Brazil’s boom has gone bust — but only for the time being, analysts and market observers insist.
High inflation, political uncertainty, a slowdown in the domestic economy, the potential fallout from the sovereign-debt crisis in Europe, fears of a double-dip recession in the U.S. and concerns over the sustainability of growth in China — since 2009, Brazil’s largest trading partner — have prompted many global money managers to reconsider their exposure to Latin America’s largest economy.
Foreign investors pulled 1.1 billion reais ($701.3 million) out of Brazil in the first half of the year, according to the Bolsa de Valores, Mercadorias & Futuros de São Paulo, or BM&F Bovespa, exchange. Nearly half of this year’s net outflows took place in June, the same month in which the International Monetary Fund lowered its forecast for Brazil’s real gross domestic product growth from 4.5 percent to 4.1 percent for 2011 and from 4.1 percent to 3.6 percent for 2012.
These growth rates stand in stark contrast to those of last year, when Brazil’s economy expanded by 7.5 percent — its best performance in decades. But the slowdown — and its downward pull on the stock market — was not unforeseen.
“In February we highlighted the multiple risks that companies would be facing this year: tight spare capacity, inflationary pressures and government actions to curb demand,” recalls Carlos Constantini, head of research at Itaú BBA in São Paulo. “We concluded by saying that, due to these pressures, equities would not perform well this year.”
Itaú’s analysts were right: The benchmark Bovespa index tumbled 12.1 percent from late February through July.
Such prescient forecasting helps Itaú claim the top spot for a second straight year on the All-Brazil Research Team, Institutional Investor’s annual ranking of the nation’s top equity and fixed-income analysts. Itaú captures 13 total team positions, one fewer than last year. BTG Pactual repeats in second place, with 11 positions — also one fewer than in 2010.
BofA Merrill Lynch Global Research jumps two places, to No. 3, after picking up one position, for a total of nine. Santander is the biggest upward mover; the Spanish bank doubles its number of positions, to eight, and leaps from seventh place to fourth. Results are based on responses from nearly 530 buy-side analysts and money managers at some 300 firms that collectively manage an estimated $278 billion in Brazilian equities (approximately 47 percent of the MSCI Brazil index’s market capitalization of $587 billion at the time of polling) and $108 billion in Brazilian fixed-income instruments.
Constantini is one of many research directors who believe that the current downturn will be short-lived. “Once some of the uncertainties surrounding the global scenario, such as the euro zone debt crisis, go away and the period of weak equity portfolio inflows due to seasonality ends, the local market will pick up again — probably in the fourth quarter,” he says. “The combination of ongoing investments in infrastructure, cheap valuations and a soft landing — lower risk of inflation spiraling out of control — provides unique opportunities for investors.”
To help ensure that portfolio managers have the information they need to avail themselves of those opportunities, Itaú has been expanding its research operations in Brazil. Over the past year the firm added two analysts, for a total of 32, and increased stock coverage by three companies, to 132. “We expect to hire three more people dedicated to Brazil because we are spinning off a few sectors — agribusiness, health care and education, and food and beverage are now covered by senior analysts who were previously part of someone else’s team,” Constantini says. “As we promote some of our talent, we need to replace them.”
BTG Pactual is also in expansion mode. “We have increased our analyst base substantially, adding at least one analyst per team,” says Rodrigo Góes, co-head of research at BTG Pactual in São Paulo; he is also the No. 1 analyst in Transportation, which along with Capital Goods was broken out this year from Aerospace, Transportation & Industrials — a sector in which Góes reigned supreme for the past six years. “We currently have 35 analysts and cover 153 stocks,” he adds. Last year at this time, the firm employed 28 analysts who followed 107 Brazilian companies.
Góes also believes that Brazil is ripe for a turnaround, but one that is being delayed by factors beyond its control. “We enter the second part of the year with extremely volatile markets reflecting macroeconomic uncertainties, particularly in developed markets,” he says. “The crisis impacting the euro zone and the U.S. — which is effectively a continuation of the crisis that started in 2008 — has dragged global equity markets down considerably, with investors adjusting for a scenario of materially slower growth ahead.”
Although problems in developed economies will continue to affect emerging markets for some time, the latter “should be able to sustain respectable relative growth barring any mismanaged fiscal and monetary responses,” he believes. “Markets with strong domestic support should be able to outperform those more levered to exports, and the same can be said for stocks. In Brazil we strongly favor stocks of companies that have sound business fundamentals, strong competitive positioning, recurring revenues and a low dependence on external factors.”
