Reforms and currency boost Mexico's capital markets

Mexico has orderly and innovative capital markets, with government-issued and blue-chip corporate bonds dominating the fixed-income sector, which is larger in volume terms than equities. A well-developed foreign currency market – the world’s most-traded emerging markets currency – is also a prominent asset helping to drive activity. On the equities side, meanwhile, the Mexican Stock Exchange (Bolsa Mexicana de Valores, BMV) has been operating for over a century, though the number of listed companies and their market capitalisation remains small in relation to the size of the economy. Santiago Urquiza, president of Enlace, a financial markets and OTC interdealer broker company, told OBG that the Mexican markets have performed well so far in 2015, and that growth and government reforms have also been positive, with markets, volumes and credit expansion also lending hope to further activity moving forward. In addition, Mexico has been an early adopter of Basel III bank reserve requirements leading to generally cautious risk management, but this has not held back capital markets, which remain liquid.

Recent Performance

During the course of 2014 Mexico’s stock exchange was heavily influenced by global trends, marked by a high degree of volatility, geopolitical worries, concerns over future interest rate movements, and a somewhat mixed attitude to risk-taking. Global investors tended to move their funds into US recovery plays and away from emerging economies. Within Mexico itself there were also somewhat contradictory forces at work, with enthusiasm over the structural economic reforms tempered in the fourth quarter of 2014 by worries over the impact of lower international oil prices.

However, given political uncertainties in Brazil, following the 2014 presidential election and ongoing protests around corruption within the government of Dilma Rousseff, Mexico was the most active equity market in Latin America. According to the Citigroup research team, Mexico accounted for approximately 40% of Latin America’s total trading volume, ahead of Brazil with 32% and several Andean countries, mainly Peru, Colombia and Chile, with a combined 16%.

Composition

Real estate investment trusts led the action, raising $5bn in both initial public offerings (IPOs) and follow-ons. Mexican share prices reached a peak in September 2014, but then trended down. The BMV closed 2014 with the main share benchmark index (Índice de Precios y Cotizaciones, IPC) on 43,146, an increase of 1% year-on-year (y-o-y). In dollar terms however, the IPC dropped by 10%, reflecting the depreciation of the peso throughout 2014. In 2013 the IPC had fallen by 2.2% in peso terms. As far as market capitalisation is concerned, the companies listed on the BMV ended 2014 worth $480.2bn, down 8.7% in dollar terms. Brazil’s Bovespa, by comparison, had almost double the level of market capitalisation, with $843.9bn, though turnover was lower and share prices fell more sharply during the year (-17.3%) than in Mexico.

Larger companies dominate the BMV’s market capitalisation and significantly influence the overall performance of the index. Telecoms giant América Móvil saw its shares rise in September 2014 when investors welcomed its plan to spin-off some subsidiaries to meet new regulatory requirements. As a whole, América Móvil was up by 7.8% y-o-y in peso terms. Shares in leading broadcaster Televisa, meanwhile, rose by 28% in 2014, while energy reforms boosted interest in the oil and gas sector. IE nova, the subsidiary of oil company Sempra Energy, benefitted from government pipeline building programmes (see Energy chapter). Retail stocks performed less impressively, however, with January 2014 tax increases seen as holding back consumption growth. Walmart Mexico, which trades as Walmex, fell 7.4%, while Grupo Sanborns, a pharmaceuticals, retail and restaurant chain, was down 17%. Companies linked to tourism performed well, with ASUR (which operates Cancún airport) improving 19% and Aeroméxico 14%.

Turning The Tables

The BMV remained somewhat subdued in the first quarter of 2015, with the total market capitalisation rising about 1.3% in nominal terms to MXN7.1trn, which was worth $470.9bn at the time. Despite the nominal increase, this represented a fall of 1.9% in US dollar terms. Elsewhere in Latin America, market capitalisation in the first quarter for the São Paulo, Lima and Bogotá bourses fell more steeply than the BMV in dollar terms, down between 9% and 19%.

One of the more local issues for Mexico is that while corporate profitability is expected to improve as the recovery gathers pace, many stocks are already trading at high p/e ratios. According to an equities report by Banco Santander, net aggregate income in the first quarter of 2015 for listed Mexican companies tracked by the IPC, specifically those that had filed profit-and-loss reports by late April, was down 20.6% year-on-year. However, telecoms operator América Móvil, one of the leading stocks, accounted for most of this downtrend. Excluding América Móvil, aggregate earnings before interest, taxes, depreciation and amortisation was up by 8.3% y-o-y. According to Santander, “In our opinion companies have reported a relatively strong performance in terms of sales and operating revenues, which can be explained in part by the weak base of comparison in the first quarter of 2014.” The bank said it expected corporate performance to strengthen as Mexico’s economic recovery gathered pace.

