The New Mexican Wave……….

Last week Gulabo (Anisha) got married. Many a heart breaks as she had been the queen bee of our group and draws her connection to my B-school fun and frolic. Most of us - married and unmarried, attended the ceremony dressed up in almost our bridal suits. The others however flocked at BnC – on of the City’s oldest pubs, drinking for their ceremonious defeat. Pink fair, “round” and beautiful she came down to me the next day and asked where the couple should go for their Honeymoon. I replied –Mexico, and this is why I persuaded the new couple for the destination…………

When it comes to global manufacturing, Mexico is quickly emerging as the “new” China.

According to corporate consultant AlixPartners, Mexico has leapfrogged China to be ranked as the cheapest country in the world for companies looking to manufacture products for the U.S. market. India is now No. 2, followed by China and then Brazil.

In fact, Mexico’s cost advantages and has become so cheap that even Chinese companies are moving there to capitalize on the trade advantages that come from geographic proximity.

The influx of Chinese manufacturers began early in the decade, as China-based firms in the cellular telephone, television, textile and automobile sectors began to establish maquiladora operations in Mexico. By 2005, there were 20-25 Chinese manufacturers operating in such Mexican states Chihuahua, Tamaulipas and Baja.

The investments were generally small, but the operations had managed to create nearly 4,000 jobs, Enrique Castro Septien, president of the Consejo Nacional de la Industria Maquiladora de Exportacion (CNIME), told the SourceMex news portal in a 2005 interview.

China’s push into Mexico became more concentrated, with China-based automakers Zhongxing Automobile Co., First Automotive Works (in partnership with Mexican retail/media heavyweight Grupo Salinas), Geely Automobile Holdings (PINK: GELYF) and ChangAn Automobile Group Co. Ltd. (the Chinese partner of Ford Motor Co. (NYSE: F) and Suzuki Motor Corp.), all announced plans to place auto making factories in Mexico.

Not all the plans would come to fruition. But Geely’s plan called for a three-phase project that would ultimately involve a $270 million investment and have a total annual capacity of 300,000 vehicles. ChangAn wants to churn out 50,000 vehicles a year. Both companies are taking these steps with the ultimate goal of selling cars to U.S. consumers.

Mexico’s allure as a production site that can serve the U.S. market isn’t limited to China based suitors. U.S. companies are increasingly realizing that Mexico is a better option than China. Analysts are calling it “nearshoring” or “reverse globalization.” But the reality is this: With wages on the rise in China, ongoing worries about whipsaw energy and commodity prices, and a dollar-Yuan relationship that’s destined to get much uglier before it has a chance of improving, manufacturers with an eye on the American market are increasingly realizing that Mexico trumps China in virtually every equation the producers run.

“China was like a recent graduate, hitting the job market for the first time and willing to work for next to nothing,” Mexico-manufacturing consultant German Dominguez told the Christian Science Monitor in an interview last year. But now China is experiencing “the perfect storm … it’s making Mexico – a country that had been the ugly duckling when it came to costs – look a lot better.”

The real eye opener was a 2008 speculative frenzy that sent crude oil prices up to a record level in excess of $147 a barrel – an escalation that caused shipping prices to soar. Suddenly, the labour cost advantage China enjoyed wasn’t enough to overcome the costs of shipping finished goods thousands of miles from Asia to North America. And that reality kick- started the concept of “nearshoring,” concluded an investment research report by Canadian investment bank CIBC World Markets Inc. (NYSE: CM)
“In a world of triple-digit oil prices, distance costs money,” the CIBC research analysts wrote. “And while trade liberalization and technology may have flattened the world, rising transport prices will once again make it rounder.”

Indeed, four factors are at work here the so called - Mexico’s “Fab Four”

• The U.S.-Mexico Connection: There’s no question that China’s role in the post financial- crisis world economy will continue to grow in importance. But contrary to the conventional wisdom, U.S. firms still export three times as much to Mexico as they do to China. Mexico gets 75% of its foreign direct investment from the United States, and sends 85% of its exports back across U.S. borders. As China’s cost and currency advantages dissipate, the fact that the United States and Mexico are right next to one another makes it logical to keep the factories in this hemisphere – if for no other reason that to shorten the supply chain and to hold down shipping costs. This is particularly important for companies like Johnson & Johnson (NYSE: JNJ), Whirlpool Corp. (NYSE: WHR) and even the beleaguered auto parts maker Delphi Corp. (PINK: DPHIQ) which are involved in just-in-time manufacturing that requires parts be delivered only as fast as they are needed.

