Mexico's manufacturing sector readies for Industry 4.0

A number of factors bode well for Mexico’s industrial sector. Cheap labour costs, proximity to the US market and improving human resources have attracted global firms. Additionally, as trade tensions between the US and China show no signs of abating, multinationals are now looking to move manufacturing to Mexico in order to maintain ties to the US market and avoid additional tariffs. That said, the election of President Andrés Manuel López Obrador – better known by the acronym AMLO – has brought uncertainty to the industry through polices such as halting development at planned special economic zones (SEZs). While exports remain robust, manufacturing growth was sluggish in 2018, increasing by a marginal 0.23%. A rebound in the first half of 2019 failed to occur, with 25 out of 29 industrial segments reporting declines in activity, according to the National Institute of Statistics and Geography.

Nevertheless, Mexico’s productivity and labour costs remain attractive, with the World Bank ranking Mexico 51st out of 137 countries on its Global Competitiveness Index in 2017, up from 61st three years prior. “Mexico’s manufacturing platform is highly competitive and productive,” Emilio Uquillas, country representative at the Development Bank of Latin American, told OBG. “This provides a key advantage for expanding trade relationships to new markets, including China.”

Precious Metals 

In 2018 mining activities made up 8.2% of industrial output, according to the Mining Chamber of Mexico (Cámara Minera de México, Camimex). The sector contributed MXN443bn ($22.9bn) to the economy, comprising 2.4% of GDP. It is the country’s sixth-largest generator of foreign currency reserves, with contributions up from $17.5bn in 2017 to $18bn in 2018. As the number-one producer of silver, and the ninth-largest producer of gold in 2017, precious metals play a key role in the mining industry. Together, gold and silver comprised 44.5% of the total value of mineral output in 2018. There have been positive movements in the precious metals industry. Gold prices increased by 8% in the first six months of 2019, to a six-year high of $1481 per oz in July 2019. Meanwhile, the negative correlation between precious metal prices and stock market performance could mean prices will increase, given that forecasters predict a global economic slowdown in the short to medium term.

Industrial Metals

Investment in the mining industry has maintained its upward trajectory, with figures reaching $4.89bn in 2018, up 13.7% from $4.3bn in 2017, but still far from its $8bn peak in 2012. Unlike precious metals, industrial metals could face challenges as investors wary of global trade tensions and economic performance put the brakes on new developments.

However, there are some exceptions to this trend. Demand for copper and lithium, which are integral to electric vehicle battery production, will likely rise due to a worldwide push to transition away from petrol engines (see analysis). UK-based Bacanora’s lithium mine development in Sonora and Grupo Mexico’s El Arco copper mine in Baja California both underscore the increasing investor interest in the two commodities.

Food Processing

According to the National Agricultural Council, as of March 2019 agricultural processing accounted for 8.5% of GDP, employing around 14% of the labour force nationwide. Mexico ranked as the 10th-largest exporter of food in the world, sending products to 180 countries and generating a value of $35bn in 2018. Key crops include avocado and mango, for which it is the number-one producer, as well as tomato, melon, watermelon, cucumber, papaya and chickpeas, among others. Combined with tobacco, food and beverage production comprises around one-quarter of Mexico’s manufacturing GDP, according to a report on Mexican agri-business released by the Ministry of Foreign Affairs of Denmark. Growth in agri-business reflects both local and global demand for manufactured and processed food products.

Mexico is home to important brands, such as conglomerate Bimbo, the world’s largest bakery. Bimbo owns global brands Thomas’ English Muffins and Sara Lee, which are popular in the US market. Mexico is also a strong producer of ultra-processed foods, including Guadalajara-based Valentina hot sauce bottled by Salsa Tamazula, and processed fruits and vegetables. Locally, Sigma Alimentos, Herdez and Sabritas are among the top producers of snack foods and processed meats.

However, food security policy promoted by the administration of President AMLO could see a shift away from large-scale food processing in the medium term in favour of smaller developments. The National Development Plan 2019-24 seeks to reduce dependence on imports and increase self-sufficiency by pledging to support coffee and sugar farmers, and by subsidising rice, maize, milk, bean, wheat and cattle farmers. Still, the long-term global trend of increased demand for processed products will likely benefit manufacturers.

Beer & Tequila

The country remains the top exporter of beer and the only producer of tequila in the world. Beverage giants Grupo Modelo and FEMSA México control the majority of the beer market, with flagship products like Corona, Modelo and Pacifico. Furthermore, FEMSA México is also the main bottler of Coca-Cola in Mexico and Latin America. In 2018 Mexico exported $4.5bn worth of beer, amounting to 28.5% of global beer exports. This was followed by the Netherlands ($2bn, 12.9%) and Belgium ($1.8bn, 11.1%). Mexico is also one of the world’s fastest-growing exporters of beer, expanding by 86.3% between 2014 and 2018, and placing second only to South Korea, which was up 111% during that same period.