Pedro Martins Jr., BofA’s São Paulo–based head of Brazil research, acknowledges that global as well as domestic factors have been ratcheting up anxiety, but he believes that investors will tune out the noise and focus on the fact that, from a valuation standpoint, Brazil is a very desirable place to invest.
“The secular bull market remains supported by a low level of public, household and corporate debt, nurturing a secular case for strong economic growth,” says Martins, who claims the No. 2 spot in Equity Strategy. “Plus, valuations are attractive on the back of a massive derating observed since the fourth quarter of 2009.”
BofA picked up four people since last year — three in equities and one in fixed income — for a total of 41 analysts and strategists; they track 118 stocks, ten more than one year ago.
The domestic economy is key, agrees Marcelo Audi, Santander’s head of Brazil equity research. “What we have highlighted to investors is the fact that in the current environment of weak global economic growth, Brazil stands out as a more defensive economy — that is, it is less dependent on global demand growth and is more driven by domestic demand growth,” says Audi, who works out of São Paulo and repeats in third place in Equity Strategy. Strong secular growth is likely to continue for the next five to ten years, he adds, fueled by a continuous reduction in income inequality, increasing penetration of banking services to the growing ranks of the middle class and ongoing investment in infrastructure.
“Therefore, despite the slowdown in the pace of GDP growth that we expect from the robust 7.5 percent in 2010,” Audi explains, “we believe that economic growth can maintain an average around 4 percent per annum this year and next — a soft landing in our view — which is favorable enough to maintain double-digit earnings-per-share growth in 2011 and 2012, thus being supportive for equities.”
Santander’s 13 Brazil-based analysts follow 113 companies, up from 102 last year, and Audi says they will add coverage of 12 to 15 stocks in the coming year, particularly in aerospace and transportation, food and beverage, health care and education, homebuilding and real estate.
The volatility in Brazil’s stock market is mirrored by changes in this year’s ranking, with fully one third of the No. 1 analysts enjoying their first appearances in the top spots in their respective sectors. Among those new to the winner’s circle is Morgan Stanley’s Guilherme Paiva, who climbs one rung to capture the crown in Equity Strategy. Paiva, who is based in New York, “has something that not many strategists have: market timing. He always gives a sense of moment on his recommendations and deeply understands the flows,” observes one money manager. “Plus, he is not afraid to give contrarian calls — that’s uncommon as well.”
In October 2010, Paiva became one of the first strategists to turn bearish. “We entered the second half of 2010 bullish on Brazilian equities but started to scale down our risk exposure in the fourth quarter because commodities stocks had had a nice run and domestic stocks were not pricing in monetary tightening and inflation risk,” the 36-year-old strategist explains. “Therefore, we started to recommend more defensive sectors such as utilities and telecoms and inflation-protected businesses such as toll roads and shopping malls. We ran an underweight recommendation at the country level for Brazil between January 27 and April 5.”
Paiva changed his view in the spring, after Brazil’s central bank instituted its second rate hike of the year, signaling its intent to more aggressively combat inflation, which hit a six-year high of 5.91 percent last year. “In early April we started to gradually turn more positive again on interest-rate-sensitive domestic stocks because the valuation story for the group had cheapened, and we identified early signs that policymakers would continue to adjust fiscal and monetary policy to contain rising inflationary pressures — and not fall further behind the curve,” he says. “The current macro outlook for the country still is complicated, but now at least equity investors are being compensated for the current inflation risk.”
Paiva, who worked as an equity strategist at Deutsche Bank Securities before moving to Morgan Stanley in November 2009, holds a 1996 bachelor’s degree in economics from the Catholic University of Rio de Janeiro and a 2002 MBA in finance and statistics from New York University’s Stern School of Business.
He notes that investor expectations have changed over the past year. “There has definitely been an increase in demand for macro research,” he says. “This trend reflects the fragile nature of the global economic recovery and the imbalances that developed and emerging economies have — at least so far — only partially successfully addressed. I believe macro will remain in high demand for at least another few years because economies that have suffered from banking and sovereign-credit crises usually need five to seven years to correct their imbalances.”
