Wednesday, April 16, 2014
As host of the 2014 FIFA World Cup in June and the 2016 Summer Olympic Games, Brazil has increasingly become a focus for the world’s spotlight. The image the world sees is not an unblemished one. Although Brazil barely experienced recession in 2009 and its economy rebounded strongly in 2010, there has been a marked deceleration since then. We believe the large investments needed to host the FIFA World Cup and Olympics could give a much-needed infrastructural boost to the economy, but doubts have been raised with regard to the ability to complete some of these projects on time, along with safety concerns. Large-scale protests against corruption, poor or nonexistent public services, and rising living costs are also issues to contend with. While we are indeed seeing some improvements in infrastructure development in large cities, overall, the Brazilian economy’s solid fundamentals have weakened in the last couple of years. Brazilian financial assets have proved particularly vulnerable in such an environment—especially as Brazil’s growth expectations have declined, the currency has fallen heavily and the country’s current-account deficit has widened. In addition, investor confidence has weakened because of uncertainty surrounding government policy, as well as creeping interventionism and protectionism. Investment sentiment toward Brazil has not been helped by government moves to claim huge back taxes from a mining company and other large corporations. And, a ruling is pending from the country’s Supreme Court on whether to force banks to reimburse clients for losses stemming from government policies dating back more than 20 years. In our view, a ruling could have a huge impact on Brazilian banks and hurt lending activity.
Looking forward, we think the slowdown of economic activity in Brazil is likely to persist, as indicated by the latest business surveys and tightening financial conditions. Despite slowing growth in Brazil, the country’s central bank has had to raise its policy interest rate from a record low of 7.25% in 2012 to 11.0% in April of this year to deal with persistent inflation. Investors also have remained concerned about the deterioration in the country’s fiscal outlook, which culminated in Standard and Poor’s (S&P) downgrade of Brazil’s long-term debt from BBB to BBB- in March, although this sovereign downgrade risk had been expected and already priced into the market. However, although the country’s current account position has been declining, Brazil continues to record primary surpluses sufficiently large enough to stabilize Brazil’s net debt-to-gross domestic product ratio. The ratio at the end of February was much lower than those of the United States and most western European countries, although debt servicing requirements are increasing.
Despite these negative headwinds, there are potential catalysts that could provide areas of investment opportunity going forward. In our view, Brazilian currency reserves remain high relative to the country’s foreign-currency debt, and we believe the decline in the value of the Brazilian real against the US dollar will continue, which could help the current-account deficit (although we believe it will likely also feed inflation). In addition, the lagging impact of slowing growth could favor select core Brazilian bonds, and valuations are increasingly attractive. We believe the local real interest-rate curve is still above its equilibrium level due to the combination of risks hanging over fiscal sustainability and domestic economic imbalances. We believe those risks (mainly a potential overheating of domestic demand and a current account deficit of 3.69% of GDP in the 12 months through February1) are likely to diminish over the next few years due to the tightening of liquidity in the economy and increases in the tax burden, providing a potentially appealing environment for Brazilian bonds.
We also believe there is significant upside potential in terms of market sentiment. In our view, Brazil’s government is certainly aware that the policy adjustments needed to curb inflation and repair public finances would likely hurt growth in the short term, but once the October presidential election is over, we may see a policy shift toward a more market-friendly and less interventionist government. As we see it, the government has already inconspicuously started to reverse some policy excesses—such as targeting a primary surplus of 1.9% of GDP and the gradual reduction in the credit growth of public banks—and even the re-election of the current president, Dilma Rousseff, could lead to adjustments that would help restore investor confidence. The tightening of fiscal policy that we expect over the next couple of years and a decline in fiscal policy uncertainty could, we believe, lead to additional bond investment opportunities due to attractive risk premiums in the local yield curve. Brazil’s five-year local currency bond yielded 12.35%, as of April 7th, which looks compelling when compared to other local emerging or developed debt markets around the world.2For example, a five-year note in the United States yielded 1.68%, 3.16% in South Korea, and 5.1% in Mexico, as of April 7th.3 Even though Brazil’s central bank increased its 2014 inflation forecast to 6.1% from an earlier estimate of 5.7%, which we believe may surprise to the downside, Brazil continues to offer some of the highest real rates in the world.
We are also aware that the pressure exercised by social movements to improve health, education and public transport services could prove a potential boon for domestic companies in these sectors. The market has already largely priced in a depressing economic scenario for the Brazilian economy, and any improvement over these bearish expectations could lead to upside surprises in many asset classes, including select sectors and equities. And when the fiscal and political uncertainties dissipate, we believe Brazil’s strengths as the world’s third-largest food exporter and an important oil exporter could come to the fore again. Brazil also has a world-class research base in biotechnology and deep-sea hydrocarbon exploration, as well as a number of innovative domestic companies that have benefited greatly from the huge expansion of the country’s middle class in the past 20 years.
While Brazil may no longer be the darling of the emerging markets world it once was, the pessimism may now be overdone relative to fundamentals, providing opportunity for investors that may be overlooked by others.
(Source: Franklin Templeton website)
Knights Grand Cross of the Most Excellent Order of the British Empire are not made every day. Ratan Tata has just received the honour. It is another marker of the former Tata Group chairman’s role in Tata Motors’ success with the reborn Jaguar Land Rover.
Fully owned by the Indian group since it was acquired from Ford in 2008, the UK carmaker is now run by Germans, earns most of its money selling Range Rovers to China, and in many analyst models, makes up about nine-tenths of the value of each Tata Motors share. JLR is a different beast to 2008. But it will also be an expensive one to expand further. There may be one more marker to go, then. It is time Tata Motors seriously considered raising the funds required through listing part of its stake in JLR.
Consider the challenge. JLR plans effectively to double in size by the end of the decade – producing at least 700,000 lighter, more efficient, cars. Capital spending will be more than £3bn a year for the next few years, more than 10 per cent of revenue. The industry average is 8 per cent. Tata could allow this to continue, true. Margins on the flagship Range Rovers are very high. But they may not get much higher, and rival German premium carmakers have plenty of cash – and much more volume – to innovate with.
This might not convince Tata to sell a stake to the market straight away. JLR’s first Chinese plant begins production later this year: another marker to get through. However, in the long term, UK investors might prefer direct JLR exposure to running complicated sum-of-the-parts valuations on Tata Motors shares. They may even value JLR at a greater multiple than well-established BMW, if JLR’s best growth is ahead of it. If so, that would be a turnround from the last time any UK carmaker was publicly traded: Jaguar – in 1990.
Future Group is set to take over southern supermarket chain Nilgiris for Rs 150-175 crore, according to two people with direct knowledge of the deal. It has in principle agreed to acquire the stake of private equity firm Actis Capital along with the minority shareholding of the promoters in a transaction that could give Kishore Biyani led Future the extensive footprint in southern India he's been looking for.
The deal will be structured such that Future Group gains control of the 65% held by Actis and the holding of the Mudaliar family. In return, Actis will get a minority stake in Future Consumer Enterprise or FCEL, which runs the group's private brands business and grocery stores such as KB's Fair Price, Big Apple and Aadhaar, which will eventually put the total deal size at Rs 275-300 crore, according to the people cited.
FCEL includes brands such as Sach, associated with former cricketer Sachin Tendulkar, Tasty Treat, Clean Mate and others that are sold through the Big Bazaar and Food Bazaar outlets. FCEL is part of Biyani's ambition to expand the private brand business into a Rs 10,000-crore enterprise by 2018. Biyani, chief executive of Future Group, declined to comment.