abc Global Research LatAm Equity Insights Consumer price reality check

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1 Equity Strategy Global Research LatAm Equity Insights Consumer price reality check has the highest consumer goods prices in LatAm is below average, challenging antimonopoly agenda Big Mac index supports view on MXN upside, BRL downside Issue No. 3 Ben Laidler LatAm Equity Strategist HSBC Securities (USA) Inc ben.m.laidler@us.hsbc.com Alexandre Gartner* Equity Strategist HSBC Bank Brasil SA alexandre.gartner@hsbc.com.br Juan Carlos Mateos*, CFA Equity Strategist HSBC, SA juan.mateos@hsbc.com.mx Francisco Schumacher, CFA Southern Cone & Andean Strategist HSBC Securities (USA) Inc francisco.j.schumacher@us.hsbc.com View HSBC Global Research at: *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Issuer of report: HSBC Securities (USA) Inc Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it We sampled retail prices of 12 common consumer products across the six major LatAm markets. Price divergences are striking, reflecting differing local costs, tax structures, and competitive dynamics. Coke in is near twice the price of that in. mobile rates are more than twice those in. A fictional basket of these goods is cheapest in at USD156 and, while most expensive in (USD23),, and. When compared as a percentage of the minimum wage in these countries, as a rough proxy for relative affordability, however, is by far the most expensive, and the cheapest. Monthly minimum wages in the region are close to USD2 on average, with an outlier on the downside, at cusd15. This is consistent with the lack of real wage growth in in recent years and its strong manufacturing cost competitiveness. Our unscientific sample seems to challenge the perception that Mexican consumer prices are high, in absolute terms, supported by the oligopolistic structure of a number of industries, and a clear focus of the authority s competition reform agenda. All but three cigarettes, cement, and air travel of our 12 goods are at a discount to the LatAm average, with an average discount of 18%. Real overvalued, Mexican peso cheap. Looking at the relative price of McDonald s Big Macs in the region, versus the US (USD4.33), gives a snapshot of possible FX over or under valuation. On this basis, the BRL is still overvalued (HSBC s year-end 213 BRL/USD forecast is 2.3), while the MXN is significantly undervalued (we expect appreciation to 12.2 by end-213). HSBC s REER analysis is less binary, showing the BRL, for example, closer to fair value versus history. Sector highlights. mobile rates are close to the LatAm average. s rates are the highest. has the cheapest cable TV in the region, and the highest. Argentine (Ambev and CCU) beer prices are also the highest in the region, by far, and in line with New York prices. (Coca-Cola Femsa, Arca Contal) has by far the cheapest Cola prices, and also the world s highest per capital consumption by far. has LatAm s highest cement prices. s are close to regional average, as retail demand has been falling relative to bulk.

2 Consumer reality check We sampled retail prices of 12 common consumer products across the six major LatAm markets. Price divergences are striking, reflecting differing local costs, tax structures, and competitive dynamics. Coke in is near twice the price of that in, while Mexican gasoline is 4% cheaper. LatAm consumer prices (USD) ARG BRZ CHL COL MEX PER Beer Soft drinks Bread Burger Tissue Cigarettes Cement Gasoline Mobile Cable TV Fixed line Air fare A fictional basket of the monthly consumption of these goods is cheapest in at USD156 and, while most expensive in (USD23),, and. Monthly basket* cost Consumer basket as % of monthly minimum wage 12% 1% 8% 6% 4% 2% % Monthly minimum wages in the region are close to USD2 on average, with an outlier on the downside, at under USD15. This is consistent with the lack of real wage growth in in recent years and its strong manufacturing cost competitiveness. LatAm monthly minimum wage (USD) When compared as a percentage of the minimum wage in these countries, as a rough proxy for relative affordability, however, is by far the most expensive, and the cheapest. When looking at average wages, however, the differences adjust. monthly wages in are around USD6, and in USD88. s higher average wages adjust for the higher cost in our fictional consumer basket and both baskets cost 26% of average monthly wages. 2

