AFTER a Covid-19-driven delay in earnings release, the market is now moving fast past the peak of the season and some key observation are paramount.
The 2019 financial year was the first full year since the promulgation of the Zimbabwean dollar. As such, earnings reported for the financial year were released in the Zimdollar as the reporting currency.
In the past, under the multi-currency regime, companies reported in US dollar terms. With changes in reporting currencies come adjustments in asset pricing, which would have to be revalued in line with the depreciation or appreciation in currency. These changes could have a significant impact on the reported net profit position. Outside of asset revaluation, foreign currency assets or earnings also have to be restated or revalued using the weighted exchange rate.
Likewise, the impact would be to spur or reduce the profit position. In succeeding paragraphs, we look at how this has empirically played out on the Zimbabwe Stock Exchange.
Normally, a more stable currency in relative terms would make valuations easier and give less variance to prior reported positions. This means if there has been less volatility in currency, asset revaluations and exchange gains or losses would have less effect on profitability. On the other side, a currency which is more volatile would expose earnings to revaluations and exchange gains. In the case of Zimbabwe, changing from a multi-currency anchored on the strong US dollar, to a local currency which has been highly volatile, meant earnings would be significantly impacted by exchange loss and gain as well as asset revaluation. This explains why most companies releasing results are showing a fairer (inflation or historical) top-line growth and a very sharp bottom-line growth.
It would make one wonder why slower topline growth would attract disproportionate growth in the bottomline. Normally, it would represent firming margins due to tight controls on cost, tilt in sales to high-margin products and efficiencies in production and distribution. This, however, has not been the case with Zimbabwe. Rising inflation has meant costs cannot be aggressively lowered or commensurately recovered.
It means that defending margins in an inflationary environment cannot be easy, more so in a market with dithering demand. Companies are forced to forgo margins in order to redeem demand by meeting the customer halfway. So all earnings currently released are showing a disproportionate growth in topline and bottomline due to exchange gains and asset revaluations. Another scenario is one where companies with significant foreign currency exposure in the form of debt are showing very weak bottomlines or a seemingly proportionate and stable bottomline growth. This, too, shows the impact of same factors but in an inverse manner. With foreign debt comes exchange loss and loss naturally reduces profitability. This would cancel out asset revaluations to some extent or completely.
While all these factors have played a major role in shaping earnings in the 2019 financial year, another factor has been at the core and this is inflation. Since the second half of 2019, companies were compelled to adopt hyper-inflation accounting and this has had a huge impact on earnings. A weighted average inflation figure over the 12-month period is applied on historical revenue to arrive at the inflation-adjusted income.
Likewise, costs are adjusted by the same factor while the standard compels for the revaluations mentioned earlier. So, given Zimbabwe’s skyrocketing inflation, topline growth has been distorted to reflect all growth on a year-on-year basis, but in real terms the earnings are weaker. It is therefore important for anyone reading the financials to discount the impact of these changes in order to arrive on a more realistic view of the earnings. Particular attention should be paid to the volumes and balance sheet positions. Overall, the market is experiencing a dip in volumes as aggregate demand buckles under the pressure of income erosion.
While the change in reporting currency naturally brings with it adjustments such as revaluation of assets and exchange rate gain or loss on debt and foreign currency earnings, it is crucial to pay attention to the metrics.
Gwenzi is a financial analyst and managing director of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — firstname.lastname@example.org