Mexican market will be hurt short term by reforms

MSCI Mexico PE Ratio 3-25-2013Enlarge Graph

Recently the Mexican government has been negotiating a series of reforms to boost Mexico’s economic growth and improve its competitiveness. Once passed, these will have important repercussions in the Mexican market.

The reforms can be categorized into four key groups:

  • Fiscal Reform
  • Labor Reforms
  • Energy Reform
  • Pro-Competition Reform
  • Other

Fiscal Reform

The fiscal reforms would likely include the addition of a value-added tax (VAT) to food, personal care products and medicines. Clearly this would have a detrimental effect in these industries since consumers may reduce consumption or switch to cheaper versions of the product (likely at a lower margin for the manufacturer) to make up for the tax increase.

The reform also includes the elimination of several tax loopholes and fiscal consolidation benefits. Industrial conglomerates (e.g. Alfa, Mexichem) would see their tax burden increased if this reform passes.

Energy Reform

The energy reform aims to boost oil production by allowing private exploration, extraction and refining, which would fundamentally transform Pemex, the state owned oil company. It is unclear, but it could be possible for Pemex to become a non-governmental firm and issue shares in the market.

The energy reform is linked to the fiscal reform in that likely gasoline subsidies would be eliminated, which seems to be a trend in several large emerging markets. India implemented this last year and Russia is planning indexing fuel costs later this year. In the case of India, this caused massive inflation, especially in food prices. The reforms would probably hurt the food companies as it happened in India given increased transportation and distribution costs.

Labor Reform

The labor reforms aim to make the economy more efficient by aligning the incentives of employers and employees to improve productivity and increase labor flexibility. If implemented correctly, then then main beneficiaries would be companies with the highest labor intensity.

Pro-Competition Reform

The pro-competition reform aims at allowing smaller companies to compete more easily in industries mainly controlled by a few players. It aims to give asymmetric incentives to companies with less than 50% market share. Mexico has several oligopolies that are likely to be targeted, such as in Telecom and Media (e.g. America Movil, Televisa), Mining (e.g. Grupo Mexico, Minera Frisco), Personal Care (e.g. Kimberly-Clark, Genomma Lab) and Banking (Inbursa, Banorte), among others.

Other Potential Reforms

Other possible reforms vary based on education, pensions, healthcare and mining, among others. Healthcare may include taxing of sugar soft drinks and junk food, once again hurting food and beverages companies (e.g. Bimbo, Gruma, Femsa, Arca-Contal). Mining could be hurt if a new mining law is passed (e.g. Grupo Mexico, Minera Frisco).

Overall Impact

Overall the impact of the reforms is likely negative in the short term given the industries affected and their relative weights in the Mexican stock market. The sectors that will be hurt make up over 50% of the market1, while the sectors benefiting are less than 15%. Telecom and Media make up almost 30% of the Mexican stock market, plus 10% is accounted for by mining, plus the almost 20% of food producers/processors and retailers. This share is huge compared to the <15% share of industrials, materials and builders that will benefit from the energy and fiscal reforms.

In the longer term, reforms may be able to boost economic growth and would perhaps justify a Price/Earnings multiple closer to 20x, which would mean the current 17x multiple could have room to expand once the increased GDP growth is factored in.

  1. Percent of the IPC Index, the capitalization weighted index of the Mexican Bolsa