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How to Profit from Brazil's Future Growth?

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Gordon Pape

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Contributing editor Glenn Rogers is back this week and he's been looking south - way south - for his next investment opportunity. Glenn is a successful businessman, entrepreneur, and investor who has worked in both Canada and the U.S. and now resides in southern California. Here is his report:

Glenn Rogers writes:

Sometimes being the least ugly girl in an ugly girl contest can be a winning strategy. That's certainly been true for the U.S. market this year. Despite anemic growth, political uncertainty, massive debt overhang, etc., the S&P 500 has outperformed most of the emerging markets where the growth has been much better than here. This is particularly true of the so-called BRICs which have been stock market darlings for the last few years.

These countries are Brazil, Russia, India, and China and their economies have been showing solid growth. Brazil has expanded by over 3% but their stock market declined 17.3% this year. In Russia, where economic growth was over 5%, markets dropped 11.1%. And that's after a sharp rally in recent weeks. India has seen economic growth of almost 8% yet their index is down over 15%. As for China, its growth rate is over 9% but it has experienced a market slump of 11.6% this year.

The S&P, on the other hand, is up 0.5%. In fact, if you rank this key U.S. index against emerging markets this year, it places ahead of 20 countries and behind just one, Indonesia.

Investors have been spooked by the European debt crisis and the potential for slowing growth in the aforementioned countries and have sought the relative safety of U.S. equities and, more particularly, U.S. Treasuries. This has proven to be a good strategy but it's likely that going forward investors won't continue to overlook the superior growth opportunities that the BRIC countries offer.

Personally, I've started to shift funds into some of these countries. This can be done directly through the many ETFs that are available or indirectly by buying U.S. companies that have a great deal of exposure to these nations like McDonald's (MCD), Starbucks (SBUX), and Yum Brands (YUM), which I have recommended in recent issues. Other possibilities are Joy Global (OYG) and Caterpillar (CAT), which derive significant revenues from these high-growth areas.

For this column I decided to focus on Brazil which will be heavily in focus over the next couple of years since they are hosting two of the largest world sporting events: the FIFA World Cup in 2014 and the Olympics in 2016. Both will be held in Rio de Janeiro.

Either of these events is a big deal on its own. Hosting both is both a huge coup and a tremendous opportunity from a business point of view. Both events will require a dramatic upgrade to the infrastructure within the country, which should spur a considerable amount of economic activity.

Beyond these major sporting events, Brazil has enjoyed rare political stability for number of years and that combined with sustained growth for the last decade has transformed the country into a blossoming economic powerhouse.

Brazil has a number of things going for it including scale, abundant natural resources, and a politically favourable world position. It has no significant enemies and a large world customer base, particularly China which is anxious to acquire lots of iron ore and oil, of which Brazil has plenty. (Sounds a lot like Canada doesn't it?) As a result, economists are predicting that Brazil's GDP growth should average about 4% over the next three years. That's slower than the growth rate in recent years but a lot better than what both the Europeans and the North Americans are looking at; in fact it's probably double what we might expect.

No story is complete without some caveats and it's true that Brazil has battled inflationary pressures for years, with the rate now running around 7%. This is causing their central bank to keep interest rates high, which could be a drag on growth going forward. Corporate taxes are likely the highest in any of the emerging markets, running over 35%, and there is still a strong socialist streak that runs through the country's leadership.

These leftist tendencies were brought to light again recently when the president of Brazil, Dilma Rousseff, forced the resignation of the extremely competent CEO of the huge and profitable iron ore company Vale (VALE) because he would not push programs that the government was advocating. Prior to that, the country's crown jewel, Petrobras (PBR), was subjected to political tinkering which caused the stock to underperform its peers for many months.

But these caveats aside, it is likely that over the next couple of years investors will see significant returns by having some exposure to Brazil. Political interference aside, both Vale and Petrobras are great companies and I think you could take a position in either or both now.

Another popular ADR is AmBev (ABV) which is the number one brewer of beer and distributor of soft drinks in the country. I also own shares of Banco Santander Brazil SA (BSBR) which is currently trading 44% below its 52-week high but has a yield of 8.5% and a p/e ratio of less than eight. There are two other banks you could consider: Itua Unibanco (ITUB) and Banco Bradesco (BBD). Both are larger in Brazil than BSBR but all three tend to trade in unison so I tend to buy the least expensive issue with the highest yield.

Of course, most investors buy Brazil through various ETFs or mutual funds that focus on the area. The largest by far in terms of assets is the iShares MSCI Brazil Index Fund (EWZ). It has had a huge run this past month, rebounding by nearly 20%, but is still down about 18% year to date. This ETF holds many of the issues mentioned above but spreads out the risk that may be involved with any particular equity. Since this gives you the whole country in one neat package, it's the best choice for someone who wants to add some Brazilian exposure to a portfolio without being forced to decide between individual stocks. The closing price on Friday was US$61.76. It's my top pick for this month.

