Nick: Hello, everybody. This is Nick Robinson from abrdn and you're listening to the Emerging Markets Equity podcast, the show that explores the factors that underpin our thinking on emerging markets. We ask our expert guests the big questions from key individuals to evolving trends, all with the goal to identify and profit from opportunities in the region. Last month on this podcast, we discussed the developing trend of nearshoring. And its broad impact on the companies and economies of emerging markets. One place that we kept returning to as a beneficiary of the trend was Mexico. And it happens with two of my colleagues have just returned from an investment trip there. So today, we're going to drill down a bit and focus it on the nearshoring specifically in Mexico, and what the view on the ground is. The two colleagues joining me today are Eduardo Figueiredo, and Tiago Rodrigues from our Sao Paulo office. Edu has been with the firm about 12 years and he runs the office in Brazil, and also leads on our Latin American strategy. Tiago has been with us for about 10 years. And he runs for Latin funds alongside Eduardo, as well as being our expert on commodities companies. So, they're both extremely well placed to talk about what's going on in Mexico. It's great to have you both on welcome to the podcast, Tiago and welcome back, Edu.

Eduardo: Thank you. Thanks. Thanks for having me, Nick.

Tiago: Thanks, Nick. It's great to be on the podcast.

Nick: Eduardo, let's, let's kick off with you. Firstly, I'm very keen to know how the trip was. And then what can you also tell us about nearshoring and Mexico? And I suppose the question is, could this be the start of the next big investment cycle in Mexico? Or is there a risk for expectations are getting a bit ahead of where reality is today?

Eduardo: Sure. Well, it was a great trip. Good to be back into travelling. I haven't been in Mexico for some time. So, we met over 20 companies during the week visiting from Mexico City to Monterrey. So good sample of companies. And it was good to have my colleague Thiago with me, which proved to be who proved to be an expert in Mexican cuisine as well. So that added to, to the joys of the trip. Well, I guess, you know, being down in Mexico was good to check I think what we've been hearing from the outside at least. And I think Mexico is one of these places that being there, in person speaking to companies is also great for the engagement and the and the efforts to get closer to the companies. Well, nearshoring is a trending topic, as you know, that's visible if you look at Google trends, for example, that that the questions around nearshoring stack up as speaking up, particularly last year, and this came up in every meeting, I guess, you know, when we were there. I guess our job was really to try and separate what is a interesting narrative, or even a marketing tagline by some companies and what's reality. And you know, after the trip, I think the takeaway is probably that what we are seeing right now is really Mexico enjoying the benefits of its proximity to the US. And the implementation of the of the US MCA agreement or the renewed NAFTA agreement, where we see industries across the board that are already established in Mexico, adding capacity to meet a very strong demand in the US this is visible, for example, if you look at the FDI numbers, which were very good recently, but when you go granular into the data, you see that the majority of it for now, is really related to investments or retention of earnings from existing operation. So, I mean, those who are positive on the topic or more bullish on the topic are pointing to the anecdotal evidences, such as cases of Asian companies coming to Mexico to look into locations and real estate opportunities for new facilities and so on. However, the sceptical camp and few people we spoke to also argue that the recent winds are perhaps a bit more cyclical, coming from a strong demand in the US, and they may fade as the American economy has slowed down, while sort of the structural benefits of the so called nearshoring, which you, you and Gabriel covered extensively in the last podcast. They may take some time, and they also rely on tackling issues like infrastructure, and energy and all the structural issues that Mexico still faces. So answering your question now directly. If this is an overhype, or the start of a more prolonged cycle, I think the comfortable answer is to say, we don't know yet. And what will probably define if this is a longer cycle is if Mexico is able to tackle those structural bottlenecks and how we will be the policies from a new government, which is expected to be elected in 2024. But I guess the key is that you probably don't need to take that view right now, as we see several companies benefiting of those statements already. And we think that when we look into the assumptions, or the even the expectations, this is not being fully incorporated yet, into the numbers we see. So should the positive narrative stand, it feels like it is could still be an optionality or an upside for investors to benefit from.

