BAT Zim: Success in the eye of the beholder

The current year has begun on a downbeat note, characterised by company closures, judicial management and foreclosures.

Victor Makanda

On the earnings front, volumes, revenues and profits are plummeting. Both large and small firms are feeling the heat as confirmed in Delta’s third quarter update.

These developments nonetheless did not come as a surprise since they only reflect the weakness of the broader economy. They also explain why most market watchers have not been too bullish over the current December reporting season.

While volumes for most companies may be shrinking or under pressure what is critical in this environment, where survival is key rather than growth, is the ability to remain profitable.

Capital preservation is important and explains the reason why Barclays recent financials were cheered by the market as were those of Afdis. Strict cost management has become the way to safeguard profitability.

Zimbabwe’s leading cigarrete manufacturer, BAT Zimbabwe, also released its financial results for the year ending December 31 2013. A general assessment of these results can be misleading as one might place a Sell tag on the company as sales volume declined significantly by 17% to 1,30billion sticks for the local brand portfolio.

This subsequently resulted in a 14% decline in revenue to US$44,60million. After-tax profits were also down, by 69% from US$12,26million to US$3,77million.

Surprisingly, the board went on to declare a 100% dividend pay-out out of the US0,18 per share earnings. One would have thought the group would cede the dividend pay-out as a way of preserving its financial strength especially when the outlook is not so rosy. However, this was not the case.

A closer look at these numbers however reveals a positive performance by the company. BAT Zimbabwe’s focus on broadening its portfolio was put to test in 2013 when it managed to pay out decently and limit the extent to which revenues would decline.

This is explained by the 48% growth in its premium brand Dunhill to 9,1million sticks compared with the prior year. Where it not for the significant growth in its premium brand, total volumes would have declined much more than 17% and so would have revenues.

By virtue of being the market leader, the company managed to leverage on its position despite industry volumes shrinking due to economic stagnation, falling disposable income and lack of coinage.

BAT’s gross profit margin trends were also encouraging as they rose despite the revenue decline. The general trend for most companies has been for margin compression after revenues decline. Such trends emanate from high cost structures and rigidity in managing businesses. However, BAT managed to reduce its cost of sales by 34% to US$14,47million.

The decline in cost of sales was due to its strong focus on cost reduction and also discontinuation of cut rag exports. This saw gross profit margins rising 10% to 68%. BAT is traditionally a high margin business but its ability to further grow its gross profit margins is commendable as it enhances overall performance in the longer run.

BAT Zimbabwe also managed to implement its indigenisation plan. This was effected in its income statement through a US$10,94million share ownership trust award. The implementation of this plan eliminated the risk that other foreign owned companies face.

Operating profits were down by 44% to US$9,83million on account of this transaction.

However, adjusted operating income were flat at US$17,30million whilst adjusted after tax profits would also have been 2% higher at US$12,55million. The view that the company’s financial performance was positive emanates from this perspective also supported by the 92% growth to US$17,65million in net cash flows from operations. Positive cash generation and the elimination of the US$5,85million debt in its balance sheet is key to maintaining profitability.
From the above mentioned introspection BAT appears to be playing its cards very well in the current environment. The key risks for the group however remain in the contraction in the sector’s volume and ultimate profitability.

As long as the overall cake is shrinking and fierce competition in the cigarrete industry prevailing, profitability and margins may come under pressure irrespective of the company being the market leader. Management may need to find other revenue sources as a way of diversifying. These could come through possibly looking at its tobacco value chain beginning from tobacco farming up to the place where tobacco is sold.

Another key risk which is out of the company’s control relates to the issue of coinage and the possibility of excise duty increases which are some of the reasons for the drop in volumes. This risk may increase as government coffers are currently in a dire state which may lead the authorities to opt for hiking these taxes to boost revenue in the future.

Overall, given the currently depressed environment, BAT Zimbabwe both at the adjusted profit level and the declared US$3,77million profit performed relatively well.

Being profitable in such an environment and being able to generate cash is a mammoth task which most corporates are failing to achieve. As to whether the company remains an attractive investment stock on the bourse is entirely another matter. However, the company’s investment case lies in its zero debt balance sheet, margins growth, and reasonable dividend yield. The implementation of the indigenisation regulations requirement is also another step in the right direction.

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