Money managers continue to keep a close eye on banks, the epicenter of the global crisis, and no one covers Brazil’s Banking & Financial Services sector better, they say, than Carlos Firetti; the Bradesco Corretora analyst leaps all the way from runner-up to finish on top for the first time. Firetti’s winning calls of the past year include February upgrades from neutral to outperform on two São Paulo–based credit card transaction processors, Cielo and Redecard, citing improving earnings and declining delinquency rates, among other factors. By the end of July, Cielo had shot up 30 percent, from a split-adjusted R33.15 to R43.10, and Redecard had skyrocketed 49.1 percent, from R17.91 to R26.70. During the same period the sector tumbled 17 percent.
“Firetti made a good call when advising clients to overweight Cielo and Redecard after massive underperformance and proved that he was right on both companies’ capacity to deliver decent earnings,” says one grateful investor.
Clients also applaud Firetti’s long-standing valuation-based buy on Cetip, a Rio de Janeiro–based clearinghouse and provider of custodial services for fixed-income securities, over-the-counter derivatives and other financial instruments. “I’ve kept a buy rating on Cetip since my initiation at the end of 2009 and reaffirmed it many times in 2010 and 2011,” says Firetti, who is headquartered in São Paulo. “The stock has been a great outperformer.” Indeed it has: In the 12 months through July, Cetip shares bolted 83.3 percent and bested the sector by 112.8 percentage points. That same month, Atlanta’s IntercontinentalExchange completed its $512 million purchase of a 12.4 percent stake in the company, making the U.S.-based exchange operator Cetip’s largest shareholder.
The 42-year-old Firetti, who is also head of equity research, joined Bradesco in September 2003 from BBV Securities, where he led Brazil equity research. He holds a bachelor’s degree in economics from Universidade de São Paulo, which he earned in 1991, and an MBA from Ibmec, obtained in 2005.
Another analyst who catapults from the runner-up position all the way to No. 1 is BofA’s Fernando Ferreira, who rules the roost in Agribusiness. “He really knows the space,” applauds one U.S.-based fund manager. “And he is very responsive.”
Ferreira, who turns 28 this month, joined Merrill Lynch’s equity sales team in São Paulo in 2003 and the following year moved over to equity research. He received a bachelor’s degree in business administration from São Paulo’s Fundação Getulio Vargas in 2005.
“We have been positive on the sector over the past 12 months, based on a view that the tight supply-demand balances for soft commodities would continue to justify an abnormal level of prices that were not reflected in the prices of the majority of the stocks within the sector,” Ferreira says. “We are positive for the remainder of 2011 and first half of 2012.”
Cosan has been one of Ferreira’s favorite stocks. “We turned positive on Cosan in June 2009, and last year we reiterated our optimistic view” in the wake of the São Paulo–based ethanol producer’s joint venture with Royal Dutch Shell, he says. In a February 2010 report to investors, Ferreira cited multiple positives stemming from the recently announced JV: “Cosan will have access to the best-in-class asset in fuel distribution, and the significant reduction in net debt for Cosan, given the $1.65 billion cash injection, will enable the company to grow aggressively again.” By early April, when Ferreira issued a valuation-based downgrade to neutral, Cosan’s shares had soared 82.7 percent and shot past the sector by 22.4 percentage points. Since then, the stock has slipped 2.1 percent and trailed the sector by 1.8 percentage points, through July.
An oft-cited theme among analysts and research directors forecasting strong growth in the secular market is Brazil’s commitment to infrastructure development: The government plans to spend more than R958.9 billion to build or refurbish airports, bridges, rail service and roads by 2014, when the nation will play host to the World Cup tournament. That expenditure will continue to fuel growth in capital goods, according to São Paulo–based Daniel Gewehr, who debuts in first place in that new sector.
“We’ve had a positive view on Brazilian industrials, given the operating momentum — faster than expected growth in production volumes — and attractive valuations,” the Santander analyst says. “We believe the sector will perform positively once we see more visibility about 2012 GDP growth and investment estimates, which will show that we are not in the peak for some capital goods markets. That should happen more toward year-end.”
In May 2010, Gewehr initiated coverage on Caxias do Sul–based bus-body manufacturer Marcopolo with a buy recommendation, at a split-adjusted R3.45 a share, citing “strong recovery in the bus industry and a more disciplined competitive environment.” By the end of July 2011, the stock had sped to R6.33, a gain of 83.5 percent that blew past the sector by a stunning 54.4 percentage points.
Another winning call: Gewehr urged clients to buy shares of São Paulo’s Iochpe-Maxion in May 2010, at R15.47, largely on the strength of strong demand for products in the auto-parts manufacturer’s Fumagalli wheel division. The stock raced to R20.20 through July 2011, gaining 30.6 percent at a time when the sector was flat.
