Brazil's Telecom ADRs Are Oversold

by: Danny Furman

Some sector indexes have lost 10% or more in the last week, but the word "oversold" is not one I've heard recently. Maybe it has something to do with markets having gained 40% in just over two months, or some sort of "brude awakening" to sky high P/E ratios, but value is by no means in apparent abundance.

Telecommunications companies are generally seen as sustainable and growth oriented, and pay frequent dividends to boost cash flow and maintain a strong share price. Verizon (NYSE:VZ) and AT&T (NYSE:T) are not up anywhere near 40% from March lows, however they have reported negative growth (losses for AT&T) and were not hit nearly as hard as other sectors to begin with.

Additionally, while the DOW has droppped from 8800 to 8300 and commodities have been hit even harder, domestic telecom has remained relatively unscathed. (Click links below to view the Sogotrade charts that show dividend history and volume, both of primary concern for this analysis)

Another factor I believe is very significant is that volume for Verizon and AT&T are at all time highs. This volume has sustained for months, whereas overall market volume has been very light since April. These companies pay 5%+ dividends and have pricing power that comes with being leaders in a market with such high entry costs, making them particularly appealing investments in a dreaded recession.

While AT&T and Verizon may be good companies to invest in, they are highly integrated and have their hands entirely full maintaining existing networks and can only attempt growth when technological innovation provides opportunity. More clearly, most people in the US already have a cell phone and most businesses already use communications networks to their desired extent.

When it comes to growth and investment value, Brazil has become the BRIC's ignored "fourth wheel." Russia has ridden the oil roller coaster and most studious emerging market investors have focused on China's huge stimulus package and increased consumption as well as India's political shift. Brazil is assumed to have garnered equal attention, given the country's acronym leading position, but volume and price simply don't agree.

I believe Brazil is irrationally associated with Mexico, which borders the USA and is not even on the same continent as Brazil. Nonetheless Brazil's New York traded ADRs generally move according to news from our notoriously unsavory southern neighbor, such as flu breakouts and mafia activity (these things tend to be perceived as "negative"). More regularly, Brazil ETFs (NYSEARCA:EWZ) and ADRs fluctuate with the prices of oil and gold, both resources the country is rich in.

The last year depicted in the four year charts above shows a uniformity in movement that obviously ignores differing fundamentals. EWZ is concentrated in commodities and financials, which have universally performed similarly, gaining steadily from sharply reached March lows until pulling back recently. PBR and BVN have fluctuated consistently with their respective commodities. Also fluctuating with worldwide commodity markets have been Brazil's water, electric and telecom utility ADRs! Again this may boil down to volume, as unlike US utilities Brazil's are traded more thinly than ever. Still, these are high yielding stocks and growing companies with huge competitive advantages.

Information is much harder to come by for Brazilian ADRs than Asian ones, however Brazil's economy, from all indications, might be the best poised in the world. Bank balance sheets are relatively clean and consumption is at an all time high in what has traditionally been an export-reliant economy. Power and water usage are up and favorable trade terms with China are appparent.

Urbanization and overall growth are reasons to own a stake in Brazil's telecom industry, but price makes now a good time to buy. These stocks are 20-25% down from two weeks ago and many considered them a safehaven then.

Telemar (NYSE:TNE), which bought Brasil Telecom (BTM, BRP) recently, trades near book value with a PEG of 0.6. I feel less than certain as to how income will be distributed in the future, however Telemar now controls substantial market share. My strategy, therefore, is to own a stake in the parent company and the healthiest offspring. BTM and BRP both trade at lowly Price / Sales ratios under 1/3 with similar growth histories, but BRP has higher institutional ownership and a much stronger dividend and price history.

An important quality of these stocks is that their dividends are not regularly scheduled. They are generally announced with earnings and paid to shareholders of that date, not a future one. What this is designed to do is minimize volatility by encouraging long term investing. What it seems to do is scare investors away and leave the stocks undervalued. I see this apprehension as an excellent opportunity, with urban growth as evident in Brazil as any other country. The charts suggest that dividend announcements may be very near and, unlike most sectors, this is a historical and fundamental opportunity to "buy low."

Disclosure: Long TNE, BRP, CPL, SBS

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