Latin America’s top corporate executives are getting a reality check. After several years of booming growth, thanks in large part to their success in tapping burgeoning demand in emerging markets, top Latin executives are now feeling the knock-on effects of a recent slowdown in those markets as well as the persistent woes dogging Europe and North America. The slump in demand is forcing corporate leaders to pull in their horns, or at least recalculate their trajectory.
The two largest Latin American economies are both feeling the slowdown. The International Monetary Fund forecasts that Brazil, a darling of the emerging markets for the past five years, will grow by only 1.5 percent this year, against 2.7 percent last year and a galloping 7.5 percent in 2010. And the IMF says Mexico, which some investors have seen as an alternative to Brazil, will grow by 3.8 percent this year, faster than Brazil but virtually unchanged from Mexico’s 3.9 percent growth rate last year and down from 5.5 percent in 2010.
In general, Brazilian companies are reacting to the new international and domestic environment by reining in costs. Consider Brazil’s Vale. The mining conglomerate is one of the world’s largest producers of iron ore and copper, among other minerals, and it has benefited in recent years from surging Chinese demand for metals. But slower global growth has sent commodity prices tumbling, causing a 20.8 percent decline in Vale’s second-quarter operating revenues, to $12.15 billion, and a 58.7 percent plunge in earnings, to $2.7 billion.
For a company that had planned to ramp up its capital spending by nearly 17 percent this year, to $21 billion, that revenue hit has prompted a hardheaded rethink. In August the company canceled plans to invest $3 billion in a new potash mine in Saskatchewan, Canada.
In October, Vale also put on hold the $1.3 billion development of the Zogota mine in Simandou, Guinea’s richest iron ore deposit. The mine was supposed to have started output by the end of this year. The company paid $2.5 billion for the concession in April 2010 but its plans were thrown into doubt, following the end of military rule in the country in November 2010, as the new civilian government decided to review the mining licenses that had already been granted.
“In this environment, it’s vital that we manage cash flows carefully,” says Luciano Siani, who replaced Tito Botelho Martins as CFO in July.
Such responsiveness is valued by investors. Vale’s chief executive, Murilo Pinto de Oliveira Ferreira, was voted the top chief executive in the Metals & Mining segment by both buy-side and sell-side analysts surveyed by Institutional Investor for its 2012 Latin America Executive Team, the magazine’s third annual ranking. Vale tied for 22nd among Most Honored companies in the rankings. Sweeping honors for best CEO, CFO, Investor Relations Professional and IR Team were Cielo, a nonbank financial services company, and Klabin, a pulp and paper manufacturer.
In addition to reducing capital spending, Vale is taking steps to improve the efficiency of its supply chain to compete more effectively with rivals in Australia, especially BHP Billiton. To enhance its ability to meet demand from the Middle East and Asia, for example, the group is opening new plants and distribution centers in Oman and Malaysia, which are closer to its operations in those target regions than its existing facilities in Brazil.
The company’s new $1.36 billion distribution center and pelletizing plant at the Port of Sohar Industrial Complex in Oman, which has a maximum production capacity of 9 million metric tons of direct-reduction pellets per year, enables large amounts of raw iron ore to be stored for just-in-time delivery. It will serve as a hub for iron ore products in the Middle East, North Africa and Asia. Asia accounts for 50 percent of the group’s revenues, with a third coming from China alone.
To maximize the distribution center’s capacity, Vale entered into a partnership with Sohar Industrial Port Co. to build a 1.4-kilometer (.87-mile) deepwater terminal. This terminal will be one of the first ports in the world to receive very large ore carriers (VLOCs), huge ships able to carry up to 400,000 metric tons of iron ore.
The Oman distribution center and pelletizing plant, together with a floating transfer station in the Philippines’ Subic Bay, a distribution center and port being built in Malaysia and the VLOCs, are part of Vale’s strategy to increase its flexibility and competitiveness, even as it exerts tighter control over spending.
Brazil-based Klabin is also trying to drive costs down. It started this process at the start of last year, when the external environment was better, and that foresight has been rewarded by investors, who have sent its share price up 112 percent during the past 12 months.
