Betting on Mexico's Growth: What to Buy

The evolution of Mexico's economy is believed to be correlated more to the U.S. than to the rest of Latin America, and the country is expected to maintain a growth trend alongside its northern neighbor. Current IMF forecasts predict that the U.S. economy will grow 2.8% in 2014 while Mexico's GDP grows 3%.

So Mexico's outlook is relatively stable and positive, especially considering the rising financial turbulence hitting other emerging markets like Turkey and Argentina. Mexico will probably do better, and if it does, its stocks will show a better performance.

How have Mexico's stocks performed so far?
The iShares MSCI Mexico Capped ETF (NYSEMKT: EWW  ) , meant to represent the entire Mexican stock market, is down 4% year to date, but it's doing a bit better than other emerging peers like Brazil, whose equivalent ETF, the iShares MSCI Brazil Index, has dropped about 6%.

This Mexican ETF has a variety of Mexican stocks, but 18% of the portfolio goes to telecom behemoth America Movil. Another 7.6% goes to Fomento Economico Mexicano (NYSE: FMX  ) , and there's also a smaller position in Coca-Cola FEMSA (NYSE: KOF  ) . Because I recently commented on America Movil, let's take a look at these last two companies, which are closely related. In fact, Fomento Economico derives more than half of its profit from its 50% stake in Coca-Cola FEMSA, which is engaged in the production and distribution of beverages and is Coca-Cola's largest bottler. Another 40% of sales come from its commercial division, which holds more than 10,000 OXXO convenience stores in Mexico and Colombia. OXXO is the largest convenience-store chain in Mexico.

Fomento Economico is showing moderate growth. Total revenue grew 7.2% year over year in the third quarter, with an impressive 12.5% gain in its retail division making up for an uninspiring 3.6% gain in its bottling division. Mexico is characterized by its big number of small, family-owned supermarkets, and OXXO is starting to gain share by adding new convenience stores all across the country.

Lastly, according to a recent report by S&P Capital IQ, the soft-drinks industry in Mexico can expect cash flow and earnings to grow, driven by new product introductions and increased sales of high-margin single-serve units. This bodes well for both Fomento Economico and Coca-Cola FEMSA. The case for Fomento Economico -- and to some extent the ETF -- is simple, as their futures are strongly tied to consumer-spending dynamics. This means they have a strong correlation to the evolution of Mexico's economy. If the country does well, these are the stocks you should consider.

So should you buy?
Although the outlook is stable for the country, stocks could continue to drop as they did in the beginning of the year. Keep an eye on Mexico's forecasts, looking at consumer spending trends and expendable income growth. According to the Organisation for Economic Co-operation and Development, the average household net-adjusted disposable income in Mexico is $12,732 a year -- little more than half of the OECD's average of $23,047 a year. Any improvement in this figure is good news.

The variables that will especially pave the way for Fomento Economico's future are traffic and ticket price growth at its stores. For Coca-Cola FEMSA, you should watch volume and pricing growth.

For the particular case of the ETF, Mexico has recently enjoyed strong foreign fund inflows, making company valuations reach near-record highs. Recently, America's drawdown of quantitative easing is provoking outflows from the Mexican capital markets. Despite the evolution of income and consumption levels, this trend will probably continue, affecting valuations and, consequently, the value of the ETF in the short and medium term.

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