Q3 review, and the growing preference for small caps

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The just-ended third quarter has been a rough ride for investors on the ZSE, as well as stock markets globally. A number of analysts have pointed out in recent weeks that Zimbabwe is not immune to the developments occurring in the rest of the world, and this is evident when one looks at how the industrial index has performed over the past few months. The main index closed the period 6.1% lower, with most of the damage occurring in the last two weeks. This coincides with the trouble in other markets of the world, but also with a few homegrown phenomena which deserve attention.

[imageframe lightbox=”no” style=”none” bordercolor=”” bordersize=”0px” stylecolor=”” align=”right” animation_type=”0″ animation_direction=”down” animation_speed=”0.1″][/imageframe]Some have supposed that the indigenization issue could be driving losses on the market, but the facts simply don’t support this. The market appears to have priced in the challenges of indigenization already, and in fact recent developments have, if anything, lessened its potency. The prices of British American Tobacco and Barclays Bank of Zimbabwe, two companies most would agree are at the forefront when it comes to indigenization, have appreciated by 16.7% and 22.6% respectively. The primary driver has been an improvement in these companies’ operating performances, now that the initial shock of indigenization has passed and most have accepted it as an inevitable (and in some cases) beneficial government project.

A number of companies announced positive results during the period, and a number of share prices rose based on those results; but the majority of companies who released positive earnings saw their share prices decline. Innscor is the prime example of a company with solid future prospects, is highly cash generative in a tight economy, and is capable of maintaining significant levels of growth going forward; the share price paints the opposite picture though, falling 1.6% over the course of the quarter and rising above 70c for just two days following the announcement of their full year results. The price has subsequently dropped much further. What could lead investors to shun opportunities like this, when the global markets are offering precious little in terms of sound investments?

A trend which has developed over the past few months has been a move from large caps such as Innscor to smaller companies which offer significant upside. This seems to contradict the belief that during difficult times investors seek haven in larger, more stable companies and non-cyclical companies unaffected by recession, and illustrates that local investors are far less risk averse. This is evident in the fact that while only 43% of money invested on the ZSE in the second quarter was directed towards small to medium caps (with a market cap lower than $150 million), this metric increased to 56% in the 3rd quarter of 2011. Even more defining is a look at small caps only, whose share of total trades rocketed up in the second and third quarters to 20% and 21% respectively, from just 8% in the first. It’s likely that some money is leaving the country, but what is being left behind is left in riskier assets which hold the promise of high returns. Foreigners may be lessening their exposure to Zimbabwe in general, however, they are leaving behind a coterie of investments in smaller caps which they expect to yield handsome profits in the future.

This strategy may appear to hold some weight – the price of TN over the past quarter shows that Zimbabwean capital, often overlooked on the ZSE, is also a formidable force in shaping the direction of the market. Investors who bought into this company saw the share price appreciate a whopping 400% in just three months, mostly driven by local money.

Which of the small to medium sized companies will be next to appreciate? Well, upside in the retail sector is likely to continue due to a number of enablers. Pelhams, Edgars, Truworths and OK all look set to increase their sales into the medium term owing to structural factors such as increased levels of urbanization, and in the short term due to factors such as the extension of credit terms. Second, gold stocks will become an important part of any investor’s portfolio in the coming months, and while Zimbabwe has precious little to offer in that regard, Falcon Gold will report strong profits in their full year results expected next year. The last pick is somewhat less assured – Murray & Roberts. As the civil and construction industry begins to recover, this stock should boost its profits rapidly.

By |October 18th, 2011|Categories: Markets, Research|

About the Author:

Kudzanai Sharara
Kudzanai’s background in financial journalism with ZFN, combined with a continuing education in financial management, provide a solid grounding for his work in the research department.