HomeAnalysisA stabilising economy’s impact on profitability

A stabilising economy’s impact on profitability

By Tafara Mtutu

ZIMBABWE has been experiencing some reprieve following a rebound in its agriculture sector in 2021. The country received above-average rainfall in the 2020/21 season which underpinned the recovery of the agriculture sector.

Given that this sector is the largest employer in the country and is at the base of many industries, the rebound is rippling into Zimbabwe’s economic growth, and has warranted Zimbabwe’s 7,8% economic growth rate in 2021 by Finance minister Mthuli Ncube, up from -4,1% in 2020.

The concurrent hold on inflation rates and the introduction of the foreign currency interbank auction system have also complemented the efforts to stabilise the economy.

Zimbabwe’s year-on-year inflation has declined from 838% in July 2020 to 56% in July 2021, and it is expected to end the year under 35%. The economy seems to be returning to normalcy, but so is profitability.

The profitability of any company is typically measured by the gross profit margin, operating profit margin, and net profit margin.

The gross profit margin, or gross margin, is the profit a company makes after deducting the direct costs of making its products expressed as a percentage of revenue.

The operating profit margin, or operating margin, further deducts fixed and overhead costs, and the net profit margin further deducts non-operating costs such as the interest expense.

The profitability of many listed companies, when proxied by profit margins, had been volatile in 2019 and 2020 when the country moved away from the US dollar and back to the Zimbabwean dollar amid consecutive drought seasons and just before Covid-19.

The change in currency triggered runaway inflation rates and resulted in hyperinflation.

From a historical accounting perspective, inventory produced at lower nominal costs was sold off at higher prices that incorporated inflation expectations and resulted in astounding margins.

This was more apparent among companies that had unusually higher inventory levels in 2019 and 2020 because of the decline in disposable incomes that began in 2018 when the disparity between the US dollar and Bond notes prompted inflation.

Further, disposable incomes remained low through 2019 and 2020 and sustained the higher inventory levels. As a result, the sale of these inventories on a first-in-first-out basis exhibited high margins because of the low recorded inventory costs.

This was the case with OK Zimbabwe, SeedCo Limited, and Delta Corporation.

OK Zimbabwe’s inventories relative to revenue increased to 17% and 18% in FY19 and FY20, respectively, from a historical average of 10% and we opine that this underscoredthe retailer’s subsequent net margins of 13% in FY20 and 7% in FY21 vis-a-viz a 2014 – 2018 average net margin of 2%.

Delta Corporation’s inventories relative to revenues were also high in FY19 (18%) and FY20 (18%) relative to a historical average of 15%.

This preceded the high operating margins in FY20 (31%) and FY21 (26%) in comparison to a historical average of 19%.

SeedCo Limited’s inventories relative to revenues were also higher in FY19 (31%) and FY20 (28%) in comparison to a historical average of 26%, and its subsequent gross margins in FY20 (63%) and FY21 (65%)were substantially higher than its historical gross margin average of 52%.

Further, the change in currencies to the fast-depreciating ZWL at the timepunctuated the fair value gains on real assets that were reported in the income statement of companies that are invested in investment properties.

This largely included real estate companies and financial services companies with an extensive property portfolio. Mashonaland Holdings, for example, posted operating margins of 72% in 2019 and 55% in 2020, but net margins of 11,867% in 2019 and8,037% in 2020 because of fair value gains that reflected the increase in property values in ZWL over the period.

Similarly, First Mutual Properties reported an operating margin of 32% in 2019 and 23% in 2020, but respective net margins of 4,295% and 4,260% after fair value gains.

Now that the economy is returning to normalcy, we note a reversal of the trends that has already begun taking effect.

Most companies have cleared the inventories that they manufactured at lower costs and the current higher costs are now cutting into profit margins.

For example, after SeedCo cleared its inventories in FY21 and began manufacturing current inventories at higher current costs, its gross margin subsequentlydeclined from 65% in FY22 to 30% in its first quarter of FY22.First Mutual Properties’ performance from January 2021 to May 2021 showed lower fair value gainsof ZW$269million(US$3,1 million compared to the prior period’s ZW$542million (US$6,3 million), and net margins over the period fell from 1,677% in the five months to May 2020 to 202% in the five months to May 2021.

We observe this correction in companies with high inflation pass-through ability, that is, the ability of companies to pass the effects of inflation to customers through pricing.

Companies with limited inflation pass-through ability recorded mild margins growth, marginal changes in margins, or even losses.

These include companies that have regulators that influence prices and payment modalities, such as RioZim and Econet Wireless.

  • Mtutu is a research analyst at Morgan & Co. — +263 774 795 854 or tafara@morganzim.com

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