How to Invest in Mexico’s Energy Sector

Investors hoping to profit from Mexican energy reform should look for companies that will benefit from the drop in oil and gas prices.

Mexico Lawmakers Poised To Give Final Approval to Energy Investment Rules

Gas is flared from a tower on an oil drilling rig operated by Petroleos Mexicans (Pemex) in the Ku-Maloob-Zaap oilfield at Campeche Bay off the coast of Ciudad del Carmen, Mexico, on Friday, Aug. 1, 2014. Mexico’s Senate is scheduled to hold a vote tonight on the final measure to implement the constitutional overhaul approved in December ending Pemex’s exclusive right to crude oil production, now in its 76th year. Photographer: Susana Gonzalez/Bloomberg

Susana Gonzalez/Bloomberg

Mexico’s economic growth has disappointed its citizens, politicians and investors time and again, but President Enrique Peña Nieto, the Institutional Revolutionary Party (PRI) politician who came to power in 2012, is determined to do something about it.

Crucial to his strategy to boost Mexico’s economic growth is reforming the energy sector. His plan includes calling in major foreign producers to increase the efficiency and funding of the state-dominated energy industry, which keeps domestic energy costs high compared with other countries and sets a limit on total national oil production. Mexico’s government is also trying to drive down electricity prices by encouraging private investment and creating an independent power regulator. Growing production of U.S. natural gas — which travels into Mexico via the Henry Hub distribution point in Louisiana — is likely to cut energy costs further.

“Energy reform is the most important reform,” says Richard Hall, an emerging-markets sovereign credit analyst at Baltimore-based asset management firm T. Rowe Price. “The most important aspect of it is that Mexico has been underinvesting in its oil production. There’s low-hanging fruit that hasn’t been picked.”

Investing in the theme of energy reform, however, is tricky. Profiting directly from the opening of the energy sector is problematic, because most private sector investment in production will be made by multinationals. Putting money in a sprawling U.S. oil major is not an efficient way for portfolio managers to invest in Mexican energy deregulation. Investors say that an indirect approach is needed instead: investing in companies that will benefit from the resulting drop in Mexican energy prices.

One approach is to look for companies that are heavy energy consumers. One such sector is cement, which taps into other promising Mexican themes. Cement producers will gain from the huge infrastructure spending, including for production and pipeline facilities, required for Mexico’s increased energy production.

“When it comes to building the infrastructure, it’s the local players who will benefit,” says Siby Thomas, an emerging-markets corporate research analyst at T. Rowe Price. Thomas likes paper issued by two cement makers, CEMEX and Grupo Cementos de Chihuahua (GCC). They are, he notes, investments that “come with risk.” CEMEX, rated B+ by both Standard & Poor’s and Fitch Ratings, has taken on a lot of debt to make acquisitions. GCC is rated B by Standard & Poor’s and B+ by Fitch. Both companies provide tempting yields: CEMEX’s 2022 dollar bonds yield approximately 6 percent; GCC’s paper maturing in 2020 yields a little more than 5 percent.

Mexican cement companies hold another attraction for investors: They are a good play on the U.S.’s continuing economic rebound. Cement is the ultimate nearshore manufacturing product: For practical reasons having to do with the production and transportation process, it must be manufactured either in the home country or nearby.

“Some cement stocks should do well, because of the recovery of U.S. housing and infrastructure,” says Gerardo Zamorano, director of investments at Brandes Investment Partners, an asset management firm with $27 billion in assets based in San Diego.

The petrochemical sector is another big consumer of oil and petroleum by-products. Taking advantage of this theme, €49 billion ($62.4 billion) Paris-headquartered asset management firm Carmignac Gestion is a big fan of chemical maker Mexichem.

“Mexichem will doubly benefit from the cheaper feedstock generated by foreign direct investment in oil and gas fields in Mexico,” such as ethylene, a by-product of oil and gas production, says Sandra Crowl, a member of Carmignac’s investment committee. “It will also benefit from the cheap gas transported into Mexico from the U.S. This makes Mexichem more competitive than its European rivals, and just as competitive as its U.S. rivals.”

Carmignac also likes mining company Grupo México, the world’s third-largest copper producer. At a time when many other investors are ignoring copper stocks as slackening demand from China meets oversupply from global producers, Crowl sees Grupo México as a good contrarian play. She acknowledges the “macro headwinds” facing the copper market but notes that among copper producers, “Grupo México has close to the lowest operational costs in the world.” For this reason, she forecasts that it will weather well both the necessary reining in of supply and the temporary fall in copper prices.

Responding to Mexico’s prospects for economic expansion, many investors have put money into the stocks of consumer-focused companies, which will benefit as wages respond to higher output growth. Some investors are skeptical, however. “As in other emerging markets, consumer stocks such as retailers, restaurants and broadcasters are expensive,” says Zamorano of Brandes. It is, he says, difficult to find good consumer stocks in Mexico with forward price-earnings ratios below the mid-20s. In Mexico, as elsewhere, the rise of the middle-class consumer is a well-invested story.