Mexico? Could it be the stock market to own in 2013?

03/08/2013 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Mexico isn’t on the radar screens of most investors at the moment. It should be on yours. Over the next year or more, I think Mexico will be one of the better performing stock markets in the world.

That could even be an understatement if Mexico succeeds—and it now looks likely that it will--in reforming the national petroleum law that has left the country’s state-owned oil company Petroleos Mexicanos, or Pemex, starved for capital and technology. Mexico’s oil production peaked at 3.2 million barrels a day in 2008. Production was down to 2.96 million barrels a day on average in 2011.

In this post I’m going to lay out the reasons for thinking that the Mexican economy is going to be one of the fastest growing economies in a world where economic growth is hard to come by. And I’m going to give you the name of five Mexican stocks that will profit from that economic boom and deserve a look for inclusion in your portfolio.

Why shouldn’t you overlook Mexico?

If investors think about owning any stock market in Latin America at all, it’s almost certainly Brazil and not Mexico. (It certainly hasn’t helped that most of the headlines about Mexico in recent years have been about drug murders and related violence.) But the World Bank forecasts that the two economies will grow at almost the same rate in 2013 at 3.4% and 3.3%, respectively. And over the last 12 months the iShares MSCI Mexico ETF (EWW) has gained 20.8% while the iShares MSCI Brazil ETF (EWZ) has dropped by 17.2%.

If investors think about owning the stocks of any developing economy export powerhouse, it’s almost certainly China and not Mexico. Yet Mexico’s share of imports of manufactured goods into the United States climbed to 14.2% in the first half of 2012 from just 11% in 2005. In the same period China has been losing import share. China’s share of U.S. manufactured imports peaked at 29.3% in 2009. In the first half of 2012, it had dropped to 26.4%. In the last 12 months the iShares MSCI China ETF (MCHI) has gained just 4.7% to the IShares Mexico ETF’s gain of 20.8%.

What’s going on in Mexico?

In many ways it’s a simple story of competitive advantage.

Mexico is a comparatively open economy with free trade agreements with 44 countries and where manufacturers from developed economies face less competition from state champions and less danger from state-sanctioned efforts to copy technologies.

Closeness counts especially for bulky and expensive to ship products such as computer displays and TVs. In 2009 Mexico became the world’s leading producer of flat-screen TVs, moving ahead of South Korea and China. Mexico is also the leading global producer of two-door refrigerators.

But none of these advantages would have mattered much if the difference between the cost of labor in Mexico and China hadn’t narrowed. Ten years ago Mexican wages were almost four times higher than wages in China, according to HSBC. Today labor in Mexico is just 29% more expensive and on current trend Chinese wages will pass Mexican wages sometime in the next five years. Demographic trends almost guarantee that. While China is in the midst of a major decrease in the number of young workers entering the economy, more than half of Mexico’s population is under the age of 29.

One thing that hasn’t yet been figured into the mix is the possibility—an increasing possibility—that Mexico will revise the 1938 law that prevents Pemex from partnering with foreign oil companies. The ability to exchange drilling and production participation for technology with a Chevron (CVX) or an Apache (APA) could reverse the decline in Mexico’s oil production. Bringing in U.S. companies to help Pemex develop Mexico’s reserves of natural gas from shale—Mexico, is currently an importer of natural gas—could double Mexico’s natural gas production. For example, the Eagle Ford shale formation that produces natural gas and natural gas liquids in Texas extends into northern Mexico. But while Texas is home to 6,000 wells using fracking to produce natural gas and oil, Mexico has a scant 12. The Mexican government estimates that producing natural gas from shale could turn the country into a net exporter of natural gas over the next 10 years—if Pemex can find $10 billion a year over that decade to invest in exploration and production.

This past weekend the Institutional Revolutionary Party (PRI) of new president Enrique Pena Nieto voted to end its opposition to changing Mexico’s national oil law. Changing the oil law is still a long way from a done deal—it requires a two-thirds vote in Congress since the law is embedded in the Mexican constitution. But I think the change will happen—Pemex needs the capital and technology too desperately and the upside for the Mexican economy is too tempting. The changes proposed would add two percentage points to the Mexican economy, the national Energy Ministry projects. The country has already reaped some reward from moving ahead on the idea of reform of the oil law. The yields on peso-denominated 10-year government bonds have fallen 0.34 percentage points in 2013 as bond investors and rating companies gain confidence in oil industry reforms that would add to government tax revenues over the next decade. Taxes and royalties from Pemex fund about 34% of the national budget.

