Sufficiently free election needed, equities still expensive – Exotix Capital

ZIMBABWE’S economy requires commercial bridge loans, donor support, relief on its huge dollar-denominated debt and, ultimately, an IMF program.

The first steps in this process began with the removal of Robert Mugabe (a long-standing obstacle to international re-engagement) and the charm offensive on foreign interests (Western sovereigns and multilaterals and China) by his successor, Emmerson Mnangagwa. The next step is the general election (30 July).

Obviously, a peaceful, free and fair election that is universally accepted as credible by foreign observers and establishes a strong enough political mandate domestically to commit to difficult fiscal cuts is the ideal outcome. Equally obvious, life is not usually that simple.

Here, we preview the election and assess the current state of equities.

International view of ‘free and fair’ and an outcome with which the domestic military is comfortable matter most (rightly or wrongly)

For investors in Zimbabwe, we make five points about the upcoming election.

  1. Policy – There is no substantial difference on the issue of re-engagement with international finance between either of the two main parties and their leaders – incumbent Mnangagwa of ZANU-PF and challenger Nelson Chamisa of the Movement for Democratic Change – Tsvangirai (MDC-T). In a sense, neither has a choice if they wish to drive an economic recovery.
  2. IMF – In the narrow sense of whether the election enables the next steps in re-engagement with the broad international financial community (as opposed to whether they deliver social justice and fair representation), it will be the international judgement (eg by the AU, SADC, and EU) of whether elections are conducted in a sufficiently free and fair manner that matters more than the judgement of the losing political camp domestically. It is precisely for this reason that Mnangagwa has promised independent electoral observers and allowed more political space for the opposition MDC-T to mobilise support (establishing the election date well in advance, allowing political rallies). These moves (so far) clearly differentiate the conduct of these elections relative to those in the Mugabe era. However, whether they stand up to an absolute level of scrutiny is a moot point (the MDC-T complain that state media remains partisan, the electoral register is not being disclosed in a timely manner by the election commission and state resources are used for campaigning purposes). This is in no way unique to Zimbabwe: the examples of Egypt (2018), Kenya (2017), and Pakistan (2013) demonstrate that the same elections deemed sufficiently credible by international lenders (specifically, the IMF in these cases) may not be viewed the same way by either the electoral losers or third parties judging the quality of democracy or the strength of the political mandate of the winner.
  3. China – For a period of time in the latter years under Mugabe, China remained engaged with Zimbabwe (as a lender and investor) after relations with the broader financial community had been severed. It ultimately lost patience too. But the charm offensive towards China by Mnangagwa has been no less than that aimed at the broader financial community. If it is prepared to act as the main foreign partner, China may not be as demanding on what constitutes a credible election as others. We doubt Chinese support alone is enough to rebuild the Zimbabwe economy, but it might be enough to support the military and ZANU-PF nexus for a while longer.
  4. Opposition – Chamisa and MDC-T have unified and rallied more effectively than expected after the death of charismatic leader Morgan Tsvangirai in February. Chamisa has seen off a leadership challenge (from Thokozani Khupe), integrated disaffected former party secretary generals Welshman Ncube and Tendai Biti and even attracted Mugabe’s endorsement. Political rallies have been well attended and opinion polls suggest Chamisa has, from a much lower base, made bigger gains than Mnangagwa (to the extent that one poll suggests Mnangagwa is not headed for a decisive, greater than 50% vote, in round one).
  5. Army – The fall of Mugabe was precipitated by his loss of support from the war veterans and the army (although, of course, the army took great care to ensure constitutional compliance in the leadership transition). Therefore, it is surely the case that the peaceful conduct of elections is also highly dependent on whether the army is comfortable with the outcome. Although Mnangagwa does not command universal loyalty within ZANU-PF (the legacy of the succession battle between his Lacoste faction and the vanquished G-40), he likely remains the president with whom the army is most comfortable. Again, Zimbabwe, is not unique in this respect (the same need for civilian politicians to work with military deep-states exists across many frontier and emerging market peers).

Local equities expensive for new money investment

Any discussion of fresh (new money) investment into Zimbabwe equities is redundant (or, at least, a catch-22) until repatriation flows smoothly again.

Repatriation requires a rebuilding of US$ reserves and liquidity, which, in turn, requires re-engagement with international finance.

In the interim, publicly listed equities continue to enjoy a premium because they act as a substitute for cash (which is in short supply) – the Old Mutual Implied Rate premium (the difference between the share price of the Harare listing of Old Mutual and the fully fungible London one) has increased to 106% (compared with 474% immediately before Mugabe’s fall in November 2017 and c50% in Q1 18).

If the prospect of fresh capital injection at the macroeconomic level improves, then this “cash substitute” premium in equities likely fall. But the underlying value of listed assets likely increases at the same time (companies’ cash flow prospects improve if the broader economy is resuscitated).

In other words, a judgement on whether current valuation multiples are attractive requires disaggregating the “cash substitute” premium (and one’s view of whether that increases or reduces over time) and the valuation of the underlying business (and one’s view of whether that is fair or not).

For example, beverage manufacturer, Delta, is on forward PE (on Bloomberg consensus estimates), at face value, of 30x. But stripping out the OMIR “cash substitute” premium (ie dividing by 2.06) reduces this to 15x. The equivalent figures for telecom operator, Econet, are 17x at face value and 8.3x on an underlying basis.

In practice, for those investors who are trapped in Zimbabwe equities, there is likely little option but to reinvest dividends or rotate within local equities (in Figure 3, below, we screen stocks at face value, stripping out the “cash substitute” premium).

For those considering new investments, these face-value multiples are likely still too high, regardless of whether the prospects for recapitalisation of the economy are likely to improve. An alternative might be Australian-listed miner Zimplats, although it is very illiquid (US$20k per day): there is no Bloomberg consensus, but trailing PE is 10x.


Exotix Capital