Buy or Sell? Brazilian Banks

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

As I have mentioned many times, the Brazilian economy is about to rebound (from a 1.5% GDP growth in 2012 to around 4% in 2013), and its equities have strongly underperformed the S&P 500. As many of you may already know, banks are almost always my favorite investments to play a GDP rebound. Hence, it makes sense to look at Brazilian banks.

That said, the Brazilian banking sector has been one of the most controversial sectors among the Latin American investment community over the past two years. Every sell side analyst on the Street almost always fails to predict earnings and delinquency ratios; usually they are overly optimistic. Let's take a look at the current valuations of my favorite Brazilian banks and see if, once and for all, valuations are attractive enough.

Itau (NYSE: ITUB) is the largest private bank in Brazil, with 18% of the system's total assets and 14.6% of total deposits (in November 2008 Itau merged with Unibanco). Nevertheless, the stock is down by 17.5% in 2012 after a 22.7% decline in 2011. Valuations were overly optimistic before, but now the bank trades at 2013 x 9.8 P/E and a x1.6 price to book value. This price is not cheap; it's just fair. Even with a very respectable 2012 19% ROE and 1.6% ROA the bank's ADR price (trading at $15) doesn't provide enough margin of safety.

Bradesco (NYSE: BBD) is the second largest private bank in Brazil (with 15.6% of the system's assets), and my favorite one. The bad news for investors is that the market has also preferred BBD over ITUB since it has outperformed ITUB by more than 20% this year. BBD trades at 2013 x10.5 P/E and at 2012 x1.7 price to book value. Why has the bank performed so much better than peers? Basically BBD was the bank with the lowest reduction in analysts estimates in 2012, and this is a reflection of how good BBD's business model and management is. They are great at keeping expenses low, growing operating profits to keep up with inflation, and forecasting bad credit ratios (they are less exposed to the more volatile retail segment). All that being said, and even with an expected 2013 18% ROE, the ADR price of $16.70 doesn't convince me either.

Santander Brazil (NYSE: BSBR) is Brazil's third largest private bank (with 9.6% of the system's assets), and while it does have a good business under its feet I think it's the least attractive option within this group. To give you some numbers, analysts on the Street are forecasting a 2013 8% ROE, implying a 2013 x11.5 P/E . I think STD is in a weak competitive position, and this is reflected in its comparatively low ROE. Even with a current x0.8 price to book value I consider the current $6.70 ADR price to be too rich. The 20% discount to book value is more than justified by its low profitability level. 

Brazil's real private consumption is expected to grow by 4.3% in 2013. Its real fixed investment is also poised to grow by an outstanding 6.5%. But will banking sector ADR prices benefit from such growth? I think not. Brazilian banks are fully valued. The banking businesses are going to benefit from higher growth and increased commercial activity, but the prices of their equities shouldn't outperform the Brazilian indexes. If the price of a great bank such as BBD goes down to x7 P/E I would definitely go long, but not at current multiples. If you want to bet on Brazil, just go long its ETF EWZ, and you should outperform the banking sector.


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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