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).