The move followed the appointment of Fabio Schvartsman as CEO in February 2011.
Schvartsman, voted the best CEO in the Pulp & Paper segment by both buy-side and sell-side analysts, had spent most of his career at Brazilian conglomerate Ultrapar Participações, where he was most recently CFO. At Klabin he initiated a cost containment process called Matrix, developed by the Institute for Managerial Development (INDG), a Brazilian management consultancy, that places top managers in charge of specific items such as energy, labor and technology.
“It’s a very simple process that enabled us to create a ladder line of control,” says Schvartsman, who notes that the process will remain in place for the foreseeable future and that it has allowed Klabin to reduce costs by hundreds of millions of reais a year.
During the first half of this year, Klabin’s earnings before interest, taxes, depreciation and amortization climbed 35 percent, to 593 million reais ($291.3 million) from 439.3 million reais, as its profit margin expanded to 27 percent from 20 percent last year on the strength of declining unit costs.
But Klabin isn’t just cutting costs: It plans to invest $3.5 billion, the most in its history, in the construction over the next two years of a pulp mill, called the Puma Project, close to the group’s 250,000-hectare (965.3-square-mile) forest plantation in Parana state. The mill will be the first in the country to produce both long-fiber and short-fiber pulp. Because both types of fiber are needed for paper production, the group will have a competitive advantage when it markets the pulp.
Cielo, the largest Brazilian credit and debit card operator, is yet another group that has decided to reduce operating costs in light of the challenging economic environment in Brazil this year. Like Klabin, it has used INDG to help institute cost control measures. Also like Klabin, Cielo is making new investments and as a result saw its domestic market share grow to 61.1 percent in the second quarter of this year from 56.9 percent in the fourth quarter of 2010.
Cielo has little choice but to reinvest in the business, as it is facing new competition in its home market of Brazil after losing its government monopoly on Visa card processing in July 2010. To fend off competition from its main rival, Redecard, and take share from it for MasterCard and Diners Club transactions, Cielo used $670 million of the $4.13 billion it had raised through a June 2009 IPO, at that time the biggest ever in Brazil, to acquire Merchant e-Solutions, or MeS, of Redwood City, California. MeS, which has a full-service payment platform for financial institutions and merchants, processes more than $14 billion per year in domestic and international payments for more than 65,000 merchants. The acquisition increases the number of Cielo’s merchants by less than 6 percent, to 1.2 million, but enhances Cielo’s ability to attract more, says CEO Rômulo de Mello Dias, voted the top chief executive in the nonbank financial services segment by both sell-side and buy-side analysts.
“MeS has state-of-the-art e-solutions for merchants,” says Mello Dias. “It shows that we are committed to growing our business in the long term.”
In particular, he notes, MeS’s technology should help Cielo secure its domination of online payment processing. The company already has 90 percent of that market, but e-commerce accounts for only 7 percent of sales in Brazil today. That is expected to rise to 20 percent by 2020.
The top executives of another Brazilian company that ranks highly in II’s survey are also adjusting to slower growth by seeking to expand market share.
Localiza Rent a Car, which is headquartered in Belo Horizonte, Brazil, and is the largest car rental company in Latin America, has seen its revenues this year decline by 13 percent, reflecting the slowdown in the domestic economy. Last year, its retail division saw its annual revenues increase by 25 percent while its fleet rental division rose by 21 percent. The retail division normally grows at five to six times Brazilian economic growth, but the country’s GDP grew a mere 0.4 percent in the third quarter from the second.
Yet CEO José Salim Mattar Jr., voted top chief executive in the Transportation segment by sell-side analysts surveyed by II, vows to accelerate the company’s growth by driving smaller competitors out of business. Localiza currently has a 37.5 percent share of the car and fleet rental market in Brazil and operates out of 253 distribution centers there. Going forward, the company plans to open 20 company-owned and another 20 franchised distribution centers per year for the foreseeable future.
“Localiza plans to be the consolidator, not by buying these businesses but by growing organically,” says Salim Mattar. “We believe it will be difficult for many of these small businesses to compete with us.”
