Chit Chat Stocks - Why We Own Consorcio ARA (Ticker: ARA.MX)

Episode Date: October 28, 2022

This is our Arch Capital Update episode, a monthly recurring series where we explore holdings and decisions made for our investment partnership. Consorcio ARA constructs and sells entry-level and middle-income residential housing developments in Mexico. The company was founded in 1977 in Mexico. Brett and Ryan dive through Consorcio ARA and outline the investment thesis for why we own the company in our Arch Capital limited partnership. ------------------------------------------------------------------------------------------------------------------------------------ What is Arch Capital? Arch Capital is a concentrated, long-only equity fund aiming to compound capital at an above-market rate. Arch managers are perpetual learners with a long-term focus that strive to build wealth with our partners through intelligent capital allocation. Learn more here: https://www.archcapitalfund.com/ ------------------------------------------------------------------------------------------------------------------------------------ Timestamps Why we own Consorcio ARA (1:08) Management (18:36) Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome to Chit Chat Money. This is our monthly Arch Capital episode. We are going to try to do a portfolio update for the fund that Brett and I manage once a month. Sometimes it'll be a pitch,

sometimes it'll be just an update on maybe a new holding or an existing holding that we've added to or even sold. Basically, anything that we think is a meaningful update for listeners, we're going to try to do that. We're trying to pair a little bit of the Arch Capital with our Chit Chat Money listener base. So today we are talking about our smallest holding as a percentage of the fund, Consorcio Aura. This also wraps up our home building month. So we've done now NVR, DreamFinders Homes, Zillow, LGI Homes. And today we are doing Consortio R, which is the Mexican home builder. Anything else that I should add on the intro there? Yeah. Before we go, I'll talk about what Consortio R is, but I should note that

the first day that this will come out, it'll still be under the CCM Plus subscription. However, if you are subscribed to that, we are ending that, like we said on the last episode. So just another update on that in case you didn't listen to the LGI one. We're going to make these free from now on. We're still going to do the newsletter updates along with it, make those free as well. And we're also going to do the same format with the Arch Capital episodes and the themes. However, we're not going to make it behind the payroll. If you paid, thank you very much for that.

And if you're listening to this and you didn't pay, hey, we're back on the free tier. So all the episodes will be free from now on. I think that explains it fully. But yeah, thank you again for anyone that tried to subscribe. It was an experiment. didn't go as we expected um or you know we think it's like cnn plus yeah something like that we wanted to quit uh and you know keep things back going uh in a way that we think is best for the long term and not delay the inevitable uh so we made everything free it's going to be ad supported

um going forward all right let's move into consortium aura i guess one other thing if you're interested in the fund we have a website that'll be linked in the show notes check that that. We just posted our Q3 letter talking about buybacks and stuff when share declines. But let's get to it. What is Consortio Ara? This is a company that I don't think any listeners have heard of, maybe a few, because I know some stuff is floated around Twitter and that's how we found it and Value Investors Club as well. But Consortio Ara is a home builder in Mexico. It is a diversified business that focuses on both affordable, middle income and higher income homes. It also apartment buildings, other dwellings, and across the whole country of Mexico. However, its largest operations

are both in Mexico City and the state with Cancun in it. It's got a weird spelling, so I just call it kind of the Cancun state. Consortio R runs a fairly traditional home building model and invests in new properties by purchasing land that it'll eventually build on. That's how it has a sizable land bag today, which is approximately 30.7 million square meters, which it estimates is enough to build over 120,000 homes. For reference, in 2021, the company sold approximately 6,464 homes. If a company keeps up its current home building pace, or excuse me, selling pace, it could build homes for over 18 years without acquiring any more land. So that, we'll get into it later, but the land bank is a big part of the thesis here. Of course, it is unlikely that

management will stop buying land uh for example it purchased more last quarter but it's an interesting exercise to go through nonetheless they do have a huge backlog of land um that they'll go through and that is making their book value a lot higher than uh it's a huge part of their book value it's a huge part of the balance sheet i'll talk about the positives and potentially some negatives there and how that you know it might not be worth what it is the land bank is has been shrinking uh yeah the business yeah the mexican industry home building industry has gone through a huge contraction from about 2015 and then covid kind of accelerated it but it was weird timing um if we look at this s&p global report which we'll link to in the show notes uh the

