Smart Investment Guide to Brazil

NEW YORK (TheStreet) -- As host of the FIFA World Cup (2014) and the Olympic Games (2016), Brazil will accelerate private and public sector spending beginning this year, providing excellent opportunities for long-term investors.

In the coming years, both private and public spending will continue to outpace GDP growth, in line with the increasing domestic demand. However, a widening current account deficit and increasing interest rates present downside risks, during 2010.

After a modest economic downturn in 2009, Brazil's GDP expanded 9% year over year during the first quarter of 2010 on robust domestic consumption and new investments. For the full year 2010, the economy is forecasted to grow 7.13%, the fastest since 1994.

Inflation kept pace with the growing economy reaching 5.2% in May, above the central bank's target rate of 4%. The central bank has already hiked interest rates to 10.25% from 8.75%, in an effort to contain inflation.

Currently, Brazil's Bovespa Index is trading at a PE multiple of 13.1 compared to 14.9 of the S&P 500 Index. In comparison, China's Shanghai Composite Index and India's BSE Index are trading at higher PE multiples of 17.6 and 17.9, respectively. At the current prices, Brazil market provides an attractive opportunity for higher returns.

After looking at several sectors of Brazil, oil and gas, metals and mining; and food and beverages are the top three sectors to play with the Brazil stocks. The outlook for the airlines and chemicals sectors remains bleak on intense competition.

Airlines

The Brazilian National Civil Aviation Agency's air traffic statistics indicate that load factor for May 2010 was 60.3% in the domestic market, a 1.1% increase year over year.

The increase in air traffic for U.S.-listed Brazil airline companies Gol Linhas Aereas Inteligentes ( GOL) and TAM ( TAM) was 14.9% and 9.4%, respectively, below the industry's demand growth of 20.1%.

Both these major airline companies reported load factors below the industry's average, according to Banco Factor. As smaller companies are gaining market share at the expense of major airlines, the industry could witness a price war, similar to U.S. airline industry, if similar trends continue in the industry. In the current scenario of slower growth in Brazil's air travel, a price war will lead to lower profitability for the industry. The sector's outlook remains bleak, at least in the short-term.

Banks

Brazil will likely see improved credit quality and delinquency rates for both individual and commercial loans, as the unemployment rate has been declining and companies' profits have been increasing.

Banking stocks Banco Bradesco ( BBD), Itau Unibanco Banco Holding ( ITUB), and Banco Santander ( BSBR) will benefit from the higher interest rate environment because of the asset-sensitive balance sheet of these banks.

Chemicals

The Brazil chemical industry will face difficult times ahead, as the recent success of the global industry has been primarily due to cost efficiency and demand growth, which, in turn, shifted the industry's production epicenter to China and the Middle East. The industry is thriving in China because of a large domestic market and cheap labor, whereas the Middle East offers abundant feedstock supply and lower corporate taxes.

Brazil's Braskem ( BAK) witnessed lower utilization rates, even during the first quarter when the economy grew 9%, due to unscheduled power outages and deficient energy supply.

The average utilization rate of ethylene crackers is already around 91%, providing little scope to increase production further. The current global oversupply of petrochemicals will pressure prices leading to overall declines in chemical companies' gross margins.

Food, Beverages

Growth of Brazilian retailers such as Companhia Brasileira De Distribuicao ( CBD) will be driven by credit expansion, rising income levels, and low penetration of modern retail chains. Brasil Foods ( BRFS) will benefit from increasing disposable incomes.

Increased disposable incomes boosted beer and soft-drink sales with beer sales tracking the 22% growth during the first quarter. Brewers such as Companhia de Bebidas das Americas (Ambev) ( ABV), Latin America's largest brewers and controlled by Anheuser-Busch InBev NV ( BUD), had to import beer for the first time in the company's 125-year history after local supplies were exhausted. The ongoing FIFA world cup will further increase the company's sales.

Metals and Mining

Major steel producers Gerdau ( GGB) and Companhia Siderurgica Nacional ( SID) are likely to experience a price pinch during the second half due to a worldwide demand slowdown, which prevents producers from increasing steel prices. However, Brazil's steel mills are better placed than their counterparts in China due to larger vertical integration that protects them from increasing raw material costs to some extent.

VALE ( VALE) will likely outperform the other mining giants BHP Billiton ( BHP) and Rio Tinto ( RTP) on the price outlook for iron ore that accounts for around 60% of the company's revenues.

Oil & Gas

The country's Petroleo Brasileiro ( PBR), better known as Petrobras, has been a favorite with investors, including billionaire investor George Soros.

While most oil majors have been cutting back on exploration and development, Petrobras has laid their capital expenditure plans until 2013 ensuring that the company will grow faster than the industry average. In addition, the company has an expertise in deep water drilling rigs providing a competitive edge and is among the lowest cost oil producers in the world. The outlook for the stock remains robust.

Telecom

Brazil's Telecom industry will continue to enjoy outstanding growth in the mobile and broadband markets. However, local fixed-line telephone segment will likely stagnate despite the low tele-density. Hence, fixed line and mobile phone operators, Brasil Telecom ( BTM), Tele Norte Leste Participacoes ( TNE) and Telecomunicacoes de Sao Paulo ( TSP) will likely underperform pure mobile service providers TIM Participacoes ( TSU) and Vivo Participacoes ( VIV).

On Wednesday, Telefonica ( TEF) raised its bid to $8.72 billion to buy Portugal Telecom's ( PT) stake in Vivo. Telefonica and Portual Telecom each own 50% stake in Brasicel, which in turn owns 60% in Vivo.

The huge disparity between the rich and the poor will likely be more evident in the telecom sector. The rich continue holding multiple mobile connections while a number of Brazil households cannot afford to have any kind of telecom service. Buoyant economy and government sponsored schemes will help the poor to come out of the poverty, thereby supporting the growth of telecom sector in the long run.

Karvy Global Services (www.karvyglobal.com), a subsidiary of the Karvy group (www.karvy.com), provides specialized research in asset classes including stocks, mutual funds and insurance to leading Wall Street firms.

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