Brazil: Let the Feeding Frenzy Begin

by: Otto Rock

...but be smart and take the short-term profits.

There will be plenty of time to position yourself for the long term once the S&P investment grade upgrade starts to make a real impact on the Brazilian economy. However the chances of hot money sloshing in tomorrow are pretty high, with articles such as this one linked here predicting 25% index gains for 2008 fuelling the sheep money fire (remember the ADRs traded in New York yesterday, but the Brazilian markets were closed for May Day).

So where are the trades? Let's assume you don't have access to the Brazilian market directly and want to play the ADR stocks; here are a few to consider:

ERJ: the Embraer ADR. This one has lagged the market somewhat this year, despite being a great Brazilian success story and having an order book stacked up in the billions of dollars. Expansions in workforce have started getting the planes out to customers more quickly recently. It's something of a national jewel, this one.

VIV: Mobile phone play Vivo jumped 6.4% yesterday, but there's plenty more where that came from. Sector consolidation in Brazil is making the competition less cut-throat., and VIV should begin to perform well on its bottom line. As the North loves a growth stock in a growth sector, I expect Vivo to be a hot money target.

CIG: Cemig is a Brazilian energy play that popped 2% yesterday, but it still under its 52 wk highs. At $21 now, if this breaks $23 it'll be off to the races. [CORRECTED]

SBS: Sao Paolo water company SBS is sitting here at a great, great price. Dividend yield is attractive, and I have its forward PE pegged at 8X presently. That could easily expand to 12X now that investment grade is here. SBS is probably my top Brazil pick from here, but at the same time may not get the first wave of hot money washing over it.

ITU: Banco Itau got a big pop on strong volume yesterday on the investment grade news, and will be one of the first in line to receive hot money when Sao Paolo opens tomorrow. It may be close to fully priced on fundamentals right now, but there may well be a lack of logic in Brazilian trading over the next couple of sessions. Trade it on a momentum basis.

GGB: Gerdau Steel has resisted all downgrades on its climb to its current all time high. With a PE of 11.5X right now, there's more in the tank now that Brazil is "officially a serious country"*. Again, don't be afraid to take a short term profit on GGB, but be thinking about a longer term position afterwards.

So there are six ways to play the investment grade party. You'll notice that PBR and RIO aren't on the list. This because they're already 'world class' investment risks and won't be first in line to get "the pop" from this news. Another way to play Brazil is the useful ETF play, EWZ. Finally, the Brazilian bonds may have tightened considerably these last 48 hours, but with the high interest now on offer to more institutional money, they will still have plenty of buyers on Friday. Another good option to consider.

I hope this little overview helps in its own small way. However I'm sure you'll need to do more DD on any or all of these before making a good investment decision.

Disclosure: Long SBS, VIV