The Sun Will Rise Again For Brazil

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Brazil has disenchanted investors over the last couple of years: economic growth has slowed down considerably, structural problems are becoming more evident, and Brazilian stocks have underperformed other markets in recent years. But the long term fundamentals are still intact and the Brazilian economy could be about to turn around in the following months, so maybe it’s a good time to go shopping for opportunities among Brazilian stocks.

Blame It on the Real

The Brazilian Central Bank has recently reduced its GDP growth estimate for 2012 to an uninspiring 1%, well below the expansion of 5% or 6% which has been observed during the booming years in Brazil. This is the second disappointing year in a row, as the economy started decelerating in 2011, when GDP increased at a 2.7% versus a much more exciting 7.5% in 2010.

Brazil’s finance minister Guido Mantega famously popularized the term “currency wars” back in September of 2010, and Brazilian authorities have focused their attention on exchange rates over the last years. Foreign investment and capital inflows can be great drivers of economic development in the long term, but on shorter timeframes they can also have undesirable consequences on exchange rate levels.

The Brazilian real has appreciated notoriously during the booming years, and this has been a big headwind for the industrial sector. The country has taken measures to curb short term capital inflows and reduce interest rates, and it seems to be achieving its target since the real is stabilizing above 2 reals per dollar, which is a comfortable level according Brazilian policymakers.

Currency appreciation is not the only problem the Brazilian economy has faced during the last years, the country is a main commodities exporter, and the Chinese slowdown has been another considerable drawback for its economy. The good news is that recent economic data from China is signaling an acceleration of economic growth, and this could be a big positive for Brazil in 2013.

Government Intervention

 The government has taken all kinds of measures to boost competitiveness, like cutting payroll taxes, increasing infrastructure investing, and working aggressively to reduce electricity tariffs. At the same time, lower interest rates combined with thinner credit spreads charged by state owned banks are making credit much more accessible to Brazilian companies.

This has backfired to some degree: fears about increasing interventionism and aggressive negotiations with the corporate sector are not improving the business climate at all, so authorities should probably step back for some time and allow the economy to follow it´s natural course to recovery without so much intervention from the public sector.

 After all, Brazil is still a BRIC country with abundant natural resources, an expanding middle class and solid political institutions. The country´s debt is rated investment grade since 2008, and it has more than enough international currency reserves to withstand any short term volatility. There is no reason to believe the economy won´t start growing again in the middle term.

The Chinese recovery, combined with recent economic stimulus and higher infrastructure spending in preparation for the 2014 Soccer World Cup and the 2016 Summer Olympics bode well in regards to timing. After two consecutive years of slowing down, The Brazilian economy looks ready for higher growth rates in 2013 and beyond.

Opportunities in Brazil

Major oil company Petrobras (NYSE: PBR) is selling for a bargain P/E ratio of 6.5, and this is not a boring company at all. Petrobras is seriously exposed to government risk and fluctuating oil prices, but it also has some very exciting growth opportunities due to its unique offshore oil findings. 

Petrobras has discovered different fields with enormous potential in Brazil's shores since 2007. The company is expected to invest more than $200 billion in offshore projects that could easily triple the company's current production in the following years, if not more. The company needs high oil prices in order for these projects to be profitable, but investors could see some fantastic returns if things turn out as expected for Petrobrás.

 Iron ore miner Vale (NYSE: VALE) is another commodity producer with very reasonable valuation, the company trades at a P/E ratio below 9 and yields more than 3% in dividends. Iron ore prices posted the biggest quarterly climb on record in the final three months of 2012, in anticipation of higher demand from China. If this trend continues, Vale should see expanding earnings and better profitability for its investors in the middle term.

Brazilian banks could be an interesting way to bet on the expansion of the local middle class, as demand for all kind of financial services tends to rise quickly with income levels.  Itau Unibanco (NYSE: ITUB) is the biggest Brazilian bank, and it has a diversified exposure to different regions of the country and various business areas.  Itau has a leadership position in segments like credit cards and corporate lending, coupled with ambitious plans to expand all over Latin America. At a P/E ratio below 12, Itau is not expensive at all.

AmBev (NYSE: ABV) is the largest brewer in Latin America. It produces, distributes, and sells beer and PepsiCo products in Brazil and other Latin American countries. AmBev is the market share leader in six markets: Brazil (69% share), Canada (41%), Argentina (77%), Bolivia (97%), Paraguay (96%), and Uruguay (97%). The company has rock solid competitive advantages given by its valuable brands and unmatched distribution network, but it looks a bit expensive at a P/E ratio near 28.

Bottom Line

Brazil is one of the most promising emerging markets when it comes to long term potential for growth and soundness in its economic fundamentals. After two consecutive years of slowing down, the economy could be about to rebound in 2013, so Brazilian stocks looking quite interesting right now.

acardenal has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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