of late. Your half year report for 2016 shows your continued focus on the core business: production, processing, distribution and retailing of cold chain food products. In short, you own and dominate your value chain making you a vertically integrated giant. You have also been aggressive in your expansion strategy albeit pursing stringent cost control. Tight fisted means you grow value. Literally.” – Dr. TFHZPC

“Doctor, what about his performance compared to this time last year?” Nurse

“On performance, I noted that your operating profit this year was up by over 200% compared to the same time last year. Phenomenal for a Zambian company.  There was an improvement on return on sales over the period with cost of goods sold against sales remaining fairly stable. Internally, there was a marked improvement in administrative expenditure which is essential for growing value. Keeping an eye on “SGA” is crucial to any business that seeks to generate value because this cost can destroy if not kept in check. There was also an upward improvement in turnover of inventory and fixed assets. The latter implies sweating of assets improved over the period.”

“Doctor, what about their liquidity and risk?”

“There was a notable 2% drop in gearing, specifics will be known at the end of the year, however it shows prudence in capital budgeting. In addition, your currently obligations are easy covered by easily liquefied assets showing healthy liquidity. This has been boasted by your improved working capital management. Money is coming in quicker than it was a year ago. Evidence of this is through your USD7.4million Zamhatch breeder farm deal which eliminated bottlenecks in your supply chain. The joys of vertical integration.”

“Will Shareholders be happy?”

“Return on equity and capital employed have shown tremendous improvement. This will certainly please investors looking for equity growth (in this case north of 13%).  They will have confidence in the business model. The macro outlet strategy will grow the company’s revenue as the company reaches the masses.”

“What are the prospects for the future?”

“I do not possess a crystal ball but what I do know is that there are echoes of an agenda that promotes agriculture. A SWOT on this would imply possible threats of competition with opportunities of further growth for the company through the incentives government will put in place. Keep an eye on those agricultural subsidies though. There could be opportunity lurking in there somewhere. Needless to say, your strength as a highly liquid extant player will ensure you dominating the market for some time to come. If any competition gets out of line, medication for this would be an acquisition of the culprit if their numbers are right and their strategy is solid. You have done it before. We believe you will do it again. Nurse, next patient please.”

INVEST TRUST – 2016 Half Year Review

We have been closely following the quest for positive earnings for Invest Trust Bank. Our annual review of the bank highlighted some of the challenges faced by this local offering. Following their recent publication of their half year performance, it is small wonder that they have now appointed a new Chief to head the bank. Simangolwa Shakalima comes to the bank on a back of a performance that was hit by the Bank of Zambia policy rate adjustment among other things. However, there are other issues reported in their interim report that include the impact of higher amounts and incidences of money market borrowings and increase in overnight lending rates (shows latency in changing a strategy that caused problems). The cost of money was expensive for the bank.

A spot check on performance showed a 9% increase in interest income (good), 34% increase in interest expense (bad), a 40% reduction in Net Interest Income (where they make their money), a 7% reduction in Other Operating Income (good, shows they are trying) and a 20% reduction in Net Interest and Other operating income.  

Their balance sheet told a story of a 12% reduction in total assets, a 1% reduction in loans/advances, a 6% reduction in customer deposits and a 35% reduction in shareholders' equity. Value continues to be destroyed. The talk of dividends will not be on the minds of shareholders as they will certainly be pushing the new chief for a turnaround. Incentive is there as they have seen reduction in equity with the issuance of new shares in a bid to raise capital.

At the moment, their management team indicate they will continue to execute prudence in operation expenditure. In addition, they will be looking for cheaper money and hope to woe more clients to the bank (economies of scale). This will be achieved through offering new products to potential clients.  

However, the prospects of higher defaults remains a deep concern due to the increase interest rates. They are formulating a strategy to deal with this that includes stronger underwriting. Hopefully, no more value will not be destroyed else the new chief will have a bumpy ride into the 2017.  

