Idea Brunch with Ian Bezek
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Ian Bezek!
Ian is currently a private investor living in Colombia focused on Latin American equities. Ian previously worked as an analyst at Kerrisdale Capital and now writes an investing Substack and is active @irbezek on Twitter.
Ian, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to move to Colombia and be a private investor in Latin American equities?
I worked for a New York-based hedge fund, Kerrisdale, for several years after college. Kerrisdale is an activist firm that publishes research, and being in that environment taught me a lot about the investing process and how to communicate ideas with the industry. However, looking around the industry in New York, I saw it wasn’t a long-term career path for me. Between the stress, cost of living, and so on, it wasn’t where I wanted to be when it was time to have a family.
So I left Kerrisdale in 2014 and went traveling in Latin America and ultimately ended up meeting my wife while I was in Colombia. Over this time, I learned Spanish and lived in Mexico, Colombia, Guatemala, and Argentina. We returned to Colombia after my wife completed her graduate degree abroad, and we’ve now lived here for the past six years and are raising our two kids here in the Caribbean region of Colombia. I have used my past experiences and connections to offer investors a unique perspective on investment opportunities throughout the region.
What are some common mistakes new investors make when investing outside the U.S. and what have you found are the key ingredients for success when investing in developing countries like Mexico or Colombia?
A big one is treating all emerging markets equally. There are very different levels of governance and institutional credibility between countries. Kerrisdale made its initial fortunes thanks to shorting a wave of low-quality Chinese reverse mergers that presented untrustworthy financial statements to their U.S.-based investors. I have retained a deep skepticism of Chinese, Russian, and other such equities in autocratic countries. I am, in fact, still short a Russian ETF that was halted indefinitely when Russia invaded Ukraine. It’s wise to remain skeptical of emerging markets as a broad asset class.
On the other hand, there are emerging market countries with a much better track record of having stable democratic governance with reasonable protection of property rights, independent judiciaries, and fair treatment of foreign shareholders. Investors should assign very different risk premiums between countries that treat foreign shareholders poorly and ones that respect them. In my view, a credible emerging market like Poland or Chile, for example, should have a much lower risk premium than, for example, China or South Africa.
Another key factor is to look for incentives. Emerging market companies often have family ownership or other controlled structures that are less common in developed markets. Many EM stocks look cheap but stay cheap forever because there is no way to catalyze a rerating in an undervalued stock.
Here in the local Colombian market, for example, an insurer announced a share buyback in 2021 and had to explain to the public what a buyback even was, as it was the first such program in Colombia in more than a decade. It may be easy to find a company trading at 0.5x book value in Colombia, for example, but that alone doesn’t ensure that the stock will trade back to a reasonable valuation unless there is some alignment of interests with management or other such catalysts.
You have tweeted extensively about publicly traded Mexican airports (e.g., PAC, OMAB, and ASR). Recently, those stocks have fallen significantly due to concerns around Mexican government changes regarding airport tariffs. Given the volatility, why are Mexican airports good investments today?
Yes, I’m a long-time bull on the airport industry and have been extensively involved in the Mexican ones since the end of 2016 when they became deeply discounted due to the Trump election sell-off in Mexico. That worked out well until March 2020. The Mexican airports sold off about 70% in a matter of weeks during the onset of Covid-19. After calculating that they had plenty of liquidity to survive even a long-term stoppage of international flights, I added to those positions. Mexican airport traffic recovered dramatically and is now about 30% above 2019 levels, and the airport stocks shot up and – in aggregate – became my largest portfolio holding.
Up until this summer, the Mexican airport stocks were trading at all-time highs. But they have now dropped about a third off their prior levels. This comes for two reasons. One, there is a jet engine recall that has impacted a large portion of the fleets at discount carriers Volaris (NYSE: VLRS) and VivaAerobus. There will be fewer available seats in the Mexican market until that is resolved, and that’s an overhang on the airport story; shares were already down about 10% thanks to that.
And then the government got involved and created a panic. In October, the Mexican government informed the airports that it would be changing the tariff structure around the airport contracts. These contracts were signed in 1998 and run for 50 years, through 2048, with possible extension out to 2098. The contracts have a set compensation formula and include 5-year reviews where the airport operators lay out planned capital expenditures for the next five years while applying for an increase to the passenger fees they charge as compensation for improving the airport assets.
The announcement of an unspecified change in the contracts led to broad panic. There were fears of everything ranging from confiscation or nationalization to a punitive taxation structure that would crush the airports’ profit margins. The media headlines and social media chatter made it seem like the airports were in deep trouble. The most Mexico-exposed of the airport operators, Centro Norte (NASDAQ: OMAB), saw its stock drop 40% in a day, and it bottomed out at $50, down fully 50% from its recent highs.
The truth, however, ended up being much less dramatic than the social media chatter. The government and the airports negotiated, and the result ended up being a small increase in taxes on the airport operators which will reduce revenues by about 5% and cut earnings per share in the high single digits range.
And, it’s important to note, the Mexican airports received assistance during the pandemic. EBITDA margins at Centro Norte, for example, spiked from 70% pre-pandemic to as high as 78% in recent quarters. The government’s move now will merely return EBITDA margins back to about 70%, where they were in 2019. If this move had been presented as ending the sector’s pandemic-related excess profitability, I don’t think it would have made such a media sensation. And 70% EBITDA margins are incredible, we shouldn’t lose sight of that.
Unfortunately, because emerging markets get so little media coverage, investors generally rush to conclusions after hearing one or two bad headlines. Now, the narrative is that Mexico’s government is a meddling group that is untrustworthy and we’ll probably be stuck with that perception until the next presidential election in Mexico (which is set for June 2024).
The airports are back to trading around 10x EV/EBITDA, however, which is well below their long-term historical averages. Top-line traffic growth looks to be around 10% annually (excluding the engine recall issue) and earnings grow faster than that. I’d also note that they pay large dividends. Centro Norte and Pacifico (NYSE: PAC) both pay close to 100% of free cash flow as dividends. Pacifico should be able to pay about $7/share in annual dividends off of its current post-tariff adjustment earnings power, which leads to a 5% starting dividend yield which can subsequently grow at a low double digits rate for an extended period.
More broadly, Mexico’s economy is continuing to position itself for long-term success. In the wake of the pandemic, we’ve seen a dramatic restructuring of supply chains to bring production closer to end markets. For the North American market, Mexico is the only capable supplier of cheap labor at scale with good ground logistics connections to the United States and Canada. Mexico overtook China as the U.S.’ #1 trade partner earlier in 2023, and that advantage should only grow as we see new factories sprouting up across the U.S./Mexico border states. From autos to aerospace, food & beverage, packaging, medical devices, and even consumer electronics, there is an endless stream of new investments and factory expansion headlines. This bodes well for any firms that are in Mexican transportation, logistics, industrial real estate, and so on.
While there is vigorous debate over Mexico’s president and his economic policies, the money tells the real story. Multinational companies are aggressively investing in Mexico and have made themselves comfortable with the political and economic situation on the ground. And the Mexican Peso has been one of the world’s strongest currencies over the past five years; capital has been coming in steadily despite the uneven political headlines.