Description

I think it's time to go long Mexico.

I've always had a soft spot for Mexico equities. The country is dominated by a bunch of greedy oligopolies that are very "rational" and in general super profitable. This is especially in the case in the banking space. 

Like a lot of LatAm, banking is consolidated in MX and very profitable. In fact the Mexican banks have some of the best deposit franchises in the world, which allows them to make most of their money on the liability side without taking a lot of credit risk. As a result, the leading banks are very profitable and make excellent profits throughout the cycle. Regional is case in point, with ROAs averaging about 2.5% through cycle, troughing at 2.0% in 2020 and 1.2% in 2009 GFC. They run with moderate leverage levels, therefore ROEs are around 20% cross cycle.

Mexican equities have been destroyed by political uncertainty both in the US and in Mexico. On one hand is renewed trade war if Trump gets elected. The other is Morena gutting the judiciary and possibly turning the country into a true narco-state with judges in the pockets of the cartels.

As a result, the Peso is in free fall and Mexican equities are one of the worst performing markets in the world this year.

So that is to say, any call in Mexico has to be in part that the abovementioned problems are an overreaction. I personally have this view, and in fact I suspect Sheinbuam will govern more from the center than the far left. Her recent inauguration speech was far more moderate than what people were fearing, which actually sent the bank shares up strongly in the last few days. The US election is a toss up so I'll let you make your judgement there. It does seem to me though that equities are pricing in some very dire outcomes.

The fundamental thesis on Regional Bank is very straight forward. I chose this one because the business model benefits from reshoring/near shoring, and because it seems a little bit more insulated from fintech disruption. In practice the stock price is very correlated to Banorte. 

Regional is a business bank headquartered in Monterrey. Most loans originate in the wealthier and more industrialized northern areas of Mexico. They predominately lend against real estate collateral. Loan growth should be HSD, as they push more into consumer loans and also as industrial/manufacturing investment in MX is quite strong.

The core of the business is relationship banking for businesses. They have teams of very experienced bankers cultivating personal relationships with small and medium sized businesses. It's sort of like a First Republic model. They have retained these banker teams very well and incentivez them richly. Churn in the core workforce therefore is low. I like this model because it has proven to be difficult to replicate, and they do business differently from the mass market banks like Banamex and Banorte. Moreover, the model seems a bit more insultated from fintech competition from the likes of MELI and NU.

Historical growth has been robust and I would expect that to continue. They are deepening branch networks both in the North and also in Central mexico. Several years ago they struggled in breaking into the Mexico City area but seems to have ironed out the kinks.

Given the rich ROAs and low valuation, the div yield is very nice. Currently in the 6%+ range. I personally suspect that will climb into the 8% range as payout ratios will go up.

Despite the huge profitability the bank trades for merely 1.4x book and 6x PE. I find this very attractive.

Catalyst

 Collect a fat divvy and wait for growth and re-rating. Hope political risks recede. US elections.