3 Our unscientific sample seems to challenge the perception that Mexican consumer prices are high, in absolute terms, supported by the oligopolistic structure of a number of industries, and a clear focus of the authority s competition reform agenda (for details, see Juan Carlos Mateos s 13 December report, Equity Strategy/FI Strategy & Economics: The Mexican President: First steps, firm steps). All but three cigarettes, cement, and air travel of our 12 goods are at a discount to the LatAm average, with an average discount of 18%. consumer goods vs LatAm average (USD) Difference Beer % Soft drinks % Bread % Burger % Tissue % Cigarettes % Cement % Gasoline % Mobile % Cable TV % Fixed line % Air fare % -18% A countervailing view is that the dominant driver of relative prices across the region is trade openness (exports + imports). On this count, scores well, with exports+imports equal to 61% of GDP (see chart below), compared to only 19% in. Less openness tends to imply more pricing power. This is supported by the Big Mac index (next section), where is also somewhat expensive, another relatively closed economy. The big surprise on the Big Mac index is, though a word of caution here that the Economist has removed the country from its index as it controls prices, distorting the data. LatAm trade openness (exports+imports/gdp) CHI MEX PER VEN URU ARG COL BRA Openness (% of GDP, 211) Looking at the relative price of McDonald s Big Macs in the region, versus the US (USD4.33), gives a snapshot of possible FX over or under valuation. On this basis, the BRL is still overvalued (HSBC s year-end 213 BRL/USD forecast is 2.3), while the MXN is significantly undervalued (we expect appreciation to 12.2 by end 213). HSBC Big Mac Index vs US Big Mac price 25% 15% 5% -5% -15% -25% -35% HSBC s REER analysis is less binary, showing the BRL, for example, closer to fair value versus history see the chart below. For additional currency REERs, see Clyde Wardle s Emerging Markets FX Roadmap: The long and short of it. (14 December 212). 3

4 BRL REER index Source; HSBC A word on methodology. Items were mainly surveyed from online retail sites of the major country supermarket chain. Goods were for the category market leader. Standard prices only. No special offers. Items surveyed Item Format Beer 35cl 6 pack cans, market leader Soft Drinks 1.5L Coke Light non-returnable Bread Sliced white bread 4g or nearest, market leader Burger McDonald s Big Mac Tissue 1 roll paper towel. midrange Cigarette 2 pack, light, entry level brand Cement Sack, 5kg, market leader Gasoline Basic, unleaded, 1 liter Mobile Prepaid, per minute, cheapest Cable TV Basic, 4 channels or equivalent, monthly Fixed Line Unlimited minutes plan, monthly, market leader Airfare Capital to 2nd city, cheapest return, economy, 4wks Beer (Lauren Torres) has LatAm s cheapest beer prices, even as it has one of the lower beer per capita consumption levels. SABMiller is the market leader. By contrast, another SABMiller market has some of the highest. Beer prices in and both markets where Ambev/ABI are (or about to be) market leaders have similar prices. Argentine (Ambev and CCU) beer prices are the highest in the region, by far, and in line with New York prices. Argentines still manage to consume a globally competitive 43 liter/capita annually. Beer prices (35cl six pack, leading brand) Soft drinks (Lauren Torres) Soft drink prices are generally the most closely bunched of all the prices we looked at. (Coca-Cola Femsa) has the highest prices. (Coca-Cola Femsa, Arca Contal) has by far the cheapest but they are still twice the price of Coke s local water brand. It may be no coincidence that has the world s highest per capita Coke consumption, by far, at about 7 eight oz servings per capita. This is three times that of. has both the highest cost in our survey and the lowest per capita in the region (under 15 eight oz servings). Soft drinks: Diet Coke, 1.5L non-returnable

5 Cement (Francisco Suarez) (Cementos Argos, Cemex/Cemex LatAm Holdings, Holcim) has the highest retail cement prices in LatAm, while (Cementos Pacasmayo and Cementos Lima) has some of the cheapest. Mexican (Cemex) and ian (Camargo Correa, Votorantim, Lafarge) cement prices are close to average for the region, and both have similar consumption levels, around 4kg/capita. Mexican retail demand has been falling relative to bulk, impacting cement prices, as the industry has fragmented and pricing power has eroded. Industry capacity utilization rates are only 63%. Cement Prices (5kg Bag, Market Leader) Mobile (Richard Dineen) (Telefonica), (AMX), and (Entel) have the cheapest per minute mobile calls (pre-paid). has by far the most expensive, in line with some of the world s highest interconnection fees. mobile rates are close to the LatAm average. Mobile telecoms voice prices generally deflate over time. This is because of the lack of voice call quality differentiation (on a call, it is difficult to tell the difference between operators), and the high number of mobile competitors (three to five, generally) that consequently compete on price. High-inflation countries such as are the exception where operators can increase voice prices, but generally these increases lag behind inflation. has the highest mobile prepaid per minute price in the region in large part because has the highest mobile termination rate (MTR) in the region, as other countries have cut these rates significantly over the past few years. While s MTR now is one of the lowest in the region following the greater than 6% cut in 211, prices still remain higher than much of Latin America (other than due to the high MTRs and due to high inflation) primarily because of the strength of America Movil s Telcel, which commands 7% mobile subscriber market share. Mobile: Prepaid, per minute, cheapest Cable TV (Richard Dineen) (Televisa, Megacable) has the cheapest cable subscription rates in the region, while (Clarin, Telefonica) has the highest. LatAm cable TV pricing tends to increase over time as demand and penetration levels increase, and there are only one or two major players per market. has high cable TV prices (for the region) due to high inflation and Clarin s Cablevision having almost 5% market share. 5

