Mexico On Sale (And How Best To Play It)

By Chris at www.CapitalistExploits.at

Ok, this is getting a bit ridiculous.

Ever since Americans picked the bully over the crook, and the Mexican Peso began acting like a penny stock just after the promoters begin dumping stock, I"ve been literally inundated with questions about Mexico. It seems I"ve got a lot of American readers super keen to look for value where others fear to tread. A good thing!

I did point out back in early December what I thought about the long Mexico trade and in particular the long MXN trade idea.

I showed this chart of the iShares MSCI Mexico Capped ETF (EWW) which is a decent enough proxy for the Mexican stock market. Today it"s pretty much unchanged from when I first showed it to you over a month ago.

Here"s what I said then:

The reason I chose to show you this chart, one going all the way back to the GFC, is because I want you to see the forest and not get caught up in the gnarly branches and roots of the trees, and as such realise that despite all the brouhaha crossing your news feeds. Trump’s election is IRRELEVANT to this market. The trend was in place well before Trump began lashing out at the Mexicans and Chinese for stealing America’s rice bowls KFC.

So that was, and still is, my macro thesis and how Mexico plays into it.

Sure, the Peso is cheap and by many accounts the greenback is not, but this is knee jerk, first level thinking to simply buy something when it"s cheap. When digging down into the bowels of the market to try figure out what"s driving capital flows and liquidity, I come to a different view.

This is the nexus of the articles I wrote about the eurodollar market. I urge you to drink lots of coffee and read it as well as the subsequent two articles: "The Eurodollar Market: It"s Not Working" and "Collateral Damage", in which I explained my thesis as to why we"ve been experiencing deflation during ridiculous monetary expansion. A lot of my investment thesis stems from those articles and the knock on effects.

I"d planned to get some thoughts on Mexico when speaking with Mark Yusko today as he"s recently back from a trip there, however the conversation went long on other topics and so that"ll have to wait for another day. Maybe I"ll hit record and publish it as a podcast, which could be fun.

Instead, today I thought to bring you my buddy Kuppy"s (Harris Kupperman) take on Mexico because it"s a topic we"ve discussed quite a bit. And since Kuppy is a great stock picker (and I"m more of a macro guy), I thought I"d share with you his thoughts on how best to play the Mexico on sale story.

Enjoy!

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I am writing to you from Santiago de Queretaro, Mexico, where the whole country is having a yuuuuge Donald Trump victory sale. Mexico is one of my favorite countries to visit. It combines a laid back attitude, friendly people and an outstanding culinary tradition.

It also helps that it’s currently one of the cheapest places on the planet—one of many reasons that I’ve spent 5 weeks here recently (Yucatan and Central Mexico thus far).

Mexico has always been known as an affordable place with cheap beer and tacos, but the last two years have taken that dynamic to an extreme.

Where else is the brand new AC Marriott $42 per night? In touristy San Miguel de Allende, we booked a 2,500 foot, 2 bedroom suite on the main square for $75 a night. Food for two with a bottle of mezcal is about $30 at the most posh of restaurants.

It’s verging on silly.

Between the two thirds decline in the Mexican Peso over the past two years and an over-dramatized fear of violence, the tourist economy is basically running on free. They’re just happy to see you and thankfully, my Mexican fiancé can translate my pathetic gringo Spanish as we travel around.  

5-year peso chart: 2/3 of the value is gone in just the last 2 years

If you don’t have a trip planned to Mexico, get working on it. I don’t think it will stay this cheap for long.

Let’s start with the obvious question—is it dangerous?

I tend to like statistics as opposed to jaundiced media reporting. The USA has a 4.5 per 100,000 homicide rate. Mexico is pushing 20, or about four times as bad. Given that I’m not terribly scared in America, four times worse doesn’t seem that bad.

When you dig into the numbers, you realize that much of this crime is drug related. In fact, if you aren’t involved in narco-trafficking, the homicide rate isn’t much worse than that of the USA.

Furthermore, most of the violence seems clustered in a few cities and states. I wouldn’t go to Baltimore or East St. Louis on vacation, why go to the Mexican version? Strip that all out and Mexico is on par with most of America.

Unfortunately, a few dramatic incidents have cost Mexico millions of visitors a year. Eventually, perceptions will adjust to reality and the tourists will flock back—especially given how affordable it is.

I have now taken two trips to Mexico during the past 10 weeks. The whole time, I’ve kept asking myself, “How do you play this?” It’s so cheap.

Despite threats of change from Trump, I know this is an overreaction. Mexico is sure to bounce back and keep growing--though, the economy may shift slightly from manufacturing towards tourism due to how cheap it is to visit.

The thing is, just because something is cheap, that doesn’t mean there’s always a “play.”

