Striking gold. (Cover).

Following a year in which the Bolsa Mexicana de Valores (IPC) is expected to be trimmed of as much as 10% of its value, investors may take a decidedly hands-off approach to pouring money into the Mexican stock market. When it comes to some sectors, that would be a mistake.

In a wide-ranging investigation by a team of BUSINESS MEXICO reporters, analysts' brains were picked to determine precisely which sectors-and the top options within those sectors--will likely beat fruit for investors in this coming year.

Opportunity abounds across sectors, many analysts say, and intelligent navigation of these troubled fiscal waters can lead to ports of prosperity.

However, investors should beware that global fiscal woes, particularly in regard to Mexico's powerful northern neighbor, loom as a profound threat, particularly in sectors such as conglomerates and among large, multi-national companies.

On the plus side, the government's attempt to kick start the economy through more aggressive home lending makes housing stocks a very attractive option in this new year. Also looking good, banks continue to recover the confidence of the public-and shed their notorious past associated with the peso devaluation of 1994 and subsequent bailouts --and one analyst hinted at the prospect of 50% ROIs for a couple of particularly enticing financial outfits.

Limited choice continues to characterize some sectors, specifically retail with the monolithic Walmex standing tall and telecommunications, which could be called Carlos Slim, Inc. But despite the compact field in which to play in both these sectors, winning investments of course can be had.

Other sectors take ion a local flavor, with media revenues dependent largely on the intensity of midterm elections (campaign advertising) and the popularity of reality shows (teenage spending dollar). And of course, in this country with the highest per capita consumption of soda, the beverage market figures to move independent of such world fiscal events as a hiccup in the Nikkei. As one investor put it, "People don't stop drinking Coke Just because there's a recession."

Perhaps that is not the most specific or esoteric of investment advice, but the point is clear, the opportunity is there. With the grand idea now laid out, BUSINESS MEXICO presents a detailed analysis of seven key sectors of the Mexican economy and the opportunities and pitfalls lurking in each.

Financials

On the upswing, banks hold promise of fat returns.

Andrew Watson 

Mexico's banking stocks will provide good returns to investors in 2003 as the industry continues to recover business lost during the 1994-5 economic crisis, analysts say.

"I think you have tremendous growth potential, given the low level of banking sector penetration," said Jason Mollin, a Latin American banking analyst with Bear, Stearns & Co.

Banks are just now winning back the customers they lost when thousands defaulted on loans after interest rates soared in the wake of the December 1994 peso devaluation. Performing loans to the private sector, made up of consumer, housing and commercial loans whose interest and principal are being repaid, increased 3% in the third quarter.

Loan growth continues to be driven by a revival in consumer credit, which began in 2001. Overall housing and commercial lending portfolios, however, are still shrinking as banks dump the remnants of the bad debt left over from 1994. Performing loans to the private sector as a percentage of gross domestic product are about one quarter of those in the United States.

"Mexico has a growing population and a financial sector that needs to reinsert itself back in the economy after a long absence," said Mollin, who estimates banks could gain 10 million new depositors over the next few years.

OPPORTUNITY FOR PAY DIRT

Analysts interviewed by BUSINESS MEXICO recommended the shares of the nation's largest financial group, BBVA-Bancomer, and those of the fourth largest, Banorte. Both of these stocks, which are quoted on the Mexican Bolsa, could generate a return on investment of up to 50% by the end of 2003, Mollin said. He expects their earnings to grow 20% in 2003 compared with last year.

"The sector's going to be a winner," agreed Luis de Urquiho, a banking analyst at Vector Casa de Bolsa. He said bank profitability is good, even though Mexican interest rates remain near to their lowest-ever levels.

They've counteracted lower interest margins by giving Out more consumer credit, such as credit cards, auto loans and personal loans. Performing consumer loans in the third quarter grew 15.9% at Banorte and 12.4% at BBVA-Bancomer, compared to the previous three months. Growth in non-performing loans remains low thanks to better credit screening.

Higher service charges have helped as well. Fee income at Banorte and BBVA-Bancomer rose more than 13% quarter over quarter. The banks have hiked fees on everything from pension funds to electronic banking services.

