Malawi Consumer Goods Industry

Malawi Macroeconomic Overview During the 2011/12 financial year, Malawi started implementing the Malawi Growth and Development Strategy II (MGDS II), as an overarching operational medium term national development strategy for the period 2011-2016 in tandem with Millennium development Goals. During the first year of its implementation, Malawi experienced a number of challenges, including reduced disposable incomes due to poor tobacco revenues, scarcity of foreign exchange, fuel shortages and power disruptions. Consequently, economic performance slowed down, and GDP grew by 4.3% compared to 6.7% in 2010. All sectors except agriculture, forestry and fisheries; and utilities registered lower growth in 2011 compared to 2010. Three sectors, namely: mining and quarrying; construction; and public administration recorded negative growth rates. The situation was worsening given that the previous regime led by the late Professor Bingu wa Mutharika fail out with development partners hence all budgetary support was suspended exacerbating foreign exchange shortages and government deficit. The new regime led by Her Excellency Mrs. Joyce Banda, who in April, 2012 ascended to power following the sudden death of Prof. Bingu Wa Mutharika, has successfully negotiated a new Extended Credit Facility program amounting to US$157 million. The ECF has is anticipated to woo back development partners and budgetary support is likely to resume. Prospects for growth in the last half of 2012 are somewhat murky although government authorities are upbeat owing to policy shifts that the new regime has implement so far. However, with a liberalized exchange rate regime coupled with an automatic fuel pricing model there is inflationary pressure mounting in the system. The central bank is responding by implementing a contractionary monetary policy in its quest to sterilise price increases hence escalating the borrowing cost which entails lower investment levels. Moreover, the utilities sector is likely to underperform given ongoing electricity blackouts and lower water supply coming out of underlying technical glitches coupled with striking employees who are seeking salary hikes as the cost of living escalates. As such the economy is unlikely to achieve a 4.3% GDP growth rate as projected by the government but somewhere around 4% as analyst portend. Manufacturing and consumer consumption trends Global consulting firms tout Sub Saharan African (SSA) countries as the next best investment frontier yielding superior returns for both foreign direct and private equity investors. The economies have registered better GDP growth rates outpacing global growth trends. Pivotal to such growth rates is the contribution of the retail and consumer goods industry to the overall economic growth. Malawi is certainly following the same growth path that most SSA countries are taking as the consumer goods industry has consistently contributed over 30% of total economic activity since 2008 (Exhibit 1). Moreover the whole industry has generally driven economic growth particularly the retail and wholesale trade sector which has posted growth rates always above GDP growth for close to a decade (Exhibit 2). Going forward, the consumer goods industry will continue being an important sector of the Malawian economy just as many countries in the SSA region.

Consumer Goods Industry Contribution

Other Sectors

Above 30% Contribution to GDP

73%

65%

66%

66%

67%

67%

27%

35%

34%

34%

33%

33%

2007

2008

2009

2010

2011

2012

Exhibit 1

25 % 20 G 15 r o 10 w t 5 h 0 2005 2006 2007 2008 2009 2010 Wholesale and Retail Trade Growth Accomodation and Food Services Manufacturing Growth Overall GDP Growth 2011 2012

Exhibit 2 Industry Overview The Fast Moving Consumer Goods (FMCG) industry is currently valued at over MWK220 billion and has been steadily growing over the years and is anticipated to hit a 12% 6 year Compounded Annual Growth Rate (CAGR) in 2012. Such growth has been generally driven by a record 48% year on year growth achieved in 2008 as the economy passed the staggering 8% growth rate milestone. Beyond the glory year 2008, year on year growth dipped to 6% and plateaud for two years and worsened in 2011 as a mere 1% growth was achieved (Exhibit 3). 2011 was a challenging year for most industries in the country as the economy being import dependent had lower dismal foreign currency inflows following poor performance of tobacco which accounts for 60% of exports. The existing regime at that time insisted on a fixed exchange rate regime hence depleting foreign reserves. Consequently retailers could not source foreign currency for their imports hence causing supply side glitches.