overall output of the home building market collapsed 47.7 percent from 2015 to 2020 there's been a bit of a small resurgence coming out of covid although it's been with interest rates rising and stuff like that, that's kind of put it, halted it in its tracks. But we'll get into the industry a little bit later. Let's go more into Consorcio Aura. Besides the general home building stuff, they have about 2.1 million square meters of the land they've set aside for commercial activities. They own already a few retail malls across Mexico, which generate consistent revenue. However, it is only a small part of the business today and is not important to the overall thesis, but something maybe to track if you're interested in them. They talk

about that revenue at every earnings report. Now, one thing that makes Consorcio R a unique compared to other companies in the home building space is that it owns its own concrete company. This is the most important commodity material for homes in Mexico. So this vertical integration helps Consorcio R insulate itself from commodity prices when they increase compared to other competitors that would be in the Mexican market. You can see that in their earnings margins over of the last few years as commodity prices around the globes have gone through. Globe, excuse me, not globes, have gone. They're kind of a big bullwhip effect, up and down, a lot of volatility there.

They've been able to insulate that because of the concrete they've owned. Now, a couple of important notes to give some context here if we ever talk about any numbers. So we're going to talk pesos today. Do the conversions if you want, but we really like to keep it in pesos just for comparison purposes. It's a lot easier. Their market cap is a tad over 4 billion pesos. They have net debt of negative 952 million pesos, which gives their enterprise value to about 3 billion pesos.

And then at the end of Q3, it had about 15.3 billion pesos of inventory split up between 4.2 billion of land currently under development and 11.1 billion pesos of works in progress. That gives them, and looking through the rest of their balance sheet, it axes out to a book value of about 14.3 billion pesos, giving them a price to book value of 0.28. So to give just, I'm going to give, I've put a few U.S. dollar figures in there. The market cap in U.S. dollars is $214 million. So just to give someone a little context on the size there. All right. And then just for the earnings numbers in 2021, they generated $691 million of operating incomes, $962 million of EBITDA, and $872 million of free cash flow to the firm.

They say free cash flow to the firm, but that's just generally just free cash flow. as we know, there's nothing different there. Those are the metrics that go into the firm though. It is. Well, it's good that it's going to the firm. That is actually a big positive that we'll probably talk about here in this episode is they do focus on cashflow as opposed to maybe some of the other home builders we've looked at. And they focus how it's coming to the firm and they can return it through dividends and share repurchases. But those are the three metrics that I think Consortio Aura focuses on a lot for their bottom line numbers. And those are what we focus on as well. Now, Ryan, do you want to give some history and important context for this investment? Because

Is this the oldest, well, maybe not the oldest, but one of the oldest home builders that's still been operational in Mexico today? Yeah, there isn't a ton of historical context that I can provide. The last 20 years, probably the most relevant, but Consorcio Aura was actually founded in 1977. So between 1977 and about 2000, I don't really have a whole lot of information, but it was founded by the Rusek brothers, predominantly German Rusek and Luis Felipe Ahumada Rusek. They both have really long names, a lot of middle names, but just think of them as the

Rusek brothers. There's really limited information on the two of them, but they're still at the helm and running the company today. They have been in this industry, obviously, more than 45 years since 1977, and they've shown durability and the ability to weather different cycles. As for the Mexican home market or the housing market, since about 2000 or starting in about 2000, U.S. private equity firms began investing really heavily into home building operations in Mexico. The one that was probably the most noteworthy was Sam Zell. He's sort of a popular

Chicago-based private equity investor. This overall influx of capital from U.S. private equity companies led to a significant home building boom in Mexico, but it was pretty much cut short around 2014, there was not only this oversupply of homes, and it was sort of a myriad of factors because there was actually some defects in a lot of the structures that were being built by some of these Mexican home builders that led people to flee these actual developments, which led to bankruptcies. Almost worse than the GFC in the United States. Yeah.

In some regards, and it was a little lagged, right? Not as a little different time period, but you had those effects plus this 2014 thing. And the actual GFC had a bit of an impact as well on Mexican housing. So it was kind of a double whammy there. But there was a large oversupply of homes and private equity dollars. Basically, a lot of the private equity companies pulled their investments from the Mexican market. But at the same time, there was also a Mexican government program that it was a subsidy program that was meant to encourage home buying demand that got cut around that 2014 period as well. So that kind of curtailed demand. So between the oversupply and the curtailed demand, there was a big crash in home prices and housing production since 2015 has been cut in half. Now it's starting to, I think, at least rebound a bit. This is supposed to be bullish, but for listeners, this lead into maybe the bull case from Sochi as we kind of give the bad context historically.

