Feature
SATURDAY, NOVEMBER 3, 2012
Betting on Brazil
By CHRISTOPHER C. WILLIAMS
The world's sixth-largest economy has hit a rough patch, but the future looks bright, given a rising middle class. Where to invest in 2013.
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While the recession risk has passed, GDP has increased at a slower pace than expected. A weaker global economy, and China's cooling in particular, hurt natural-resources producers such as Vale and contributed to a 40% drop, to $7.5 billion, in foreign investments in Brazil during the first half of 2012. At the same time, the weak real has crimped Brazilian firms' competitiveness at home by raising their costs.
Above all, emerging-market investors have been spooked by government intervention in key business sectors; the Rousseff administration has tried to influence the price that government-controlled Petrobras can charge for gasoline, and has sought to lower net interest spreads in the banking sector, hurting profit margins. Despite these moves, inflation stands at 5.2%, above the central bank's goal.
CANADA'S BCA RESEARCH HAS been underweight Brazil and other emerging markets for almost three years; managing editor Arthur Budaghyan sees no reason to change his bearish, and prescient, view yet. The just-right, or "Goldilocks" scenario for Brazil is for growth to accelerate while inflation remains stable or in retreat. But Budaghyan gives that prospect only a 5% to 10% probability of materializing. "The underlying causes of capacity strains are a lack of investment and supply-side reforms," he wrote recently. "This is capping the economy's growth potential. As such, odds are that inflationary pressure will rise strongly as soon as growth accelerates."
Recent data, however, suggest that investors are ignoring such concerns. According to numbers from EPFR Global, mutual-fund investors have warmed to Brazil recently, pouring $2.3 billion into Brazil-focused equity funds in the past two months, reversing months of withdrawal.
The iShares MSCI Brazil(EWZ), the largest Brazil-oriented exchange-traded fund, with $9 billion in assets, might look tempting, but its two biggest holdings are Petrobras and Vale. Both have ADRs and are easy for U.S. investors to buy, and neither is expensive. Petrobras fetches 10 times this year's anticipated earnings, and Vale sports a P/E of 9. But both companies face regulatory risks and possible government intrusion, and such concerns won't abate soon.
They also face operational challenges. Brazil has discovered major oil reserves off its shores, but many analysts doubt Petrobras' ability to extract it without problems. Petrobras shares dropped sharply after the company posted disappointing third-quarter earnings Oct. 26.
São Paulo-based Itaú, the biggest private bank in Brazil, accounts for 7.2% of the ETF, and 4.3% of the Bovespa. It is benefiting from rising demand for consumer-banking services, as is Banco do Brasil(BBAS3.Brazil). Both boast strong balance sheets, although Banco do Brasil trades for 5.6 times estimated 2012 earnings, well below Itaú's multiple of 9.4.
Audrey Kaplan, head of equity management at Federated Investors, likes Banco do Brasil and Ambev. The latter might seem pricey at 25 times expected earnings, but it is led by one of the best management teams in the beer business, and is poised to grow earnings by double-digits in coming years.
IF INFLATION BECOMES A PROBLEM next year, as many expect, shopping-mall, toll-road, and property companies could be beneficiaries. Mall operator Multiplan(MULT3. Brazil) is a favorite of Samuel Lieber of Alpine Woods Capital Investors, and toll operator CCR (CCR03.Brazil) is a top pick of UBS. In addition, the government's offer of low-cost credit to students could help boost shares of education concerns.
For many equity investors, the best route to Brazil runs through mutual funds and ETFs. Those looking to play the strong growth in consumer demand in Brazil and elsewhere in Latin America might consider EGShares Emerging Markets Consumer(ECON). The fund has 16% of its assets in Brazil, invests in companies that dominate their respective markets, and is less volatile than the iShares MSCI Emerging Markets Index (EEM). Its biggest holding: Ambev.
BlackRock Latin America Institutional(MALTX) counts Pebrobras and Vale as top holdings, but the fund's 10-year annualized return of 23% puts it in the top 1% among Latin American stock-fund peers.
Small- and mid-cap Brazilian stocks have outperformed their larger cousins this year, due to higher earnings and a focus on local demand. JPMorgan Select Latin(JLTSX) is a solid play on such issues, with 57% of its assets invested in Brazil, including 25% in mid-caps such as retailer Lojas Renner (LREN3.Brazil), which has rallied 59% year to date. Market Vectors Brazil Small-Cap (BRF), an ETF that affords participation in the growing educational sector through its bet on Kroton Educacional (KROT11.Brazil), one of Brazil's largest educational concerns, is another attractive bet.
Market Vectors LatAm Aggregate Bond(BONO) is the largest fixed-income ETF with exposure to Brazil, at 18% of assets, that Lipper tracks, but is only a year old. Mutual-fund GMO Emerging Country Debt (GMDFX) has 5% of its assets in Brazil, but has notched a stellar return over a longer stretch. It is overweight corporate debt.