Both financial groups have made significant reductions in operating expenses by cutting personnel and eliminating branches. Banorte is in the process of integrating Bancrecer, which it acquired last year from the Bank Savings Protection Institute (IPAB). The group reduced operating expenses 3.4% and personnel expenses 6% quarter over quarter. Analysts expect these trends to continue through 2003.

"We're looking at stable margins, reasonable fee income growth, sustained improvement in operating efficiency, a modest reactivation in lending and steady asset quality," Mollin said.

EXTERNAL CONCERNS

The main investment risk is the weakness of the economy. Confidence continues to be buffeted by concern over the flagging economic recovery in the United States, Mexico's main trading partner. Some negative investor sentiment is also being generated by talk that loans sold to Fobaproa/IPAB during the bank bailout will be reviewed, analysts say.

A possible takeover of Banorte, the only sizable Mexican bank not yet under foreign control, is one factor that might boost the bank's stock next year. In August, shortly after Grupo Financial Bital was bought by HSBC Holdings for US$1.14 billion, rumors swirled that another international bank could make a bid for Monterrey-based Banorte.

"Banorte is usually viewed as an acquisition target because it's not one of the top players in terms of size," Mollin said. "We don't incorporate any type of takeover premium into our (stock) valuation. We think it could survive on its own. But yes, I think (Banorte) is a great asset and it's undervalued."

The analysts believe likely suitors are HSBC, J.P. Morgan Chase, Santander Central Hispano and Scotiabank.

De Urquiho expects Banorte and BBVA-Bancomer shares to be priced at 27.4 pesos and 10.4 pesos per share, respectively, by the end of September 2003. Mollin anticipates that Banorte and BBVA-Bancomer will be trading at 35 pesos and 12.1 pesos per share, respectively by Dec. 31, 2003.

Andrew Watson is a finance reporter for a Mexico City daily and a freelance writer.

Telecom

One game in town and Slim holds all the cards

by Michael O'Boyle

On the question of which Mexican telecom stock to buy, the question is really which brand of Carlos Slim's stock do you want to pick? Holding an estimated 90% of the local market, 70% of long distance and 75% of wireless through little sister America Movil (AMX), Telmex and its variants offer the best option for shortterm gain as well as long-term investments.

Merrill Lynch and Salomon Smith Barney are backing Slim's wireless spin-off AMX as a buy, with high volatility risks but a good shot at strong returns. Telmex will pay off, but don't expect spectacular performance in the short term. Then there are the respectable shares of Carso Global Telecom, the holding company through which Slim owns his shares of Telmex.

STAGNATING TELMEX

While Telmex is still a good long-term investment, market limitations will cut into performance. Wireline growth potential is caged by the demographics of wealth distribution in Mexico, keeping market penetration to just over 10 lines per 100 habitants.

Moreover, Telmex is increasingly regulating itself to fend off government action against its market dominance, keeping prices nearly level for two years running and dropping connection fees for some foreign telecom companies. All these drags on profit growth will keep Telmex below average earnings for stock in the sector, says Merrill analyst Whitney Johnson.

In September, Merrill took Telmex from a strong buy to neutral. While the stock is still a good longterm investment, "Valuation is not sufficiently attractive to the pool of global money that could drive outerperformance," Johnson writes.

Salomon Smith Barney analyst Patrick Grenham adds, "It's difficult to see a catalyst to drive this stock in the near future."

All that said, Telmex is still a steady stock in a down market. Grenham expects the American depository receipt (ADR) to grow from around US$30 to US$40 per share by the end of 2003. If a new telecom law gets through Congress next spring, recommendations could change. Recent drafts seem Telmex friendly.

GOING WIRELESS

With wireless, there is room to grow. America Movil is riding on still-surging demand, although more consumers are attracted to prepaid phone cards than monthly plans. Merrill upgraded the stock to a buy in late October, projecting strong results for 2003 when AMX is expected to post positive cash flow. Johnson estimates continued subscriber growth and widening profit margins will allow AMX to cover the costs of its capital in 2003 and drive significant returns over the next few years.