Yeah. The reason I'm saying this is that it's leading to what most people now, and you can kind of see in the numbers, regard as a housing shortage. So you've got some of the demographic stuff here. I believe it's 129 million people in Mexico. they built i want to say it was like 120 000 homes uh in 2020 it was 100 close 157.8 157 800 homes so 157 158 000 homes on a 129 million uh person country if you compare that to the u.s i believe during the same year 1.6 million homes were sold and the population is only three times as large so

clearly not enough homes being built. And we're going to talk about the demographic tailwind and then sort of the age, the average age that Mexico is running into here. But to continue on the history, throughout the last two decades, most of the companies were building at will because they had this constant flow of capital coming in. During that time, the Rousseff brothers ran the ran the business a little more conservatively. In fact, Consorcio Aura generated cash each of the last eight years and soon to be nine years. So they really have proven that when everyone else was kind of losing their heads about them, they've proven that they can stick through the cycle and be a little more durable. They also, as Brett mentioned, internalized some of their concrete

production, which insulated themselves from major cost increases. So that's kind of helped them out as well. And even though it's a bit of a conservative move to do that, I think it ended up being the right decision. Ultimately, the last nine years have proved or amounted to a really impressive balance sheet improvement. So in the third quarter of 2017, Consorcio Aura had $1.5 million in net debt. So they were in a net debt position today. And this is dollars, not pesos. And, oh, billion? Not billion. It's million. This is million. It was a tiny amount of net debt, but it's US dollars. Keep that in mind. Today, they have $48 million in net cash. And they actually just took on some new notes that

they felt comfortable taking on cheaper debt. Green bonds, low interest rates. There we go. So really lots of cash on the balance sheet, plenty. And obviously they have a massive land bank that they can build on. So it's not bankruptcy. It's not a concern here. And they've really kind of made it through the eye of the storm, it looks like. They're now in a great position, not only operationally, but financially to benefit from this upcoming, I guess, demographic tailwind, which you're kind of about to talk about. So let's go to that. What is this demographic tailwind that people keep talking about for the Mexican housing market and how will consortia benefit? Yeah. Let me segue into that with a nice quote they had from their Q2 to kind of get

a little context for management commentary. Here's the quote. As we head toward year end, we will continue to focus on meeting the targets we set for 2022. The climate remains challenging. Economic growth is slower while inflation and interest rates are higher. The demographic bonus in Mexico, which means a constant demand for housing, along with the continuing supply of mortgage loans are elements in our favor. We know the climate is temporary, but our commitment is permanent. So I think the big takeaway is one, they're conservative, and two, they think for the long term, which are two positives in my book. But let's move to the demographics because they're quite exciting. And this is where, while it's not the most important part of our bold case,

we think it can bring some upside if they decide to grow this business. So I think the big question, You know, you have this land bank, you have 120,000 potential homes on their current land bank, but you need to sell homes there. So, you know, we need to know that there are going to be people that are going to want to buy these homes. So luckily, Mexico has fantastic demographics that should sustain home building demand for at least this decade, if not longer. So if you look at half the population is under 29, with a demographic pyramid that should see many people age into their home buying years over the next two decades. If you don't know the demographic pyramid, it's kind of those things with the women and the men on two sides, and then you have those bars for the different five-year age groups. So to illustrate this, and we'll have this in the newsletter that we send out, let's compare the Mexican demographic pyramid to the United States. You look at Mexico, you have a big base at the bottom, so the people under 30, there are a ton of them, and there's a lot less people that are old.

And if you look at the United States, it's a much more evenly distributed. Actually, the majority of people are kind of in that 25 to 70 range. And those are people that are already buying homes. So for Mexico, they're going to actually age in much, much more people into their home buying years over this decade. We think that is fantastic tailwind. Now, on top of this, as Ryan mentioned, there's estimated to be a huge housing shortage, according to SME Global.