IZWE LOANS ZAMBIA LIMITED – Half Year Review

The first half of 2016 posed a significant challenge for many financial institutions on the back of tightened liquidity and volatile dollar. However, good news came in the form of measures put in place by the central bank in order to avoid further volatility. Inflation appears to have peak whilst interest rates have also reached their plateau albeit driving up the cost of doing business in Zambia. Izwe’s management chose a strategy of economies of scale which has seen them create value in a sector that many feared would be hurt by regulatory measures put in place.

Their numbers show that in the first 6 months of 2016 (compared to first 6 months of 2015) they were able to increase their gross revenue by 30%. Harsh conditions in the source of capital saw their expenses and financing costs rise by 54%. However, it was not enough to hurt their bottom line as they recorded an 85.5% increase in earnings. Shareholders please smile.

It is clear from the 19% increase in operating expenses that they have a strategy to control costs in this difficult economy. Furthermore, it shows that they have the tenacity to churn out a capital structure plan that seeks out favorably priced sources of funds.  Therefore, with their scale strategy, they were able to grow their net loans and advances by 24%. Overall total asset growth stood at 15.1%. Not bad for half way through the year.

At this stage in the year, shareholders will be delighted with the 62% equity growth. However, no dividends have been declared as at publishing of the interim report. With consistency in government policies, the remainder of the year looks promising as long as fiscal parameters remain stable. Izwe intends to continue with their current scale strategy. If it works don’t change it. They have cited managing foreign currency risk and operating costs as a priority in the remaining half. All eyes will definitely be on Hon. Felix Mutati’s budget speech as it will unravel which sectors Izwe will most likely be a player financier in. 

Can the “Cardrepreneur” Create and Sustain Competitive Advantage in Zambia?

Its deals season. Brief case business with political acumen are on the rise. The dawn of small businessmen with access to some of the most lucrative deals has been reignited. They often operate as proxies (vertically integrating themselves for convenience during the short run of a deal). Value is created when the payoff comes igniting hedonistic spending until the next deal. They pop Moet when they win :-) LOL!!

This is a social factor that cannot be ignored because we see an opportunity for these street wise businessmen to actually create something credible that can compete with extant players (note to self as an extant player, these guys are in the box marked threat of competitors in Porters 5 forces model. You have been warned). Only concern is the hedonist behavior. They “gots” to check themselves before they wreck themselves. Corporate governance is another issue that they have no rules for therefore, we are inclined to be less optimistic on this front. We see aspects of agency costs rising during the process of negotiations for some deals. However, if they do get it right and collaborate correctly, we see a lot of opportunity to create competitive advantage (CA). Being new to formalized structures may be there undoing and affect their ability to sustain CA.

Sustaining CA requires an outlook on the market that is forward looking. Which often requires taking inventory of your resources and capabilities. The ability to sniff out a deal is a capability that is nontransferable. However, being a myriad player opting for ubiquitous deals can lead to loss of focus on the numbers that actually create value. Not all hugely marked deals yield competitive advantage that is sustainable. In fact, if the numbers are not done properly, value can actually be destroyed in the process.

Further to this is implementation of plowback strategy for all the winnings (those earnings / actual profit). Firms that seek to sustain competitive advantage usually have control over their appetite for dividends. They have tendencies of plowing back earnings into areas they believe will continue to yield their firms sustainable value creation. They look to the long run. This could be by investing in resources such as property plant and equipment (fixed assets that have the ability to generate income in the future).

We advise all “Cardrepreneurs” to keep an eye on Hon. Felix Mutati’s budget speech. He/She who decodes the numbers quickest will see where the opportunities to create value lie. Extant players will be watching. TFHZPC will be watching too. 

Real Estate Investments Zambia PLC – Half Year Results

The operations component of any entity that seeks to create and sustain value is the vital organ that can either allow a firm to succeed or fail. Real Estate Investments made the bold decision in 2015 to restructure the group’s operations and those changes according to its management are beginning to bear fruit. Interim results reported for 2016 show rental income increase by 61% with profit before other income, finance cost and tax (EBITDA) growing by 105%. However, earnings have fallen by 8% when compared to the same period last year owing to, in part, certain exceptional expenses on the balance sheet whose details will only be known when the final 2016 annual report is out (notes to the final audited accounts).  

