Beware of Mexico

Mexico's had a tough week. Last Wednesday, Mexican authorities discovered the body of murdered Santiago mayor Edelmiro Cavazos. This Tuesday, the United Nations declared Mexico "the most dangerous country in the Americas for journalists." Finally, just yesterday, Mexican marines reported finding a mass grave of 72 bodies, apparent victims of Mexico's ongoing drug violence.

These are just the latest tragedies in Mexico's multiyear war on its drug cartels -- a fight that pits Mexican authorities against, among others, the professionally trained paramilitary Zetas (who have since been accused of perpetrating the Cavazos killing). Just how sophisticated are the Zetas? A fascinating 2009 profile of the gang noted that they "employ a military grade arsenal ...  with expertise in infantry squad tactics, complex assaults, and other military techniques."

This is serious stuff
From where I stand in the mid-Atlantic United States, this is one of the most underreported and least talked-about stories around (though both the Los Angeles Times and Dallas Morning News offer regular coverage for interested, English-speaking readers). And while this drug war has taken a massive toll on Mexico, with some 7,600 deaths in 2009 alone, investors in Mexico seem to have shrugged off the risk. According to our Motley Fool Global Gains database, Mexican stocks today trade for almost 17 times earnings and 2 times book value.

That's not cheap in a country that runs a very real risk of political and social instability.

Buyer beware
This isn't to say that there are no opportunities in the Mexican economy. But investors should tread carefully and consider the implications of this situation.

For example, as a result of this headline risk, I've long tried to convince myself that Mexican airport operators Grupo Aeroportuario del Centro Norte (Nasdaq: OMAB  ) , Grupo Aeroportuario del Pacifico (NYSE: PAC  ) , and Grupo Aeroportuario del Sureste (NYSE: ASR  ) are compelling value opportunities, given that they are essentially monopoly tollbooths trading for less than 10 times EBITDA. But I can't quite convince myself of that. If anything, I'm starting to conclude that they're actually value traps.

Consider, for example, the traffic trends that OMA has reported at its airports in Acapulco and Juarez -- one tourist city and one city at the center of the violence. International traffic to Acapulco is down 8% thus far this year, following a 25% decline last year (which was exacerbated by fears of swine flu). International traffic to Juarez is down 58% thus far this year, after last year's 34% drop. These are massive overall declines, and they could be leading indicators for the industry if violence continues and coverage of the violence increases.

That's not to say these declines would be logical or even warranted. The current State Department travel warning for Mexico says explicitly that "Millions of U.S. citizens safely visit Mexico each year" and "Resort areas and tourist destinations in Mexico do not see the levels of drug-related violence and crime reported in the border region." That said, tourist travel is discretionary spending, and one of the elements of a successful vacation is safety -- which makes headline risk relevant to the story here.

The case underlying OMA, which operates Monterrey's airport, is slightly different. That airport benefits from more stable, business travel traffic, much of which originates from within Mexico. That said, the level of violence in Monterrey, long considered one of Mexico's safer cities, is on the rise. Not only is Santiago, where Edelmiro Cavazos was mayor, just outside of Monterrey, but the Zetas have recently been barricading major roads leading in and out of Monterrey, to demonstrate just how much power they could wield over the city. Further, three security guards for FEMSA (NYSE: FMX  ) , a Monterrey-based soft drink and beer bottle company and the operator of fast-growing convenience store chain Oxxo, were shot earlier this week in what may have been an attempt to kidnap one of the company's executives. With more episodes like that, the corporations that call Monterrey home could opt to move, fearing for the safety of their staff. The State Department has already authorized employees stationed in northern Mexico to send their families back to the States.

Don't write off the whole market
Drug violence in Mexico is a real and growing problem that is not getting enough coverage here in the U.S., and it has important implications for investors. That said, while Mexico's risk profile is significant, and I'm not too interested in investing in the country's airports, the country is not without its investing merits.

In fact, now is a good time to put high-quality Mexican companies such as FEMSA and America Movil (NYSE: AMX  ) on your watch list, since it's inevitable that Mexico's rising risk profile will eventually spook investors and spark a sell-off of these stocks. Unlike the airports, these two Mexican companies operate in defensive growth industries (telecom and consumer staples, respectively) and have a presence across Latin America. Thus, violence in northern Mexico should not have such a negative impact on their underlying operations. If anything, it may actually give you a chance to be opportunistic.

Get Tim Hanson's Global View column every Thursday on Fool.com, or by following him on Twitter.

Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of FEMSA and America Movil. America Movil, Fomento Económico Mexicano, and Grupo Aeroportuario del Centro are Motley Fool Global Gains selections. Grupo Aeroportuario Del Sureste SA de CV and Grupo Aeroportuario del Pacifico A.B. de CV are Motley Fool Hidden Gems recommendations. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 26, 2010, at 11:48 AM, woo131 wrote:

    You are the guys that were pumping ASR and PAC for a long time. They are still great investments; after all, lots of drugs going by air as well as by ground. I find your comments to be egregious and sensationalist without adding much in the way of improved understanding.

