Description

Long: Grupo México Transportes (GMXT)

Headline

Grupo México Transportes (GMXT) is currently the leader of the railway duopoly in Mexico and is set to continue expanding their market share of the Mexican goods travel sector. It also owns a unique asset in the Florida East Coast Railway (FEC), which transports cargo from Jacksonville to Miami. We believe that GMXT is undervalued. GMXT is owned by Grupo México, Inbursa SA and free-floating shares representing 70%, 16.6% and 13.4% ownership of the company, respectively. This low percentage of free-floating shares, and the fact that most of these are owned by large pension funds (Afores), means that GMXT has low liquidity (1 to 1.5 million in ADV). This illiquidity creates an opportunity to buy a unique asset at a 50% discount to Kansas City Southern (KSU), with limited downside (stock trades at its IPO price of 2017, despite significant improvements).

Description

GMXT is a railway company that moves many types of products (agriculture is its biggest segment with 26% of its revenue) in its 11,136 km of railway in Mexico and the United States (See Figure 1 for more details). GMXT’s railroad network covers 24 out of Mexico’s 32 states which generate approximately 90% of the Mexican GDP. GMXT currently controls 64% of the railway sector in Mexico competing with Kansas City Southern (KSU), making it the leading company in the railway duopoly in Mexico. GMXT also competes with the much larger trucking sector which controls most of the market. However, the market appears to be slowly trending towards railways (See Figure 2 for more information) since they are considerably better for the environment, at least four times more fuel efficient, provide a much higher carrying capacity than trucks, and offer a lower cost of transportation than tucks.

Figure 1 Revenue Mix Q1 2021 2019

Figure 2 Market Size evolution from 1999 to 2019

Competition

KSU

From our analysis, there is little competition between GMXT and KSU. Since KSU handles only two of Mexico’s main ports and has one main track inside the Mexican territory. KSU is more of a complementary service to GMXT instead of a direct competitor. Clients can choose both companies to move their cargo, since the company might require cargo to be moved to the west coast of the country and would not require KSU’s services. Along with that, GMXT has more entry points into the country, having 8 points of entry with connections to other railroad companies. It is important to note that KSU only has only one entry point (its main railway) to get into the US. This greater diversification of connections and business relationships allows GMXT to provide superior services for exports into the US. Along with that GMXT’s ownership Florida East Coast railway gives GMXT control over most of Florida’s large ports.

Figure 3 GMXT and KSU railways map in Mexico.

Over the Road (OTR)/Trucks

In most parts of the world trucks have a superior market share when it comes to transporting goods, this is also true in Mexico where trucks hold 74.4% of the market share of transporting goods. Trucks are usually more versatile and reliable, making them a preferred option to move products in most countries. However, in recent years there has been a shortage in truck drivers which has increased the cost, and the difficulty of finding capable truck drivers around the world. This upward trend in costs can be observed in figure 4, the Cass Truckload Liheaul index shows the increase in prices from 2000 until today.

Figure 4 Cass Truckload Linehaul Index (measures market fluctuations in per-mile dry van truckload pricing in the US

Key Factors

1. Continuing steady growth, control of duopoly and absorption of truck market size. If GMXT can execute their expected YoY growth of 5-6% on volume of products moved, and 10-12% on revenues they will continue to provide enormous amount of upside to their current stock price.

2. Improvement of costs by improving efficiency of locomotives. GMXT currently has subpar operating metrics vs. some of the US and Canadian railways (see Figure 3 for more information) due to various infrastructure and terrain issues in Mexico. GMXT’s upside lies with its multiple projects to improve efficiency and lower fuel costs which is improving their gross margin by at least 100 bp every year. This would leverage their operating ratio to be between 64.5% and 67.5%, which brings it closer to the industry average of 60.84% operating ratio. These projects include: creating more two-way railways so that trains can be longer and therefore send less trains and crew throughout the year; a proprietary fueling system created with GE that switches from diesel to LPG when possible to decrease fuel costs, and a new software that allows them to stack trains lowering fuel costs.