According to REIZ latest statement to LUSE, the movement in net operating earnings leading to higher headline earnings per share in 2016 compared to that of 2015 is primarily attributed to the following: a) Increase in rentals and on-going operating cost management. b) Impact of the annual rental escalation averaging 5% year on year. c) Impact of the US Dollar exchange rate which averaged K10.88/$ in 2016 compared to K7.10/$ for the same period in 2015. Some entities either gain or lose depending on how they position themselves (hedge) against exchange loses.  Furthermore, the group has increased its total assets by 84% over the period whilst at the same time opting for a longer term debt strategy (increase by 29%) and marginally using short term financing (increase by 2%) which signals cash flow control. 

Strong EBITDA seems to underscore this property giant. Revaluation of some of its investment property is partly key to this as the property market has been closely tied to the green-back. Furthermore, operating cash flows have also contributed as they increased by 63%. Bolstered this confidence, the Directors at REIZ resolved to pay an interim dividend for the year ending 31st December 2016 of K0.10 per share. This should keen investors happy and interested.

Exchange losses remains a credible threat to value creation. Thus far, the Kwacha has remained fairly stable through the electoral process that the market has been closely monitoring. However, with the current focus being operational efficiency, we envisage improved performances, all macro parameters permitting, during the remainder of the year.   

TFHZPC meets the Dragon

In his 3^rd installment of his famous trilogy, Michael Porter gave the world “The Competitive Advantage of Nations”. As I sat down in a hotel in Yantai China, I could not help but reflect on how a communist nation had been able to manage its billion plus population by steer it into a value creating machine. Strategy is not exclusively synonymous with democracy. Far from it. Any firm or country needs strategy in ensuring effective management of the entity. It enhances the quality of the decisions its leaders make by facilitating coordination in their actions and places focus on long term goals.

In Zambia, we have noted that the tri-elements of strategy are never quite known by entrepreneurs. The force is strong in these three elements therefore the must be balance in the force. Failure to have equilibrium leads to certain peril. Strategy is not the margins you make nor is it the number of customers you have in a moment. We have seen through the numerous blogs we have posted here that failure to identify the internal and external forces on a business can lead to the evaporation of customers and margins.

We are not advocating for a fixed framework when it comes to strategy. The academics merely provide us to anecdotes that can allows us to create a sustainable value creating story for the firms we create. Strategy therefore must be viewed as a means of provide a decision support system for your firm. It must be the sole tool of coordination of your firm as you navigate the muddy waters. Strategy is what provides you with a clear target for that bow and arrow you wield when you set aim and fire.

Oblivious to many Zambian business owners is where to find this strategic intent. You have been carrying it with you if you are an entrepreneur. Neglected by many is the values of the founders of the business. You may be a sole trader or corporation of mates, you have to have some sort of values that defines your drive to be in business. Once you have identified these values, you echo or exhale them into your followers (the ones you chose to be responsible over, the ones you pay a ZMW to on a monthly).  Many have told us that it sometimes feels like the dream of the owner only permeates in their minds and the people they employ don’t “share the dream”.

Failure to share the dream is what often leads to doom. This is what we have observed from our time in the Shangdon province. You see the dragon has been able to effectively communicate its vision of how China is supposed to be. They did not find themselves as a superpower by accident. Far from it, in addition to investing in resources and capabilities, they were able share the dream with a billion plus (we pass no judgment on method). We have observed through factory visits at how effective the Ford inspired assembly line has been modernized to become their most ruthless competitive weapon. 

This has yielded mass production in proportions that emerging countries can only admire. The pessimists will argue that they have the numbers. TFHZPC has a different argument. Numbers mean nothing if you do not have a strategy. 

PUMA – Half Year Results

Puma’s current half year offering is mirror of where they left off from the 2015 Annual Report. They are still faced with the same macro environmental forces that threaten value. This has put a lot of pressure on their management team to remain efficient albeit in a time when they have chosen the path of expansion of their retail offering in order to tap into the promise of stability in Zambia that could generate value. And rightly so. With the announcement of Felix Mutati as Finance Minister, the exchange rate appears to not have been rattled as much in comparison to previous election seasons.

