How To Profit From Brazil's Coming Infrastructure Boom

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Includes: BRXX, GGB, SID
by: Tony Daltorio

Ask emerging market investors what is the biggest problem Brazil faces (besides politics) and you likely get the same answer from all of them ... woeful infrastructure which causes unnecessary bottlenecks in the economy.

The country, unlike China, has been a chronic underspender - only about 2% of GDP - on infrastructure for decades. The cause of the underinvestment was the series of the financial crises which racked Brazil during the 1980s and 1990s. The poor infrastructure may cause Brazil major embarrassment in the next few years as it hosts the upcoming 2014 soccer World Cup and the 2016 Summer Olympics. The Brazilian government is well aware of that and plans to spend approximately $470 billion in an ambitious plan to upgrade the country's roads, ports, airports, power plants and telecommunications network.

Brazil will need every dollar of that investment. Take just one example of the poor infrastructure ... Brazil's roads. According to the Financial Times, its road network is actually more extensive than fellow BRIC countries China or Russia when it comes to miles per 1,000 workers. However, in Russia 80% of the roads are paved while in China 54% of roads are paved. But in Brazil only 6% of the roads are paved! Hardly a way for an emerging economy with large ambitions to grow.

Brazil's economic success over the past several years has been driven by a combination of high commodities prices and the emergence of a consuming middle class with ready access to credit. But as the middle class began consuming more goods, it began to overwhelm the capacity of highways, ports, warehouses, etc. to supply the goods, giving rise to inflation from high logistics costs. In Brazil, logistics costs end up taking about 12-15% of GDP. Compare that to roughly 5% for countries like the U.S. or Germany. No wonder then that economic growth has been choked off, with GDP falling from 7.5% in 2010 to below 2% in 2012.

So it is obvious that Brazil needs to act and quickly on upgrading its infrastructure. How can U.S. investors take advantage of the situation and profit from it? There are numerous power and telecoms companies listed on U.S. exchanges which will take part in this infrastructure build-out. There are also the Brazilian steel companies including Gerdau S.A. ADR (GGB) and Companhia Siderurgica Nacional ADR (SID) which will benefit in a big way as the ports and roads build-out gets going in earnest.

However, if an investor is looking for a broader, more cautious approach to Brazilian infrastructure, there is an ETF which fits nicely. It is the Emerging Global Shares Brazil Infrastructure ETF (BRXX). The main sector weightings (as of 6/30/12) are: Utilities - 38.86%, Industrials - 25.94%, Basic Materials - 11.57% and Telecommunications - 11.27%. The only cautionary notes on these investments is that the Brazilian central bank needs to keep interest rates on a downward slope (highly likely) and companies need to overcome the shortage in skilled labor in some parts of the country.

If Brazil does spend the necessary money to upgrade its infrastructure, its economy will benefit in the long term. According to a study by economists at Goldman Sachs, if Brazil doubled its infrastructure investment to 4-6% of GDP per year, capacity would catch up with emerging market success stories like South Korea. This, the economists believe, would boost the economy's potential GDP growth from below 4% to about 5.5%. The economists added this would "reduce income inequality by 10-20%". A worthy goal for Brazil's leaders.

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.