And again, these are just estimates. The shortage could be as high as 9.4 million housing units. So with only 158,000 units built across the country in 2020, I mean, the country will likely need to double or even triple its annual output to even get close to fulfilling this demand. If not, prices will likely rise with an increasing supply shortage. Because if you have these people aging into the market, again, this is a thesis and there are a few variables here.

So it's hard because it's a bit more complex. It's not too simple. uh it prices should rise just because of the supply shortage you know the homes will only be available for the rich people and again either way that should benefit uh from consortium are and either we get more to more supply uh or sorry more volume or higher prices and one i guess counter to that demographic tailwind that i saw from uh a good sub stack write-up that kind of spoke against consortium the consortium thesis was that you have a lot of multi-general generational households in mexico yes that is true but eventually those old people if you look

at the demographic tail end there's too many young people that there won't be enough houses um even if the old people pass down all their homes to the younger people so yeah and even and if that is a trend where you have the multi-generational households i think there's enough margin of safety within the supply shortage where if it's not as high as people say then it's still you know a pretty sizable shortage relative to the housing industry's annual volumes all right any other uh yeah i guess the last thing here so this is more long term but we also believe there's upside with the west and the united states decoupling from china and reshoring manufacturing in north america uh mexico should be able to absorb a lot of this manufacturing capacity

Are they seeing announcements from that? Theoretically, this should boost the economy and the ability for Mexican citizens to buy homes if the United States has better relationships, is sending money down there. Think of it as kind of a money flow. If there's investment down here or more vacation homes or more companies down there in Mexico from the United States, that is a wealth transfer to people that are working there. And that could benefit people's ability to buy a home. It's not a core part of the thesis.

We don't need this to happen for it to work out, but we think it's a nice tailwind that warrants any consideration. So taking all these factors into consideration, we have no problem forecasting consistent demand for consortia of ours homes over the next decade. Now, while we say consistent, we don't mean they need to grow because sometimes they do not grow. And then it's kind of the big, one of the downsides is that they are comfortable having slower years, which some investors may be frustrated with, but we're still very comfortable

and projecting that they'll have consistent demand for their land bank, even if there are some, I don't know, headwinds or the supply shortage isn't as great or the demographics don't work out. All right, let's move to management, which is a very important part of our thesis when we evaluate stock. One of the most important things we're learning in 2020, 2021, and 2022, that it's even more important than it may be us and other investors have thought, but I'm going to transition back to Ryan.

What gives us confidence in consortia R's management? Why do we trust them with our money? Yeah, management's always a big component of our thesis. And I'd say it's even, it's more amplified in this situation because it's a market that we're not familiar with, or at least not familiar investing in it. So first off, as I mentioned before, during sort of this previous mania that occurred a decade ago, the Rusek brothers maintained solid operating discipline. They survived the collapse.

A lot of companies did not. A lot of homebuyers went bankrupt during that time. And not only did they survive, but they actually generated profits every year despite diminishing homebuyer demand coming out of that. So I guess in other words, they really know how to operate a home building business and they've kind of got the scars to prove it. And they've made the improvements to insulate themselves from too many external factors like you're seeing with that concrete production capabilities internalized. Other things that I'll mention, they are pretty financially conservative, but they're still capitalizing on what we think and what they think is a cheap valuation. So in June, Consorcio Aura bought back 1.6% of their outstanding shares. At the same time, one of the founders of the business bought 2.4% of the company.

I know that's not a creative to the pro share value, but it's not a negative to have an insider buying. And then the other thing that's worth mentioning, well, the other thing is right before that repurchase of 1.6%, there was a cancellation of 1.72% of their treasury stock in April. And then on top of all of that, they raised their annual dividend by 45% versus a year ago to 290 million pesos. So it comes out to about a 7.2% annual dividend yield at the current price. So between the buybacks and the dividend yield, you're getting about a 10% shareholder return. 10% of the market caps return to shareholders every year. That shows that

they're willing to capitalize and that they're willing to increase the returns to shareholders in times of duress for the stock. I guess to boil it down to a couple of things, the company doesn't file a proxy statement, but I've seen estimates stating that German Rusek, who is the founder that I mentioned, owns 28% of the company today. So there's certainly some,

their incentives are kind of tied with ours as investors and you can see that in their actions. But the three things I boil it down to on why we trust management is one, they've got a 40 plus year track record. anytime you can sustain a business and grow a business over 40 years, that's a testament to your capabilities as a manager. Two, they focus on cash generation and they don't take big risks. I know that's why a lot of investors don't like them is because they have been so financially

