The economic situation in Brazil looks dire; should investors stay away?
Peter Taylor: We are not top-down macro investors but obviously we have to recognise the macro economic environment. Right now the outlook for Brazil is very negative without signs of a turnaround. There is a lot of bearish sentiment so we do not see light at the end of the tunnel just yet. However, as stock pickers we are not trying to catch the bottom of the macroeconomic cycle. Of course we need to analyse how the economic cycle impacts the prospects of a particular stock but if you try to catch the bottom that you will miss the best opportunity because the market is forward looking. So for us, we are keeping invested in Brazil through the cycle. I guess it’s a conceptual point – it is our investing view. We tend to invest in companies with strong balance sheets that can survive economic shocks. The classic case would be Lojas Renner, which is doing pretty well in contrast to its peers in the fashion retailing segment in Brazil. All the retailers are in the same economic situation but because Lojas Renner has more firepower and is well managed it continues to do well in the downturn. Moreover it will be placed particularly strongly when things do pick up.
The other key factor for us is valuation. I mean if you were to simply invest on the basis of next year’s GDP forecasts you would have most of your money in Mexico and the ‘Andean 3’ – not Brazil. But markets are forward-looking so the impact of the economic downturn is already in the valuations. The Mexican market is, on average, trading at a premium given the stable economic output, while Brazil is trading, on average, at a discount, with some individual stocks and sectors trading at a deep discount. So the risk is leaving it too late, waiting for everything to look rosy in Brazil and missing the bottom of the stock market.
So is now a good time to go bargain hunting in Brazil?
PT: Yes there are some interesting valuations in Brazil at the moment but I am wary of the term ‘bargain hunting’ because I don’t see this as an opportunity to pick up really beaten up companies at super cheap prices. It’s more of a time to get good companies, that were a bit expensive before, but now with the sell off look reasonably priced. In this situation, where you can’t see the light at the end of the tunnel, you don’t want to jump into a very cheap company with a weak balance sheet. Rather you want to move into the quality companies that looked expensive before but are now giving you an entry point. In general the downturn means that there is a tough backdrop for most Brazilian companies, with the exception of the exporters that will benefit from the weak currency. Another area that looks interesting is the Brazilian financial sector where the banks have sold off excessively. In Itau and Bradesco you have well-managed, conservatively-run banks trading on very attractive valuations. Yes they deserved some de-rating but it has been overdone.
The Andean 3 are pretty popular with investors; which is your favourite?
PT: Chile, Colombia and Peru are all performing better than the regional average. The economic outlook for Peru is probably brightest although all three are commodity exporters so it depends on which is doing better. Peru is a small market, the smallest of the three and recently there was talk of the Bolsa de Valores de Lima being downgraded to frontier status. It might not happen but the fact that it is even being talked about shows how small that market is. It doesn’t actually affect our opinion on company fundamentals but it highlights the liquidity problem. In fact we only have two Peruvian stocks at the moment, Pacasmayo and Graña y Montero, which are two firms linked to the construction sector with good fundamentals.
When you look at Chile, it has really suffered with the commodity crisis because it is very dependent on copper exports. However, it has shown resilience and demonstrated the advantages of being a well-managed economy. One of the things I like about Chile is that it’s a relatively deep market. That’s down to historic reasons where its strong pension fund system has bolstered local capital markets. You have quite a few local firms listed in Chile or with ADRs in New York. Traditionally one of the challenges with Chile was that the heavy investment from local pension funds meant that it traded at a premium to the wider region. That premium has dropped now, which makes it very attractive. We have four Chilean stocks in our portfolio. Fallabella [a retailer], Banco Santander Chile, Andina [a Coca Cola bottler] and Parque Arauco [a shopping centre operator]. They’re well-run companies and, with the exception of Banco Santander Chile, they operate in neighbouring countries, giving you exposure to the wider region. Colombia is somewhere between the two in terms of size. And it’s been hit hard recently with the fall in oil prices. If I had to pick a favourite I would go for Chile.
The two most exciting LatAm investment stories are the energy reform in Mexico and the election of President Macri in Argentina; are you investing in them?
PT: The energy reform in Mexico is very positive for the entire Mexican economy so you don’t need to be directly invested. Indeed finding a direct play is difficult anyway, given the monopoly that has existed to date. But it’s such a significant milestone that it is good for the entire economy, regardless of sector. There are also a number of other exciting reforms in Mexico, for example in telecommunications. They might not be as significant as energy but having reforms across a number of industries definitely stirred things up. Of course it’s not always positive for every stock. If you’ve invested in someone that benefited from entrenched monopolies thus far then these reforms are not great. None of our stock picks play directly on those reforms but they will all benefit from wider effects of positive institutional reform and direction that Mexico is taking.
The puzzle with Mexico is that none of this has fed through to stellar growth just yet…
Aside from the reforms the other big advantages with Mexico are that it is closely linked to the US and slightly removed from the commodity downturn. Okay, Mexico is a net oil exporter and the government does receive revenues from the oil sector but generally speaking Mexico is much less commodity dependent than South America. It has a huge manufacturing base, which is closely integrated with North America so it’s avoiding some of the headaches affecting other Latin American economies. The puzzle with Mexico is that none of this has fed through to stellar growth just yet, but sometimes these institutional reforms take years rather than months to take effect. Of course not everything in Mexico is perfect; it still has significant challenges in terms of rule of law and the terrible consequences of drug trafficking.
Argentina presents a different practical situation for us as investors because unlike Mexico, which is a deep market with plenty of investable companies, Argentina does not offer much. That said we are looking much more closely. We’ve been meeting with Argentine companies and examining our options. We’ve tended to steer clear of Argentina because despite being stock pickers we are wary of investing in countries where economic management is a big challenge. So in that sense the new government has changed our attitude. However, the other key factor for us is valuation. The Argentine market ran up a lot in the last few years so even where there are good companies we need to make sure that the price is right.