Value in Brazilian Stocks

With new developments occurring in Brazil and elsewhere on a seemingly regular basis, we once again put a few questions to Zacks senior Latin American markets analyst Claudio Freitas, CFA about his outlook for the regions.

As you had been expecting for the past year or so, Brazil has finally been considered “investment grade.” What does this mean for the growth-oriented country?

In the medium term, it will certainly mean lower costs for capital that Brazil needs in order to finance its infrastructure. Brazil has a chronic problem of lack of savings and low rate of investments. This problem is a result of excessive government expenses, which will continue to grow in the following years.

In order to overcome this problem and become a modern and competitive country, Brazil needs to attract international investors for both debt and direct investments. In this sense, the upgrade was great news. To make it perfect I would expect the Brazilian government to cut expenses in order to make possible huge interest rate cuts in the medium term, though this is not likely. The bottom line is: the upgrade was great, but Brazil still has some domestic problems to be addressed.

Has there been an influx of new foreign capital to the Brazilian market as a result of this?

Not yet. The very short term outlook for emerging markets is not that attractive. Inflation is again an issue worldwide, mainly in emerging markets. Brazilian inflation in 2007 was 4.5%, for 2008 expectation is 6% at least. The same problem occurs in India, China, Russia, etc. An international movement towards higher rates is expected in almost all emerging markets.

At the same time, rates are very low in the U.S. It seems that most investors are reluctant to make heavy investments in emerging markets in a period of rising interest rates. Even worse, higher rates could damage commodities prices, a development that would affect Brazil.

The upgrade was great; however the business environment is not that positive in the very short-term. I believe things will be better in the last quarter of 2008.

Tell us about what you expect from Petrobras, now that it stands to benefit from a new off-shore oil discovery.

Petrobras (PBR) has been doing great, and the medium-term outlook remains very positive. The company has been announcing a new important finding every 3 or 4 weeks and the giant field of Tupi and some others in the Espirito Santo’s basin in fact might be just one giant oil find with around 50 billion barrels!

The problem (there is always a problem) is that the oil is located in the pre-salt layer, more than 5 km below the sea level. It is not clear when these fields will be explored and how much it will cost to develop the area. Nevertheless, it seems that Petrobras will be the undisputable leader of the deep water exploration in the following years, and not only in Brazil.

Which two or three companies are your top Buy recommendations right now?

The moment is not very exciting for commodity stocks, however there are some interesting companies in Brazil that are focused in the local markets and are trading at very low valuations due to the recent rate hikes. I would suggest some cash cows like electric utilities -- Cemig (CIG), Copel (ELP) and CPFL Energia (CPL) -- and wireline operators like Oi Participacoes or Telemar (TNE). Those are conservative stocks, cash-generating companies which are trading at low valuations.

Finally Claudio, Zacks & Co. is located in Chicago, and your office is in Rio de Janeiro, Brazil. Both cities are finalists for the 2016 Olympics. Which city will win this distinction, and why?

I am not sure about Chicago, but I do believe that Rio will not win this time. This is the third time Rio has tried to be nominated, and it is the first time it goes to the final. It is an achievement.

However, Rio has some problems that must be addressed first, like lack of adequate hotels infrastructure and public transportation. The security is also a concern. But maybe in 5 or 10 years Rio will be ready for the task. I wish good luck to Chicago.

Claudio Freitas, CFA is a senior analyst covering the markets in Latin America for Zacks Equity Research.

Comments

[Bear Stocks Report]

How about a more diversified approach with the iShares Brazil ETF (ticker EWZ)? We added it to our portfolio back in May 2007 and since then its up 65%.