250,000 200,000 150,000 100,000 50,000 2007 2008 2009 2010 2011 2012

60% 50% 40% 30% 20% 10% 0%

Consumer Goods Value MWK 000

Year on Year % Growth

Exhibit 3 Despite tepid growth rates posted lately, the industry remained attractive to international players with global brands like Wal-Mart through Game Stores looking to expand their footprint within the country. Before liberalization of the retail foreign direct investment in 1994, Malawi was dominated by one retail chain PTC. As the economy opened up, Malawi became a preferential destination for foreign direct investment including investment of foreign retail chains. The opening up of the economy created opportunities for foreign retail operators, especially well developed South African retail chains. Shoprite was the first foreign operator to ply its trade in the country followed by Game stores, Spar and Mr. Price respectively. Fast food brands like Steers and Debonaires Pizza also expanded in the country and recently KFC. Pick n Pay and Jet have expressed interest to come into the country in 2013. The market has seen local entrepreneurs coming up with their own prominent retail chains like Shayan, Chipiku etc. investors with Asian origin have brought an influx of non food consumer goods generally substandard and going at lower prices. Key Performance Metrics To intimately gauge the performance of consumer goods industry operators in Malawi, it is pertinent to highlight some performance metrics of two listed entities plying their trade in the industry on account of availability of credible data since the information is public. Firstly we look at ILLOVO SUGAR (MALAWI) LIMITED (exhibit 4) which has been a steady solid performer over the years increasing revenues at a 14% seven year CAGR to MWK36.4 billion in 2012. Net assets also recorded a 16% seven year CAGR in 2012. The company has been a strong cash generator over the years paying handsome dividends to investors. Like many players in the FMCGs Industry, the company has consistently achieved about 35% gross margin with a seven year average Return on Assets of 49%. Much as the company has enjoyed market benefits of being a monopoly in the sugar sector, two more sugar companies will roll out next year following different consortiums of investors investing close to MWK11.5 billion. Going forward, ILLOVO may face some competition but the demand for sugar is projected to be strong since is also used as raw materials for some products as well. Sugar consumption may soar going forward as the current supply of 330,000 metric tonnes per year will jump 60.6% to 530,000 metric tonnes in 2013.

Performance of ILLOVO will remain spectacular going forward and will remain a profitable venture to the ILLOVO group with Malawian operations accounting for 45% of operating profit.
40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 20% 10% 0% -10% 2006 2007 2008 2009 2010 2011 2012 Revenue MWK,000 Net Assets MWK ,000 Gross Margin % 60% 50% 40% 30%

Exhibit 4 Exhibit 4

Secondly, we analyze the performance of the consumer goods segment of the listed conglomerate, Press Corporation Limited (PCL). None of the subsidiaries or associate companies under the segment is listed such that bundled metrics will be considered. Under the segment there are different entities operating in various natures of businesses like supermarket chain stores, food manufacturing and distributing, fuel and oil distributing, fish farming, ethanol manufacturing , tobacco processing , beverage manufacturing and distribution and steel processing. Although it may appear cumbersome but the operations will on average give a better picture of the consumer goods industry in general. PCL has managed to grow its business line in the FMCG industry over the years but not so spectacular with a six year CAGR of 8% below the whole industrys 12%. Assets grew at a CAGR of 16% during the period under review. The group underwent a divestiture program which saw the disposal of loss making subsidiaries hence reducing revenues notably in 2009 (Exhibit 5). Given group synergies and economies of scale with the relatively huge size of entities, the group has had above average gross margins averaging 52% for six years but significantly thinning in 2010 to 36% and on its way to recovery at 42% in 2011. The company is somewhat well diversified hence able to weather macroeconomic storms; however the huge size brings in inefficiencies that yield a slightly lower Return on Assets at an average of 15% for the six years under review. A lot of value would be unlocked if the conglomerate would be unbundled so that a more entrepreneurial management style was utilized to favorably compete in the ever increasing FMCG industry.

50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 2006 2007 2008 2009 2010 2011 Revenue MWK Billions Gross Margin Net Assets MWK Billions ROA 20% 10% 0% 40% 30% 60% 50%

Exhibit 5 Profiling the Malawian Consumer Much as a bulk of consumers in Malawi is at the bottom of the pyramid where daily survival is the main concern, a research by Douglass Parker Associates has revealed that the average Malawian consumer in the FMCG young, black and educated. Most of the shoppers think that they are currently in adequately served such that about 54% of respondents cited that they need more shops to get food and groceries (Exhibits 6 through 9).

Age
40 Years+ 36-45 Years 26-35 years 16-25 Years

13% 23% 38% 26%

Exhibit 6

Education
A levels O Levels Tertiary School Senior School Junior School

1% 1% 71% 21% 6%

Exhibit 7

Race
White Asian/ Coloured Black

2% 5% 92%

Exhibit 8

More Shops Needed

11% 13% 14% 17% 32% 54%

Exhibit 9

Key Growth Drivers i. Economic Growth

Malawi has seen steady economic growth in the past few years, with real GDP growth averaging above 7% since 2006 buttressed by strong output in agricultural sector driven by the Farm Input Subsidy Program coupled with favorable weather conditions. In 2008 the economy was the second fastest growing economy second from Qatar. Such growth although at a slow pace had trickle down effects to the populace increasing per capita GDP at 14% CAGR for seven years to MWK86 Thousand in 2012 (Exhibit 10). The Increasing per capital GDP also increased consumer spending power as consumption per capital also trended up from MWK9, 864 in 2006 to MWK14, 319 in 2012. It should be noted however that per capita consumption started to abate in 2011 given macroeconomic glitches especially rising inflation that was eroding purchasing power (Exhibit 11).