Nick: Thanks, Eduardo. And I suppose Tiago bringing you in, and your impressions from the trip. What do you think the main things for companies were saying? And I suppose any particular real-life examples you can point to in terms of new investments being made as a result of this? And also, which parts of the market are most likely to benefit? Or do you see the benefits at the moment.

Tiago: So Nick I can say that there was a great excitement from companies of all sectors with the opportunity set that could arise from nearshoring. And speaking to the companies locally, I would split them into two different groups. The first group is the group of companies that are very clear beneficiaries of higher FDI in the country. And the second group are the companies that will indirectly benefit from a generally stronger Mexican economy. In the first group of direct beneficiaries, we are starting to see some anecdotal evidence of what could be a structural shift in the their growth outlook. And I think a good example here that Gabriel covered in the last podcast, and that I do just mentioned, is the industrial property sector, where we met companies who were reporting very strong demand for industrial space, coming from new tenants looking to expand their operations into Mexico. And this is, according to these companies. This is resulting in a very tight property market, particularly in the northern states of Mexico, which is supporting new growth opportunities for developers and also pushing rents higher. So, think that it was interesting to hear anecdotes and stories of Asian companies going into Mexico to meet with the executives of these companies. And they were keen to understand all things Mexico related because they were considering bringing their operations to the country and to increase investments in this in manufacturing capacity there. On the on the group of indirect beneficiaries that I mentioned, I would say there is a growing optimism from all companies and these are generally the companies that are starting to create more positive expectations that higher investments and more dynamic economic growth in Mexico will lead to higher employment, better disposable income, and consequently, higher consumption. And I think an example here is the consumer sector and Mexico. The Mexican equities index is heavy, weighted towards some of the consumer names, and the companies we met there, they would not be naturally tagged as beneficiaries of such trends. But companies are actually seen right now a relatively resilient consumer environment. And they believe that a stronger economy, an economy that that that grows at above average levels, could support better consumption environment for longer. So, I think to wrap up and go back to the comments from Eduardo, I think the consensus view is certainly positive. But the materiality of the impact is still hard to assess. And there are more sceptical views in the market, which suggests that maybe what we are seeing that the early signs that we are seeing are not yet the effects of nearshoring and are simply natural correlation with a stronger investment cycle in the in the US, I guess. Only time will tell. But it's it should be quite supportive.

Nick: Thanks, Tiago. Yeah, I mean, it's certainly sounds very interesting that companies are talking about this and are very excited about this. And I suppose there's a bit of supporting evidence coming through, like you say, in terms of FDI data and plenty of anecdotes. But the time is time is likely to tell I suppose. Bringing on to Eduardo in Tiago mentions these indirect beneficiaries of nearshoring. And I suppose one group in the market that's quite a large part of the Mexican market would be the Mexican financial stocks as potential indirect beneficiaries. I'm sure you saw a few Mexican financial stocks while you were in Mexico. So, what's been the message from them specifically, in terms of how nearshoring could benefits?

Eduardo: Yeah, that's true. We saw quite a few of the large banks in Mexico and some of them expose it directly to the northern region. So, I think we got some, some insights into that. And I think most banks we spoke, they are believers on the nearshoring benefits. But I guess due to the difference in positioning or geographical presence, that the level of enthusiasm or even the, the description on how they will benefit differs a little bit. So, at the macro level, I guess most would agree that the recent trends coupled with initial signs of what would be a more prolonged investment cycle, enough to maybe cushion Mexico from a US slowdown, when we challenge banks of their outlook for growth, in light of market forecasts of a US recession around the corner, for example, most pointed to the resiliency of the Mexican economy, with nearshoring itself and the strength in manufacturing, being a question this time around when comparing to toward the cycles of slowdown now. I guess, if you speak to a bank in the north, and we spoke to one bank in particular who is focused on SME segment, and I think that that's a case where they would probably point to, perhaps a more direct benefit from being exposed to the northern region more directly, and also exposed to the supply chain, in a way via the small and medium sized businesses that that will benefit from, from a growing manufacturing base into those regions. And but the interesting bit that that's not something new for them, because if you look around over the past five to 10 years, even within the northern region, we have seen a stronger growth in that region already, precisely because Mexico, due to the, you know, the expansion of NAFTA agreement, and now more recently with the renewal of the agreement with the US MCA framework, that Mexico was already enjoying that status or that nearshoring trend, if you can, if you want to call it so. I think we did see some of the larger banks, for example, willing to move into those regions like hiring managers, there were some big announcements made by a leading bank of expanding their presence into the north. So, I guess, in one way or the other, regardless of how they describe, I think most are adding to the exposure or at least preparing to the growth that that is likely to come from the region.

