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 Last month's article on "The risks and rewards of investing in Brazil" asked the question "Is now the time to invest in Brazil?" while explaining some of the risks which investors need to be aware of. Over the last month, despite continued growth prospects for the Brazilian economy, some of those risks I mentioned have reared their ugly heads, notably exchange rate risk.
Indeed, some blame the strength of the Brazilian real against the U.S. dollar for the 11.4% decline of the Bovespa, São Paulo's stock exchange, over the past 30 days. During this time, the Brazilian real strengthened 5.34% against the dollar, with one dollar now fetching only 2.62 reals, down from 2.75 last month.
This is not good news for Brazilian exporters, as a strong currency translates into higher prices for its exports, making it more expensive for countries wishing to import their products. Some analysts also point out that a weakening U.S. dollar is leading to interest rate increases in the U.S. in order to entice more capital given a weakening currency.
This has caused investors to shift assets out of developing country markets like Brazil and into safer, increasing-yield havens like the U.S. So how has recent volatility in exchange rates effected some specific Brazilian companies?
Among the blue chip Brazilian ADRs most severely impacted by exchange rate risk are the exporters, such as steel giant Companhia Siderúrgica Nacional, mini-mill steel producer Gerdau S.A., mining giant Companhia Vale do Rio Doce, and Brazilian state run oil company Petrobras, Petróleo Brasileiro.
By now, most of you have heard of China's insatiable demand for steel, a key ingredient needed to transform the infrastructure of their booming economy. Recently, however, some analysts are pointing to signs of weakening domestic steel demand (and prices) combined with a slowing in exports caused by a tax change, which has led to a sell-off in the steel sector.
Yet if you believe China's soaring demand for steel will continue, you may want to look at Companhia Siderúrgica Nacional (CSN), also known as National Steel Company. CSN is a vertically integrated company that produces a range of value-added steel products, including slabs, hot and cold-rolled coils and sheets for the distribution, packaging, automotive, home appliance and construction industries.
National Steel also runs its own iron ore, limestone and dolomite mines, and has also made strategic investments in railroads and power supply companies. The Company's products are sold both in Brazil and abroad as a main raw material for several different manufacturing industries, including the automotive, home appliance, packaging, construction and steel processing industries.
At a recent US$ 20, CSN (nyse: SID) trades at a low 6.9 times estimated 2005 earnings. Analysts warn, however, that weaker steel prices at a time of surging prices for inputs, such as coking coal and power, have caused recent nervousness in the steel industry, fueling concerns of overcapacity.
Another play in the steel sector is Brazilian steel producer Gerdau SA. Gerdau is engaged in the production of crude steel and related products based on the mini-mill concept, whereby steel is produced in electric arc furnaces from scrap and pig iron.
The Company manufactures steel products for use in civil constructions, manufacturing and agribusiness, as well as specialty steel products. Gerdau operates in Brazil, the United States, Canada, Chile, Argentina and Uruguay.
At a recent US$ 14, Gerdau (nyse: GGB) trades at an incredibly low 5.4 times estimated 2005 earnings, despite analysts (as surveyed by Thomson Financial) expecting Gerdau's earnings to fall 40% over the next year.
Another related sector effected by exchange rate risk is the mining sector. Again, rising demand from China - expected to import about 250 million tons of iron ore, up from 208 million in 2004 - coupled with rising commodity prices, is expected to benefit Brazilian mining giant Companhia Vale do Rio Doce SA, or CVRD.
CVRD, the world's biggest iron ore miner, is flush with cash thanks to surging demand and high prices for iron, the main ingredient for making steel. CVRD recently won increases from several major steel manufacturers of over 70% for its iron ore.
To take advantage of these higher commodity prices, CVRD is looking to increase investment in production of iron ore, copper, nickel and coal by more than 50%, and improve its delivery system to move more metal to ports and ship faster.
This past week, CVRD's share price slumped following a fall in world base metals prices, which left investors wondering whether the bull run in metals was nearing its end. At a recent US$ 27, CVRD (nyse: RIO) trades at a mere 6.8 times estimated 2005 earnings.
Analysts caution investors that even with higher iron ore prices, weakening steel demand and overcapacity could diminish volumes sold to steelmakers, negatively effecting revenues. And a stronger real against the dollar is seen as negative for CVRD because it reduces the company's export revenue.
Turning now to the oil and gas sector, should oil prices remain high due to ongoing geopolitical turmoil in oil-producing nations, Petróleo Brasileiro S.A. (Petrobras), Brazil's national oil company, may reap some share price appreciation.
Petrobras is engaged in the exploration and production of oil and gas in international locations, with the significant international operations in other Latin American countries. After several years of mild production growth, Petrobras has put some new platforms in place and some analysts expect oil production to grow substantially over the next few years.
At a recent US$ 41, Petrobras (nyse: PBR) trades at a still low 8.8 times estimated 2005 earnings. Although Petrobras revenues are in U.S. dollars, the ADRs still face exchange rate risk should the real continue to strengthen against the dollar, as investors may continue to shift out of emerging market equities and into fixed income investments in more developed countries.
Confused? Well, you should be, given the variety of short-term factors which can impact upon a company's share price. Daytraders will need to track the markets every hour, but if you are a long-term believer in "the country of the future", take into consideration the long-term prospects for the real against the dollar, the long term demand for steel and minerals from China, and the long term outlook for oil.
Next week, we'll take a look at Brazil's airline sector, reviewing prospects for Brazil's largest aircraft manufacturer Embraer-Empresa Brasileira de Aeronáutica S.A., and GOL Linhas Aéreas Inteligentes S.A, Brazil's low-fare, low-cost airline.
All information and content herein is furnished "as is" without warranty of any kind, express or implied, including but not limited to implied warranties of merchantability, fitness for a particular purpose, or non-infringement of third party rights. In no event will the author or his affiliates be liable for any damages, including without limitation direct or indirect, special, incidental, or consequential damages, losses or expenses arising in connection with this article. The author does not own positions in any of the above-mentioned securities.
Questions and comments to Gary Sands, the author, may be sent to sandsgary@yahoo.com.
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Gary Sands
Another Neo Con propaganda Cyborg
Any market has some risk
Brazil right now look much better then the US Stock market.