The fuel company reported an increase in revenue of 19.6% as at June 2016 in comparison to the same period last year. EBIT was up by 63.6% whilst earnings were up by 10%. Curiously, EPS was only up by 9.3% according to the unaudited results published by LUSE. Marginal number of shares movement? Perhaps (we will find out when the next annual report comes out). Cost of sales was up by 18% whilst operating cash flows dropped by 8.7%.

Value generating capabilities (assets) grew by 41.8% indicating its seriousness with its expansion projects that are seeing its property plant and equipment (PPE) portfolio grow. This has impacted its immediate liquidity position which has dropped by 22% (expansion projects chew cash). At the same time, the fuel company has managed to reduce its long term and short term borrowings by 7 % and 26% respectively which represented the 20% reduction in total liabilities for the firm.

Overall performance thus far shows a 1% fall in return on sales in this low margin sector. Return on capital employed now stands at 6% (from 7%) and return on equity at 4% (from 5%). The half year has seen the company marginally sweat its assets and it hopes its prospects will improve in the remaining 6 months. So far, return from its investments in PPE have fallen from 12% to 8% (largely influences by the macro forces). Furthermore, the cost of capital has dealt a huge blow on its financing costs. What will be interesting is if an when the IMF recommendations for removal of subsidies on fuel come into effect. Will that be another macro factor that will cameo in the next year’s annual report?  TFHZPC is watching.    

The Cost of Capital in Zambia

Entrepreneurs beware. Capital budgeting is real. You could be starting up a small “nthemba” that sells talk time, setting up a butchery in high density area, investing in heavy equipment that will see you offer a service that many locals only dreamed would be provided by Multinational Corps (MNCs): knowing your cost of capital is real.

The story begins with how to raise capital for that brilliant idea. The options are as follows: Use your salary (Zero interest rate albeit leads to diminished lifestyle in the interim), Borrow from family (0 to 50% interest depending on how large your relative’s appetite for interest is), get a salary advance (0% interest), get an unsecured personal loan (most commercial banks have interest rates north of 30% at the moment) or visit the proverbial loan shark with his moving target interest rate (backed by either title deeds or your car’s white book. These guys are ruthless).

You have the money (most likely from multiple sources) and you invest in the deal. You structure what you believe is a good margin for the product that you are offering. However, overtime it becomes excruciatingly painful to meet all obligations on time (overheads, statutory bills etc). But, you had put a profit margin on your offering that was not only acceptable to the market but promised to catapult your business into the lime light. What on earth happened? How did competitive advantage evaporate? Where did it all go wrong? The answer is knowing the cost of capital of your business. Some will argue that it is an academic exercise. To an extent, it probably is. But in the same vein, how were you so sure that the margins you sort took into consideration that impact of cost on capital? We are told of tails of tenders that are won which promise yields north of 100%, however when we piece together the sources of financing that enabled the facilitation of the deal, we make discoveries of secured financing at high interest rates, agency costs for the facilitation of these deals (believed to be paid for from the proprietor’s pocket but we know where the money is coming from) and problems in the time value of money especially in an era of fluctuating exchange rates.

Cost of capital in its simple form is the price you pay for accessing debt and equity. For debt, issues of interest and tax rates are important. For equity, if you have a pile of cash and would rather not put it in the bank or in treasury bills for belief that a high return is expected if you invest in your company. This is by no means the complete definition but it brings the subject into perspective of some of the elements faced by many companies in Zambia.

Knowing or even having a guesstimate of your cost of capital can help you position your business in an industry that attracts competition. It allows your product to not only give you a return on investment that is positive but also provides you with strategic insight as to whether you are playing the game well in the market or need to exit if value is being destroyed.

We believe that judgment regarding the cost of capital is the quintessential trade-off between business risk and financial risk. On the one hand, firms seek to be in markets they believe yield attractive profits whereas on the other hand the devil is in the detail of their capital budgeting that can either yield success or failure over the long run. The entrepreneur must remember that in its simplest form, financing of business adventures whether through debt (going to financial institutions) or equity (organic financing) attracts a cost that must be of important consideration else the risk failure is very high. We have learnt so far, that premier companies are known to adjust their capital budgeting strategies from time to time. This is the signal that they are aware of the importance of the cost of capital. There is something to be learned there. 

