Brazil – Never let a good crisis go to waste
Brazil has featured heavily in the international press in recent months, sadly for wrong reasons. Whether it’s political or corporate scandals, an economic downturn, which has taken many market participants by surprise due its severity, or the rampant Zika virus, currently being addressed.
Nevertheless, for both domestic and foreign investors, at least for the political turmoil, sentiment appears to indicate we are at peak crisis levels, and as an end game, perhaps we shall see the findings of the ‘Panama Papers’ as being the straw which breaks the camel’s back on the political front. Year to date, after being heavily oversold in 2015 and combined with the stabilisation in commodity prices, the Brazilian stock market is a global top performer.
For those unfamiliar with the Brazilian stock market, there are some important aspects to highlight. Given the absolute size of the economy, ranking in the top ten on a global basis, the stock market is woefully underrepresented in terms of the number of listed stocks. With around 400 listed stocks to choose from, this places Brazil as 28th in the global index rankings of the number of listed companies. In addition, the Bovespa is highly concentrated, with the top-five companies representing around 50% of the index value. These large capitalisation stocks – which have the most significance on the index – consist of commodity and financial services companies that are highly dependent on global macroeconomic and commodity trends.
At Focus Brazil Research, we take a different approach, choosing rather to search for companies below the radar that can withstand cyclical volatility. We concentrate on firms which either have unique business models or those exposed to long-term structural growth themes across the country. A consequence of this strategy is a focus on mid-capitalisation firms which have limited, or poor quality, corporate research coverage. Providing research on these names bridges the gap between corporates and investors, without the numerous conflicts of interest that are normally associated with investment banks.
Despite the economic crisis and the subsequent falls in the stock market, fundamentals of a number of names have gone from strength to strength. We highlight the healthcare sector – and specifically winners and losers in the drugstore sector. In the period since the beginning of 2011, RaiaDrogasil, which operates a successful chain of pharmacies that are largely located in the more metropolitan areas of the Southeast of the country, has seen its share price rise triple. RaiaDrogasil, with its clear and conservative strategy, has clearly been the winner in the listed sector since its merger. This compares with its main peer, Brasil Pharma, embarking on an aggressive regional buy and build strategy, causing major operational integration challenges, leading to the subsequent dilution and collapse of the share price.
Separately, we would note that not all industries have seen a linear movement in their operations and fundamentals. Aside from the national commodity companies, one area that has undergone some of the most significant restructuring in recent years has been the real estate sector, and in particular, home-builders. This sector, with over 15 listed names, is one of the most highly represented in the Brazilian stock exchange. Following a period of excess capital raising and aggressive launches, the sector has had to deal with a multi-year period of restructuring and downsizing. While the top-down economic backdrop of Brazil would, at best, suggest caution and at worst, panic, there will be selective long-term success stories in the sector.
While the press concentrates on the bigger picture stories which gain internet page views and sell newspapers, in the background there are a number of high-quality firms getting on with their business. These firms have been through periods of military dictatorship, impeachments of Presidents and hyperinflation. The current political and economic storm, while challenging, can be navigated successfully. Looking at the overall index at a time when there has been a sharp correction to the Brazilian stock market, which has been driven by a reversal of bearish trades and fuelled largely by a stabilisation and rally in commodities, participants may be wise to take caution when monitoring the Bovespa from current levels. We would also highlight the risk of a dollar appreciation causing an outflow away from emerging markers, back towards dollar denominated assets. Nevertheless, for those looking to dig a little deeper into small- and mid-capitalisation names, there are a number of interesting candidates.
Focus Brazil’s first report “Iguatemi Empresa de Shopping Centers – Reassuringly Expensive” is now available on ResearchPool.
The views expressed are those of the author, Sebastian Davidson, and do not necessarily reflect the views of Focus Brazil Research Limited. They are subject to change, and no forecasts can be guaranteed. The comments may not be relied upon as recommendations or investment advice.
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