Brazil remains a compelling growth story, but it doesn't dance to the same rhythm every year. This year has been disappointing, but the beat could grow lively again in 2013.
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| Leonardo Martins/Getty Images
The view across Rio de Janeiro's beautiful Botafogo Bay.Añadir leyenda
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The carnival is over in Brazil, at least for the next six months. After surging 7.5% in 2010, the world's sixth-largest economy is expected to grow just 1.5% this year and 4% in 2013, amid slowing global demand for natural resources and a sluggish industrial sector.
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Reflecting these challenges, the country's stock market has been one of the worst performers in 2012, with a year-to-date gain of 2.9%, and Brazil's currency, the real, dropping sharply in value against the U.S. dollar. If the government, led by center-left President Dilma Rousseff, can't spur industrial production sufficiently in the months ahead, gross domestic product could fall short of next year's estimates, while consumer-price inflation, already at a steep 5%-plus, could accelerate, driven by rising food prices.
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But don't give up on the land of sun and samba, because Brazil's longer-term prospects could make it one of the world's best investments in years to come. The Brazilian middle class continues to grow, as does its disposable income, which is spurring demand for products from cars to eyeliner to beer. The jobless rate is a low 5%, and consumer trends could become even more powerful in the next decade, regardless of developments in other parts of the world, including China.
Although the economy mostly has stumbled since Rousseff took charge in January 2011, the president has continued many of the market-friendly policies of her predecessor, Luiz Inácio Lula da Silva. Brazil has lowered interest rates and cut taxes, and is planning to ramp up spending on infrastructure, which could pay big dividends down the road. Much of the spending involves preparations to host the 2016 Summer Olympics, an event that could showcase Brazil's progress and burnish its image in the eyes of the world.
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The Bovespa, Brazil's benchmark stock index, trades for an inexpensive 11.7 times this year's expected earnings. While its price/earnings ratio is richer than those of fellow BRIC members Russia and China (India rounds out that quartet), Brazil's financial system arguably is more transparent than the other three, and its shares, more liquid.
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When the Brazilian economy was roaring, with growth of 6% to 7% a year, investors could throw darts at the Bovespa and effectively strike gold. Now, those seeking exposure to Brazil would do best to look beyond the major stock index, which is dominated by export-oriented commodity producers such as Petroleo Brasileiro,or Petrobras (ticker: PBR), and mining giant Vale (VALE), to sectors and companies, large and small, that could benefit from rising consumer demand domestically. The big Brazilian banking franchise Itaú Unibanco Holding (ITUB), the Latin beverage behemoth Companhia de Bebidas das Amèricas, or Ambev (ABV), and several educational concerns are on some smart investors' shopping lists.
"You need to be more selective today," says Rudy Martin, president of Latin Capital Management in Jupiter, Fla. "Brazil is no longer a one-decision investment. You need to explore it company by company, considering the sector outlooks, and quality and intentions of management."
Fixed-income investments are another sensible option. Lupin Rahman, a fund manager at Pimco focusing on emerging markets, likes Brazilian government bonds denominated in local currency.
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With the central bank of Brazil having cut interest rates by 5.25 percentage points in the past year, to an all-time low of 7.25%, in a bid to spur economic growth, sovereign bonds have rallied. Not only do yields on Brazilian bonds sparkle alongside 10-year U.S. Treasuries, which pay a paltry 1.7%, but "Brazil's creditworthiness is strong and getting stronger," Rahman says.
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BARRON'S RECOMMENDED CONSUMER-ORIENTED SHARES last fall in a major look at Brazil ("Better Times in Rio," Nov. 7, 2011), when we said a selloff in the Bovespa amid fears of a recession presented a long-term investment opportunity. The index rallied more than 17% after our story, to about 68,400, before retreating to a recent 58,383. One recommendation, retailer Companhia Hering(HGTX3.Brazil), has performed well in the past 12 months, as has Ambev, whose American depositary receipts rose 21%, to $40.79.
.
Reflecting these challenges, the country's stock market has been one of the worst performers in 2012, with a year-to-date gain of 2.9%, and Brazil's currency, the real, dropping sharply in value against the U.S. dollar. If the government, led by center-left President Dilma Rousseff, can't spur industrial production sufficiently in the months ahead, gross domestic product could fall short of next year's estimates, while consumer-price inflation, already at a steep 5%-plus, could accelerate, driven by rising food prices.
.
But don't give up on the land of sun and samba, because Brazil's longer-term prospects could make it one of the world's best investments in years to come. The Brazilian middle class continues to grow, as does its disposable income, which is spurring demand for products from cars to eyeliner to beer. The jobless rate is a low 5%, and consumer trends could become even more powerful in the next decade, regardless of developments in other parts of the world, including China.
