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Published on Jan 3, 2013 in Newsletter

Is Mexico, Latin America’s #2 economy, gradually overtaking #1 Brazil? In a word, YES!

Performing due diligence in Latin America since 2000, we’ve had the opportunity to observe the economic growth of a number of countries. The countries in Latin America where we’ve evaluated companies, for a potential merger or investment, have included Brazil, Mexico, Argentina, Chile, Honduras, and Costa Rica. Of these, our major focus has been on both Brazil and Mexico. Subsequently, we’ve been in a unique position to evaluate businesses in these countries as well as observe economic changes that have taken place over the past dozen years.

During this time we’ve constantly heard many of our colleagues extol the virtues of Brazil – and they should! It’s the #1 economy in Latin America and it has an impressive record of growth. However, we never seem to hear much about Mexico, and this surprised us since it has a booming economy, stable government, low inflation rate, and a high percentage of domestic savings. Therefore, we decided to share with you the reasons why we feel that Mexico will eventually become the dominant economy within Latin America, as well as some of the economic and social differences we’ve observed between Mexico and Brazil.

To start, Brazil has an economy that’s twice the size of Mexico’s, at almost $2.4 trillion. But, according to analysts at New York based Nomura Securities, that differential could change in as little as ten years: 1, 2

“Over the past decade, Brazil has undoubtedly been the shiniest macro story in Latin America, offering investors ample opportunities. Looking forward, however, stars appear to be increasingly aligned for an economic outperformance of Mexico. A changing of the guard is slowly but surely taking place.”

In the coming decade Nomura forecasts that Brazil will experience an average growth of between 2.75% and 3.25%. However, the Mexican economy is expected to grow even faster at an annual rate of between 4.25% and 4.75%. Moreover, the United Nation’s Latin American commission has estimated Mexico’s growth in 2012 at 4%, significantly greater than the 2.7% forecast for Brazil.

Mexico hopes that the growth of their economy won’t go unnoticed among investors as they eventually want to add an “M” to BRICS, an acronym for the world’s largest emerging economies, putting themselves in the company of Brazil, Russia, India, China, and South Africa. But being included in BRICS may not be necessary. Jim O’Neill, who coined the term BRICS in 2001, and is now the Goldman Sachs Asset Management Chairman, has come up with a new term called MIST. MIST stands for Mexico, Indonesia, South Korea, and Turkey. Mr. O’Neill believes that these countries offer significant investment opportunities. The MIST nations are currently the biggest markets in Goldman Sachs’s N-11 Equity Fund, accounting for three-quarters of the fund. 1,2,12

As Mexico continues to demonstrate rapid economic growth, investors are beginning to take notice. In the first seven months of this year investors placed $3.4 billion in the Mexican stock market versus only $2.9 billion into Brazil’s. Money managers are following suit. Geoffrey Pazzanese, co-manager of the Federated InterContinental Fund, for example, has 12% of the fund’s holdings in Mexico versus 8% in Brazil. In addition, many investors believe that Mexico is more supportive of foreign investment than many of its neighbors. This is best demonstrated by the World Bank’s Ease of Doing Business Index where Mexico went up one slot this year, from 54 to 53, while Brazil declined six spots to 126. 1,2,11

Another factor fueling Mexico’s growth has been the balanced budget rule that was passed in 2006 forcing the government to be fiscally responsible. As a result, real domestic growth grew 5.5% in 2010 and 3.9% in 2011. Moreover, Mexico’s National debt is stable at 27% of GDP while the United States is at 98% of GDP and rising. Public debt in Mexico is also lower than other nations, at 35% of GDP, and it continues to decrease. In comparison, England’s debt is over 60% of GDP. Also, the domestic savings rate in Mexico is higher than Brazil, at 23.6% of GDP versus 17.3%. Inflation remains low at 3.8% compared to 5.45% for Brazil. 3,7,15

Another reason for the rapid growth in Mexico’s economy has been the narrowing of the wage difference between China and Mexico which gives Mexico, with lower inherent shipping costs, an advantage in trading with the U.S. In the past ten years wages in China have quintupled, and oil prices have gone up by 300%. As a result, what was a 260% gap between Chinese and Mexican wages in 2006, is now only 10%. 7 Also, international manufacturers, once focused only towards China, now are looking to Mexico, with its cheaper inherent transport costs, as a source of manufacturing.

Another factor that has become increasingly important in fueling Mexico’s growth has been the rapid increase in foreign manufacturing facilities. Sony, General Motors, Audi, and a host of other companies have invested significantly in Mexico because of their low cost manufacturing capabilities, stable economy, and well-established infrastructure. According to The Economist, by 2018 the U.S. is projected to import more goods from Mexico than from any other country. “Made in China” may very well give way to “Hecho en Mexico.” 3, 4

Even though Mexico’s manufacturing rose from 2% of GDP in the 1980’s to 24% today, the country knows it can’t rely solely on manufacturing to fuel its economy. Increasingly important are market ties with the U.S., maintaining the strength of the peso against other currencies, controlling inflation and wages, and increasing sales to the U.S. and Canada under The North American Free Trade Agreement (NAFTA).