Production of tequila is booming in response to global demand. According to the National Tequila Regulatory Chamber, tequila production increased by 13.9%, to 309.1m litres, in 2018. That same year exports grew by 5.5%, with 222.7m litres sent abroad. The US comprises 82.5% of Mexico’s total tequila exports, followed by Germany. Production is somewhat constrained, however, as the blue agave plant – the raw material used to make tequila – takes an average of seven years to mature. This, coupled with rising demand, has contributed to price hikes and put pressure on smaller producers.

Steel 

The steel industry is mainly concentrated in central and north-east Mexico, with three of the country’s nine smelters located in Nuevo León, which, together with Coahuila and Michoacán, is among Mexico’s top-three producers of liquid steel. According to the National Chamber of Mexican Iron and Steel Industries, Mexico is the world’s 14th-largest producer of steel, with volumes expanding by 1.5% in 2018 to reach 20.2m tonnes. That year 67% of exports were shipped to the US, followed by Colombia (11.6%) and Canada (4.7%).

However, there are a number of challenges for metallurgical plants. “Natural gas restrictions have affected production,” Erika Hernández, the director of statistics at Camimex, told OBG. “This has affected companies all over the country, resulting to decreases in output.” Additionally, the sector was affected by the 25% tariff on steel and 10% tariff on aluminium imposed by US President Donald Trump in March 2018. While the taxes on Mexican steel were removed in early 2019, the US is considering adding new duties on fabricated steel. The performance of the steel industry will likely have knock-on effects for related industries.

“The diversity of steel companies in the country means it can provide the recycling market with an ample supply of scrap metal,” Bernardo Llaguno Garza, CEO of recycling company Riisa, told OBG. “However, high recycling capacity means Mexico has to import scrap metals to keep up with the demand for ready-made recycled products used in the local construction, automotive and electronics markets.”

Electronics

Electronics manufacturing has considerable potential. The sector receives around $5bn in investment per year, and it is estimated that electronics manufacturing will grow by 2.5% per year through 2020. A number of multinationals consider Mexico their regional manufacturing base, including Japan’s Sony and Toshiba, South Korea’s Samsung, and US firms Zenith and Dell. While growth in exports over the past two decades has had a positive effect on the country’s electrical manufacturing base, the overall level of local content in electrical exports is low, with the country serving primarily as an assembler of imported electronic goods. For example, LCD screens are the industry’s main export, responsible for 25% of Mexico’s electronic machinery exports, but local content hovers at around 15% for flat-screen TVs. This has led the government to seek direct partnerships with multinationals operating in the country to augment the national value chain, increase the participation of small and medium-sized enterprises (SMEs), and encourage greater interaction between multinationals and suppliers. According to offshoring services firm Tecma, local electronics manufacturing has grown thanks to double taxation treaties with more than 40 countries and some 28 investment promotion and protection agreements.

Electronics

Oil and gas are the feedstock of the petrochemicals industry, which produces plastics, industrial chemicals and other derivative products. While the country remains a large producer of oil and gas, production has declined over the years, and Mexico has become a net importer of derivatives like diesel and petrol. This lack of raw materials has affected the main segments of the petrochemicals industry, resulting in shortages. “The factors that have the greatest impact on the polymers industry are the supply of raw materials,” Pascal Kornfuehrer, managing director of polymer supplier Covestro México, told OBG. “This improved somewhat in 2018, but it continues to cause issues.”

An important milestone project was the Etileno XXI plant, built in the city of Coatzacoalcos in Veracruz, by a consortium led by the Brazilian firm Braskem, in partnership with Mexico’s Idesa Group. This $5.2bn project to supply more than 1.1m tonnes of polyethylene per year to the local market was the first major private sector petrochemicals investment since the 1990s and, according to the World Bank’s International Finance Corporation (IFC), which partly financed the plant, Etileno is the petrochemical industry’s largest-ever project-financing transaction in the Americas.

However, in 2018 and into 2019 the plant was running at 75-80% capacity due to a lack of sufficient ethane gas supply. While materials can be imported, this will likely eat into margins. “Oil and gas production has unfortunately been decreasing, and so if we do not have raw materials – ethane, methane or propane gas – widely available, it becomes hard to attract new investments,” Cleantho de Paiva Leite, director of business development at Braskem Idesa, told OBG. “You need a constant supply of raw materials before you make large investments.” Further commenting on the situation, Ary Naïm, the country manager at the IFC, told OBG that development of Mexico’s energy sector would be crucial for broader industrial growth. “We see the necessity of certain projects, such as Etileno XXI. This is a significant opportunity for Mexico to focus on its primary resources and add value to them,” he added.

Industry 4.0 

One of the primary goals of the Ministry of Economy (Secretaría de Economía, SE) is to fully embrace emerging disruptive technologies in industry. Across the country, the number of national research labs grew from 11 in 2013 to 72 in 2018, according to the National Chamber of Industrial Transformation, and universities in Mexico now produce over 110,000 graduates in engineering and technology fields each year.

“Mexico has traditionally lagged behind advanced economies in terms of research and development (R&D). However, its industrial sector has matured to the extent that it creates R&D within its borders, which it then exports to the world,” Martin Toscano, CEO of speciality chemical provider Evonik, told OBG. “A greater focus on education is partly responsible for this.”