To sum up, there are many ways to get involved with what appears to be a bright future in Brazil and since their markets have lagged this year you are buying some of these assets at discounted prices. That's not going to last forever.

Update of Previous Recommendations:

Heineken N.V. (HINKY)

Originally recommended on July 7/07 (IWB #2725) at $28.60. Closed Friday at $23.48. (All figures in U.S. currency.)

We originally recommended this stock way back in 2007 and it has gone downhill since then. At the time, the stock was trading for $28.60 and it closed on Friday at $23.48.

You would have thought that one of the world's largest breweries would have fared better during the recession. Heineken produces over 200 international and specialty beers including Amstel, Newcastle Brown Ale, Fosters, Coors Light, and their signature Heineken brand. Their products are distributed in 70 countries around the world.

Earlier this year, the stock briefly reached a 52-week high of $30.86. Then it traded down with the market to about $21 although it has since recovered somewhat. The price action has been much better lately and their recent quarterly results show that the world's third-largest brewer increased volumes at higher prices than in the same period last year, lifted particularly by sales in Africa and Russia.

The stock is yielding 1.9% and I think it's a reasonable bet that we may once again test the $30 level. So I would recommend holding for now but if we get close to its 52-week high I would ring the register and try something new.

Action now: Hold.

Diageo PLC (DEO)

Originally recommended on Sept. 4/07 (IWB #2731) at $85.42. Closed Friday at $85.38. (All figures in U.S. currency, unless otherwise stated.)

Another alcohol-soaked recommendation that has not done much is Diageo, which is one of the largest distilleries in the world. It controls household names like Johnny Walker, Smirnov, Capt. Morgan, Tanqueray and many more. This stock closed on Friday at $85.38, which almost exactly where it was when we recommended it in 2007. Given everything that's happened since, that's actually not a terrible performance.

Diageo has traded in a narrow range this last year between a low of $71.11 and a high of $86. It pays a decent dividend of 3% which, given where Treasuries are today, looks pretty attractive. The stock has been in an upward trend recently and appears to be headed higher. Meanwhile, you're getting paid to wait.

Recent results from the year ended June 30 saw the company increase net sales by 5% while volume growth grew by 3%. Diageo continues to generate free cash flow of over £1.7 billion and as a result, they increased their final dividend.

As with Heineken, this is a global country with broad geographic presence and a product that never seems to go out of style. Diageo continues to acquire companies around the world, particularly in emerging markets. Despite the fact that it is not made us a lot of money, it certainly hasn't lost us any and we have enjoyed a good dividend. My inclination would be to hold this one for at least another quarter.

Action now: Hold.

Covidien (COV)

Originally recommended on April 19/10 (IWB #20115) at $51.09. Closed Friday at $47.59. (All figures in U.S. currency, unless otherwise stated.)

This U.K.-based medical device maker was spun off from Tyco in 2007. It has traded in a narrow range this past year, between a low of $41.35 and a high of $57.65. It is currently about $10 below its high and is yielding just 1.9%.

Covidien produces a broad range of products in the medical device, pharmaceutical, and medical supply areas. Management has been aggressive in trying to diversify and grow the business by making three acquisitions during a period when prices were relatively low.

In the second quarter, the company reported net sales were up 14% overall with medical devices sales up 22%. adjusted diluted earnings per share from continuing operations were up 19% and guidance for the rest of the year was positive. Third-quarter earnings are due on Nov. 15.

Covidien has a strong share buy-back program along with their on-going dividend distributions which are currently $0.90 per share annually.

Action now: Hold. Watch the upcoming quarterly results and see if management reaffirms guidance going forward.

Baidu Inc. (BIDU)

Originally recommended on Feb. 21/11 (IWB #21107) at $128.80. Closed Friday at $137.76. (All figures in U.S. currency, unless otherwise stated.)

Baidu is the Google of China and I've made the mistake of trading this stock far too often. At this point, I think you could just consider this a buy and hold China growth play for the long haul.

The stock has been extremely volatile, trading between $94.33 and $165.96 over the past year. That has made for some heart-wrenching moments, especially for active traders. A few weeks ago when all the Chinese Internet stocks were getting crushed there was a golden opportunity to load up on this stock but it's now trading at $137.76, still off its highs but not quite the bargain it was then.

Third-quarter net income skyrocketed by 85% to $295 million. Revenues jumped by 85% to $654.7 million, which was beyond even what the company was projecting. Baidu has also been acquiring related websites, which will expand their footprint, as well as partnering with mobile phone makers to make it the default search engine on those handsets. In fact, Baidu has managed to secure 80% of all branded mobile handsets using the Android operating system in China. The company has 75.9% share of the search revenue in China with Google was its closest competitor at just 18.9% of revenues.

This can be a scary ride but I think you have to own some of this stock if you have any interest in participating in China's growth. If you're a bargain-hunter, wait for the dips to buy.

Action now: Buy with a target of $180. But remember, this stock is not for the faint of heart.

- end Glenn Rogers

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 4.3/5 (7 votes)

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