Brazilian Investment Opportunities

• Many stocks in Brazil have the potential to double in 2017, but they also have the potential to lose 50%.
  
• We’ll briefly describe investment opportunities and our approach to the research.
  
• Emerging market volatility should be considered a great thing, not a risk.
  

Monday we discussed the current situation in South America. Reading the article, available here, will give you a good intro into what we’ll discuss today.

The source of our long-term investment ideas comes from constant research on macro trends. These ideas are bound to benefit from positive economic, demographic, and political environments.

Today we’ll look into the fundamentals of each specific opportunity the Brazilian market offers to find the best risk reward opportunities. We strive for opportunities that have low risk due to their intrinsic values, cash flows or market positions, and high potential rewards.

Analysts usually value a company based on its past quarter and only see one or two quarters into the future. As we look beyond that, our stock picks are still under the potential influence of short term news but have the fundamentals to thrive in the medium and long term.


Companhia de Bebidas das Americas (NYSE: ABEV): ABEV is a Brazilian brewing company owned by Anheuser-Busch InBev (NYSE: BUD) with operations in Brazil (54% of revenue), Central and South America (35%), and Canada (11%). Its organic growth was negative -5.9% in the first 9 months of 2016 and its Brazilian EBITDA fell 33% in Q3 2016. However, the trailing PE ratio is still at 21.4, a bit too high for us, but seeing that the stock price is in a negative trend and has fallen 25% in the last month, maybe there could be a better buying opportunity somewhere down the road.

In any case, you shouldn’t expect miracles from ABEV but a mere good, solid long term investment. As the situation isn’t stable in Brazil, the high PE ratio is too much risk for just a stable, good company’s growth return. You can find similar companies in your domestic market. But, given the volatility in emerging markets, watch this ticker because it does have potential.

As ABEV’s earnings are stable, a currency reversal in Brazil would soon push its price much higher. The trailing EPS is R$0.76, which equals $0.21. If the Brazilian currency strengthens to R$2.5 to the dollar, the earnings would soon turn into $0.3 which, with a PE ratio of 20 which is normal or even a minimum for good brewers, gives a price of $6, which gives us 20% upside potential. On the other hand, more bad news from Brazil, or increased emerging market fears, could send the stock down 20%. If this happens, things get interesting because the downside gets smaller while the upside remains the same.

As you’ll see, many Brazilian stocks will fall under this currency influenced potential return.Weak economies and banks are never a good matchup. However, when things start to get better, banks are a great place to be in.

Banco Bradesco (NYSE: BBD): BBD suffered badly in the beginning of 2015, as Brazil slide alongside all other emerging markets, as the stock fell from above $12 at the end of 2014 to $3.51 by January 2016. Since then, the stock has climbed back to its current price of $8.16, and has a PE ratio of 10.1. Past earnings look to be in a stable growth trend, except for last year. The current issue with BBD is that the stock price could go much lower if another “January 2016” happens for emerging markets.

Banco Santander Brasil (NYSE: BSBR): BSBR is the most expensive Brazilian bank with a PE ratio of 29.5, the highest valuation achieved in the last 10 years. The high valuation results in higher volatility with BSBR losing 10% on December 1. Itau Unibanco (NYSE: ITUB): ITUB is similar to BBD. It has stable growth and a low PE ratio of 10.

BrasilAgro (NYSE: LND): LND is a thinly traded company whose business model is the acquisition, development, operation, and sale of rural properties suitable for agricultural activities. LND has very little debt and excellent growth rates. However, earnings aren’t that stable and the price is close to book value so it isn’t a great risk reward opportunity, but it could pass as a diversification, currency play and investment in land, which is an interesting thing to do in these times of high debt levels and questionable currency values.

Braskem (NYSE: BAK): BAK is a petrochemical company that produces plastic products.

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BAK’s petrochemical production

Unlike the other companies we’ve discussed so far, BAK is a company that benefits from the weak Real as costs get lower while revenues increase. Currently, it boasts a PE ratio of only 11.2 but investors have to be warned that BAK has no consistency in earnings with huge swings from very negative results to the extremely positive it’s seeing now. It’s currently trading close to 52-week highs, has a debt to equity ratio of 4.2, and a 90% dividend pay-out rate. Such indicators aren’t what I’d call a positive asymmetric risk reward situation.

BRF S.A. (NYSE: BRFS): BRFS is interesting because it’s one of the largest global producers of fresh and frozen protein foods in the world. Food producers are always excellent takeover targets at high premiums, but the current PE ratio of 29 seems a bit high. Even if BRFS manages to hit EPS of R$3.72 as it did in 2015, it would still result in a PE ratio of 13 which is good but not stellar. As much as such a PE ratio is attractive in a consumer staple industry, the fact that the company has more than 50% of its revenue from Brazil and has made multiple global acquisitions lately—largely increasing its debt to equity ratio from 0.33 in 2011 to the current 1.17—makes it a risky play. The risk reward situation here is neutral.

