Latin America: Riches to be had but stay alert for long term promise
The Brazilian stock market is a rich gold mine, but is best viewed in the long term, says Edmund Games
There are over 500 listed companies on the São Paulo and Rio stock exchanges. Liquidity is re-stricted for many of these companies because of small floats, but that is changing as the foreign investor becomes more active. The local market is closed to the foreign individual investor, and the foreign institutional investor faces an element of bureaucratic friction in registering capital. Many of the popular Brazilian stocks trade in ADR form in New York, however, and there is top-quality research available. Corporate managements are accessible to investors, and company disclosure is quite good. Consensus estimates suggest the market is selling from nine to ten times projected 1997 earnings and at approximately 60% to 70% of stated book value.
The best perspective from which to view Brazil is the long term. Significant stock market inefficiencies and valuation anomalies can and do exist, at least over the short term, and the alert investor can add value through good security analysis and independent thinking.
Inflation is estimated to have been between 11% and 12% in 1996 and should reach single digits this year. President Cardoso's stabilisation program has been a success, bringing the inflation rate down and purging inflationary expectations from the system. Growth of 4% to 5% a year is being led by capital formation ratios approaching 20% of GDP. Foreign direct investment for 1997 is estimated at $10bn. Brazil is clearly moving in the correct direction, but the reform process has not been completed and a great deal remains to be accomplished.
The Brazilian stock market has been one of the rich gold mines among emerging markets and the dollar value of the São Paulo Stock Exchange has increased almost five-fold since the Brazilian stock market was opened to foreign institutional investors in mid-1991.
Two industries - telecommunications and electric utilities - account for almost 46% of current market capitalisation with petroleum representing an additional 9.5% of market value and the mining industry just over 4%. In all, these four sectors account for almost 60% of the dollar value of listed Brazilian common stocks. Almost all of the companies included in these four industries are controlled by eith-er the federal or state governments. With the exception of the government-controlled mining giant, Vale do Rio Doce, the parastatals' business is focused almost exclusively on the domestic economy. All of these companies, though, have been badly managed, with unrealistically low selling prices, bloated payrolls, obsolete plants, haphazard earnings, little or no dividends, and, until several years ago, stock market valuation which were at deep discounts to shareholders' equity.
The top six parastatals in the Bovespa Index accounted for over 75% of the daily trading volume on average during 1996 and for almost 38% of the stock market's capitalisation.
Vale do Rio Doce is slated to be privatised this year, and the state of São Paolo should also begin selling its electric utility assets in 1997. Petrobas, the government-controlled oil company, may never be privatised, but its earning power is being liberated from the burden of absorbing significant subsidies and profits should benefit accordingly.
There is still a lot of investment in the electric utility sector, but is not uniform among all companies. The discounting process is well advanced in some cases, such as CESP, Copel and Paulista Force y Luz. Investors have perhaps one year, possibly two years, of further outstanding investment opportunity in the Brazilian utilities and other restructuring candidates, such as telephone companies, before the market completes the process of discounting the success of the restructuring programme.
Our Brazil Fund portfolio had almost 41% of its equities invested in parastatals at the end of 1996 and six of its top ten holdings were restructuring candidates. Assets in both this fund and our diversified Latin American portfolios are already being shifted from public sector Brazilian stocks to private sector companies. Currently, we favour steels, pulp and paper companies, banks, chemicals and retailers.
Investment performance for Brazilian portfolios has been mainly a function of their concentration on parastatals, for which the Bovespa Index is an appropriate performance benchmark. The FGV 100 Index, consisting entirely of private sector companies, had a simply horrible competitive performance in 1996, rising by less than 7% versus 23% for the S&P 500 Index and 53% for the Bovespa Index. What goes around comes around, and broader diversification among Brazilian stocks now seems the appropriate strategic course of action. Edmund B Games Jr is managing director, Scudder Stevens & Clark in Boston