conservative, but I think they've seen the cycles and you can see by all the, I guess, dead home builders in Mexico that not taking the big risk was the right move for them. third one they've demonstrated their alignment with shareholders through the recent capital allocation decision so it's easy i think for ship for executives to sometimes pretend they're aligned with shareholders but when you're allocating capital or you're returning tons of capital to shareholders each year and you're doing incrementally more so when the stock comes down shows me that you you do have the right alignment with us all right what about yeah i I guess we just wrapped up a month of looking at homebuilders.

And I think on nearly all of them, we came away and said less interested. So yeah, we're talking about why we own one. So what are, I guess, the main downsides of the homebuilder business model? Why do you think Consortio Aura or why do we think Consortio Aura will do well in spite of this? Yeah, I think after studying the other homebuilders for the last month or so, we've come up with two main downsides of the homebuilding industry that they're tough working capital dynamics and then impacts from macroeconomic developments outside of company control.

Let's talk about both and why we're comfortable just given Conservatory R's position in the industry, the management stuff that Ryan talked about, and just their history of the ability to generate earnings. So first, the working capital dynamics. I mean, home builders generally have a tough time converting their operating income into cash flow because a lot of these earnings get stuck, quote unquote, in works in progress, inventory, stuff like that. I mean, Conservatory R definitely has that problem.

We see their works in progress. is a huge portion. It's much greater than their market cap or enterprise value. But in spite of this headwind, they have generated healthy free cash flow for many years coming out of the housing crisis of 2008, I think. And we don't have all the numbers. Only one year was negative cash flow, I think. And it's eight consecutive years. It's going to be nine once 2022 ends. So I think, I mean, look, we can talk about all day about how bad the home building business is. And we've seen that in some of the companies we've studied outside of NVR having difficult time converting earnings into cash flow. But Consortio Aura is very, very consistent

in what they do. Is it growing? No. And we'll talk about that kind of in the risk section later. For example, though, on their homepage, this is right on the homepage, and it shows that they focus on cash flow. They quote, for the eighth year in a row, we've generated positive free cash flow to the firm in 2021, this time totaling 871.9 million pesos. I mean, we appreciate the focus on cash flow. And even though the business model is constrained versus something that is a much cleaner, better working capital dynamics, it helps us think that they are aligned with what we want as shareholders, and that is generating free cash flow that they can return to us through dividends and buybacks. Now, the other thing that's not as positive for

Consortio Aura, but we think will be fine given the price we're paying, is in the macroeconomic developments that include rising interest rates that can hurt home affordability. When interest rates rise, mortgage rates tend to rise as well, which all listeners, I think, in the United States, at least, are seeing today in 2022. It's such a hot topic right now. I mean, that can make it harder for people to buy homes. This is happening in Mexico at the moment as well. The country is trying to fight inflation.

The central bank has increased its interest rate from around 4% in the 2022 trough. It was a little higher than 4%, but that's relevant, whatever, to just over 9%. today. While this is a concern, Consorcio Aura did generate cash from the 2016 through 2019 period as interest rates rose significantly in Mexico. And it's generating cash in 2022 with them rising again. So if things get really bad in Mexico from an interest rate perspective over the next year, and they rise even further, maybe it'll get so bad that they have a tough time. and housing prices go down or something like that. And it's, you know, it's bad for one year.

That could happen. However, with the demographic tailwind, the housing shortage that we talked about, we think they'll be fine even if the macroeconomic picture worsens in Mexico. Could margins deteriorate? Sure. Could the business go into a rough patch

if we have a global depression? I mean, definitely, but they're not. I mean, look, we're talking about global depression as the downside that's not. Like that's the downside for every stock. We think of stock trading at about 0.28 times book value is a good bet versus other parts of the market if we get a huge downside in the global economy, especially one that consistently generates cash flow. Yeah, let's walk through the valuation because, to be honest, this is really why we own the business. And I think Brett laid out there some of the reasons that home builders aren't the most advantaged business models and they're potentially kind of tied at the hip with just the housing market generally.

