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TRAVEL REPORT - MARS 2020 Brazil€¦ · TRAVEL REPORT - MARS 2020 Brazil Long and winding road to...
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TRAVEL REPORT - MARS 2020 Brazil Long and winding road to recovery! We just came back from Brazil where we spent a whole week visiting companies on the ground in Sao Paulo and Rio de Janeiro and participating at the BTG Pactual conference, a great annual event for Brazil investors. In total, we met more than twenty companies from different sectors over one week including health plan providers Hapvida and Notre Dame Intermedica, financial group BTG Pactual and its subsidiary Banco Pan, dominant stock exchange operator Brasil Bolsa Balcäo (B3), largest online brokerage platform XP, specialty retail operators Lojas Renner, Arezzo, Magazine Luiza (e- commerce leader), CVC and BR Distribuidora, software editors Linx and Totvs, fintech groups Stone and PagSeguro, private education groups Afya and Cogna (ex. Kroton), highway concession companies CCR and EcoRodovias, privately held logistic companies Sequoia and Vamos (the latter will soon list publicly), dominant oil major Petrobras and iron ore key player Vale. At time of our visit, Brazilian business leaders with whom we spoke felt little concerned with the risk of Covid-19 epidemic; Vale was the only exception as a result of its China dependent business. On the economic front, they applauded the progress achieved by the government under the leadership of Jair Bolsonaro and Paulo Guedes and felt confident in the long-awaited economic recovery, driven by domestic demand. Lojas Renner, Arezzo and CVC have all observed improved consumer confidence. However, some of them worry about potential slowdown in the pace of structural reforms. The adoption of the pension reform last year is an important step but there is no guarantee of future success. Some of the upcoming reforms are complex in nature (eg. Tax reform), the tension between executive and congress is hardly a secret to anyone and municipal election in October makes Congressional calendar shorter. We came back reassured by the messages from the private sector. However, the political dimension seems difficult to apprehend and we don’t expect meaningful recovery before the second half of 2020. MACRO FOCUS Exceptional decline in inflation, interest rates and currency The Brazilian Real suffered sharp devaluation during the period of 2017-19: it dropped from 3.27 to 4.03 against USD, recording a 23% decline! Year to date, the correction has further accelerated, and the 20% decline makes the BRL the worst emerging markets currency of the year. This sharp correction could be first explained by successive cuts of interest rates as a result of expansionary monetary cycle initiated by Brazilian Central Bank (BCB) in the hope to restore economic growth. As a reminder, the benchmark Selic rate has dropped from 12.25% in 2017 to 4.25% as of today, a record low. Although the monetary policy committee (Copom) has signalled its intention to suspend cuts early February, the threat of coronavirus pandemic is pushing BCB to continue with further monetary easing and opens the door to further interest rates cuts. With inflation forecast at 3.25% (BCB projects 4%), Brazil’s real interest rates have never been so low! As a result, BRL has lost its historical status of high yielding currency and no longer appeals to “carry trade” investors. Another explication could be the growing scepticism of investors regarding the expected economic recovery. After 2 years of disappointment (forecast GDP growth at 2.5 to 3% in the beginning of the year vs. real growth at 1.3% for 2018 and 1.1% for 2019), the economic recovery is still tepid. Several indicators have turned weaker than expected: such is the case of current account deficit that increased in January (2.9% of GDP vs. 2.7% in December) or lower investments in 4Q19 (-3.3% qoq). On top of this, the growing threat of COVID-19 could affect export activities as well as the domestic economy (77 infection cases as of 12 March). In the current context where world economic growth has downside risks, BRL joins other commodity currencies and oil all suffering strong correction. Since the beginning of the year, the Russian Ruble is down 17% against USD, the South African Rand is down 15% and the Chilean Peso down 12%. Although we have little visibility on the recovery of the currency, we believe the correction has been excessive and current level (USD/BRL at 4.92) shall not be far from the bottom. On the macro front, Brazilian economy could generate better growth this year driven by domestic demand. On one hand, access to credit has been improved and job creation is in the right direction. Despite a still high unemployment rate, 39M jobs have been added to the formal sector in 2019, which is the highest level since 2013. On the other hand, this improved outlook and favorable monetary environment could encourage private investment. This scenario would change investors perception on the BRL: from a high yielding currency to neutral, and eventually to a growth currency!
