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Nearshoring in Mexico Benefits Corporate Credit Quality

By Alberto Moreno - Fitch Ratings
Senior Director

STORY INLINE POST

By Alberto Moreno | Senior Director - Thu, 08/17/2023 - 13:00

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Nearshoring in Mexico is benefiting companies’ business profiles, with the potential to continue to be the main engine for the country’s manufacturing platform. Mexican exports of manufactured goods grew 11% in the last 12 months (LTM) ended June 30, 2023, according to National Institute of Statistics and Geography (INEGI). The potential is for  US$50 billion of additional exports, 10% of 2022 total exports.

Financial profiles for Mexican corporates with a Fitch rating (on  international and national scales) are expected to remain relatively stable in the short term. Median leverage metrics for the portfolio, measured as Adjusted Net Debt to EBITDAR, is projected around 1.8 times (x) and 1.7x in 2023 and 2024, compared to 1.8x in 2022. 

Profitability for Fitch-rated Mexican corporates also is expected to slightly improve in 2023, with a median EBITDAR margin of 19% versus 18% in 2022. Some effects of nearshoring are already factored into this improvement, but the full potential is expected in the coming years, as investment is deployed, capacity ramps up and operations stabilize. 

This expected improvement comes amid a difficult business environment characterized by high inflation and rising interest rates that dent companies’ ability to generate cash flow. Higher CAPEX (capital expenditures) aimed at adding or increasing manufacturing capacity will consume most of the companies’ internally generated cash flows, which in turn will require them to finance their investments at a currently higher financial cost.

Other challenges that Mexican and foreign companies willing to establish operations in the country face include, among others: a) integral policies that foster investment; b) improved infrastructure investment, particularly in energy transmission and distribution; c) training of labor force in technical capabilities required by the industry; and importantly, strengthening investment certainty by improving the rule of law.

Regarding this last issue, the main factors that may deter Mexican economy in the next six months mentioned by economic specialists polled monthly by Mexico’s Central Bank (July 2023), are related to governance, particularly public safety (24% of answers), weak rule of law (12% of answers) and corruption (6% of answers). These factors affect companies’ competitiveness due to the associated costs.

On the other hand, Mexico is one of the largest foreign direct investment (FDI) recipients. FDI inflows to Mexico reached US$36.2 billion in 2022, 14.7% higher than 2021; moreover, Mexico registered FDI inflows of US$18.6 billion in 1Q23. Of that, 53% was related to manufacturing activities, signaling the momentum of nearshoring. 

Mexico is one of the most open economies in the world for FDI; it has multiple trade agreements — the most relevant is the United States-Mexico-Canada Agreement (USMCA), signed in 2020. Mexico’s privileged position serves the North American region, which represents more than 25% of the world’s GDP. 

In addition, it has 13 free trade agreements (FTAs) with 50 countries, including the USMCA and FTAs with the European Union, 10 countries in Latin America and the Trans-Pacific Partnership, among others. Mexico is a member of the World Trade Organization (WTO), the Asia-Pacific Economic Cooperation (APEC), the G-20 and the Organization for Economic Cooperation and Development (OECD).

Sectors that benefit from nearshoring in Mexico include auto and related, machinery and equipment, medical equipment, electronics, appliances, logistics, industrial real estate, among others. Mexico’s northern and central states were the main recipients of FDI in 2022. Nuevo Leon, Coahuila, San Luis Potosi and Guanajuato stand out.

The sector that shows active dynamism is industrial real estate. In 2022, demand for manufacturing and logistics space related to relocations and additional capacity was close to 16.5 million square feet  and the expectation for 2023 is favorable. Demand has pushed vacancies to historic lows and rent prices up, particularly in the northern states. New space is coming online but demand may outpace offerings.

The US and Canada hold the larger portion of investments in the country, as a result of the integration of the North American region. Other countries have invested in Mexico over the years, namely Spain, Germany and Japan. Recently, the large investments in the steel industry carried by Ternium, marked Argentina as an important investor in the country. Moreover, Ternium announced a US$1.9 billion investment in new capacity in Nuevo Leon. 

Current projects that are in place or have been announced to transfer capacity to Mexico represent close to MX$15 billion (US$866 billion). The recently announced new Tesla factory does not compute as a transfer since it is new capacity. Newsfeeds estimate that this investment could initially represent around US$1 billion, with escalations up to at least US$5 billion. 

Importantly, announced capacity by Chinese manufacturers could reach around a third of the US$15 billion in the pipeline. As mentioned, the USMCA, in conjunction with Mexico’s proximity to the US, trained labor and adequate facilities are favorable factors for Asian companies willing to serve North America. 

Mexico’s challenge is to take advantage of these opportunities and capture a large portion of investments. As a result, this would increase FDI, support real wage increases and become a strong engine for the whole economy through increased disposable income for goods and services consumption.

Photo by:   Alberto Moreno

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