This is the third in a series of articles regarding the outlook for emerging market investments in 2006 and beyond.
When investors talk about emerging markets these days, much emphasis is given to the BRIC countries -- Brazil, Russia, India, and China -- mostly because of the size of their populations, their above-trend economic growth rates (even for emerging markets), and the rising numbers of middle class consumers in each nation.
Don't get me wrong; I believe that these emerging markets deserve the attention they receive. After all, I have already touched on China in a recent article and plan to address the other BRIC nations in the near future. But the subject of today's commentary is our southern neighbor, Mexico.
I'll be the first one to admit that Mexico's economy has generally not lived up to its potential; OCED's preliminary Economic Outlook report No. 79 predicts Mexican GDP growth of 4% in both 2006 and 2007. While that's a respectable figure by developed market standards, it's significantly below the International Finance Corporation's estimates of overall emerging market GDP growth of 5.5%-5.9% in 2006 and a further 5% in 2007.
I'm also aware that Mexico's economy is probably more sensitive to a slowdown in U.S. economic growth than other emerging markets. Government news agency Notimex reports that remittances from Mexicans working abroad totaled a reported $11 billion in the first half of 2006, representing the second largest source of foreign income after oil. Any slowdown in this important source of income to millions of Mexican families couldn't help but dent domestic consumer spending.
Finally, while the Mexican election debate seems to have been officially ended by the Federal Electoral Tribunal's decision to confirm the election of pro-market candidate Felipe Calderon as president-elect, his left-wing rival Lopez Obrador shows little sign that he will comply with the ruling.
Are these issues that investors need to keep an eye on? You bet they are.
Does this mean that investors should look for greener pastures elsewhere? Not necessarily ... but it does force the individual investor to pick companies better positioned to prosper in this challenging environment.
In my previous article, "You Can't Afford Not To," I mentioned that emerging markets investors needed to focus on corporations that hold a dominant share of their home markets, have robust growth prospects, and are attractively valued: essentially, blue-chip companies. In Mexico's case -- because of its slightly below-average (for emerging market) growth rate and greater sensitivity to the effects of a slowdown in U.S. economic growth -- I'd add the caveat that these companies should also have either a strong international (non-U.S.) presence or be tightly focused on serving a particularly attractive niche of the domestic market.
Fortunately, Mexico has an abundance of such companies, ranging from Cemex
Let's take a quick look at the dynamic duo.
American Movil, spun off from Telefonosde Mexico
While there has been some concern voiced on Wall Street about slowing subscriber growth -- and the pace of gains has been moderating -- American Movil is still on track to grow its subscriber base by its targeted goal of 32% this year, and Morgan Stanley expects a further 28% increase in 2007. Furthermore, investors need to remember that Latin America's cellular markets remain relatively underdeveloped, with an average penetration rate of approximately 45% compared with the rate of more than 90% in Western Europe.
American Movil hasn't been a slacker in terms of monetizing its expanding subscriber base, either. For the first six months of the year, the company reported that total revenues were up 27% from the previous year's period, while operating profits climbed by roughly 76%. With shares trading at around 13 times upwardly revised fiscal 2007 estimates of $2.80 -- a significant discount to its projected long-term earnings growth rate of 31% -- I'd say that investors should dial up the company's financials and take a closer look.
While American Movil should benefit from the international scope of its operations, Homex -- the second largest homebuilder in Mexico, in terms of units -- is a pure-play on Mexico's housing market and focuses on providing homes for low-income and middle-income families.
In simple terms, the outlook for Mexican homebuilders is bright. According to government estimates, there was an estimated housing shortage in Mexico of roughly 4.3 million homes in 2001. In order to address this issue, the Mexican government -- flush with oil receipts -- has been loosening up the purse strings of government-funded mortgage operators like INFONAVIT, FOVISSTE, and SHF. These three operators, which supply virtually all mortgage financing to the general public, have increased their spending by some 81% since the end of 2001. The spigot is unlikely to be turned off anytime soon, since the government committed itself to building/financing more than 750,000 homes in 2006 alone.
Think there will be a housing glut soon? Think again. A survey by the Mexican Population Council showed that there were 31 million Mexicans in the breadwinning 20-49 age group in 2000, a number that is expected to grow to more than 46 million by 2020, with a commensurate increase in housing demand.
Homex has been able to cash in on this demand, as illustrated by the company's pro forma results for the second quarter (assuming the inclusion of a recent acquisition in both quarters). On that basis, home sales rose 18%, revenue climbed 24%, and net income jumped 28%.
With shares of Homex trading at around 12 times fiscal 2007 Street estimates of $3.00, a 32% discount to their estimated long-term growth rate, I think that investors won't be mortgaging their futures if they decide to build a position in this stock.
All in all, investing in Mexico carries its fair share of risk, but the potential rewards can be quite worthwhile, especially if investors hedge their bets by taking positions in companies that should profit in good times or bad -- companies like American Movil and Homex.
What foreign stocks have the Fool's analysts picked? Take a trip Around the World in 80 Minutes to see.
Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than reading The Financial Times, rooting for the New York Giants, or pondering the vagaries of life (pretty unsuccessfully up to this point). He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.