Nick: Thanks. Yeah, I mean, certainly It's interesting, I think when one of the trends that we talked about for a number of years has just been the cost differential of manufacturing in Mexico, particularly versus Asia and China, and how Mexico has become a lot more competitive. And I suppose, you know, the fact that the north appears to be doing so much better than the south of Mexico at the moment in terms of economies is testament to that lower potential costs of manufacturing that you get, because of the just the fact it's closer to the US and there's less, less cost in terms of moving stuff around. I suppose Tiago, switching onto you, thinking about some of the other risks associated with the nearshoring I mean nearshoring in emerging markets often means companies gain access to, to lower cost workers, like in the case of Mexico versus China. But you get at that expense, you get other risks, like the politics or currency. And AMLO, the president of Mexico has been a bit more populist of late. So, do you see politics as becoming more of a significant risk to the Mexico story?

Sure, well, the politics were a secondary topic during the meetings we had during the trip. And that was, despite a lot of headline noise. From AMLO while we were there, and the fact that we are approaching the 2024 presidential elections in the country. That said, I think you're right in highlighting the there certainly risks on the political front. The general view, while we were there, is that AMLO will attempt to deliver on his campaign promises, especially ahead of the next presidential elections, and he will do everything to support his party, more than which is yet to decide on its new presidential candidate. So, expect a noisier political environment starting now in the in the second half of 2023, which could bring risks to some regulated sectors and market perception in general I would say. One thing that that I can say, though, is we have been we have been seen growing noise on regulatory aspects and potential regulatory changes, involving government contracts and concessions. But I think that one comfort that investors can have is that Mexican institutions have been working pretty well, particularly the supreme court have acted in support of checks and balances and have prevented unorthodox reforms from having a strong effect on critical sectors of the Mexican economy. And I think one good example here was the great dilution in the in the bill that was proposed to revamp the mining law in the country. The discussion started with a very draconian draft, but this was later diluted in congress due to strong pushback on many unconstitutional in an economical amendments that this initial draft was trying to implement. So I think in the end, the new mining law will have a limited impact on existing mining operations. Although slightly changing rules around concession length and renewal. So, I think the point here is that there is noise, but the institutions have been working pretty well to prevent the worst.

Nick: So, to follow up on that Tiago. Suppose, one thing companies would be concerned about if when investing in Mexico is risk of nationalization. And we have seen some nationalization recently controversially, I think there was a section of railway that Grupo Mexico owned that they had to recently hand over to the state. So, would you be concerned about that or you think it's just a one off?

Tiago: Yeah, Nick, I think this is a good point. I believe there's certainly ideological component at play here. And most controversial policies and actions implemented by AMLO’s administration, they are examples of how the ideological agenda plays here. But I think that it's worth taking a step back. And in analysing some of the setbacks that we've seen in Mexico's market openness, since he took office, I think the most significant change was certainly the reversal of a pro market energy reform implemented by the previous administration. And this resulted in policies favouring by increasing investments from the state owned Pemex and CFE. We also saw measures where ideology plays a strong role, including the recent nationalization of lithium deposits, the cancellation of Mexico City's new airport concession, and during the trip when we even discussed recent talks about Mexico reviving its airline, and what the impacts that could have in the in the air travel sector. Think of all these actions they have been noisy and controversial. And they certainly raise questions about the attractiveness of investing in Mexico from a risk point of view, especially in more regulated sectors. Still, I think that in most cases, the Mexican government manage to respect contracts and manage to reimburse affected bodies and these actions and the relatively fair terms. And the case you raised on Grupo Mexico is a good example of the latter. The way the state announced its intention to take over a very small section of the company's railway was rather hostile. That said, after all the noise, the government negotiated a very compelling compensation proposal for a group of Mexico and offered a long concession extension in exchange for a railway which accounted for only 1% of the group's transportation business. Another example of controversial nationalization if you will, was the acquisition of a Iberdrola renewable assets by the CFE. At first the news framed the government as attempting to expropriate private assets. But in the end, the CFE ended up acquiring these plans for a very generous valuation of $6 billion. So, I think what I'm trying to say here is that Mexican politics are noisy and the way policies have been implemented under this administration certainly raised the risk perception of doing business in the country. That said, so far, the country has avoided the worst and have respected private property one way or the other. And I know we'd highlight that as I said previously, going forward, we should expect a volatile and noisy news flow on the political front as we approach the presidential elections. That said whoever takes office in after the 2024 election will have to deal with challenges in order to support critical private sectors. If the country wants to fully capitalise on the nearshorting opportunities that we are discussing here.