GDP per Capita

Exhibit 10
60% 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 2007 2008 2009 2010 2011 2012 10% 0% -10% 50% 40% 30% 20% Per Capita Consumption Growth

Exhibit 11

ii.

Population Growth FMCG industry players world over are closely watching the next 1 billion consumers in Africa as population in the continent continues to surge. Malawi happens to have one of the fastest population growth rates at 2.758% annually ranked at number 17 the whole world. Out of the estimated 16.3 million people, 45.1% are under 15 years old, about half 52.2% are within 15-65 years old age bracket. This indicates that Malawi is fairly a young country with enormous opportunities for FMCG industry players especially in the food and consumer electronics sector (Exhibit 12).

Age Structure
0-14 years 15-64 years 3% 65 years and over

45% 52%

Exhibit 12 iii. Urbanization Recent data indicate that 20% of the population in Malawi is in the cities with an urbanization rate of 5.3% per annum second only from Burkina Faso. As such cities in Malawi are growing at high rates with Lilongwe the capital increasing 4.3% per annum, Blantyre the commercial capital adding 2.8% a year, Mzuzu is increasing at 4% per annum. People are moving from rural areas to urban areas in search for employment and other income generating activities. Such people are joining the consumer base for retailers after considerably increasing their income levels. iv. Foreign Direct Investment(FDI) Given high economic growth registered in SSA countries against tapering growth rates in advanced economies investors in the retail sector are in incessant pursuit for growth which countries like Malawi may provide. Coupled with more liberalized FDI policies in the country with minimal restrictions more and more retailers are anticipated to expand in the country going forward. v. Construction of Retail Space Pension fund managers and other institutional investors have shifted their attention to infrastructure and property development recently to optimize long term return on their portfolios. With the newly passed pension act which makes a pension mandatory for any firm with five employees; there be will more funds available for investments in long term projects. Financial services group NICO has invested considerably in

property development having constructed the first shopping mall in Malawi, Chichiri shopping centre in Blantyre housing Shoprite and Game stores. Following success of the mall NICO replicated the strategy and constructed Lilongwe City Mall where Game and other retailers are tenants. Currently plans are underway to spear head Shoprite in Mzuzu city. Old Mutual group through its property development subsidiary, MPICO is currently constructing the retail gateway worthy MWK8 billion and has already attracted South African retailers like Pick n Pay and Jet.

vi.

Sociological Changes Most people in Malawi are slowly adopting some aspects in the western culture which is coming with increased affluence and human rights. This is mainly driven by consumption of international media on DSTV, Free to Air decoders and mobile internet. As such mostly the youth and young adults associate success with eating out hence patronizing places like Hungry Lion, Steers, Nandos and KFC more often to prove a point to their peers.

Opportunities The retail sector in Malawi is imature Players that will come with superior brands will capturethe growing market There is huge potential as most consumers are not served especially in rural areas. Banks are tapping such slowly retailers can too

Nascent Market

Untapped Market

Availabilty of human capital

literacy levels for the young and energitic has been on the rise to 80%

Cross Selling

Retailers may take advantage of selling some services like finanacing and electronic money

Political Will

Thecurrent government will try to implement policies that will foster private sector led growth hence a favourable environment . Moreover country and polictica l risk is minimal as the ciounty is stable

Risks, Uncertainties and Challenges a) In the short term, the economy is on a recovery state which entails more austerity expenditure patterns hence depressed economic growth.

b) The country is preparing for elections in 2014, consequently there will be uncertainty in economic policy and country risk issues as authorities tend to loosen up targets so as to woo voters. c) Current macroeconomic policies that are more market based have come with negative consequences to consumers purchasing power as inflation is on an upsurge given constant depreciation of the local currency. In addition, the flexibility in policies brings in a challenge in planning d) The country has had underlying structural problems of importing more than exports which hurts the balance of payments and puts pressure on the exchange rate and foreign currency reserves. e) The economy is still grappling with infrastructure issues like poor road network increasing operating cost for retailers. Moreover supply of electricity and water is highly precarious f) The bulk of the consumer base is at the bottom of the pyramid as they normally purchase to survive. Most of these buy from the informal market which means more investment in distribution network for operators g) With increasing attractiveness for the country for FCMG operators across the world, the market anticipates some more competition especially from Chinese traders who normally operate in rural areas and have substandard goods which are cheaper and appeals to both the rural and urban poor. Market Entry Points

Market Research

Politically Neutral

Aggressive Marketing to break brand loyalty

Local Strategy

Use Local Talent (Top Management)

Learn from other operators in other countries

Local Partners

Distribution Network

Sell more smaller units at a lower price

Raw Materials Suppliers