In 2016, Michael Mundashi’s board ushered in a new managing director in Godfrey Machanzi (an engineer turned MBA) and finance director Nigel Curran both legacy employees of the tobacco giant (24 years of combined years of service to date). Michael cites bearish 3% GDP growth, slump in global commodity prices, low energy generation in the region, ‘bull whip’ inflation,tight monetary policy, discriminatory excise duty (400%) which inadvertently fueled illicit trade as some of the macro factors that affected the company in the year under review. On illicit trade, two dominant forces prevailed: illicit by suspect price products with tax stamps and those without. WARNING – SMOKE AT YOUR OWN PERIL.
Erosion of value is admitted. The AR shows a continuing decline in dividends over the last 3 financial years. Michael is very candid on the apparent. The tax regime hurt the company. Revenue down by 11.6%. Turnover down by 14%. Operating profit down by 47.7%. Bleeding they were, however of note is the 182.3% increase in inventory (inventory days shot up from 46 to 135 days). Product was not moving off the shelf in light of the dual illicit forces. To address this, his team will be looking at strengthen the brand and working with government to curb the nonsense.
With no long term debt on the books (the nature of the business does not warrant it), the company sort short term facilities through bank overdraft. This helps with working capital in the interim. Although, cost of sales marginally fell by 4%, their acid test position moved from 0.85 in 2015 to 0.43 in 2016. This implies a weakened position in ability to pay short term facilities. In some cases it manifests itself by ‘negotiated’ dates of payment on short term liabilities (supplier’s dilemma). However, Michael admits the deliberate move in acquiring the OD and hopes for a bullish outlook in 2017.
With a 46.4% drop in earnings, return on capital employed fell by 77% albeit in the region of 170%. Similarly, Return on equity fell by 49% but was still north of 115%. EPS eroded by 44.4%. However, shareholders will be slightly pleased with a depreciated dividend being declared. When earnings decline, the dividend policy is the aid to memory for stakeholders as value is protected.
Going forward, there is optimism from the fact that the advalorem tax (is a tax whose amount is based on the value of a transaction or of property) component of 145% of CIF will no longer apply in 2017 bringing some relief to the cost of doing business. However, the 20% excise tax remains a credible threat as it continues to inspire illicit trade. The company is placing a bet on their brand in a market were switching costs are very low and buyer power is very high. Price elasticity of demand and legislation enforcement will be the difference between value growth or value decline.