Two ways to play the Latin building boom

While Britain wallows in debt, Latin America is forging ahead with massive infrastructure projects, says James McKeigue. Here, he reveals a great story that most investors are missing out on.

When Brazil overtook Britain as the world'ssixth largest economy this year, it was just the latest reminder that a new world order is being established. This is a world where fast-growing economies in Latin America and Asia are now challenging the traditional dominance of the Western world. And there are a clutch of economies in Latin America that I am particularly excited about.

The thing is, if you visit these countries, they don't actually look like they are catching up with us. Back in 2008, I was working with a US commodity magazine, Oil and Gas Investor. I was sent to investigate a billion-barrel oil find off the coast of Rio de Janiero. And in mythree months there, the city lived up to all my expectations. The nightlife was great. And interviewing people about the challenging new frontier of 'pre-salt oil' was pretty exciting too.

But it was a nightmare to get around the city. I spent countless hours trapped in the back of boiling taxis. I remember one day my cab inched past a metro station and I just had to jump out. I'd seen a map of the metro and it looked pretty extensive. And sure enough it seemed to go to the neighbourhood where the meeting was.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free
https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But halfway through the journey the train stopped and everyone got out. It turned out the fancy looking metro map wasn't quite what I'd thought. Only some of the stops were covered by the trains the rest were bus routes marked out to look like trains. I was struck that a city like Rio de Janeiro, the vibrant home tosix million people, had a less-extensive urban rail network than Manchester.

Of course, I'm not the only one to notice this. The Brazilian government has unleashed a huge infrastructure spending package to get the country up to speed for the World Cup and Olympics. The massive sums involved just in August a £40bn package was announced have attracted investors and construction companies from around the world.

But despite the massive amounts of money and interest in Brazil, I think some of the region's most interesting infrastructure plays lie elsewhere. And there is a great story here that most British investors are missing out on.

Colombia and Peru- a great infrastructure story

There are two aspects to an infrastructure story the need for something, and having the money to build it. You'll find both these things in abundance in Latin America.

The fact is and this may come as a surprise to some of you countries such as Colombia and Peru are in far better macroeconomic nick than the UK. It hasn't always been like this. During the 80s, Peru was riven with violence as the government battled with left-wing insurgents, Shining Path. The instability deterred investors, and the economy struggled to grow. Unable to balance the budget, the government printed money. As a result, inflation rarely fell below 50% in the decade, peaking in 1990 at an incredible 10,000%.

But in the 90s, controversial president Fujimori helped to turn things around. The son of Japanese immigrants, Fujimori was a virtual unknown before his shock election victory in 1990. In ten short years he seized dictatorial powers, waged a war against neighbouring Ecuador, crushed the insurgents, returned the country to democracy before fleeing to Japan when a corruption scandal threatened to bring down his presidency.

Unsurprisingly he's a pretty controversial figure in the country he's now in prison for directing death squads against the guerrillas. But one thing that can't be denied is his economic success. He brought inflation under control and opened up the country's natural resources for investors. And that laid the foundations for a remarkable economic turnaround.

Since 2003, the economy has grown at an average rate of 6.6% per year. The Peruvians used the good times wisely and the national debt has fallen to 22% of GDP from almost 50% in 2003. In Britain, it's more like 68% of GDP.

Colombia, further to the north, has a similar story. Like Peru, it has struggled with violence. Both from Farc, a left-wing insurgency, and from drug gangs. During the 90s, its capital, Bogot, held the tragic distinction of having the highest murder rate in the world. But, like Peru, it's turned the corner.

Backed by the US military, it has adopted a hardline stance against Farc and the drug lords and won major successes against both. Last year the murder rate fell to a 26-year low, while a new round of peace talks being held with Farc have raised hopes for an end to one of Latin America's longest-running insurgencies. The economy has also undergone a massive transition.

Colombia's economy has grown at an average yearly rate of 4.5% over the last ten years, and last month it overtook Argentina to become thethird biggest economy in Latin America, after Brazil and Mexico. Debt has been paid off, down to 46% of GDP from 52% in 2003.

That doesn't sound as impressive as Peru, but crucially, external debt, which is the sum of public and private sector obligations to foreign creditors, has fallen steadily from 40% of GDP in 2003 to 22% today. Cutting foreign debt matters, because it makes a country less dependent on the mood swings of foreign investors.

In short, both countries can afford to roll out infrastructure.

A massive infrastructure deficit

Just as these two governments have successfully set about cutting their spending deficits, they're now turning their attention to the infrastructure deficit.

