When she won re-election to a second term as President of Brazil on Sunday, October 26, Dilma Rousseff promised change.
Well, change is what the markets in Brazil got yesterday although it was change of a kind that surprised just about everyone. And the surprise is big enough and has enough positive long-term implications for Brazil’s finances and stocks that I will be adding the New York traded ADRs of Itau Unibanco (ITUB) to my 12-18 month Jubak’s Picks portfolio http://jubakam.com/portfolios/jubaks-picks/ tomorrow, October 31.
In the Banco Central do Brasil’s first meeting after the election, Brazil’s central bank raised its benchmark Selic interest rate by 0.25 percentage points to 11.25%. The bank had pretty much sat on its hands during the election campaign while inflation climbed well above the upper edge of the bank’s target. In-country and overseas investors and economists decried the inaction as evidence of the central bank’s lack of independence. Of course, the critics said the bank wouldn’t raise interest rates in any already slow economy when any further slowing might cost Dilma the election. Worries about the politicization of the bank rose to such a pitch that the markets had started to anticipate that Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings would move relatively quickly to downgrade the country’s debt.
A 0.25 percentage point rate increase isn’t a huge move and it certainly doesn’t restore the central bank’s reputation, but given how pessimistic financial markets had become, this surprise produced a rally in Brazilian stocks a day after they had sold off on Dilma’s victory. The iBovespa stock index climbed 2.52% in today’s session in Sao Paulo.
The positive market reaction to a move that will cost the economy growth in the short-term is extremely interesting—and is the reason that I’m buying Itau Unibanco now.
The move to raise rates, the markets believe today, is a sign that Dilma’s second term will move back toward a more orthodox policy of fighting inflation in order to restore faith in Brazil’s economy and its financial discipline. While we’ll have to wait and see how far this move toward fiscal discipline goes—it’s going to take work from Dilma to curb the appetite of the legislative arm of Workers’ Party for more spending and more subsidies—Dilma has the opportunity to send the markets a powerful signal when she appoints a new Finance Minister to replace the thoroughly discredited Guido Mantega. (“Discredited” is what happens when you predict 4% growth and deliver 1% with 6.3% inflation.)
If her choice—and this seems likely after the Banco Central do Brasil’s move—is seen as a voice for fiscal discipline, the markets will cheer. And Brazil will be likely to stave off a credit rating downgrade.
That’s the background for my pick of Itau Unibanco and the reason that I’m pulling the trigger on this pick now.
But I like Itau Unibanco as an individual stocks because the bank, the largest privately owned bank among the six banks that control about 75% of Brazil’s market, has worked hard to control costs and to prevent an erosion of loan quality during Brazil’s consumer credit boom. In the second quarter of 2014, for example, the 90-day delinquency ratio fell by 10 basis points. Net interest income in that quarter grew by 8.9% from the previous quarter as net interest margins improved by 70 basis points.
Going forward Itau Unibanco has a strong domestic and Latin American story to tell. The company is the market leader in credit cards in Brazil with 62 million accounts through its Hipercard and Itaucard brands. (In 2012 it bought the remainder of Redecard, Brazil’s second-largest credit card payment processor. That market share in credit cards would give Itau Unibanco a huge boost to revenue and earnings–if Brazil can right its economic ship so that the economy can generate a little more growth so that tapped out consumers have a little more room on their balance sheets.
In Latin America Itau Unibanco has been a major beneficiary of the divestiture trend by the world’s biggest banks. Partly out of a need to raise capital but also partly out of evidence that it is really, really hard to run a bank that does business everywhere, big global banks such as Banco Santander (SAN), HSBC Holdings (HSBC) and CitiGroup (C) have been selling off banking units to super-regionals such as Itau Unibanco. In 2014 Itau Unibanco acquired control of Chile’s Corpbanca (BCA), which had already acquired Helm Bank in Colombia. Itau is also making a strong push into Mexico where CitiGroup, one of the market leaders, has experienced a series of scandals.
The ADRS of Itau Unibanco popped 10.7% on October 30 on the central bank’s surprise. The move to $14.75 at the October 30 close in New York still leaves the ADRs well short of their September 2 high at $18.32 and even the October 14 “Dilma is trailing in the polls” high of $16. (Caveat investor—this is very volatile stock right now. In between those highs, Itau Unibanco has seen $13.25 on October 1 and $12.86 on October 27, the “Dilma wins” plunge.)
A return to $18, near the September 2 levels, would be a 22% gain from the October 30 close. I think that’s a reasonable initial target price while we see if Dilma can keep surprising the financial markets. One of the advantages of being as disliked by the financial community as she was before the election is that gaining a higher approval rating is a relatively easy task.
It does get harder from there, of course.