“Daniel is very close to the companies he covers, so he is up to date on the names — and he has a strong knowledge of valuation,” observes one money manager. Adds another: “There are only a few analysts who really understand Brazil’s capital goods sector, and Daniel is one of them.”
Gewehr, 29, earned a bachelor’s degree in business administration in 2004 and a master’s degree in finance in 2007 at Porto Alegre’s Universidade Federal do Rio Grande do Sul. He directed equity research for the pension fund of Porto Alegre–based steel maker Gerdau before moving to Santander in 2007.
Gewehr’s colleague Valder Nogueira, who covers Technology, Media & Telecommunications, is also enjoying a first appearance at the top of the roster. Nogueira, 41, earned a bachelor’s degree in finance at the University of Texas at Austin in 1993 and worked at Brasil Telecom Participações, Empresa Brasileira de Telecomunicações and other telecommunications services providers before joining Santander in 2005. He covered the sector for Itaú from 2008 to March 2010, when he returned to Santander.
Nogueira “comes straight to the point — which I appreciate,” declares one satisfied investor. “His recommendations are based on a thorough understanding of the companies and the global dynamics of the market.”
That understanding was on display in Nogueira’s comprehensive analysis, beginning in April 2010, of the likely impact of Madrid-based Telefónica’s acquisition of Portugal Telecom SGPS’ stake in the Brazilian operations of Vivo Participações and PT’s subsequent investment in Rio de Janeiro–based Telemar Norte Leste, as well as the opportunities he spotted at Tim Participações, the Rio-based unit of Milan’s Telecom Italia Mobile.
“We assumed coverage on Vivo Participações and Tim Participações showing that the segment was actually in a successful transition from an irrational growth model to a more balanced approach, reducing execution risk and earnings volatility,” explains Nogueira, who works out of São Paulo.
He put a buy rating on both stocks, with caveats: “Each story has a different leading theme, with Vivo being the champion of consistency, whereas Tim appeals to investors who are anticipating the continuation of a turnaround story,” he wrote. “The market seems to be currently more enthusiastic about Tim’s turnaround theme (and upcoming potentially positive news flow) than Vivo’s successful yet unexciting story.”
Tim’s shares jumped 69.2 percent, from R4.52 to R7.65, from April 2010 through July 2011.
Nogueira pounded the table on Vivo last September, on a price dip to R43.85, on the belief that “the market is not properly pricing in either the strengthening of Telefónica’s competitive position in its operations in Brazil” or the likelihood that Telefónica would streamline costs — and thus boost profitability — by merging its newly acquired asset with its Brazilian fixed-line subsidiary, Telecomunicações de São Paulo. He was right. In December, Telefónica announced that the two Brazilian units would be combined; by early June, when Vivo was delisted following its merger with Telesp, the stock had skyrocketed 63.7 percent, to R71.80, and bested the sector by nearly 35 percentage points. The following month, Telesp reported that second-quarter net income had jumped 30 percent, to R1.1 billion.
After the delisting, Nogueira upgraded Telesp from hold to buy and dubbed it his top pick for the remainder of this year and the first half of 2012. “We see it as a compelling integrated story, with an appealing carrying cost: an estimated 8 percent dividend yield,” he says. “In addition, the estimated fiscal, cost, capital expenditure and revenue synergies arising from the Vivo-Telesp integration are low-hanging fruits which we believe the company will quickly capture.”
Dividend yield is becoming increasingly important to investors, he adds. “We believe that the sector will undergo a challenging second half on heated competition, the unfolding of a shareholder reorganization at Telemar and, mostly, dividend-yield-seeking strategies, in light of the volatile Brazilian equity market,” Nogueira explains.
Other analysts agree that more turbulence lies ahead.
“Our updated year-end target for the Bovespa is 60,000 points,” says Paiva, the Morgan Stanley strategist. As recently as July he had been calling for the Bovespa to hit 75,000 by late December. (The index closed July at 58,823, down 15.1 percent year-to-date.) “Market dynamics have changed; therefore we have adjusted our views,” he adds. “The sovereign crisis in Europe continues to unfold, and we are worried about the endgame. The structural problem remains unchanged: too much debt. The key question is, ‘Who will foot the bill?’”
Nonetheless, he remains positive about the long-term prospects of Brazil and says his optimism is rooted in the country’s solid fundamentals. Investors that feel similarly upbeat will find that the analysts on the 2011 All-Brazil Research Team stand ready to help them prepare for Brazil’s return to boom times.