ZAMEFA Rosetta Mwape Chabala Interview

TFHZPC - How has the year been so far (2016)?

Rossetta – Surprising very! Our half year results just came out and they are way much better that 2015’s half year results. 2015 was a much tough year on the back of energy increases and exchange losses. Many companies made losses but we did ok despite all the challenges because so many things hit at once. Last year was very difficult to predict. You held today and lost tomorrow.

TFHZPC - On the Microenvironment?

Rossetta – On the back of all the challenges, we had to tighten our belts. Cable industry has been affected globally. The industry is shrinking. Speculators are looking at the copper prices and seeing what happens next. But being an extant player (a long term player from 1968).

Currently undergoing a divestiture. As at February this year, we were able to find a buyer which is indicative of people seeing value in our business and the potential it holds. The company is strategically placed. We are the only company in Zambia that manufactures cable is situated 60 Km from the mine therefore we are literally able to manufacture in our back yard. Parabola is a competitor and they are doing copper cathode and rods

TFHZPC - On competition

  Rossetta – At the moment you will see that the market is ........

The full interview will be coming soon on #TheRealMeetsBusiness Series.

First Quantum – Half Year Results

The mining company has had a phenomenal run over the last 3 months leading up to June 2016. According to their CEO and Chairman Philip Pascall, two of the company’s strategic bets are paying off. The first is its improvements in cost and efficiency notably at Kansashi in Zambia. What is fascinating about this mine is that the company has been able to reduce its cost of acid which forms a key ingredient in the smelting treatment as it generates acid organically helping cut costs. Furthermore, this mine had the highest quarterly production since Q3 2014. The second bet is its successful completion of the sale of Kevista mine and refinancing of senior debt facility by putting in place a new $1.815 billion debt facility  that have helped strengthen its balance sheet. Due to this improved position, they are keen on continued development of the Cobre Panama project amidst the current global volatility in commodity prices.

On a macro level, changes to the Zambian mining tax regime, effective June 2016, that saw a reduction in the royalty rate for open pit mines from 9% to a sliding scale of between 4% to 6% (based on the copper LME price) which also helped with the good run.

Overall, the company had an 18.9% increase in revenue compared to the same half year period in 2015. EBITDA rose by 107% with earnings increasing by 1.6%. The operating cash also saw a leap of over 165.7% increase signal improved liquidity management at the mine. This is further observed in its over 140% increase in cash on balance sheet. Cost of sales marginally increased by 8.2% whilst prudent financial management lead to a 24.4% reduction in administrative costs.

Going forward, the mining company will continue on a financially prudent strategy that will ensure the successful completion of Cobre Panama. Despite focus being on this project, shareholders will be please with some cash back from interim dividend of CDN $0.005 per share in respect of the financial year ended December 31, 2016 that was announced. The dividend will be paid on September 19, 2016 to shareholders of record on August 26, 2016. The ex-dividend date is August 24, 2016 (We shall cover what these dates mean in an upcoming blog).

How to Fight a Price War in Zambia

Entering into a price war is usually a distant thought for the average Zambian entrepreneur. On the one hand, some often chose to ignore it and face certain doom over the long run (evidence from small businesses that have closed down due to failure to compete on price). Others on the other hand, chose to engage in a war without fully understanding the consequences and not know how they can compete.

The truth is, price wars are ugly. They have been the demise of many good businesses over the years. When we looked at the low cost airlines in the USA, we found that price wars were so ugly that management teams would forego profits for market share much to the dismay of shareholders. We have also seen evidence of price wars in the Zambian noodle market (Ezee Noodles taking on in store brands from major retailers and Chinese offerings).

However, it does not have to be ugly if the players in the game take steps to protect their earnings. This is how they can approach it from the perspective of Akshay R Rao’s Harvard Business Review (HBR) article with additions from the team at TFHZPC.

