Investors were thrilled when Mexico elected the reform-minded Enrique Pena Nieto at the end of 2012. They have been less enamoured by the subsequent stagnation of the economy.
GDP growth has fallen from 4-5% over the three years to 2012 to just 1.1% last year.
The slowdown, which has continued into this year, is partly due to the initial impact of the reforms, and partly to other factors such as the tax on junk food and sugar-rich drinks.
These reforms cover wide swathes of the economy but particularly affect telecoms, financials and energy stocks. The slowdown has had a particularly severe impact on the stock market, given that domestic demand-related stocks account for an unusually high weight of around 70% of the market’s value.
Mexican stocks were broadly flat last year and have performed poorly so far this year. In spite of this the price-to-earnings (PE) multiple remains reasonably high, due partly to the index composition: in most countries, consumer names are priced more highly than cyclicals.
As the economy has slowed, earnings forecasts have been revised down. However, the market’s PE ratio has not fallen much. The estimated PE multiple for 2014 is 18 times, compared to 11 times for emerging markets as a whole.
One advantage Mexico has is its relationship with the US, which accounts for some 70% of its exports. While some emerging markets have been under pressure due to concerns about the impact of rising US rates, Mexico represents an emerging market that can benefit most from the continued recovery of the US economy. It is also one of the world’s least geared major economies, with government debt only 42% of GDP and private credit only 27%.
The benefits of increased integration with the US can also be seen from the perspective of individual companies. One example is Alfa, a petrochemicals business. Its experience in shale oil and gas in Texas puts it in a strong position for when this industry opens up in Mexico. Likewise, Genomma Labs is a drugs and personal care products maker and distributor which has businesses in the US, partnering with the likes of Walmart and Walgreens. We like both Alfa and Genomma.
2014 is likely to be another year of sub-par economic growth. However, the coming three years will see the first benefits of reforms, which could boost growth to 4-5%, which compares favourably with many emerging markets.
Fiscal and educational reforms have already been implemented; the latter in the face of strong resistance from teachers’ unions, while competition rules have been overhauled. This year will see the passage of critical legislation concerning energy, telecoms and financial services.
Very low credit penetration presents a source of growth going forward as banks expand their balance sheets. With a boost to infrastructure spending from the recently-announced $590 billion 5-year programme, growth is likely to accelerate from the middle of this year. These reforms should benefit the market as a whole as they filter down through the economy.
Julian Mayo is co-CIO at Charlemagne Capital