Johnson estimates earnings of 0.74 cents per ADR, at a 5.5% yield, for 2003 and US$1.36, at a 9.2% yield for 2004, performing significantly better than market peer Vodefone Group.

Trading at US$13.55 per ADR in October, Merrill projects AMX will fetch US$17 per ADR by end of 2003. While Salomon Smith Barney is even more bullish with an end 2003 target of US$24.

For AMX flagship Telcel, subscription growth is expected to decline, but so will marketing expenses. Wireless penetration in the Mexican market is around 25% versus a potential 30%, and the number of Telcel subscribers should keep growing at over 10% per year, projects Johnson.

Meanwhile, AMX's other American holdings are picking up steam. Its consolidation of Brazil's Telecom Americas into its financial results in July produced lower-than expected net debt of US$3.56 billion, according to third quarter results. As America Movil's books fade to black and the cash rolls in, look for Slim to grab at Bell South's Brazilian holdings, Johnson wagers.

As for Mexico's other Telecom stocks, Telefonica's companies, boosted by the acquisition of Pegaso's market share, will do battle with Telcel to split up the dividends of Mexico's dwindling untapped market. The stock should provide a decent return. Iusacel will continue to tank due to its shaky debt situation. Ricardo Salinas Pliego's Unefon will continue with its small share, without much to offer in big returns.

Michael O'Boyle is a finance reporter for a Mexico City daily and a freelance writer.

Media

Two heavyweights fight for scraps following lean year

by Morgan Lee

Despite the advertising bonanza surrounding the 2002 World Cup and new reality shows, Mexico's media sector has suffered this year on the Mexican Stock Exchange.

Stock in Grupo Televisa in early November was trading at just two-thirds the price of its 12-month high. By the same measure, TV Azteca stock faired even worse.

"This sector is one of the most punished in Mexico," explained investment fund manager Rogelio Gallegos of Actinver Fondos de Inversion. "It's a sector that has one of the best margins of all sectors on the stock market--for the perfomance that both companies have."

Beyond Televisa and TV Azteca, analysts say there simply are no other media options on the Mexican stock market, although the financially troubled and relatively small Grupo Radio Centro also is publicly traded.

Televisa and Azteca share some of the same liabilities, including operations in a costly U.S. broadcasting market and a general exposure to fluctuations in the Mexican economy. Analysts expressed cautious enthusiasm for investment in Televisa, the entertainment conglomerate run by media heir Emilio Azcarraga Jean. A Banamex investment report gave Televisa a "speculative buy" rating in November, noting its non-television units continue to show low profitability.

MOVES IN THE MARKET

Meanwhile, Televisa's move to buy into a joint live entertainment venture with Corporacion Interamericana de Entretenimiento (CIE) has been widely applauded as a good strategic move. The deal gives Televisa a 40% stake in Ocesa Entretenimiento, a new CIE subsidiary dedicated to staging live events and shows.

"Economically speaking, Televisa is paying in advance for the synergies created with Ocesa Entretenimiento, so it's not a cheap deal for Televisa," explained Latin America media analyst Francisco Rivero of Santander Central Hispano. "But strategically speaking, it makes a lot of sense."

Rivero, also the head of research for Santander's Mexico office, rated Televisa stock as a "buy" in early November. "We really like it at these price levels," Rivero said.

TV Azteca also has been trading at low levels but leaves the investor with more unknowns, he said. "The value of TV Azteca is very depressed and it is trading at a significant discount compared to Televisa," Rivero pointed out. "However, there are a bunch of uncertainties around TV Azteca that justify the depressed valuation right now."

Uncertainties include TV Azteca's investment in the troubled telecom upstart Unefon. TV Azteca profits disappointed analysts in the third quarter of 2002, leading Banamex to lower its investment recommendation to "neutral."

COUNTING ON CAMPAIGN COFFERS

Media investors can look forward to a boost in sales from midterm 2003 elections. But 2003 is a congressional election year, not a presidential year, and campaigns will not command the resources that characterize the high-stakes fight for Los Pinos.

President Vicente Fox's recent modification of longstanding federal broadcasting laws trimmed the amount of time allotted to government announcements.

