Tags: Brazil, Mike Caggeso

Brazil Economy Expanded 5.8% in 1Q; Central Bank Likely to Raise Rates Again

By , Money Morning •

By Mike Caggeso
Associate Edtior

Driven by heightened domestic spending, Brazil's red-hot economy posted its fastest first-quarter growth since 1995.

The 5.8% economic expansion - the country's 18th consecutive quarterly gain - fuels the notion that its central bank will continue raising interest rates to dampen inflation and demand.

"The figures show domestic demand is still strong," Zeina Latif, an economist with Banco Real in Sao Paulo, told Bloomberg News. "The central bank will remain concerned with a mismatch between demand and supply."

Since April, Brazil's central bank has raised its benchmark rate, called the Selic rate, twice - from 11.25% to 12.25%. And economists are forecasting it could be raised as high as 14% at the bank's next meeting.

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Food cost inflation in Latin America's biggest economy had surged to 5.25% by mid-May, and well above the central bank's generous target of 4.5%.

Walking the line between curbing inflation and promoting growth is tough for every emerging economy. In Brazil's case, kicking up interest rates again will throw a wet towel on one of its hottest consumer markets - real estate.

"The economy is strong but we can't say for sure it'll continue this way if inflation eats into consumer incomes and credit begins pulling back," Carlos Thadeu de Freitas Gomez, chief economist with Brazil's National Confederation of Commerce, told Bloomberg.

Safe From U.S. Woes

Investors shouldn't worry because, if anything, that's a good problem to have.

Secondly, Brazil is far enough removed from the sagging U.S. economy because South America as a whole has strong energy, mining, financial and agriculture industries, making them less reliant on U.S. imports.

Last year, Brazil's main stock market index, Bovespa Holding SA, rose 71% - even faster than India's.

And on Feb. 20, Brazil displaced China to become the world's biggest emerging market, according to a key index - Morgan Stanley Capital International Global Emerging Markets (MSCI GEM). 

That shift will likely attract billions in new money to Brazilian stocks, especially from money managers who benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investment Director for Money Morning.

"Anytime a country moves to the top of that index there's a strong re-indexing effect," Fitz-Gerald said. "And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They're going to move substantial amounts of money into Brazilian stocks."

Brazil Profit Plays

There are plenty of stocks to choose from. There are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40 to 50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

  • Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a Price/Earnings ratio of 12.20 and dividend yield of 2.4%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.
  • Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued about 13 times earnings, though its dividend yield is only 1.2%.
  • Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology - and the willingness to work with the oil majors. Its shares are up 168% in the past year, but the stock's P/E still is only 19.37. It has a 1.3% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world's monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.
  • Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that's a growth business, and not dependent on commodity prices. With a P/E of only 8.33 and a yield of 2.7%, this is one stock I have to say I love.
  • TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It's concentrated in the populous southeast and northeast regions of Brazil, with a P/E ratio of only 6.15 and yield of 4.25%.
  • Telecomunicacoes de Sao Paulo SA, or Telesp (ADR: TSP) provides the fixed line telephone system for Sao Paulo. Before you sneer, consider this: the company has a dividend yield of 9.8% and a P/E ratio of 10.07 (which means the dividend is only just covered). And it's majority owned by Spain's Telefonica.
  • Voturantim Cellulose (ADR: VCP) is a pulp and paper company, with a P/E ratio of 13.95 and a dividend yield of 2.8%. Trees grow fast in the tropics and VCP definitely benefits from that!

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