Run With the Real on These Brazilian Stocks: ABV and CPL

The Brazilian real has doubled in the past five years, reports Ryan McLean in the Morningstar, which makes it all the more surprising that Warren Buffett has taken a recent shine to the currency as his shelter from the U.S. dollar. However Morningstar recommends not the currency, but two particular stocks - AmBev (ABV) and CPFL Energia (CPL) - as a more advantageous way to stake a claim on the real's future.

Although we caution that leverage of any kind works both ways, we think investors who are confident in the real's prospects relative to the dollar would do well to consider these companies. If the currency does poorly, the underlying strength of these businesses should help cushion the downside.

AmBev is one of the most profitable brewers in the world, and McLean is particularly impressed with the company's "ruthless efficiency, vast scale, and powerful brands." AmBev has taken stakes in Argentina's Quilmes and Canada's Labatt, and complements its own operations with carbonated soft drinks.

AmBev has many qualities we love, but the firm does not come without uncertainty. Sales are concentrated in Latin America, where economic and political risk is relatively high. Many of the firm's input costs, as well as about $3.5 billion of debt, are denominated in U.S. dollars. Should the real depreciate, these payments could become dangerously expensive. On the other hand, if Buffett's currency bet is right, AmBev's leveraged cost structure could entail handsome rewards.

CPFL Energia, Morningstar's second recommended Brazilian stock, is riding the wave of growing sales in electricity-thirsty appliances and electronics goods. While noting the risk of power rationing brought on by drought conditions (Brazil's electricity market is heavily hydro-dependent), McLean remains upbeat on the company:

"Scale and natural monopoly status confer CPFL a sustainable competitive advantage. The firm's difficult-to-replicate distribution networks, which are concentrated in the economically vibrant southern states of Sao Paulo and Rio Grande do Sul, represent a sizable barrier to entry. We expect that CPFL will build further scale as it acquires local utilities in the fragmented Brazilian market. Rising per-capita consumption (currently one fifth of U.S. levels) will also help drive CPFL's top line. Operating costs, meanwhile, should remain in check, as Brazil's reformed regulatory system rewards efficiency.

However, these two stocks are not currently trading at any sort of bargain price, having soared in recent years along with the domestic market.

Comments

[sorrentocap...:]

Very good. With the new oil find off the coast, there is even more opportunity for the real to appreciate, relative to other currencies, particularly the USD. Good plays would include any solid company that does not rely on exporting their products (as they are now more expensive to foreigners). I'm thinking telecom, power generation, energy, infrastructure, etc. Also, if you're in the market for a vacation place near Rio, they are still cheap.

2008 Apr 14 11:50 PM