Profit from the energy of Brazil’s private sector

Philip Salter
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THE Brazilian stock market has beaten its fellow Brics – Russia, India and China – since 2002 and its future looks strong. Carlos de Leon, who manages the Allianz RCM Brazil fund, is an advocate for the country’s long-term potential. Whether in energy, healthcare, education or retail, de Leon believes that Brazilian companies will be able to profit from the rise of the world’s fifth biggest country.

The Allianz RCM Brazil fund was launched on 7 October 2010. De Leon manages the fund with Michael Konstantinov, who also runs the £1bn Allianz RCM BRIC Stars fund. There are two ways of looking at the fund, according to de Leon. It can either be seen as a play on the Brics, or a play on the Latin American market. As the table shows, Brazilian equities have outperformed the other Brics since 2002 and gone from representing around 30 per cent of the weighting of the MSCI Latin America index a decade ago, to around 80 per cent today. “This shows you the shift that has taken place,” says de Leon. The fund is benchmarked to the MSCI Brazil index, but is more weighted towards mid to small cap companies.

De Leon points out that although Chile, Peru and Colombia have also grown, the Brazilian stock market (Bovespa) outshines its regional competitors. In China, GDP growth has not been concurrent with equity rises, but de Leon suggests that this is not the case with Brazil. He says this is because the Bovespa covers every conceivable sector, has great breadth of stocks and is very liquid, with daily trading of over $3bn, plus a similar amount of American Deposit Receipt (ADR) trading. For de Leon, it “offers tremendous opportunities in terms of investment.”

With commodities on a high, Brazil is well placed: much of its economy is based on oil, gas, iron ore and food revenue. Vale, the second-largest mining company in the world, makes up 8.62 per cent of the fund, while the Brazilian state of Mato Grosso has the size, soil fertility and weather patterns to supply an increasing amount of the world’s food, says de Leon. Energy is a particular focus of the fund. According to de Leon it will be “a massive investment theme for the next ten years,” and “Brazil is a hotspot in the global energy industry. It was very appealing five or ten years ago and it is even more so now.” There are two big sedimentary offshore basins in Brazil, the Campos Basin and the Santos Basin, which hold huge reserves of untapped oil. “The challenge for Brazil is not to find reserves, but to exploit them at a competitive cost,” says de Leon.

Petrobras is the main player in the oil industry and accounts for 9.61 per cent of the fund’s assets. It is the largest company in Brazil, has a market capitalisation of $228bn, and 14bn barrels of oil in proven reserves with an average reserve life of around 14.7 years. “Now it is all about execution, converting reserves into production and cash flow. That’s what the market is focussing on at the moment,” say de Leon. Traditionally the oil produced by Brazil has been thick crude oil, but recent finds are thinner, so once refineries have been upgraded, profits should flow.

Private companies are growing to meet the demands of healthcare and education. Rising wages and the formalisation of employment – shifting employees from the black to the white economy – combined with a relatively low unemployment level. has put pressure on employers to offer better benefits to employees. Healthcare is a growth industry. De Leon likes Odontoprev, Latin America’s largest dental benefits provider, Diagnosticos da America (DASA) and Fleury, medical diagnostic services providers.

Education is also a growing industry in emerging markets and is a big issue for the Brazilian government. The government offers tax breaks for the education sector and facilitates the industry by taking on the risk of financing, covering the costs of students who drop out. But the private sector delivers the education. De Leon likes Anhanguera, a postsecondary education group that runs campuses focused around Sao Paulo. It teaches about 295,000 students, who undertake courses for around three to four years. These are not wealthy students, working to pay fees in the evening, but upon graduation they can expect to double or triple their salaries.

Retail is another trend that de Leon is keen on. Natura, Brazilian equivalent of Avon, employs a direct sales model, with an astonishing 1.2m sales representatives. De Leon believes it is very well run. According to de Leon the big growth story in retail is responding to the growing “C” class, those earning R$1,200 to R$4,800 per month. Interestingly, de Leon says that Brazilian consumers prefer buying Brazilian goods, which bodes well for indigenous companies.

De Leon delivers convincing reasons for why investors should take a look at Brazil. As with any emerging market, risks and opportunities present themselves in equal measure. Provided the political stability confirmed by Luiz Inácio Lula da Silva’s smooth handover to Dilma Vana Rousseff remains, any bumps in the road should be handled well by a flourishing private sector.