6 also has one of the highest pay-tv penetration rates in the region (over 8%). In contrast, has one of the lowest pay-tv penetration rates in the region (4.5%) due to the huge popularity of free-to-air broadcast content, eg tele-novelas and sports. While s penetration rate is lower (c36%), higher taxes in impact that country's average price. Cable TV prices (monthly, basic) Fixed line (Richard Dineen) Fixed-line telephony is considered a necessary service by governments. Additionally, most LatAm countries have fixed line incumbent operators, which have had a monopoly on fixed line that came with certain universal coverage requirements. In short, the government expects cheap nationwide fixed-line access. Therefore, fixed-line prices are generally more regulated than mobile prices, which sometimes causes a disparity when comparing fixed prices across the region. For example, the Argentine government has in place a decadelong fixed-line price freeze, which is why fixed-line pricing appears relatively low, despite high inflation in the country. In, Telmex (c8% fixed-line market share) has not raised rates since 21, primarily due to regulation. Fixed line (unlimited plan, monthly, market leader) Gasoline The wide variance in gasoline prices reflects local tax rates and whether the country is an oil producer. has the highest prices in the region, having to import all its needs. has the lowest, being a significant producer (though also a gasoline importer). Much of the region including and has regulated or subsidized retail gasoline prices, largely designed to maintain relative price stability. Not included in this survey is Venezuela, a large producer that heavily subsidises prices, so pump prices are around USD.2/liter. Gasoline (basic, unleaded, 1 liter)

7 Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Ben Laidler, Alexandre Gartner, Juan Carlos Mateos and Francisco Schumacher Important disclosures Stock ratings and basis for financial analysis HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a -3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice. Rating definitions for long-term investment opportunities Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock s domestic or, as appropriate, regional market established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5 percentage points over the next 12 months (or 1 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 1 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change. 7

8 *A stock will be classified as volatile if its historical volatility has exceeded 4%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 4% benchmark in either direction for a stock's status to change. Rating distribution for long-term investment opportunities As of 18 December 212, the distribution of all ratings published is as follows: Overweight (Buy) 46% (28% of these provided with Investment Banking Services) Neutral (Hold) 37% (27% of these provided with Investment Banking Services) Underweight (Sell) 17% (2% of these provided with Investment Banking Services) Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at * HSBC Legal Entities are listed in the Disclaimer below. Additional disclosures 1 This report is dated as at. 2 All market data included in this report are dated as at close 18 December 212, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 8

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10 Global Equity Strategy Research Team Global Garry Evans Global Head of Equity Strategy Daniel Grosvenor daniel.grosvenor@hsbcib.com EU and US Peter Sullivan Head of Equity Strategy, EU and US peter.sullivan@hsbcib.com Europe Robert Parkes robert.parkes@hsbcib.com CEEMEA John Lomax john.lomax@hsbcib.com Wietse Nijenhuis wietse.nijenhuis@hsbcib.com Asia Herald van der Linde Deputy Head of Research and Head of Equity Strategy, Asia- Pacific heraldvanderlinde@hsbc.com.hk Devendra Joshi devendrajoshi@hsbc.com.hk Steven Sun stevensun@hsbc.com.hk Roger Xie rogerpxie@hsbc.com.hk Taiwan Jenny Lai Head of Taiwan Research jennylai@hsbc.com.tw South East Asia Neel Sinha Head of Equity Research, South East Asia neelsinha@hsbc.com.sg India Jitendra Sriram Head of Research, India jitendrasriram@hsbc.co.in Korea Brian Cho Head of Research, Korea briancho@kr.hsbc.com