NAFTA is an agreement between the U.S., Mexico, and Canada eliminating tariffs between these countries. In effect, NAFTA created the world’s largest free trade zone linking 450 million people and $17 trillion worth of goods and services. This has proven to be a boost for the Mexican economy as it’s resulted in increased sales of goods to the U.S. Currently, 78% of all Mexican exports go to the U.S. This has created a trade imbalance where Mexico now runs a trade surplus with the U.S. Also notable is the fact that Mexico’s total tax take is 22% of GDP which is considerably lower than that of Brazil, which is at 36%.4, 7,8,9,10,11

Lastly, increasing competition through the dissolution of monopolies is also an important component for Mexico’s future growth. As an example, according to Tim Johnson of the Miami Herald, if you enter a store in Mexico you’re likely to find only two brands of fresh milk, Lala and Alpura, with two companies controlling the milk market. The same can be said for beer, whose distribution is controlled by two conglomerates. Two companies control much of the distribution of medicine and health and beauty products. One or two companies also dominate cement, soft drinks, cold meats, confectionaries, cornmeal (tortillas), domestic appliances, and glass. For bread, most brands belong to a massive company called Bimbo. In media, two networks control 97% of the country’s television viewership. In telecommunications, the world’s wealthiest man, Carlos Slim Helu, controls Telcel, Mexico’s biggest cellular network, as well as Telmex, which operates most of Mexico’s fixed-line telephones.

The impact on Mexico of these monopolies: limiting what could be explosive growth; increasing the cost of basic goods, sometimes by as much as 40%; preventing competition from entering the market and lowering the price of consumer goods; and preventing companies from becoming much larger and adding a more dynamic growth component to the economy. 14 In addition, monopolies are not only limited to private companies, but they also exist in state-run enterprises. For example, all gas stations in Mexico belong to Pemex, the state oil company. All electricity comes from a state utility.14

Credit, the ability to borrow, is also a major difference between Mexico and Brazil. Brazil has a well-established banking / investment infrastructure which provides greater access to capital. With a ratio of bank debt to GDP in Mexico at one third that of Brazil, many view this disparity as a great opportunity for future growth as credit becomes more prevalent within Mexico. 6, 17

Other factors affecting the Mexican economy has been the decreased birth rate among Mexican women which has gone from an average of seven children in the 1960’s to a current average of two. In the next ten years Mexico’s birth rate is expected to fall below that of the U.S. 4

With all this going for it, Mexico continues to have a global PR problem. According to Shannon O’Neil, senior fellow for Latin American Studies at the Council on Foreign Relations, most Americans have a different view of their southern neighbor than the economic powerhouse we’ve described. When advertising firm GDS&M and Vianovo consultants asked Americans to describe Mexico, most responded by answering drugs, followed by poor, and then unsafe, viewing Greece, El Salvador, and Russia more favorably. These views mostly reflect the news headlines and media reports to which we’re exposed. But the news headlines don’t provide a view through the entire window, but merely through a single pane of glass.  In over ten years of our working with companies in Mexico, we’ve never had a problem conducting business and found institutions and business executives there to possess a high degree of integrity. In fact, we find that conducting business in Mexico is not only comparable to working with companies in the U.S. and Europe, but sometimes far easier. 5

Mexico’s public image is often viewed in light of immigration issues and drug-fueled violence that has gained international attention. Mexico’s economic and political growth, which has now surpassed its Latin American neighbors, is often ignored by the media in favor of more newsworthy crime and border issues. Yet Mexico’s problems are far from unique. In fact, Brazil also has a problem with the rising rate of violent crime. Placed in the top 20 countries for intentional homicides, Brazil has a murder rate that’s almost twice that of Mexico, averaging 25 per 100,000 inhabitants versus 14 for Mexico. In addition, drug-related violence in Mexico seems to be becoming far less prevalent and occurs mainly in the interaction between cartel members and law enforcement.

Lastly, we constantly hear about the immigration issue – and it is an issue. Most in the U.S. believe that there are streams of Mexican immigrants entering the U.S. and that this stream will continue unabated. However, in reality, there are more Mexicans leaving the United States and returning to Mexico than those entering the country. The reason: the U.S. economy is flat while the Mexican economy is robust and providing employment opportunities that were not available in Mexico in prior years.4, 16,18

The relationship between Brazil and Mexico is very competitive. These are the two largest countries in Latin America and they continually vie for regional influence and international clout. In the past, Brazil’s rapid growth relied partly on its commodity exports to China. As China experienced rapid growth, they imported more from Brazil and the Brazilian economy prospered accordingly. However, with China’s economic growth slowing to a more sustainable level, Brazil has also experienced a corresponding decrease in its economic growth. Mexico, which is not a commodity-based economy, has had no such barrier to its continued growth.

For most Americans, Mexico’s impressive economic growth goes unnoticed.  Few seem to notice the economic powerhouse on our southern border. Those who have turned their focus towards Mexico have benefited from an expanding economy with a GDP greater than South Korea and the potential to soon become the dominant economy in Latin America. 4




Alan Refkin               David Dodge

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This publication is for informational purposes and reflects the personal opinions of Thornhill Capital. This publication is not intended to convey any legal, accounting, or investment advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer, investment advisor, certified public accountant, or other relevant professional.