South of the Border, Down Brasilia Way

by Travis Johnson, Stock Gumshoe | July 3, 2009 2:37 pm


Brazil’s economy is finally growing now, a growth that it started getting credit for a few years ago, before the expansion really started — five years ago, it was enough that Brazil under President Lula seemed to have a handle on inflation and a reasonably pro-business government. Now, it’s one of the few large, stable economies in the world that’s really growing.

The commodity bull market came at the perfect time for Brazil, as they welcomed Chinese purchasers with open arms and shipped tankers full of iron ore, soybeans and oil around the world — and the whole country started to be valued by foreign investors as a commodity producer. Brazil is now China’s largest trading partner, surpassing the US.

That was perhaps the jump start that the economy needed, and the big multinational commodity companies in the country have certainly profited nicely … but Brazil is (arguably) becoming one of the stronger consumer markets in the world, too — an economy that didn’t experience irrational exuberance but does have a population that is (slowly) growing more affluent … and banks that have been largely rational, though Brazil’s homebuilding stocks had plenty of trouble last year, too, since even a strongly growing economy will suffer when its primary exports become less valuable. Brazil is a meld of cultures, and it also seems to be a mix of its neighbors — take a piece of frightening fiscal past from Argentina, a bit of stable European business center from Chile, and a chunk of agricultural powerhouse and melting pot from the United States, and you’d come close to getting something like Brazil. Throw in that they have more fresh water than anyone else in the world, a huge amount of land, plenty of oil for a growing economy, and a large, young, and growing population, and the big picture seems to favor this being Brazil’s century.

Or, given their past propensity for economic calamity, at least Brazil’s decade or so.

So how does one invest in the Brazilian consumer economy? The easy way to do it is through an index, but the country is broadly perceived by investors as being a commodity play, and the country stock market index (for our purposes, we’ll use the iShares EWZ ETF) is, likewise, dominated by a few large banks and resource companies. If you buy EWZ you’re really buying Vale (iron ore), Petrobras (oil), and Itau Unibanco and Banco Bradesco (banks, as you probably guessed). Energy, commodities, and financials together make up almost 75% of the index. Probably still a good investment, but I’m interested in finding out whether Brazil has some stocks that might perform reasonably well even if commodity prices continue to jump around like kangaroos in a sack race.

So what of consumer companies, agriculture, utilities? Agriculture stocks should probably be thrown in with the big commodity exporters, since Brazil is one of the world’s breadbaskets — so you could also consider companies like Aracruz Cellulose (ARA) or Votorantim Cellulose (VCP) in the cellulose industry, or Cosan (CZZ) for sugarcane ethanol (there are a couple other big sugar firms in Brazil, but they’re harder for US investors to buy — CZZ has been losing a lot of money and taking on more debt of late), and foreign firms with big businesses in Brazil like Bunge, to be part of this export-led sector.

What we’re left with after that is the stealthily growing consumer economy in Brazil, which is much less predictable but might also become hugely profitable in the years to come — and although several of these companies have had big problems in the past year because of the swinging moves of the Brazilian Real, including some catastrophic derivatives hedges that blew up in their faces, it should be possible to find domestic companies that might be a bit less subject to the vagaries of international trade and foreign exchange rates.

There are a few reasonably large plays in this space, like Redecard or the brand new IPO VisaNet (they do MasterCard and Visa transactions in Brazil, respectively, and are controlled by the big banks — neither is easy to buy in the US, though Redecard has a pink sheets ticker RDCRL that almost never trades), Perdigao (PDA) and Sadia (SDA … I own Sadia — together these two dominate the meat and prepared food industry in Brazil, and the two companies are merging, but they also export heavily and had big currency problems last year), a few beverage and bottling companies, retailers and restaurants, and the telecoms and utilities.

Of that last group, Tele Norte (TNE) is the largest domestic telecom player and it is certainly still looking for growth as well as continued solid cash flow. I wrote about them for a Carla Pasternak teaser earlier in the week, and I’ve become tempted by those shares (I won’t buy them, if at all, for at least three days, of course, since I’m writing about them here). They have just started reporting consolidated earnings after their takeover last year of one of their major competitors (Brasil Telecom — which still also trades as a subsidiary), so the prospects for continued sustainable cashflow and future growth seem pretty solid, even if there’s a chance that this year will show continued weakness due to the costs of the acquisition and their other growth investments (particularly their wireless buildout). So I like TNE as a relatively defensive telecom company — not unlike Verizon in the US, which I own, or France Telecom (FTE), America Movil (AMX), or a dozen other strong, high dividend wireline/wireless telecom firms around the world. Nice dividend, potential growth, and a real, valuable stable of assets that would be difficult or impossible to build from scratch.

And in the utility space, the one that catches my eye is water — the big publicly traded water utility is SABESP (SBS) — full name Companhia de Saneamento Basico do Estado de Sao Paulo, if you’re keeping track. They run the water and sewage services for about 20 million people in and around Sao Paolo, and for about five years they were a wonderfully steady grower — they got teased by the Motley Fool’s Global Gains service a few times in recent years, and they pay a dividend, though it’s not a remarkably large one for these times (has recently been in the 3-5% range). I would expect that growth will be moderate and they won’t be able to smother their customers with huge rate increases, but even though they bounced off the lows of the crash they’re still far, far below the highs of a year or two ago. And they are authorized to expand outside of Sao Paolo, which they’re trying to do, and internationally, the latter of which seems to be underway very cautiously and slowly, with an initial project in Costa Rica.