Non Price Responses

This includes revealing your strategic intentions and capabilities, competing on quality, co-opting contributors and lobbying for higher standards of products from regulators.

Evidence of Non Price Responses in Zambia

When the Bank of Zambia makes a policy statement on revision of interest rates, the banks fall over themselves to get as much information about the revision of their revised interest rates. By so doing, they are being open about their strategy. MTN, Zamtel and Airtel have all exposed their tariff plans (although required by law) subsequently revealing their cost advantages. A look at some of the participants at Zambia Bureau of Standards (ZBS) shows the intention of players who seek to protect their value. In Lafarge versus Dangote et al., the former increased their number of offerings in cement types (road cement, slab cement, plastering cement etc) as opposed to their competitor’s generic 32R and 42R flavors.

Price Responses

This involves using complex price actions, introducing new products, deploying simple price actions.

Evidence of Price Responses in Zambia

When purchasing data bundles from any of the 3 mobile players, customers have a choice from plethora of complex data packages to suit a customer’s needs (So che and Spaka). Pepsi Zambia with its arsenal of soft drinks that are in all segments of the drinks market with matching prices. Vodafone Zambia bundling modems with 2GB data bundles as it enters the game mobile internet data.

Epilogue

The Zambian market is very diverse. Consumers are constantly seeking for the best price for a good product. Every industry must understand these desires in order to fashion prices that are acceptable to customers whilst protecting value. Understanding price elasticity of their products is also an important factor that can lead to a better understanding of why the company found themselves in a price war. On the downside, we believe that quality of product is being compromised and will have huge ramifications in the future. Stopping the war all together is arguably the best but we don’t live in a rational society. Continued education on product quality and enforcement of standards by regulators may be the only thing that can save us destruction of value and substandard products. 

Lafarge 2016 Half Year Review

When we reviewed the 2015 annual performance of the only cement player on the LUSE, we indicated that they were in a price war with a player who had aggressive intentions of growing market share through using low prices and controlling or incorporating components of the vertical chain of cement distribution unlike incumbent competitors.

As at mid-year review, the story this year for Lafarge is that of 42% drop in revenue compared to its first half year performance in 2015 with investors high by a drop in dividend of 63%. Ironically, domestic volume are down 42% but exports are up by 22% for the same period.

With a 6% increase in its investment in property plant and equipment, the management note that there has been a margin decline despite cost reduction due to increased power costs and exceptional restructuring costs. Furthermore, the macro environment continued to be difficult for the manufacturer with tight liquidity (affecting working capital) and the proverbial price war. This inevitably led to the 89% fall in earnings despite efforts according to its Emmanuel Rigaux (CEO Lafarge Zambia) of continued cost base adjustment in order to remain competitive. However, exports are now their key value generator. Furthermore, are they are looking to key huge contracts with the construction of the Kenneth Kaunda International Airport, Kafue Gorge Lower project among others that will help to mitigate the difficult market.

It is not the Lafarge management teams’ fault that they are currently engaged in a price war. However, the behavior of players that have entered their market is synonymous to entrants in a market whether they believe that there are huge profits to be made. In a case like this, it is best of understand how the company found itself in a price war in the first place. The next approach, as Lafarge has rightly done is to compete on economies of quality and product scope. At the moment, they offer a dynamic range of product compared to their competitor. However, with the end of rational economics at play, most consumers will look at price before quality as the product cement has price elasticity when it comes to demand. With this in mind, we believe that the game cement may be won through standards. When more players enter the market, the chances are that barriers to entry when issues of regulation and product standards are left unchecked, the dominant players may have to consider pushing of ubiquity in product standard in the market. The player with the largest investment in research, patents and development eventually wins.  

The Quest for the Ultimate Value Creating Machine

When the team at TFHZPC sat down to look at all the reviews of the 20+ companies on LUSE, the thing that stood out from most companies is the techniques they used in sustaining their operations. It is very clear that many of these companies have a clear focus on how they perceive their operations at the moment and in the future. Any company that has ambitions of being in existence for the long term must understand the role its operations component plays in the bigger picture of creating value. To understand this, Professors Hayes and Wheelwright of Harvard University, developed a four-stage model which can be used to evaluate the role and contribution of the operations function (every company has one, if it does not, disaster is eminent). Their model essentially evaluates a company’s intent regarding its internal and external outlook. On the lower end, the model views the company’s operations function as negative which tries to evolve into a positive force that has sustainable competitive advantage on the higher end. The former approach is what leads many companies to believe that the pricing of their products is the only thing that matters. Far from it!

