Mexican Retail market tied to U.S. Economy.

As the Mexican and American economies have become tightly linked, will a U.S. economic slowdown foreshadow hard times for American retailers doing business south of the border?

Mexico has great allure to American retailers wanting to set up shop abroad. Rising personal incomes, combined with a young population, will help support the growth of retail sales, including clothing, cosmetics and household goods, says John H. Rittenhouse, national practice manager in KPMG’s Operations Risk Management practice in San Francisco.

“Preference for [American] goods is widespread, particularly among young people, and brand recognition is strong. The sale of imported products is rising rapidly,” he says.

Mexican consumers between the ages of 16 and 24 years old make up almost 55 percent of the population, the highest percentage of any upper-middle income country in the world, Rittenhouse says.

Mexico’s largest trading partner is the United States, which accounts for almost a quarter of its GDP. But those ties can also be a drag on the Mexican economy; according to economics research firm FocusEconomics, which says a slowdown in the United States is hampering economic conditions in Mexico.

In addition, growth in remittances from the United States to Mexico slowed to 3 percent in the first quarter, compared to a 28 percent rise during the same period last year. “Mexican workers send back billions in remittance each year, which is an important part of the Mexican economy,” says Bruce Barren, CEO of Los Angeles-based EMCO/Hanover, a mid-market financier.

“Over the past decade, retailers have rushed to set up stores in Mexico,” Barren adds. In addition, Mexico has provided U.S. companies, including food manufacturers, tax incentives to establish businesses. This helped attract foreign investment, he adds. “The labor has been inexpensive and there’s a growing middle class.”

Over the past decade, foreign retailers, including Wal-Mart Stores, have carved out a profitable niche in Mexico. The largest retailer in Mexico is Wal-Mart de Mexico (Walmex), which has more than 903 stores. It reported $18.3 billion in sales last year, up 16 percent from $15.4 billion in 2005. Between 2005 and 2004, sales increased 13.7 percent.

Domestic retailers such as Soriana have also experienced strong growth. It expects sales to increase 15 percent this year, while Gigante, Mexico’s fourth-largest big-box chain, has also reported strong sales growth.

Like companies in other sectors, retailers have flourished thanks in part to the 1994 North American Free Trade Agreement (NAFTA). Barren claims at least half of all new jobs in Mexico stem from the trade agreement, which is helping to create a burgeoning middle class.

Mexico’s GDP grew 4.4 percent last year, according to FocusEconomics, and is expect to grow 3.4 percent this year. (U.S. GDP grew 3.3 percent last year, according to the U.S. Department of Commerce, while in the first quarter of 2007, GDP increased 1.3 percent.)

Although retail growth is still strong, Barren says there’s a risk of overbuilding in Mexico. Retailers could be investing more heavily in China and India, which offer more sustained growth, with annual GDP increases of 8 to 10 percent.

“The fringe benefits, including medical costs, are expensive in Mexico,” Barren says. “Companies must be prepared for this — it’s difficult to terminate a Mexican employee.”

While Asia is a lure for many U.S. retailers, developing retail operations in Mexico is a less arduous process, says Richard Talbot, president and CEO of Talbot Consultants International in Ontario, Canada. “Going into China and India requires a lot more homework,” Talbot says. “There’s much more bureaucracy to deal with, such as working with local partners. It’s much easier to cross the border than to go to China or India.”

But while American retailers should be cautious about over-expanding in a market so dependent on the health of the U.S. economy, Mexico’s underlying fundamentals are still strong, says KPMG’s Rittenhouse. He points to Wal-Mart de Mexico’s 16 percent increase in sales last year.

Credit growth is also playing an important part in Mexican retail, Rittenhouse says. From 2002 to 2006, the number of credit cards issued rose 170 percent to 20.2 million, according to the Bank of Mexico. Greater competition in the banking sector, and retailers extending credit, will help to support sales growth and customer loyalty.

About 81 percent of purchases in Mexico are made with cash, according to the Nilson Report, a payment research company based in Carpinteria, Calif. Only 7 percent of the purchases are made with a credit card, compared to 49 percent in the United States.

As the use of credit increases among Mexican consumers, Rittenhouse says retailers should focus on their core business of offering quality merchandise at affordable prices. Retailers too heavily invested in the credit business put themselves at risk to losses from defaults if the economy turns sour.

Over the last several years, for example, many U.S. retailers have sold off their credit card portfolios to reduce their exposure to default.

There’s a risk when retailers set up a bank, which they are allowed to do in Mexico. But doing so could help differentiate them from competitors, Rittenhouse says.

Last year, the Finance Ministry gave Wal-Mart de México permission to own a bank, and the retailer is scheduled to open a bank in the second half of this year. Analysts say doing so could help boost sales because as many as 80 percent of Mexicans do not have bank accounts.

By Kathleen Kiley, Managing Editor, Consumer Markets Insider
Courtesy of http://www.kpmginsiders.com