FMCG stocks skyrocket after Unilever delisting confirmed

Enthusiastic investors expect the $500m to stay in the sector, driving up valuations.

KARACHI:

The consumer goods sector, it seems, can do no wrong. In anticipation of the $500 million being paid out to Unilever Pakistan’s minority shareholders being reinvested into the sector, virtually every single consumer goods company listed on the Karachi Stock Exchange (KSE) was either at or near its upper lock on Thursday. But is the investor enthusiasm premature?

The short answer to that question seems to be yes: investors appear to be making a key mistake that is the hallmark of every bubble: an irrational exuberance that mistakes a stock’s pricing for its value. Pricing a stock means to try to figure out how much investors are willing to pay for it. Valuing it means figuring out how much it is intrinsically worth. The two can be very different.

When valuation leads to a larger number than pricing, you have on your hands a value stock worth buying. When the reverse is true, you have a bubble that can only end in a crash.

For at least the past couple of years, investors have consistently been willing to pay more for a consumer goods stock than for a stock in any other sector. According to BMA Capital, the sector trades at nearly 34 times 2012 earnings, much more than the seven times earnings that the overall market trades at.

This enthusiasm is at least partially justified. The difference in revenue growth between the food and consumer goods sector and the rest of the stock market is not that high: 18.8% per year between 2006 and 2011 for the FMCG sector compared to 16.2% for the overall KSE, according to data compiled by the State Bank of Pakistan. The difference, however, shows up in the profit growth: FMCG profits grew at 21.7% per year between 2006 and 2011, compared to just 7% for the broader market.

And high-performers within the sector are doing even better, since the sector’s increasing scale and infrastructure development is helping a rise in profit margins. Companies like Nestle Pakistan have already seen their operational expenses as a percentage of total revenues plummet as they reach economies of scale.

Small wonder then, that investors want to stay in those stocks, even after the Unilever Pakistan delisting. “Investors expect the Unilever buyback money will chase other consumer stocks and this explains the upper price circuits in most consumer stocks. Engro Foods (up 4.9%), National Foods (up 5%), Thal (up 5%) Bata Pakistan (up 5%) and Murree Brewery (up 5%) all traded at or near their upper price circuits,” wrote Muhammad Raza Rawjani, a research analyst at Elixir Securities, in a note issued to clients on Thursday.

Nonetheless, the exuberance in food and consumer goods stocks is not entirely driven by the intrinsic value in the sector. At least part of it has to do with the fact that there are simply too few consumer goods companies listed on the stock exchange, and the few that are listed are very closely held.

One the largest and most liquid food companies listed on the KSE is Engro Foods. Yet portfolio managers have already begun to complain that the free-float of the stock is not enough to sustain high enough trading volumes. Investors are practically begging its parent Engro Corporation to do a follow-on offering to satisfy demand.

In their pursuit of liquidity, foreign investors have resorted to asking their brokers for block trades – where their broker directly procures a large block of shares and sells it to them for a higher fee than usual. The stocks are acquired from some of the largest institutional investors in the country.

“The portfolios of National Bank of Pakistan and State Life Insurance Corporation are like the attic of the capital markets: nobody has looked at them in ages, but we are pretty sure they have everything,” said one finance professional based in Karachi who wished to remain anonymous.

But there is a limit to how much NBP, State Life, and others can continue selling. Ultimately, investors’ increasing appetite needs to be satiated with more investment options. This means the country’s investment bankers need to start doing their real job: getting good companies with solid earnings and growth trajectories to list a substantial proportion of their shareholding on the market. If they do not, they will have only themselves to blame for the next crash.

Published in The Express Tribune, April 5^th, 2013.

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