Ranking The BMV

Alejandro Legorreta, CEO of Sabino Capital, a local think tank which has compiled a Valuing Investing Forum (VIF) index to help rank the performance of international stock markets over 2014, ranked the BMV 27th among 40 exchanges included in its survey. The index is compiled by giving each country a numeric score across seven pillars: economic stability, economic regulation, banking efficiency, and stock market depth, access, efficiency and stability.

According to the composite score, the strongest stock markets are Canada (scoring 78.1), Singapore (70.2) and Switzerland (69.7). The US ranked 10th with a score of 59.8. Among Latin American countries, Chile leads the way at 12th (58.6), then Mexico at 27th (47.4), Peru at 30th (44.6) and Brazil at 32nd (43.4).

Relative to the average scores, Mexico scored well in terms of economic stability, economic regulation and stock market price stability, with the IPC judged to have a comparably low level of volatility. However, the country is below average in the other four pillars. Legorreta said the biggest challenge for Mexico is its low rate of access: meaning the low number of companies actually listed on the exchange. He also noted that it is a highly concentrated market, with the top-10 listed companies responsible for most of the market capitalisation. Mexico also scores poorly for market depth. “The goal is to get more and more small and medium-sized enterprises using the stock market to fund their growth to generate jobs and wealth,” Legorreta said.

The Search For Depth

One measure to increase depth in the Mexican equity markets is capitalisation of listed companies expressed as a percentage of GDP. According to the World Bank, in 2012, the latest year for which cross-country comparable data was available, market capitalisation in Mexico stood at 42.3%, compared to 54.7% in Brazil, 115.5% in the US and 117.7% in Chile. However, Mexico’s market capitalisation is gradually increasing: in the five years to 2005 it averaged 19.7% of GDP, a figure which then rose to 35.3% in 2010. The greater depth of Bovespa, the Brazilian bourse, is largely attributable to Petrobras, the majority state-owned oil and gas giant. Pemex, the equivalent company in Mexico – which along with Petrobras is one of the largest enterprises in Latin America – is not listed on the BMV.

Mexican market players are not enthusiastic about adding depth exclusively by listing Pemex or other large state-owned companies. Santiago Urquiza, president of Enlace, a local brokerage group, told OBG, “Rather than getting a lot of large state-owned companies to list their shares, I think the priority should be to get lots of private companies to do so. That is what we are trying to achieve.” The number of listed companies can be increased from around 140 at present to more than 200 in five years’ time, according to Urquiza.

Rodrigo Ocejo, the CEO of Kuspit, an online trading company, told OBG that the most important challenge facing the sector is “the democratisation of the stock market”. According to Ocejo, “This market lacks dynamism. We need more people buying shares, more people understanding the market, to generate a virtuous circle where more people start seeing the exchange as source of funds for their companies.” The number of companies joining the BMV – around 10 each year – needs to be increased, he said. Ocejo also said much needs to be done to change attitudes. According to his calculations there are around 50,000 individual retail investors in stocks and shares in a country of nearly 130m inhabitants. He explained that only a very narrow sector of society understands the exchange and feels comfortable investing in it directly.

Behind this is a range of cultural factors, including the strength of the family firm in Mexico, which tends to have an ingrained conservative outlook, a mind-set where investors place a premium on having majority control, and a generally low level of financial awareness. Kuspit is one of a handful of companies seeking to bring online investing to Mexico’s middle classes.

According to Ocejo, a more dynamic stock exchange would boost transparency and minority shareholder liquidity, which would be beneficial to the country’s economy as a whole. The emergence of a new generation of technology-friendly investors would contribute significantly to this transition, he said.

IPOS

A total of 147 companies were listed on the BMV at the end of 2014 (of which 141 were Mexican and six were foreign-owned). This compared to 363 companies listed on the Bovespa in Brazil, 307 in Chile, 263 on the Bolsa de Valores in Peru and 73 in Colombia.

Jaime González Aguadé, president of the regulatory National Security and Banking Commission, told OBG, “We have a large and efficient debt market, which is the main source of funds for many companies. However, we think the equity market should be a bigger source of funding for many family owned companies. We are taking steps to try achieve that.” One issue is that while at any point in time various IPOs seem to be in the pipeline, the number that actually go all the way to market has tended to be smaller than hoped. According to the BMV there were a total of 13 IPOs in 2013, with this number falling to just four in 2014.

Marissa Garza Ostos, deputy-director of stock market analysis at Banorte, told OBG, “If you talk to brokers there seem to be 10 to 12 IPOs in the pipeline at any given time, but they are not coming through. With high valuations, companies are eager to launch. However, it seems that at the last moment they pull back, worried about overvaluation and price volatility, particulalry getting closer to a US Fed rate hike. IPOs too are being affected by the flight to quality, with investors worried about buying shares that are not very liquid,” she said.