3. High cash flowing business. GMXT is a high cash flowing business that has the possibility of paying better dividends with a stable CapEx. Their dividend yield currently stands at 3.30%, this is much higher than the industry average which stands at around 1.5-2%, with companies like CSX and KSU’s dividend yield of 1.07% and 0.67% respectively. Moreover, we believe that GMXT can pay higher dividends given that its Dividend to Net Income (i.e. payout) currently stands at 54.86%. With only 1.5x Net Debt to EBITDA the firm has a strong balance sheet, which provides room for a special dividend or other corporate actions. We believe that GMXT could nearly double its dividend by 2023, which would lead the yield to around 6%.

4. Strong Ownership and Management. GMXT is currently owned by Grupo Mexico, and in turn Germán Larrea. He is one of the best operators in the country. Between Grupo Mexico and Group Inbursa (owned by Carlos Slim) they currently own 86.6% of the business, while most of the remaining shares are owned by large pension funds with a 10-year review of their holdings. This gives GMXT low liquidity but demonstrates the belief these companies have in the prospects of the business.

The Opportunity

GMXT has the potential to have 92% upside with limited downside. The company has solid revenue growth potential, more room to lower costs and is trading at 8x EV/EBITDA, which is around 50% lower EV/EBITDA multiple than their competitors (which trade at around 12-18x EV/EBITDA).

Figure 5 EV/EBITDA comparison between GMXT and competitors.

We believe that they are undervalued due to the lack of liquidity of their stock as well as believed to be less valuable than their US competitors for being a Mexican company. However, should not be the case since Mexico is a critical part of NAFTA and is one of the US’ largest trading partners, which continues to grow as animosity with China increases. Along with this, KSU gets 50% of its value from its Mexican transport segment and is valued much higher. 

GMXT is very well run and is owned by Grupo Mexico, which is in turn owned by German Larrea. He is considered by many in Mexico to be one of the best operators in the country. We expect GMXT to continue to improve its costs and is expected to reduce its operating ratio to around 65.5% by 2023. This makes its operating ratio fairly close to the industry average of 60.84%.

Figure 6 Operating Ratios GMXT and competitors 2020.

Even with GMXT’s liquidity issues, they have a high dividend payout rate that provide constant returns every quarter. Their improving cash flow aims to provide better dividends every year and provide constant value from the company. Even if the stock price does not improve GMXT is not will continue to increase its value to the stockholder through higher dividends.

Figure 7 Dividends of GMXT in following years, maintaining a 60% payout ratio.

Note: GMXT lowered the dividend in 2020 as a conservative measure at the onset of COVID.

Risks

1. Lack of Liquidity. This may cause large funds to steer away from this stock and create a value trap. As an alternative, a way to play this name is to invest in Grupo Mexico, which is also trading below its SOTP and has more liquidity, although that would be a larger bet on copper. The low liquidity is offset by the fact that GMXT will continue to provide good dividends.

2. KSU and CNR provide too much competition for GMXT. CNR’s acquisition of KSU now provides a single railway system that spans from Mexico City all the way to Canada, which could be attractive to potential clients. In theory, GMXT could face logistical competition that it cannot compete with and lose market size against KSU and begins to lose the duopoly. We believe that this is unlikely since GMXT and KSU are not competing in most parts of the country and are more of complementary businesses; moreover, GMXT has a partnership with UNP, which has one of the widest railroad networks in the USA (other than political, there are no reasons why UNP would eventually try to buy GMXT).

3. Recession. Most of GMXT’s business comes from exports to the United States and Canada. While insulated some by taking share of trucks, GMXT’s revenues would decline if Mexico’s trade relationships or the region’s economic activity were to decline.

Catalyst

• If a KSU acquisition closes, maybe investors will believe GMXT could be a candidate to be bought by UNP 
• Increased dividends allow investors to see they can wait while they wait for a corporate event to create liquidity
• Continued good performance of GMXT will attract some smaller investors