1998 LUSE YEAR-END MARKET REPORT

THE ECONOMY

Unlike 1997, a year which saw falling inflation and interest rates, relatively stable exchange rates and a growing economy, 1998 can only be described as an economic disaster in Zambia. With falling copper and cobalt prices, continued protracted delays in the sale of the remaining ZCCM assets (in particular the Nkana and Nchanga mines) and the resulting (at least temporary) termination of donor support, the economy went into a tailspin. The significant gains achieved in 1997 on the inflation, interest rate and exchange rate fronts were all lost in 1998.

As we enter 1999, there is renewed, though greatly subdued optimism (compared to the beginning of 1998), that the mine sale saga will finally come to a merciful close. In mid-January, the government and Anglo American jointly announced the signing of a detailed Memorandum of Understanding which, if all pre-conditions are met, will result in the sale of the remaining key mining assets to Anglo by the end of the first quarter. If history is to be any guide, however, investors must proceed with caution until such time as a sales agreement has been signed and ownership transferred.

Inflation, which closed 1997 at 18.6% after declining consistently during that year, showed a dramatic reversal in 1998, ending the year at 30.6%. The declining economy which contracted by an estimated 2%+ during the year, combined with the need to import maize for the second year in a row pushed the inflation rate up, reversing the gains made in 1997 and eliminating any possibility of achieving the Bank of Zambia’s targeted 8% inflation rate for the year. The rate targeted for 1999 is 15%.

Consistent with increasing inflation rates, interest rates climbed throughout the year; from a low of 12.3% for 28-day T-bills in January to 34.8% in December. If the 15% inflation target for 1999 is achieved, it should result in declining interest rates over the course of the year.

The exchange rate dropped by 64% in 1998, going from Kw 1,427.50 to the US Dollar at the close of 1997 to Kw 2,342.50 to the US Dollar by the end of 1998. While non-traditional exports provided about US$ 315 million in foreign exchange (similar to the 1997 results), its percentage of foreign exchange receipts increased due to the decline in copper prices and production, and the non-receipt of US$ 235 million in balance of payments support that had been pledged by the donors at the Paris Club meetings. Had it not been for the contracting economy and the resulting decrease in demand, the Kwacha could have easily fallen further.

The government projects economic growth for 1999 in the 4% range. Coming after the disastrous 1998 results, this achievement would be nothing short of miraculous. It is highly dependent on several critical factors. First, there must be a turnaround in the mining industry driven by Anglo American’s takeover of the Nkana and Nchanga mines and related assets, and its re-investment in the same. Obviously, an improvement in the international prices of copper and cobalt would provide greatly needed assistance in this regard. Second, the manufacturing and construction industries, which have been in the doldrums for the past two years, must be revived, largely on the back of the mining industry. And, finally, tourism and agriculture, which have shown so much promise for several years, could begin to make an important contribution to the economy in 1999 supported by investments from major regional and international groups.

In line with the overall economy, performance on the LuSE in 1998 declined dramatically after the market’s record 90%+ real growth in 1997. The LuSE index opened the year at 210.7 and closed at 161.48, a 23% decline in nominal terms, but a 53% drop in U.S Dollar terms due to the dramatic fall in the value of the Kwacha during the course of the year.

While the number of trades increased marginally, going from 3,741 in 1997 to 3,772 in 1998, this was primarily due to small, Zambian investors selling off shares to meet short-term cash requirements. By all other indicators, the market showed declining performance. The volume of shares traded declined by 41.5%, from 269.6 million in 1997 to 157.9 million in 1998, while turnover dropped by over 59% in real terms going from US$ 8.77 million in 1997 to US$ 3.56 million in 1998. This is reflected in the lower participation by foreign investors in the market. While net foreign investor inflows to Zambia registered US$ 818.8 million during the year, this represented a 43% drop from the US$ 1.43 billion net inflow experienced in 1997.

There were two new listings during the year. First, National Breweries, in which the government offered its 30% shareholding interest, came on the market in early 1998. The offer was only 91% subscribed. This was largely due to concerns investors had over the offer price which many felt was on the high side, and the announcement by Zambian Breweries that it would be making an investment in the opaque beer industry and providing direct competition to National Breweries, the major brewer of opaque beer in the country. Second, in November, Pangaea/EMI was the sponsoring broker for the listing of Standard Chartered Bank, the first bank stock to be listed on the exchange.

With the exception of Standard Chartered Bank, whose share price increased by 36% in nominal terms following its listing on the Exchange, all of the other major stocks registered price declines during 1998. During the year, trading was most active in Zambia Sugar, Standard Chartered, Chilanga Cement and Zambian Breweries shares.

ROTHMANS

Starting the year at Kw 95 per share and closing at Kw 80, Rothmans suffered a 16% nominal decline in price and 48.6% in U.S. Dollar terms during the course of the year.

Rothman's unit sales grew by 29% over 1997 due to the largely successful campaign to introduce low cost brands and win back the segment of the market that had been lost to raw leaf smokers. Nevertheless, the company’s performance continues to be adversely affected by the declining economy as disposable incomes remain under severe pressure and increasing input costs as a result of the depreciating Kwacha.

Prospects for the future are contingent on increasing disposable incomes, which are directly tied to improvements in the economy; once again, the mining industry issue.

We have a HOLD on Rothmans, pending the conclusion of the sale of the remaining ZCCM mining assets. Should this proceed with Anglo American as planned, the future prospects for the company should improve.

