Small Cap Bargains South Of The BorderElisabeth Malkin
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 bids, the planners have covered the conference-room floor with papers. "They haven't slept in two days," says Associate Director Miguel Gomez-Mont Urueta. That kind of energy distinguishes one of the hottest small companies on the Mexican stock exchange.
GEO, based in Mexico City, is just one of several promising small companies listed on Mexico's bolsa that have caught Wall Street's eye. For investors who want to diversify beyond market heavyweight Telefonos de Mexico, small-cap opportunities abound in everything from auto parts to pasta. "They're plays that make emerging markets attractive," says Jorge Suarez Velez, managing director of Afin Securities International in New York, which specializes in taking small Mexican companies public.
Smaller stocks have held up well as the market has steadily climbed since Mar. 11. Analysts attribute gains to expectations that domestic interest rates will soon begin to slide and some renewed foreign interest in the Mexican bolsa. Most small caps have also shown stronger year-to-date gains than the index--which is up 9.66% in peso terms. But many have lagged the overall index performance for the past 12 months, so they look cheap given their strong cash flows and growing markets.
GEO is the leader in its niche. To help meet a housing shortfall estimated at 6 million units, the company 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% this year but still trade at 11.3% times estimated 1996 earnings--a modest 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 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 its backlog of private-sector projects.
Also on the list of favorite small caps is pasta maker Tablex, with 55% of the local market. Mexican pasta consumption per capita is about one-third the U.S. level. But Tablex, which gives out free samples and prints recipes on packages, believes the market will grow. Although the stock is up about 17% so far in 1996, Scott Wilkins, an analyst at ING Barings, considers it cheap, given that profit margins should be about 20% this year.
A small, family-run company that wins praise from analysts is Grupo Industrial Saltillo (GISSA) in the northern city of Saltillo. Operations are so lean that employees are asked not to take the elevator if they're going up one flight to avoid delays. GISSA has financed expansion in its three units--auto parts, construction, and kitchenware--mostly with cash. Exports have fueled growth while the domestic economy is in recession, says Bond Snodgrass, an analyst at Abaco Casa de Bolsa, a Mexico City brokerage. Up more than 33% since yearend, the stock is still trading at just 10.5 times projected earnings.
BUY AND HOLD. One caveat: Stocks of even strong small caps such as GISSA tend to be illiquid and thus most appropriate for investors who can buy and hold. And as always in emerging markets, there is the possibility that currency slides will wipe out price gains. PYPSA, which trades on Mexico's intermediate exchange, is registering for ADRs to improve liquidity. A few small caps, such as Grupo Casa Autrey and GEO, trade on the New York Stock Exchange or over the counter, but most are listed only in Mexico. U.S. brokers can make them available, but they charge hefty commissions.
Retail investors may prefer to look for mutual-fund groups, such as Fidelity Investments and Merrill Lynch, that might buy international small caps. Small caps tend to lag market swings and then outperform in a rally, says Jean van de Walle, a portfolio manager at Alliance Capital Management. For adventurous investors, that's reason to learn some new names.