Range of options in Mexico's capital markets provide attractive investment opportunities

The Mexican peso is the second most actively traded emerging market currency, after the Chinese yuan, signalling a strong investment vehicle for the county’s assets. Its capital markets are tightly regulated, but this has not greatly hampered innovation, with a number of new financial products becoming available to investors in recent years. The sovereign bond market has been particularly well developed over the past two decades, while corporate bond issuances have also been increasing, particularly among leading parastatals, such as the state-owned energy giant Petróleos Mexicanos (Pemex) and the Federal Electricity Commission (Comisión Federal de Electricidad, CFE), as well blue-chip private firms.

Growth Potential

Compared to the fixed-income and forex markets, however, the equity market lags behind comparable economies in terms of listings, liquidity and market capitalisation at MXN7.4trn ($445.6bn) as of January 2017, according to Banco de México (Banxico). José-Oriol Bosch, CEO of the Mexican Stock Exchange (Bolsa Mexicana de Valores, BMV), told OBG, “This is absolutely a question of financial culture and education. A lot of the population does not understand the stock market, and some companies do not even know the requirements for being listed, or that they can use it to finance their debt.” Regarding the bourse’s potential , Fredie Farca Charabati, CEO of Mexican exchange house Masari, told OBG, “The benefits are clear: the vast majority of Mexican-listed companies are growing significantly faster than the national economy.” Although Mexico is an important producer of oil, the country does not have an active commodity market – its Maya blend of crude oil being sold directly by Pemex to refiners and end users – while the domestic market for derivatives has been relatively stagnant in recent years.

New Exchange

Recognising Mexico’s relatively low equity market capitalisation as a potential opportunity and seeing scope for a new entrant into debt listings in 2013, private firm Central de Corretajes has been preparing to launch a second market, the Institutional Stock Exchange (Bolsa Institucional de Valores, BIVA), which is expected to begin operations by the third quarter of 2017.

Challenging Times

Reflecting the broader economic uncertainty in the latter part of 2016, following the election of President Donald Trump in the US, Mexico’s financial markets have faced greater volatility. In the first quarter of 2017 the peso appreciated by 5.01%, yet the equity market has fallen further from its peak and bond yields have increased as Banxico hiked interest rates, which in February 2017 were raised by 50 basis points to an eight-year high of 6.25%. In this environment, market participants expect 2017 to be a challenging year. In a January 2017 report, Bloomberg indicated that beyond concerns over US policies regarding the North American Free Trade Agreement, the weakening peso and inflation could deliver a third year of slower growth, with GDP expected to expand by between 1.3% and 2.3% over the course of 2017, according to Banxico estimates.

Equity

The BMV came into being following the merger of Mexico’s three regional predecessor markets, centred on Mexico City, Monterrey and Guadalajara, respectively. Geographically, its listings reflect this history, with other regions still being underrepresented on the exchange. For example, 10 states have no listings whatsoever. In total, there are 165 firms on the BMV, with the top 35 by market capitalisation making up the widely watched Índice de Precios y Cotizaciones (IPC). The IPC reached an all-time high of over 48,696 points in August 2016, up 13.3% from the end of 2015, on the back of strong earnings growth, following growth of 2% the previous year. It closed 2016 at 45,643 points, up 8.38% from the start of that year. By early March 2017, the IPC stood at around 47,5000 points. With a combination of strong earnings growth – earnings before interest, tax, depreciation and amortisation increased by around 10% in peso terms – and prices coming off their August highs, the IPC’s price-to-earnings ratio overall stood at 22 at end-2016, down from 30.5 one year earlier. Juan Francisco Rich Rena, managing director of equity research, and Montserrat Araujo Nagore, junior analyst, at Grupo Financiero Interacciones, both told OBG that despite reaching new highs in recent years, in 2015 the IPC broke the strong up-trend in prices that had been ongoing since 1994, while advances in 2016 were not enough to push a return to that trend.

Liquidity

Even as prices have been broadly advancing in recent years, liquidity has stalled. Having risen significantly from MXN9.9m ($597,000) in 2010 to a peak of MXN14.4m ($868,000) in 2013, the average daily traded value on the BMV has since stagnated, reaching only MXN13.7m ($826,00) for the first three quarters of 2016. Liquidity remains particularly weak among smaller stocks, such as those outside the main IPC index. In terms of market capitalisation, Mexican equities lag behind other economies of a similar size and smaller Latin American neighbours, such as Chile. According to the World Federation of Exchanges, Mexico was the 23rd-largest country by market capitalisation, despite having the 15th-largest economy in the world. Market capitalisation would have to double for Mexico to achieve a rank of 15th. In the year to the end of October 2016, the top-five performers were steel manufacturers Grupo Simec and Industrias CH, and mining firms Industrias Peñoles, Minera Frisco and Autlán, which grew by 158.4%, 138%, 117.8%, 90.5% and 90.3%, respectively.

