The government of Brazil has once again intervened in Petrobras, the country’s largest company, in which it holds just over 50% of the voting shares (and 28.7% of the total share capital). President Lula decided to remove the company CEO Jean Paul Patres and replace him with Magda Chambriard, who seems more willing to follow the directives of a government that wants to use the company to achieve certain political goals. Any executive interference in a listed company tends not to be to the liking of the market, which fears that the interests of shareholders will be put on the back burner. Petrobras shares fell over 20% in the month following the decision, dragging heavily on the Bovespa, where it has a weight of close to 15%.
This is not the only explanation for the index’s poor performance so far this year. Lower expectations of Fed rate cuts have bolstered the US dollar, which affects countries like Brazil with significant debt in this currency.
However, it is not all dark clouds over Brazil. First quarter GDP growth was 0.8% against the expected 0.5%, raising expectations for the remainder of the year to 2.2%. The main driver of growth is expected to be private consumption, which could provide a boost to corporate profits. We are also seeing a resilient labour market, and fiscal stimulus should give impetus to the economy in the short term in 2024, which has the highest number of working days in two decades.
In addition, Brazil is in the midst of a cycle of interest rate cuts, with seven consecutive cuts to 10.50% at the time of writing, down from 13.75% last year. Out of the last six full rate cut cycles, the MSCI Brazil Index (in USD) performed positively in four of them, accumulating a 96.7% return. Just two of them were negative, with a cumulative return of 17.3%.
In terms of valuation, despite the 16.24% ROE (return on equity) and solid growth, the MSCI Brazil is trading at 7.4x earnings, compared to the 9.3x average of the last five years and the 14x of its emerging market peers. For those interested in the dividend, it offers a 6.7% return.
The escalation of government interventionism is something that certainly needs to be monitored closely, but Brazil’s economic potential is there at valuations we have not seen for some time.
Date of report: July 10th 2024