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Mexico: Different Investment Lens Required INSIGHTS Global macro Trends Volume 4.4 • may 2014 Mexico: Different Investment Lens Required By Henry H. McVey, Head of Global Macro & Asset Allocation And Vance SercHuk, Executive Director of the KKR Global Institute Mexico: Different Investment Lens Required Given both the breadth and depth of a new reform agenda, we think Mexico is approaching an inflection point that offers the opportunity to invest in both the equity and debt of companies that can finally take advantage of a more level playing field as the prior regime of monopolistic pricing in several key industries KKR GLOBAL MACRO & ASSET ALLOCATION TEAM is disrupted. Importantly, investing in Mexico requires that an investor look through a different emerging HENRY H. MCVEY Head of Global Macro & market lens. Specifically, Mexico is not a pure-play Asset Allocation urbanization story nor is it a low GDP-per-capita story +1 (212) 519.1628 [email protected] that has the potential to double overnight. Also, unlike many of the Asian countries that we visit, Mexico’s DAVID R. MCNELLIS +1 (212) 519.1629 fortunes may actually be non-correlated, or potentially [email protected] even inversely linked to China’s success. Rather, with FRANCES B. LIM 87% of its exports destined for the United States +1 (212) 519.1630 [email protected] and the government committed to expanding trade agreements with both Asia-Pacific and Latin American REBECCA J. RAMSEY +1 (212) 519.1631 peers, Mexico is much more of an open economy [email protected] investment story than many of the other emerging JAIME VILLA markets countries many investors know. +1 (212) 401.0379 [email protected] Special thanks to Vance Serchuk, Executive Director of the KKR Global Institute, who co-authored this report and provides valuable geopolitical advice to the KKR Global Macro & Asset Allocation Team on an ongoing basis. “ Always bear in mind that your MAIN OffiCE own resolution to succeed is more Kohlberg Kravis roberts & co. l.P. important than any other. 9 West 57th street suite 4200 ” new york, new york 10019 ABRAHAM LINCOLN + 1 (212) 750-8300 16TH PresIdenT oF The unITed StaTes COMPANY LOCATIONS AMERICAS new york, san Francisco, Washington, d.c., menlo Park, houston, louisville, são Paulo, calgary EUROPE london, Paris, dublin, madrid ASIA hong Kong, beijing, singapore, dubai, riyadh, Tokyo, mumbai, seoul AUSTRALIA sydney © 2014 Kohlberg Kravis roberts & co. l.P. a2ll rights rKKReserved. InsIGhTs: Global macro Trends as someone who has been married to a houston, Texas native for it – mexico cannot achieve the efficiencies in other areas of almost 14 years, it should come as no surprise to folks that I have its economy, including manufacturing, exports, logistics, and spent a considerable amount of time enjoying the many compelling electricity that it so desperately needs. cultural aspects of mexico. In fact, I spent my honeymoon in cabo san lucas on the west coast of the country in 2000, and in recent • To date, though, mexico remains a “show me” story. For start- years my family, often using houston as a jumping-off point, has ers, mexico’s productivity growth has been running, on aver- explored various destinations throughout mexico. age, at only half that of brazil, 1/8 of India, and 1/16 of china since 19906. more recently, GdP growth has been lackluster, however, over the past few months my trips to mexico have been consumer confidence is down, and unemployment is rising more frequent—but less family-oriented. specifically, with President again. our bottom line: The current administration should deliver enrique Peña nieto’s “resolution to succeed” in delivering broad- not only on its long-term reform agenda to improve productivity based reforms across energy, financial services and telecommuni- but also on its tactical mandates, including infrastructure spending cations gaining momentum, my colleague Vance serchuk, the execu- and public works, to boost growth during this transition period. tive director of the KKr Global Institute, and I have visited mexico several times to try to better understand what we now believe is an • as the reform agenda gains momentum, we believe strongly inflection point in the country’s political and economic history. that asset allocators would benefit more from owning small- and mid-cap mexican equities versus higher profile large- Importantly, beyond the robust contacts we now enjoy through the capitalization stocks. already, since July 2012, which coincides KKr Global Institute on the geopolitical and macro side, KKr also with the election of Peña nieto, the mexico Imc 30 Index, mex- has a notable footprint In mexico though its private equity effort ico’s mid-cap index, has outperformed the large-capitalization as well as its 10 portfolio companies, which employ nearly 12,000 index (mexican bolsa