In my search for stocks that will go up as oil prices go down, I can’t think of a market with more leverage to the downward movement in oil prices than the Indian stock market. And I can’t think of an individual stock in that market with more upward leverage to falling oil pries than Indian bank HDFC Bank (HDB)—which is why I will be adding the bank’s New York traded ADRs to my Jubak’s Picks portfolio http://jubakam.com/portfolios/jubaks-picks/ tomorrow, November 18.
The structure of the Indian economy—the country imports 80% of its fuel—and the Indian fiscal and financial cycles are powerfully concentrating the effects of falling oil prices. For example, the government of Prime Minister Narendra Modi has used falling oil prices as an opportunity to end price controls and subsidies to consumers on diesel fuel and natural gas. That’s had the effect of reducing the government’s budget deficit at the same time as the falling cost of fuel imports has reduced the country’s current account deficit. India’s current account deficit has dropped to its lowest level in six years. Expectations are that the Reserve Bank of India will see enough of a decline in inflation (from lower fuel prices) and enough of an improvement in the national accounts to start lowering interest rates around the end of the fiscal year in March 2015. (Consumer price inflation dropped to 5.52% year over year in October, below the central bank’s target of 6%. The Reserve Bank next meets on December 2.) The central bank’s short-term benchmark repo interest rate is at 8%.
Lower oil and fuel prices plus a cut in interest rates would give a big boost to an Indian economy that the State Bank of India, the country’s biggest bank, estimates will grow by 5.8% in fiscal 2015. The Modi government has set a target to increase the growth rate to 7% to 8% within two to three years.
You can get exposure to that story through a broad-based India ETF such as the iShares MSCI India ETF (INDA.) That ETF has gained 31.8% from November 18, 2013 through the close on November 17, 2014.
Or you can look for an individual stock that is likely to leverage those trends even further.
A bank such as HDFC Bank, one of the largest privately owned banks in India, will benefit from a general recovery of growth in the Indian economy and from any interest rate cuts from the Reserve Bank of India. And it will benefit more than almost any other Indian bank. Almost 50% of the bank’s loan book is made up of retail loans—demand for retail loans is likely to pick up with the economy at a faster pace than corporate loan demand and retail loan interest rates tend to come down relatively more slowly than the benchmark so HDFC should see rising net interest margins. The bank has done a good job of keeping lending standards high during the economic slowdown—the gross bad loan ratio is just 1%–and the bank’s capital ratios are in good shape with a capital adequacy ratio of 15.7% as of September 30.
The bank also looks to be positioned to benefit as well from a more relaxed attitude from the Reserve Bank of India and the Modi government as growth picks up and as the country’s fiscal posture improves.
On November 14 India’s Foreign Investment Promotion Board approved an increase in permitted foreign ownership for HDFC Bank to 74% from a previous limit of 49%. That will let the bank go ahead with a 100 billion-rupee ($1.6 billion) sale of shares that will boost the bank’s capital available for lending just as the economy starts to speed up.
That approval is likely to revive talk—and maybe even actual negotiations–of a merger between HDFC Bank and mortgage lender and parent HDFC. The recent scrapping of tough reserve requirements and the recent increase in permitted foreign ownership remove two of the biggest obstacles to a deal which would create India’s largest privately owned lender. A deal, depending on its structure, could lower the cost of funds for HDFC’s mortgage business at the same time as it allowed HDFC Bank to escape current high reserve and restrictive lending allocation requirements. I’d put the merger talk in the “buzz” category of rumors, but a little buzz never hurt a stock price either.
I calculate a target price of $62 for the ADR as of August 2015. That’s roughly a 20% gain from the November 17 closing price of $51.93.
The resumed tumble in the yen has been good for shares of Japanese exporters, even as the Japanese domestic economy has faltered. The New York traded ADRs of Toyota Motor (TM) have climbed 4.2% from August 22 through the close on September 24.
A weakening yen hasn’t been nearly as kind to shares of non-export companies. The ADRs of Mitsubishi UFJ Financial Group (MTU) are down 1.3% in that same period.
And I think this divergence is likely to continue for a while. The Japanese economy, which staged an initial recovery after the implementation of Abenomics, faltered with the March increase in the national sales tax. It now looks like the Bank of Japan will have to weaken the yen further if the Abe government is to hope to restore growth and push inflation higher.
Which is why I’m holding my position in Toyota Motor but selling out of my Jubak’s Picks portfolio Jubakam.com/portfolios/jubaks-picks/ position in Mitsubishi UFJ Financial. I’m not actually getting rid of my position in Mitsubishi UFJ Financial; instead, I’ll be moving it to my long-term http://jubakam.com/portfolios/jubak-picks-50/ sometime in the first week of October.
Let me explain my thinking on why holding onto Mitsubishi UFJ Financial is a good idea, even though I favor selling for investors with shorter (12 to 18 month) time horizons.
Mitsubishi is the strongest of the big three Japanese banks in terms of its overseas operations and network. Some of that dates back to the bank’s roots in the Bank of Tokyo. Some is a result of acquisitions: Union Bank of California, a hunk of Morgan Stanley, and Thailand’s Bank of Ayudhya.
