Erste Asset Management Investment Blog

Brazil: fundamentally sound companies despite political uncertainties

Brazil: fundamentally sound companies despite political uncertainties
(c) iStock

In the current environment of global uncertainties in emerging markets due to idiosyncratic events in Turkey and Argentina, the trade conflict between the USA and China and with regard to the presidential election, late September was probably one of the most exciting times to visit Brazil. To my surprise, I did not see any oversized campaign posters either in Rio de Janeiro or in Sao Paulo. However, the topic was omnipresent in personal conversations. The result of the election seemed uncertain, and the voters came across undecided. The country is divided between the right-wing candidate and former army officer, Jair Bolsonaro (affiliated with Partido Social Liberal, PSL) and the left wing with Fernando Haddad, the substitute candidate filling in for the former president Lula da Silva (who due to a prison sentence for corruption was not allowed to run for office). Fernando Haddad is the former mayor of Sao Paulo and is supported by the left workers party Partido dos Trabalhadores (PT). The weekly magazine “The Economist” has recently referred to the right-wing candidate Bolsonaro as “Latin America’s latest menace”. By contrast and not surprisingly, the markets reacted positively to his the clear first-round victory due to his political agenda and the economic programme by his adviser, Paul Guedes.

Prior to a site visit to the cellulose and paper producer Suzano on the last day of the conference, 21 companies, the Brazilian Development Bank BNDES, and a local political consultant, Arko Advice, had been holding Q&A sessions on current developments, latest company results, and strategic, future plans in the preceding days. Almost all companies we visited had improved their fundamental data again, continued to lower their debt, and boosted their liquidity ratios over the previous two to three years. However, all companies are currently caught up in the maelstrom of global turbulences on the markets. While this trend reverted in the first two weeks of October, the economy is still poised for the second round of an election with unclear economic and political consequences for Brazil and its corporate sector. The general consensus among the companies was to tackle overdue strategic projects and large investments only after the elections amid decreased levels of uncertainties. The dominant corporate sectors in terms of economic output and headcount in Brazil are: 1) energy (we visited Petrobras, Ultrapar, Raizen, Cosan, and Ocyan) with sales of more than EUR 100bn and a headcount of 250,000; 2) food and meat production, with the companies we visited, i.e. JBS, BRF, Mafrig & Minerva, generating sales of about EUR 65bn and operating at a headcount of 400,000. The third sector with companies such as Vale, parts of Votorantim, Cementis, and Suzano produces, processes, and exports commodities. They generate sales of close to EUR 60bn and have a headcount of 150,000.

The one- to one-and-a-half-hour talks with the various companies were meticulously scheduled, very intensive, and incredibly instructive. Without wanting to go into excessive detail, here are some of the impressions of a few selected companies we saw:

  • The government-owned company Petrobras is one of the world’s biggest oil and gas companies with largely local production of most recently 2.8mn barrels per day. The company is still cutting debt with planned proceeds from asset sales of USD 13.5bn to 15bn generated as free cash flow by the end of the year.
  • The private hospital consortium Rede D’or has recorded average growth rates of 25% over the past five years. 100% of its income is generated from private health insurance policies, which in turn depend on private household income, the general unemployment rate, and the economic growth rate of Brazil. Some 47mn of more than 200mn Brazilians are potential customers.
  • The Brazilian Development Bank BNDES will be granting roughly the same volume of loans this year as last year, i.e. close to BRL 70bn (some EUR 15bn). 40% thereof will go towards local infrastructure projects, 20% each to trade and services, with a focus on innovation, sustainability, and clean energy.
  • Vale, one of the world’s biggest metal and mining companies (global no.1 in iron ore and nickel production), earns a premium above the price of internationally traded iron ore with every single tonne sold, since its product is of outstanding quality. The sales price is derived from different raw material standards and an optimum blend of aluminium oxide Al2O3 and silicon dioxide SiO2.
  • The biggest Brazilian media group Globo, much like many companies in the sector, has suffered from sustainably brisk international competition (Netflix, Amazon and others) and falling profit margins for numerous years. The company generates two thirds of its sales from advertising and one third from successful in-house productions (which were very popular among the local conference attendants).
  • The two meat-exporting companies, BRF and JBS, are still navigating the legacy of the tainted-meat scandal of 2017. BRF is currently divesting its production facilities in Europe and will thus discontinue high-value products that have been specifically developed for export markets such as Europe, attain higher standards, but are too expensive for the domestic market.
  • The government-owned Cemig group wants to re-focus on its core business, i.e. the production, transformation, and distribution of energy through 116 power plants and a grid of 600,000km (i.e. 15x the circumference of Earth), and intends to sell all other investments.
  • Suzano owns 1.2mn hectares of eucalyptus forests. This is roughly equal to a quarter of the entire forest stand of Austria. Eucalyptus trees follow an economic life cycle (planting to uprooting) of five to seven years, and the company is currently working on a process to produce 100% eucalyptus cellulose for nappies. The company expects higher growth rates and profit margins in this segment than in traditional paper.

The Brazilian economy has only just entered a recovery phase after one of the most difficult recessions of the country, caused by the biggest corruption scandal in the history of Brazil, “Lava Jato” (a corruption scandal worth billions around the government-owned company Petrobras, in English referred to as the “Car Wash Scandal”), an expected budget deficit of 8.9% of GDP (N.B. Italy has just caused a stir with a planned deficit of 2.4% of GDP), and the resulting rapid growth of government debt. That being said, on a corporate level, debt ratios remain low, and fundamental data have improved. If the new government were to initiate the urgently needed fiscal consolidation, privatisations, and a social and pension reform, we would review our current, tactically neutral positioning on the basis of selected companies.