Although the economy mostly has stumbled since Rousseff took charge in January 2011, the president has continued many of the market-friendly policies of her predecessor, Luiz Inácio Lula da Silva. Brazil has lowered interest rates and cut taxes, and is planning to ramp up spending on infrastructure, which could pay big dividends down the road. Much of the spending involves preparations to host the 2016 Summer Olympics, an event that could showcase Brazil's progress and burnish its image in the eyes of the world.
.
The Bovespa, Brazil's benchmark stock index, trades for an inexpensive 11.7 times this year's expected earnings. While its price/earnings ratio is richer than those of fellow BRIC members Russia and China (India rounds out that quartet), Brazil's financial system arguably is more transparent than the other three, and its shares, more liquid.
.
When the Brazilian economy was roaring, with growth of 6% to 7% a year, investors could throw darts at the Bovespa and effectively strike gold. Now, those seeking exposure to Brazil would do best to look beyond the major stock index, which is dominated by export-oriented commodity producers such as Petroleo Brasileiro,
"You need to be more selective today," says Rudy Martin, president of Latin Capital Management in Jupiter, Fla. "Brazil is no longer a one-decision investment. You need to explore it company by company, considering the sector outlooks, and quality and intentions of management."
Fixed-income investments are another sensible option. Lupin Rahman, a fund manager at Pimco focusing on emerging markets, likes Brazilian government bonds denominated in local currency.
.
With the central bank of Brazil having cut interest rates by 5.25 percentage points in the past year, to an all-time low of 7.25%, in a bid to spur economic growth, sovereign bonds have rallied. Not only do yields on Brazilian bonds sparkle alongside 10-year U.S. Treasuries, which pay a paltry 1.7%, but "Brazil's creditworthiness is strong and getting stronger," Rahman says.
.
BARRON'S RECOMMENDED CONSUMER-ORIENTED SHARES last fall in a major look at Brazil ("Better Times in Rio," Nov. 7, 2011), when we said a selloff in the Bovespa amid fears of a recession presented a long-term investment opportunity. The index rallied more than 17% after our story, to about 68,400, before retreating to a recent 58,383. One recommendation, retailer Companhia Hering
While the recession risk has passed, GDP has increased at a slower pace than expected. A weaker global economy, and China's cooling in particular, hurt natural-resources producers such as Vale and contributed to a 40% drop, to $7.5 billion, in foreign investments in Brazil during the first half of 2012. At the same time, the weak real has crimped Brazilian firms' competitiveness at home by raising their costs.
Above all, emerging-market investors have been spooked by government intervention in key business sectors; the Rousseff administration has tried to influence the price that government-controlled Petrobras can charge for gasoline, and has sought to lower net interest spreads in the banking sector, hurting profit margins. Despite these moves, inflation stands at 5.2%, above the central bank's goal.
CANADA'S BCA RESEARCH HAS been underweight Brazil and other emerging markets for almost three years; managing editor Arthur Budaghyan sees no reason to change his bearish, and prescient, view yet. The just-right, or "Goldilocks" scenario for Brazil is for growth to accelerate while inflation remains stable or in retreat. But Budaghyan gives that prospect only a 5% to 10% probability of materializing. "The underlying causes of capacity strains are a lack of investment and supply-side reforms," he wrote recently. "This is capping the economy's growth potential. As such, odds are that inflationary pressure will rise strongly as soon as growth accelerates."
Recent data, however, suggest that investors are ignoring such concerns. According to numbers from EPFR Global, mutual-fund investors have warmed to Brazil recently, pouring $2.3 billion into Brazil-focused equity funds in the past two months, reversing months of withdrawal.
The iShares MSCI Brazil
They also face operational challenges. Brazil has discovered major oil reserves off its shores, but many analysts doubt Petrobras' ability to extract it without problems. Petrobras shares dropped sharply after the company posted disappointing third-quarter earnings Oct. 26.
São Paulo-based Itaú, the biggest private bank in Brazil, accounts for 7.2% of the ETF, and 4.3% of the Bovespa. It is benefiting from rising demand for consumer-banking services, as is Banco do Brasil
Audrey Kaplan, head of equity management at Federated Investors, likes Banco do Brasil and Ambev. The latter might seem pricey at 25 times expected earnings, but it is led by one of the best management teams in the beer business, and is poised to grow earnings by double-digits in coming years.
IF INFLATION BECOMES A PROBLEM next year, as many expect, shopping-mall, toll-road, and property companies could be beneficiaries. Mall operator Multiplan
For many equity investors, the best route to Brazil runs through mutual funds and ETFs. Those looking to play the strong growth in consumer demand in Brazil and elsewhere in Latin America might consider EGShares Emerging Markets Consumer
BlackRock Latin America Institutional
Small- and mid-cap Brazilian stocks have outperformed their larger cousins this year, due to higher earnings and a focus on local demand. JPMorgan Select Latin
Market Vectors LatAm Aggregate Bond
Brazil remains a compelling growth story, but it doesn't dance to the same rhythm every year. This year has been disappointing, but the beat could grow lively again in 2013.
.
.
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