This article will focus on the stocks of three top Brazilian companies who all have generous dividend yields to offer current and potential investors. The three companies that we will discuss today here are Petrobras (NYSE:PBR), Itau Unibanco (NYSE:ITUB), and Vale S.A. (NYSE:VALE). For purposes of discussion and analysis, we will also include a discussion of the preferred shares of Petrobras (NYSE:PBR.A) and Vale (NYSE:VALEP).
This article will strive to increase awareness for the generous dividends that these companies pay shareholders, in addition to bringing to light reasons why I believe investors should consider placing these stocks in their portfolios. Furthermore, recent catalysts and economic conditions present a favorable long-term outlook for these stocks in my opinion, and those will be discussed here as well.
Itau Unibanco provides financial services and products in Brazil, and is one of the largest banks in the country with a current market capitalization of $96.45 billion.
Lately, the share prices of Itau Unibanco and Petrobras have rallied strongly, attributed in large part to strong recent earnings by Itau Unibanco and also because of the upcoming presidential election. Marina Silva is now the front runner based on recent polls, suggesting that she may be able to win the election. She is viewed as a candidate that is more center-left than left, and as a result, this could bode well for Petrobras.
Petrobras provides discounted pricing for some products that can cause certain segments to operate at a loss if oil prices affect it unfavorably, and also some view a change in government as a potential catalyst that could enable Petrobras to generate a higher return on assets. Nonetheless, public approval for the current president is high and I believe that the political system in Brazil is working. With the people happy in general with the government, this could bring long-term rewards as the companies in Brazil grow with a rising middle class who in the end, will be the consumers of the products. This can also lead to increased factory production long-term, with Vale and Itau Unibanco benefiting since these companies can be considered bellwethers of the Brazilian economy.
One important fact that I would like to stress in this article is that the dividends that these companies pay do not seem to be widely known by potential investors. I myself only found out about the dividend that Itau Unibanco pays first-hand, as by default I received some shares from a previous investment that I had which merged with Itau. On stock quote pages such as on Yahoo! Finance, the dividends that these companies pay are either incomplete, or are not there at all. This, in my opinion, has an unintended consequence of discouraging potential investors from buying shares because they do not realize how generous the dividends from these companies actually are.
I say that the dividends are generous because as history as shown, the all-time highs for these companies are much higher than current share prices. For instance, Petrobras' common shares (ADRs) are trading at $19.12 as of 8/28/14, which is up from a 52-week low of $10.20. However, on 5/14/2008, Petrobras had an adjusted closing share price of $54.41 according to Yahoo! Finance. As a result, its shares still have a long way to go to achieve record highs, and to be able to own a company that pays a handsome dividend in addition to having a chance at a 100% gain is rare. On 5/14/2008, Vale's common stock closed at an adjusted price of $31.14. It currently trades at $13.11 as of 8/28/2014.
The dividends that these companies pay are great, but when one takes a look at the preferred shares of the companies, the dividends are even better. Itau's ADRs, however, are the preferred shares so there is no difference in preferred versus common shares for that company.
Per the NASDAQ website, Petrobras common shares paid a dividend of .44394 per share in 2014 and based on its closing price of $19.12 on 8/28/14, that represents a dividend yield of 2.32%. That is pretty good, especially considering the potential upside in capital gains if the stock goes back to its all-time high. But when we take a look at Petrobras' preferred shares, which have no voting rights, we see (we have to look at the investor relations site from Petrobras from this one, it is not listed on the NASDAQ web site) that it paid a whopping dividend of .7343 (net). Based on its 8/28/14 closing price of $20.32, this provides a dividend yield of 3.614%. If you have noticed the increases in share price lately, you will see that the preferred shares typically will very closely follow the price action of the common shares. This is another rare phenomenon with these Brazilian stocks, as typical preferred shares with U.S. companies do not offer much upside potential. It is likely that there will be no more dividends in 2014 from Petrobras, however one never knows.
For Vale, it is a much simpler example. Based on personal knowledge (I own shares of both VALE and VALEP) I know that the dividend paid out of common shares is the same as the dividend paid out by preferred shares. VALE (common shares) closed at $13.11 on 8/28/14 and VALEP (preferred shares) closed at $11.67 on 8/28/14 as well. These dividends can be found at the NASDAQ page for it here and the total dividends for 2014 will be .815. This gives us a 6.22% dividend yield for the common shares and a 6.984% dividend yield for the preferred shares. On 8/28/2014, the share prices of miners such as Vale declined steeply due to lower forecasted demand for iron ore and a weakening view of iron ore prices. This may provide a solid opportunity for income investors to snap up shares. A dividend was just declared as well, which is half of the total for the year. The dividend yield is high because risks of it being decreased next year are prevalent due to concern about iron ore prices. I believe, for reasons that we will discuss here shortly, that there should be no long-term cause for concern.