Localiza also expects growth of its fleet division to pick up as more companies decide to rent their fleets rather than buy them. In the U.K., for instance, 47 percent of large and medium-size companies rent their fleets, compared with only 5.4 percent in Brazil.
Top corporate executives are focusing on market share despite or because of slowing economic growth in Mexico as well as Brazil. Grupo Financiero Banorte, a Mexican bank based in Monterrey in the north of the country, has made two acquisitions in the past two years that helped push its assets under management to 1.4 trillion Mexican pesos ($107 billion) at the end of the second quarter, a 31 percent increase from the same period last year.
In April of 2011, Banorte acquired its smaller competitor Ixe Grupo Financiero for 16.2 billion pesos, giving it access to Ixe’s portfolio of wealthy clients, mostly in the Mexico City metropolitan area. That followed by seven months the purchase of a 50 percent stake in XXI, a Mexican pension fund, for around $200 million from U.S. insurance company Prudential.
The two deals are just the latest in a string of acquisitions that have increased the bank’s share of industry assets from 1.5 percent
20 years ago to 15 percent today and taken it from the 17th largest bank in the country to the third.
But CEO Alejandro Valenzuela del Río, voted the No. 3 chief executive in the Financials/Bank segment by buy-side and sell-side analysts surveyed by II, concedes that the deals represent integration challenges. “This is a work in progress,” says Valenzuela. “It’s important that all the senior management plays as one team.”
Although he says he is encouraged to see the latest acquisitions help the bank continue to grow overall market share, he notes that Banorte still ranks only No. 5 in the country in credit card volume and points to a huge opportunity to take business from its 40 or so competitors by cross-selling newly acquired customers.
Valenzuela says the key to success here is to offer better service and pricing, though he acknowledges that “it takes time to gain market share, as there is a degree of client inertia and people do not change their credit card operator overnight. Credit cards are a very competitive market.”
Not every member of this year’s Latin America Executive Team is facing tougher conditions. Some of their companies are well insulated from the downturn because of fundamental trends, including the continuing growth of the middle class despite a rising population. Although that phenomenon is obviously predicated on strong growth, few executives in this promising situation think the downturn will be long or deep enough to end it.
Consider Kroton Educacional, the third largest private educational company in Brazil, with 145,000 students at 53 campuses and an additional 271,000 distance learning students who attend a class at 450 learning centers at least once a week. Kroton expects that number to rise by 20 percent this year before acquisitions, thanks in part to government-supported loans and a 7 percent annual increase in the number of students between the ages of 18 and 24.
But acquisitions are likely to give a significantly greater boost to Kroton’s growth, if the past is any indication. In June 2009, when Kroton had only 45,000 students, Advent International, a global private equity firm headquartered in Boston, acquired a 26 percent stake in the company and proceeded to modernize its management and governance to help the company buy and integrate competitors. The group made seven acquisitions in the past year alone — four small ones (which each added 3,000 to 7,000 students) and three big ones (adding more than 7,000 each).
“The company was almost treated as a start-up,” says CEO Rodrigo Galindo, voted the No. 1 chief executive in the Education segment by buy- and sell-side analysts. Although Galindo is quick to note that Advent doesn’t run Kroton, he says its largest shareholder has M&A and financial specialists who have been “very helpful.” Galindo, who had a long career at the Brazilian educational group IUNI and eventually rose to become CEO, was named chief executive of Kroton ten months after it acquired IUNI in March 2010. He adds that with the Advent investment in Kroton, “the right mix was created between people with educational and financial knowledge.”
Kroton sees much more opportunity for further consolidation of the educational sector in Brazil, which has some 2,300 institutions and establishments that are potential candidates. Even now, Kroton accounts for only 5 percent of the market for 18- to 24-year-old students, with a 25 percent share of the distance learning market but only 2 percent of the on-campus market.
Kroton also sees an opportunity to grow through better use of technology designed for the classroom or home-based distance learning. With this in mind, the company is developing what it calls “adaptive learning methodologies” that enable students to monitor their performance more closely, though the company cannot estimate what this will cost.
Spending on deals and technology hasn’t taken Kroton’s eye off the bottom line. Galindo says the company expects a productivity and efficiency push to widen its ebitda margin to 30 percent in the next few years from its current level of 10 percent.
