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THE reporting season gathered momentum this week with more than five companies publishing their financial statements.

These included retailers, Edgars Stores and Truworths; insurance giant Afre Corporation and its subsidiary Pearl Properties; and the milk products’ producer, Dairibord.
Marked improvements in operations were noticeable in all of them but financial performances were largely within expectations. The top lines of the income statements grew as companies ramped up capacity utilisation but earnings remained subdued because of high operating costs and colossal interest payments on borrowings.
It is difficult at this point to rate financial statements as good, bad or anything in between, because the economy has operated under multiple foreign currencies for only one year so far. In addition, the country is coming out of a hyperinflationary period which had its own systems.
The buzzword in hyperinflation was value retention. Companies concentrated on growing their balance sheets through acquiring whatever assets that could retain value even if they fell outside the domain of their operations. Net asset value became the most preferred measure of performance while profitability indicators such as operating and net margins fell down the pecking order.
Now the economy is relatively stable with the adoption of multiple currencies and businesses are going back to basics. Equally, it means that in evaluating performance analysts now also have to go back to basic financial statement analysis which prioritises profitability. Profit expectations by investors and analysts always put pressure on management to grow the bottom-line at all costs or risk being labelled non-performers.
When put under pressure to produce good results companies have an option to grow earnings by cutting costs while leaving revenues unchanged or worse still reduced. Profits can come from reducing the cost of goods, reducing payrolls, and lowering incentive compensation among other measures without having to sell more. In the end, however, there is only so much a company can do to reduce operating expenses. It can be helpful as an interim strategy but in the long run real growth should come from selling more products or services.
Aiming for long run growth in the business obviously comes with a cost, particularly in the short term. This is apparent from the financial statements of the few companies that have so far announced results. Take the two retailers Edgars Stores and Truworths as examples.
Dollarisation came when they had overpriced stocks which were acquired when only licensed entities were allowed to trade in forex. To restock, they had to borrow money from local banks usually at high cost. As at January 9 this year Edgars had borrowings of US$4,6 million at an average cost of 38%.  The high gearing of 182% plus internal cash flows was used to fund inventories and debtors which stood at $4,2 million and $2,4 million, respectively.
Clearly from their income statement Edgars need to grow revenues beyond US$11 million achieved in 2009 to cover their operating expenses and reverse the trading loss of US$2,3million. This entails borrowing more, at high cost, to build up stock and to further boost credit sales. The company projects revenue growth to US$30 million with a pretax profit of US$2 million in the next 12 months.
The balance sheet of Truworths as at January 3 was similarly heavily geared also for the noble reason of building up stocks and increasing credit sales. Revenue for the year to July 5 is anticipated to hit US$15 million from the sale of largely cheaper imports to more credit customers. Truworths was profitable in the first half and the anticipated volumes growth could boost earnings further although competition from informal markets such as Mupedzanhamo remains a threat at the lower end. 
Another company to announce financial results this week was Afre Corporation which reported significant recovery in premium income across all subsidiaries. The contribution of reinsurance to total premium declined to 36% from 90% largely because business at other units such as short term insurance, employee benefits and medical savings funds picked up. Total income stood at US$35,2 million with net premium earned coming in at US$17,2 million while rental income was US$3,9 million. Claims were generally high across the board with the medical savings fund topping the list at 131% as it relaxed its conditions to attract new clients. Attributable earnings for the year ended December 31 were US$9,2 million.
The growth on Pearl’s rental income is encouraging although it was largely driven by aggressive upward reviews on rent beyond what many tenants could afford as evidenced by high arrears. Rental income for the year to December  2009 was US$4,2 million with yields improving to 4,85% from 1,21% in 2008.
The company targets a regional yield of 7,5%-10% which if done excessively could push more tenants into arrears and drive vacancy rates beyond 10%. Well, in the interim profitability could be increased by replacing local corporates who are failing to pay with NGOs.  But once the economy fully recovers the company would need the same corporates to sustain further growth.

 

Ranga Makwata

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