Nick: Well, thanks for that Tiago that definitely provides some comfort. Perhaps, Eduardo, let's maybe finish with a broad question on Mexico and you being based in Brazil, you be extremely familiar take with the leaps taken forward in Brazil in terms of stock market development, and I suppose the perennial question I have is why don't we see this in Mexico? Company’s listed in Mexico still mostly the same companies that were listed there 15 years ago?

Eduardo: Yeah, that's a good question, Nick and something we struggle sometimes to understand ourselves, when you look into the indicators of, let's say capital market penetration, as measured by tickets market cap to GDP, or even number of stocks and so on, and compared to, to peers in other emerging markets, you can see that Mexico is maybe below potential. So, I mean, with these things, there's always an element of supply and demand that maybe helped to explain. You mentioned Brazil and I guess, in Brazil, it's perhaps a bit easier to point, for example, to historical high interest rates, creating a problem of demand for equities, right lower location to equities, at points in time, less developed institutional, investor, base, and so on. And the recent boom that we saw, let's say 2020-21 of IPOs is an evidence of that when you start to see rates moving to single digits for a longer period of time that naturally flows into more companies willing to come to the market and filing for, for an equity insurance. With Mexico, the explanation is a little bit more tricky in that maybe you have historical reasons of why companies, for example, opted to fund its active activities via the debt market, actually, you do have a very active corporate that debt market in Mexico, instead of equities, and many Mexican companies either for being close to the US in some shape or form. By being for example, subsidiaries of foreign companies tap it directly the offshore markets rather than going to the local market, and even rather than going to the local banks. So, others would point on the other hand, for example, the lack of a strong development bank, as you've seen Brazil, and perhaps a still nascent capital market ecosystem, which includes the role of the pension funds in investing to equities, as an explanation for why you haven't seen many companies. So probably, I don't know which, which is the right explanation. But I think worth pointing that even when we look into some of those factors, or maybe those bottlenecks, we are actually seeing a gradual improvement. For example, we have seen attempts to modernise the securities law in Mexico to promote more companies into coming to the market, but also the pension fund reforms that that are expected to drive further increase in AUM for the pension fund industries and therefore bring more allocation to domestic equities as well. So, despite all theories, I guess one of the best answers came from one of the executives we met during the week that he described as ultimately, equity issuance is a result of a need for capital to growth, or an exit route for financial investors. And the fact is, Mexican companies maybe didn't need yet to have that to tap into the equity market, because again, because they either were supported by a strong parent or maybe funding their growth was enough via what they managed, to get into the debt market. So I think we will see this changing when you need when you do see a next cycle of growth. Perhaps this is when Mexico will take a much needed step forward with regards to governance standards as well and practices because, again, why would you do that if you are not desperate to four capital right now.

Nick: Thanks, Edu, so hopefully a brighter future ahead for Mexico, certainly, if the if nearshoring leads to a big investment cycle that brings lots of new companies to market, so that would be a great prospect. Let's cross fingers. So that feels like a good place to drive a podcast to a close. So, thank you, Eduardo and Tiago, for joining today.

Eduardo: Thank you, Nick. Always a pleasure to be here.

Tiago: Thank you, Nick. That's great.

Nick: And thanks, everyone who took the time today to listen in. If you enjoyed today, then please download our other podcasts from our website or wherever you normally get your podcasts. Watch out for our next episode and tune it.

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