Mexico’s resilient banks offer outperformance

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By:
Rob Dwyer
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Expected to ‘de-couple’ from weakening macro; alternative valuation highlights growth potential.

Analysts see value in Mexico’s banks despite the increase in political risk and cuts to macroeconomic growth forecasts since the election of Donald Trump in the US.

A report by UBS’s Latin American financial team, led by Philip Finch, has found that Mexico’s banks could offer the best long-term performance in the region.

Finch’s team compared the size of each Latin American country’s listed and non-listed financial entities to their GDP. The results show that Mexican banks have the cheapest implied valuation (market value-to-GDP ratio) of 10.1%, compared with Brazil’s highest regional valuation of 19.1%.

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Philip Finch, UBS

Finch argues that measuring the implied market value of a country’s banking industry to the size of its GDP enables cross-border comparison of “what the market is pricing in relative to the industry’s structural growth potential”. 

Mexico’s financial industry’s combined valuation is 10.1% (with a 12.6 time 2017 estimated price-to-earnings ratio). Argentina’s financial industry is 10.7% of GDP, Chile’s 12.1%, Colombia’s 13.5%, while Peru and Brazil have the highest implied market value at 19.3% and 19.4% respectively. 

Peru’s high valuation is particularly surprising in view of its relatively low credit penetration, with a loan-to-GDP ratio of just 38%.

Finch says the analysis supports UBS’s overweight stance on Mexican banks (with the top picks being Banorte and Inbursa). However, despite his categorization of his bullish call on Mexican banks as ‘contrarian’, his peers at Credit Suisse also argue that Mexican banks offer potential outperformance despite the weakening outlook for GDP growth

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Marcelo Telles, banking analyst at Credit Suisse in New York, says he expects Mexican banks’ earnings to decouple from the macro trend

Alonso Cervera, Credit Suisse’s Mexico economist, recently slashed his 2017 forecast for Mexican GDP growth to 1.7% from 2.5% due to the negative impact from Trump’s anti-Mexican policies. Cervera expects that the US president’s impact on Mexico will be dramatic and will include lower real wage gains, higher interest rates, lower consumer and business confidence, a tighter fiscal stance and greater risk aversion by commercial banks. 


Inflation expectations

Despite Cervera’s bearish macro call, Telles believes that an increase to interest rates – provoked by the rise in inflation that accompanied the falling value of the peso – will provide the banks with the basis for a structural improvement in net interest income (NII).

Telles expects average 2017 rates will be around 270 basis points higher than in 2016, which will lead to “a large decoupling of NII growth vis-à-vis volume growth and are expected to more than offset the [macroeconomic] headwinds.”

He also believes that consumer lending will be resilient because of high growth in formal wages that will offset the overall slowdown (from 13% growth to 10%). “Despite higher inflation and lower economic growth as headwinds for consumption, we believe banks are on the better side of Mexico’s consumption story as formal employment is still expected to grow in 2017, leading to real wage bill growth despite some expected decline in real wages. A better loan mix, combined with higher rates should fuel strong NII growth, which in our view are being overlooked by the market,” argues Telles.

However, not all analysts are so optimistic. Benjamin Theurer, who in January assumed coverage of the sector for Barclays from Victor Galliano, maintained a neutral view of the industry but lowered the bank’s 2017 year-end price targets for three of the four banks under coverage.

“The biggest risks are related to a worsening credit quality on the back of a deteriorating macroeconomic environment,” Theurer says. “In our view, [this is] not an imminent risk as trends have been positive but any deterioration in credit quality and increasing NPL ratios (especially within consumer loans) could have adverse implications for the sector and stocks under coverage.”

Barclays analysts cut the 2017 price targets for Grupo Financiero Interacciones and Crédito Real by 15% and 25% respectively and lowered Santander Mexico by 11%. They kept Banorte’s target price unchanged “as we believe Banorte has the best-in-class diversified offering and the most attractive growth outlook for 2017.”