Brazil’s Weg Profit Margin Rebounds on Payroll Tax Cut

Weg SA, Brazil’s biggest maker of industrial machinery and power equipment by market value, says a payroll tax cut will ease pressure on rising labor costs, helping it to reverse a three-year drop in profit margins.

Brazil is reducing payroll taxes for manufacturers by 20 percent this month as part of a stimulus effort. Weg, which is valued at about $5.9 billion, posted a drop in earnings before interest, depreciation and amortization as a percentage of sales to 16 percent in 2011 from 23 percent in 2008. Marcopolo SA, the second-biggest industrial company, boosted margins to 14 percent from 9.8 percent.

“Even with a delay, government measures are on the right track not only for Weg but for the industry as a whole,” Chief Financial Officer Laurence Beltrao Gomes said in a telephone interview from Jaragua do Sul, Brazil, where Weg is based.

Weg’s falling margins underscore how Brazilian companies are being hurt by labor costs that Morgan Stanley says are accelerating at the fastest pace relative to benchmark inflation in a decade. Weg rose 2.2 percent this year in Sao Paulo trading before today, compared with a 6.6 percent gain for the Bloomberg Americas Machinery Diversified Index. Marcopolo surged 32 percent in the period, while Brazil’s benchmark Bovespa index fell 1.7 percent.

The company’s stock fell 10 centavos, or 0.5 percent, to 19.10 reais as of 2:10 p.m. in Sao Paulo trading.

65 Billion Reais

Brazilian Finance Minister Guido Mantega announced the cuts in payroll taxes in April as part of a stimulus package of at least 65 billion reais ($33 billion) to make local companies more competitive. Last week, the government said it would increase purchases of buses, tractors, trucks and other equipment by 6.6 billion reais by year’s end and cut the long-term reference rate for loans from the state development bank to a record low of 5.5 percent from 6 percent.

“Weg is one of the industrial companies that benefits from the government’s incentive package” as it has been affected by higher costs and price drops, said Mario Bernardes Junior, an analyst at Banco do Brasil SA, who has an equivalent to a buy rating on the stock. “The main difficulty in the industry is how to pass on the real increase in wages and costs to the consumer at the risk of losing competitiveness,” he said by telephone from Sao Paulo on June 25.

Inflation slowed to 4.99 percent in the 12 months through May from 7.31 percent in September, while services inflation decelerated to 7.59 percent from 8.54 percent in September, according to the central bank’s inflation report on June 28.

Labor Costs

“The differential between labor costs, or services inflation, and goods has never been this big,” Arthur Carvalho, Morgan Stanley’s Brazil chief economist, said in an interview June 25. “It’s likely taking place at the expense of firms’ margins.”

Weg expects sales to grow about 18 percent this year, the same rate as in 2011, Gomes said. Revenue from its engines and industrial parts business is doing well and expanded 8 percent in the first quarter from a year ago, he said. Demand for energy generation, transmission and distribution equipment has been falling, presenting a challenge for Weg, he said.

Brazilian industrial output fell in May for a third straight month, according to a government report yesterday. Production is down 3.4 percent this year.

Weg is benefiting as a weaker Brazilian real makes imports more expensive and exports more competitive, Gomes said. Brazil’s real has rallied 23 percent against the U.S. dollar in the past 12 months, the best performance of the 16 most-traded currencies tracked by Bloomberg.

Industry payrolls had a real increase of 3.4 percent in the three months through April, according to the central bank.

Growth Forecasts

President Dilma Rousseff’s efforts to shield Brazil from the global slowdown are failing. The central bank cut its forecast for economic expansion this year to 2.5 percent from 3.5 percent, while economists in a central bank survey published July 2 lowered their estimates for an eighth straight week to 2.05 percent.

“The measures help some companies, but they are not enough to change the industry outlook,” Carvalho said.

The government is “creating palliative measures that don’t address the real issue,” Pedro Galdi, chief strategist at Sao Paulo-based brokerage SLW Corretora, said in a June 28 telephone interview. “What needs to be done is invest in infrastructure, cut spending on government administration and promote reforms.”

Other measures that would help include a tax break on industry investments and simplifying the country’s “extremely complex” tax structure, Gomes said.

“The measures need some time to mature and are important,” he said.

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