Four Brazilian Firms Poised to Profit from Two Powerful Spending Trends

By Jennifer Yousfi
Managing Editor

Brazil is no longer just a tourist hot spot, but a solid profit play for savvy investors, too. And one of the best ways to profit from Brazil’s expected 4.8% growth in gross domestic product this year is to invest in one of the Latin American nation’s infrastructure-focused firms.

Business has been good in Brazil, with the government and consumers alike enjoying the benefits. That means everyone has money to spend for improvements, whether it’s for the nation’s infrastructure or personal lifestyles.

Brazil’s government is planning huge investments to improve Brazil’s highways and byways. At the same time, a growing middle class is eager to snap up new automobiles and homes.

Certain Brazilian companies are well positioned to profit from the convergence of all of these spending trends. They supply the raw materials needed both to build new roads, as well as new dishwashers. And with such strong spending trends fueling growth, Brazilian firms that cater to both these needs are poised to reap the rewards.

Infrastructure Spending Spree

Merrill Lynch & Co. Inc. (MER) recently raised its annual infrastructure-spending estimate for emerging markets by 80%, as developing countries utilize large cash reserves generated by their fast-growing economies to bolster domestic development, BusinessWeek reported.

Investment in infrastructure will rise from $1.25 trillion to $2.25 trillion annually over the next three years, Merrill Lynch estimates. China, the Middle East, and Russia will account for 70% of infrastructure spending, but Brazil won’t be lagging far behind. 

The government’s program to facilitate infrastructure and construction investment, Programa de Acelere do Crescimento (PAC), was announced in January 2007 by Brazilian President Luiz Inacio Lula da Silva. The program is designed to provide government aid to complete construction projects more quickly and will focus on everything from upgrading oil, natural gas and electricity systems to expanding transportation and sanitation systems, as well as telecommunication networks throughout Brazil.

Through a combination of government funds and private investment, it is estimated that $235 billion (BRL500bn) of infrastructure development will occur during 2007-2010.

That’s a close match to Merrill’s own estimate of $225 billion in Brazilian infrastructure investments over the next three years.

And no one is in a better position to benefit from this huge influx of capital investment than Brazil’s own domestic resource companies. Without the huge shipping charges associated with buying steel from Asia or Australia, its only natural that contractors will turn to fellow Brazilian firms when it comes time to buy raw materials.

Consumption-Hungry Middle Class

While industrial and government capital investment is surging, consumer spending in Brazil is on the rise as the red-hot economy helps to expand the Latin American nation’s middle class.

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

And that expanding middle class is more than ready to spend some of its newly found disposable income on items such as automobiles, new homes, appliances and electronics. Household consumption rose 6.6% in the first quarter of this year, according to the nation’s statistics agency.

High inflation is taking a toll on consumers and a recent rate increase by Brazil’s central bank is expected to hurt consumer spending. But even with this expected slowdown, personal consumption growth is expected to increase 5.2% in 2009 according to economists at Itau Corretora de Valores SA.

A lot of those big-ticket items being purchased by the new middle class consumers are being assembled right there in Brazil, making Brazilian firms that supply raw materials such as steel and iron a smart bet for investors.

Four Brazilian Profit Plays

Here are a few of the firms set to profit from Brazil’s current trends:

  • Companhia Siderurgica Nacional (ADR: SID) is a vertically integrated steel producer headquartered in Sao Paulo. CSN produces carbon steel and its products are a main raw material for several different manufacturing industries, including the automotive, home appliance, packaging, construction and steel processing industries. As an added benefit, CSN’s holdings include its own source of iron ore, as well as mines that provide all of the required limestone and dolomite, and a portion of the required tin for its steel-making processes.

[CSN] is producing steel at the same time as raw material, so it is not exposed to price fluctuations,” Jack Dzierwa, co-manager of the U.S. Global MegaTrends fund (MEGAX), told MarketWatch. “It helps manage margins much better than if you were at the mercy of an outside supplier.”

CSN is up 4.12% year-to-date and the stock has traded in a range of $13.64 to $52.46 over the past twelve months. With a close of $31.08 yesterday (Monday), CSN is trading at a relatively affordable Price/Earnings ratio of 13.28, with a juicy yield of 6.26%.

  • Formerly known as Companhia Vale do Rio Doce, Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. The world’s largest iron-ore producer with ancillary operations in gold, nickel, copper and other metals, Vale recently announced it would invest $5 billion to construct a power plant and steel mill in northern Brazil.

The project is a double boon to the mining company, as the steel mill represents Vale’s first solo-venture into vertical integration. And the 600-megawatt thermoelectric power plant will provide plenty of energy for Vale’s various operations in the region.

This project is fundamental to guarantee energy to our projects, including to iron-ore, nickel, aluminum and copper operations,” Vale’s Institutional and Sustainability Director Walter Cover said in a telephone interview with Bloomberg News.

Vale closed at $24.81 yesterday and has traded from $13.64 to $52.46 over the past 52 weeks. The stock has been badly beaten down this year, but the new projects show great promise for reducing margins and creating a new revenue stream. Vale is trading at a forward P/E ratio of 11.95, with a yield of 0.94%.

  • All these infrastructure projects and consumer manufacturing firms need fuel to keep them going and Brazil’s Petrobras (ADR: PBR) is just the one to supply it. This is one of the few emerging market oil companies with access to modern technology - and the willingness to work with the foreign oil majors. Petrobas is just coming off a record second quarter, with the highest earnings in the firm’s history.

Petrobras closed at $47.77 yesterday. Its shares are up more than 75% in the past 12 months, but the stock’s forward P/E still is only 9.20. The possible upside: Petrobas finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. Despite oil’s recent pullback, we’re ultimately looking for oil prices to rebound and head higher.

  • Companhia de Saneamento Basico (ADR: SBS) is better known by its nickname, Sabesp. This Brazilian firm is the water and sewage system provider for the growing city of Sao Paulo. And with all of the new industrial and home construction currently underway in Brazil, Sabesp is definitely a growth business, and a virtual necessity. 

In June, Sabesp signed the Public - Private Partnership contract of the Alto Tietê System, which represents a $190 million (BRL310mn) project that will expand water treatment facilities in the Alto Tietê region and directly benefit 3.1 million people. Construction is slated to begin in approximately four months. It also recently received state approval to raise its tariff index to 5.10%.

Sabesp shares closed at $45.77 yesterday and have traded in a range of $37.07 to  $57.46 over the past 52 weeks. Its shares are down 2.62% year-to-date, but have a one-year return of 9.79%, and are currently carrying a forward P/E of 8.13.

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