Another Brazilian company riding the back of the Latin American demographic bonus is BR Malls Participações, which is headquartered in Rio de Janeiro and is the largest shopping mall company in Brazil, with 48 malls, up from just six in 2006. Like Kroton, BR Malls is benefiting from the sharp rise in the number of middle class households in the country and managing to weather the economic downturn well as a result.
To be sure, chain store sales are down this year, but BR Malls CEO Carlos Medeiros Silva Neto, voted the No. 1 chief executive in the Real Estate segment by both buy- and sell-side analysts, isn’t troubled by the slippage, thanks to strong demand from retailers. BR Malls’ occupancy rate for its total of 1.51 million square meters (4.95 million square feet) of leasable nonkiosk space and another 855,000 square meters that it owns is 97.5 percent.
“Our tenants want to expand, want to grow their businesses,” says Medeiros. He sees particularly strong interest on the part of U.S. and European retailers who target emerging markets as their main source of future growth and favor Brazil over other such markets because its population’s consumption habits are similar to those of markets elsewhere in the West.
With that in mind, BR Malls is building six more malls and expanding six existing ones, which together will increase its total leased space to 1.8 million square meters and its owned space to 1 million square meters.
Saturation is a long way off. Only 20 percent of retail sales in Brazil take place in shopping malls, compared with 40 percent in Europe and 50 percent in the U.S.
Lojas Renner, one of the largest apparel department store chains in Brazil, has also shrugged off the downturn and is making a big effort to expand its business in regions of the country that continue to show strong growth. Lojas Renner’s success during the past few years has been driven by the rise of the middle class, like Kroton’s and BR Malls’, but it has also profited from rising tourism, says CEO José Galló, voted the No. 1 chief executive in the Retailing segment by both buy- and sell-side analysts.
Between 1995 and 2011 the company’s revenues and ebitda grew, respectively, by an average of 19.6 percent and 32.8 percent annually.
“That kind of increase is not so common,” Galló tells II.
Although some 90 percent of its stores are in shopping malls, the company believes there are opportunities to expand into small towns in the northeastern and central-eastern parts of Brazil. The company forecasts it will have 408 stores by 2021, almost double the 210 it has at present.
Galló observes that many companies are taking advantage of tax incentives offered by provincial governments to relocate to the northeastern region, which is only six hours by air from Europe.
The central-eastern part of the country is devoted largely to farming, especially soy production, which Galló notes is one of the fastest-growing industries in the country.
CFO Adalberto Pereira dos Santos, voted the No. 2 chief financial officer in the Retailing segment by both buy- and sell-side analysts, says that as incomes improve and more people become able to afford basic necessities, their consumption patterns change and they start to buy more stylish clothing, which works to Lojas Renner’s advantage, as it targets consumers in all income categories.
Pereira dos Santos explains that the number of people of working age — 15 to 64 years old — is projected to expand until the year 2020: “That means more customers for us.”
Another Mexican company facing a tougher environment is Coca-Cola Femsa, which is 30 percent owned by the U.S. drinks giant Coca-Cola and ranks as the largest franchise bottler in the world. During the second quarter of this year, Femsa’s operating income grew 7.8 percent, to 4.7 billion pesos from 4.4 billion pesos a year earlier, on a 27.9 percent increase in revenues, to 36.3 billion pesos from 28.4 billion pesos.
The company operates in nine countries, with 46 percent of the group’s ebitda coming from Mexico and Central America, and the rest from South America. That kind of geographic diversity requires acute responsiveness to local trends in tastes and demand, says José Castro, director of investor relations and voted No. 1 by sell-side analysts in the Food & Beverages segment.
“You have to understand the consumption patterns in each of the territories,” says Castro. For example, he notes, in Colombia the people prefer water and fruit juices, so there the company offers larger sizes of that type of beverage.
That understanding of local preferences led the company to introduce orangeade to the Mexican market three years ago. Today it sells 40 million cases of the drink each year there, more than all its products combined in some Central American countries.