however, we think the floor is really, really high for this business. And I'll walk through why that is. So as of their most recent quarter, Consorcio Aura had 1.26 billion shares outstanding at its current price, $3.30 a share. That's in pesos. The market cap is 4.16 billion pesos or $214 million. I already mentioned that. On their balance sheet, they have about $213 million US dollars worth of land bank value, and that's carried at cost. So if we include half of the land bank value, and you could even omit it if you want, it really doesn't matter, but I'm just doing it to kind of be conservative and use half the land bank. And you include the net cash that they have on hand, which is 48 million US dollars. So they have 25% roughly of their entire market

cap in cash. The enterprise value comes out to about $55 million or $1.1 billion pesos. You can, like I said, omit the land bank value if you want. I mean, it has some value. It might be inflated, but it definitely has some value. But I mean, yeah, it could be worth less than they paid for it, but it's not like they're marking it up to, I don't know, going rates for land at the time or like the average price per square foot or something like that. It's how much they paid for it. That's what they carry it on their balance sheet app. But over the last 12 months, they've earned, and the last 12 months, to be clear, free cashflow is slightly depressed. I'll talk about why that is. But over the last 12 months, they've earned $32 million US dollars

in operating income and 17 million US dollars in free cashflow. Right now, free cashflow is lagging operating income because they're working on, I think it was, what was it? Nine big apartment buildings. Six big apartment buildings that are all nine stories. So big, big units. Okay. And that is being held on inventory right now. So it's being held in working capital. So it's not benefiting free cashflow once that closes, which I believe is expected to be 2023. Early 2023. Yeah. That'll get included there in their cashflow. So basically it's trading at an enterprise value to depressed free cashflow multiple of three times. And so that kind of, to me, shouts attractive. But then on top of that, they pay out that dividend that

currently yields 7.2%. They increased it by 45% this year. I think they're probably going to increase it next year. They pledged to buy back $100 million worth of pesos next year, which is 2.4% of their shares. So between those two, shareholders are getting basically a floor of 10% of the market cap returned to you. And the potential optionality, I guess, that those payouts grow.

Yeah, or the business grows, yeah. I mean, the upside is really that they grow, well, not just volume, because they have the mix between expensive homes and really cheap homes, but they grow their top line, which they haven't since 2015-ish. really since the GFC due to that supply crunch

that Ryan outlined in the history there, where that could reverse and we're thinking it could reverse. And that's why the demographics are so important because that's where we think the huge upside potentially could be. But when we look at the valuation, the floor is so low as well that we think it's a great risk-reward opportunity. Yeah, and if the valuation contracts any more from here,

like let's say it has, which would be pretty drastic if it halves and they continue their dividend payout, which they certainly have the capacity to do. You're looking at a 15% dividend yield. Like you're literally getting that in convert in pesos, but it's convertible to dollars each year. That's, that's pretty good. Yep. All right. Do you want to talk about why this, I mean, the stock performance has been underwhelming.

And so I believe it's actually down since before the GFC, why do you why is that and why do you think it'll change yeah i mean before it's down a lot since the gfc now look their total return they've had a lot of dividends so that total return is going to look a little bit different but it's an important question to ask because when you look at the company you're like okay stock's down a ton the business might not change much why should we expect to get good returns here um and this is a subjective question but we think there are a few reasons that the stock is down a lot from the GFC that are psychologically kind of maybe blinding some investors that know the stock and are keeping people away. First, the company has struggled to

grow unit volumes and revenues since the GFC. It's probably given investors little confidence that management is focused on growing the top line, which I know is very important for people and has seen that valuation, the multiple compression. However, we're already at the very, very depressed multiple. So from our point of view, this is kind of moot because we don't need volumes to grow to earn very, very strong returns from the stock going forward. Now, second one is that it's a dead stock. I mean, the stock is down so much. It's a small cap company going to micro cap, I guess, if you're in the United States terms. We believe a lot of investors just don't know this opportunity exists. And if they do, they are fed up with what the stock has

done over the last 10 years. If you've covered a stock for 10 years and it's gone nowhere, you know that you're going to be frustrated and that can really hurt your hurt yourself psychologically you might be like look i understand the thesis but i don't want to touch that thing we've all done it and then third one is that and i think this is the most important because it's kind of more fundamental to the business is the company has used the majority of the free cash flow it has generated over the last five years to pay down debt um and reversing itself like where i mentioned earlier from a positive to a negative net debt position as well as pay out the dividends. So those aren't going to show up in stock price returns with either, right? Because

