Violent, impoverished - and attracting billions

While you were relaxing this Sunday, two politicians were giving it their all on the last day of an incredibly tense presidential campaign in Honduras. The political battle shone the spotlight on an interesting region for investors...

While you were relaxing this Sunday, two politicians were giving it their all on the last day of an incredibly tense presidential campaign in Honduras. It was the first time since civilian rule was established some 30 years ago that a new political party threatened to shake up the status quo.

The candidate from the ruling conservative party, Juan Orlando Hernandez, faced an unprecedented challenge from his left-wing opponent, Xiomara Castro.

For Castro, who would be the country’s first female leader if she won, this is about more than just politics. Her husband was ousted in a 2009 coup backed by Hernandez. It marked the end of democracy, human rights and the rule of law in Honduras.

This election is Castro’s chance to exact revenge. It is also an opportunity for the troubled nation to move forward and undo the legacy of the 2009 coup. So far the result seems too close to call, but early voting returns indicate that it will be a tie.

A cynic may perhaps wonder why anyone would even want the job. As the second-poorest country in the Americas after Haiti, Honduras still struggles with the problems that many of its neighbours have left behind. It is one of the most violent places on earth, with 20 murders per day.

And organised crime has a tight grip on society, with tens of thousands of young people joining fearsome gangs known as maras. Huge inequality fuels further crime, and the powerful military exerts too much influence on the country’s politics. For all these reasons, the economy is still under-developed. It is still very dependent on banana and coffee exports, with some growth in textile manufacturing.

But despite all these problems, I think that the elections in Honduras are symbolic of the momentum in that nation. And the same could be said for its Central American neighbours. These countries are all undergoing changes that will make this region a place where New World readers can make money.

Location, location, location

Central America is made up of Belize, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama and is home to around 41 million people.

The largest nation is Guatemala with 14 million people, while the smallest is Belize with just 300,000 people. The rest have between three million and seven million people each. Meanwhile, the Spanish-speaking Caribbean island of the Dominican Republic often joins Central American regional initiatives or bodies.

One of the main things Central America has going for it is its strategic location. It is sandwiched between the northern and southern hemispheres and also provides the shortest link between the Atlantic and Pacific oceans. The most obvious beneficiary of this so far has been Panama. Its canal earns about $2.5bn a year in direct fees and indirectly contributes 10% of GDP.

Since taking over control in 1999, Panama has worked to increase the benefits it gets from the canal. For example, it is currently in the middle of a $5bn project to widen the canal to allow larger ships to pass through it.

It has also encouraged logistical and transport firms to set up base in the country. This shrewd use of the country’s best asset, its location, has helped the economy grow by 10% a year – the fastest in Latin America.

Now there are signs that its neighbours are keen to do the same. Nicaragua has attracted $40bn of Chinese investment to build a rival canal. Like so many others, I’m sceptical about the business case for it. But if the Chinese decide to push ahead for strategic reasons, it would be a huge boost for the Nicaraguan economy.

Not wanting to miss out, Guatemala and Honduras are also investing in a ‘dry canal’ – ie, a freight railway linking the Atlantic to the Pacific. Again, this plan is based on not just transporting goods, but also on trying to leverage more benefits for the economy.

There will, therefore, be several export-processing zones and business parks along the route that will attempt to lure international firms to set up in the country.

Extending its physical links to the wider world isn’t the only thing going on in Central America. Through a series of free-trade agreements, it is also integrating into the world economy. Central American countries already have an agreement with the US, and this year they’ve added to it by signing a deal with the EU.

Once it comes into force, the EU will cut tariffs on 92% of Central American imports. If you combine the EU and US deals, Central American exporters now have easy access to more than one billion of the world’s wealthiest consumers.

So what will they sell?

One of the region’s main industries is agriculture. Thanks to its tropical climate, rich volcanic soil and abundant freshwater supplies, almost anything can and does grow in Central America. The area is a major exporter of coffee, bananas and tobacco. It has also built up some niche value-added industries in premium rums and cigars.

Diageo, for instance, recently paid around £100m for a stake in Guatemalan rum maker Zacapa. All of these producers will receive a boost as the new EU deal starts to take shape. Banana growers, for example, will see their tariffs fall from €176 to €75 in just eight years.

Central America also has a lot of light manufacturers. The plants mostly focus on textiles, cheap electronics and machine components. Better still, they can be found in tax-free export zones across the business-friendly region.

These maquiladoras were first set up in Mexico to make goods for the US. However, as Mexico has moved up the manufacturing value chain, they have become more common in Central America.

I’ve visited export-processing zones in Nicaragua and seen everything from women’s underwear to BMW car parts being made and shipped to America. These Central American manufacturers are gradually gaining expertise.

The manager of the underwear factory was keen to stress to me that this was complex stuff because they were working with new materials and different sewing techniques.

My conversation with that manager made me realise that when a country is starting a manufacturing industry from scratch, it takes time to build up expertise and supply chains – even for products that would seem quite simple.

And thanks to its longstanding deal with the US, Central America’s textile manufacturers have already completed this process. This means they are now well-placed to sell to Europe.

Moreover, Central America’s good demographic profile means that it will likely become ever more competitive in these areas. It might be a small region, but it has a young and growing population. That creates a growing labour force, which keeps wages competitive and gives industry room to expand.

Buying spree

I’ve been writing about Central America for a while now, but I’m not the only one to see potential in the region. Colombian financial firms have made a series of large acquisitions in recent years, snapping up Central American banks, pension funds and insurers.

Part of the reason is cultural – Panama used to be part of Colombia before the Americans engineered a separatist uprising – but it’s also because they see potential.

David Bojanini, CEO of Grupo Sura, which recently bought up HSBC’s assets in Panama for $2bn, told me that he expects the region’s recent progress to continue. “You have a young, growing population, very open economies and increasing wealth. It’s a very exciting opportunity for us.”

Of course, for David Bojanini, snapping up firms in Central America is relatively simple. For small, private investors based in the UK, it’s a lot more challenging. When I’ve written about the region before I’ve suggested Copa Airlines (NYSE: CPA) and Cable & Wireless Communications (CWC). And I have to blow my own trumpet a bit because they’ve both done pretty well.

Copa is up by almost 50% since I wrote about it back in February, while Cable & Wireless is up 20%.

Of the two, CWC is probably the most risky. In effect we are betting on the management’s ability to find more opportunities in the region. So far the signs are good. Since I last wrote about them, they have doubled the amount of bandwidth they can use in Panama.

It’s a strong investment in their biggest markets and it should pay off as Panamanians start to use more data on their phones. With the company keen to enter more Central American markets, now could prove a good time to buy, if you haven’t already.

• 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.