Companhia Brasileira de Distribuicao-CBD (NYSE: CBD): CBD is the largest retailer in Brazil and is controlled by the French group Casino Guichard Perrachon SA. It isn’t profitable currently as it has seen margins decline in the last few years. However, it is a company poised to benefit from eventual economic growth in Brazil.

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CBD’s portfolio

Retailers are great, but the minimum I expect from them is to be consistently profitable. I would prefer to buy Wal-Mart (NYSE: WMT) which pays a nice dividend, is profitable, and has a proven business model over a retailer in Brazil that doesn’t really make money.

Companhia Siderurgica Nacional-CSN (NYSE: SID): SID is just below its 52-week highs at $3.5 after reaching a penny stock low of $0.72 in January 2016. Its revenue is related to the situation in Brazil, but also to the price of steel as steel is its main product.

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SID’s operations

Due to the crisis in Brazil, its revenue went form 65% domestic in 2014 to 43% today. When Brazil recovers, it will be an excellent time for SID. However, the downside is also open as too much is related to uncontrollable things like the price of steel. As many still expect a glut in iron ore we could see another fall in steel prices. Gerdau (NYSE: GGB) is in a similar situation to SID.

Embraer (NYSE: ERJ): ERJ is in the aircraft business and it mostly supplies commercial jets up to 130 seats. It’s currently at 52-week lows. The industry and the company will benefit from more and more people flying around the world, but the company isn’t that related to Brazil, except for the costs being denominated in Reals.

Fibria Celulose (NYSE: FBR): FBR is a producer of paper tissue and is benefiting from the weak currency as costs are lower while revenues are mostly in dollars. Similarly to ERJ, this investment isn’t a Brazil play, but more a global tissue play.

Gafisa (NYSE: GFA): GFA is a small national homebuilder with a market cap of $209 million that was hit hard by the current crisis and oversupply issues in Brazil. Despite the crisis, the company has been lowering long term debt and will see great upside when the dust around Brazil settles and the economy picks up.

Gol (NYSE: GOL): Buying GOL in January 2016 would have given you a 10-bagger by October. However, you would have had to buy into a company that has negative equity, galloping debt, and hasn’t been profitable in the last 7 years. A clear high risk, high reward situation, especially as the price is already down 50% from its high. As the main potential catalyst for GOL is a foreign buyout, sales have been consistently declining and the debt is huge. It isn’t a situation where I would go for a deeper analysis.

Petroleo Brasileiro-Petrobras (NYSE: PBR): PBR is the company whose scandals and corruption made many heads roll, including the impeachment of Brazil’s former president Dilma Rousseff. Its performance will be correlated to the price of oil.

Sebesp (NYSE: SBS): SBS is a mixed capital company responsible for providing water and sewage services in 366 municipalities of the State of Sao Paulo, supplying water to 28 million customers. It has stable debt levels and operating income. Its stability gives it a margin of safety, so it is a company to follow to try to seize the opportunity that might be created by general Brazilian market weakness.

Telefonica Brasil (NYSE: VIV) & Tim Participacoes (NYSE: TSU): VIV and TSU are stable companies in an industry that is well perceived by the market and therefore both have PE ratios of 20 at the moment. This makes them a a long-term Brazil currency play and increases their risks as technological disruption makes people communicate for free. A company we can also include in this bunch is Ultrapar Participacoes SA (NYSE: UGP) which, through its subsidiaries, is engaged in distribution of LPG, fuel and related businesses, production and marketing of chemicals, and storage services for liquid bulk. The company is stable, has a high PE ratio, and is a currency play.

Vale S.A. (NYSE: VALE): VALE doesn’t have much to do directly with Brazil as its performance is related to iron ore prices.

We’re now left with electrical utilities which include Centrais Eletricas Brasileiras (Electrobras) (NYSE: EBR), Comp. Paranaense de Energia-COPEL (NYSE: ELP), Companhia Energetica de Minas Gerais-CEMIG (NYSE: CIG), and CPFL Energia (NYSE: CPL). Their PE ratios vary from 4 to 23, so there might be opportunities for long term market recognition alongside economy related growth and currency benefits in this sector.


This is just a brief example of how much you can find out by turning over stones. Sooner or later an opportunity with low long term risk and high potential benefits arises. If the fundamentals are in place and the price is low enough, it’s time to start accumulating.

Opportunities will come as no one will ever be able to convince me that a country’s performance changes a few percentage points per day as has been the case for the Brazilian ETF.

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Brazil ETF since November 1, 2016

This volatility in the short and medium term, as many of the companies described above went 100% up and 50% down in 2016, is what creates great opportunities. By knowing what is going on in a company, you can understand when the market is overreacting.

source: investiv