Tapping into Brazil’s growing economy

In particular, market analysts like consumer staples and consider many of the valuations in this sector to be attractive. Many analysts also like financial services companies as a way to get exposure to rising consumer spending.

Brazil is the fifth-largest country in the world by both size (8.5 million square kilometres) and population (more than 203 million). It is also the seventh-largest economy. Although Brazil’s standard of living is low, it’s climbing fast. Gross domestic product per capita has risen to almost US$12,000 this year from US$3,000 in 2003, notes Al Wadhah Al-Adawi, an emerging-markets equities specialist in London with GLG Partners Inc., a subsidiary of Man Group PLC, which manages Scotia Latin American Fund.

Brazil’s economy is similar to Canada’s, as it relies on resources and a sizable manufacturing sector. The latter, like Canada’s manufacturing sector, has struggled because the Brazilian real, which has been free-floating since 1990, appreciates in response to high resources prices — particularly when combined with sound economic fundamentals and high interest rates. The central bank’s benchmark rate is currently 11.5%.

Brazil is the world’s second-largest iron ore producer; the third-largest producer of bauxite, the key input for aluminium; and it is home to Vale SA, the world’s second-largest mining company and among the biggest iron ore and nickel producers.

Brazil also is a major agricultural producer and is a significant exporter of coffee, soybeans, beef, sugar cane, ethanol and frozen chickens.

On the manufacturing side, Brazil exports aircraft, electrical equipment, automobiles, textiles and footwear.

Nevertheless, there are challenges. Of particular concern is controlling inflation as wages rise quickly in response to higher inflation. This is a legacy of Brazil’s years of hyperinflation, which resulted in inflation indexing for labour contracts, explains Matthew Strauss, vice president and portfolio manager with CI Investments Inc.’s Signature Global Advisors division in Toronto.

Brazil also is subject to large inflows of foreign capital, which can push the real way up. The government attempts to control this through taxes on incoming investments.

Here’s a look at some of the companies in Brazil that have American depository receipts trading on the New York Stock Exchange and are favoured by analysts:

> Banco Bradesco SA is the top Latin American bank pick for J.P. Morgan Securities LLC analysts. They are comfortable with the bank’s credit-quality trends and believe that the bank “is conservatively shoring up the balance sheet for a scenario in which the economic backdrop worsens more than expected.”

> Companhia Brasileira DE Distribuição sells food, general merchandise, electronic goods and home appliances in its supermarkets, big-box stores and home-appliance stores. CBD also has a consumer-finance division and a unified e-commerce platform.

With the acquisition of furniture and home-appliance retail chain Casas Bahia in 2010, CBD became Brazil’s largest non-food retailer, with the purchasing power and economies of scale that go with a leading market position, says Stéphane Champagne, a portfolio manager with CI’s Signature Global Advisors in Toronto, who adds that CBD has recently gained market share from its main competitors, Walmart Brasil and Carrefour SA’s Brazilian stores, both of which face challenges.

However, not everyone is as enthusiastic. J.P. Morgan’s analysts have an “underweight” rating on CBD’s stock. They are concerned about lower food sales as growth slows and the execution of the restructuring at Casas Bahia.

> Brasil Foods SA is one of the world’s largest poultry producers; the company also sells frozen pasta, frozen vegetables and soybean products. Al-Adawi thinks the stock’s current valuation does not reflect the “significant” synergies that will come as the company completes its acquisition of Brazil-based food producer Sadia SA.

J.P. Morgan analysts, who give Brasil Foods an “overweight” rating, note that the company is expecting an almost twofold increase in sales by 2015.

> Ecorodovias Infrastrutura E Logística SA operates toll roads and provides other road-related services. This firm will be a major beneficiary of the infrastructure buildup for the World Cup and the Olympics, says Al-Adawi.

> Itaú Unibanco Holding SA’s shares are currently trading at a discount because of an increase in non-performing loans. Al-Adawi says this creates an unusual opportunity to pick up shares in a bank well positioned going forward and whose management he considers to be “extremely professional and strong.”

J.P. Morgan analysts have an “overweight” rating on the stock.

> Petrobras SA is a major player in offshore drilling for oil discovered in 2006 more than 400 kilometres off Rio de Janeiro. Al-Adawi expects earnings growth of 10%-12% annually over the next five years, much greater than the other major global oil firms will experience. Yet, Petrobras is trading at a slight discount to its global competitors, at 7.5 times earnings vs an average of 8% for the group.

Strauss also likes Petrobras, but analysts with J.P. Morgan feel Petrobras shares are fairly valued, given the high cash requirements for the initial development.  IE