Over the past 3 months the ZSE was characterised by a bear market partially explained by reduced activity from speculators since the capital gains tax review.
In addition, a combination of restricted lending and higher interest rates compelled investors to unwind positions and unlock funds from the stock market. The market cap has drifted below the 7-year average in real terms. Does this present a BUY signal?
Policy measures introduced prior to the 2022 Mid Term Budget attempted to preserve gains made in the productive sector during the 2020/21 period by employing mechanisms to contain inflation. The Mid Term Budget seemed aimed at the consumer side of the equation to defend disposable incomes and therefore support consumer demand levels.
Reviewing civil servants’ salaries and tax-free thresholds will go a long way in cushioning the formally employed consumer.
The informal market, which makes up 88% of the labour force, prefers the US$ and so has been spared from effects of a devaluing currency. Delta trading update is a testament to resilient demand despite rampant inflation. Policy incentives coupled with company driven pricing initiatives are likely to keep consumer demand buoyant and sales volumes steady.
During the inflationary environment in 2020 the ability to re-price goods whilst Cost of goods sold (COGS) and operating expenses lagged on currency arbitrage resulted in abnormal Earnings before interest, taxes, depreciation and amortization (EBITDA) margins across all industries.
However, in the current inflationary environment businesses are required to reprice goods in line with the Interbank Rate while COGS and operating expenses follow trends on the parallel market.
The rate premium has potential to discourage consumers from using hard currency in formal stores leading to a decrease in dollarized revenues. Margins for consumer facing business are expected to contract going into the 2nd half of 2022.
Resilient demand and shrinking margins speak to marginally compressed earnings in real terms and not a collapse of the bottom line as the weak prices would suggest. The bear market is more a symptom of the broader macro environment and not a reflection of expected company earnings. There is now a dislocation in valuations with the market trading at an average price-to-earnings (P/E) (+1) of circa 9.55x and an estimated EV/EBITDA (+1) of 4.34x vs 7-year historical averages of 14.4x and 9.5x speaking to BUYING opportunities in selective counters.
Despite attractive buying opportunities, prospective investors are unsure of a position to take. There is no clear indication of where the bottom is or when the market may begin to turn which may leave a “fear of loss”.
To manage the risk, it is possible to stagger investments into the market, purchasing shares in tranches. If the market continues to fall, one can invest again averaging the losses.
In time the market will eventually turn and at least a portion of one’s investment would have bought shares at their lowest prices. So long as all investment tranches are purchasing shares at far below the fair value there will be some return once the market turns.
We recommend selective stock picking focused on monopolistic businesses with defensive volumes trading at discounts to their fair value.
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