CHILANGA CEMENT

One of the star performers of the market in 1997, Chilanga suffered much the same fate as other stocks during 1998. Its price dropped from Kw 155 at the beginning of the year to Kw 140 by the end of the year. While this represented only a 10% drop in nominal terms, in U.S. Dollar terms, the stock lost 45% of its value in 1998.

The performance of the construction industry in general, and Chilanga in particular, is directly tied to the performance of the economy as a whole. With the precipitous decline in the Zambian economy, 1998 saw Chilanga aggressively penetrating export markets, in particular the re-opening of Burundi, Malawi, the DRC and, to a lesser extent, Zimbabwe. In addition, in conjunction with its majority shareholder, the Commonwealth Development Corporation (CDC), the company made a successful bid for the acquisition of Mbeya Cement in Tanzania. This was a strategic move to prevent a competitor from taking its markets in East Africa. While a good, defensive move in the longer term for the company, in the short term it will negatively impact the company’s performance as markets in East Africa historically served by Chilanga will now be addressed by Mbeya.

We recommend Chilanga as a BUY ON PRICE DIPS in the short term. Should the sale agreement with Anglo be concluded, the immediate prospects for the company would improve dramatically and our recommendation would immediately shift to strong buy.

ZAMBIA SUGAR

Zambia Sugar continues to be the market’s most liquid and actively traded stock. The country’s sole producer of sugar, its price opened the year at Kw 28 per share and traded during most of the year around Kw 22. It recorded a high of Kw 32 per share in mid-year, but closed the year at Kw 14, representing a decline in real terms of 69.4%.

The price was adversely affected by two key factors. First, the declining Kwacha pushed up production costs. This, combined with the smuggling of sugar early in the year that required the company to reduce prices to compete, had an adverse impact on performance during the first half of the year. Second, given the difficult economic conditions, employees who had participated in the "Employee Stock Ownership Plan" (ESOP) and who had fully repaid loans extended by the company for them to purchase shares in the initial public offering, decided to sell their shares almost at any price. This seriously depressed the share price.

Cost control measures instituted in late 1997 and the shutting down of non-core businesses began to have a positive impact during the year, and the yearend results (a shortened 6-month year due to the change in the company’s fiscal yearend from March to September) were extremely encouraging.

At the depressed price, we recommend the stock as a BUY.

ZAMBIAN BREWERIES

Opening the year at a price of Kw 215 per share, Zambian Breweries stock attained a year high of Kw 260 in March before dropping to close the year at a low of Kw 200. In U.S. Dollar terms, this represented a decline in value of 43.3%.

In spite of this performance, which was driven by the poor economic conditions prevailing in the market during the course of the year, Zambian Breweries remains the dominant (and will soon be the sole) brewer of clear beer in Zambia. It is a highly profitable company and has the most attractive dividend payout record of any company in the market. The company is managed by South African Breweries which also owns 45% of the shares of the company.

It recently made an offer to acquire a controlling interest in Northern Breweries, the only other brewer of clear beer in the country. The offer was accepted and the purchase has been provisionally approved by the Zambia Competition Commission. Once final approval is given (and this is anticipated), Zambian Breweries will effectively have a 100% share of the clear beer market in Zambia.

While 1998 was a difficult year for the company and the high excise duties continue to adversely affect results, with the anticipated turnaround in the economy and the virtual monopoly position the company will enjoy in the clear beer market, we judge this stock to be a STRONG BUY. Unfortunately, only a small portion of the company's shares are publicly held and large blocks are almost impossible to obtain hence the recommendation is STRONG BUY FOR RETAIL CLIENTS.

STANDARD CHARTERED BANK

Standard Chartered was undoubtedly the market’s best performing stock of 1998. Opening the year at Kw 14 per share, it remained close to this level throughout much of the year. In November, just prior to its listing, it was still at this price level. Following the listing, however, investors responded and the price jumped to Kw 19 during the month following the listing, representing a 36% increase in nominal terms and a 25% increase in real terms. The listing will reduce the Bank’s income tax rate from the marginal 45% rate applicable to banks, to a rate of 30% for quoted companies. We estimate that this will save the Bank over Kw 1.5 billion in taxes for 1998 alone.

Since the completion of the Bank’s re-structuring which resulted in the closure or sale of seven branches throughout the country and the re-focussing on its core businesses of corporate banking, trade finance and treasury operations, the Bank’s performance has consistently improved and we expect this to continue into the future. We rate Standard Chartered a STRONG BUY.

We anticipate that activity on the LuSE will increase in the coming year. With the successful conclusion of the ZCCM saga, there will be more interest not only by investors, but also by companies seeking to raise capital, something that the Exchange has not yet been utilised for to date. We also anticipate that there will be more recently privatized companies listing on the Exchange, in stark contrast to the dearth of companies during 1998. Should the mining industry turn around and economic growth resume the upward trend which began in 1997 and which stalled in 1998, the coming year could be an attractive one for the market.

This circular is strictly confidential and is intended for the sole use of the addressee. It may not be reproduced, circulated or disclosed without the prior written consent of Pangaea Partners Zambia. The information herein is based on information from sources deemed reliable, but Pangaea accepts no liability for any loss resulting from the use of the information contained herein or from any omissions. Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures. Pangaea Partners (Zambia) Limited, Pangaea Securities Limited, their affiliates, directors, officers and employees may have a long or short position in Zambian securities including any described herein.

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