So how do you invest in Mexico’s economic boom?

A good place to start is with the stocks of companies that will prosper as Mexicans get wealthier and live better. This is a familiar theme from developing economies such as Brazil and China and it applies to Mexico as well.

In this category I’d put Industrias Bachoco (BACHOCOB.MM in Mexico City or a very thinly traded IBA in New York) and Gruma (GRUMAB.MM in Mexico City or a very thinly traded GMK in New York.)

Industrias Bachoco is Mexico’s leading producer of chicken. As incomes go up, so does consumption of protein. Chicken is a key part of Mexican cuisine and Industrias Bachoco has about 30% of the Mexican poultry market. The company expanded into the U.S. market in 2011 with its acquisition of OK Industries. The shares are up 58% in the last 12 months.

Gruma is Mexico’s—and indeed the world’s--leading corn flour manufacturer and tortilla producer and it distributes its corn and wheat flours and finished products such as tortillas and flatbreads in 105 countries. About two-thirds of sales come from outside Mexico. In December the company bought back a 23% stake from Archer-Daniels Midland (ADM.) In the fourth quarter the company’s results took a big hit from labor and production troubles in Venezuela and from foreign exchange losses on that country’s currency. The stock is up 50.2% in the last 12 months.

Shares of Mexico’s homebuilders have been pounded on a shift in government construction subsidies from single homes to apartments. Cash flow has collapsed at these companies calling into doubt their ability to meet big debt loads they took on to acquire land. But the shares rallied strongly on March 6 on news that the government will cover as much as 30% of bank losses on loans to the homebuilders. That relieved fears that the companies wouldn’t be able to secure needed bank financing. Desarrolladora Homex (HXM in New York or HOMEX.MM) is the biggest in the sector with the best liquidity in New York. (Rounding out the top three are Corp GEO (GEOB.MM in Mexico City) and Urbi Desarrallos Urbanos (URBI.MM in Mexico City).)

CEMEX (CX) is a less go-for-broke way to invest in housing (and infrastructure and commercial construction) than the shares of homebuilders. Not that CEMEX hasn’t had its own challenges. The cement maker loaded up with debt to finance acquisitions in the United States just in time for the collapse of the U.S. housing sector. That resulted in 13 straight quarterly losses that threatened to send the company into default. In the last year the stock has climbed as the company has restructured its debt—extending maturities on $6.7 billion in debt in 2012, for example. Now the goal is to return to profitability, to regain the company’s investment grade credit rating, and to grow EBITDA (earnings before interest, taxes, depreciation, and amortization) by 80%, much of it thanks to a recovery in the U.S. housing market, by 2016. The United States is the company’s biggest foreign market.

And last another Mexican company big on expanding exports to the United States: Grupo Televisa (TV.) Grupo Televisa has an amazing 70% share of the prime-time audience on Mexican TV thanks to licenses that give it operation of four of the 10 TV stations in Mexico City. A large number of repeater stations retransmit this programming throughout the rest of the country. Televisa also produces Spanish language programming for audiences in Mexico and, increasingly, the United States. In 2010 it bought a 5% stake in Univision with an option to acquire another 35% of the company that distributes Televisa’s programming in the United States. The company has used the cash flow from its TV stations to become a major player—with about of half of Mexico’s subscribers—in Mexico’s pay TV and cable market. Televisa owns a 59% stake in Sky Television, 100% of Cablemas, and parts of Cablevision and TVI.

These five stocks—three of which trade in New York as American Depositary Receipts (ADRs)-- should be enough to get your started on adding Mexico to your portfolio.

Around the turn of the last century, Porfirio Diaz, president of Mexico almost continuously from 1877 to 1911, is alleged to have said, “Poor Mexico, so far from God and so close to the United States.”

Right now, though, with Mexico’s economy powering ahead because of the country’s proximity to the U.S. market, Diaz’s lament seems very out of date.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund owned shares of Grupo Televisa, Industrias Bachoco, and Urbi Desarrallos Urbanos as of the end of September. For a full list of the stocks in the fund see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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