The Brazilian government is embroiled in a bribery and corruption scandal that could topple President Dilma Rousseff, whose approval rating has plummeted to a mind-boggling low of just 8 percent — and nearly two thirds of the populace want her impeached, according to a Datafolha survey released in early August.
The nation’s economy remains mired in its steepest recession in more than two decades. Its currency is at a 12-year low against the dollar, while inflation has surged to a 12-year high (9.56 percent). The unemployment rate is rising, and consumer confidence is falling — and it’s hard to find anyone who thinks the situation will improve anytime soon.
“The path to recovery will be very slow,” affirms Ilan Goldfajn, chief economist at Itaú BBA in São Paulo. “Brazil will have to cut costs, and since the economy is highly indexed, it takes longer to reduce unit labor costs. We expect the labor market to weaken further. In addition, fiscal consolidation is proving more challenging, especially in a recession where revenues are collapsing.”
The government has been forced to postpone — by several years — its objective of debt stabilization, he adds. Against such a backdrop Goldfajn expects the economy to shrink by 2.3 percent this year and 1 percent next year. “Growth is likely to resume only in 2017, and still at a very mild rate, just 0.4 percent,” he contends.
Emerson Leite, Credit Suisse’s co-director (with Edward Weaver) of Latin American equity research, concurs. “A V-shaped or sharp recovery is unlikely this time, and growth will probably stay weak,” he says, adding that his team projects a real gross domestic product slowdown of 2.4 percent this year and 0.5 percent in 2016.
Leite, who works out of São Paulo, cites three domestic issues inhibiting recovery: “One, confidence levels at an all-time low, which makes a rebound in household consumption and investments improbable in the short term; two, the need to control inflation and public accounts, which limits the government’s room to apply stimulus through monetary and fiscal loosening; and three, the resistance to structural reforms — labor, tax and social security reforms — which still stands as a daunting challenge, with the government facing difficulties in passing legislation through Congress.”
There are external considerations as well. “We see several headwinds that restrain better GDP growth — weak growth in Brazil’s main trading partners, like Argentina, and a worsening in commodities prices for key Brazilian exports, like iron ore,” he adds.
Although many global investors have opted out of Brazilian securities, at least until signs of sustainable recovery appear, there are exceptions, according to Carlos Constantini, Itaú’s director of research. “Two types of investors continue to make incursions in the Brazilian equities market: first, the very long-term holders, who are seeing through this cycle and find value in selected names; and second, the opportunistic, smart money investors, who are coming to play specific events and trading strategies, such as buying stocks and selling futures,” he says. “The weaker real and high interest rates have contributed to attracting these types of investors.”
Doubtless those money managers — along with others currently taking a wait-and-see attitude toward Latin America’s largest economy — look to the sell side for insights into where the market is headed, and the firm whose guidance they value most highly is BTG Pactual, which helms the All-Brazil Research Team, Institutional Investor’s exclusive annual ranking of the nation’s best sell-side analysts, for a fourth straight year. It wins 18 spots, the same number it captured in 2014. Itaú BBA lands in second place for a third consecutive year. Last year it trailed BTG Pactual by two team positions; this year just one.
Credit Suisse, at No. 3, is the highest-ranked nondomestic firm again this year. Its total surges by three, to 15. Rounding out the top five are Bank of America Merrill Lynch and J.P. Morgan, with 12 and ten positions, respectively; last year each claimed 11.
Eleven firms are presented on this year’s roster; to view the full list, click on the Leaders link in the navigation table at right, or the Best Analysts of the Year to view the individuals in first, second and third place in each sector, plus a list of runners-up (where applicable).
Nearly half of this year’s top-ranked analysts — nine of the 19 — finish in first place for the first time. For information about these winners and other survey highlights, click on Overview.
David Beker is among the researchers celebrating a first appearance at No. 1. The BofA Merrill economist scores a spectacular debut atop the roster in Sovereign Debt at a particularly interesting time for the sector. In late July, Standard & Poor’s downgraded from stable to negative its outlook for the nation’s credit rating — which the agency had lowered to just one notch above junk status back in March — after the government slashed its primary surplus target from 1.1 percent of GDP to 0.15 percent (from 66 billion reais [$18.8 billion] to just 8.75 billion reais) and announced deep cuts in spending, citing sharply lower tax revenue.
Other ratings agencies may take even more aggressive action.
“The focus is on Moody’s decision now,” says Beker, who is based in São Paulo and also earns a runner-up position in Economics. “We expect a one-notch downgrade, and chances of the outlook to stay negative clearly increased. The prospects for higher debt-to-GDP ratios ahead increased the odds for the country to lose its investment-grade rating over the next 12 months.”