Ipo & Secondary Offerings

The BMV recorded three initial public offerings (IPOs) in 2016, down from six in 2015 but up from two in 2014. The 2016 IPOs reached a total value of MXN4.9bn ($295.3m), the same as in 2014, but down sharply from the MXN30bn ($1.8bn) recorded in 2015. Coming to the market for the first time in 2016 were three construction firms: Planigrupo, Casas Javer and Vinte Inmobilaria. Companies that conducted IPOs in 2015 were auto parts manufacturer Nemak, financial services firm UNIFIN Financiera, metals producer Elementia, hotel manager RLH Properties, and real estate firms Cadu Inmobilaria and GICSA. Each subsequently made follow-on issuances in 2016.

In February 2017 Mexico’s first IPO since Trump won the US presidency was carried out by tequila producer José Cuervo. Such was the popularity of the offering, it was more than eight times oversubscribed and was priced at the top of the expected range at MXN34 ($2.05) per share. The BMV had seven equity issuances in the pipeline, with the IPO of food and beverage firm Sigma Alimentos, a subsidiary of Mexican conglomerate Alfa, expected in 2017. However, a February bond issue by the company for $646.2m suggests they might continue to look to debt markets to raise capital. Moreover, in light of prevailing economic, political and market uncertainties in the first quarter of 2017, it is possible that new equity issuances will be more subdued overall.

Mila Disillusion

In 2014 the BMV joined the Integrated Latin American Market (Mercado Integrado Latinoamericano, MILA) for equities. MILA was set up in 2011 by the stock exchanges of Chile, Colombia and Peru to broaden the pool of potential investors for the countries’ equity markets and to improve their collective critical mass vis-à-vis Brazil’s BOVESPA, the largest single market in the region. In 2015 the National Securities and Banking Commission (Comisión Nacional Bancaria y de Valores, CNBV) focused on making the regulatory amendments necessary on the Mexican side to effectively integrate its capital markets with those of MILA’s.

Mexico’s first ever IPO to be carried out on the MILA platform was that of CADU Inmobilaria, which came to the market in December 2015. Between May 2011 and November 2016, MILA recorded 18,225 transactions, for a total value of $435.6m. Reflecting the fact that Mexico had joined relatively recently, its shares accounted for less that 1%, or $3.2m, of the total transacted amount, over $3m of which related to operations in Chile and the remainder in Peru. According to reports in February by local financial media, MILA’s total market capitalisation was $808.8bn at the end of 2016, was up 3.9% in 2015.

Fibra

Similar to real estate investment trusts, fideicomisos de inversión y bienes raíces (FIBRAs) are financial instruments through which a trust can acquire and develop real estate assets in Mexico for the purpose of leasing them. Since 2004, FIBRAs have had a dedicated, and favourable, tax regime to encourage investors. They have proved particularly attractive to local institutional investors, such as administradoras de fondos para el retiro (AFORES), or retirement funds administrators. Between 2011 and 2016 more than MXN152.1bn ($9.2bn) has been raised through FIBRAs via 19 transactions.

However, after a bumper year in 2014, with five transactions totalling MXN53.8bn ($3.2bn), issuance of FIBRAs has tailed off significantly. There has been only one transaction in each of the last two years: FIBRA HD in June 2015 for MXN1.5bn ($90.4m) and FIBRA Plus in November 2016 for MXN1.58bn ($95.2m). In January 2017 the BMV reported it was preparing to issue a further two FIBRA transactions.

Fibra E

In 2016 FIBRAs saw a new innovation with the listing of the first new FIBRA E by Promotora y Operadora de Infraestructura, also known as PINFRA, an infrastructure operator that already has an equity listing on the BMV (see analysis).

Similar to the conventional FIBRAs, these new financial instruments are dedicated to securitising revenue streams from mature energy and infrastructure assets. Pemex and CFE – two energy-related parastatals that are estimated to have, by far, the largest amount of relevant assets – are expected to be big issuers of FIBRA E in the future. Indeed, in January 2017 the BMV reported that it was preparing two new FIBRA E transactions to be issued in 2017.

Ckd

In 2009 the authorities first offered a new financial instrument known as development capital certificates (certificados de capital de desarrollo, CKDs) to be issued by and quoted on the BMV. They were developed to mobilise investments by pension funds in assets and projects that would deliver attractive returns in the long term. Bosch told OBG he sees CKDs “as a way of sowing economic seeds for companies that will one day have the maturity and capacity to go into the debt or equity markets.”

Over the 2009-16 period 80 CKDs have been issued, raising MXN96.5bn ($5.8bn) to finance investments in private equity, infrastructure, energy projects, real estate and lending. The year 2015 was a record year for CKD issuance, with 22 transactions worth a total of MXN17.8bn ($1.1bn). This fell to 13 transactions for MXN8.5bn ($512.3m) in 2016, while as of January 2017 the BMV reported having 24 further CKD transactions in the pipeline.

