10 Brazilian Stocks for 2011

NEW YORK ( TheStreet) - Recently Luiz Inacio Lula da Silva, Brazil's outgoing presidentl, claimed his country is destined to be the fifth-largest economy by 2016.

Now touted as the eight-largest economy, Brazil could lead the transition from the oil era. Rising income levels and declining unemployment rates boosted consumption levels. Brazil's central bank expects gross domestic product to grow at more than 7% in 2010, and one of the foremost reasons for this strong growth is the improving credit scenario.

In a recent report, Brazil's central bank said it expects to close the year with $30 billion foreign direct investments. Although annual inflation is seen spiraling above 5%, analysts foresee the rate remaining within the central bank's mandated limit, and this could be a positive factor for stock markets.

In recent months, Brazilian banks saw robust demand for loans, both personal and from small and medium enterprises. Meanwhile, earnings of metals and mining companies grew at a brisk pace during 2010, with analysts expecting the momentum to continue in 2011 as well.

The country's oil giant Petroleo Brasileiro (Petrobras) ( PBR) is exploring deep water reserves to meet bulk energy requirements.

We have identified 10 stocks across sectors like banking, commodities, telecommunication, and transport, which investors can consider for diversifying their portfolios. These stocks will likely generate 16-33% gains during 2011, according to analysts' consensus estimates.

The stocks are stacked in terms of upside, great to greatest.

10. Tele Norte Leste ( TNE) provides telecommunication services, including products such as fixed and mobile telephony and data transmission services.

During the September quarter, revenues were lower than expected on account of the drop in broadband and mobile subscriptions. However, margins came in better than expected at 37%. TNE's bid to takeover Portugal Telecom, details of which are still awaited, would entail future investments.

Capital expenditure amounted to 8% of revenue in the 2010 third quarter. TNE now proposes to raise $8 billion to $8.5 billion in capital in the first quarter of 2011, which is likely to reduce its existing debt from 2 times of EBITDA to around 0.8 times. However, analysts expect actual capital raising to be lower at around $3.5 to 5 billion.

The stock is trading at 2.7 times its estimated 2012 enterprise value per EBITDA.

9. TIM Participacoes ( TSU) provides telecommunication services and has a 24.5% market share.

TIM reported revenue growth of 6.1% as its customer base expanded to around 47 million at the end of the third quarter. Another positive has been an uptick in the minutes of usage, an indication of greater talk time during recent quarters. Furthermore, increased 3G connections during the recent quarter boosted EBITDA margins to 25.3%.

Declining subsidies, commissions, advertising and promotions costs boosted profitability. Another feature of operational efficiency has been the lower impact of bad debt, which stands at 2% of service revenue at the end of the September quarter, compared to 2.9% in January.

For the fourth quarter, management is focusing on expanding its customer base, improving margins, and generating cash. Currently, the stock is trading at 5 times its 2011 estimated enterprise value per EBITDA.

8. Gerdau ( GGB) is an integrated steel player operating in Brazil, North America, and Latin America.

The company acquired Gerdau Ameristeel in August. To consolidate its plans further, Gerdau recently announced the acquisition of Acos Villares, a company engaged in the production of long steel. Gerdau paid 6.8 times its estimated 2011 EBITDA to close the deal, a cheaper transaction multiple. Through this acquisition, Gerdau expects to increase its exposure in specialty steel.

Analysts expect the company to deliver a net profit growth of around 30% to 35% in 2011, riding on the back of improving fundamentals. The stock is trading at 7 times to 7.2 times its estimated 2011 enterprise value per EBITDA, compared to the peer average of 6 times to 6.2 times. In addition, the company has a dividend yield of 1.7%.

7. Banco Bradesco ( BBD) is one of the top five banks in Brazil in terms of assets.

Analysts hold a positive outlook on the stock, given its medium-term growth prospects. Earnings are expected to grow at 20% to 30% in 2011. An improvement in asset quality would also upgrade earnings profile in 2011. The bank's provision coverage stands at 122.6%, up 100 basis points from the June quarter.

Corporate and auto loans, which accounted for two-thirds of total loans, did not perform well. Overall, the increase in total loans was slower than forecasted at 20% year over year. However, payroll loans, personal loans, and SMEs grew rapidly at 71%, 50%, and 27.5%, respectively.

Tighter spreads that declined 30 basis points quarter-over-quarter plunged net interest margins to 7.5% at the end of September. Moreover, the bank has a 25% market share in insurance premiums. Dividend yield stands at 0.9% with a capital adequacy ratio of 16.8%, as of March 2010. The stock is trading at 3 times its 2011 book.

6. Banco Santander Brasil ( BRRB) is a leading full-service Brazilian bank with the fourth-largest asset size in the country.