There’s an old adage in finance that you don’t buy the currency of Spanish speaking countries. Pull up a 10-year chart of any of these countries and it will be obvious why that adage has weight—pull up a 50-year chart and you won’t even be able to zoom in to where we are today. The peso has overshot recently, but it’s not an asset I want to own.

What about assets benefitting from a weakening currency?

In property, if you can borrow at a reasonable rate in a depreciating currency and get paid rent in US dollars, you’re going to make a fortune. Unfortunately, for most foreign property companies, rents are long-term and struck in depreciating local currencies.

However, the hotel sector is largely immune to this. They can adjust their room rates daily.

Fibra Hotel (FIHO12: Mexico) and Fibra Inn (FINN13: Mexico) have both borrowed in Mexican pesos. Right now, the rates they’re receiving are silly. Look up some of their hotels on the internet: $20 here, $30 there.

This is because there is a lag in how fast they can re-price room rates to take advantage of the decline in the peso—especially as many of their customers are business travelers with budgets in pesos.

However, their costs are mostly fixed, the assets were built with pre-depreciated currency—they’re now worth much more in current pesos than it cost to build them. The supply of new hotels will slow as it costs much more in current pesos to build new ones—all the old ones have a massive competitive advantage until room rates fully reset.

Meanwhile, due to Trump’s victory and the decline in the peso, Mexican hotel REITs are being priced like something awful is about to happen—instead, a weaker peso is a huge boon to them.

In terms of valuations, I don’t think annualizing current quarter cash flow is the correct measure to look at—as room rates in Mexican pesos will likely rise in future quarters.

That said, they trade at about ten times pro-forma AFFO and pay pro-forma Q4 dividends around 9% adjusted for stabilization of new assets. That’s very cheap for a property company with minimal leverage. With mostly fixed costs, I can model these companies to be trading for more like 6 to 8 times AFFO looking forward a year—due to a normalization of hotel rates on a fixed cost structure.

A more typical measure of valuation in the hotel industry is price per room. Adjusting debt for rooms still under construction, these companies trade at enterprise values of around $30,000 to $35,000 a room, while comparable rooms cost at least twice that to construct in Mexico. This would imply that they trade for less than half of replacement cost.

Interestingly, the Mexican hotel market is much more fractured than the US market. As the market consolidates, there are lots of hotels that can be purchased for 10 cap rates—even before economies of scale at a larger REIT increase the returns.

Given the low leverage at both of these companies and how cheap debt is, there is likely to be continued growth as these companies take advantage of distressed players and make highly accretive acquisitions.

Fibra Inn priced in US dollars since the IPO

Fibra Hotel priced in US dollars since the IPO

In summary, I have started small positions in each—I’m looking for further declines before I really add size.

Deep down, I don’t think they’ve bottomed yet. However, they’re very cheap based on almost any metric you can use. They have growth pathways and the re-adjustment of room rates over the next few quarters should flow through the cash flow statements.

Meanwhile, due to dividends, you’re paid well to wait. No one ever gets the exact bottom and Mexico is stunningly cheap, incredibly close for Americans and I expect that travel will increase as a result.

Over the next few quarters, one of two things will happen—either Trump and Mexico will reach an acceptable solution on trade where the currency recovers and average daily room rates reflect something closer to historical rental rates in Mexico when priced in US dollars or the cheapness of the country drives more tourists and occupancy increases, while room rates are re-priced closer to previous dollar rates.

Either way, I see RevPAR in US dollar equivalents increasing dramatically over the next few quarters.

In any case, I’m celebrating Trump’s victory with cheap cerveza, a cheap hotel room and two very undervalued REITs. I continue to seek out other opportunities in Mexico (stay tuned).

Disclosure: Long FINN13 and FIHO12

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That"s it for today folks. Have a great week!

- Chris

"Mexico"s making a fortune off the United States." — Donald Trump

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VeTeRaN'S DaY 2016...

Today is veteran"s day.

Following Tuesday"s election result, I received a thank you email from, Ray Jason, a regular Zero Hedge reader who blogs under the nom de plume, the Sea Gypsy Philosopher.

He is also a Vietnam veteran.

Ray said a few very nice things and mentioned that he had written a post on Phan Thi Kim Phuc the "Napalm Girl" for which she later thanked him.

Many of you will recall my Napalm Girl mashup with the Droner in Chief blowing up in the background. 

Naturally, this drew my immediate attention and I read the post. Although he wrote it three years ago when Obongo and the Neocon circus started banging on the Syria war drums like on MTV, it remains timely.

Timely because our newly minted President elect has held out the promise of exiling the Neocon war mongerers.

We mustn"t let him forget that many of us were initially attracted by this among other good reasons.

