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 Business News | April 2007 
A Look into Latin American Markets: Mexico
 Kimberly DuBord - Briefing.com
Over the last year, the Mexican Bolsa Index (Indice de Precios y Cotizaciones or IPE) has outperformed three of the four "BRIC" countries widely touted for their growth prospects. Only the Shanghai exchange, returning a breakneck 138%, has outpaced the Bolsa, having gained 44% over the last 12 months.
It has been a relatively undeterred upward ascent for Mexican stocks over the past few years on strong economic growth and tempered inflation, with the exception of a dip last June ahead of the presidential elections, after which the Bolsa rose nearly 70%.
The Emerging Markets have become an entrenched part of a diversified portfolio. As global markets move more and more in tandem, investors are looking overseas in search of higher returns. This trend has borne out over the last decade as interest rates neared 0% in Japan and borrowing costs fell to a four-decade low in the US, making foreign investment even more attractive.
Given its trading status with the US, Mexico tends to track the US market, in particular Fed rate policy. The Bolsa has a correlation of 0.75 to the S&P 500. A correlation of 1 means stocks move in lockstep.
Valuations remain attractive on a global comparison, but appear a bit stretched regionally with Brazil looking more attractive at current levels. The Bolsa trades at 8.5x forward and 12.8x trailing earnings, compared to its 5-year average of 14.1x.
While the risk/reward scenario has become less compelling from last year due to slowing growth rates, we remain cautiously optimistic on Mexican equities. The accelerated pace of reform by newly-elected Felipe Calderon, after limited gains under Vicente Fox, underscores the growth prospects ahead, particularly within the domestic segments like housing and energy.
The greatest risk at this point is a hard landing in the US. We don't, however, see this scenario playing out. Instead we project economic growth of 2% for the first half of the year, accelerating to 3% by year end.
Growth & Inflation
The Mexican economy, the second largest in Latin America, is expected to grow 3.6% in 2007. Last year, the economy expanded by 4.8% piloted by 4% growth in the manufacturing sector, 4.9% in services, and 4.8% in agricultural. The pace of economic growth in the first quarter is estimated to have slowed to 3.5% sequentially from 4.3%.
Inflation remains a primary concern. Rising food prices, ranging from tortillas, corn (thanks to the thirst for ethanol in the US) and tomatoes have caused the central bank to miss its inflation target of 2-4% in five of the last six months. Last month, inflation crept up to 4.14% from 3.98% in January. Core inflation was 3.95% - the highest level in nearly 5 years.
The 75% jump in tortilla prices, a staple of the Mexican diet, has raised concerns over the pace of consumer spending. Mexican corn prices have risen more than US prices, causing tortilla prices to double to nearly 10 pesos per kilo. The government capped prices in January at 8.5 pesos. The typical family eats 3 kilos/day, accounting for 17% per capita disposable income, according to Santander Investment. It has been several years since consumers, particularly the lower classes, have seen this type of inflationary pressure.
On March 23rd, the Bank of Mexico held its overnight lending rate unchanged at 7% for the 11th consecutive month. Most economists, however, anticipate that if inflation continues to rise in coming months, there will be further tightening ahead. The move was widely anticipated as a result of the decline in core inflation in the first half of March to 0.16% from 0.23%.
The central bank shifted its rhetoric by focusing on a balance of risks in the coming months. Bankers noted there is no "significant evidence" that rising prices for food items have spread to wages, inflation expectations and other prices. It now expects a general inflation rate of 3.5-4% by year-end, but noted if inflation remains above 4% for several months, the risk of price increases grows.
Foreign-Direct Investment
While economic activity has remained relatively strong, a slowdown in the US will cause a domestic slowdown. A slower US economy is expected to reduce foreign direct investment in Mexico by 3% this year to $18.3 bln. This comes after a 6% rise in 2006 - the second highest rate in the country's history.
Oil & Gas Complex Sovereignty
There have been calls for Mexico to open up its oil and gas industry. President Felipe Calderon has vowed to push for greater foreign participation via strategic partnerships, but is expected to stay away from promoting outright private investment. This is an extremely politically sensitive issue, particularly given the wave of nationalism of basic material assets in the region.
Oil revenues generate 38% of total income. Pemex, the state-run monopoly, is the only oil company in the world to post net losses, projected at $7 bln, in 2006. According to industry experts, production in the Cantarell field, the world's second largest oil complex and source of 60% of all Mexican oil, appears to be trailing off more sharply than expected. Pemex forecast production will decline by an average of 14% per annum between 2007-2015.
Pemex has begun ramping E&P spending to boost production, but it lacks the financial and the technical know-how, particularly in deepsea drilling, where most argue the future of Mexico's oil production lies. Recently, it's signed several key rig contracts with Noble (NE), including 10 jackups at a dayrate of $170k vs. the prior contract rate of $65k.
Stocks
For the sake of brevity, we've briefly covered a few widely-covered ADRs. While our regional preferences lean towards Brazil, we do like some domestic names here, including wireless provider Movil (AMX, Mkt Cap US$81 bln) based on expected margin acceleration and cash flow generation, Grupo Aeroportuario given its position in this high volume growth industry, Grupo Televisa (TV, Mkt Cap US$14.6 bln) on Triple Play and gambling growth opportunities and possibly Cemex as the US economic outlook solidifies.
Fomento Economico Mexicano SA or Femsa (FMX; Mkt Cap US$13 bln) is the largest beverage company in Latin America. Coca-Cola Femsa (KOF Mkt Cap US$6.6 bln), the largest bottler, which has been the primary growth driver for the company, has become a major drag on operations. The unit has been forced to lower prices in Mexico due to rising competition from low-cost soft-drink brands.
Margin pressure will ensue due to lower soft drink concentrate prices from weak pricing in Mexico City, increased competition from Big Cola in Tabasco and Colombia and rising sweetener costs from higher corn prices.
On the flip side, beer sales remain quite strong, helped by Femsa's agreement with Heineken NV, which expires this year. Sales rose 13% last quarter, far outpacing growth in the entire US market. Rising competition, margin pressure, and share valuation restrain our view on the stock for the near-term. The stock trades inline with global peers.
The fact that Cemex SA (CX; Mkt Cap: $26 bln), the world's third-largest cement company, sells most of its products in the US and Canada has tempered its outlook due to the downturn in the housing market. The shortfall in February new home sales dampened the view of a quick revival in housing. Despite attractive growth rates, concerns over US economic growth and the housing slump will continue to loom large over the exporters. At signs of relief on either front, we would be picking up shares given Cemex's growth prospects and expanding global footprint.
The Triple Play has reinvigorated the US cable and telecos and now the game has moved across the border. On March 5th, eight Mexican cable companies signed accords to offer television, broadband access and voice services over Telemex's network. (Telefonos de Mexico -TFONY; Mkt Cap US$31.7 bln).
However, the Communications and Transportation Ministry hasn't completed a convergency agreement designed to allow telephone and television companies to compete openly with one another. Currently under Mexican law, Telemex, unlike Verizon (VZ) and AT&T (T) in the US, is barred from offering TV programming. This fact continues to hinder the outlook for Telemex, raising speculation that the company may be considering shedding assets to unlock value.
Grupo Aeroportuario del Pacifico SA de CV (PAC; Mkt Cap US$2.3 bln) operates, maintains, and develops 12 airport concessions in the Pacific and central regions. Sales have grown 60% over the past three years, while profits have more than doubled. Double-digit sales growth and ongoing margin expansion is expected to produce 7% earnings growth this year, followed by 15% next. |
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