The bank focuses on SME and retail lending, which grew at 15.8% and 14.2% year-over-year during the September quarter, respectively.

BSRB's net interest income grew 3% sequentially, coming in lower on account of pressure on NIM. Lower-than-expected growth in loan loss provisions and operating expenses scaled up net income nearly 31% during the September quarter and 40% during the first nine months of 2010.

Non-performing loans are trending lower, standing at 6.1% during the September quarter, narrowing 50 basis points sequentially and 160 basis points year over year. BSRB's return on equity improved to 11.8% in the September quarter, compared to 10.8% in June. The stock is trading at 1.6 times to 1.7 times its estimated book.

5. Embraer ( ERJ) manufactures commercial and defense aircraft with the defense business contributing around 10% toward revenues.

Third-quarter revenues stood at around $1.04 billion, lower than analysts' estimates due to lower revenues from defense and other services. However, gross margins stood at 22.1%, up 70 bps from the June quarter. Higher margins resulted from deliveries in Brazil and China and improved productivity.

Embraer recently announced that its Legacy 650 business clinched European and Brazilian certification, which could result in faster volumes for its medium and large business jet deliveries, beginning fourth quarter 2011. The company is planning to launch a new commercial aircraft in 2011.

The management expects revenues to reach $5.25 billion in 2010. Analysts expect gross margins to range between 20.7% and 20.9% for 2011 and 2012, respectively. The stock is trading at 10 times to 11 times its estimated 2012 earnings.

4. Itau Unibanco Holding ( ITUB) is one of the largest private banks in Brazil.

During the September quarter, SME and retail lending were up 30% and 21%, respectively, while corporate loans increased at a slower pace at 7%. Overall, loan growth stood at 18%.

NIIs were lower at 3% quarter-on-quarter due to pressure on NIM, which dropped due to higher funding costs and competition.

However, analysts foresee an earnings growth of 20%-30% during 2011 as operating costs could drop due to a reduction in branch integration costs. Favorable asset quality trends should also improve earnings. The bank's return on equity at around 25% is encouraging. The stock is trading at 3.4 times its estimated 2011 book.

3. Petroleo Brasileiro ( PBR) is an integrated state-owned oil and gas major in Brazil operating in segments like exploration, production, and refining. The company has forged partnerships with several international oil companies like Royal Dutch Shell ( RDS.A) and Exxon Mobil ( XOM).

Petrobras recently acquired Libra oil field in the Santos Basin. Analysts believe that additional acreage would be able to sustain the present production growth rates of 5% to 7% until 2015. The company has a replacement ratio of 144%, surpassing the ratios for China Petroleum & Chemical Corporation ( SNP) and PetroChina ( PTR). Replacement ratio indicates the reserves added over production.

Petrobras' estimated oil reserves are at about 11 billion to 12 billion barrels of oil equivalent with a production output of more than 2 million barrels of oil equivalent per day. The company has a refining capacity of 1.9 million barrels per day with utilization of over 90%, one of the best in the industry.

Petrobras has been an underperformer vis-à-vis crude oil and its peers in the recent few months. Analysts expect substantial upside from current levels during the upcoming months. The stock is trading at 11-12 times its 2011 earnings.

2. Companhia Siderurgica Nacional ( SID) is an integrated steel producer in Brazil with interests in mining and logistics.

Net sales for the first nine months were up 38% due to higher domestic sales. The uncertainty in global markets has dipped the share of exports in overall revenues to around 27%, compared to 29% during the same period last year.

The company's efficient cost-containment strategy lowered selling and administrative expenses. EBITDA margin improved to 43.1% during the first nine months of 2010, compared to 30% in the year-ago period. However, analysts believe that a weaker price outlook for steel and higher capex related to investments in a railroad and securities trading could damp earnings, going ahead.

The stock is trading at 5 times its estimated 2011 earnings value per EBITDA and analysts expect a 30% to 35% earnings growth next year.

1. Gol Linhas Aereas Inteligentes ( GOL) is a budget airline operating in Brazil and on routes to South America and the Caribbean.

Net revenues came in at around $1.8 billion, up 26% year-over-year. The company's yield increased 2.4% year-over-year, although declining 7.2% sequentially due to a shift in traveler profile. Despite higher demand, the focus on profitability contracted domestic market share, while international markets grew at a robust 25% year over year.

Higher maintenance expenses and fuel costs saw operating costs inch up, but escalating demand saw net profits rising 40% year over year. The company is embarking on a fleet renewal and modernization plan and is purchasing around 30 aircrafts to cater to growing demand.

However, firm crude oil prices could damp margins, going ahead. The stock is trading at 12 times to 14 times its estimated 2011 earnings with a dividend yield of around 3%.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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