Forget China, Brazil's a cheaper investment
The bustling economy survived the global slump in style, and many of its stocks are still reasonably valued.
(Fortune Magazine) -- Brazil has a lot of reasons to celebrate these days. It recently won the competition to host the 2016 Olympics in Rio de Janeiro, as well as the 2014 World Cup.
Its once-troubled economy has bounced back from the global financial crisis more quickly than many, and its government debt earned an investment-grade rating from Moody's in September. Unemployment is down from its March peak, wages are up, and the Bovespa index, which tracks the country's biggest stocks, has climbed 77% so far this year.
Much like China, Brazil recovered quickly because of its fast-growing domestic economy. In fact, while investors tend to think of Brazil as a net supplier of food and fuel to the rest of the world, exports actually account for less than a quarter of the country's GDP.
"Its economy is insulated and domestic-driven," says Pedro Martins, a Bank of America Merrill Lynch Latin America analyst, who is based in São Paulo.
The key point for investors is that Brazilian stocks are still cheaper than those of other powerhouses like China and India. On average, they are trading at 12.9 times next year's estimated earnings, compared with China's 19.1 and India's 18.4, according to Martins. (The S&P 500's forward price/earnings ratio is 18.)
To be sure, the country still struggles with income inequity and political risks, including the upcoming presidential election. But Martins believes the ascendant middle class will be a boon to domestic sectors like banks, infrastructure, and consumer staples.
And while Brazil's economy will expand by 3.5% next year, according to International Monetary Fund estimates, Martins believes that many Brazilian companies will do much better, averaging 26% earnings growth.
U.S. investors can buy shares of Brazilian companies through emerging-markets funds like BlackRock Latin America (MDLTX), which has returned 32% annually over the past five years, or the Market Vectors Brazil Small-Cap ETF (BRF), which invests in 56 small-cap stocks.
They can also choose from the many stocks that trade as ADRs in the U.S. For example, Itau Unibanco (ITUB), Brazil's biggest bank, is on Bank of America Merrill Lynch's list of recommended equities. "Because of the rise of the Brazilian real, banks are looking attractive," says Martins. "We expect loan growth to hit 20% next year."
"They have a huge market share in Brazil, which is a great place for selling beer," says Jim Moffett, manager of the $4.6 billion Scout International fund. Despite AmBev's impressive growth potential -- analysts expect it to boost profits by 14% annually over the next five to seven years -- it's trading at a discount to brewers like Heineken and SABMiller.
Fortune has on numerous occasions recommended Petrobras (PBR), the Brazilian oil behemoth (for the record, we still like the stock, which is trading at 10 times trailing earnings). A lesser-known stock with a related focus is Ultrapar Holdings (UGP), the fuel distributor that transports Petrobras's gas to retail outlets. Auro Rozenbaum, an analyst at Brazil's Bradesco Corretora, is partial to Ultrapar because of its stable margins and highly efficient operations.
Domestic consumption may be leading Brazil's recovery, but exports aren't far behind. Unlike China, whose shipments of manufactured goods will be slow to return to pre-crisis levels, Brazil ought to experience resurgence in demand for its natural resources. Pedro Herrera, an analyst at HSBC, likes the country's agribusiness sector because it profits from both domestic and global growth.
Two of Herrera's favorites are Cosan (CZZ), which sells sugar and ethanol, and Brasil Foods (PDA), a meat processor. Herrera says Cosan will experience growth in both divisions -- sugar abroad, ethanol at home -- as well as from newer ventures like logistics.
Brasil Foods, which was formed by the merger of rivals Perdigo and Sadia, is a "poultry powerhouse" that sells mainly processed foods in Brazil and raw meat to regions like Europe. Herrera thinks the company's global reach will pay off: "The recovery around the world will be a driver for growth."
Brazilian mining giant Vale (VALE) is already riding the wave of recovery -- Brazil's iron ore exports have jumped, largely because of China's appetite for steel. Dahlman Rose analyst Anthony Rizzuto says that despite headwinds from a strong real, Vale, which is trading at 13 times trailing earnings, compared with an industry average of 15, will continue to achieve high margins thanks to its rich resources and low production costs.