jebmo’s posthaven

An Ian's Insider Corner member asked me: If I like investing in Mexico, what about investing directly in Mexico's stock exchange? It is in fact listed - in Mexico, not surprisingly - as Bolsa Mexicana de Valores (Mexico:BOLSAA) (OTC:BOMXF).

Important note: The Pink sheet listing doesn't trade frequently. If you want to buy or sell shares, you are highly advised to do so via the Mexican exchange. If you do trade in the pink sheet listing, be aware it's a simple one - no ADR ratio: One Mexican share = one pink sheet share. The current correct price for BOMXF is $1.60 (M$30.04/divided by exchange rate).

Mexico's stock exchange. Source

Mexico's stock market is a middleweight by global standards. According to World Bank data, the total market capitalization for Mexican stocks as of 2015 was $402 billion. There are multiple ways to view that. Let's start with the negative. Apple (NASDAQ:AAPL), by comparison, is worth more than $700 billion; thus, all of Mexico's market is just more than half an Apple.

In the country rankings, Mexico's market is the 19^th biggest in the world, ranking just behind Belgium and ahead of Russia. It's also just behind Brazil despite Brazil having twice the population of Mexico. Not bad. To Mexico's credit, its market and corporate governance are generally quite respected, and as a result, Mexican companies tend to trade at higher valuations than you'd see in a median emerging market.

On the downside, much of Mexico's wealth and industry are controlled by family-run operations. These tightly-held businesses have little need for outside capital and don't want minority shareholders telling them how to run their affairs. As a result, there are just 51 Mexican listed businesses that did $1 billion or more in revenues in 2014 – as compared with thousands in the US and other developed markets.

This family dynamic may be changing; more and more family-run businesses have gone public in Mexico over the past decade. However, the market still has quite a ways to go to reach the same level of popularity/competitiveness that you'd find in more mature economies.

On the plus side, the government has privatized quite a few state-run assets. The country's three listed airport operators, for example, are a novel and innovative approach to privatizing big infrastructure. Since going public in 2006, the Mexican airport players have shown remarkable growth, demonstrating how private management can find opportunities that a state bureaucrat might miss.

My 2017 top pick, Grupo Aeroportuario del Pacifico (NYSE:PAC) - operator of Guadalajara, Tijuana, Cabos, and Puerto Vallarta's airports, among others - has put up 17.1%/year annualized since its IPO in 2006. You'll struggle to find listed infrastructure plays in developed markets offering that sort of potential.

PAC investor day at the stock exchange March 29, 2017. Source: Bolsa Mexicana de Valores.

New and innovative listings aside, a huge chunk of Mexico's businesses remain privately-held. And the exchange is not all the developed. Derivatives markets, for example, generate barely any trading volume.

That lack of development may make the Mexican stock exchange a steal at today's prices. Many sources of profits for western market operators, such as NASDAQ (NASDAQ:NDAQ), simply don't move the needle yet in Mexico. Listed stock options are virtually non-existent in Mexico for example.

Walmex (WMMVY) - one of the exchange's largest companies - saw a grand total of 34, 3, and 3 stock options trades in the months of October, November, and December, respectively. Femsa (NYSE:FMX) saw 3, 13, and 4 options trades over that same time-span. As far as options markets go, in some cases, you'd find better liquidity for Mexican companies' options on the NYSE than you would on their home exchange. That could change for the Mexican exchange going forward (but no guarantees).

Similarly, futures are hardly traded in Mexico. 30-year bond futures - a hot contract in the US - haven't traded a single time since mid-2015 in Mexico. 10-year swaps have witnessed exactly three trades over the past two years.

The flagship dollar/peso currency contract counts volume in the hundreds on a monthly basis; that's nothing given the amount of currency hedging the country needs with its vast trade flows to and from the United States. Only the IPC futures contract (equivalent to the ES S&P 500 contract in the US) does real volume, and even that one only moves about 100k contracts a month.