Innovation Centres

In a similar vein, June 2018 saw the opening of the Regional Centre for Industrial Productivity and Innovation 4.0 in Querétaro. The purpose of the centre is to incorporate 3D printing, digitalisation and other computer-aided technologies into SMEs. The project was supported by the Technical University of Querétaro, the Mexico-US Science Foundation, the SE and the Secretariat of Sustainable Development for the State of Querétaro. While the push to embrace Industry 4.0 has been mostly encouraged by private companies, there are also a number of government-backed initiatives. In 2016 the state government launched the Nuevo León 4.0 programme, which works to build an advanced industrial base centred around innovative and automated technologies, alongside the development of a number of R&D centres. The state has become the pre-eminent regional hub for advanced industry and manufacturing, and a centre of digitalisation.

Embracing Industry 4.0 is not without its challenges, however. According to Carlos Sierra von Roehrich, the CEO of the Japanese chemicals manufacturer Kuraray, only around 30% of Mexican industries have fully gone through the digital transformation.

“The transformation process is complex and expensive, and some companies do not have a qualified individual who can effectively manage a company’s needs,” he told OBG. A large digital infrastructure gap also persists between areas, underscoring the need for more equitable investment. “Mexico has a remarkable technology gap between urban and rural areas,” Javier Moreno, sales director at Japanese multinational Daikin, told OBG. “However, this will undoubtedly change, particularly as the south and south-east of the country become more attractive investment destinations.”

In the interim, Mexico remains a strategic country for innovation, R&D and Industry 4.0, according to José Varela Garza, president and CEO of 3M México. “We are in the same time zone as the US, making Mexico the lab of the US in many aspects. Global firms can find affordable and skilled human capital here, though the country needs more qualified engineers to ensure it remains competitive on a global scale,” he told OBG.

Free Trade Zones

There is no doubt that Mexico is a manufacturing powerhouse, with industrially manufactured products making up 88.2% of exported goods by value. In 2018 Mexican exports grew by 10.1% to reach $450.5bn, of which $371.9bn worth of goods went to the US. Vehicle sales accounted for over one-quarter of total exports, or $115.5bn, followed by electrical machinery and equipment (18.2%) and computers (16.7%). The development of free trade zones has always been viewed as a key step in promoting investment in Mexico’s industrial sector. In April 2018, for example, then-President Enrique Peña Nieto announced a stimulus package to develop seven SEZs at a cost of MXN50bn ($2.6bn). Among other advantages, companies located in the SEZs would benefit from a 0% corporate tax rate for 10 years. Together, the seven SEZs were slated to attract MXN700bn ($36.2bn) in investment in the succeeding 10-15 years.

However, claiming the zones were of “no benefit” to the surrounding areas, President AMLO cancelled the SEZ project in April 2019. Instead, the administration has focused efforts on creating a free trade zone (FTZ) along Mexico’s 3800-km northern border with the US. The policy is driven by President AMLO’s promise to keep Mexicans working in Mexico instead of losing them to the US. The FTZ includes an income tax adjustment from 30% to 20%; a value-added tax (VAT) cut from 16% to 8%; and price incentives on petrol, natural gas and electricity within the FTZ. The minimum wage was also doubled from MXN89 ($4.60) to MXN176 ($9.10) per day. The VAT benefit in particular could provide enough of an incentive to attract companies to the FTZ. As is true across many sector’s, industry’s main concern is taxation, and specifically the VAT applied to commodity exports. SMEs, in particular, report that they find it difficult to keep up with production and export levels when VAT is applied at a higher rate.

Eastern Promises

Meanwhile, the potential for growth and expansion in new markets outside the US is growing. Mexico exports $10.8bn worth of goods to China. Machinery comprises around 45% of this, followed by mineral products (19%), transport-related products (13%), instruments (9.2%) and metals (5%). As China has named Mexican industry one of its top-five destinations for foreign direct investment, it is increasingly basing manufacturing in the country.

Localising production in Mexico has the added benefit of allowing Chinese companies to bypass many of the barriers currently being imposed by the US as trade tensions between the two countries continue. At the same time, Chinese companies will be able to take advantage of the US-Mexico-Canada Agreement and maintain access to the US market, while also opening up additional avenues for Mexican-made products.

Outlook

The industrial sector in Mexico is making gains in some strategically important areas, and strong performance in the mining, electronics and agri-business segments is driving overall growth. Even as protectionist measures and bilateral trade tensions dominate the headlines, Mexico is strategically positioned to support Chinese manufacturers looking to bypass US tariffs. A number of risks and uncertainties remain for several industrial segments, however. The shortage of oil and natural gas supply, the absence of a government-led policy and criminal activity along supply routes are causes for concern. Still, investors will likely see ample opportunities in Mexico’s strong ties to the global economy, especially the US and China.

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The Report: Mexico 2019

Industry & Mining chapter from The Report: Mexico 2019

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