Zimbabwe’s election on 30 July 2018 heralds a new beginning after the abrupt end to President Robert Mugabe’s 37-year reign in November 2017. We are not picking favourites among the presidential candidates, rather we are rooting for a credible election process that allows Zimbabweans to freely vote for a leader of their choice. A democratic outcome, respected by politicians and the military, will dispel any doubts on Zimbabwe’s commitment to political reforms.
Unfortunately, the post-election celebrations ought to be short lived. Zimbabwe’s economic challenges have been well chronicled, but the most pressing for any new regime will be to constrain fiscal spending, dig out of the mountain of bad debts and arrears, and establish a functional currency regime. The illusion of a government running a US dollar economy by printing ever-greater amounts of quasi-currency instruments is simply unsustainable. Inevitably, the proliferation of ‘bad’ money forces citizens to physically hoard ‘good’ money exacerbating the chronic shortage of US dollars in Zimbabwe’s formal banking system.
Locally, market participants are signalling an implicit currency devaluation in the varying discounts applied to electronic money and bond notes in exchange for a real US dollar. For foreign investors, the implied currency devaluation is reflected in adjusted asset prices. One common approach is to use Old Mutual’s share price in Zimbabwe compared to the JSE listing, which implies discounting a dollar in Zimbabwe to 42 US cents. However, this currency proxy has been extremely volatile on thinly traded volumes. In the past year, the implied value for a dollar in Zimbabwe has oscillated from as low as 17 US cents in November 2017 to as high as 68 US cents in February 2018.
We have steadily discounted the value of the Allan Gray Africa ex-SA Equity Fund’s holdings in Zimbabwe since December 2016 and, as conditions worsened, we adopted a fair value methodology in September 2017 to value each of our Zimbabwe holdings. The aggregate carrying value implies a 60% discount to market prices at the end of June 2018. In other words, we are effectively discounting a dollar in Zimbabwe to 40 US cents.
These multiple implied exchange rates illustrate that the market is grappling with uncertainty. Adopting a functional currency regime will require credible fiscal restraint, but it helps attract foreign investors who stay away when they can’t efficiently price risk in US dollars and also repatriate their money. This is similar to our recent experiences in Nigeria and Egypt. In both countries, policy makers had imposed capital controls and were rationing scarce US dollars to defend unsustainable currency pegs. The authorities had little to show for these efforts until they let their currencies adjust to reflect market reality, which helped unlock investor inflows.
Finding opportunities in a new Zimbabwe
Despite the risks and uncertainty, we have accumulated material positions in thriving businesses well-positioned for Zimbabwe’s recovery. The Fund has a 22% exposure to Zimbabwean assets and 90% of this exposure is concentrated in Econet and Delta. Both companies reported strong operating results over the past quarter.
Econet has established an enviable position as the dominant mobile money payments platform in Zimbabwe. In March 2018, the value of Zimbabwe’s mobile payments jumped to 60% of all retail payments (mobile, internet, card and cash transactions) compared to 22% two years ago. Understandably, this dramatic shift has been at the expense of reduced cash payments from 42% of retail payments to just 5% currently. Notwithstanding Zimbabwe’s current cash shortages, does this pattern represent a permanent shift in consumer behaviour? The jury is out, but it is difficult to envision many Zimbabweans will be willing to stand in queues again to pay their utility bills. If the trend holds, Econet is the new poster child for successful mobile money platforms. In their latest financial year, Econet’s revenue from mobile financial services was 29% of total revenues, up from 10% just 3 years ago. In Kenya, Safaricom’s revenue contribution from their MPesa mobile money platform is 27%, and it took 8 years to grow from 9%.
Delta’s full year results demonstrated significant improvement in operating performance. Volumes for lager beer increased by 43% in the second half compared to the similar period in the prior year. They are benefitting from improved cash availability in the economy, but constrained by the inability to source adequate real US dollars to buy critical inputs or pay foreign creditors.
In the second quarter of 2018, we revalued both companies on the basis of the strong operating results. This revaluation impact is incorporated in the effective discount to our Zimbabwe holdings, which is noted above. Our valuations reflect cautious optimism that the outlook is improving but investors still face currency devaluation risks and can’t repatriate funds out of Zimbabwe.
Conclusion
Zimbabwe’s journey from the brink under Mugabe’s rule to the prospect of political and economic reforms offers great hope for the people of Zimbabwe. A functional currency regime accompanied by reliable fiscal reforms will help attract capital inflows to re-capitalise the economy. We can’t predict the pace of reforms, but we believe that owning great businesses at conservative valuations should allow patient investors to realise a substantial gain from Zimbabwe’s eventual recovery.
Aside from revaluing these Zimbabwean assets, other material changes to the Fund include increased exposure to select Nigerian banks as these stocks pulled back after the strong rally in the first quarter of 2018.