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.
Is the discount big enough?
The Brazilian government has reportedly offered to settle its tax dispute with iron ore miner Vale (VALE) for about half of the $14 billion the government has claimed the company owes in taxes on the sale of foreign subsidiaries from 1996 through 2008. And under the settlement Vale would get to pay the $8.5 billion in the settlement over 15 years.
The company has maintained that it doesn’t owe the taxes the government claims and has been fighting the case in court. The company could continue that fight or it could take the offer.
This hasn’t been a great year for mining stocks and for iron ore miners in particular as slower growth in China has cut into demand while past investments in new mines have added to supply. But shares of Vale have decidedly underperformed shares of competitors such as BHP Billiton (BHP) and Rio Tinto (RIO) because of the uncertainty of this tax case. The amount of the government claim is, after all, three times net profit from 2012. In the last 12 months shares of Vale were down 5.03% as of November 19 while shares of BHP Billiton were up 4.04% and shares of Rio Tinto were ahead 10.37%.
If Vale takes the deal, it would remove substantial uncertainty from the stock and close the valuation gap with BHP Billiton and Rio Tinto. Read more
The New York traded ADRs of Brazilian airline Gol Linhas Aereas Inteligentes (GOL) went on a tear during the first two days of this week on a jumbo jet full of good news. (Gol is a member of my Jubak Picks http://jubakpicks.com/jubak-picks-50/ long-term portfolio.)
The ADRs climbed 9.4% on October 21, and another 4.6% yesterday. Today they pulled back 0.54% along with the general market.
What was the news? Read more
Brazilian utility stocks are taking a pounding on new government policies that will end the practice of automatic extensions of 20-year, no-cost concessions to provide electric power, that will increase the price of concessions to the point where inefficient utilities might not be able to make money, and that will pay very low prices for the replacement value of assets to utilities that lose their concessions.
The goal of the new policies are to cut some of the world’s highest electricity rates in an effort to reduce inflation. The new rules are projected by the government to reduce electricity rates by as much as 28%
The changes, announced yesterday September 11, whacked 5.3% today off the share price of a utility such as CPFL Energia (CPL). CPFL is a member of my dividend income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/ )
And that’s the good news in the sector. Shares of Cia. Energetica de Minas Gerais (CIG in New York), Brazil’s largest utility by market value, are down 20.8% today. Shares of Cia. de Transmissao de Energia Electrica Paulista (TRPL3.BZ in Sao Paulo or CTPZY in New York) are down 37.1% in Sao Paulo.
What accounts for the big differences in the impact of these changes to companies in the sector? Read more
Pretty much what you’d expect in first quarter earnings from a steel exporter in the current global economy—but after a 20% gain in 2012—more than twice the 9.6% pickup in Brazil’s Bovespa index—what you’d expect wasn’t good enough. Shares of Brazil’s Gerdau (GGB) fell 2.3% on May 3 after the company reported earnings. The New York traded ADRs (American Depositary Receipts) then traded down another 4.4% on Friday May 4 as the U.S. market sold off on a disappointing April jobs report. And today, Tuesday May 8, Gerdau is down another 4.3% on the sell-off prompted by another turn of the Greek and Spanish debt crisis. (Gerdau is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
All this hasn’t taken Gerdau quite back to where it was on December 30 ($7.78) but at $8.275 at 2 p.m. on May 8 it isn’t all that far away.
Let me begin with the company’s first quarter earnings report as the foundation for my suggestions of what to do with this stock. (Now, now, nothing quite that impolite.)
Gerdau reported first quarter 2012 net income of $370 million reais ($192 million.) That was even with the fourth quarter of 2011 but down—5.4%–from first quarter of 2011 net income of 391 million reais. Analysts had expected that net income would climb to 436 million reais. Revenue rose 10% from the first quarter of 2011.
In the short-term the problem this quarter was the result of heavy rains in Brazil that hindered production. Exports dropped 21% in the quarter.
Longer term the problems are rising costs and weaker global demand. Read more