A Big Coke Deal for Mexico

| Jan. 28, 2011 |

Published by Minyanville

Bordering El Paso, Texas, Anapra is the poorest neighborhood in the northern border-town of Ciudad Juárez, a major gateway for drug traffickers into the United States. Its sandy streets have no running water, no real livelihoods, are witness to countless murders, and only received electricity less than a decade ago.

Yet a bright red truck regularly delivers a cargo of soda bottles to this desert border town. Mexico is the world’s largest per capita consumer of the Coca-Cola (KO) brand and a local merger this week will create the world’s third-largest Coca Cola bottler. Soft drink bottler Arca bought peer Contal, creating Arca Continental in a $2.3bn deal. The company now only has Femsa (KOF) to look up to, another Mexican bottling giant and Latin America’s largest.

Shares in the companies increased 16% for Arca and nearly 20% for Contal on Monday as the general stock market index fell 0.5%. The merger will lead to Arca Continental having sole presence in Ecuador as well as in northern Argentina. Expected annual sales will be over £3bn.

Giant Mexican bank Banamex described the deal as one “that we have all been waiting for, for almost 10 years.” Credit Suisse (CS) warns that Femsa will be likely forced to reconsider its strategy.

The Mexican economy has had a strong, though somewhat volatile week. The central bank of Mexico left the key interest rate at 4.5%, where it has been since July 2009. This is in contrast to many emerging economies, including Poland, India and China as well as Brazil, Peru and Chile in Latin America—and comes as a surprise after Mexican newspapers just a week ago were warning of the threat of high inflation. However the Bank of Mexico expects the rise in the consumer price index at the end of last year to settle back down over the course of 2011.

With the rise of maquiladoras (assembly plants) in border towns such as Juárez over the last 50 years, accelerated since NAFTA was signed in the early 90's, the Mexican economy is now finding a helping hand from the Chinese workforce. Rising wages in the East are causing more companies to build factories in Mexico, creating more job opportunities. Folding chairs and barbecue grills maker Meco and premium leather goods maker Coach (COH) are just two US companies switching from China to south of the border, with Meco planning to invest $10m in a northern Mexican plant.

Mexico is estimated to have ended 2010 with over 12% of the US import market. This is crucial for its economy: more than 80% of exports head north. With rising food prices set to boost Chinese inflation and push wages higher, this is more good news for Mexico and analysts in Mexico hope this will further increase their share of the US import market.

Relations with the United States had a slight boost this week as Secretary of State Clinton visited Mexico, talking primarily about its war on drugs. She heaped praise on President Felipe Calderón’s strategy, despite the number of drug-related deaths surging massively since December 2006 when he took power. Clinton offered an extra $500m to help combat drug crime, adding to the Merida Initiative, a $1.4bn anti-drug plan formed under the Bush administration in 2007.

However, William Simmons, an academic from Arizona State University working on legal remedies for the situation in Juárez, was less than impressed with the announcement:

“We need to give more aid from the US side in terms of humanitarian assistance and infrastructure assistance but instead we give five high-powered helicopters to the Mexican military, which is just going to exacerbate the drug war... If either country thinks they're going to win a war of attrition against the drug cartels, they're crazy. The cartels can replace their footsoldiers and the leadership quicker than anyone can kill or arrest them.”

As reported last week, the drug war is thought to be having a rather detrimental effect on Mexico’s economy, with industrial and tourist hotspots such as Monterrey and Acapulco recently seeing a huge rise in brutal drug crime. Already in 2011 80 people, including 14 police officers, have been killed in the city of Monterrey alone. Cemex (CX) is one of the biggest of the 50,000 corporations that are based in the city.

Relations have been slightly edgy between the US and Mexico as President Calderón noted this week that the US had not complied with NAFTA obligations to allow Mexican truckers to operate on US soil. Calderon has retaliated by levying tariffs on 99 US products.

However, Mexico’s trade deficit narrowed in 2010. Total exports were $298.4 billion, up nearly 30% from 2009. Inevitably, increased demand from the United States (owing to its recovery) has helped strengthen Mexico’s position. The manufacturing sector is one of Mexico’s strongest with a total value of $246 billion in 2010. The powerful auto industry increased 53% from 2009, accounting for $65 billion. Oil exports also rose 34.8%, to $41.7 billion.

The peso continues to be slightly volatile with the currency closing on Thursday at MXN12.026 to the dollar. The rate did fall below MXN12.0 last week so it's slightly up. Mexican authorities are “committed to the markets” and happy with the floating exchange value.