the company pays off the dividends, not on the company's balance sheet anymore. And if you're reversing from a positive to a negative net debt position to get your balance sheet more conservative, that's also not going to show up as well, but they've already done the heavy work there. So we're not banking on consortia R to grow its revenue and unit volumes in order for this to be good investment. All we need to do is for the company to generate the cash and what it's done per four in prior years, and the entire enterprise value will have been generated in cash within approximately three to five years, probably closer to three, like Ryan mentioned before. Yes, previously, a lot of that was just sitting on the balance sheet, but now they've stated

that with the big negative net deposition, they're comfortable returning a lot of cash to shareholders, and they don't think they need to shore up the balance sheet anymore. uh you know i mean it's not it might not drive the stock price higher but the dividend payouts will be uh as ryan said the yield is going to get so high that uh we'll just make a lot of money there now the big risk with these assumptions that are at court a consortium just keeps accumulating pesos on its balance sheet um the risk is there but again the the that feels a bit unlikely because they have the consistent dividend strategy, which why would we expect that to change? Also, they have the buyback strategy as well, which will increase that

dividend per share. I don't think there's anything else about stock going down because that's not a huge part here, but I think one important thing that Ryan, I'll switch back to you are the risks. So what are the main risks we're watching for this investment and how will we know if the thesis is wrong? Yeah. I guess you already kind of mentioned this, but ultimately over the next three to five years, a consortium still generates anywhere near as much cash as they did in the last five. This investment is going to be good. It's going to produce good returns. So the big risk is anything that would influence that cash generation. And so to me, that is ultimately going to come down to home buyer demand. And there's no perfect way to track

that demand but we think the best way is to just follow the number of homes sold in mexico each year and the changes in mexican interest rates because obviously all l sequel horizon rates limits affordability um which could hurt we talked about something like every show which could hurt their margins yeah exactly and so the mexican lending rate uh over the last year has not been turning in the right direction it's currently 9.2 percent versus five and a half percent at the start of this year and mortgage rates in particular are above that i believe they've been quoted to start right around 12 percent um for most home buyers uh so much higher than the market or the than the u.s market but it really hasn't had that big of an influence on uh

consortio r's ability to sell homes so i think part of that is just that they were already so elevated that the going from 10 to 12 wasn't as quite of a big of an impact as it had as that 2% rate change had in the US. Exactly. When you're sub 3% mortgage rates going up higher, I mean, that's super low number. Also, the housing market was already in a huge downturn in Mexico from 2015 to now. So prices have not, I don't think they're in the same sort of, I won't call bubble, but inflated trajectory that they went on in the United States from kind of the 2014 period to now, which it seems like the industry sort of went in the opposite direction. The other risk here is that currency risk that Brett kind of alluded to. They earn money in

pesos and eventually will have to convert to US dollars. So if the peso depreciates versus the US dollar, our real return could be diminished. Fortunately, they pay out that 7% dividend yield each year. So it alleviates some of the currency risk because you can convert it at the time it's paid out. The other part, the peso has held up really well as of late to the US dollar. It's a testament to that thing that, again, it's not that important, but the reshoring to North America, I think is probably important to that regard. We're not forex traders, so that dividend yield really helps us because we'll be able to take some of that return converted to US dollars each year. But I think that the Mexico-Canada-United States partnership is going to be

very, very helpful for the currency not to get devalued. But again, looking at the risk, it got devalued by about twice of what it was. It was like 10 to 1 for the USD after 2010, and then it bumped up to 20 to 1 at some point in that mid-2010s range. And that could happen again, and that could be a big risk for us. If that does happen, it's certainly going to impact our real returns. However, the dividend certainly helps the dividend payout. Last risk It's just that the land value that they're quoting on the balance sheet, the land really isn't worth as much as they're quoting it for. As I mentioned, it's carried at cost, but some of this land could be worth less than

they bought it for, or they could develop homes on it and not do so profitably, which is quite the destruction of value. There was a good, there's some good notes on that, on that sub stack that anyone that becomes bullish because of this we want you to read that bear piece as well because he had some good points he's a mexican analyst um all right last question i guess i'll lead into it you want to just i guess you ask me because that's that's the format why all right so and i guess this is kind of what i've argued with you a little bit is this is a market we don't know we haven't invested there before. Should we avoid Mexico as a market? And how big is that foreign exchange risk? Because