Itau is an exciting company for dividends. While the yield is not as high, it pays out a monthly dividend. This NASDAQ page for the Itau Unibanco shows the dividends in 2014 so far. Since the remaining dividends for 2014 are still not set in stone, we will have to calculate the yield based on 2013 dividends. This is another example of financial stock quote pages having the wrong yield for it, as Yahoo! Finance shows it only having a .5% dividend yield. Its NASDAQ page shows that it paid out about .47 per share in dividends in 2013 (please keep in mind that currency translation for ADRs makes these estimated numbers to some extent) for a yield of 2.7%. (.47 divided by 8/28/14 closing price of $17.52). Itau has generously paid increasing dividends recently in addition to having several stock dividends. Most recently, it did so on March 20, 2014 and it also approved a 10% increase in the monthly portion of the dividend, which took effect on August 1, 2014. So far in 2014, of the three companies presented here, Itau surpassed earnings estimates for the first half of 2014. With the Brazilian economy struggling this year, this has boded well for the stock price because expectations are rising for what a booming economy in Brazil would bring if Itau is already having great results now. For example, in the second quarter of 2014, it had very impressive interest income.
So far in 2014, Petrobras is having a strong year. Its earnings are close to what it earned in 2013, however so far the results trail 2013. There are some major catalysts for it though. For one, a deal for Bolivian natural gas importing is expected to provide a 2014 fiscal year earnings benefit of $128 million. Based on a Brazilian Real currency exchange rate of 2.24, this translates to $286.72 million Reals. This will provide a short-term boost to earnings in addition to a great long-term benefit, as Brazil will receive preferential treatment in these natural gas finds in Bolivia.
In 2013, Petrobras' third quarter earnings were the weakest quarter of the year. Per the NASDAQ web site, Petrobras is forecasted to have .40 per share (ADR share) in earnings in the third quarter. This is sharply higher than third quarter 2013 earnings. As a result, full year 2014 earnings are expected to grow about 5.5% from 2013. ($1.76 per share estimated versus $1.67 actual (per Yahoo! Finance) in 2013). Based on this, the dividend for 2015 appears in great shape to grow because Brazil has mandatory dividends based on earnings further quantified by Petrobras' policy to pay out no less than 25% of net earnings to shareholders as dividends. The dividend paid in 2015 will be based on 2014 earnings.
Another major catalyst for Petrobras comes from the macro point of view in terms of a potential policy change that could accompany the appointment of a new president in Silva. In my opinion, the recent share price increases of Itau have been as a result of earnings growing despite the economy not being in great shape. For Petrobras, however, the share price increase is coming from the potential of a more pro-business government being appointed with the presidential election looming. Petrobras, with some of the largest oil finds in the history of the world, has a lot to gain with a stronger pro-business approach. In my opinion, the $54 share price the company enjoyed in 2008 is only a glimpse of what the future could bring. I also view a good government as having a vested interest in Petrobras, due to the fact that it owns over 50% of the company. Regardless of who becomes president, I believe that Petrobras is in a strong position for large capital gains in the next 5-10 years, and those gains can be jump-started by a presidential election win by Marina Silva.
Petrobras still pays a high subsidy to enable people to purchase imported gasoline at a price that is lower than Petrobras' cost. While the November 2013 price increase in gasoline was a step forwarding to remedy this hindrance to Petrobras' earnings, it stopped short of providing details as to if and/or when the required fuel subsidies will expire.
With a new administration, there are two changes that could come about that would help Petrobras become more profitable, in my opinion. Firstly, Silva could buck the trend and allow these subsidies to end, which would then allow Petrobras to sell this gasoline at a price above its cost. Secondly, a more pro-business approach could lead to the government selling some of its 54% stake in the company. By having this ownership, the government controls the voting rights of the company, which in recent history has prevented it from maximizing its profit potential. If the government reduced its stake to something along the lines of 10%, it would give the majority shareholders the chance to bring about this meaningful change. In my opinion, Petrobras would be much more valuable if its full earnings potential were unlocked.
Itau Unibanco, as previously mentioned, has produced amazing results this year considering the fact that the economy has struggled. Its total assets as of 6/30/2014 were up over 5% when compared to 6/30/2013. I rarely notice analyst recommendations when conducting research, but on this one I have to give credit where credit is due. Zacks Investment Research nailed it, giving it a 1 strong buy rating around the time that these earnings came out and it rallied just as predicted. That firm currently rates it a 2 (buy).
A new and exciting venture for Itau Unibanco is that it signed a 5 year agreement to become the lead sponsor for the Miami Open Tennis Tournament. This is the fifth largest tennis tournament in the world.
Itau has had an international banking operation in Miami since 1971. It has sponsored the Miami Open, previously known as the Sony Open, for six years. It is now taking over the role of the lead sponsor of the event. It is well known as an event that highlights players all around the world, not just the players from the United States. Itau targets high net worth Latin American clients through its international banking operations, the hub of which is in Miami. The event itself has been in play since 1985.