On its surface, the change appeared to cut government airtime and benefit the industry.

Analysts point out, however, that much of the time allotted to government broadcasting was never utilized because of the high cost of video and radio production. Overall, the effect of the legal changes is likely to be negligible, according to analyst Inigo Gonzalez of GBM Grupo Bursatil Mexicano.

"Although you can look at it from one point of view as more time, I think now the government has put together a very clear definition," Gonzalez said. "And I don't think it will have a negative impact on the networks."

Gonzalez said he considers both broadcasters to be attractive investments, noting their "duopoly" of the Mexican marketplace mitigates some of the pressure felt by media companies in other parts of the world.

"It really leaves few options for businesses, medium and large," Gonzalez said. "If they want publicity to reach an important market, there's little more than these networks."

Gallegos of Actinver said if the Mexican economy improves, media stocks will get more attention from investors next year.

"If we keep seeing an environment of low interest rates, controlled inflation, and we see growth," Gallegos said, "given the value of the companies, the market is going to concentrate a lot more on them."

Morgan Lee is a correspondent for the Albuquerque Journal and a Mexico City-based freelance writer.

Conglomerates.

Despite risks, opportunities to cash in on nation's top players abound

by Michael O'Boyle

Mexican conglomerates will face trouble next year due to the uncertainty of the economic recovery, volatile world markets and slumping commodity prices, but some are still making a buck.

Despite the downturn, Carlos Slim's sprawling Grupo Carso will do well in 2003. Industrial divisions will be boosted by sales of home construction and furnishing products for the housing boom. Sanborns and Sears units will keep doing well, buoyed through the tough times by ample credit subscribers. Globo and Mixup stores still draw crowds, and, for Citagam's sake, smoking remains in style.

RIDING SLIM'S BABY

Grupo Carso is UBS Warburg analyst Bond Snodgrass' top pick for the sector. With shares trading at under 25 pesos in Mexico City, Snodgrass sees a deal. He expects local share price to hit 41 pesos by end of 2003. For 2002, earnings per share are estimated at 2.83 pesos, and 2.57 pesos per share in 2003.

While a soft economy will dampen sales next year, he is confident productivity gains from new cost-cutting measures and other managerial acrobatics will keep up margins. The government push for housing construction bodes well for Grupo Carso's industrial divisions. Construction accounts for 51% of the combined revenue for Grupo Carso's industrial divisions--Condumex, Nacobre and Porcelanite--and for 21 percent of Grupo Carso's own earnings.

For bargain hunters, by all meaningful measures, Grupo Carso stock is going cheap, says Snodgrass. Moreover, the company's management shows it knows how to create the shareholder value over the long term. Grupo Carso is the strongest Mexican conglomerate with a significant margin between its capital costs and return on invested capital (2002E -- ROIC: 15.5%, WACC: 9.8%).

Grupo Carso is also insulated from the economic convulsions shaking the global market, with only 9% of revenue stemming from exports, compared to Desc or Alfa with 45% and 30%, respectively. Moreover, only 1% of revenue is linked to commodities, versus Desc's 51% and Alfa's 62%.

BEATING EXPECTATIONS

Still, despite the economic slowdown, Alfa repeatedly reported record sales and Ebitda (earnings before interest, tax, depreciation and amortization) during the first three quarters of 2002, continually beating analysts' expectations. The weak economic recovery in the U.S. has led to downward revisions in estimates for next year, but Banamex analysts are still recommending the stock as a buy.

Stefaan Peeters and Claudia Medina, of Banamex, point out Alfa managed to post record sales in 2002, and they still expect 2% growth of Ebitda in 2003. As a good buy, they say, the stock is currently undervalued compared to its own history.

Alfa's steel division, Hylsamex, will see gains from a favorable steel tariff shielding the Mexican and U.S. market, boosting its sales to U.S. and domestic clients. Its chemical and plastics division, Alpek, will continue to deliver growing sales fueled by its new South Carolina plants producing plastic bottles (PET, PTA) and other high-demand synthetics.