  • Report this Comment On August 26, 2010, at 12:10 PM, TMFMmbop wrote:

    As we disclose at the bottom, all three airports are picks of our premium services. I simply happen to disagree with the conclusion of those analysts and could be wrong. That said, we all embrace our core value of being motley and able to air different opinions on Fool.com.

    Tim Hanson

  • Report this Comment On August 26, 2010, at 3:47 PM, TMFOpie wrote:

    Hi Woo131,

    At Hidden Gems where we follow the Mexican airports we're fans of their tollbooth-like business models but recognize, as Tim does above, that operating in Mexico and tied to consumer travel habits is an inherent risk for these investments. That's nothing new, really, though at times the news seems to get worse, then a little better, then worse again (right now the environment is looking on the "worse" side). So if you own these small-cap stocks then you want to make sure they are part of a well-diversified portfolio of stocks to give you some balance against the exposure to Mexico and global leisure travel to its coasts.

    Thanks,

    Andy

    HG co-advisor

  • Report this Comment On August 26, 2010, at 5:05 PM, SweetMircha wrote:

    Do you think that we should also be wary of our Wal-mart de Mexico shares, maybe especially since there was a recent share split?

  • Report this Comment On August 26, 2010, at 5:12 PM, TMFMmbop wrote:

    WMMVY is an interesting case, though I think it will prove more defensive than the airports. That's because it 1. Has a presence across Mexico 2. Recently received the right to expand south into Central America. The valuation is a premium to its parent, so that's something else to consider.

    Tim

  • Report this Comment On August 26, 2010, at 8:14 PM, xetn wrote:

    I think you totally miss the point. The point is the "war on drugs". Legalization would totally "disarm" the cartels because they would be stripped of their product (the demand and the resultant high prices). The war on drugs is a total failure, even though it has spread internationally. It has done nothing to to prevent the use of drugs and the very high prices that people willingly pay for them.

    I am not an advocate of drug use (I don't use them) but it is a waste of money.

  • Report this Comment On August 26, 2010, at 10:04 PM, mountain8 wrote:

    Lets see, 4400+ killed in Iraq since we went there for a year, ten years ago. 28,000 killed in the mexican-drug war, (7600 in '09 alone). Where should Obiwan be sending the troops?

  • Report this Comment On August 26, 2010, at 10:41 PM, TMFBent wrote:

    The drops at Acapulco don't need to be attributed to fear of drug violence. Could just be that vacation deals to Acapulco aren't measuring up. (See Cancun, below.)

    "International traffic to Juarez is down 58% thus far this year, after last year's 34% drop. "

    It's past my bedtime, so maybe I'm not reading the press releases right, but International traffic at Juarez is a victim of small numbers to begin with. There's barely any overall traffic change at Juarez, because 99.9% of the traffic at Juarez is domestic.

    That's not an exaggeration, (here's the PR:http://ir.oma.aero/releasedetail.cfm?ReleaseID=498171)

    And it's not unusual. Here are the numbers from 2008. (http://ir.oma.aero/common/download/download.cfm?companyid=OM... PR July 08 Traffic final.pdf)

    At Juarez, -58% = - 361 passengers.

    Domestic traffic at Juarez (about 700,000 passengers per year, versus about 1,500 international) is down only 2.5% on the year.

    "The case underlying OMA, which operates Monterrey's airport, is slightly different. That airport benefits from more stable, business travel traffic, much of which originates from within Mexico."

    That's what I always thought too, until the past couple of years worth of passenger numbers (or what I remember of them) upended that thesis. OMA's business traffic has been, counterintuitively, more volatile and slower to recover growth than the tourist-led traffic at ASUR. While ASUR's numbers were up 21% for July, and are up 14% for the year, OMA's were up only 4.5% for July, and are down slightly for the year.

    Comparing just major hubs, at OMA, Monterrey's up only 0.2% so far this year, 4% for July. ASUR's Cancun is up 24% for July, 13% for the year. (Those ASUR cancun numbers are about flat with 2008, and 7-10% above 2007.)

    Among the airport groups, the traffic into Cancun seems to be stickiest of any, come hurricane, swine flu, or drug wars. Morover, at all the airport groups, international tourist travel tends to be higher margin than domestic business because tourists blow a lot more money on ancillary goods and services. If you have to pick one, stay with the one that gathers the most gringo tourist bucks, and that's ASUR.

    Either way, I'll take all the FEMSA, airports, and america movil I can get, thanks.

  • Report this Comment On August 27, 2010, at 5:22 AM, Castlerock wrote:

    The casualties in the Mexican drug war are mainly criminals (including corrupt government officials) killing each other for control of routes and plazas. Of course there is always the unintended collateral damage but to say that the country is not safe is very far from reality. I can honestly say that outside of the drug cartel conflicts there is more crime as a percentage of population in some of our cities than in Mexican urban areas. I have been traveling once a month for the past 15 years to many of the big towns besides Mexico City and have never had a problem. It is amazing the misinformation the press disseminates. My company and I will keep part of our portfolios invested in the Mexican economy for the forseeable future. By the way next month Mexicans will celebrate their independence and I'm looking forward to have some Patron Margaritas in my favorite water hole down there. Viva Mexico!

