Two Brazilian Stocks for Any Portfolio

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

Brazilian equities took a hit in 2011 when the MSCI Brazil index went down by 25%. In 2012 the index didn't do much better, down again by 9%. But, after a series of interest rate cuts and a sharp currency depreciation, growth is expected to accelerate from 2012's 1.5% to 4% in 2013. Furthermore, Brazil's long term fundamentals are intact: institutional factors are ameliorating, and a 200 million population is getting richer and many millions are entering the middle class every year.

I think that you may want to put in your portfolio something that will benefit if investors fall, once more, in love with the Brazilian story.

As I said in previous posts, ETFs can be great when you want overall exposure to a country or a sector but you don't have much knowledge about the specifics of any particular asset. If you want some exposure to Brazil, iShares has a very well-constructed ETF named EWZ (NYSEMKT: EWZ) that tries to replicate the MSCI Brazil Index with 79 securities. The fund has a reasonable total expense ratio of 0.59% and its main assets are Oil giant Petrobras, mining champion Vale, Itau Bank and the leading brewer AmBev (NYSE: ABV). EWZ's cash dividend yield is 2.8% and its a good play for a economy in fast recovery but its quiet expensive trading at x17.8 P/E.

Given Brazil's fundamentals and its economy being in recovery I would rather buy two assets that are a direct bet on (1) a growing middle class and (2) a huge need for infrastructure. The two companies that I would use to build my portfolio are South American beer king ABV and the local steal champion Gerdau (NYSE: GGB).

ABV is South Americas biggest brewer (& PepsiCo's bottler), and a true cash machine with amazingly efficient management. The company, which is 62% owned by AB-InBev (NYSE: BUD) -the world's biggest brewer- was funded by the Brazilian billionaires that  today control BUD: Lemann, Sicupira and Telles. After selling Banco du Garantia, this business trio bought Brazilian brewer Brahma, and later on they bought their biggest competitor, Antartica.

The merged company which took the current name of AmBev, continued its expansion buying Argentina's Quilmes, which not only controls 77% of Argentina's beer market but also has strong monopolies in Uruguay, Paraguay and Bolivia. Today ABV has over 70% of Brazil's massive beer market and the best possible margins in the industry (EBITDA margin is 48%!). The reason is simple: margins depend heavily on the pricing power that gives you a large share of the market and on being able to distribute fixed costs over a bigger amount of hectoliters. Besides, margins are poised to grow as populations get richer and start to choose more expensive products (this is already happening in Brazil and Argentina).

I like ABV even if it looks expensive at x22 P/E. It pays a 4.1% dividend yield, and the management never ceases to surprise me. Just so you know, the company's 2013 ROIC is expected to be 56%. Its a great company fairly valued that is poised to ameliorate your portfolio.

GGB, which is the largest producer of long steel in the Americas, is my second Brazilian pick. The company is going to benefit largely from Brazil's recovery in 2013 and 2014. Even if it's an international steel company, by 3Q 2012 61% of its EBITDA came from Brazil. The country needs infrastructure, and GGB will be key in the process. Even if it looks expensive at LTM 3Q 2012 x9 EV/EBITDA, sales growth and better steel pricing will be there to repay debt (today at x2.7 EBITDA) while increasing earnings and helping margins (at 3Q 2012 GGB had a 10.5% EBITDA margin). Trading at x1 Price to Book, I would make GGD and steel part of my play on Brazil's recovery.

As I said before, ETFs can help you diversify without much knowledge, but I would risk myself further and would go for a Brazil growth portfolio with GGB and ABV; a big stable and growing consumer goods company, and one steel company ready to leverage Brazil's  recovery and subsequent currency stabilization.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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