Hopes of an uptick in the number of listed companies were boosted, however, by signs that multiple-purpose financial firms (Sociedades Financieras de Objeto Múltiple, SOFOM) were beginning to join the BMV. One of them, Unifin, listed in May 2015 by floating 36.5% of its shares and joined two others already on the exchange: Crédito Real and Financiera Independencia. Although there are 3060 registered SOFOMs in Mexico, the aforementioned are the only three currently on the stock exchange. Enrique Bojórquez, president of the Association of Specialised Mexican Financial Institutions, has said that others, including Adamantine, a company focusing on the mortgage and real estate sector, might joint them. Among others reportedly planning to list is Exitus Capital.

Pension Funds

One factor that has gradually made available more funds is the growth of retirement fund administrators, known in Spanish as “administradoras de fondos para el retiro”, or Afores. Since their introduction in the 1990s, Afores have been growing steadily and investing a proportion of their assets in the stock exchange. Coverage is still far from universal – for example most people in the informal sector make no pension contributions – but given Mexico’s demographic structure, contributors to the system will grow faster than beneficiaries for some time.

According to the National Commission for the Pension System, the main regulator, in early 2015 there were a total of 52.7m individual Afores accounts, but there was a gender difference among them, with 39% held by women. This, in part, reflects the fact that there are currently fewer women than men in formal employment.

Víctor Herrera, managing director of Standard & Poor’s Mexico division, told OBG that assets are expanding at roughly 20% per annum, a combination of growth in the number of contributors and appreciation of investments. He noted a compound annual growth rate (CAGR) of 20%, equating to the total value of Afores assets doubles every four years. The problem, as he put it, was that they were running out of local stock-exchange listed companies to invest in.

Bond Markets

Since the financial crisis of the early 1990s the Mexican bond market has grown in overall size, composition and diversity. In 1995 around 20% of public debt was domestic and 80% was foreign. By 2014 some 70% of the total was in peso-denominated securities, while 30% was in foreign currency bonds.

While in 1995 most maturities were for a year or less, there are now a wide range of tenors of up to 30 years and beyond. In 2010 the government issued its first 100-year foreign currency bond. The main classifications include short-term zero-coupon Mexican Federal Treasury Certificates (maturities of up to one year), long-term fixed-rate Mbonos (with bonds of up to 30 years), real-rate Mexican linkers Udibonos (with bonds of up to 30 years) and floating-rate bonds (up to five years).

There is also an important corporate debt market, with a total value of around MXN1.02trn ($68.6bn), and a CAGR of 14.1% since 2009. A total of MXN212bn ($14.27bn) was issued in 2013, incorporating a range of new issues such as Fibra Uno (infrastructure), IE nova (energy), Aeroméxico (airline), Cultiba (soft drinks), as well as the frequent participation of Pemex ( state-owned oil company) and the Federal Electricity Commission (state-owned power company).

Forex Markets

A variety of exchange rate regimes have been in play in Mexico. However, since the “Tequila Crisis” of 1994-95 the peso has floated freely with relatively minimal intervention from Banco de México, the country’s central bank. According to the “Triennial Central Bank Survey” published in September 2013 by the Swiss-headquartered Bank for International Settlements, the Mexican peso became the most heavily traded currency among emerging markets and the eighth most-traded currency in the world. A statement by the Banorte economics research team noted that, “The average daily volume exchanged worldwide hovers at around $135bn [including spot, forward and swap transactions]. The peso’s international stance and importance is indicative of the high confidence among investors in Mexico’s general macroeconomic framework and the measures adopted to increase the overall trust and transparency in financial markets.”

Outlook

A key issue for 2015 is how Mexican stocks will react to the expected normalisation of US interest rates. Tighter interest rates in the US are seen as something of a threat to emerging markets equities in general, as they are likely to create a “flight to quality”, with investors moving funds back into the US and other developed markets. However, the Mexican central bank is committed to raising interest rates in step with the US Federal Reserve (Fed), while Mexico is also exposed to the upside from US growth. Manuel Jiménez Zaldí- var, director of stock market analysis at Banorte, told OBG, “All markets have been affected by the Fed’s announcement to normalise interest rates. There has been a flight to quality; funds have been flowing back to developed economies and to the US in particular. On the other hand, a stronger US economy is good for Mexico and profit margins will improve. However, other factors are also involved. Mexican share valuations are high on a P/E basis, which may limit the upside.”

Adolfo Herrera, director-general of brokerage firm Grupo Financiero Interacciones, explained that while his group has achieved flat returns over the previous two years, he is optimistic new opportunities will emerge going forward. “We are predicting a positive return, with the IPC reaching 46,500, and we are identifying some favourite stocks to beat the index,” he told OBG.