By Patricia Gonzalez
Senior Analyst, Emerging Markets Equity
In the fog of domestic political and fiscal uncertainty, investors may still find Brazil equities poised to benefit from structural growth trends within their industries. While historically low valuations of Brazil equities generally provide the potential for greater upside, selection remains key.
The VanEck Emerging Markets Equity Investment Team’s recent trip to Brazil in November 2022 was a fascinating time to be in the country, particularly right after the elections. At the time, there was uncertainty concerning Lula’s fiscal policy, and the expectation was that a more centrist congress would keep the new president fiscally responsible. The news cycle coming out of the country has led to volatile market movements since our trip in November. However, the good news is that despite the political outlook, our meetings with the companies were reassuring of the positive fundamentals and forward guidance.
Brazil equities are trading at depressed valuations, given the overhang of domestic political and fiscal uncertainty cast by the new government. The external environment for emerging markets equities and global growth expectations have weighed down on Brazil’s equities. MSCI Brazil is trading at its lowest P/E multiple since 2010, and the country’s equities are trading at among the lowest P/E multiples across emerging markets.1
Brazil Equities Trading at Distressed Multiples
MSCI Brazil – Consensus 12-month forward Price to Earnings
Source: Bradesco BBI data as of 1/31/2023.
Attractive Valuations Across Emerging Markets
Source: HSBC research report as of 12/1/2022.
We believe the tide is turning for Brazil equities, and high-quality companies could benefit the most. The global scenario has been positive for emerging market equities year-to-date, with slower GDP deceleration, more resilient commodity prices, and disinflation underway. The China reopening and the higher demand for Brazil’s commodity exports are generally positive for Brazil’s currency (BRL) and equities.
Brazil appears to be ahead in its disinflation process compared to developed economies. The central bank could maintain the Selic rate at 13.75% for most of 2023 and start easing by the end of this year. The country’s challenge is to put a new fiscal framework that stabilizes and reduces the public debt-to-GDP ratio over time. Finance minister Hadad’s economic measures to reduce the primary fiscal deficit for 2023 in half from the expected 46 billion or 2.1% of GDP to $20 billion or 1% of GDP appears to be a net positive for the stock market.2 These factors appear to be a positive tailwind for Brazil equities, and a possible BRL appreciation could add to the real rates of return for international investors.
We are particularly excited about the prospects of structural growth opportunities for companies in our portfolio that appear to benefit from improving the valuation of Brazilian equities. We want to highlight Vamos and Rede D’Or as both companies are leaders in their respective industries and command a sizeable market share.
Vamos: Brazil’s Leading Truck and Equipment Rental Company with Growth Potential and High Profitability
The company is Brazil’s leader in truck, machinery, and equipment rental. Vamos is the most significant player commanding 80% of the market share in its industry. It also benefits from scale, as it is twice as large as its closest competitor and offers a Return on Invested Capital (ROIC) of 16%. We believe the company provides a great combination of growth and profitability. The market for truck rentals in Brazil is underpenetrated at only 0.6% of the size of the United States market. It could grow significantly; to put it in context, it is 20x larger in the U.S. than in Brazil.
The company’s large scale allows it to purchase the trucks at a big discount from the original equipment manufacturer, enabling high profitability rates. The revenue stream is pretty steady, with long-term contracts of at least 5 years in place. In addition, the average fleet in Brazil is approximately 20 years old, making it a good market for truck rentals and sales as the fleet needs to be replaced. We believe the current macro situation and the higher price of new trucks are favorable for the Vamos. Most customers are postponing the decision to buy new trucks and are considering rentals as an alternative. Vamos is trading at 16.6X P/E 2023 and 12x P/E 2024, a 17% discount below historical averages and below leading car rental company Localiza despite having higher growth (>40%) and higher profitability.
Rede D’Or: Brazil’s Leading Hospital Operator Poised for Growth and Consolidation
The company is the largest hospital operator in Brazil, with over 50 hospitals, and focuses on the premium segment. The healthcare market in Brazil is very fragmented, with many players struggling to survive, especially due to the pandemic. Rede D’Or is a solid player with extensive knowledge, scale, and a strong balance sheet. Rede D’Or has been a market consolidator and currently has a 15% industry market share. The company could double that market share over the next few years. It has a strong record of accomplishment and has one of the best management teams in the industry.
Rede D’Or was founded 20 years ago and since then has completed 39 acquisitions, all doing better than expected. Most of the acquisitions have been successful and accretive, and the company has increased margins in every hospital it operates. Currently, Brazil has 2 beds per 1,000 habitants, but the government guideline is to have 5 beds per 1,000 inhabitants. There is an opportunity for growth, and Rede D’Or is well-positioned to capture that growth. We believe 2023 could be a good year for the company driven by higher price adjustments, organic growth, M&A opportunities, and scale. RedeD’Or is trading at 24.8x P/E 2023 and 16.8x 2024, which is attractive given the strong earnings and growth prospects (with a 3-year CAGR of ~40%) for the company.
Despite Brazil’s fiscal and macro overhang, our portfolio companies may benefit from the structural growth trends presented in their respective industries. While selectivity remains key, we believe Brazilian equities look attractive at current valuations. Our trip to Brazil reaffirmed our conviction in our investee companies, and we expect valuations for our portfolio companies to be steady or even rise from here.
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1 Sources: Bradesco BBI and HSBC research reports 1/31/2023.
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The MSCI Brazil Index is designed to measure the performance of the large and mid cap segments of the Brazilian market. With 48 constituents, the index covers about 85% of the Brazilian equity universe.
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