Investors continue to grapple with the 2% front-end tax on Brazilian Real purchases for bond and equity investments. One might expect that the efficiency of the market is such that arbitrage will keep the ADR in line with what one would pay for the local shares, but this does not seem to be the case, making the ADR a potentially viable alternative to the local shares. Here is our work, using Petrobras (PBR) as an example.
- Each U.S. ADR is worth two local shares. The local shares are trading around BRL41.4. Using an exchange rate of BRL1.7285 = $1, that means that each local share is worth about $23.95. If a foreign investor wanted to buy it, they would pay $23.95 plus 2% or $24.43.
- The ADR should trade for twice that or $48.86. But the ADR is trading around $47.91. Excluding the 2% tax, fair value would be $47.90.
Although analysis needs to be done on the stock-specific level, Petrobras ADRs look cheap relative to the local shares. This is not meant to be the final word, however. Rather, the point of the exercise is to see if the ADR can be a viable alternative to the local shares in minimizing the exposure to the new tax.
Disclosure: No positions
