When considering the state of the world and that life is unlikely to regain a semblance of normalcy possibly as far into the future as the second half of 2021, we may see a bifurcated approach among countries regarding the handling of this virus. Some countries will follow the path of Brazil, Sweden and Turkey which have let the virus spread naturally, accepting the fact that it is so widespread globally that the genie cannot be put back into the proverbial bottle. In the process these countries are limiting the impact on their economies, which is still quite significant nonetheless. The other group of countries are likely to undergo a prolonged period of repeated closings and re-openings.
At present, it appears Uzbekistan has chosen the second approach, though the government appears to be attempting to keep quarantine restrictions as non-invasive as possible in order to protect the incomes and livelihoods of its citizens. The most likely reason for the country choosing this approach is in an attempt to not overwhelm the fragile and ill-equipped healthcare system. So, until the government can ensure that healthcare infrastructure is no longer at risk of being overwhelmed, this period of closings and re-openings is expected to continue. We would therefore expect a third quarantine period to take place sometime in October or November.
The practicality of Uzbekistan’s Gold reserves
As many Asian Central Banks understand the value of gold and continue to increase their holdings, western Central Banks have largely done the opposite and sold large chunks of theirs in recent years. While gold is regarded by some economists and business people as an archaic relic, Uzbekistan is an important case study for why gold is so valuable for emerging economies.
The first half of 2020, like in many countries, was a challenge for Uzbekistan in relation to exports, which fell 7% year on year. Meanwhile, imports rose 3.6% due to the continued re-industrialization of the country and strong demand for animal protein, specifically beef. When excluding the country’s USD 2.12 bln in gold sales, the current account deficit stood at USD 6.52 bln. Now, accounting for the gold which was sold during the period, the current account deficit narrowed by 32.6% to USD 4.4 bln. Gold is an important commodity the government uses to decrease the current account deficit, and as global trade slows, with increasing competition for a shrinking global economic pie, Uzbekistan has a guaranteed way to make sure its current account deficit, expected to move into surplus in the mid-2020’s on the back of rising exports and a decrease in machinery imports, does not get out of hand; if it so wished it could sell enough gold today to move the country into a trade surplus. This puts Uzbekistan in a very unique position, providing strong support to the country’s finances in what will be a long road on the way back to normalcy in the global economy.
At the end of the first half 2020, Uzbekistan’s foreign exchange reserves stood at USD 32.32 bln, of which USD 19.60 bln was gold, equivalent to 11 mln ounces (the Central Bank of Uzbekistan continually replenishes its gold reserves through purchases of physical gold in local currency from state-owned mines). As of 31st July 2020, these 11 mln ounces of gold are valued at USD 21.73 bln or 41.77% of GDP.
Portfolio company performance
The fund’s portfolio companies showed broad performance during July, though the standouts were cement producers. Due to the first nationwide quarantine, initiated on 16th March 2020, Uzbekistan customs increased the time to clear goods at land borders where it took up to 28 days for imported cement to go through. The issue has been resolved as it now only takes 2 to 3 days to clear customs, but this bottleneck amid continued strong domestic demand led the price of PC-400 bulk cement (the most common type of cement produced in Uzbekistan) to rise from UZS 458,000 on 1st January 2020 to UZS 800,000 on 30th June, a 74.67% increase. Qizilqum Cement (QZSM), the fund’s largest holding at 33% of AUM, and the largest producer of PC-400 cement, saw its share price appreciate by 22.8% during the month. QZSM's strong performance for the month however was met with softness in some of the fund’s other holdings, merely due to low liquidity into month end, which impacted July performance by an estimated −3.6%.
QZSM had its best quarter since we first visited Uzbekistan in May 2018. Second quarter 2020 earnings per share were UZS 314.35, or a 103% increase year on year. QZSM ended the month trading at a P/E of 2.48, P/B of 0.54 and an EV/ton basis of USD 7.25 (this compares very favourably to the replacement cost of capacity of USD 110 to USD 120/ton).
The fund also benefitted from performance in a cooking oil company (whose raw material is cotton seeds) and one of the two Kyrgyz companies the fund holds—an airport operator. The cooking oil company ended the month +27% and announced a 2019 dividend which equates to a yield of 10.2%. The Kyrgyz airport operator also announced a strong 2019 dividend which translates to a yield of 14.1%.
At the end of July 2020, the fund was invested in 28 names and held 4.1% in cash. The markets with the largest asset allocation were Uzbekistan (93.6%) and Kyrgyzstan (2.3%). The sectors with the largest allocation of assets were materials (59.2%) and industrials (14.6%). The fund's estimated weighted harmonic average trailing 12 months P/E ratio (only companies with profit) was 3.36x, the estimated weighted harmonic average P/B ratio was 0.69x and the estimated weighted average portfolio dividend yield was 6.34%.