Brazil’s government remains in turmoil, with an ongoing power struggle that may play out through the Olympics this summer.
No matter what happens in Brazil politically, we believe from an economic standpoint 2016 is going to be a tough year, as the market is anticipating -3.7% GDP growth on the back of last year’s -3.8% output.1
This is Brazil’s worst recession in decades — so why was the MSCI Brazil benchmark up 28% in first quarter?2 Why the disconnect?
In our view, President Dilma Rousseff has effectively lost control. She has lost the confidence of the people, and with that lack of support, her coalition has disbanded and an impeachment process is currently ongoing. (At the time of this writing, Brazil’s senate had just voted to put President Rousseff on trial for allegedly illegally manipulating fiscal accounts.)
If President Rousseff’s impeachment is approved by Brazilian lawmakers, she would have to step down from office for 180 days to defend herself in a trial. During that time, Vice President Michel Temer will likely serve as acting president. We believe Temer will return to a more orthodox economic policy that reins in inflation, focuses on reforms, and, hopefully, returns the country to growth. This belief is what has spurred the market.
Opportunities in Brazil
Despite the political uncertainty, our strategy, as always, is to focus on company fundamentals — particularly Earnings, Quality and Valuation (EQV). With that in mind, I would like to highlight one promising company we own in Brazil — the stock exchange BM&F Bovespa (4.33% of Invesco Developing Markets Fund as of March 31, 2016), which has near-monopoly status in the company’s most important businesses. The company’s EBITDA margin is close to 70%3, with a high single-digit free cash flow yield and a balance sheet that is net cash. The company is also in the process of acquiring Cetip (2.34% of Invesco Developing Markets Fund as of March 31, 2016), another high-quality, Brazilian, non-bank financial institution, which has a virtual monopoly in securities registration.
With the acquisition, we believe BM&F’s revenues may become more resilient, and earnings visibility could lead to further re-rating. With high barriers to entry for competitors and strong cash flow generation, BM&F could be a stronger company after the acquisition, benefiting from the opportunity to serve Brazil’s population, which is still largely underserved in financial services. Additionally, with a new government administration and a better macro outlook, BM&F was stronger last quarter, gaining 81% year-to-date through the end of April 2016 in US dollar terms.1 Despite the recent political movements, we believe the company is still undervalued, from a longer-term perspective.
Outlook for Brazil
Brazil had a massive sell-off last year but has been a top performer year-to-date. Overall, the Brazilian market is trading at 12 times forward earnings,4 which seems expensive to us, considering that its five-year average price-to-earnings ratio is 10 times.4 However, we believe earnings are depressed and do not fully reflect the long-term potential of the market. Although the market was up strongly in first quarter, long-term valuations in some cases are still attractive if we assume reversion to average profitability.
1 Source: Bloomberg as of April 30, 2016
2 Source: MSCI as of March 31, 2016
3 Source: FactSet Estimates as of March 31, 2016
4 Source: FactSet Estimates, Invesco as of March 31, 2016
Important information
EBITDA is the acronym for earnings before interest, taxes, depreciation and amortization. The EBITDA margin divides this figure by total revenue to give a picture of a company’s operating profitability.
Price-to-earnings (P/E) ratio, also called multiple, measures a stock’s valuation by dividing its share price by its earnings per share.
Forward price-earnings ratio is one measure of the price-earnings ratio calculated with forecasted earnings, usually for the next 12 months or next full fiscal year, rather than current earnings.
Free cash flow is a measure of financial performance calculated as operating cash flow minus capital expenditures.
Data is as of March 31, 2016 unless otherwise stated.
Holdings listed are for informational purposes only and are not buy-sell recommendations.
An investment in emerging market countries carries greater risks compared to more developed economies.
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Despite political turmoil, there are still bright spots in Brazil by Invesco
