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Over the past couple years, Brazil stock investors have been drinking Caipirinhas to drown their sorrows. Down the road, they could be drinking Caipirinhas to celebrate their good fortune.
The Caipirinha is the national cocktail of Brazil.
Taste and simplicity likely contribute to the Caipirinha’s ubiquity: All one needs to imbibe a basic Caipiriniha is an Old-Fashioned glass, two ounces Cachaça (distilled sugar cane juice), two tablespoons brown sugar, half a lime (cut in four wedges), and crushed ice. With that simple construct you can begin your journey into memory-hole ecstasy… or agony.
For the past three years or so, it’s been mostly agony for investors who ventured into Brazil’s perpetually emerging market. Money floods into Brazilian equities on a tide of euphoria as ferociously as the pororoca (tidal waves) flood the Amazon in late winter.
Just as ferociously, money recedes when euphoria gives way to reality. Investors hapless at navigating the roiled waters are left holding a bag of clearance-priced Brazilian stocks. Today, Brazilian issues languish – many trade at 50% to 75% discounts to their hype-driven highs.
Time to buy. It’s not as bad as the bleary-eyed pessimists would lead you to believe. Brazil, as the world’s seventh-largest economy, still has the potential to create a plenitude of wealth for its citizens, while the following three stocks have the potential to create plenitude of wealth for the intrepid income investor.
Petroleo Brasileiro SA Petrobras (Petrobras) (NYSE: PBR): 4.2% Yield
Petrobras is Brazil’s quasi-private energy giant. The company generates over $140 billion in sales annually and commands a $116-billion market cap. Petrobras shares trades at less than half of where they traded three years ago. The company has been plagued by mismanagement and outright profligacy, driven by government mandates (Brazil’s government is the largest shareholder). Operating margins have been halved over the past five years.
Petrobras is at an inflection point; it can no longer afford its politically sycophantic ways – mostly by offering below-cost petroleum products to the plebeians. The good news is that Petrobras will likely be given more control over its pricing policies after the October elections. This should enable management to raise prices and get a better hold on finances to enable margins to once again widen.
Petrobras is cheap, trading at only 0.80 times sales and 0.72 times book value. What’s more, the P/E multiple is only 7.4 based on 2015 earnings estimates. Throw in a 4.2% yield, and you’ve got the making of a worthwhile value play.
Companhia de Saneamento Basico (SABESP) (NYSE: SBS): 3.9% Yield
The name might be unpronounceable, but the business is one any investor can comprehend: SABESP provides sewage and water treatment to São Paulo’s vast population.
SABESP’s business is about as unglamorous as it gets, but imagine life without the SABESPs of the world. Better yet, don’t. Then again, SABESP’s business is also about as recession-proof as it gets. We all need to use the loo and we all need drinking water, regardless if the economy is expanding or contracting.
SABESP’s shares are trading at a 67% discount to highs achieved two years ago. The stock is out of favor due to uncertainty over rates SABESP can charge. The state is creating a new regulatory regime, and the timeline for the new regime to commence regulating is unknown.
The haze of uncertainty on pricing that engulfs SABESP today should dissipate before the end of the year. Odds favor a price hike based on passed regulator concessions. By that time, though, much of the value in SABESP shares will have been flushed away by investor buying.
Gerdau SA (NYSE: GGB): 3.3% Yield
Gerdau is an old-fashioned blast-furnace steel producer. Therefore, it’s also an old-fashioned cyclical company. Steel demand is cyclical, and the cycle has been down in recent years. Gerdau’s share price has been down as well. Its shares hover near a 52-look, and trade at about a third of where they traded three years ago.
That’s good news for value investors. The time to buy a cyclical stock is in the trough of the cycle. Gerdau is in that trough. It’s shares trade at only 0.5 times sales and 0.73 times book value.
Better yet, unlike many cyclicals, Gerdau makes money while mired in the trough. Over the past 12 months, it’s earned $0.47 a share, which translates to a 12 P/E multiple. Steel demand is expected to ramp up in the waning months of 2014, and continue ramping up through 2015. Next year, Gerdau should earn roughly $1.00 a share, which puts the forward P/E at a bargain-basement 5.7.
When earnings ramp up, Gerdau’s share price and its dividend payout will ramp up as well.
I like Brazil’s depressed equity market, but I don’t expect it to stay depressed. A year or so from now I suspect that a Caipirinha or two will be hoisted by investors who bought into today’s value proposition.
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