Emerging markets: Opportunities in Brazil

While emerging-market headlines tend to be dominated by China, positive trends are evident in areas outside of the world’s second-largest economy. With its abundance of energy and commodities, Brazil is a prime example. As an agricultural heavyweight, supplying soya beans, corn, beef, coffee and sugar to many parts of the world, its economy is thriving. This was evident in Q2 GDP, which expanded by 3.4% year on year and prompted the Brazilian Finance Ministry to raise its 2023 GDP forecast from 2.5% to 3.2%¹.

It's also evident in Brazil’s trade surplus, which is reaching record levels. The annual record was in 2022, at $61.5 bn, but this figure has been surpassed in 2023, now at $80.2 year to date². Exports have been supported by a record harvest, while imports are down due to increasing self sufficiency in energy.

Ahead of the curve on interest rates…

More broadly, Brazil is one of several emerging markets whose monetary policy is diverging from developed markets as inflationary pressures ease. Brazil’s central bank was early to take a hawkish stance on inflation in the wake of the Covid pandemic and started raising interest rates in March 2021, a full year ahead of the Federal Reserve. Having got ahead of the curve, Latin American countries have started to ease monetary policy. Chile led the way in being the first to start cutting interest rates. Brazil quickly followed suit at the start of August with a 50bps reduction in the SELIC rate, followed by two further cuts of 50 bps in September and October, taking the rate to 12.25%. The Brazilian central bank indicated that this pace of monetary easing is likely to continue.

Volatility provides opportunities

Yet over the past year, political risks have taken centre stage, as they often have for Brazil in the last few decades. Former two-time president Luiz Ignacio Lula da Silva beat incumbent President Jair Bolsonaro in October 2022. Investors worried about Lula’s fiscal plans and the potential impact of his left-wing administration on state-controlled enterprises, which has led to periodic weakness in the Brazilian stockmarket. Historically we have found times of political uncertainty to present good opportunities for investors – selling can often be indiscriminate in volatile periods. The weakness in the market has meant that our process has uncovered some undervalued opportunities. Our holdings in Brazil are linked by some consistent themes:

High dividends – Substantial dividends are available in the Brazilian market, offered by companies with good growth prospects and attractive valuations. For example, oil company Petrobras paid out almost $40bn in dividends last year, on a market cap of just over $80bn. The company has this year switched to a more conservative dividend policy and introduced share buy backs, but dividend payouts will remain generous. Within financials, Banco do Brasil and insurance company BB Seguridade offer yields of around 10%.

Energy self-sufficiency/transition – One of our holdings is Companhia Energetica de Minas Gerais (Cemig), a Brazilian power company headquartered in Belo Horizonte, capital of the state of Minas Gerais. It is involved in the generation, transmission, distribution and commercialization of electricity and also in the distribution of natural gas. Cemig supplies electricity in an efficient and sustainable way, with investments in hydroelectric plants (60 out of its 83 generation projects), wind farms and solar energy.

Commodity demand – We hold Gerdau, a steel producer with operations in Brazil and the US. There is a clear increase in demand in both markets thanks to upgrades to infrastructure as well as positive demographic trends resulting in higher consumption. Gerdau owns its iron ore mines, close to its steel foundries, which reduces the costs of production. The company has a strong balance sheet and pays out high dividends.

The financial sector has also benefited from commodity demand, particularly in agriculture. One beneficiary is state-owned Banco do Brasil, the leader in the booming agribusiness sector. This is leading to higher loan growth and lower non-performing loans.

Banco do Brasil has a strong market position in a higher yielding credit environment, with around 60% share of rural loans. Yet the stock is trading on a p/e of 3.8x with a dividend yield close to 11%. This is a similar level to a 10-year Brazilian government bond yield, but on an equity that is very undervalued and which has been growing its value per share³ at 21% (Chart 1). We expect the share price to keep pace with the improving outlook.

Chart 1: Banco do Brasil

Note: value-per-share and share price relative to MSCI Emerging Markets Index. Value-per-share (VPS) is a combined measure of earnings, cash flow, operating profits, dividends and asset value per share. Reference to specific stocks should not be taken as advice or a recommendation to invest in them. 

Continuing to favour Brazil 

Brazil is at the end of its monetary tightening cycle and inflation is coming down. The country has an abundant supply of energy and commodities, which is supporting a stronger growth outlook. Our process continues to uncover opportunities there.