IPc Index) and the mscI mexico by 46% people across mexico. and 44%, respectively7. separately, we also think that private credit and non-bank financing represent notable opportunities, so what are our big-picture thoughts on mexico and how should particularly given 80%+ concentration of the banking sector investors position their portfolios? see below for details: by just seven or eight financial institutions that cater largely to mega-cap and multinational corporations8. • simply stated, mexico requires a different investment play- book than that of many of its emerging market peers. already, • Though we are positive, the mexico story still has several key consumption is a robust 69% of GdP1, GdP-per-capita is high geopolitical and macro risks. In particular, weakness in rule at around $11,0002, and urbanization stands at almost 80%3. of law institutions—and the associated problems of criminal- mexico is also an extremely open, services-based economy, ity, violence and corruption—still acts as a significant drag on with major bilateral trade agreements with more than 40 coun- GdP. all told, Grupo de economistas y asociados estimates that tries. Finally, with 87% of its exports going to the u.s. and the annual GdP would be 600 basis points higher if money spent by country poised to benefit from growing access to cheap u.s. the government on national security went to households to boost natural gas, mexico is more closely linked to north american private consumption9. Finally, while the reform agenda of Presi- growth – not china’s GdP trajectory4. dent Peña nieto is well defined and credible, mexican history is littered with reform stories that stumbled in implementation. • With small current account and fiscal deficits, mexico has been a good emerging markets (em) investment story since our bottom line: Given both the breadth and depth of the current the Great recession. however, as we describe below in more reform agenda, we think mexico is approaching an inflection point detail, we think mexico has the potential to be a great one if it that offers the opportunity to invest in both the equity and debt of executes on the structural reform agenda put forth by Presi- companies that can finally take advantage of a more level play- dent Peña nieto. all told, potential GdP growth could increase ing field as the prior regime of monopolistic pricing in several key to approximately 4.5% from 2.8%, we believe. industries is disrupted. If we are right, then mexico’s equity market capitalization as a percentage of GdP could increase notably from • contrary to press reports of late, mexico is not just a pure-play its current level of just 40% of GdP (Exhibit 1). From a sector energy reform story. To be sure, energy reform is an important perspective, we are bullish on real estate, financial services, energy piece of the macro puzzle (e.g., current receipts from PemeX services, infrastructure, healthcare, and logistics. account for fully one-third of tax revenues5), but a compre- hensive overhaul of the sector is crucial because – without 6 Data as at January 31, 2013. source: OECD. 1 Data as at February 21, 2014. source: Instituto nacional de estadística Geografía e Informática, haver analytics. 7 Data as at april 30, 2014. source: bloomberg. 2 Data as at april 13, 2014. source: World bank, ImF, haver analytics. 8 Data as at december 31, 2013. source: J.P. morgan estimates, central bank of brazil, superintendencia de bancos e Instituciones Financieras 3 Ibid.1. (chile),superintendencia Financiera de colombia, comision nacional 4 Data as at december 31, 2013. source: Instituto nacional de estadística bancaria y de Valores (mexico), and superintendencia de banca, seguros, y Geografía e Informática, haver analytics. aFP (Peru). 5 http://www.ri.pemex.com/files/content/Pemex_outlook_I_120906%20 9 Data as at april 11, 2014. source: Global source Partners, “Mexico: Outlook %28new%20Investors%29_ri.pdf and Challenges Ahead.” KKR InsIGhTs: Global macro Trends 3 EXHIBIT 1 EXHIBIT 3 The Potential for Better Equity Representation Relative to We Expect Mid-Capitalization To Narrow the Gap With GDP in Mexico Is Now Significant Their Larger Peers… 130% Stock Market Capitalization as a % GDP Average Company Market Cap 8,000 110% 96% 7,000 $6,684 68% 6,000 58% $5,013 48% 5,000 45% 41% 40% 32% 31% 4,000 3,000 y o $1,980 e ea c sia r k azil s 2,000 xi r o frica India Chile e u ur China K B A R T M Colombia 1,000 Indonesia South South 0 data as at april 18, 2014. source: bloomberg. IMC30 MEXBOL MSCI Mexico data as at april 30, 2014. source: bloomberg, mscI, Factset. EXHIBIT 2 Mexican Mid-Cap Stocks Have Outperformed Large-Cap EXHIBIT 4 Stocks by a Wide Margin Since the Election of Peña Nieto ..Driven By Valuation Convergence and Stronger Growth in July 2012 of Mid-Cap Stocks Relative Performance of Mexican Mid-Cap vs.
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