At present, the Colombian government currently spends 1% of its budget on infrastructure. That's shockingly low. The European average is 5% of GDP while the Chinese invest around 9% of GDP.

The lack of spending is exacerbated by the country's challenging geography. The Andes mountain range, thick jungle and a tropical climate in places make it extremely difficult to transport goods and people around. As the Colombian ambassador to the UK pointed out with some frustration at a recent meeting: "It costs more to send bulk goods within certain points in Colombia than to ship them to Europe!"

But now Colombia is addressing the problem with an extensive range of road, rail and air links. According to Vanessa Buendia from the Infrastructure Journal, "the ten-year development plan is estimated at circa $20.5 billion".

It's difficult to get across how important these infrastructure works are for the country. Unlike Britain, where we're debating a new railway to shave minutes off the journey from London to Manchester, Colombia's plan will link thousands of remote communities. As Antonio Navarro Wolff, a former leader of the M-19 guerrilla movement and now a politican, pointed out in the FT, infrastructure matters because "guerrillas start when roads end".

Another serious problem for Colombia is displaced people. During the violence of the 80s and 90s, many Colombians were forced from their homes. As a result, there are now an estimatedfive million displaced people. Solving the problem completely will be complicated, because there are many conflicting claims for land.

However, one step the government is taking is to build massive housing projects 'Mega Proyectos'. To give you a sense of scale, the Ciudade Verde project on the outskirts of Bogot will have 350,000 apartments and houses. It is basically a mini city and will include hospitals, schools and the hydroelectric plants needed to provide power.

In total, the projects are likely to increase public spending on infrastructure to 3% of GDP. But the government isn't planning to pick up all ofthe tab itself. It's keen to attract private-sector backing, and has drawn up concessions for major projects. For example, by 2014, the government expects to concession 100% of the four-lane road network and 50% of railways.

Peru also has a massive infrastructure deficit. In fact a report from the World Economic Forum calculated that Peru has the second-biggest infrastructure gap in the region, just behind Bolivia. That's partly a product of challenging geography and decades of underinvestment. But it's also because Peru's economy has grown far more quickly than the infrastructure supporting it.

Like Colombia, Peru has a $20bn plan. But it is even more ambitious aiming to spend it all in the next five years. $11bn will go towards upgrading transport routes across the jungle and mountain regions. It will involve building 7,000km of new road and paving 85% of the existing roads, so that they can withstand seasonal weather changes.

Meanwhile, $8.3bn will be spent on railways linking towns in the mountains to ports on the country's Pacific coast, and on a new commuter line in the capital, Lima. There will also be money for new airports, telecommunications systems and river management.

Again, government spending is only part of the story as the Peruvians have a good record of involving the private sector. Since 2006, pending private investment in Peruvian infrastructure is up 300%, hitting $7bn last year.

Just as in Colombia, the infrastructure plan also has a strong social element. For left-wing president Humala, extending railways, roads and power lines is a very tangible way for him to spread the benefits of the country's economic growth to some of its poorest people.

Who will benefit most from the infrastructure boom?

In the longer term, better infrastructure will reduce costs for firms working in the region. Natural resource firms in particular will benefit both from improved links to the remote hinterland, where resources are often found, and better ports that allow them to export their produce. But in the more immediate future, construction firms, building material producers and engineers will share the spoils.

The positive thing about both countries is that they want foreign firms to take part in infrastructure projects. When Colombia completed the 'Ruta del Sol' coastal highway in 2010, for example, Brazilian and Italian construction companies took a large share of the $2.9bn deal.

Steel makers should also benefit. In particular I like Latin American steel maker Ternium (NYSE:TX). However, it's not really a pure play' for this story. Like its competitors, it's a large multinational whose overall share price won't be driven solely by events in Peru or Colombia. Likewise, all of the Latin American infrastructure funds are dominated by Brazilian holdings and don't offera way in to Colombia and Peru's infrastructure boom.

My preferred way to get direct exposure is the listed cement producers in both countries. Fortunately, many of them have a dual listing in America, which means they are relatively simple and cheap for British investors to trade. In particular, the Peruvian firm, Cementos Pacasmayo (NYSE:CPAC) is worth researching further. I'll be taking a closer look at Peruvian and Colombian stocks in thearticles to come.

This article is taken from The New World, MoneyWeek's FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.

James graduated from Keele University with a BA (Hons) in English literature and history, and has a NCTJ certificate in journalism.

 

After working as a freelance journalist in various Latin American countries, and a spell at ITV, James wrote for Television Business International and covered the European equity markets for the Forbes.com London bureau. 

 

James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. 

 

He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.