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.