• The Lost Cost Advantage: A decade or more ago, in any discussion of manufactured product costs, Asia was hands-down the low-cost producer. That’s a given no more. Recent reports – including the analysis by Alix Partners – show that Asia’s production costs are 15% or 20% higher than they were just four years ago. A U.S. Bureau of Labour Statistics report from March reaches the same conclusion. Compensation costs in East Asia – a region that includes China but excludes Japan – rose from 32% of U.S. wages in 2002 to 43% in 2007, the most recent statistics available. And since wages are advancing at a rate of 8% to 9% a year, and many types of taxes are escalating, too, East Asia’s overall costs have no doubt escalated even more in the two years since the BLS figures were reported.

• The Creeping Currency Crisis: For the past few years, U.S. elected officials and corporate executives alike have groused that China keeps its currency artificially low to boost its exports, while also reducing U.S. imports. The U.S. trade deficit with China has soared, growing by $20.2 billion in August alone to reach $143 billion so far this year. The currency debate will be part of the discussion when U.S. President Barack Obama visits China starting tomorrow. Because China’s Yuan has strengthened so much, goods made in China may not be the bargain they once were. Those currency crosscurrents aren’t a problem with the U.S. and Mexico, however. As of Monday, the dollar was down about 15% from its March 2009 high. At the same time, however, the Mexican peso had dropped 20% versus the dollar. So while the Yuan was getting stronger as the dollar got cheaper, the peso was getting even cheaper versus the dollar.

• Trade Alliance Central: Everyone’s familiar with the North American Free Trade Agreement (NAFTA). But not everyone understands the impact that NAFTA has had. It isn’t just window-dressing: Mexico’s trade with the United States and Canada has tripled since NAFTA was enacted in 1994. What’s more, Mexico has 12 free-trade agreements that involve more than 40 countries – more than any other country and enough to cover more than 90% of the country’s foreign trade. Its goods can be exported – duty-free – to the United States, Canada, the European Union, most of Central and Latin America, and to Japan.

In the global scheme of things, what I am telling you here probably won’t be a game-changer when it comes to China. That country is an economic juggernaut and is a market that U.S. investors cannot afford to ignore. Given China’s emerging strength and it’s increasingly dominant financial position, it’s going to have its own consumer markets to service for decades to come.

Two Profit Play Candidates

From a regional standpoint, these developments all show that we’re in the earliest stages of what could be an even-closer Mexican/American relationship – enhancing the existing trade partnership in ways that benefit companies on both sides of the border (even companies that hail from other parts of the world).

In the meantime, we’ll be watching for signs of a resurgent Mexican manufacturing industry that’s ultimately driven by Chinese companies – because we know the American companies doing business with them will enjoy the fruits of their labour.

Since this is an early stage opportunity best for investors capable of stomaching some serious volatility, we’ll be watching for those Mexican companies likely to benefit from the capital that’s being newly deployed in their backyard.

When Gulabo gets back from her lifetime trip, will ensure new findings being added to my Mexican outlook to justify my recommendations. Cheers….

The Asian Grand Prix and the Nano Story

I first met Vishal in a smart little pub sharing the same table over a peg of Vodka. Simple, emotional but yet highly intellectual when it comes to things that are otherwise “World famous in Hyderabad”. Everything gets him excited …. Red wine, Subprime crisis, his recent love – life, erratic Sensex ……. all of them. After almost a year of knowing each other he seemed to impress me with the most envious quality in him – his innocence. I wish he never looses this trait.

Off late he calls me late in the night seeking suggestions on various problems that he loves getting into. I am left with no other option but to oblige him each time, as neither of us strictly remembers when I decided to father him or he decided to be my adopted prodigal. This I write in response to one such conversation with him where in before buying an i10 he wanted to know about the emerging Giants of the World Auto Industry!!

Surprised?? Vishal is full of these.

Back in May I recommended that readers should buy shares in Ford Motor Co. (Wish I had access to them) on the grounds that the U.S. car maker would gain market share from the bankrupt General Motors Corp. and Chrysler Group LLC. Ford’s third-quarter profit and healthy October sales growth show I called that one right. One doesn’t like to blow one’s own trumpet excessively, but if you’d followed my advice in May, you would today be sitting on a profit of nearly 50%. However, while I admire Ford for its brilliant strategic decision not to cave in and accept government-sponsored bankruptcy, and wish it well in its future battles with GM and Chrysler, I’m not sure the company that Henry founded represents the future for the global automobile industry.

