UBS: Earnings Momentum in Mexican Equities

Earnings momentum is a key factor for successful investment in Latin American stocks. A portfolio that rebalances monthly via buying stocks with revised earnings estimates outperformed those stocks in the bottom half of this earnings revision criteria over various periods in the past.

How effective is earnings momentum as an investment approach?

Leveraging on the work of our UBS quant team, we show how earnings momentum is a key factor for successful investment in Latin American stocks. A portfolio that rebalances monthly via buying stocks that are seeing revisions in upward earnings estimates outperformed by 5% in the last 6 months, by 15% in the last one year, and by 27% in the last 3 years (see Fig 4, 5 & 6) those stocks in the bottom half of this earnings revision criteria. We expect this trend to continue. Hence, we present here a full list of Mexican stocks that are seeing UBS and consensus earnings revisions move higher, and also highlight how much of these revisions might already be priced in their recent stock performance.

How can we anticipate which stocks will see estimate revisions?

We first calculated the contribution of first quarter Sales, EBITDA and net income to the full year results in last 5 years (2012-16) for all the Mexican companies. Then we ran the same exercise to calculate companies' reported 1Q17 results as a % of full year 2017 estimated results. The difference between the 1Q17 contribution and the average of last 5 years is defined as the "spread". The higher the spread for any particular company, the higher is the likelihood of its 2017 earnings estimates getting revised up. We provide full list of spreads of revenue, EBITDA and net income in Figure 1, 2 and 3, respectively.

Who are the winners and losers based on this methodology?

Based on this methodology, OHL Mexico appears to be a clear winner on all three fronts - revenues, EBITDA and earnings. Apart from this, we would expect positive sales estimates revision for Genomma, Mexichem and all Mexican airports (OMA, GAP and ASUR), while potentially reduction in sales estimates for Penoles, Arca-Contal and Pinfra. In terms of EBITDA, there seems to be clear upside to consensus estimates for Coca-Cola FEMSA and for FEMSA, while downside risk to estimates for Penoles, Lala, Kimber and Bimbo. Lastly, in terms of earnings, we see material upside potential to '17 consensus estimates for Coca-Cola FEMSA, Inbursa and GAP, while downside estimate risk for Bimbo, Lala and Liverpool.

Mexico's 1Q17 results came better than expected; time to buy overall market?

We do not recommend buying the overall Mexican equity market and continue to recommend Brazil instead. Here's why: Mexican companies delivered a robust median increase of 17%YoY, +16%, and +22% in revenues, EBITDA, and earnings, respectively during 1Q17. For a detailed review per company please see Figs 8, 9 & 10. Earnings came much better than expected in Utilities (Ienova), Telecom (America Movil) and Materials (Cemex and Penoles), and disappointed in the Discretionary sector (Liverpool and Nemak). But even if we see earnings estimates for the overall Mexican market move up, we don't expect these revisions will impact 2018 estimates (+14%YoY) in a material way. Additionally, despite the 1Q17 earnings beat, Mexico's ROE has been trending down from ~16% in '11 to its current 13% LTM-1Q17. During those years (2011 to date) Mexico's equity market rerated from 13x to 18x forward PE. Essentially the market has ignored that the cost of debt locally has risen by over ~300bps in the last 12 months. We thus expect Mexican equities to de-rate from their current 18.2x '17e P/E. Especially as we see with caution some key variables for the overall economy such as credit slowing down in the second half of the year. At that time we would expect news coming out of Brazil to become increasingly more positive. We shall see. Our preferred names: Banorte, GMexico, Terrafina.

You will find the whole research paper here.

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