Mexico: Investors' new China

Market Watch
Nov 6, 2012

By Ivan Martchev

Some forget that California, Nevada, Utah, a small part of Wyoming, Arizona, New Mexico, Colorado and Texas were actually part of our southern neighbor a long time ago. But apart from the serious immigration issues brought on by a huge land border, Mexico's proximity to the U.S. — as well as intertwined cultural heritage — offer serious investment opportunities for believers in free trade.

Mexico is the only up-and-coming emerging market that has such close economic connection to the U.S. With a growing population of 108.6 million, Mexico sends 78.7% of its exports to America and gets 49.8% of its imports from here. The only other economy with such economic leverage to the U.S. is Canada, yet it is well-developed and has a completely different investment climate.


Organized crime is a serious issue, but the outgoing Calderon administration has done a lot to remove the bulk of the cartel leaders. If the next administration keeps up the pace, one can see the Mexican government prevailing in its war on the cartels. Corruption also is a serious issue, but isn't that the case in China and India, too?


There has been a huge resurgence of manufacturing in Mexico as shipping across the border is easy, while hauling stuff halfway across the world from China actually costs more in an increasing number of cases. The surge in Chinese non-private urban wages — up 14.3% year-over-year in 2011 to 42,452 yuan (US$6,717) — is a major culprit for the shift. Chinese wages at privately held companies also grew 12.3% on an inflation-adjusted basis in 2011. Mexico, with an estimated 2012 GDP/capita of $10,514, is more developed than China ($5,899 GDP/capita), yet labor is no longer four times cheaper in China like it was 10 years ago.


The iShares MSCI Mexico Investable Market Index Fund , which represents the benchmark MSCI Mexico IMI Index, is near an all-time high, while the mega-benchmark MSCI Emerging Markets index is not, and neither are the MSCI country indexes for any of the BRICs .

Also, at a time when Spain-based Santander  is under serious pressure, the recent IPO of its locally funded Mexican subsidiary saw strong investor interest and was priced at a valuation multiple much higher than that of the problematic parent. The Mexican economy's leverage to the U.S. used to be singled out as a weakness, but with the European situation and China slowing down, it has turned into a strength.


Many U.S. companies have taken notice and increased operations there. Costco  recently bought out its Mexican joint venture partner, in effect doubling its stake in the country. Walmart   has had great success with its separately incorporated subsidiary Walmart de Mexico , and AutoZone  also has successfully expanded there.


Still, playing Mexico with U.S. companies is more difficult thanks to the much smaller size relative to the U.S. economy. Walmart de Mexico is different, as it actually is a separate, $52 billion company controlled by Walmart with pink sheet-traded ADRs in the U.S.


WalMex, as the company often is called, grows faster than Walmart as it is smaller and disposable incomes in Mexico also grow faster. In the 2001-11 period, WMMVY showed a 15.9% compounded annual growth rate (CAGR) of sales, an 18.8% CAGR of EBITDA, and 17.5% shareholder return CAGR. There were serious bribery issues that hit shares earlier in 2012, but permit problems are not solely a Mexican issue.


WalMex is the lowest-cost major retailer in Mexico, and in a way, it is duplicating its strategy from the U.S. by also operating stand-alone supermarkets that take out inefficient small shops in the country. This matters to Mexican consumers as food is a much bigger component of their disposable incomes.


In the latest reported quarter, WalMex had MXN $87.3 billion in sales from Mexico with MXN $13.6 billion coming from adjacent Latin American countries. Total WalMex return on invested capital (ROIC) is an industry-leading 19%. (WalMex management conveniently includes ROIC for Costco and Target  of 12% and 11%, but forgets to include the WMT ROIC, which likely is lower based on the comparison of other profitability metrics).


Mexico seems to have made a turn for the better, and despite its numerous problems, the environment is changing and its stock market has noticed. Since the country is less developed than Brazil, Argentina or Chile on a GDP/capita basis and is less exposed to China and Europe than any other major emerging markets, that outperformance is likely to continue.