  • Report this Comment On August 27, 2010, at 9:27 AM, TMFMmbop wrote:

    Re: Juarez... This is a city that's been at the center of the violence for a long time, and it's precisely because it's small that declines will show up there first -- making it a canary in a coal mine, so to speak. While Seth is correct that domestic traffic to Juarez has declined just 2.5% this year, the fact is that's an already depressed base. Through the first 7 months of 2009, domestic traffic to Juarez was down 35%. This is a city in serious trouble seeing depressed economic activity.

    As for betting on the big tourist hub, that just seems to me to be a bet with limited, knowable upside and significant, unknowable downside should the violence affect an American tourist and/or the Dept. of State issue a more explicit travel warning to Mexico. I try to avoid bets like that, especially given the way the drug violence in Mexico is tending and the inability of the government to make policy or tactical adjustments.

    But as I write in the article, this doesn't mean to write off Mexico, particularly when it comes to consumer staple type stocks that cater to Mexican consumers.

    Tim

  • Report this Comment On August 27, 2010, at 12:15 PM, TMFBent wrote:

    I don't think Juarez is the canary. I think it's just the scariest percentage number on the PR.

    Let's take a look at another city in Chihuaua, err, Chihuaha. This is also a city that has had major drug-related violence (including 10 deaths in one night in May). Yet its July traffic is up 20% YOY, It's up nearly 12% so far this year, and it has always drawn a larger number of passengers (both domestic and international) than Juarez.

    http://ir.oma.aero/common/download/download.cfm?companyid=OM...

    Lots of violence in Durango. It's also up this year. (International up more than 20%)

    Lots of violence in Sinaloa, where OMA has the Maz airport. July traffic up 8% (international too) and more than 5% for the year (international growth stronger than domestic) and this, too, is a more important airport than little Juarez.

    Lots of violence in Taumalipas; just across the regional border is Tampico, which shows 20% international growth for July, 18% YOY (and has always had many more international passengers than Juarez). The Matamoros airport in Taumalipas is state-owned and doesn't show traffic figures on its web site, that I can find, anyway.

    The data are all over the place, but the strongest moves are actually up. Pick any of several different numbers, and you could make the (absurd) argument that the violence is fueling an increase in air travel so far this year. (Do it at random and that would be the likely result, since 8 of 13 OMA airports are showing increases in traffic so far this year.)

    The broader picture, and what's more important to me than horrific headlines, is that in a really down economy, OMA traffic so far this year is flat (down 0.3%), down 1.4% domestic, up 5.2% international.

    ASUR traffic is up 10% for the year, and PAC traffic is up 6%.

    PAC, of course, runs the airport in Guadalajara, where Mexico's most notorious drug kingpin was recently killed, and that city's traffic is up 12% so far this year.(And it's PAC's biggest airport, serving 400,000 plus passengers a month.)

    ASUR

  • Report this Comment On August 27, 2010, at 12:19 PM, gimponthego wrote:

    Living 140 miles North of Mexico I have many friends with ranches and hunting leases between here (San Antonio) and the border. Once you've left the city going South and spin off to the various Farm And Ranch Roads (FM's) it's every man for himself. To go unarmed is insane. Aside from the immigrants pouring North onto private property, breaking into ranches and hunting camps..robbing them blind, the cartel drug wars and, now the real threat of kidnapping, it's only a devoted hunter who travels in groups ,or a "real" fool, that goes into the brush land deep in South Texas . I would no more trade a stock from a country that treats their people like cattle forcing them North than fly to the moon. Mexico..Stay Away In Every Way If You Value Your Life, Family And Money, IMO.

  • Report this Comment On August 27, 2010, at 12:59 PM, TMFMmbop wrote:

    Looking only at year-over-year numbers might mean you're missing the longer-term trend. Remember, 2009 travel totals were extraordinarily depressed by the outbreak of swine flu and they have recovered somewhat this following following that outbreak. That said, travel to all of the cities you mention remains substantially down since 2008:

    Chihuaha -4%

    Durango -16%

    Tampico -25%

    Overall -21%

    These are heady declines as measured by total travel through the first 7 months of the year from 2008 to 2009. I guess it just comes down to whether you want to believe what could be a shorter-term blip of recovery from very depressed 2009 numbers against a clear longer-term trend.

    Tim

  • Report this Comment On August 28, 2010, at 12:20 AM, badnicolez wrote:

    Just got back from Mexico on Monday. Puerto Penasco in the state of Sonora. Beautiful beaches, warm water, gracious people, low prices, and have never seen any violence there or on the drive down from Phoenix. We go every other month or so, and have never had any problems. I feel safer down there than in many parts of Phoenix. If you stayed away from news here in the US and the specific areas down there with the violence, you'd never know anything was wrong.

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