Situations Improve in BrazilOctober 25, 2005 | Comments : 0 Recommended this article: (0)
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After a significant labor crisis rocked the Brazilian economy some months ago, the country's economy again seems to be on secure footing. For an update on this issue, as well as other goings on in Latin America these days, we spoke with Claudio Freitas, CFA, Zacks' senior Latin American analyst.
How has the major political crisis in Brazil progressed lately? Do you still consider this a main issue affecting Latin American stocks?
The Brazilian political crisis has been changing during the last 4-6 weeks. It is true that the crisis still remains and that it will continue to create problems for the government in the following months. However, it is now much more focused within the Congress than with the president himself; therefore, I understand that the potential for major negative economic changes because of this is now much lower than it was a month or two ago. Im becoming more convinced each day that the crisis is not a major investment issue anymore.
I believe this high-growth environment will continue for a long time. I feel that the current economic situation in Latin America is not a result of short-term economic recovery after so many crises. Rather it is a result of huge economic changes, which include sound economic policies in countries like Brazil, Chile and Mexico; increasing demand for basic products and commodities from fast-growing Asian countries; international companies seeking to invest in low-wage countries; and high international liquidity. As long as China continues to grow and the U.S. does not face a recession or a major economic slowdown, Latin America will continue to grow.
What issues should investors be concerned about when considering Latin stocks?
There are some important issues to be considered; some are positives, some are a source of risk. In Brazil, I am encouraged by the more favorable outlook for local interest rates. As a matter of fact, the Brazilian Central Bank decided to cut rates for the first time in its September meeting, and made another cut in the October meeting. After many interest rate hikes during 2004 and the first half of 2005, I now believe this is the beginning of many rate cuts in the following months, providing some support for internal demand.
In Mexico, the situation is similar--the Mexican Central Bank is now reducing domestic interest rates. The potential for cuts is not comparable to the Brazilian situation, nevertheless it is also positive for the Mexican economy.
U.S. inflation remains a great concern. Recently released figures have increased the fear that U.S. inflation could be accelerating, and that the Fed could increase U.S. rates more agressively as a consequence. This is a potential threat to international economic growth, and specifically to Latin Americas business environment.
Unlike other Latin American countries, Argentina has been implementing a strange economic policy based on political issues and short-term targets. As a consequence, inflation has been increasing. I am concerned over the medium-term results of this policy.
Is there much M&A (merger and acquisition) activity going on in Latin America? If so, where?
Yes, there is. In fact, there is M&A activity going on in many different segments, though I would like to focus on M&A prospects in the telecommunications industry in Brazil. This industry remains fragmented, competition is fierce, and operating margins have been shrinking. I believe it is time for some consolidation, and I also believe that the consolidation process will start with Brasil Telecom (BRP). I believe that in the next months there is a great chance that TIM Participacoes (TSU) will finally acquire control of BRP from Banco Opportunity and Citigroup. I also believe that Telemig (TMB) will be one of the first companies to be sold when the consolidation process starts.
Do you have any Buy recommendations for us today? Any Sells?
I believe the Brazilian equities are more attractive now as a results of the improved outlook for domestic interest rates. I like the retail sector, particularly Pao de Acucar (CBD). I also believe that Brasil Telecom (BRP) will be benefited by the beginning of the consolidation process in the Brazilian telecom industry. Lastly, there is also a good upside potential for Cemig (CIG), an electric utility with an attractive valuation.
I would avoid Telesp Cellular (TCP), a Brazilian wireless operator. The company is facing fierce competition and has been posting disappointing results.
Finally, what is your overall outlook for the region over the next 3-6 months?
I continue to have a positive view on Latin America for the next several months. I also believe investors should be overweighting Latin American stocks. The risk of increasing interest rates in the U.S. as a result of higher inflation remains a concern, and the volatility of the Latin American equity markets have been increasing in the last two weeks as a result of this uncertain environment, though I remain confident that economic growth in the region will continue and that the stocks are still trading at very attractive valuations.
Claudio Freitas, CFA is a senior Zacks analyst covering various sectors within Latin America.
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