OPINION | Is Varun’s tax holiday helping the company take the fizz out of competitors?

By Simba Mandonye

Has Varun Beverages’ Zimbabwe’s Special Economic Zone (SEZ) status given the PepsiCo franchise an unfair advantage over its industry peers? The numbers definitely say so.

The purpose of SEZs, under the Zimbabwe Investment Development Agency (ZIDA), is to encourage investors (both local and foreign) to invest their capital in Zimbabwe. SEZ status gets you riding on a whole lot of benefits, which is good, depending on how you look at it.

Varun Beverages was registered in Zimbabwe in 2015, became operational in 2016, and notification of its declaration as an SEZ company in Feb 2019. Going by that date, it will enjoy tax exemption till 2020, unless a different operational date is being used.

Let’s talk about the SEZ benefits for a moment. These include:

· Zero-rated corporate tax for the first five years and then 15% is charged thereafter.

· Duty-free importation of equipment to be used in the SEZ

·        Raw materials and inputs imported for use by a company in an SEZ will be imported duty-free.

· Zero-rated capital gains, etc.

A look at the tax line items in Varun Beverages’ financial statements shows us that they have been enjoying those exemptions. I am not sure if they paid their tax obligations in 2019 or they wrote it off given SEZ status.

2020 Income statement: Varun Beverages Zimbabwe
2020 Financial position extract: Varun Beverages Zimbabwe

Varun Beverages India entered Zimbabwe’s beverage market through a joint venture with Glaciem Pvt Ltd, Zimbabwe’s second biggest beverage maker. Varun Beverages India has an 85% shareholding and Glaciem has 15%.

A Joint venture (JV) is a common horizontal growth strategy that firms use to enter foreign markets. The JV entry strategy enabled Varun to benefit from shared development costs and risks, access to Glaciem’s local knowledge, and to gain “political acceptability”.

Varun uses cost leadership as its core competitive strategy, which means that they focus on capturing the bottom of the pyramid. Given our economy, consumers in Zimbabwe will go for a lower price any day. The SEZ status was heaven sent and complements their strategy. That tax benefit they are getting is obviously going towards reducing their product prices and penetrating the market.

You have probably noticed how insanely cheap Varun’s products are. These include Pepsi, Seven-up, Mirinda, Aquaclear water and other brands. Yes, we already know that Varun Zimbabwe has a parent company with an insanely strong balance sheet.

Knife for knife, they have the ability to last in a price competition with anyone. Having SEZ status really made them invincible to any competition in Zimbabwe. This means they can push their prices even lower, without breaking a sweat.

Varun has arrangements with the Reserve Bank of Zimbabwe for making US dollars available at pre-agreed rates for repayment of its USD denominated loans, according to the company’s annual report.

Varun is one of the biggest recipients of US dollar allocations on the RBZ forex auction, while access for rivals remains limited.

Other competitors should not dare compete on cost, for now. Adopting a strategy to wait out the five years of zero-rated corporate tax that Varun is enjoying is more of an act of faith than reason. After five years, Varun will enjoy 15% tax, and their competitors will be charged 24.72%.

This means Varun Beverages will still have a price competitive advantage over others in the beverage industry. In addition to this, Varun is investing in efficient production facilities with the capital equipment being imported duty free. Cost leadership is their working totem.

Back of the envelope calculation of Return on capital employed (ROCE) gives a 11 % (2020) and 35% (2019) return. If these numbers are true, then SEZ status is really paying off, and investors will be smiling all the way to the bank.

Here is a comparison of financial performance.

In 2020 revenue was ZWL8,100,261,613 (US$99,041,427 at the time of writing) versus ZWL5,983,484,180 (US$79,538,224) in 2019.

EBITDA, in 2020 was ZWL 2,432,593,623 (US$29,743,181) compared to ZWL306,509,222 (US$ 4,074,134) in 2019.

Varun is not wasting time with its SEZ status. It is gaining market share in both the carbonated and non-carbonated beverages sector. We will get to see other players’ management strategic competence in their response to Varun’s moves. They cannot play foul, otherwise they will go out of business. It may be a hard time for those in management in the beverage industry, but I am confident in them.

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