Cerpi

In another new innovation, the first investment project certificate (certificado de proyecto de inversión, CerPI) came to the market in 2016 when investment management firm Mira Manager raised MXN800m ($48.2m). This was the first step towards the firm raising finance totalling MXN4bn ($241.1m) to invest in urban construction projects. CerPIs are designed for institutional investors, and require a co-investment of at least 30% of the project amount. In the case of Mira Manager, the co-investor was Canadian long-term institutional investor Caisse de Dépôt et Placement du Québec, participating with MXN4.1bn ($247.1m). Similar in design to CKDs, CerPIs provide administrators with more influence over the projects being chosen and strategies employed. While a strong appetite for CKDs is anticipated from local AFORES, the extent to which insurance firms will take up these new instruments is as yet unclear given the stringent requirements they face under a new fiscal regime based on Solvency II requirements (see Insurance chapter). In January 2017 the BMV reported that it was planning one additional CerPI.

Pe & Venture Capital

In a special report on private equity in Mexico published in May 2016, EMEA Consulting Services signalled that “the tide appears to be turning” as more investors in the segment look to the country, where previously there was a stronger focus on Brazil. The report noted that some $8.7bn had been raised through Mexico-dedicated private equity funds during the 2008-15 period, with a portion of the $12.7bn in pan-regional funds also allocated to the country. AFORES are viewed as being instrumental in further developing the segment since being granted permission to invest up to 10% of their assets in private equity in 2009.

While the Mexican authorities had reportedly been considering reducing the tax rate for private equity investors from the marginal income tax rate of around 35% to the capital gains tax rate of 10%, no such measure was ultimately included in the budget for 2017, which was approved in October 2016.

Bond Market

The market for fixed-income securities in Mexico is also well developed, with the sovereign market being among the most important in emerging markets, thanks in part to the solid investment grade rating of the government’s debt of “BBB+” from both Fitch and Standard & Poor’s credit rating agencies (see Economy chapter). The most important sovereign issues are Mbonos, the standard fixed-rate bonds with terms ranging from three to 30 years, which account for nearly half of all outstanding government debt. UDI bonos are inflation-linked bonds, also issued with terms ranging from three to 30 years. Bondes D are floating-rate bonds issued with terms of up to five years. Short-term, zero-coupon federal Treasury certificates (certificados de la Tesorería, CETES) have been issued weekly by the government since 1978, with terms ranging from one week to two years, although more typically in recent years with maturities of six months or a year.

According to figures from Banxico, foreigners held over MXN2trn ($120.5bn) in Mexican sovereign bonds at the end of the third quarter of 2016. Mbonos were the mostly widely debt held by foreigners, accounting for 81.2% of foreign holdings, while foreigners held a total of 59.7% of all Mbonos. International investors also held 34.8% of all CETES, but only 8.39% of UDI bonos and a 0.2% of Bondes D.

Corporate Bonds

The Mexican corporate bond market is relatively less developed, and remains concentrated among a small number of parastatals, notably Pemex and CFE, mortgage funds, such as FOVISSSTE and INFONAVIT, and top-rank listed firms, such as América Móvil and Grupo Televisa. When it published its latest Article IV consultation for Mexico in November 2016, the IMF noted that overall corporate debt stood at 35% of GDP, adding that almost all of this was denominated in foreign currency. Mitigating this concern was the fact that most large corporations hedge their currency risk. With steep declines in the peso, however, this is something that is likely to draw further scrutiny in the future.

Between the sovereign and corporate markets, the BMV recorded 110 issuances of long-term debt in transactions totalling MXN158bn ($9.5bn) in 2016, down significantly from the 168 issuances worth MXN269bn ($16.2bn) in 2015. Although the number of short-term debt issuances also declined from 835 in 2015 to 782 in 2016, there was a modest increase in peso terms from MXN267bn ($16.1bn) to MXN304bn ($18.3bn). In January 2017 the BMV reported that it had 33 debt issuances in the pipeline.

Forex Market

The Mexican peso is the most widely traded, free-floating emerging market currency, with an equivalent of $97bn traded every day on average during the three years to April 2016, down from $135bn in 2013. Banxico intervenes only occasionally in the market at periods of high volatility, such as in January 2017, which encourages some speculators to treat the peso as a proxy for emerging market currencies (see Economy chapter).

According to the “Triennial Central Bank Survey”, published in September 2016 by the Switzerland-based Bank of International Settlements, the Mexican peso had been overtaken by the Chinese yuan as the most-traded emerging market currency, as it reached daily average trading equivalent to around $202bn. However, China’s exchange rate is managed by its authorities.