Together steel and petrochemical products make up around 60% of the Monterrey-based giant's revenue. Trading under 17 pesos per share, Banamex has set an end 2003 target price of 30 pesos per share and estimates earnings per share at 4.09 pesos for 2002 and 3.29 pesos per share in 2003.

While Snodgrass agrees steel and plastics will show strong returns for Alfa, he worries their commitment to money-losing ventures is a cause for concern. Steel companies required costly bailouts during recent years and rescues of Alestra and Sidor are still pending.

Among other conglomerates: Desc's auto parts division was hit hard by the shuttering of Daimler Chrysler Lago Alberto plant, crimping sales 29% in the third quarter. Higher supply costs also dented Desc's bottom line in the third quarter, and Snodgrass cut his 2002 earnings per share estimate down to 1 cent or less.

Analysts say Gissa's price could rise over the next 18 months if its diversification into aluminium cylinder heads and blocks takes off. Industrial conglomerate Imsa will share in the good fortune of high steel prices in the Mexico-U.S. market and growing housing construction. Banamex endorses the stock as a buy.

All estimates anticipate at least a moderate economic recovery, and any downturn changes the story for most of the sector.

Michael O'Boyle is a finance reporter far a Mexico City daily and a freelance writer.

Housing

Windfall of government credits makes this sector quite salacious 

Andrew Watson

State-run housing trusts are planning a 23% increase in lending to homebuyers in 2003, making housing stocks a sure bet for investors, analysts say.

If all goes according to schedule, housing organizations will grant 530,000 credits and subsidies for the acquisition and construction of homes in the coming year. That's an increase of 100,000 compared with 2002.

The expansion is part of President Vicente Fox's National Financing for Development Plan (Pronafide), which commits the administration to raise the annual quota of housing credits and subsidies to 750,000 by 2006.

Apart from homebuyers, the main beneficiaries will be the nation's leading homebuilders, Consorcio Ara and Corporacion Geo. These Bolsa-quoted companies rely mainly on loans from clients of housing trusts Fovi, Fovissste, Infonavit, Progresiva and Prosavi to finance housing construction.

It was hoped a total of 475,000 credits would be disbursed from the trusts in 2002. Fovissste, however, has been running behind schedule because of an administrative bottleneck. The state workers' housing fund is expected to grant just 60% of the 100,000 loans allocated for 2002.

Investors have punished shares of Ara, which is more reliant on Fovissste credits than Geo. The latter receives 80% of its funding from Infonavit clients and the rest from Fovi and Fovissste. Ara shares fell nearly 62% between early May and mid July.

Rumors of fraternal strife between president German Ahumada and his brother, vicepresident Luis Felipe Ahumada, also hurt the stock in 2002.

GOOD TIMES AHEAD

But Ara will be making up for lost time during 2003, analysts say.

"The problems with Fovissste are resolved," said Cecilia del Castillo, a housing sector analyst at Grupo Financiero Banamex. "There's a good outlook for lending next year. The bad year is already priced into Ara's stock."

Del Castillo expects Ara stock to appreciate 32% to 21 pesos by the end of 2003. But Carlos Hermosillo, an analyst at Vector Casa de Bolsa is less certain the homebuilder's difficulties are completely resolved.

"There are doubts about whether this is going to be repeated in 2003 or if Ara is going to be able to substitute Fovissste credits with something else. When you end a project with Fovissste, you can't just start another one with Infonavit," he said.

"Assuming the process of granting building permits is settled in the coming months, we could see interesting growth at Ara," said Hermosillo, whose target price is 20 pesos per share.

Geo, meanwhile, has been reducing its once-heavy debt load. The company has increased cash flow by extending payment terms with material suppliers, thus enabling it to retire more short-term debt.

"There was too much leverage. Although it wasn't critical, Geo's financial burden was heavy," said Hermosillo, who notes that Geo reduced net debt by 100 million pesos in the third quarter of 2002. "It seems they have solved that problem and operating profitability is improving."

Geo's earnings before interest, tax, depreciation and amortization (Ebitda) increased 7.5% compared with the second quarter. The rise was 2.3% at Ara. For the coming year, the analysts expect growth of more than 10% in sales and Ebitda at both Ara and Geo. Other factors point to a boom year for the two companies.

