The Sizzle In Mexican Small Caps

Wall Street has taken a fancy to a group of hot performers

It's a day of quiet chaos at the headquarters of Corporacion GEO, Mexico's largest low-income-housing developer. Rushing to meet a deadline for submitting contract bids, the young planners have covered the conference-room floor with papers. "They haven't slept in two days," says associate director Miguel Gomez-Mont Urueta.

GEO, based in Mexico City, is just one of several hot small companies listed on the Mexican stock exchange that have caught Wall Street's eye lately (table). For investors who want to diversify beyond market proxy Telefonos de Mexico, small-cap opportunities abound in everything from auto parts to pasta. "They're the kind of play that makes emerging markets attractive," says Jorge Suarez Velez, managing director of Afin Securities International Ltd. in New York.

GIMME SHELTER. Smaller stocks held up well in February, as the Mexican bolsa index slid 6.6% in response to higher-than-expected inflation and unemployment, plus worries about rising long-term interest rates in the U.S. Small caps also show stronger year-to-date gains than the index--which is up just 2.81% in peso terms. But many have lagged behind the overall index performance for the past 12 months, so many analysts consider them cheap given their strong cash flows and growing markets.

GEO, like several others among these stocks, is the leader in its market niche. To help meet a housing shortfall estimated at 6 million units, the company designs and builds low-cost homes backed by mortgages from Mexico's two leading public-housing funds. Thanks to sophisticated design and mechanized construction techniques, GEO consistently beats out rival bidders. Its American depositary receipts (ADRs) are up around 8% so far this year but still trade at 11.5 times estimated 1996 earnings--a discount compared with other stocks in the sector.

Another play on the construction revival expected as Mexico's economy gradually improves is engineering company Grupo Profesional Planeacion y Proyectos (PYPSA). Since it doesn't buy bulldozers and cranes, its balance sheet is strong. And an alliance with Britain's Trafalgar House PLC is helping PYPSA export its services. At about $15 an hour for top-notch midlevel engineers, PYPSA easily beats international competitors. Analysts like its 31% operating margin and backlog of private-sector projects.

KITCHEN SAVVY. Also on the list of favorite small caps is Tablex, Mexico's leading pasta maker, with 55% of the local market. Mexican per-capita pasta consumption is about one-third the U.S. level. But Tablex, which gives out free samples and prints recipes on its packages, believes the market will grow. Although the stock is up 13% so far this year, Scott Wilkins, an analyst at ING Barings Ltd., considers it cheap, given that profit margins should be about 20%.

A small, family-run industrial company that wins analysts' praises is Grupo Industrial Saltillo (GISSA) in the northern city of Saltillo. Operations are so lean that employees are asked to avoid the elevator if they're going up only one flight. GISSA has financed expansion in its three divisions--auto parts, construction, and kitchenware--mostly with its own cash. Up more than 13% since yearend, the stock is still at just eight times forward earnings.

One caveat: Stocks of even strong small caps, such as GISSA, tend to be illiquid, and thus most appropriate for investors who are willing to buy and hold. Retail investors may prefer to look for mutual-fund groups, such as Fidelity and Merrill Lynch Asset Management, that invest in international small caps. But if the bolsa moves up, it may be worth tolerating some illiquidity. Small caps tend to fall behind the rest of the market and then outperform in a rally, says Jean van de Walle, a portfolio manager at Alliance Capital Management. For adventurous investors, that's more than enough reason to learn some new names.

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