Political epilogue: in the first round of the presidential elections, the two candidates Haddad, and slightly ahead, Bolsanora came out on top, as predicted by Arko Advice at the end of September. This result prolongs the global trend of anti-establishment, frustrated voters and a shift of the political centre to the fringes on either side and thus to populists also in Brazil, although both candidates have to contend with historically high disapproval rates among voters. Bolsonaro is disliked in particular by female voters due to sexist and misogynistic statements, whereas Haddad, as successor to Lula, represents a possible continuation of the existing corrupt system to many Brazilians (“Lava Jato”) and is therefore no alternative for many Brazilians either. Which candidate is favourite to win the second round? Persistent tailwind, the movement against corruption and thus against PT, and the fact that since 1989 the winner of the first round has always been victorious also in the second round (if there was one) suggests a victory for the right-wing populist and more market-friendly candidate Bolsonaro. In addition, Bolsonaro can count on the support from three important power blocs in Congress, the so-called BBB representatives (bull, bullet and bible) for agriculture, military, and the evangelical groups in the country. Even in the event of Bolsonaro’s victory, the planned and, from an economic perspective, urgently needed election promises (and their implementation) such as a general social and pension reform will be difficult to pass in the Chamber of Deputies (30 different parties) and the Federal Senate (21 parties) due to the highly fragmented structure and in view of the required majorities. The closer team with at least five former generals, on the other hand, and their law and order agenda, involving the fight against crime and corruption, could pick up speed quite quickly.

Disclaimer:
Forecasts are not a reliable indicator for future developments.

RESPOND TO THE ARTICLE

Legal disclaimer

This document is an advertisement. Unless indicated otherwise, source: Erste Asset Management GmbH. The language of communication of the sales offices is German and the languages of communication of the Management Company also include English.

The prospectus for UCITS funds (including any amendments) is prepared and published in accordance with the provisions of the InvFG 2011 as amended. Information for Investors pursuant to § 21 AIFMG is prepared for the alternative investment funds (AIF) administered by Erste Asset Management GmbH pursuant to the provisions of the AIFMG in conjunction with the InvFG 2011.

The currently valid versions of the prospectus, the Information for Investors pursuant to § 21 AIFMG, and the key information document can be found on the website www.erste-am.com under “Mandatory publications” and can be obtained free of charge by interested investors at the offices of the Management Company and at the offices of the depositary bank. The exact date of the most recent publication of the prospectus, the languages in which the key information document is available, and any other locations where the documents can be obtained are indicated on the website www.erste-am.com. A summary of the investor rights is available in German and English on the website www.erste-am.com/investor-rights and can also be obtained from the Management Company.

The Management Company can decide to suspend the provisions it has taken for the sale of unit certificates in other countries in accordance with the regulatory requirements.

Note: You are about to purchase a product that may be difficult to understand. We recommend that you read the indicated fund documents before making an investment decision. In addition to the locations listed above, you can obtain these documents free of charge at the offices of the referring Sparkassen bank and the offices of Erste Bank der oesterreichischen Sparkassen AG. You can also access these documents electronically at www.erste-am.com.

N.B.: The performance scenarios listed in the key information document are based on a calculation method that is specified in an EU regulation. The future market development cannot be accurately predicted. The depicted performance scenarios merely present potential earnings, but are based on the earnings in the recent past. The actual earnings may be lower than indicated. Our analyses and conclusions are general in nature and do not take into account the individual characteristics of our investors in terms of earnings, taxation, experience and knowledge, investment objective, financial position, capacity for loss, and risk tolerance.

Please note: Past performance is not a reliable indicator of the future performance of a fund. Investments in securities entail risks in addition to the opportunities presented here. The value of units and their earnings can rise and fall. Changes in exchange rates can also have a positive or negative effect on the value of an investment. For this reason, you may receive less than your originally invested amount when you redeem your units. Persons who are interested in purchasing units in investment funds are advised to read the current fund prospectus(es) and the Information for Investors pursuant to § 21 AIFMG, especially the risk notices they contain, before making an investment decision. If the fund currency is different than the investor’s home currency, changes in the relevant exchange rate can positively or negatively influence the value of the investment and the amount of the costs associated with the fund in the home currency.

We are not permitted to directly or indirectly offer, sell, transfer, or deliver this financial product to natural or legal persons whose place of residence or domicile is located in a country where this is legally prohibited. In this case, we may not provide any product information, either.

Please consult the corresponding information in the fund prospectus and the Information for Investors pursuant to § 21 AIFMG for restrictions on the sale of the fund to American or Russian citizens.

It is expressly noted that this communication does not provide any investment recommendations, but only expresses our current market assessment. Thus, this communication is not a substitute for investment advice, does not take into account the legal regulations aimed at promoting the independence of financial analyses, and is not subject to a prohibition on trading following the distribution of financial analyses.

This document does not represent a sales activity of the Management Company and therefore may not be construed as an offer for the purchase or sale of financial or investment instruments.

Erste Asset Management GmbH is affiliated with the referring Sparkassen banks and Erste Bank.

Please also read the “Information about us and our securities services” published by your bank.

Subject to misprints and errors.

Share post:
Exit mobile version