POSITIVE FACTORS ABOUND

The companies have plentiful territorial reserves that enable them to anticipate rising land prices and keep costs low. Both are shifting their emphasis toward middle-income housing, which generates higher profit margins. Increased lending by banks and non-bank financial institutions (Sofoles) is expected to generate higher demand in this sector. Infonavit, the largest state housing trust, has said it will dedicate more credits to homes worth more than 500,000 pesos in the coming year.

Congressional elections in July should help the stocks, as additional housing loans are traditionally granted during voting season, the analysts argue.

The beginning of mortgage securitization is also expected to boost stocks in the next few months, as this will generate liquidity in the mortgage market.

"We think that whatever news about the continuation of the current dynamism, structural changes and operating efficiency, will benefit the sector--and share prices," Del Castillo concludes.

Andrew Watson is a finance reporter for a Mexico City daily and a freelance writer.

Retail

Walmex looms monolithic over bit players in changing landscape

by Morgan Lee

Competitive, saturated and very risky--this is how analyst Gaspar Quijano of Vector Casa de Bolsa described the business environment in Mexico's retail sector.

The retail industry has grown rapidly during the past year--perhaps too rapidly. Between August 2001 and August 2002, the number of retail stores nationwide increased by 571--a 10.3% leap--among members of the Mexican Association of Self-Service Stores (Antad). Meanwhile, industry sales grew at a slower pace across the three main categories of service.

Sales increased at self-service stores by 5.5%, at department stores by 6.4%, and at specialized retail stores by 6.7%. What's more, the legions of street vendors in Mexico's informal economy still bite off a large portion of daily sales. These considerations combined with the financial results among publicly traded retail companies have made stock analysts cautious in their recommendations.

Quijano said the sector "has more disadvantages than opportunities," noting corporate profits and stock performance in retail are dwarfed by areas such as telecommunications. Nevertheless, at least one retailer continues to shine financially: Wal-Mart de Mexico (Walmex). U.S.-based Wal-Mart remains the majority owner of Walmex, which leads the retail field here in size, profits and strategic influence. Although there are only about 74 Wal-Marts in Mexico, Walmex controls 584 business locations if its other properties--Sam's, VIPS, Bodega Aurrera, Suburbia and Superama--are included.

A GIANT IN THE SECTOR

Walmex continued to grow--and grow more efficient--during 2002, posting a net profit of US$234 million during the first nine months, a 10% increase over the same period last year.

Its ruthless pricing and mantra of "everyday low prices" continued to dictate industry behavior--whether competitors liked it or not.

After members of Antad crafted a new ethics code that forbid publishing price comparisons, Walmex quit the association, taking about 20% of Antad sales with it. The giant's October departure raised questions about Antad's very survival and the relevance of its statistical reports.

Analysts don't hesitate to call Walmex the best bet among stocks in the retail industry. And its voting shares were selling in late October at around US$2.50--just 76% of the 12-month high.

Despite the now-colossal size of Walmex, the retailer showed no signs in 2002 of financial fatigue.

"Given that Walmex has been opening stores in zones that still haven't been explored and aren't attractive to other companies, there's still a lot of room for them to expand," Quijano said.

OPTIONS TO DIVERSIFY

Despite Walmex's success, analysts said it remains wise to diversify among retail stores, and there are other retailers on the Mexican Stock Exchange worthy of consideration.

Three companies currently vie for second place behind Walmex: Controladora Comercial Mexicana, Grupo Gigante, and Organizacion Soriana.

Analyst Mauricio Brocado of IXE Casa de Bolsa recommended Soriana, singling out the company for its profit margins, which are higher than Walmex's. Focused in northern states, Soriana shows some vulnerability to the downturn in the maquiladora industry. But many competitors share that exposure and retailers concentrated in more central locations face greater competition from Walmex. Soriana's stock was selling for an "attractive" price in October, Brocado noted.

Quijano of Vector brokerage also recommended Walmex and Soriana among self-service retailers.