And we sure as hell should be asking why that Necon jackass John Bolton"s name has been showing up in reports of potential candidates for UN representative!

I asked if I could share Ray"s post here on Veteran"s Day and he was kind enough to consent. So here it is.

Thank you Ray.

And a Banzai7 hat tip to all you veterans out there, including you Dad.  

by Ray Jason 

The Sea was mild and soothing as I sailed alone in the western reaches of the Caribbean.  It had been four days since my last human contact.  Such exile does not disturb me - it comforts me.  The wind was light, and the waves were small and melodious - like the cello phrase in a string quartet.

          Although quite relaxed, I was also vigilant, because my position was near the busy shipping lanes between the Panama Canal and the Yucatan Channel.  Suddenly, I sensed a nearby hazard.  My first scan of the horizon revealed nothing.  On my second, more careful sweep, I saw her – a gray smudge of a ship, still half below the undulating cusp of the Earth.  I took my binoculars from their rack and focused them.  What I saw slammed me backwards - both physically and emotionally.   She was one of them – a gray, military transport vessel that was all too familiar to me.  I had served aboard one - a U.S. Navy ammunition ship in Vietnam.

 
          

                                    *******

I had not willingly done so.  I had been drafted just after receiving my bachelor’s degree.  My first decision was whether to flee to Canada, as my courageous college roommate had done, or to let them take me.  My next choice was between a two year Army enlistment or the four-year Navy sentence.  Wishing to neither kill nor be killed because of anyone’s insipid “domino theory,” I chose the USN.  As someone who survived higher education with my capacity for critical thinking still intact, I already knew that war was horrible and this particular one was senseless and despicable.  I was not an ideal recruit.

          The toughest part of my service was being a closet pacifist aboard a ship full of gung-ho, pseudo-warriors.  And these were the worst kind - the swaggering, macho types, who had the luxury of never facing any real combat.  I kept my secret to myself, just as I kept my self to myself.  In fact, I do not have a single friend from that chapter of my life.  When I would go ashore and meet actual soldiers, they were not gung-ho at all.  They were beaten down and regretful and frightened - and wanted only to be away from there…to be home…to be far from all that madness.

          I never talk about this with my friends.  And it rarely enters my consciousness.  But that dark ship on the horizon, transporting munitions and mutilation to who knows which target this time, just staggered me.  To ease my anguish, I tried the comfort of my favorite classical music.  It didn’t work, and neither did dousing myself with buckets of sea water.  Although I resisted, I knew that the only way out of my agony was to burrow deeper into it.  

          

                                   *******

So I brought out her picture.  I keep it protected in an envelope hidden in one of my favorite books.  I unfolded it tenderly, and gazed one more time at all the evil, meaningless terror of war captured in a single frozen instant from 40 years ago.  I spoke to her once more as I had done many other times down the decades, when I needed solace: 

“Hello again, Napalm Girl.  Keep on running!  There must be some place, somewhere, free from this horror and insanity.  You must find that place.  You deserve that place.  Never stop running!!!”

          She is crying out, “Too hot!  Too hot!” as she flees.  Grotesque flaming jelly from the sky has burned most of the little dress from her nine year old body.  The rest she ripped off herself as she kept running and screaming “I’m dying!  I’m dying!”  

When the heroic photographer got to her, she was whimpering, “Water, water.”  He emptied his canteen on her.  With ferocious determination, through insane traffic, he managed to get her to a hospital in Saigon.  They said she was so badly burned that she would never live and they would not accept her.  He flashed his Associated Press photo credentials and said, “Don’t let this child die or everyone will hear about it!”  They took her in.  And they saved her.  

That Vietnamese photographer, Nick Ut, deeply understood the ravages of war.  His older brother, who was his personal hero, had already died photographing the misery of combat.  When Nick answered the call of basic human decency, and rescued that terrified little girl, he had no idea that on the film in his camera was one of the most profound and powerful photographs of all time.  He was only 19 years old.

Even though the immortal Napalm Girl picture touches me in my core being, it is the one with her mother sitting beside her in the hospital that truly haunts me.  The woman’s quiet dignity as she comforts her innocent frightened child overwhelms me.  In her noble, image, I can see what an almost unbearable burden but blessing it is to be a Woman, and to be a Mother, in this world of torment.  And it sickens me to realize that it is almost always men that cause this needless anguish.

Decades later, I can still imagine their likely conversation as the child asks the mother, “What was that horrible fire that fell from the sky?”  

And the mom might reply, “It was some terrible new weapon - like a bomb, but different.”  

“But why did they drop it on us?” asks the little girl.  “We were just children and old people hiding in the temple from the planes.  We didn’t hurt anybody!”

