When the history of Covid-19 is written, it may be recorded as the Zoom era. The videoconference provider has spread as rapidly as the virus. It’s users have risen 30 fold from just 10 million in December 2019 to almost 300 million in April 2020. Like Google and Xerox, Zoom is a now used as verb.
Investors are clamouring for exposure to Zoom and its videoconferencing peers, such as Cisco Webex, Google Hangout, and Houseparty. Some are seeking proxies in the EM and FM world. Though they are technology companies, these players are positioning themselves as consumer stocks rather than tech platforms. They have the hallmarks of trendy restaurant stocks such as Chipotle with high operating expenses. It is also similar to disruptive food delivery companies such as GrubHub.
However, a discerning investor in the EM/FM space would be well-served to look beyond the crisis. Investors should look for the tried and tested, rather than a company that owes its success to the lockdown. The lockdown cannot last indefinitely and Zoom's nosebleed valuation may become hard to defend.
Though Zoom is at 2110x FY20 PE, Buy recommendations vastly outnumber the Sells. Bloomberg consensus expects its net earnings to reach US$1 billion by 2024. This would imply that its users would need to triple to 750mn, assuming ARPU remains stagnant.
The surging usage numbers do not accurately reflect the prospects. The surge in users mostly comes from the free tier, where users can host calls of up to 40 minutes. The customer growth from paid users is not as robust. The user experience has suffered with increasing numbers of free users, as higher usage increases the bandwidth requirements. The churn rates have risen recently, while its margins are faltering. Costs are escalating without a commensurate rise in average revenue per user. There are also security concerns, which may lead to Zoom aversion.
Investors are betting that Zoom's usage will expand due to an indefinite lockdown, and changing work and education habits after lockdowns ease. This is a dangerous assumption. Zoom's moat is not that strong, and switching platforms is free and relatively painless. People may switch to rival video platforms like Facebook Messenger, Hangout and Houseparty, while new businesses could spring up specialising in particular niches, be it work, informal meetups or education.
FMCG in FM are on a sound footing
By the sharpest of contrasts, the Fast-Moving Consumer Goods (FMCG) companies that form the bedrock of consumption in developing markets are on a sounder footing. These stocks have borne the brunt of the sell-off despite the resilient sales that have prospered during lockdown. The sell-off could be rooted in the fear of currency weakness in Nigeria, Indonesia, Pakistan and Sri Lanka. The basket of these four currencies have fallen by an average of 4% YTD.
However, these businesses are of immense value, with or without Covid-19.
Firstly, they have strong brands that are unlikely to be dislodged by capricious customers. Unilever's Lux is the leading soap brand in Nigeria. It is ubiquitous and has been a dominant brand for generations. In Pakistan, Unilever's Cornetto ice creams have weathered currency crises, terrorism and consumer collapses.
Second, the FMCG majors have mastered the strategy of selling to the bottom of the pyramid. They sell in small unit sizes and to the mass market. Unilever sells Lux shampoo in Nigeria, Pakistan and Indonesia. These are markets where the average wage is barely US$4 per day. By pricing these products at 20 US cents a pack, they can reach the relatively untapped fortune that resides at the bottom of the pyramid.
Third, FMCG have higher ROE than almost any other industry. High ROE companies enjoy a margin of safety to continue generating ROE even in the event of high interest rates and/or inflation. If we see an inflationary spiral in frontier markets, the FMCG cohorts would be a better investment than fixed deposits or local bonds.
FMCG have solid balance sheets
In a time of crisis, the robustness of the balance sheets of the FMCG companies stand out. There are twin issues facing FMCG companies in developing countries – the threat of currency depreciation and debt escalation.
We test 42 consumer companies to assess their ability to withstand a potential interest rate hike and currency depreciation. We use six metrics including net debt ratio, ratio of foreign debt to total debt and proportion of COGS in foreign currency. We call this the Teflon index.
FMCG companies such as Nestle Nigeria, Unilever Indonesia and Nestle Lanka are in the top half of the table. They fare well on this metric due to their highly branded product mix, low leverage and ability to pass on input price increases.
Total shareholder returns show the power of compounding
The total shareholder return (TSR) of the frontier FMCGs in the past decade is a testament to this factor. The five FMCGs have all generated TSR in excess of 102%, with the exception of the Unilever Nigeria. The returns are robust due to the high ROEs and the consistent high dividend payouts. This leads to the FMCG's acting as compounding investments. Zoom has only been listed since April 2019 and while its return so far has been very strong, the entirety of it has been due to share price appreciation.