Homex: Where the Growth Is

S&P likes the Mexican homebuilder's steady revenue growth and conservative lending practices, and ranks the shares strong buy

by Kenneth Leon, CPA From Standard & Poor's Equity Research

While the U.S. housing market continues to suffer, homebuilding has been thriving just south of the border. The Mexican housing sector, representing 3% of that country's gross domestic product (GDP), delivered impressive growth in the past few years, in our view, pushed by the pressing need for affordable homes, economic stability, and strong government support.

We view Mexican homebuilder Desarrolladora Homex (HXM; recent price, 61) as a compelling growth company in an emerging market. We think the combination of high market growth potential in the Mexican housing market with its low penetration of home ownership, along with the company's conservative cash management practices, will lead to positive earnings growth and a strong balance sheet. We also believe Homex will perform above U.S. homebuilders on most financial and operating metrics.

Another factor in our strong buy recommendation is that Mexico and Homex use conservative lending practices compared to the U.S. market, in our opinion. Mortgage loan issuers (government agencies and private banks) use fixed interest rates, have up-front fees of up to 3%, provide loans with terms of up to 30 years, require down payments of 10% to 20%, and require unemployment insurance. Mortgages also provide interest expense tax-deduction benefits. In addition, Mexico's largest mortgage lender, Infonavit, is offering credits for homes bought with solar water heaters, energy-efficient lightbulbs, and other energy conservation items.

The American Depositary Shares (ADS) carry Standard & Poor's highest investment recommendation of 5 STARS (strong buy).

Mexican Housing Market

Although the U.S. economy, which accounts for about 80% of Mexico's exports, may be in a recession, the Mexican government believes the U.S. subprime mortgage situation and resulting economic woes will have only a limited impact on Mexico beyond the volatility created in the financial markets.

We believe it is unlikely a subprime mortgage problem will spread to the Mexican mortgage market where 100% of mortgage-backed offerings are made with fixed-rate mortgages.

By our analysis, there appear to be more conservative lending requirements in Mexico. These include mortgage insurance supported by federal and private institutions, detailed credit/risk analysis on all mortgages, credit bureau verifications, and required down payments in the 10%-to-20% range.

The Mexican government has pegged construction as a strategy for growth. Between 2007 and 2012, the Mexican government expects $250 billion will be invested for the construction of infrastructure, and $200 billion to be approved to cover estimated demand for 650,000 new households per year, resulting in the need to build 4 million new homes. This is in addition to about 2.1 million families that require independent housing today.

Most homes in Mexico cost less than $40,000. In spite of the advances in Mexico's housing sector, the market shows no signs of a bubble, in our view. Housing prices increased about 40% between January, 2000, and May, 2006, compared to a 107% rise in U.S. prices in the same period.

By 2010, government officials estimate there will be 30 million homes in Mexico, which will require the creation, on average, of 740,000 homes per year for the period between 2001 and 2010. By the year 2020, the 25-to-50 age bracket is expected to account for 38% of the country's total population. We believe structural changes in the country's mortgage market should enable the homebuilding industry to realize growth in the affordable entry-level and middle-income housing segments.

But according to Mexico President Felipe Calderón, Mexican housing growth will slow, as the industry reached a government target, with homebuilders planning to invest 8% in housing this year, compared to 16% in 2007 when lenders authorized a record 1.2 million mortgages. Mexican homebuilders Homex, Geo, and Urbi Desarrollos Urbanos also expect slower growth due to shortages in land reserves and delays in building permits.