Latin American Balance Sheet Leverage Is Increasing

Includes: AMX, BRFS, CX, EC, PBR, TV, VALE
by: The Outsider

The current expansionary monetary policy throughout the developed world and the zero-interest rate policy in the U.S., have made cheap credit available to a great number of borrowers. As risk-free assets pay bondholders a negative real rate of return, many investors were pushed towards new horizons in their hunt for yield. A few years ago, many companies in Latin America had difficulty issuing new debt, but nowadays capital markets are much more willing to take risk. This means that some assets that were considered risky in the past are now suitable investments even for investors who are usually risk-averse. Therefore, emerging market debt has become a popular investment theme, due to the current low yield environment present in most developed markets.

Over the last couple of years, Latin America has grabbed a lot of interest for global investors resulting in lower sovereign debt yields and narrower corporate debt spreads, reaching levels that many would have thought impossible a few years ago. Currently, most Latin America countries are able to issue long-term debt at the lowest spreads in history to U.S. Treasuries. This led investors to seek higher returns in corporate debt, enabling Latin America corporations to issue more than $100 billion in new debt last year.

This resulted in corporate balance sheets far more leveraged nowadays, compared to the recent past. Investors usually see emerging market companies as safer than U.S. or European companies because their debt levels have been historically lower. However, as leverage has increased throughout Latin America over the last three years, this may no longer be the case. This increased leverage leads naturally to higher debt payments and cash becomes more scarce, reducing their ability to pay bondholders going forward. Also, some optimistic equity valuations can start to be questioned, as risk has increased and the companies' free cash flow generation capacity has decreased.

Based on the net-debt-to-EBITDA ratio and debt-to-equity ratios, leverage has increased clearly over the past three years. This can be seen in the following table, for some of the largest companies in Latin America.

Company P/E Ratio Div. Yield EV/EBITDA Net Debt/EBITDA Debt/Equity
2010 2011 2012 2010 2011 2012
America Movil (NYSE:AMX) 11.4 1.5% 5.3 0.9 1.3 1.4 90% 129% 134%
Petrobras (NYSE:PBR) 12.2 1.3% 6.0 0.9 1.6 2.8 37% 47% 57%
VALE SA (NYSE:VALE) 17.5 4.8% 5.9 0.6 0.6 1.5 39% 29% 40%
Brasil Foods (NYSE:BRFS) 41.5 0.1% 18.1 1.6 1.8 3.0 53% 57% 65%
Televisa (NYSE:TV) 25.1 0.4% 8.3 0.8 1.5 1.3 94% 98% 85%
CEMEX (NYSE:CX) 57.6 - 11.1 6.8 7.9 6.7 115% 145% 134%
Average 27.5 1.6% 9.1 1.9 2.5 2.8 71% 84% 86%

On average, these companies net-debt-to-EBITDA ratio increased from 1.9x in 2010, to 2.8x in the past year. The debt-to-equity ratio rose from 71% to 86%, during the same period. However, there are a few exceptions, such as Ecopetrol (EC) or Wal-Mart de Mexico (OTCPK:WMMVF), which maintained their strong balance sheets over the past few years.

Nevertheless, even though debt levels have increased significantly over the last two years, debt yields have declined. This means debt investors are now receiving significantly less return for more risk. Equity investors are also facing a lower risk-return proposition, as multiples have expanded but companies appear to be currently riskier. Credit agencies are taking note of this balance sheet deterioration across Latin America, with credit downgrades exceeding upgrades during 2012. On the other hand, equity markets continue to be pushed up by central banks' liquidity injections despite the increased risks. Sell-offs, like the one experienced in Japan last week, should be a warning sign for investors that despite equity markets being at all-time highs, fundamentals may not support current valuations and a more selective investment process may be required.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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