The 2013 acquisition of Bank of Ayudhya won’t be the last acquisition that Mitsubishi makes in Asia outside of Japan but it does show you why Mitsubishi and other Japanese banks are expanding into the region. The Thai economy is forecast to growth three times faster than the Japanese economy in 2014. The net interest margin at Bank of Ayudhya was 4.2% in 2013. Japan’s three largest banks have an average net interest margin of just 0.93%. (In 2013, Mitsubishi also acquired a stake in the Vietnam Joint Stock Commercial Bank for Industry and Trade, known as VietinBank.)
Nor is the acquisition strategy limited to Asia. Also in 2013, Mitsubishi agreed to buy US hedge fund administrator Butterfield Fulcrum Group and it acquired $3.7 billion in US real estate loans from Deutsche Bank through Union Bank of California.
The acquisition strategy makes sense if you think of it as a version of the yen carry trade. What Mitsubishi is buying are ways to put the yen it can raise so very cheaply in Japan at work in countries with higher interest rates than Japan.
In the long-term, this is a very attractive strategy.
Unfortunately, in the short-term, a cheap yen makes acquisitions for this Japanese bank more expensive and-especially with other Japanese banks bidding for overseas assets-a weak yen does raise the possibility of overpaying for these assets.
That’s one reason I don’t want to hold Mitsubishi in a relatively short-term portfolio such as Jubak’s Picks. The other is, as I’ve been harping on lately, I’d like to raise some cash from stocks with what seem to be modest near-term upside in case the earnings season that starts in two weeks gives me buying opportunities in stocks with higher earnings and revenue growth rates.
I’m selling Mitsubishi UFJ Financial Group out of Jubak’s Picks with a 3.4% loss since I added it to the portfolio on March 26, 2013.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. (Please don’t read any opinion of the market into that cash position. It’s taking longer than I anticipated to wind up the asset management company behind the fund.) I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.
Shares of Mitsubishi UFJ Financial Group (8306.JP in Tokyo or MTU in New York) kept on tumbling today despite unexpectedly positive earnings for the third quarter. Net income climbed to 255 billion yen ($2.5 billion) in the three months ended on December 31. That was a 5.4% increase from the December quarter of 2012 and beat the average estimate of 200 billion yen by analysts surveyed by Bloomberg. The bank is now 86% of the way to its profit target for fiscal year that ends on March 31 2014.
So why is the stock down 12% from December 31 to the close on February 3? And why does it look poised to fall some more in the short term? (Mitsubishi UFJ Financial Group is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ At the $5.88 February 3 close the ADRs traded less than 1% below my original March 26, 2013 purchase price of $5.92. I’m leaving my target price at $7.10.)
The problem is worry about the bank’s exposure to the sinking Japanese stock market and brutally low loan margins. Read more
Not surprising that the financial sector led the U.S. market down today. The Standard & Poor’s 500 stock index closed down 0.13% on January 16 as the Financial Select Sector SPDR (XLF) dropped 0.63%.
Today’s villain was a big miss by Citigroup (C) before the open. Tomorrow doesn’t look a whole lot better for the sector because, after the close on January 16, American Express (AXP), Capital One (COF), and Sallie Mae (SLM) all reported significant earnings misses. American Express came in with fourth quarter earnings of $1.21 a share versus a consensus projection of $1.25. Capital One reported $1.45 a share instead of $1.57. And student loan company Sallie Mae announced 61 cents a share versus the analyst consensus of 73 cents a share.
The three stocks were down 0.14%, 2.21%, and 5.08% in after-hours trading
American Express was the victim of expectations that were a bit too heady. The company just about matched Wall Street’s projected revenue number at $8.54 billion (just shy of consensus at $8.55 billion) and came in just a few pennies short on earnings per share despite solid cuts to operating expenses (down 8%), an increase of 8% in spending by card members, and a drop in reserves for loan losses of 17% from the fourth quarter of 2012. Wall Street wanted more after the 59.3% return for the stock in 2013.
On the other hand, Capital One reported the kind of bad news we’ve heard from banks such as JPMorgan Chase (JPM) and Citigroup (C). Revenue dropped 1.4% from the fourth quarter of 2012. Loan growth was worse than piddling with auto loans falling by 3% and home loans declining by 4%. Net interest margins declined 16 basis points and provision for credit losses increased 13%.
These results, unfortunately for the sector, echoed Citigroup’s earnings report before the open today. The bank reported 85 cents a share in earnings when Wall Street was looking for 99 cents (or 95 cents depending on what consensus counter you follow.) The culprits were weaker than expected revenue, higher than expected provisions for loan losses, and greater than expected expenses. (Citigroup is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
The good news for the sector and the market is that tomorrow’s financial reporting from banks is dominated by regionals and that group has been doing better than the big money center banks. Read more