Department store stocks were not recommended by Vector because of the lack of interest among investors. The advice even applied to profitable, publicly traded companies such as El Puerto de Liverpool and Grupo Palacio de Hierro.

Among specialty retailers, Quijano picked Corporativo Fragua and Alsea.

Alsea is the company behind Domino's Pizza in Mexico, newcomer Starbucks Coffee Co., Pan Caliente, and frozen bread maker Alysa. Equipped with its own distribution network, Alsea has been able to fuel the explosive growth of Domino's, which started with seven locations in 1990 and now includes 425 stores. Quijano sees Alsea's joint venture with Starbucks as a good investor opportunity.

"The growth that Starbucks is going to bring should mean good returns," Quijano said.

Morgan Lee is a correspondent for the Albuquerque Journal and a Mexico City-based freelance writer.

Beverages.

Have a drink and a smile: recession can't quench thirst

by Paul Day 

The Mexican beverage sector has reaped the benefits of the Latin American crisis and a weak economy throughout 2002, according to sector analysts.

Banco Santander's Latin American Equity Research report says Grupo Modelo stock prices, a favored stock in the sector, were boosted by several factors, including a heightened degree of perceived risk in other regional countries and a subsequent move to a more stable Mexican stock market.

"This risk is associated with the presidential elections in Brazil and the lingering uncertainty with the short-term outlook in that country during the transition to a new government," wrote Santander's Alexander Robarts, who authored the report.

For this reason, Santander advises investors to favor Modelo over its Brazilian rival AmBev. While macro-economic factors have played in Mexico's favor, investors seeking protection from volatile markets have turned to drinks for more than just relative stability.

Traders consider the beverage market to be a haven in times of volatility. As one investor put it, "People don't stop drinking Coke just because there's a recession to quite the same extent as they may stop buying new cars."

MODELO MAKES INROADS 

Within the Mexican market, a number of factors led investors to prefer Modelo over Femsa, which is the holding company of Coca-Cola/Mexico, over the course of 2002. Modelo and Femsa are decidedly the largest players in the sector.

Femsa's larger participation in Mexico's north than Modelo has meant the latter has not felt the effects of the U.S. recession quite as hard and Modelo's profits reflect this. Its move toward increasing exports, part of a successful bet by the company on a weakening currency, has paid off as the peso devalued against the dollar to unexpected lows during the year.

"We also point out that Modelo posted the best third-quarter 2002 in our Mexican beverage universe and our expectations for a strong fourth-quarter 2002 are driven by lower selling expenses and increased export profitability," says Robarts.

Femsa's relatively low stock prices are not, however, part of a trend likely to continue into next year, according to one trader who would only speak on the condition of anonymity due to company policy.

"Femsa is a very good option right now because it is cheap and will see much greater growth next year," the trader said.

The company has spent the last several years concentrating on debt and corporate restructuring, which it has now completed, leaving it in a position for expansive growth in 2003, according to the trader. Femsa's recent takeover of Ciel water and its move toward new water products was well received by traders.

"Water products should account for 10% of total Mexican volume by 2004, up from 5% in the first nine months of 2002," Santander says in praise of the Femsa strategy.

SODA WARS

The rumor of a luxury tax hike began circulating in November and led to a 4% across-the-board decline in soft drink share prices. Finally, the old Pepsi-Coke war has traders balancing risks and placing bets on relative market strategies in Mexico. The war recently stepped up a notch after Pepsi Bottling Group (PBG) bought Pepsi-Gemex this year.

PBG said after the buy, "distribution and point-of-sale execution are two top priorities," meaning it would be concentrating forces on cooler placement strategies, an area Santander sees as a center point for increased competition between the two giants. Investors remain bullish toward Femsa however.

"For 2003, I think Femsa will keep up its market domination due to its current portfolio of practically zero debt. They (Femsa) remain a buy recommendation for us," says Angelo Garcia from the Vector Casa de Bolsa brokerage company.

Santander agreed in saying, "The market's overstated and lingering concern about new competition provides an attractive entry point in Femsa, and we reiterate our strong buy recommendation on the shares."

Paul Day is a Mexico City-based freelance writer.