The following opinion feature is by Rufus Mwanyasi. It was first published in the Business Daily.
The rise in the number of quoted companies that have issued profit warnings — where a company advises investors that its earnings will/may drop by at least 25 per cent — to 13, up 18 per cent from the previous year, is a sure reflection of challenging business environment.
These companies now represent over 20 per cent of total listed securities and include four companies from the manufacturing sector, three from the transport sector and the rest scattered in between retail, oil and gas, construction, finance and media.
I will look at why this number has increased and what the investor should do. One of the fundamental challenges businesses have faced this year is the high cost of financing.
The Monetary Policy Committee raised the Central Bank Rate (CBR) to 11.5 per cent last July, up from 10 per cent (June) which increased from 8.5 per cent (April) — a rate maintained since May 2013.
Consequently, corporates with large debts are being forced to deal with rising debt obligations which is squeezing out earnings. ARM Cement, for instance, is now seeking to retire its expensive short-term debt through issuing a privately placed five-year bond.
In the same vein, higher interest rates have also meant low share price valuations from a fundamental perspective. A higher discount rate means a company’s cash flows are worth much less, hence a lower stock price.
True to fact, investors have “fled” the 13 stocks owing to lower intrinsic valuations. Average share price losses year-to-date stand at -37 per cent compared to -22 per cent by the overall market.
Another key challenge has been the weak shilling. A weaker local currency has offset some of the benefits of low energy prices experienced this year and hence, for some, operational expenses have remained high owing to high cost of imported inputs.
Companies with foreign-denominated debt have also had to suffer from the weak shilling.
In the past 12 months, the shilling has shed 12 per cent of its value against the dollar, 15 per cent to the UK Pound and seven per cent to the Euro.
Other challenges include rising inflation, slowing regional economy and increasing competition.
Reacting to the said challenges, some of these companies have instituted measures to bring back earnings to positive territory.
These measures have ranged from staff lay-offs (Standard Group), debt restructuring (ARM Cement), management overhaul (Uchumi), cash infusion (Mumias) to asset disposals (Sameer Africa). It remains to be seen whether these steps will lift earnings.
Having said that, what’s the investor to do? Investors ought to pay attention to what is transitory and what is permanent.
If dwindling profitability is a result of poor strategic choices (bad product mix, too much leverage, bad marketing policy), then investors should avoid such companies for such issues tend to be permanent unless there is a management overhaul.
However, if dwindling profitability is as a result of the cyclical nature of the business and/or are one-off events, then such issues are temporary and investors should not be scared investing in such stocks.