Many Zambian startup companies are on the lower end of the Hayes and Wheelwright model. We infer this from the statistics from PACRA that show many companies continuously underperforming or seeking dissolution after a few years of existence. The thing about being on level 1 is the negative perception regarding competition and the persistent firefighting just to remain relevant. When the business idea is coined by the entrepreneur, very little thought is given to the sustainability of the operations. There is nothing wrong with perusing the idea as a primary focus however, once you are up and running, reality dawns in and the business soon realizes that it is unable to fend off new entrants into the attractive market they have entered. Furthermore, they also discover that their value preposition is one that can be easily replicated leading to many copy cats entering the market. Before we know it, the blood bath of competition ensues and the constant firefighting leads to destruction of value.  

However, adopting external neutrality (assessing the competitive forces and finding that blue ocean) is the first step of entering into level 2 of the Hayes and Wheelwright model. Questions that are answered when one is in this level include: Is my product better delivered compared to my competitor?, What differentiates my ubiquitous product from everyone else is?

For the premier companies we have reviewed, signals are ubiquitous in how they are able to achieve level 2 (external neutrality) and level 3 (Internally supportive). A recent example of this is in CDC’s recent investment in Zambeef. CDC is development finance institution from the UK which invests in promising businesses in Africa and South Asia with aim of supporting economic development to create jobs. The deal saw CDC gain a 17.5% stake in Zambeef. This was done by Zambeef offering ordinary shares and convertible redeemable preferential shares to CDC allowing it to raise $65M. 

This investment essentially now allows Zambeef to close off any outstanding deals from M&As (mergers and acquisitions. Notably RCL Foods), liquidate any long term debt and aid in the aggressive rollout of the companies micro outlet stores across the country (its latest value creating gem) and settle finance costs to partners that facilitated the transaction such as Pangaea Securities Limited. The deal clearly shows that Zambeef understands its operations and views the operations function as providing the foundation for its competitive success.

We believe that the key for the Zambian SME to breakthrough lies in understanding these four stages. At the heart of it is owning the operating activities of the firm. We are very sentimental about operating cash flow and debt because we understand that demise or success of many companies lies with these two figures. 

Madison Financial Company Limited - 2016 Half Year Review

The Management team at Madison Financial will be proud of their performance in 2016 thus far. At the halfway mark, they have achieved a 31% improvement in interest income compared to the halfway mark of last year. This inspired an increase in profit before tax of 1263% which was largely attributed to improvements made in its operations. However, the macro conditions (largely increased lending rates, higher exchange rates and inflation) continued to impact the business as its cost of sales rose by 49%.

Madison has managed to increase its customer deposits by over 300% and has increased its loans to them by 13%. So far, they have reduced their debt by 14% signaling a restructuring of its corporate finance strategy (do we use borrowed funds, liquidate or finance organically?) as noticed by the sharp decrease in financing activities on their cash flow statement by 88%. This has also led to a sharp reduction in its comparable gearing from the previous year by 142%.

Although Shareholders will note that the return on their funds dropped from 93% to 76%, their funds still grew by 13% (positive equity growth). However, return on the firm’s capital employed remains stable at 14% when compared to the same time in the previous year. Furthermore, improvements in its non-current asset turnover signals that management is working hard to push their strategy of exploiting their fixed assets. Patience of investors is also being tested as no announcement of a dividend has been made in the first half of the year.

Rising operating costs attributed to a higher exchange rate and inflation will continue to plague the company. In addition, they will have to contend with quite a bit of impairment attributed by defaulting SMEs (business is tough these days). Their strategy will definitely be to reduce this impact in the coming 6 months while also managing the increased leading rates which it is currently in competition with the main stream banks and other micro leading companies.