Mexico’s economy gaining traction

Mexico was hard hit in 2009, with real gross domestic product dropping by 6.1% as it reeled from the impact of the U.S. subprime mortgage crisis. But it recovered quickly and wasn’t affected much by the European sovereign debt crisis last year.

The consensus forecast for economic growth is around 3.2% this year, says Phil Langham, chief investment officer with RBC Global Asset Management Inc. in London. Nevertheless, he points out that Mexico has a presidential election on July 1, which could result in growth surprising on the upside, as it has often done in the past in presidential election years.

Governing parties like to go into elections with a strong economy and the Mexican authorities have the resources to stimulate the economy through increased infrastructure spending and expansion of credit availability. A similar growth surprise could happen in the U.S., in which this is also a presidential election year.

In addition, there could be stimulus from higher-than-expected prices for oil, a major sector in the Mexican economy. Certainly, the price of oil hasn’t shown the weakness that many analysts expected in the first quarter thus far as markets continue to worry about whether the U.S. will be able to grow its economy by 2%-2.5%, the European sovereign debt crisis and a significant slowdown in China.

Most analysts also consider the Mexican peso to be undervalued right now, which will be helpful for exporters.

Looking ahead, growth in the Mexican economy is expected to continue at a healthy pace of around 3.5% in 2013, assuming that none of the worries about the U.S., Europe or China materialize.

The country is not, however, without its share of challenges. A high-profile one is the drug war. Others are government ownership of the oil industry, lack of competition in the telecom sector and inflexibility in the labour market in that it is difficult to let workers go.

There are security concerns in the north, where the drug war is underway, says Matthew Strauss, vice president and portfolio manager with CI Investments Inc.’s Signature Global Advisors division in Toronto. Although the affected area has spread a little, it isn’t a major problem for firms elsewhere in the country, he adds.

All the major political parties accept that reforms are needed in the nationalized energy sector — but no one knows how quickly, and in what form, this will happen. Strauss thinks private sector involvement is needed to increase efficiency and to expand drilling aggressively, particularly offshore.

Meanwhile, lack of competition in telecom leads to higher prices or inefficiency in services than would otherwise be the case.

Mexican firms are hindered by the difficulty in firing workers. This is a common problem in emerging countries that needs to be addressed, says Strauss.

On the other hand, Mexico’s central bank has done well controlling inflation, and government finances are in good shape.

Here’s a look at some of the companies that portfolio managers hold in their funds that have American depository receipts trading on the New York Stock Exchange:

> America Movil Sab De Cv. This company is by far the largest wireless provider in Latin America, with about 220 million subscribers, says Gerardo Zamorano, a limited partner with Brandes Investment Partners LP in San Diego, who leads the firm’s research in telecom and is a member of the emerging-markets investments committee. He considers the stock very attractively priced, at about 10 times free cash flow.

The firm originated as a spinoff from Telefonos de Mexico SAB de CV (Telmex) in 2000. By 2010, America Movil was so big that it purchased Telmex Internacional SAB de CV, which Telmex had spun off in 2007 to manage its Latin American and yellow-pages directory businesses, and 60% of the parent Telmex. In 2011, America Movil brought its ownership in Telmex to 93% of the firm.

Zamorano describes America Movil as one of the least leveraged global telecom players, with a good acquisition record and a “great history of dividend increases and buybacks.”‘

Langham, who also holds the stock in RBC Emerging Markets Equity Fund, expects significant growth in telecom in the next decade from data transmission and says America Movil is in an extremely strong position to benefit from that growth because it was the largest fibre-optic infrastructure in Latin America. He also notes that it has a very strong balance sheet.

Analysts with J.P. Morgan Securities LLC in Mexico have an “overweight” rating on the stock based on its strong, free cash-flow generation and solid positioning in the Mexican cellular market, with about 70% of subscribers, resulting in high margins.

> Cemex Sab De Cv. This is one of the largest global cement companies, with operations all over the world. Zamorano considers this as a medium-term bet because the firm is currently suffering from lower sales in the U.S. due to continued housing market weakness in that country. The U.S. accounted for only 16% of sales in the nine months ended Sept. 30, 2011, vs 23% for the full year 2007.

Zamorano does not expect “meaningful” increases in U.S. demand in the next 12 to 18 months, but he expects the U.S. housing market will start improving at some point, which will lead to a big bounce-back in earnings and, thus, in Cemex’s share price.

The company has also been affected by the European sovereign debt crisis and resulting recession in southern European countries, particularly Spain, which is a significant market for the company.

However, sales are good in northern Europe, Mexico, the rest of Latin America and Asia, resulting in an 8% increase in total sales in the nine months ended Sept. 30, 2011, vs a year earlier.

Analysts with J.P. Morgan have an “overweight” rating on the stock “as a tactical play on the short-term strengthening of U.S. economic growth and overdone credit concerns.”

> Coca Cola Femsa Sa De Cv.
A holding in CI Emerging Markets Fund that Strauss manages, this firm is the largest bottler of Coca Cola in the world, distributing to more than 200 million consumers in nine Latin American countries. However, analysts with J.P. Morgan only have a “neutral” rating on the stock.

> Grupo Financiero Banorte. Banorte is one of Mexico’s biggest banks. And Strauss is keen on Mexico’s banking sector because it benefits from the robust domestic demand and has strong growth prospects as credit — which is very low at the consumer level — expands. Although he admits that Mexican banks are “maybe not as strong as elsewhere in Latin America,” Strauss still believes they will remain relatively healthy.

The J.P. Morgan analysts have an “overweight” rating on the stock, noting that “expense synergies [from a recent acquisition] should allow for healthy earnings growth.” They note the bank says “higher-margin consumer loans are growing disproportionately fast,” and it thinks it can gain market share from foreign competitors distracted by what’s happening in Europe.

> Grupo Televisa Sab De Cv.
A holding in Strauss’s CI fund, this is the biggest broadcaster and provider of Spanish-speaking television programs in Latin America; it is also expanding in the U.S., where its network is one of the fastest-growing. It also provides cable, satellite and pay-TV services.

However, analysts with J.P. Morgan only rate the stock as “neutral,” saying they expect weak core broadcasting revenue long term and consider Televisa’s current valuation “demanding vs its peers.”

> Gruma Sab De Cv. One of the world’s leading producers of corn flour and tortillas, Zamorano says Gruma is by far the market leader in Mexico and the U.S. It also sells its products in Europe, Central America, Venezuela, Asia and Oceania. He considers it an excellent defensive stock because many people eat tortillas regardless of the economic climate.

> Wal-mart De Mexico Sab De Cv. Another holding in Strauss’s CI fund, the firm offers exposure to retail and health care, and continues to expand rapidly. With a relatively young population, Mexico’s retail business is doing very well and is a long way from saturation, says Mark Mobius, executive chairman of the emerging markets group with Franklin Templeton Investments in Singapore.

Analysts with J.P. Morgan expect traffic in the Walmex stores to further accelerate in 2012 “as consumers perceive better value.” They consider the stock a defensive one “in a bearish environment given its net cash position and potential to accelerate [share] buybacks.”

Although Walmex’s stock is trading at about a 20% premium to its Latin American peers, the J.P. Morgan analysts note that its return on equity is twice as high. IE