The Case for Brazilian Bank Stocks
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Emerging markets provide many growth opportunities that are not usually found in most developed ones -- banking in particular is a business that can benefit strongly from long-term secular trends that should keep fueling growth for many years, in the case of Brazilian banks. High economic growth, a rising middle class, and lots of room for financial and real estate business expansion are some of the aspects to keep in mind when considering a position in this sector.
Inflation has always been a problem for Brazil, which used to have inflation rates above 100% annually since the '80s. The country's politicians didn't have the political will to cut government expenses and control monetary policies and the situation exploded in 1993 with a 5,000% inflation rate for that year.
Needless to say, that kind of economic environment makes it virtually impossible to have a solid and growing financial system. Inflation rates and other economic hurdles create an incommensurate amount of uncertainty and long-term planning is very complicated. Interest rates would need to be prohibitively high for consumers and companies.
However, things started changing dramatically in 1994 with the implementation of Real Plan by Fernando Henrique Cardoso. Brazil implemented fiscal, monetary and institutional reforms that brought inflation under control and created a much more suitable environment for long-term investment and financial system expansion. The reforms of the '90s were the prerequisite for Brazil's rise into the elite of high-growth economic powers that are shaping the global economic scenario of the future.
Luis Ignácio Lula da Silva won the presidential election in 2002 and was reelected in 2006; this was a historic period that brought inflation rates below 5%, promoted stable economic growth and also generated an unprecedented rise in the incomes of the less-favored social classes. This produced an outstanding expansion of the Brazilian financial sector: credit growth averaged 22% annually from 2003 to 2011 and total credit went from 26% of GDP in 2002 to more than 47% currently.
The expansion of the middle class has produced a big increase in demand for services like credit cards and personal loans. The mortgage industry is expanding rapidly but is still quite small -- real estate credit is around a 3% of GDP and economists are expecting a growth rate of more than 20% annually for that industry over the next several years.
Although there are some recent trends like an increase in loan delinquencies that need to be monitored, the Brazilian financial system presents extraordinary growth opportunities that merit some consideration from long-term investors with a tolerance for price volatility in the middle term.
Itaú Unibanco (NYSE: ITUB) is the biggest Brazilian bank and has a very diversified exposure to different regions of the country and various business areas. The company has a market cap of $93.25 billion (USD) and trades at a P/E ratio of 11.3, which doesn't look excessive considering its attractive growth potential. In the last quarter the bank reported a 17.5% increase in net income in comparison to the previous year, when measured in local currency.
Banco Bradesco (NYSE: BBD) is the third largest lender by assets in the South American country, with a $69.5 billion market cap and trading at a P/E ratio of 11.45, which is similar to Itau's valuation. Bradesco is also well diversified and has a strong presence in the smaller business segment. The company showed a 14.2% increase in net income for 2011 measured in the Brazilian currency Reais.
Banco Santander Brasil (NYSE: BSBR) is a listed subsidiary of Spanish Banco Santander (NYSE: SAN), which owns nearly 80% of the Brazilian institution. Santander Brasil has many differences with Itau and Bradesco. To begin with it's much smaller with a $36.4 billion market cap; it also trades at an 18.3 P/E ratio, which is higher than the valuation ratios of Itau and Bradesco. Profitability ratios are also smaller for Santander Brasil, with a return on equity ratio in the area of 6% versus ratios above 20% for both Itau and Bradesco.
However, the situation needs to be followed closely, since Santander Brasil has much lower leverage than its competitors, so if the company decides to increase lending it could clearly generate higher earnings growth in the next year, as well as an increase in profitability levels through the utilization of more borrowed funds.
I wouldn't expect a smooth upward trajectory for these companies in the future, but as long as Brazil keeps controlling inflation and generating strong economic growth, these banks should do better than fine. Over the long term, they provide a nice opportunity to beat the market.
The Motley Fool has no positions in the stocks mentioned above. acardenal has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
