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Magazine Issues » June 2010

BRAZIL: Rio-tail therapy

Growth in Brazil is not just driven by commodities, but is largely in the hands of domestic consumers, finds Angele Spiteri Paris

Brazilian equities – a popular flavour since the beginning of the year – have largely been seen as a commodity play along with other Latin American countries close by that are steeped in base metals. But fund managers behind the wave of interest in Brazil over the past few months say this is a broad misconception. The real story in the market, according to them, lies in domestic cyclical stocks and any sector linked to the rising power of Brazilian consumers.

Alexander Gorra, director at BNY Mellon ARX, a Brazilian equity, alternatives and fixed income fund manager, says: “The financial markets in Brazil are slowly transforming. They’re shifting from having a commodity weighting to domestic cyclicals, more retail-oriented stocks and consumer discretionary.”

Gorra explains that although commodity stocks currently represent around 50% of the Brazilian index, they only account for 10% of the economy.

“Viewing Brazil as a commodity play, from an international point of view, is easy. People immediately think of Petrobras and Vale and this is something straightforward to understand,” says Ignacio Cerezo, managing director, Latin America, at Principal Global Investors.

Petrobras, an energy company, is Brazil’s largest company by market value, while Vale is the world’s largest iron ore producer. Together, they represent almost 40% of the MSCI Brazil index.

“It is a misconception that Brazil is primarily a commodity play,” says Dhiren Shah, co-manager on the BlackRock Emerging Markets Fund. “Ten years ago, this was true but this is no longer the case. Brazil has one of the most favourable demographics in the world, with consumer spending propelling domestic demand.

This is one of the major factors that will drive the economy for the next ten to 20 years,” he says.

Since being placed in that elite group of ‘Brics’, along with Russia, India, and China, Brazil has grown at an average rate of 3.8% per annum.  The country’s GDP per capita rose to $10,200 (€8,340) in 2009 from $10,300 in 2008, and local consumer demand has continued to expand at an impressive pace.

Furthermore, the domestic economy has proven to be resilient and the country has increased the number of jobs available. “The consumer’s spending power has increased significantly. Brazilian consumption growth is one of the most interesting stories around,” says Shah.

According to Gorra, of BNY Mellon ARX, it is the consumer demand that makes Brazil a good investment. “Growth-oriented domestic plays offer the best value,” he says.

Shah, of BlackRock, says: “Consumer staples are generally deemed to be boring stocks elsewhere in the world, but in Brazil they are growing significantly each year. They present a very compelling growth opportunity.”

As consumer-related sectors are under-represented in the stock market, it means there is more room for growth in these areas before companies become listed. Gorra says the retail sector accounts for about 12% of the Brazilian economy yet is only 4% of the index. In view of this, investors looking to make the most of growth opportunities in Brazil are often encouraged to take the active manager route, rather than seek exposure through an indexed product.

Gorra says Lojas Renner, Brazil’s biggest discount retailer, is one of the names poised for growth in the sector. In April, the firm reported first-quarter net income of R$36.9m (€16.3m), up from R$10.9m a year earlier.

Lojas Renner attributed the increase of its net profit in the period in part to the rise of its revenue, which increased to R$505.7m from R$419.1m.

This strong performance of the retail sector can be seen across the board as Brazil retail sales went through the roof earlier this year. Sales rose 15.7% in March, compared to a year earlier. This was a result of surging consumer demand. The increase was the largest since 2001 and beat the 14% gain forecast by economists surveyed by Bloomberg.

In addition to the retail sector, Shah, of BlackRock, believes Brazilian financials could also offer good value because, he says, banks in Brazil will benefit from rising credit penetration.

Itau Unibanco, for example, is Brazil's largest private-sector bank and could look to become one of the most profitable banks in the world.

Cerezo, of Principal, says: “The rise of the lower fee classes has driven a host of financial solutions. The extension of consumer finance is now coming into play and we will see consumer leverage increase in the coming years. Really, any sector linked to the Brazilian consumer will do well over the next five to ten years.”

Gorra, of BNY Mellon ARX, says that along with the retail sector, infrastructure and utilities will be the biggest beneficiaries of future GDP growth. He says that, much like in the retail sector, the interesting companies are not yet represented in the index and their upsurge in growth will probably happen before they are included in the Brazil index.

A number of fund managers say that one of the most attractive companies is América Latina Logística (ALL), a railway operator. In its most recent earnings report, the firm said its consolidated investments increased 56.5%, from R$146.5m in Q1 ’09 to R$229.3m in the first quarter of 2010. ALL chief executive Bernardo Hees said he expects company investment in 2010 to total R$1bn.

But although the Brazilian economy is well diversified, the indices representing the country still do not reflect this.

Index changes
The MSCI Brazil index, which currently has a heavy commodity weighting, will eventually replicate what is happening in the real economy. And Gorra says this has already started.

“The MSCI Brazil gets reweighted every quarter and over the last quarters, commodity weightings have begun to decline,” says Gorra.

Cerezo, of Principal, says: “If managers don’t have a research function based in Brazil they won’t get true exposure to the economy. They will invariably stick to large-cap names and end up with a commodity play.”

Shah, of BlackRock, says: “Investors are yet to fully discover that the Brazil story is not just about commodities. They are beginning to understand this.”

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