More likely – while Chrysler will become a money-pit that is closed only by political means, and GM will limp on as a smaller and marginally profitable U.S. and European producer – Ford will slim down to become a specialty producer of cars tailored to the tastes and needs of the U.S. market. It’s well known that the auto preferences of U.S. consumers differ greatly from those of their European counterparts. It comes down to this: Ford should be able to make money by limiting its “world car” ambitions and focusing on those needs.

Detroit Will Need to Learn from Asia In the world as a whole, the big auto story has been the continued advance of manufacturers from China and India. In China, the cheap-money policy of the People’s Bank of China has helped fuel a continued boom in automobile purchases, to the point that 2009 vehicle sales in China will reach the million mark – making the Asian nation a bigger auto market than the United States. In fact, even if China were to suffer a recession, that market is likely to remain the world’s largest long-term – despite the fact that the U.S. market will recover substantially from its 2009 lows. If China has the world’s largest automobile market, we should be paying attention to trends in Chinese manufacturing, because those guys will now possess economies of scale that in the long run should enable that country’s factories to undercut the cost structures of Western manufacturers. From 10,000 miles away, the most interesting Chinese automobile manufacturer would appear to be Geely Automobile Holdings Ltd.

Geely manufactures automobiles for China’s domestic market. More interesting, it has specialized in “pastiche” reproductions of famous Western brands, which sell at discounted prices to wealthy Chinese. It has several Mercedes-type models, some Ferraris and other Italian sports cars, and a Rolls Royce/Mercedes hybrid. Of course, Geely can only do this because of China’s slowly improving, but-still problematic disregard for intellectual property laws. However, in a world where China is the largest automobile market, it may well be that Geely’s approach to automobile design and manufacture is the wave of the future. Indeed, the ability to manufacture efficiently even in much-shorter production runs may bring this to the U.S. market. One can imagine a business in which the customer could order a product tailor-made to his or her specifications from a catalogue that includes the broadest possible design cornucopia. If, for example, you want a 1924 Hispano-Suiza H6B, you’ll be able to have one. It makes a Hispano-Suiza H6B noise, and probably rides like the original. But it will also have modern safety features, low maintenance costs and a modern, efficient non-polluting engine.

In the immediate term, Geely has submitted a bid of around $2 billion to buy Swedish automaker Volvo from Ford. From Ford’s point of view, this makes sense. Ford sold the luxury brands Jaguar and Land Rover to India’s Tata Motors Ltd last year, having taken the view that high-quality/small-volume automobiles were tough to make money on, and had little synergy with its mainstream business. Selling Volvo would get Ford out of the specialty market altogether, and enable it to concentrate on its core Ford and Lincoln/Mercury brands. The only major impediment appears to be intellectual property: Ford owns a large number of Volvo patents and design specifications and doubtless regards Geely’s insouciant attitude to intellectual property as a threat.

Geely shares trade in the U.S. Pink Sheets, as well as in Hong Kong, and currently trade at about 13 times historic earnings. But the share price has really run up – to the tune of about 800% – during the past year as the company became better-known to Western investors. At current levels, Geely shares are trading at about twice their inflated 2007 peak price, so investors should conduct their own due diligence and approach the stock with due caution. China is not the only source of new competition for the United States’ Detroit and Germany’s Wolfsburg. The Indian market has also been expanding rapidly, although it is still only about one quarter the size of the Chinese market.

Tata Motors appeared well placed in early 2008 in that market. However, its Jaguar/Land Rover purchase – made at roughly the market peak – made the company appear very unstable, indeed. Tata’s other new product venture – the Tata Nano, which is designed to sell for 100,000 rupees (about $2,300), a price that’s roughly 40% lower than rival offerings – also was delayed in September 2008, when Tata had to move its proposed manufacturing facility owing to local opposition. However, Tata’s earnings in the quarter to September more than doubled from the same period in 2008, on only a 13% increase in revenue. Since the company also raised $750 million in convertible bonds during the quarter, the immediate cash flow worries have largely dissipated.
Moreover, the Nano introduction was a great success. Production is expected to ramp up to 250,000 vehicles in 2010-11, and the car is expected to maintain a large price advantage over competitors for at least a couple of years. Losses at Jaguar/Land Rover also are lessening, so Tata looks likely to survive and grow rapidly in the years to come. Like Geely, its shares have run-up sharply in the last few months, but looks like a sound long-term investment. In Europe and the United States, the automobile sector looks mature and not very interesting. In Asia, however, there is true growth ahead. Asia also possesses companies such as Geely and Tata, which are trying innovative strategies to capture that growth. As an investor, I prefer to go where the growth is, even if relative prices are higher and risks more substantial.