Two Big Reasons to Remain Bullish on Brazilian Stocks

By Jason Simpkins
Associate Editor

Brazilian stocks as measured by the country's Bovespa benchmark stock index has fallen 20% from its May 20 record, but that doesn't mean it's time to give up on Latin America's largest economy. Brazil still has plenty to offer, and with stock valuations low, it's a good time to go bargain hunting.

In fact, a big reason why Brazilian stocks have dropped is because the country's central bank has been forced to raise rates to curb inflation. Policymakers have raised the benchmark rate twice since April, to 12.25%. Of course, inflation isn't a problem unique to Brazil.

Inflation in India has been at alarmingly high levels since the first week of June, when it jumped from 8.75% to 11%. And many analysts expect government data released today (Friday) will show wholesale prices soared to a 13-year high of 11.75% in the week ended June 28.

China's consumer price index (CPI), the nation's primary gauge of inflation, increased 7.7% in May, after hitting a near 12-year high of 8.7% in February, and is expected to rise 7.2% year-over-year in 2008.

The European Central Bank raised its key interest rate a quarter point last week, after inflation hit a 16-year high of 4% last month, and U.S. Federal Reserve Chairman Ben S. Bernanke has also struck a more hawkish tone with regards to tightening monetary policy.

Brazil, said yesterday that its benchmark IPCA inflation rate rose 6.06% in the past 12 months, higher than the central bank's 4.5% target, but still below the spiraling rates of China and India, and only marginally higher than inflation in the European Union.  Today's inflation rate is also a marked improvement over the 12% Brazil clocked in 2002.

Also, unlike the United States and Europe, which are both grappling with sluggish growth as well as soaring inflation, the Brazilian economy is expected to expand by a bullish 4.8% this year.  And there are two big reasons why.

Brazil's Booming Consumer Class

By 2030 an additional 2 billion people will have joined the global middle class, according to research by Goldman Sachs Group Inc. (GS). That's a third of the world's population and enough to cause a "shift in spending power towards middle-income economies." With its rapid growth and abundance of resources, Brazil figures to be a major focal point of that shift.

In the past two years, more than 23 million people have leapt from Brazil's lower income classes into "Class C," which is defined by households with incomes between $450 and $745 a month. Class C, Brazil's middle class, now makes up about 46% of the country's population, according to Reuters.

The percentage of the population that makes up the lowest two classes, "Class D" and "Class E," dropped from 51% to 39% from 2005 to 2007.

This shift has caused a boom in consumerism throughout the region. Household consumption rose 6.6% in the first quarter of this year, according to the nation's statistics agency.

While the majority of incomes have traditionally been spent on staples such as food, an increase in household wealth has resulted in a surge in spending on luxury goods. Sales of big-ticket items, like cars, homes appliances and electronics, have jumped 80% since 2005, according to Forbes.  Brazil has also become the fifth largest cosmetics consumer in the world.

Domestic demand has also been fueled by an increase in credit. The number of credit cards in Brazil rose 91% between 2002 and 2006, to 79 million, or one for every 2.3 people. And consumer loans, excluding credit cards, are expected to grow by 25% this year after soaring 40% in the first quarter, Erico Ferreira, president of the National Association of Credit, Financing, and Investment Institutions told Bloomberg News.

The surge in spending helped Brazil's services industry, which accounts for about 60% of the economy, to grow 5% in the first quarter. Increased demand also boosted manufacturing by 6.9%, and agriculture, which now accounts for less than 10% of gross domestic product (GDP), grew 2.4%.

"Brazilians don't get scared by 6% inflation," Ferreira told Bloomberg. "Companies want to profit from the growing economy and they know that to do so they need to offer longer maturities at lower rates."

Brazil Makes Some New Friends

Another big reason investors should keep believing in Brazil is that it has made some powerful new friends abroad.

Brazil's resources are highly coveted by other emerging markets, particularly fellow BRIC country China, who is desperately seeking fuel for its own economic expansion. Brazil sent 6.7% of its goods to China last year, double the level of 2001.

Trade volume between China and Brazil totaled $29.7 billion in 2007, jumping 46.4% year-over-year, according to the latest statistics of China's Ministry of Commerce.

Perhaps that's why the Brazilian government has launched its "China Agenda" program, which involves a series of coordinated measures by the government and private sectors to triple Brazil's exports to China and encourage more Chinese investment in Brazil.

According to Xinhua, Brazil wants to triple its exports to China from $10.75 billion in 2007 to $30 billion by 2010.

The Brazilian government has identified 619 products that are in high demand in China as priority export items to the country.  Meanwhile, the government has also proposed to include more manufactured products in its exports to China, 74% of which now are low-value commodities such as soybeans and pig iron.

Brazil has also sought out stronger ties with Middle Eastern powers. Most recently, plans were made to establish a permanent commercial center in the United Arab Emirates to promote investment between the regions. The U.A.E. is home to the Abu Dhabi
Investment Authority, or ADIA, a sovereign wealth fund with an estimated $875 billion in assets. Brazil is the world's sixth-largest economy and home to an internal market of approximately 190 million consumers.

The new center will serve as a permanent exhibition of products from Brazil and Latin America, and tap developing investment and marketing opportunities between the regions.

It will also enhance Arab-Brazilian relations through the presence of future Gulf investments in Brazil, Ahmed Yassine, president of the Trade Exterior Chamber of Brazilian-Arabian Gulf and North Africa, told the Emirates News Agency. Yassine led a delegation of Brazilian businessmen on a tour of the region.
"An estimated 20 million people of Arab origin live in Latin America and 7 million of them are in Brazil," Yassine said.

In 2007, Gulf countries imported $4.6 billion in goods from Brazil, an increase of 4.8% from 2006.

Trade between Brazil and the Arab countries reached $9.4 billion in the first half of 2008 – 60.1% more than in the same period in 2007,
Gazeta Mercantil reported. June's figures were also the highest ever for that month, with Brazilian exports totaling $966.15 million.

Profiting From Brazil's Growth Spurt

With low valuations scaring off the fair-weather investors there are plenty of Brazilian stocks to profit from the country's strong growth prospects. There are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40 to 50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

  • Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a forward P/E ratio of 12.94 and dividend yield of 0.45%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.
  • Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued at about 12 times forward earnings, though its dividend yield is only 0.74%.
  • Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology - and the willingness to work with the oil majors. Its shares are up 90% in the past year, but the stock's forward P/E still is only 9.20. It has a 0.5% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world's monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.
  • Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that's a growth business, and not dependent on commodity prices. With a P/E of only 8.67 this is one stock I have to say I love.
  • TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It's concentrated in the populous southeast and northeast regions of Brazil, with a forward P/E ratio of only 9.43 and yield of 2.17%. 

News and Related Story Links:

  • Gazeta  Mercantil:
    FOREIGN TRADE: Brazilian-Arab trade breaks record in 1H
  • Money Morning:
    Brazil Economy Expanded 5.8% in 1Q; Central Bank Likely to Raise Rates Again