My guess is that the heroic mother, overwhelmed with grief by the sight of her incinerated child, might have said something like this.  “I do not know the answer, my beautiful daughter.  But I do know that you survived this horrible thing, and your pain will go away and you will heal.  And someday, life will be sweet and sensible again.  Now, try to go to sleep, and when you awake, I will be right here beside you.”              

                               *******

Kim with one of her children.

The dark gray death ship passed a few miles ahead of me, and has now disappeared beyond the horizon.  But even though it is no longer visible, its malignancy still torments me.  I stare again at little Kim’s photo in my hands, and ask myself, “How can I best honor her suffering?”  And then I realize that what makes her pain-wracked image so universal and so immortal is that it lays bare the true nature of war.  And that the best way to repay my gratitude, is to use my power as a writer, to further expose this loathsome evil.  

                              *******

Tragically, as I type these words, the war drums are beating again.  The Deceiver-in-Chief has scheduled a national address in which he will knowingly lie about the need for this latest “regrettable but necessary action.”  Then the commentators will babble on about “sufficient justification” and “reprisals” and “surgical strikes.  But they will never discuss what war actually is.  And that is because, at its core, it is sick and perverted and senseless.  

If someone invades your home and threatens your family, it is your right and your responsibility to protect them, even if it necessitates violence.  This type of personal duty is decent, courageous and just.  But war is the killing of human beings with whom we have no personal grievance.  War is Mass Psychotic Hypnosis.  But it is never initiated by ordinary people. One morning at breakfast, a million Norwegians do not spontaneously decide that it would be a good idea to invade Ireland that afternoon.  

No, this type of insanity can only be seeded and nurtured by certifiable sociopaths.  Unfortunately, we don’t call them lunatics, and banish them to asylums.  Instead we anoint them as political and religious leaders.  These diseased power addicts use cold-blooded manipulation to convince enormous groups of people that other groups of people are their enemies…and so they must go forth…and annihilate them.    

Nick and Kim at the Vietnam Vets Memorial

.

Here is another truth about war that the self-righteous, talking heads deliberately avoid.  Those who make the wars never have to fight the wars.  The Great Deciders will never be in a night ambush, where the fear is so overpowering that their bodily control abandons them, and they shit themselves.  And the defense contractors, engorged on obscene profits, will never have to kick open a mud hut door after strafing it with automatic weapons fire, and discover a heap of dead children beneath a wounded mother, who is so traumatized that she cannot even scream.  And the media tycoons cheerleading for more carnage, will never rush to the flag-draped coffin of a dead son or daughter and wrap themselves around it in fury as the military band tries to sound heroic.

And here is yet another profound truth that the acceptable, credentialed pundits never state:  War doesn’t work!  It never makes the world a better place.  For thousands of years, humanity has waged hundreds of wars, but they never achieve their supposedly noble ideals.  They never “end all wars” or “bring everlasting peace” or “insure self-determination” or any of the dozen other excuses that are used to incite people to massacre one another.  What it does succeed at doing is bringing misery, murder, mutilation and madness to ordinary, decent people.   

So listen carefully as the highly paid military and political analysts parade across your television screens, proclaiming the need for this latest “kinetic action.”  Observe how these shrewd distorters evade the three paramount characteristics of war that I have just discussed.  None of them will address what war really is.  Nor will they mention that those who benefit from war do not suffer its horrors.  And finally, they will not admit that war never brings good into the world and is actually a plague that sickens the human project.

                              *******

                   

Recognizing that war is Mass Psychotic Hypnosis, how do we overcome those who mesmerize us?   How do we break free from their spell?  Certainly our liberation will not come from those at the top.  War rewards them too handsomely.  

We must rely on our numbers.  We are many, they are few.  When the chant from the anti-Vietnam protests, “Hell, no…we won’t go!” became a reality and not just a slogan, the war machine sputtered and died.  Refusal is our best strategy.  We must refuse to serve in their militaries or in their terror cells.  We must refuse to resolve disputes through violence.  And if they incarcerate us for our resistance, that is a better fate than killing someone who is not an enemy.  And when enough of us refuse, their prisons are not large enough to hold us.  

I am perfectly mindful that such thinking is idealistic and foolhardy, but perhaps it will inspire others to come forth with better options for ending war.  Yet, even if such ideals are useless, we must try - if for no other reason than to honor Kim Phuc, the Napalm Girl.  We must sculpt a world where an innocent little girl does not have to race down a road with the flesh peeling off her body, trying to outrun her own death! 

I urge you to visit www.kimfoundation.com.  Dedicated to helping other children who are victims of war.

Almost every day something utterly insipid "goes viral" on the World Wide Web.  Perhaps we can help spread this little essay at this critical time when the war drums are again thundering Inside the Beltway.  By doing so, we can all honor the Napalm Girl.