Six South America Profit Plays

Like most other markets, Brazil has been battered by the credit crisis – the BOVESPA index is currently down 28% in October alone and no less than 52% from its peak as recently as May. It now appears to represent excellent value, with a historic Price/Earnings (P/E) ratio of only7.0.

But are Brazil’s prospects good enough to justify investing there?

Brazil was included in the “BRIC” (Brazil, Russia, India and China) group of rapidly emerging markets that Goldman Sachs Group Inc. (GS) created in 2003. At that time the country didn’t deserve the distinction. Long-term growth since the 1970s had averaged less than 2% per capita, and the country had barely avoided bankruptcy in 2002. Every time the world had experienced a credit crunch, Brazil had been caught up in it, chiefly because of the country’s enormous international debt load.

Brazil got lucky. First, socialist President Luis Inacio “Lula” da Silva proved to be surprisingly moderate, not much to the left, economically, of previous Brazilian governments, perfectly willing to welcome foreign investment and generally friendly to the United States. Also, in 2003, energy and commodity prices began their long climb as part of a worldwide commodities rally that saw prices peak at astronomical levels earlier this year.

Since Brazil was not an oil exporter, there was no one single source of new wealth that the government could seize. Instead, revenue flowed to mining companies, the oil company Petroleo Brasileiro SA, better-known as Petrobras (PBR), and numerous agri-business operations that benefited from the rise in agricultural prices. It didn’t hurt at all when in November 2007 Petrobras discovered about 36 billion barrels of oil in an offshore Brazilian field.

Even Brazil’s ethanol program, which had been a hopeless boondoggle for a generation since it started during the oil crisis of 1979-82, suddenly became the envy of the world, as rising oil prices made Brazilian sugarcane the world’s cheapest and most economically and ecologically efficient source of newly fashionable ethanol. With oil prices down in the $20-a-barrel range, the ethanol-from-sugar program was a typical example of misguided Third World government planning. But at $140 a barrel, it was a bonanza.

Even at $60 a barrel, it is still a useful diversification from petroleum.

Brazil’s debt position improved after 2002 in three ways:

• The outstanding amount of debt has been reduced through modest repayments.
• Its ratio to gross domestic product (GDP) has dropped sharply, as GDP in dollar terms has shot up with the revaluation of the Brazilian real against the dollar.
• And its interest costs have dropped with Brazil’s improving creditworthiness and the generally low level of global interest rates.

Brazil’s ascension to “investment grade” status in spring 2008 appeared to cement the improvement in place; its public sector debt to GDP ratio in June 2008 was around 40%, lower than Britain’s, for example.

The financial crisis and economic downturn of 2008 has made life more difficult for Brazil. Oil and other commodity prices have sharply declined, reducing the value of Brazil’s exports. The real has declined over 30% against the dollar, increasing Brazil’s foreign debt, which is mostly dollar-denominated.

The Brazilian stock market’s decline will undoubtedly have a substantial negative wealth effect, making it more difficult for Brazilian entrepreneurs to finance new projects. On the other hand, a forecast by The Economist has Brazil still growing at 4.6% in 2008 and 3.4% in 2009, with consumer prices rising 6.0%. The Central Bank of Brazil has a good grip on inflation, with its Selic short-term rate at no less than 13.75%, while it is injecting funds into the banking system to battle the global liquidity shortage.

With continued economic growth, modest inflation, and stock prices at bargain levels for U.S. investors, Brazil is well worth considering. There are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40 to 50 more traded on the over-the-counter market.  A few attractive examples you might want to look include:

Banco Itau Holding Financeira SA (ITU). This stock features a Price/Earnings There are three large banks listed on the New York Stock Exchange: The other two are the other two are Banco Bradesco SA (BBD) and Uniao Bancos Brasile SA (Unibanco) (UBB). However, Itau is the cheapest of the three, though only slightly.

Companhia Vale do Rio Doce, now referred to only as Vale (RIO). This is one of the true global blue chips. It has a market capitalization of almost $56 billion, and its stock has fallen by fully 75% since May. It is an iron-ore company with ancillary operations in gold, nickel, copper and other metals, and its shares are trading about four times projected 2008 earnings. The stock features a 5.0% yield. As one of the world’s low cost producers of iron ore, it should bounce back once conditions become more clear.

Petroleo Brasileiro SA, better known as Petrobras,  is one of the few emerging market oil companies with access to modern technology and willingness to work with the oil majors. Down by 60% in the last five months, the stock’s prospective P/E ratio is now only 5.5. It has a dividend yield of 1.3%. Petrobras remains a fairly low cost oil producer, since its production comes from conventional, albeit offshore sources.

Companhia de Saneamento Basico, also known as Sabesp (SBS). This is the water-and-sewage system for Sao Paulo. Now that’s a growth business, and is one that’s not dependent on commodity prices or on rapid Brazilian economic growth. The shares feature a P/E ratio of only 3.1 and a yield of 8.0%. This one must surely be a bargain; it has very little dependency on the economy.

Votorantim Celulose e Papel SA (VCP). This is a pulp-and-paper company, with a prospective P/E ratio of 6.0 and a dividend yield of 9.5%. Trees grow fast in the tropics; VCP benefits from that!

Finally, you should consider the Brazilian ETF, the iShares MSCI Brazil Fund (EWZ). The fund was more than $5 billion in size at Sept. 30, and currently trades at a P/E of about 7.0 with a dividend yield of 3.0%.

As I said, Brazilian stocks are currently in the bargain-basement category, and well worth a look.

Original post

Comments

[bt310:]

One major problem with South American companies is their currencies and the adverse effect a stronger dollar has on their earnings. If a Brazilian company earned $1 Billion Real last October it translated to $550 Million US. If a company earns $1 Billion Real in October of this year it translates to only $430 Million US. That's a 22% drop in earnings automatically. I liked those companies but will wait for their currencies to stabilize.

2008 Oct 24 11:55 PM

[Globel E:]

Any thoughts on GFA ?

2008 Oct 25 01:38 PM

[WorldLeader:]

Recent currency devaluation has actually helped some of these companies profatabilities since they export in dolars (specially Vale). On the other hand, the majority of the analysts expect the dolar to bounce back to 1,90 Reais (from current 2,25) by December 2008, and to remain at that rate till December 2009.This is not bad in terms of stability if you consider that this exchange rate is as low as it was 9 years ago in Brazil.

2008 Oct 28 12:37 PM

[Alan von Al...:]

"Petrobras is one of the few emerging market oil companies with access to modern technology and willingness to work with the oil majors."

US majors and US vendors give Petrobras modern oilfield technology and what does state-owned socialist Petrobras do with it? --

RIO DE JANEIRO, Oct. 28 (Xinhua) -- Brazil's President Luiz Inacio Lula da Silva will visit the Cuban capital of Havana on Thursday to meet with the country's leader Raul Castro, presidential spokesman Marcelo Baumbach confirmed Tuesday. During the meeting, an agreement on the exploitation of oil off the Cuban coast will be signed between the two nations' state-owned oil and gas companies, Petrobras and Cuba Petroleo

2008 Oct 29 03:41 AM

[Chancer:]

I have read forecasts that the Brazilian real estate market is set to collapse.

Any comments?

2008 Oct 30 04:28 PM

[ablanco32000:]

where did you read that? i would like to know about that, but intererest rates are to high there to have a bubble. thanks


On Oct 30 04:28 PM Chancer wrote:

> I have read forecasts that the Brazilian real estate market is set
> to collapse.
>
> Any comments?

2008 Dec 05 02:07 AM