Transcript of TRAVEL REPORT - MARS 2020 Brazil€¦ · TRAVEL REPORT - MARS 2020 Brazil Long and winding road to...
TRAVEL REPORT - MARS 2020
BrazilLong and winding road to recovery!
We just came back from Brazil where we spent a whole week visiting companies on the ground in Sao Paulo and Riode Janeiro and participating at the BTG Pactual conference, a great annual event for Brazil investors.
In total, we met more than twenty companies from different sectors over oneweek including health plan providers Hapvida and Notre DameIntermedica, financial groupBTG Pactual and itssubsidiary Banco Pan,dominant stock exchangeoperator Brasil Bolsa Balcäo(B3), largest online brokerageplatform XP, specialty retailoperators Lojas Renner,Arezzo, Magazine Luiza (e-commerce leader), CVC and BRDistribuidora, softwareeditors Linx and Totvs, fintech groups Stone and PagSeguro, privateeducation groups Afya and Cogna (ex. Kroton), highway concession
companies CCR and EcoRodovias, privately held logistic companies Sequoia and Vamos (the latter will soon list publicly), dominant oil major Petrobrasand iron ore key player Vale.
At time of our visit, Brazilian business leaders with whom we spoke felt little concerned with the risk of Covid-19 epidemic; Vale was the only exception as aresult of its China dependent business. On the economic front, they applauded the progress achieved by the government under the leadership of Jair Bolsonaroand Paulo Guedes and felt confident in the long-awaited economic recovery, driven by domestic demand. Lojas Renner, Arezzo and CVC have all observedimproved consumer confidence. However, some of them worry about potential slowdown in the pace of structural reforms. The adoption of the pension reformlast year is an important step but there is no guarantee of future success. Some of the upcoming reforms are complex in nature (eg. Tax reform), the tensionbetween executive and congress is hardly a secret to anyone and municipal election in October makes Congressional calendar shorter. We came backreassured by the messages from the private sector. However, the political dimension seems difficult to apprehend and we don’t expect meaningful recoverybefore the second half of 2020.
MACRO FOCUSExceptional decline in inflation, interest rates and currencyThe Brazilian Real suffered sharp devaluation during the period of 2017-19: it dropped from 3.27 to 4.03 against USD, recording a 23% decline! Year to date,the correction has further accelerated, and the 20% decline makes the BRL the worst emerging markets currency of the year. This sharp correction could befirst explained by successive cuts of interest rates as a result of expansionary monetary cycleinitiated by Brazilian Central Bank (BCB) in the hope to restore economic growth. As areminder, the benchmark Selic rate has dropped from 12.25% in 2017 to 4.25% as of today, arecord low. Although the monetary policy committee (Copom) has signalled its intention tosuspend cuts early February, the threat of coronavirus pandemic is pushing BCB to continuewith further monetary easing and opens the door to further interest rates cuts. With inflationforecast at 3.25% (BCB projects 4%), Brazil’s real interest rates have never been so low! As aresult, BRL has lost its historical status of high yielding currency and no longer appeals to“carry trade” investors.Another explication could be the growing scepticism of investors regarding the expectedeconomic recovery. After 2 years of disappointment (forecast GDP growth at 2.5 to 3% in thebeginning of the year vs. real growth at 1.3% for 2018 and 1.1% for 2019), the economicrecovery is still tepid. Several indicators have turned weaker than expected: such is the caseof current account deficit that increased in January (2.9% of GDP vs. 2.7% in December) orlower investments in 4Q19 (-3.3% qoq). On top of this, the growing threat of COVID-19 couldaffect export activities as well as the domestic economy (77 infection cases as of 12 March).In the current context where world economic growth has downside risks, BRL joins othercommodity currencies and oil all suffering strong correction. Since the beginning of the year, the Russian Ruble is down 17% against USD, the South AfricanRand is down 15% and the Chilean Peso down 12%.Although we have little visibility on the recovery of the currency, we believe the correction has been excessive and current level (USD/BRL at 4.92) shall not befar from the bottom. On the macro front, Brazilian economy could generate better growth this year driven by domestic demand. On one hand, access to credithas been improved and job creation is in the right direction. Despite a still high unemployment rate, 39M jobs have been added to the formal sector in 2019,which is the highest level since 2013. On the other hand, this improved outlook and favorable monetary environment could encourage private investment. Thisscenario would change investors perception on the BRL: from a high yielding currency to neutral, and eventually to a growth currency!