Femsa has since tried to duplicate the success of orangeade in Mexico by introducing other flavors there and is seeking to replicate the initiative in South American countries in which it operates. Late last year Coca-Cola launched orangeade in Venezuela, where it says the product has been well received.
Castro says such moves will yield substantial organic growth from increasing per capita consumption of its beverages.
But it will come none too soon if the recent fall in the value of the peso against the U.S. dollar persists. With the company’s material costs tied to the dollar, Femsa’s expenses, including labor costs in Venezuela and Argentina and freight costs in Argentina and Brazil, rose by 38 percent during the second quarter of the year. That brought its profit margin — operating income as a percentage of sales — down to 13 percent from more than 15 percent a year earlier.
Three acquisitions in Mexico over the past year — including Grupo Tampico for 9.3 billion pesos, Grupo Cimsa for 11 billion pesos (including debt), and Grupo Fomento Queretano for 6.6 billion pesos — boosted sales 28 percent during the period, but beverage volume excluding the new units was little changed.
CFO Hector Trevino, who tied for the No. 3 spot among finance directors in the Food & Beverages segment according to sell- side analysts, said during a conference call in July that he expected margins to improve in the second half of this year. Femsa plans to make further acquisitions within the highly fragmented bottling industry in Latin America as well as the Asia-Pacific region.
For example, teams are now studying the operations and finances of Coca-Cola Co.’s Philippines unit, as the Mexican company evaluates whether to make its first foray outside Latin America.
Yet the deal is evidently not a sure thing. In February, Femsa entered a 12-month exclusive agreement with Atlanta-based Coca-Cola to discuss buying a controlling stake in the Filipino unit. While Trevino said in April that a decision could come by the end of September, he acknowledged during the July conference call that it might take until the end of the year.
In contrast, Tim Participações, the Brazilian subsidiary of Italian telecommunications group Telecom Italia Mobile, is hunkering down in the face of economic difficulties. The company says it finds customers spending less on telecom services as they choose instead to pay down debt.
Nonetheless, Tim’s revenues during the second quarter advanced 7 percent from a year earlier, to 4.5 billion reais from 4.2 billion reais, and its ebitda rose 6 percent to 1.2 billion reais, from 1.1 billion reais. Its share of the mobile market has grown from under 25 percent two years ago to 26.7 percent today.
But the company has had to spend heavily to achieve that. Total capital spending was 1 billion reais last year, 45 percent more than the year before. Given the slowdown in customer spending, that large investment is likely to hurt earnings going forward.
“The telecommunications industry in Brazil is becoming more competitive,” says Rogério Tostes Lima, who heads investor relations for Tim and was voted No. 1 in the Technology, Media & Telecommunications segment by both buy- and sell-side analysts. To make things worse, the company’s accounting practices are reportedly under investigation by Brazilian and U.S. regulators.
Also struggling is Desarrolladora Homex, the leading Mexican construction and real estate company that ranked 27th in the overall rankings. Homex mainly constructs affordable housing in Mexico, with some 92 percent of the units it builds priced between $15,000 and $42,000. The group also has an infrastructure division, however, and is building two prisons in Mexico that together will have a capacity of 4,000 inmates. Prison construction enables the company to take greater advantage of its aluminum-mold technology, employed in both housing and prison construction, says Homex IR officer Vania Fueyo Zarain, voted No. 1 in that position in the Cement & Construction segment by sell-side analysts and No. 2 by buy-side analysts. “The type of construction is not that different,” says Fueyo Zarain.
During the second quarter, prison construction accounted for 1.8 billion pesos of Homex’s revenue, or 25 percent. However, total revenue fell 1.2 billion pesos, or 14 percent, short of the 8.4 billion-peso median estimate of seven analysts surveyed by Bloomberg. The reason: Volume declined in its core homebuilding business, with home sales for the quarter down from the previous period by 11 percent, to 11,154 units.
The company is deepening its involvement in prison construction as a result. Along with the revenue shortfall announced in July, Homex said it would acquire the outside interest of an investor in one of the prison construction projects.
If there’s any consolation for Homex, much of the rest of the 2012 Latin America Executive Team is also adjusting to a more difficult regional reality.