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Mean Reversion for Oil, Consumer Stocks to be Powered by Economic Rebound

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Despite being cheap, the foundation for beaten down oil and consumer goods stocks to outperform other sectors on the Nigerian Stock Exchange (NSE) lies mostly on the performance of the wider economy.

In a year (2020) when Nigerian equities measured by the NSE all share index rose 50 percent, major laggards such as the oil and gas index down – 13.84 percent and consumer goods index -3.29 percent were masked by the broad index gains.

This then begs the question what would make valuations in the lagging sectors revert back to their historical averages (the so called mean reversion). Mean reversion is a theory used in finance that suggests that asset prices and historical returns eventually will revert to the long-run mean or average level of the entire dataset.

If it materializes for oil and consumer stocks, then it would provide another leg up for stocks and in theory enable those that missed the 2020 rally to ride such names as Guinness Nigeria, International Breweries and Seplat up to new highs.

Consumer firms like Unilever Nigeria and International Breweries which recorded negative free cash flow as at September 2020, are reeling from weak consumer purchasing power, rising cost of production, foreign exchange scarcity and decrepit infrastructure.

Rising domestic demand vs. supply in 2021 is looking favorable as the economy begins to repair and population growth, reopened borders and higher oil prices improves sentiment towards consumer and oil firms.

The NSE all share index has a price to earnings ratio of 15, compared to about 11 for the consumer index.

Commodity prices should rebound this year as the coronavirus retreats and depressed demand for air travel, and tourism makes a comeback.

The Nigerian economy should also exit recession in the first quarter of 2021, which should be confirmed by May.

The bottom line is that with major blue chip stocks all haven risen so far so fast, the next place investors can find hidden value would be in beaten down names that failed to rally last year.

In finance paying a higher earnings multiple for equities lowers the return one should expect to earn. Therefore with many stocks trading at multiyear highs, investors may begin to nibble at some quality consumer and oil stocks likely to deliver solid equity returns in the near future as Nigeria’s macro story improves.

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