TRAVEL NOTE - MARS 2020
STOCK FOCUSHapvida (Sales of $1.8bn, market capitalisation of $7bn) Notre Dame Intermedica (Sales of $2.4bn, market capitalisation of $5.3bn) We have met both Hapvida and Notre Dame Intermedica, two of the leading private healthcare planproviders in Brazil. With a 25% penetration rate, the private sector is still underdeveloped. It has been affectedby the economic recession since 2014 as the system is mostly financed by corporates. The sector is also underhuge cost pressure as a result of strong and recurrent medical cost inflation (17-18% pa). However, as a resultof poor public services (due to budget constraint), the development of a private alternative is inevitable. In thisenvironment, large vertically integrated groups such as Hapvida and Notre Dame that operate low-costbusiness models and own healthcare facilities have important competitive advantages. They can face both highmedical inflation and low reliability of third-party hospitals (30% more expensive because of volume-basedbilling system). Despite of the economic downturn in the past years, these two groups generate strong growththanks to market consolidation (780 players in 2017 vs. 1200 in 2007). Should there be economic recovery andsubsequent job creation, they are well positioned to accelerate their organic growth.Created in 1979, Hapvida offers healthcare plans (2.2M members) and dental plans (1.7M) to both corporate andindividual clients. The group is controlled by the founding family (70%) and operates a vertically integrated
business model since 2004. Through its network of 40 hospitals (2500 beds), 42emergency centres, 160 clinics and 141 diagnostic units, Hapvida is almost self-sufficient (93%). The group has a low medical loss ratio of 62% vs. sectoraverage of 81%. Historically dominant in the North and North East regions (24%and 30% of ms respectively), Hapvida has accelerated its development in newregions through recent acquisitions of Sao Francisco and Grupo America. Theseoperations are interesting as they bring both growth (1M new members) andsynergies but the group still needs to prove its capacity in terms of integrationin new regions. As of Notre Dame Intermedica, a competitor controlled by
Bain Capital (20%), the group is vertically integrated at 71% and also has a lower than sector average medicalloss ratio (75%). As a dominant player in the state of Sao Paulo (15% ms), Notre Dame has higher exposure tocorporate clients (95% of its members vs. 73% for Hapvida), an attractive segment thanks to a less strictregulatory requirement (flexible pricing, possibility to end non profitable contracts).Regarding their financials, both groups have strong balance sheet and enjoy net cash position. Notre Dametrades at a 2020 PER of 29x and EV/EBITDA of 14x vs. 27x and 15x respectively for Hapvida justified by higher historical growth. However, the consensus couldunderestimate the earning growth of Hapvida (estimated at 19% this year and 29% in 2021) as its synergies with Sao Francisco could be greater thanexpected.
STOCK FOCUSStock Focus: BTG Pactual (Revenue of $2bn, market capitalisation of $6bn, 0.8% of GemEquity)The financial group BTG Pactual was created in 1983 in Rio de Janeiro. It has been weakened by the economic recession and alleged charges against itsformer President, André Esteves for his involvement in the “Lava Jato” scandal (acquitted in 2018), the bank nicknamed “Better Than Goldman - BTG” is back in
full force, helped by a better macro environment and motivated employees (who controls 76.5% of the bank through ameritocratic partnership). At our meeting in Sao Paulo, President Roberto Sallouti expected the Brazilian economic recoveryto accelerate and all bank activities to benefit.At first, investment banking division should continue to outperform. The number of IPOs in 2020 should be at least asnumerous as last year although 2019 was a year of record. The growth of corporate lending should accelerate to reflect
better business climate with same credit quality. Increased transaction volumes at Brazilian financial markets arein favour of its sales & trading division. The group has also made progress in asset management division thanks to
the digitalization of its platform and market share gain vis-à-vis universal banks. As to the development of BTG Digital,the retail investors dedicated trading and online wealthmanagement platform, management remained discreet forcompetitive reasons. However, “all the operating objectivesfor 2019” have been achieved. It is also interesting topinpoint that XP, one of the rare competitors of BTG Digitallisted in December 2019 has already a market capitalizationof $10bn!After its recent correction, the share trades at 2020 PER of7x and P/B of 1.3x. The bank is sufficiently capitalized: itsTier 1 Capital ratio is at 12%. Its ROE is at 18% withpotential upside but BTG prefers to give priority to
investment (2% of ROE, mostly for BTG Digital). Ariel Wang
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