But writing about TNE and thinking about utilities earlier in the week got me thinking — what else can we do to get at the Brazilian consumer?

Lots of other people are thinking the same thing — Wal Mart is boosting its investment in Brazil this year, they’re pouring almost a billion dollars into building their presence. And if the new GM survives, it will be largely thanks to their success in China and Brazil — they’re going forward with a multi-billion dollar investment to build cars in South America, with much of that money going to Brazil (and yes, Brazil is one of the markets where GM is actually a profitable business).

There are a few big international companies that are relatively easy to buy, listed in the US — that includes AmBev (ABV), the Brazilian beverage giant that’s really a big player across the Western Hemisphere; Embotelledera Andina (AKO-A), the Chilean Coke bottler that also does a major business in Brazil in beer and soft drinks. And if we expand the idea of “consumer” a bit we can get to Ultrapar (UGP), the refinery, fuel and chemical company.

Elsewhere in telecom, there is also one cable tv and internet company that’s available as an ADR — that’s Net Servicos de Comunicacao (NETC), which has a footprint in some of the more populous regions and sounds promising, but has also already bounced 70% from its lows (and doesn’t pay much of a dividend).

And then we get to retailing … if you want direct Brazil exposure (ie, you don’t want the small slice of Brazil sales from Wal Mart), there’s really only one big play left. Tthat’s because the big grocer/hypermarket operator — Companhia Brasileira de Distribuicao (CBD) — is in the process of trying to buy the big general/electronics retailer Globex Utilidades and their Ponto Frio brand, which will again make CBD Brazil’s largest retailer. CBD looks pretty interesting, the shares are up about 50% this year, which makes me think I should have been looking at them earlier, but they’re still well off their highs of the last several years (they came close to $50 before the wheels came off last year). They are still profitable, with very rapid sales growth and decent margins for a mass market retailer — of course, even though they’re the biggest home-grown retailer, they do have to compete with global titans Wal-Mart and Carrefour, so it isn’t exactly a free ride. If you do look at this one, go straight to their website for the financials[1] — most of the US websites can’t seem to get the currency and data correct.

And finally, yes, you can buy the “McDonald’s of Brazil” — it hasn’t had quite the same outperformance this year as we’ve seen from the McDonald’s of the rest of the world, but the largest fast food company in Brazil is growing fast. Brazil Fast Food (BOBS, trades over the counter) was profitable last quarter, and it is consolidating around a few brands — its own Bob’s hamburger chain, which is heavily franchised across Brazil, and a string of KFC and Pizza Hut restaurants, along with some smaller regional brands. Earnings were down substantially from last year in this most recent quarter, but they did still earn seven cents a share during what they described as tough times — and same store sales were up by more than 11%, with growth substantially higher than that because they’re also continuing to grow their store base. This is certainly a risky one, but they think they’ll have a network of better than 700 restaurants by the end of this year … and if we annualize their recent, depressed earnings, we get a PE ratio of about 12 (that would be 28 cents of earnings, which is just a wild annualized guess, and the recent $3.35 share price) — I haven’t dug very deep into this one yet, but it has come to my attention a number of times in the last few years, and this is as cheap as the shares have looked to me in a long time — at the current price, if we assume that there aren’t any skeletons hiding in the closet (as I said, I haven’t dug very deep yet), this seems like a pretty inexpensive way to get exposure to a rapidly growing restaurant business. Fast food companies in general are seeing most of their growth come from overseas, so why not buy one that’s just overseas?

And of course, there’s always the little fella lurking in my portfolio that I seem to be holding on to largely as a reminder of the mistakes I make — Gol Linhas Aereas Inteligentes, the discount Brazilian airline that I still have fond feelings for, but which has been an awful business (and stock) for a couple years. In some way, this is also a play on consumers, since they are levered to the new flier, the traveler who hadn’t ever flown before and can spring for something slightly more expensive than a bus ticket. Of course, Gol also had a terrible plane crash, and bought Brazil’s old international flagship carrier Varig out of bankruptcy, and has seen increasing costs and decreasing sales of late — but hope springs eternal. Oh, and it’s also owned by a controlling family that could always try to take the company private at these depressed prices and leave shareholders like me to book their losses. Oh, well — and yes, there is a second major airline in Brazil, too, TAM, which has also lost investors a lot of money … at least I only bought one of them.

So what do you think? Do you prefer the big international commodity plays, or the (relatively) conservative Brazilian banks? If so, then certainly the ETF is an easy way to go — or would you like to find a way to invest in the growth of Brazil’s consumer economy? If the latter, do any of these utilities, retailers or restaurants appeal to you? Have some others in mind that I haven’t mentioned? Feel free to share. And if you’re in the US, have a great holiday weekend and Fourth of July!

Endnotes:
  1. go straight to their website for the financials: http://www.gpari.com.br/eng/home/index.asp

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