In response to the government’s target revision, “we closed our recommendations on the long end, and we remain neutral on rates despite the recent sell-off due to the aforementioned sources of uncertainty,” he reports. “[Credit default swaps] widened more than bonds in the five-year sector, and there we like selling the basis.”
Beker is bearish on the real in the medium term, he adds, “but at current levels we prefer to be tactically neutral given the recent sell-off.”
Education is one of the industries targeted by government spending cuts — more than 10 billion reais as of late July — but sector champ Bruno Giardino, who vaults from third place to lead this lineup for the first time (and also claims a runner-up spot in Health Care), believes the impact will be fairly modest.
Owing to the newly limited access to the Fundo de Financiamento ao Estudante do Ensino Superior, a program that provides low-interest loans to students pursuing higher education, “companies are challenged to bring new students and/or retain existing students in a less supportive environment, aggravated by Brazil’s macroeconomic deterioration,” the Santander analyst observes. “The higher share of non-FIES students could also negatively weigh on profitability, as the price and delinquency dynamics are less favorable. On the flip side, the new, challenging environment could accelerate industry consolidation movements, which if well executed could result in significant value creation.”
Giardino, who is stationed in São Paulo, says he is “cautiously positive” on the sector’s prospects. “In spite of the industry headwinds, we believe that listed companies are prepared to overcome such challenges,” he says. Among the names he is recommending is Bela Horizonte–based Kroton Educacional, owing to its “sound execution track record, its large exposure to the distance-learning market — which is unaffected by FIES changes — and the potential synergies to be extracted” from last year’s merger with domestic rival Anhanguera Educacional Participações, he explains.
Another pick: Recife’s Grupo Ser Educacional, which “stands out for its relatively cheap valuation, offering greater margin of safety than its peers, and for the preferred allocation of FIES contracts to the North and Northeast regions, where the company has the core of its operations,” Giardino notes.
Not surprisingly, the nation’s economic and political turbulence — not to mention rising inflation and its effect on purchasing power — is dragging down consumer confidence. The Fundação Getúlio Vargas index fell to 82 (out of 200 points) in late July — a record low.
“The whole macro and political environment remains very fluid, which is negatively impacting expectations,” contends Credit Suisse’s Tobias Stingelin, who rises from second place to first in Retailing. “Consumer confidence might improve once we see signs of stabilization — inflation coming down, the currency stabilizing, companies no longer firing, interest rates coming down, and so on. This is a process, and it will take some time for consumer confidence to recover.”
In the meantime, the São Paulo–based analyst is bearish. “We have been recommending that investors stay out of the sector, as we have still not touched bottom,” he says. “It is too early to be brave on a six- to 12-month view. Investors that have a long-term horizon might be looking for some names already, but the environment will be tough in 2015 and probably also in 2016.”
That’s true, says Morgan Stanley’s Guilherme Paiva, on top in Equity Strategy for a fifth straight year. “Brazil is going through an adjustment process to correct the misallocation of resources — capital and labor — that the commodities boom created, and that was exacerbated by past government policies,” the New York–based strategist says. “We do expect the economy to struggle in the second half of this year and in 2016, as the current macro policy mix is not conducive to a solid economic rebound.”
But there are opportunities to make money, he believes, as the weak currency is a boon for exporters. “We are recommending some exporting stocks in the aerospace, food and pulp sectors,” he says, citing Embraer, BRF and Suzano Papel e Celulose, respectively, as examples in each industry. “These companies should continue to benefit from a weaker currency in Brazil. In addition, we like some defensive stocks in beverages, such as Ambev; financial services, such as Cielo; and information technology — Totvs is one example. These corporates should be resilient to an economic slowdown.”
Although the real had plunged to 3.50 against the dollar in early August, “there is still room for more depreciation,” insists Itaú’s Goldfajn, who claims his third straight victory in Economics as well as a second-place debut on the Sovereign Debt roster. “The deterioration in the country’s fiscal fundamentals raises more doubts regarding Brazil’s ability to keep its investment-grade rating, and the fiscal accounts are unlikely to improve soon. Foreign investors may require better terms to invest in the country, including a more depreciated exchange rate. We estimate that the rate may reach 3.55 by the end of this year and 3.90 by the end of 2016.”
The 2015 All-Brazil Research Team is based on the views of 695 buy-side analysts and portfolio managers at 367 institutions that manage an estimated $261 billion in Brazilian equities and $139 billion in Brazilian debt.