For now, the listed equities are the main business driver for the stock exchange. Volume there has been steadily building over the years. The most recent quarter was particularly good, you can thank volume doubling(!) in Nov. '16 versus the same month last year presumably since traders were reacting to Trump.

But even excluding the Trump bump, revenues have been steadily and strongly growing. The business has doubled in size since 2008, and tripled since 2005. Margins have been rising; there haven't been any issues there as operations pick up.

If you're bullish on Mexico, this is the sort of investment that should bring pleasing results over time. 2016 was a slow year for Mexican IPOs, this year could be better, it's already off to a good start with Becle (OTCPK:BCCLF), the maker of Jose Cuervo, and one other new listing.

Valuation

There's only one stock market in Mexico at the moment so there's no direct comparable. There are plans for a second exchange, so consider this as a risk factor, though I'm skeptical the second exchange could achieve critical mass, given the overall low level of volumes in Mexican trading currently.

As compared with developed market exchange operators, there is more concentrated economic cycle risk here; Mexican markets could be badly crippled if the government took a turn toward socialism, for example. While center-right politicians continue to rule the political scene in Mexico, a socialist came fairly close to winning in the last election before fading late. And current president Enrique Peña Nieto has seen his popularity slip for a variety of reasons including economic weakness, a perceived inability to manage the narco situation, and the goings on with the U.S. since Trump's victory. Mexico votes for president again in 2018.

However, that risk, I'd argue, is outweighed by the upside should Mexico continue down the road toward becoming a developed market. An advanced capitalist economy should have a far higher market cap than Mexico does for its equities, and there should be massive amounts of activity in derivatives such as futures and options. If Mexico can continue liberalizing financially (and signs still point to good odds on that proposition), there should be plenty of low-hanging fruit.

Yes, Mexico's stock market isn't particularly cheap. With the recent rebound, it's now back up to about 19x earnings (and was at 25x prior to last quarter's unusually good results). That's not expensive compared to western markets in general, but you're not getting all that much of a discount either. The balance sheet comes with net cash, which makes the valuation picture a bit better. Still at 12x EV/EBITDA and more than 6x sales, you're paying full price to get in this name here.

Given the near-complete lack of liquidity for the Mexican exchange's US listing, and the stock's relatively decent performance over the past year, this isn't the lead idea I want to champion out of Mexico. It really doesn't do much to diversify one's portfolio if you already own a fair bit of Mexican exposure; it's hard to imagine scenarios where a portfolio of Mexican holdings such as those I've discussed previously go one way and the exchange itself does the opposite.

That said, if my bullish call on Mexico is right, you'll make money owning this. No question about that. The 3.7% dividend yield is also nice. If you want more Mexican exposure, I can endorse its stock exchange with no reservations. You won't find many businesses with this good a natural growth profile. And it's still so small - net income was just $50 million last year - that the scope of the upside is huge if Mexico evolves into a far larger financial market.

The Economist Intelligence Unit forecasts that by 2050, Mexico will overtake Russia and Italy to become one of the world's 10 largest economies. Its stock market in that scenario is likely to move up nicely from its current 19th place ranking globally by market cap.

Zooming in on the near term, what should we expect in the short run? As for this year, I think the rebound in the Mexican peso is just about played out. When the peso hit 22 in the height of Trump fears, I stuck a 19 target on the peso for year-end 2017. We're already back up to 18.7 today - beyond what even I, a Mexico bull, had expected. Upside from here is limited unless the dollar breaks down more generally.

For 2017, let's suppose the peso moves up to 18.5 and Bolsa Mexicana de Valores trades back up to 32 pesos a share - where it was just before the election. That'd bring the BOMXF pink sheet listing up to $1.73 - a respectable gain from today's $1.60 price but hardly the biggest upside you can find in a Mexican share today.

Bolsa's stock - Mexican listing in pesos:

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Disclosure: I am/we are long FMX, PAC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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