Below are some highlights from a recent research trip to Brazil where I attended the JP Morgan LatAm Conference.
Technically, Brazil is almost in a recession and the consumption environment has been a challenge with retailers continuing to see sluggish sales in the beginning of Q3. In general, the tone at the conference was cautious regarding the consumption level in South America over the next 12 months. Real wage gain is getting squeezed, currently at 2% and decreasing in Brazil. The consumer is still deleveraging from big ticket spending last year (e.g. cars, white goods). The common themes that came out of this conference were top line and lower operating leverage/margin pressure, smaller real wage increase, decreased pressure on margin from the labour force, cost cutting/restructuration initiatives, and flat capital expenditure in 2015.
JK Iguatemi, high end mall, Sao Paulo, Brazil
For domestic consumer product companies, no acceleration of volume is expected for the second half of 2014 and volumes growth remains fine, as long as the pricing is in line with inflation. Commodity cost remains benign in 2015 (e.g. sugar, grain). Discretionary retailers (e.g. durable goods, apparel) remain cautious over the next 6-12 months. In contrast, exporters of meat and protein remain upbeat because their exports are mainly in U.S. dollars. Furthermore, with new export openings in China and Russia, Brazil should finally benefit from benign grain costs over the next year.
Arezzo, shoes retailer chain, Sao Paulo, Brazil
Retail sales are -1% and are expected to remain consistent throughout the year due to inflationary and unemployment pressure. In general, online retail sales growth is accelerating at 20-30%, mainly in urban centers. The two leaders in this space are B2W and Via Varejo. There isn’t a strong Amazon presence at the moment. Most of the retailers have just begun to sell online over the past two to three years.
Lojas Renner, Brazil’s largest department store chain, Sao Paulo, Brazil
The country needs to rebalance its taxation system between sectors and regions by implementing a common tax (i.e. VAT). According to the company that I met with, taxes are increasing for corporations in Brazil. In terms of reform, infrastructure is the most important followed by rail, highway, ports, and airports. This will be financed by the Brazilian Development Bank (BNDS) and the local and foreign private sector. BNDS is lending (subsidizing) companies/projects at 6% versus the Sistema Especial de Liquidação e Custodia (Special Clearance and Escrow System) (SELIC) at 11%. Finally, the new government could propose less intervention from the BNDS in the future.
Hering specialty apparel store chain, Sao Paulo, Brazil
Despite the past four years of disappointingly low growth, inflation kept creeping higher. Headline inflation would be roughly 130-200 basis points higher (depending on the exchange rate) if not due to the distortions from the current administration’s decision not to allow upward adjustments in electricity tariffs, bus fares, and fuel prices. This means, while facing a weakening labour market, the next administration will face higher inflation. The real challenge is core inflation which remains elevated, close to 6.5%. The actual drought should be negative for food prices with utilities potentially going higher following the next election, according to the opinions expressed at the conference. Regarding foreign exchange, most of the companies that I met at the conference are working with a devaluation of the Brazilian Real to levels between $2.30 and $2.40 in U.S. dollars over the next 12-18 months.
Puntofrio electronic store (owned by Via Varejo), Sao Paulo, Brazil
Some Brazilian companies that I met with during the conference mentioned that they had started to lay off staff for the first time in a decade. Layoffs occurred at the manufacturing facilities in Manaus (north west of Brazil) due to weaker sales and economic activities. Some retailers started layoffs in the first two quarters of 2014 by cutting salespeople on the floor. At 4.9% the unemployment rate can only trade up. Over the past 12 months provincial and municipal governments have been hiring people. A higher unemployment rate should be positive on company margin as it has been one of the principal sources of margin pressure over the past three years.
Drogasil pharmacy store chain, Sao Paulo, Brazil
In Brazil real estate activities remain slow while interest rates (SELIC) at 11% remains high for consumers and promoters, who are finding it more difficult to get financing from banks. The homebuilders, in its Q2 2014 results, mentioned that they continue to be in a cautious mode. With weak sales growth (12.8% on average vs. 21% in Q2 2013), rising inventories (17 months of sale vs. 15 months in Q1 2014 and 13 months in Q2 2013) and heightened risk of price cuts, it is no surprise that homebuilders are holding back on launches and reviewing their plans for the year. The secondary market is also unexciting, with its downward trend continuing (-33% year over year). Regarding the retailer, most of them have confirmed that square footage growth should at least remain the same or decelerate over the next 12 months due to the weaker economic environment.
Extra Hypermarket store (owned by Pao Acucar, Brazil’s largest supermarket chain), Sao Paulo, Brazil
On the election front, the first round should occur in the first week of October and the second round should occur in the last week of October. The three main candidates include: the current President, Dilma Rousseff (Worker Party) who is supported by the rural population along with classes C, D, and E (roughly 55% of the population); ex-Senator Aecio Neves of Minas Gerais (PSDB) of the Brazilian Social Democracy who is supported by the middle and upper classes along with the financial community Party (PSDB); and finally, Marina Silva from the Brazilian Socialist Party (PSB). Dilma Roussef is viewed as not delivering the reform promises over the past four years. Her main opponent Marina Silva, who was the minister of the environment under Lula, is a pro-environment and is supported by the intellectual and pro-environmental groups. The main challenge for any of the candidates will be to implement reforms.
Other South American countries
Most of the companies that I met with mentioned that, over the past six months, they have started to see slowness in Chile (tax reform), Peru and Argentina (hyperinflation). At the moment, Colombia seems to be immune.