that could really hurt our real returns. Is it even worth investing there? Yeah. So look, this isn't some crazy statement. We believe the Mexican market is riskier for US investors for a variety of reasons than investing in the home market. It includes not having boots on the ground, just at the companies, including having the language barrier, which hurts us when reading any sort of maybe reports that we'd be able to see in the United States, although they do have their earnings reports in English, but just general third-party reports, whatever. Second, having less confidence in the political environment, acting in the best interest of corporations. We've seen that in Mexico, plenty in their history. And third,

the currency gets devalued, as we mentioned, which mattered a ton to us. I mean, because of this, we think we need to see a huge discount to value. Ryan, you have something to add before? There is also the chance that the peso appreciates versus the U.S. dollar. That is true. So we cannot. That's not what's happened historically, but it's possible. Yes, exactly. So there is that uncertainty, which I think we do need to get a discount for, which I'm about to lead into.

But there is the uncertainty could be positive. So it's not like it's all negative there. But because of all these risks that I think everyone is aware of investing in emerging markets, or maybe Mexico may not be an emerging market, but whatever, in between emerging and Western, we need to see a huge discount to value and a fantastic risk reward opportunity if we were going to buy a Mexican stock over an American one. So if we were going to buy, say, Consortio Aura over NVR, we need a big, big, big discount. We want the future returns to be much, much higher because the risk is higher. For this reason, we do not entirely avoid international stocks, but just hold them to a higher return standard to compensate for this risk. I mean, with Consortio Aura, when we look at the stock today, we think there's fantastic opportunity for shareholders over the next three to five years. and it comfortably could return 20% to 30% if things go right.

Now, if things go poorly, the returns are probably closer to just the dividend yield, given all the cash you're going to generate. We still think the floor is very, very high, as we've outlined. But compared to, say, another stock in our portfolio or another stock on the watch list that we're looking at, we want this company to have much, much higher standards. So we don't put any numbers exactly on it, but let's say that our hurdle rate for an American stock is like 15% given the risk reward that we wanted to return a 15% return over three to five years, something like that. For a Mexican one, to compensate for the risk, we might have it at 25%. We want that much upside.

We want that much of an opportunity because we want to hold ourselves and anchor ourselves to that risk and make sure if we're taking it, there is enough there. And you talked about having a discount to the U.S. home builders. So, NVR, when we last analyzed it, had an enterprise value to free cash flow of 11 times. As I mentioned earlier, the enterprise value to free cash flow on Consortio R is about three times. Then depending on how you slice it, two to five maybe, and four could be even less. I mean, and honestly, cumulative, you know, NVR is not going to generate its entire enterprise value in cash for the next three years. consortia are might that's the huge difference to us however though this is the lowest stock we do a little inside baseball here we rank we force rank our stocks every two weeks uh and then do

a discussion with each other to see any updates just consistently get an update on where we stand with all our stocks this is uh the lowest one on the ring so if another opportunity comes in the along in the united states it is possible we can replace consortia are in the fund even if we thought it had a higher forward return potential just because of the risk of investing outside our home market. So we found something, I mean, something that we've been looking at recently is Ally Financial. If we kind of come to the conclusion that we're comfortable and understand that business trust management, all that good stuff, we kind of project some sort of range of forward returns or what any sort of scenarios could be. And we think it is a little bit less

thing in the source you are out, we might replace it simply because the country risk is much less. All right, Ryan, anything else? And then I guess we got to wrap things up. No, I think that's it. You pretty much summed it up there, but there's more uncertainties with this investment than I'd say any other investment in our portfolio. But at the same time, I'd argue this could have the most upside returns-wise over the next three to five years. So that's kind of, we try to be right. We're more worried, I guess, about accuracy than upside. And that's why we rank it pretty low and have it as one of our smallest holdings, but that is going to do it. This is definitely a time to remind listeners that we aren't financial advisors and anything we say

on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients do have a position in the security discussed in this podcast. Thank you all for listening. We'll do, we're trying to do a portfolio update with Arch Capital every month. And they'll be free after this. So hopefully a wonderful way to get a better insight into how we kind of invest personally and professionally. All right. Well, we'll see you guys next time.

Bye.