Derivatives

The Mexican Derivatives Exchange (MexDer), run by the BMV, is the only listed derivatives market in the country, offering futures, options and swaps. The BMV also has a routing agreement with the Chicago Mercantile Exchange. Liquidity has fallen dramatically in the main futures market, with the number of contracts traded daily having declined from its 2011 peak of 183,519 to only 49,149 during the first three quarters of 2016. The futures contract mix has also changed substantially, as short-term interest rate contracts made up 63% of those traded in 2010, but had almost disappeared by 2016. At the same time, currency futures had increased from 14% to 73% of the total over the same period. Recent initiatives at MexDer include the central clearing of standardised contracts, which became effective in April 2016, and increased capital requirements for over-the-counter contracts.

Regulatory Architecture

The CNBV, underpinned by the CNBV Law, is a devolved body of the Ministry of Financing and Public Credit, which is responsible for authorisation, regulation, supervision and sanction within the financial system. It oversees the BMV, as well as the nascent second bourse, the Institutional Stock Exchange, which is set to be launched in mid-2017 (see analysis), as well as the brokers, asset managers and intermediation services in the markets’ orbit. In 2015 much of the agency’s efforts focused on implementing the 2014 financial reforms, which involved around 70 amendments to regulatory provisions. The CNBV also carried out 630 inspection visits that year, up 26% in 2014. As well as putting in place the necessary regulatory framework for the running of a second market in 2017, one of the CNBV’s major innovations during 2016 was to run stress tests on brokers to ensure they were capitalised well enough to withstand adverse scenarios. Going forward, Álvaro Meléndez Martínez, chief economist of the CNBV, told OBG that the results of these stress tests will allow the CNBV to take any necessary, institution-specific remedial action outside of the public eye.

Brokers & Asset Managers

There are 36 brokerages registered with the CNBV, accounting for MXN5.41bn ($326.1m) in assets under management as of June 2016, spread between 224,625 client accounts. The market is concentrated, however, with the top-five firms accounting for 48.3% of assets in December 2016. These are led by Inversora Bursátil, subsidiary of Grupo Financiero Inbursa, with 33.9% of the market and MXN2.3bn ($138.6m) in assets under management. It is followed by Acciones y Valores Banamex with a 16.75% market share, BBVA Bancomer (12.75%), Banorte-IXE (8.89%) and Group Financiero Actinver (5.26%). At the end of November 2016, the CNBV reported that the aggregate capitalisation index of the sector as a whole was 24.95%, more than triple the regulatory minimum of 8%, and over double the 10.5% level when the 2.5% supplementary capital buffer is added. There was a wide range in capitalisation levels among the 36 registered brokers, however, with some such as Vector and Invex Grupo Financiero hovering above the 10.5% level, at 12.18% and 12.44%, respectively. At the same time, some such as Deutsche Securities and Barclays Capital had aggregate capitalisation indexes that were multiples of more than 50 times the 10.5% level, at 565.12% and 563.23%, respectively.

According to the CNBV’s latest annual report for 2015, there were 563 mutual and investment funds in operation at the end of that year, up only slightly from 561 in 2014. Together these accounted for MXN1.9trn ($114.5bn) in total assets under management. Many of these funds had previously operated as investment companies, but were required to convert into investment funds by July 2015, as stipulated in the 2014 financial reforms.

Another important aspect of the financial reform was the introduction of what is known as open architecture, which means that investors will be able to access the fund that is most suited to their investment profile and risk-tolerance level.

Outlook

In light of external and domestic economic and political uncertainties, as well as rising interest levels, the Mexican equity market is expected to tread water in 2017. Ana Sepúlveda, associate director of equity research at Invex Grupo Financiero, told OBG that her firm expects the market to grow by 4% in 2017, broadly in line with inflation. She pointed to cement as a sector with great potential, with building materials firm CEMEX having completed the restructuring of its finances, while the rising interest rate environment is expected to boost margins in the banking sector. Sepúlveda expects telecoms to remain under pressure, however, as recent reforms will likely negatively impact margins. The food sector could also prove a weak spot as private consumption growth moderates and peso depreciation continues.

Likewise, rising interest rates in the US and Mexico can be expected to keep bond prices under pressure, with yields already on the rise in late 2016. With the introduction of two new financial products aimed at stimulating infrastructure investment in 2016, namely FIBRA E and CerPIs, 2017 will prove a litmus test of their capacity to impact Mexico’s capital markets in the way that FIBRAs and CKDs have in recent years. With interest rates at historically low levels and in a climate of low investment yields, Mexico’s AFORES have been forced to diversify their investments. On an international scale this is frustrating, precisely because funds in Mexico are limited to just 20% foreign investment, while in Chile this figure is 80%. However, overall the capital markets are likely to continue to see positive growth in the years ahead.