While the damage to Mexico's housing sector hasn't matched that in the U.S., the last few years have still been difficult. Lower remittances from the U.S. have slowed down many parts of the Mexican economy, including the housing sector. Business is starting to improve, though, and investors looking to play improving standards of living in Mexico and Brazil ought to take a look at Homex (NYSE:HXM).

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Focused on Entry Level ... For Now
One of the issues with Homex is that management has shown its willingness to look outside of its traditional operations in the interests of growth. For example, Homex has long focused on entry-level homes (475 to 825 sq ft), but has periodically tried to expand into middle-market homebuilding - without a lot of benefits to show for it. Similarly, the company has relatively recently expanded into the business of building prisons; penitentiaries could certainly add revenue and cash flow, but it's a different kind of business with different dynamics and demands.

Nevertheless, Homex is back to doing what it has always done best - building entry-level homes. Homex operates in 21 Mexican states and is one of the leading builders in major cities like Mexico City, Tijuana and Guadalajara. Homex has also expanded into Brazil, where it presently operates in two states.

SEE: Earning Forecasts: A Primer

Under-banking Is an Obstacle
One of the traditional issues with the entry-level housing market in Mexico is the state of the Mexican banking industry. Compared to the U.S., banks are for the middle class and up, leaving lower-earning Mexicans to more marginal (and expensive) sources of capital. This makes the level of remittances from the U.S. (and the number of Mexicans working in the U.S., documented and legal, or otherwise) a significant factor.

BBVA (Nasdaq:BBVA) and Citigroup (NYSE:C) are responding to government pressures to be more inclusive and grow the retail mortgage market, but this is a long-term process. Consequently, Homex is going to need to see a pick up in the U.S. economy (and demand for migrant labor) to see better near/intermediate-term results.

Plenty of Room
There are a lot estimates thrown out as to the level of under-supply in Mexico's housing market, but the bottom line seems to be that Mexico needs more housing. That's a good market opportunity, but one that Homex will split with other companies like GEO and Urbi in Mexico, and Gafisa (NYSE:GFA) in Brazil. Of course, there are also the myriad of small builders that make up so much of the market in many areas.

Of course, investors don't have to go with a builder to see some of the benefits. After all, Homex has had a very dicey record of producing free cash flow, though the structural free cash flow numbers are better. There's also the matter of significant insider family ownership that may bother some investors. Consequently, investors may also want to consider stocks like Cemex (NYSE:CX) that should benefit from a general improvement in the Mexican economy.

The Bottom Line
Looking at Homex's current valuation (price/book, forward P/E, EV/EBITDA), the shares look undervalued. Couple that with a free cash flow analysis and the shares look pretty interesting. If Homex can produce 10% free cash flow growth over the next decade, these shares could be significantly undervalued. That said, investors need to understand that there are above-average risks here and this is a pretty speculative play.

SEE: 5 Must-Have Metrics For Value Investors

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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