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Stock Strategist

Latin America Going Strong

We sift out the region's gems.

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At Morningstar, we're always on the lookout for quality businesses that are priced cheaply. Latin America is home to several of the former, but, after years of double-digit market returns, does it offer any of the latter?

The pickings are slim, but we still see value. In this article we'll highlight two companies that not only possess attractive economics, but also are priced at bargain levels. The first is a monopolistic airport operator, and the second, a world-class cement producer. Not coincidentally, both are based in Mexico's dynamic business capital, Monterrey.

We'll also suggest three candidates for your radar screen: an iron-ore giant, a cutting-edge aerospace manufacturer, and a U.S. utility with an extensive regional presence. All three are heavily weighted to Brazil, a country which we profiled in a recent Stock Strategist article and which has now garnered prized investment grade status. This vote of confidence blew even more wind into local equities' sails, and at today's prices we're inclined to hold off with these three. But when the next buying opportunity comes knocking, we'll be ready.

A Five-Star Bargain

 Grupo Aeroportuario del Centro Norte (OMAB)
Two trends in Mexico--rising personal incomes and the emergence of low-cost carriers--have fostered a fundamental shift from bus to air travel. This bodes well for Grupo Aeroportuario del Centro Norte (OMA), each of whose 13 airports has essentially a local monopoly.

Greater passenger traffic means more parking fees, retail royalties, and other unregulated sales at OMA's airports. And because of the firm's mostly fixed-cost structure, each incremental peso boosts profits more than the last. Indeed, OMA's operating margins have widened by more than 10 percentage points in the last three years. As the firm's revenue mix continues to evolve toward unregulated sales, we think the margins will widen further.

A number of macro events, including hurricanes and a softening Mexican economy, could set OMA back. Still, we think the company's entrenched position and long-term growth opportunities more than compensate for these uncertainties.

A Four-Star Pick to Watch

 Cemex (CX)
Mexican cement maker Cemex profits from the cost disparity between its operations and those of its less proficient peers. It also leverages its role as a major cement trader, filling incremental demand in places where supply is tight. These operational advantages, together with brand power in its core Mexican market, produce prolific margins and cash flows at Cemex. Steady cash flows, in turn, allow the firm to obtain cheap financing with which to acquire competitors. Through this strategy, Cemex has evolved from a small domestic player into a global powerhouse, further enhancing its scale advantage.

Despite today's housing market head winds, the firm's profitability has held up well. And once the housing bloodbath subsides, we think Cemex's competitive advantages will prove more lucrative than ever.

Three Firms for Your Radar

 Vale (RIO)
Surging global demand for iron ore, the main component in steel, spells opportunity for Vale. As the world's largest iron ore supplier, Vale wields considerable bargaining power. The company's clout was evidenced recently when management negotiated a 65% price increase with customers in China. Vale's top-line strength, together with its low-cost, Brazil-based operations, support phenomenal operating margins by commodity producer standards.

Going forward, we think Vale's greatest challenge will be managing industry cyclicality. Although pricing power and operational advantages should provide a downside cushion, a prolonged slump could slice Vale's margins and stall its ambitious expansion program. Risks aside, we consider Vale an excellent vehicle for investors seeking to stake a claim on global economic growth.

 Embraer (ERJ)
We think low-cost jet maker Embraer has a leg up over its one serious rival, Bombardier. Demand for regional jets is trending toward larger aircraft. As Bombardier races to bring larger models on line, we expect Embraer will capture incremental share with its market-ready planes, some of which seat up to 118 passengers. Meanwhile, high barriers to entry should keep prospective market entrants in the hangar.

Although Embraer's maintenance and repair business should help take the sting out of a cyclical downturn in aerospace markets, the firm's bread and butter will remain new aircraft orders. Still, we're confident in Embraer's long-term staying power and profitability, and at the right price we think it would make an attractive holding for internationally minded investors.

 AES (AES)
Whereas demand for power in the U.S. is expanding at 1% a year, in Latin America it's skipping along at 5 times that rate. Latin American consumers of electricity are not only rising in number, they're increasing their individual usage. As income levels rise, people are buying more power-thirsty home appliances. Given the huge disparity in per-capita power consumption between Latin America and more developed markets, we think the revenue runway is long.

As a utility that derives more than half its revenues in the region, we view AES as well-poised to benefit from this growth. The firm's largest presence is in Brazil, but it also operates in eight other Latin American markets, with operations in both generation and distribution.

Just as AES enjoys Latin America's higher-growth prospects, it also carries some of its uncertainties. Regulatory risk is the greatest threat, in our view. The firm's essential-service nature could make it a target for lower allowed returns or, in some markets, even nationalization. But for risk-tolerant investors, we think this global powerhouse holds excellent potential.

Ryan McLean does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.