I view expanding into markets where returns on investments may be greater as a positive, while waiting for the Brazilian economy to strengthen. With this move, the company intends on tapping into the potential of a growing Brazilian population in Miami.
Additionally, this sponsorship in Miami has the added benefit of allowing Itau to branch out to the United States. While at first, the bank is targeting the Brazilian population in Miami, it provides an opportunity for Itau to become well known in the United States, starting in Miami. If Itau can penetrate the United States market, it has the potential to significantly grow revenues by offering competitive prices on its services and gaining a new customer base. It is an important step if the company wishes to establish itself as a global bank, and not just one known for dealings in Brazil. It is stepping up its efforts by becoming the lead sponsor, because that will give it much more exposure through this tournament.
Of the top 25 U.S. communities with the most residents born in Brazil, Florida has several cities that place high on the list, per Wikipedia. Loch Lomond, Florida, for example, is estimated to be the leader in this category with 15.8% of the entire U.S. population of residents originally born in Brazil.
The event allows Itau to continually connect with its target audience. Between its international customers, Brazilians who watch the event, and potential customers from the United States, it is a medium that can enable it to gain more business relationships. The tournament drew 300,000 spectators in its most recent event, and with its lead sponsorship role, its effective conversion rate for new clients should increase. Its targeted advertising effort should give it an optimum chance to bear fruit in the United States because it represents a segment of its existing customer base already.
By targeting this market, the company can capitalize on capturing more market share with Brazilian-Americans, but as mentioned before, it can also be a great way that it can continue to gain access to the U.S. market. If the company can respond to the U.S. customer needs, in addition to providing competitive prices for services and excellent customer service, I believe that it can win over a nice market share bolstered by its lead sponsorship of the Miami Open.
This brings us to Vale, and with its current share price, I believe it offers the most undervalued scenario currently. While there is a risk that remains if iron ore prices and steel demand continue to deteriorate in the short-term here, insofar as it relates to its 2015 dividend, I believe that its growth is inevitable. China is the largest buyer of iron ore, and with Chinese housing starts and sales struggling recently, that demand has dwindled along with it. With the rural population of China obviously needing housing, a growing Chinese economy will support the eventual build-out of homes which will necessitate many years of strong growth.
For 2015, Goldman Sachs sees an increased supply of iron ore and believes that the price per metric ton will be about $80. This is likely to add pressure on smaller mining companies, who have a higher cost of production, if this comes to fruition.
It is estimated that Rio Tinto and BHP Billiton pay between $40 and $50 per metric ton in production costs. I believe that Vale, being one of the top three mining companies, pays somewhere in that neighborhood as well. That being the case, iron ore prices can drop and the company can still be massively profitable. Additionally, with the pressures being placed on smaller companies the lower the selling price goes, it will allow Vale to grab more market share.
Large mining companies that control most of the market are upping supply this year, such as Rio Tinto, and its effect may not be as positive in the short term. Long term, however, as these companies including Vale increase market share and establish more business relationships, it will decrease their competition when the market turns for the better. Commodity and iron ore prices will not continue to decrease in my opinion, and a bull market will re-emerge at some point.
Vale realized a price of $84.60 on average, during the second quarter of 2014 for iron ore. This clearly is well above the cost of production, evidenced by its $1.96 billion profit. The challenge, as I see it, for Vale is for it to be able to up its supply and sell more units and succeed at it.
Two major catalysts for a share price revival of Vale are as follows. One, it is continuing to sell off non-core assets. If it follows in the footsteps of BHP Billiton Limited, it could potentially spin off some of these assets/companies to shareholders instead of selling them. This is not an entirely unlikely scenario and if it does so, the current market has shown that these actions are viewed as a major positive.
Additionally, as the Forbes article link above shows, another reason as to the lack of current demand of iron ore in China is due to the government disallowing polluting steel plants. I view this as a positive for Vale because it will leave companies in the game that are following the rules, and it will allow Vale to gain an even larger market share. New government rules for factory pollution in China will just lead to a new learning curve that plants must follow, and they will. Short term, it has added pressure on the iron ore market but with the growth of the housing market being inevitable in China, it will lead to pent-up demand at some point.
In conclusion, these three companies discussed here offer two great attributes for current and potential investors. One, they provide a steady income stream from dividends. Secondly, they can be considered bellwethers of the Brazilian economy and offer great access to the economic growth of the country. Based on the Yahoo! Finance list of components for the most well-known ETF for Brazil (iShares Brazil, EWZ), the five ticker symbols mentioned here make up 21.64% of the fund holdings. Rarely will you find a group of large-cap companies with high dividend yields that have the potential to double or triple on their way to reclaiming their all-time high. You have that right here.
As always, please conduct your own research and due diligence before investing in any stock.
Disclosure: The author is long VALE, VALEP, ITUB, PBR, PBR.A.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.