Sitting with my wife’s family during one of Colombia’s 18 official holidays this Monday, my mind wandered back to an article about low productivity growth in Latin America. The article in the current issue (pdf) of Finance and Development by the IMF describes the chronic problem of productivity growth rates and several possible causes. While the article focused on the social implications of the problem, I couldn’t help but feel that the information could help to analyze sectors as investment opportunities as well.
The IMF reports that despite booming economic growth in the region, the gap between the region and developed countries in per capita growth and incomes is not closing. The problem stems from two issues, the region’s low productivity growth rate and high population growth. The article places most of the blame squarely on structural and regulatory issues, which certainly deserve their share, but I would contend that the issue is partly cultural as well. Latin Americans work to live, rather than their North American counterparts’ concept of live to work. It is a more relaxed way of living, but income per capita is sacrificed as well.
The article points to an interesting fact in the development of Latin America, which helps analyze the situation and possible investments. The historic development model, that followed by the developed world and now Asia, is a process of development from agrarian to manufacturing base then to growth in the service sector. Latin America, however because of poor industrial policies, skipped directly from an agrarian base to the service sector. Sixty-percent of the regions’ labor force is employed in the service sector, compared with just 20% in manufacturing. Raising labor productivity in manufacturing to be comparable to that of Asia would only increase overall productivity by a third of a percent. This means that countries focusing their efforts on manufacturing may lag those targeting the larger service sector. It also provides possible ideas for emerging market diversification. Manufacturing may have the relative strength in Asia, while the service sector has the momentum in Latin America.
Data shown in the table below is from the Groningen Growth and Development
Center. It shows average productivity growth rates by sector for four Latin American countries and the United States for the period from 1980 to 2005. Data for the other countries within Latin America show similar results. One would assume, because of diminishing marginal returns, that productivity growth rates in emerging markets would exceed those in a developed market. This is not the case for most sectors in Latin America. The data shows relative strength in the agriculture and basic materials sectors in the four countries with an average growth rate of 3.6% and 5.9% respectively versus the growth rates of 3.0% and 7.1% in the United States. Productivity growth in all other sectors lags that of the U.S., while growth in manufacturing, construction, wholesale & retail trade, and finance is close to half that in the States. Chile is the notable exception within the group with the highest productivity growth rates in agriculture, transportation & communication, and finance. Colombia’s growth rate in its basic materials sector has been truly impressive at almost twice the regional average, even higher than that of oil heavyweight Brazil.
(Click charts to enlarge)
As is often the case, the data can be used to justify differing investment approaches. If you believe the region can significantly improve productivity in the weaker sectors, then a strong case could be made for growth in the laggards. It would seem much easier for Peru to increase productivity in its basic materials sector from an historic mean of 2.5% than for Colombia to maintain a growth rate of 10.2%. Though I am positive on the region as a whole, given structural and cultural issues, I do not believe the region will be able to improve productivity rates in most sectors. This alone would lead me to overweight commodities producers, basic materials, and companies in transportation & communications. I am positive on the finance, insurance, and real estate sector given recent reforms and market integration, though productivity growth in the sector is almost half that of the United States. The data leads me to be less optimistic in the utilities and manufacturing sectors. By country, historical growth in productivity should help Chile and Colombia relative to Peru and Brazil.
Country exposure through exchange traded funds is available for Brazil, Chile, and Colombia. The Global X FTSE Colombia 20 ETF (GXG
) has a market cap of $143.5 million and trades at a leading price-to-earnings of 19.4 times. The fund is passively managed with 22-stocks and designed to follow the broad-based market performance in Colombia. The fund’s largest sector exposures include financial services & banks (41.2%), oil & gas (17.1%), industrials (10.7%), and utilities (9.6%). The iShares MSCI Chile Investable Mkt Fund (ECH
) has a market cap of $706.6 million and trades at a trailing price-to-earnings of 18.5 times. The fund seeks to replicate the broad market performance in Chile. The fund’s largest sector exposures include utilities (24.6%), industrials (20.0%), materials (18.9%), and consumer staples (13.2%). Though the fund holds a large position in utilities, the impressive rate of economic growth in Chile is hard to resist. The iShares MSCI Brazil Index Fund (EWZ
) has a market cap of $11.0 billion and trades at a trailing price-to-earnings of 12.9 times. The fund is managed to follow the broad-based market performance in Brazil. The fund’s largest sector exposures include materials (24.0%), financials (23.3%), energy (22.6%), and consumer staples (9.22%). Over the last 12-months the Colombia fund is up approximately 6% while the Chile and Brazil funds returned 0% and -10% respectively. For the period since February 2009 returns for the Colombia, Chile, and Brazil funds are 166%, 83%, and 62% respectively. Given returns in both periods and valuations, investment in the Brazilian fund may be warranted despite having the lowest productivity growth rate of those studied. With market integration and financial market stability, the Colombia and Chile funds could still provide growth despite impressive returns to date. Sector funds within the Latin American space are not available, though there are some sector funds for emerging markets in general. The table below shows a selection of american depository receipts available that match our investment theme of strong productivity growth in transportation & communication and basic materials.
TeleNorte Leste Participacoes SA (TNE
) is a telecommunications service provider in Brazil. The company provides fixed-line and mobile services, data transmission, and Internet services. The company has a market cap of $6.5 billion and trades at a trailing price-to-earnings of 11.6 times. It has been slightly more aggressive than competitors with a little over twice the debt relative to equity, much of this due to an aggressive acquisition model. The stock is down 2.4% over the last year. The stock is a strong candidate for a Latin America infrastructure portfolio
as well. I recently posted a neutral opinion on emerging market infrastructure in general due to reliance on government spending for a large portion of revenue.
Lan Airlines SA (LFL
) operates a cargo and passenger airline offering services primarily in Latin America but with 61 destinations internationally as well. The $8.4 billion company recently won approval to merge with Brazilian-based Tam Airlines (TAM
). The stock has come under pressure lately with a three-month and one-year decline of -15.0% and -11.0% respectively. Despite the weakness, it is still outperforming the airline industry index and should benefit from aggressive growth in its markets.
) is the largest oil & gas operator in Colombia, and the third-largest in South America, with a market cap of $86.7 billion. The company went public in 2007 when the government sold 10% of its stake in the domestic market. The company recently saw high demand for another 1.7% share sale to fund ambitious expansion plans. Ecopetrol’s last quarterly report saw net income surge 89% on strong oil prices and an increase in output of 21%. The stock is up 12.8% over the past 12 months.
CIA De Minas Buenaventura SA (BVN
) is a precious metals mining company operating in Peru. It also operates an electric power company and provides engineering services. The $10.8 billion company has the highest return on equity of the four presented and a trailing P/E of 13.2 times. The company has almost no debt and recently reported second quarter earnings per share 81.8% higher than its 2010 2nd quarter. The company, along with other Peruvian stocks, has seen increased volatility over uncertainty about the political future with a new administration under President Humala. To date, Humala has followed a more centrist-policy than investors originally feared. The stock is up 10.3% over the last 12 months. A strong argument can be made for relative strength in specific sectors in Latin America, given historic productivity growth rates. Improvement in productivity should be a focus of the governments within the region and significant change could mean that lagging sectors experience outperformance. Investors should do their own due diligence in analyzing the data and should not use it in isolation to select sectors or specific stocks.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.