Following the decoupling of the USD dollar from the local currency, Zimbabwe witnessed a return of the interbank foreign exchange market in February 2019 with the opening exchange rate pegged at ZWL$2.5 per US$1.

In the seven months since that policy change in February 2019, the
Zimbabwe Stock Exchange (ZSE) Industrial Index has registered 57% gains to 774.55 points, with most counters rising on the back of the monetary changes. In USD terms, the picture has however been less positive with the overall market value of the ZSE down 75% to US$1.98 billion (using an interbank rate of 15.28), compared to US$7.91 billion in

February 2019 (interbank rate of 2.5). The Table below provides clear evidence of the bleak performance as epitomized by the share price declines in USD terms for the top ten counters, which contribute about 73% to the total market capitalization of the ZSE.

Comparing the current USD prices with the 5-year performance, it is evident that most of the blue chip counters are now trading below their 5-year lowsthat were predominantly witnessed in 2016. The year was
characterised by relatively tight fiscal measures with liquidity challenges, power outages and low capacity utilisation.

Despite the economic challenges, the nine-year top five companies (Delta, Econet, Innscor, Paden-ga and BAT) asset base grew from US$787.26mln(2009) to US$5,622.7mln, driven by capital investments and the resilience of companies to withstand the storms. Based on the current USD equivalent prices, we are of the view that the market is not reflecting the investments made and hence should ideally reprice in order to account for the fundamental health of the balance sheets.

This, in our view, does reflect an upside potential and an indication of a cheaper and attractive market. While ZSE has advanced 57% in the period February 2019 to September 2019, statistics are also showing that
it has been lagging behind both inflation and exchange rates. ZSE average monthly return is at 4% relative to 14% and 40% for inflation and exchange rates respectively.

Assuming that the historical trend of trading ahead of inflation is maintained, there is potential for the stock market to rise at an average yearly return on of 14% against yearly average inflation rate of 2%.

However, viewing the Zimbabwe stock exchange through the lens of regional investors, comparative statistics are pointing to a market that is still relatively expensive. Benchmarking the ZSE’s Price to Earnings

Ratio historical trend with that of the MSCI Emerging Market Index over the past 10 years, there is a sizeable gap over the last two years. Sadly, the conclusion that can be drawn from Figure 2 is that the local bourse is currently relatively expensive, even at these depressing levels compared to
the MSCI Emerging Markets Index (Current ZSE PE of 24.23x relative to 13.94x).

Us-ing J. Welles Wilder’s Relative Strength Index (RSI) to do a technical analysis of the ZSE’s market valuation, we can determine the momentum of the ZSE Industrial index’s movement. RSI values above 70 will reflect an overbought/overvalued position while RSI levels below 30 reflect an oversold/undervalued position.

The current ZSE Industrial Index RSI value of 72.9 points to a marginally overbought/overvalued market, and thus the potential of a reversal from
selling pressures on the market.

Our short-term outlook for ZSE, based on the RSI momentum is that there will likely be aggregate selling pressure in the foreseeable short-term andn this will be occasionally tempered by the rises as investors look to equities for an inflation hedge.

The disconnect between the market’s USD undervaluation and the apparent negative momentum is testament to a market seeking direction in the face of prevailing economic challenges that have an impact on future corporate earnings growth. While USD current prices seemingly reflect that the stocks are at their cheapest and an upside potential, economic challenges continue to suppress the prospects of real earnings growth, thus justifying selling.

Recently released financial results indicate no real growth in output as foreign currency shortages, local currency devaluation, power outages, fuel shortages, low disposable income and increasing costs of operations all continue to weigh down a possible recovery and thus growth. The local currency shows a devaluation of 512% so far, putting pressure on import-
ed raw materials costs as well as general operating costs (fuel,power, water and staff costs etc.), which have been repricing relative to exchange rates.

Volatility in exchange rate movements in our view will continue to negatively affect the majority of local companies. This points to an unstable and rising cost structure, frequent repricing of goods and a subsequent decline in the quality of earnings. Given no respite in the operating environment, we foresee economic headwinds continuing to put pressure on corporate earnings and future cash flows in the short to medium term.

Recent controls by the RBZ on the trading of fungible shares as well as the difficulties faced by foreign investors in repatriating proceeds from their liquidated investments has reduced the attractiveness of the market.

Given the above scenarios, our view is that there is great likelihood of short-term volatility in the market given the momentum swings that we have witnessed this fiscal year. The broader economy still retains its long-term growth potential which will only be realised once the structural issues have
been addressed and a positive long-term trajectory has been established.

Consequently, listed equities investments are at best, a long term play (4-6-year investment horizon) and investors must be prepared to ride the short term volatility cycles.Strong balance sheets, diversity in revenue streams, strong management teams, low cost structures will be key in stock selections. Candidates in this regard include Delta, Padenga, Innscor and Seedco International as good additions to portfolio holdings. — MMC Capital.

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