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Brazil - Metals Sector
Posted by: Fede Zaldua (IP Logged)
Date: October 15, 2013 09:31AM

With the earnings season coming our way, it might be a good idea to gain some exposure to the Brazilian metals sector through Brazilian steel names or through raw material producers such as Vale (VALE). I would expect quarter over quarter earning improvements across the board in the country as higher iron ore and steel prices are reflected into corporate results. Investors such as Ray Dalio and David Dreman are already positioned to benefit from the coming results.

Strong Margin Recovery Ahead

Vale should report robust EBITDA growth of 24% as a result of cost reduction initiatives, higher volumes (iron ore sales should go up by 17%), and a depreciated Brazilian real which has been also helping the company's bottom line: Vale sells a product denominated in US dollars and has most of its costs denominated into a depreciating local currency. Actually, partly thanks to the effects of the depreciating Brazilian Real, Vale should be increasing its EBITDA margin up to 52%, from the 45% margin that the company attained during the second quarter.

In addition, Vale, which is a low-cost producer of iron ore with long life reserves, trades at a very modest valuation level. The company sells for 5.1 times 2013 EV/EBITDA and 8.3 times earnings. Moreover, Vale's low leverage (1.1 times EBITDA) and great project pipeline make it a clear option when looking for reasonably priced large capitalization Latin American assets.

Highway to Recovery

Nowadays its not easy to find steel companies that are able to attain great results. Gerdau (GGB), the largest producer of long steels in the Americas, is a clear exception. The company is set to post its best quarterly results since the second quarter of 2010. EBITDA should grow by as much as 13% qoq and 31% year-over-year. Margins should also ameliorate in LatAm and particularly in Brazil since the company was able hike prices in the domestic Brazilian market. I would also expect Gerdau to start reducing its leverage fast from the current level (2.9 times EBITDA) and to post its first positive free cash flow (FCF) yield year in more than four years as soon as 2014 (analysts expect Gerdau to reach a 6.3% FCF yield in 2014).

Overall, Gerdau, held by Clint Carlson among other investors, is a great way to get into Brazil, which should be accelerating its growth after a lackluster 2013. Besides, the company trades at a very reasonable level. After a fantastic 12 week rally (+34%) the stock sells for 2014 7.7 times EV/EBITDA and 17 times earnings.

Bottom Line

Brazil has had a less than average year in 2013. Growth slowed and social unrest awakened. That said, as investors fled the country, opportunities appeared. Companies such as Vale and Gerdau were able to take advantage of a weaker local currency and attain operational efficiencies when the country seems to be ready for a (still timid) recovery. If you are want to gain exposure to metals, Brazil looks like one good place to start looking.



Guru Discussed: David Dreman: Current Portfolio, Stock Picks
Stocks Discussed: VALE, GGB,
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