Description

We are recommending a short position in Grupo Elektra. Last September, a short idea on Elektra was posted in VIC; while we fully agree with the thesis posted by xanadu972, we think current market and company conditions make this a more appealing investment and minimize its risk. In our view, the most important catalyst has already occurred with the recent changes on the regulatory frame of the Mexican Pension Funds.

 Elektra is trading at MXN $544.01, 43% higher than the already overvalued price of MXN $381.36 in Sep 2008, when the original idea was posted. This price expansion is explained mainly by the original Mexican pension funds regulation, which maintained a low permitted deviation from indexes performance. Therefore, the price of illiquid companies' shares in such indexes boosted and significantly outperformed other members of the Mexican Stock Exchange, not particularly because of their attractive valuations or strong fundamentals, but due to the large weight of the stock in the indexes and its low liquidity, this last due to the small float that companies have left free.

 Yesterday, the Risk Committee of CONSAR (Mexico's pension funds regulatory commission), authorized the AFORES (Mexican Pension Funds) to have up to a 4% divergence when replicating local equity indexes vs. the previous 1% allowed, giving greater flexibility for stock selection; this will be the main driver for the pension fund flows to migrate its portfolio from high valuation and illiquid names to concentrate in more appealing investments.

 Overall, it is expected to see some pressure in highly illiquid names that compose the NAFTRAC and ILCTRAC indexes and in companies trading at premium valuation compared with its non NAFTRAC's peers.

 Elektra stands as the most exposed company to this coming downturn for "illiquid names in the NAFTRAC":

 Elektra has a huge amount of its free float within NAFTRACs and ILCTRACs (small float company with large weight to the indexes). Elektra has 21.6 M shares in float from a total number of shares of 243.1 M (8% of free float) and the equivalent to 7.3 M of Elektra's shares are trading in the ILCTRAC and NAFTRAC Indexes. This translates in a 33.7% share of Electra's float related with the ILCTRAC and NAFTRAC indexes (the most exposed company of the sample).

• Under the new regulation, portfolio managers will have more flexibility to avoid low-liquidity stocks.
• Elektra is one of the seven stocks with a weight in the index above 4%. The stock price is very likely to be negatively affected because of its low liquidity compared with its important weight on the indexes.
• Elektra's valuation of P/Sales 3.1x and EV/EBITDA 27.7x, seems much higher than a year ago; and way above its Mexican and international peers (its main Mexican peers GFAMSA and Coppel are trading at 11.2x and 6.4x EV/EBITDA respectively).

Catalyst

Recent changes on the regulatory frame of the Mexican Pension Funds.