Brazilian Stocks Squeezed by Rousseff as Valuations Increase

Brazilian President Dilma Rousseff
Dilma Rousseff, Brazil's president. Photographer: Jonathan Ernst/Bloomberg

Brazilian President Dilma Rousseff’s efforts to improve the lives of her 200 million citizens are coming at the expense of the nation’s biggest companies, causing profits to drop 52 percent, doubling stock market valuations and sending international investors to the exit.

Foreign money managers sold a net $2.6 billion of equities in the past two months, the biggest outflows since Lehman Brothers Holdings Inc.’s collapse in 2008, according to data compiled by BM&FBovespa SA and Bloomberg. The benchmark stock index’s price-earnings ratio jumped to 19 from 9 in September 2011 and reached a 36 percent premium versus the MSCI All-Country World Index, the biggest gap in nine years.

Rousseff hasn’t persuaded investors that her decisions to cut electricity rates, reduce consumer borrowing costs, cap fuel prices and increase competition in the mobile-phone industry will get Latin America’s biggest economy expanding fast enough to lift equities. While price-earnings ratios usually climb as growing investor confidence boosts stocks, Brazilian valuations increased because profits fell at the fastest pace since 2002.

Government intervention “clouds the earnings outlook for industries such as utilities, telecom and finance,” Phil Langham, who manages the $1.4 billion RBC Emerging Markets Equity Fund from London and holds fewer Brazilian shares than are represented in benchmark indexes, said in a Nov. 1 phone interview. “This has been an interventionist government and that’s unlikely to change.”

BRIC Stocks

Valuations in Brazil surpassed those of Russia, India and China this year for the first time since 2003, when Rousseff’s mentor Luiz Inacio Lula da Silva won the presidency. Share prices surged that year as Lula curbed the budget deficit and kept up payments on the government’s overseas debt, instead of defaulting as some investors had predicted.

Rousseff’s policies have failed to impress shareholders. The Bovespa Index has fallen 17 percent since she took office in January 2011, compared with a 1.9 percent drop for the MSCI All-Country index. The Brazilian gauge rose 1.1 percent this year, while the MSCI measure gained 8.4 percent.

The Bovespa fell 0.5 percent to 57,064.31 at the close of trading in Sao Paulo.

Shares of utilities, including Centrais Eletricas Brasileiras SA and Cia. Energetica de Minas Gerais, were among the biggest losers in the Brazilian benchmark index since Sept. 6, falling at least 27 percent as Rousseff announced plans to cut electricity rates to reduce customers’ costs and make Brazilian companies more competitive.

Bank Rates

Telefonica Brasil SA and Tim Participacoes SA, the nation’s biggest wireless providers by subscribers, have declined at least 3.3 percent since July 18 as regulators temporarily banned sales of mobile-phone plans by some carriers and approved new rules designed to increase competition.

State-controlled Banco do Brasil SA has dropped 16 percent since Sept. 6, when Rousseff said in a nationally-televised speech she “won’t rest” until banks cut consumer borrowing costs. Petroleo Brasileiro SA, the government-run crude producer, has been the worst performer among the world’s 20 biggest oil and gas companies during the past two years as policy makers capped fuel prices to curb inflation.

Energy and raw-materials producers, financial firms, telecommunications companies and utilities have a combined weighting of about 70 percent in the Bovespa index, according to data compiled by Bloomberg. Consumer-related stocks comprise about 23 percent.

Harsh Treatment

“There’s an increasing willingness of the government to become more involved in a lot of these companies,” Nick Robinson, who helps manage $15 billion in Latin American shares at Aberdeen Asset Management, said in an Oct. 9 interview at Bloomberg headquarters in New York. “It’s been a bit more harsh in the way it treats Petrobras, and more recently with banks and the utilities sector, doing these top down pronouncements on companies to change the way they do business.”

Officials from Brazil’s presidential office and the Ministry of Mines and Energy, who asked not to be identified citing government policy, declined to comment on recent interventions.

Sales of Bovespa-traded stocks and equity-linked securities, including exchange-traded funds and options, by overseas investors in September and October were the biggest since the two months ended November 2008. Emerging-market equity funds tracked by Cambridge, Massachusetts-based EPFR Global attracted about $10 billion during the same period. Mexican stock funds had inflows of $179 million, according to EPFR.

Rebound Forecast

“You’ve had a very, very sharp and sustained decline in earnings in Brazil,” Geoffrey Dennis, an emerging-market equity strategist at Citigroup Inc. in New York, said in an Oct. 30 phone interview. “Government policy may help the economy, but it’s very confusing to foreign investors.”

Brazil’s domestic stock funds recorded inflows of 5.08 billion reais ($2.5 billion) this year through October, according to the nation’s capital-markets association, known as Anbima. That compares with outflows of 1.3 billion reais for the same period last year, according to data compiled by Anbima.

Earnings in Brazil will probably rise as much as 25 percent next year as record-low interest rates boost economic growth and raw-materials companies such as Vale SA benefit from a recovery in Chinese demand, Gabriel Wallach, the chief investment officer for global emerging markets equities at BNP Paribas Investment Partners in Boston, said in an e-mail on Nov. 2.

Stimulus Boost

Brazil’s central bank has cut the benchmark Selic interest-rate by 3.75 percentage points this year, the most among the world’s 20 biggest economies, to 7.25 percent. Economists surveyed by the central bank on Nov. 1 predicted growth will accelerate to 4 percent in 2013 from an annual rate of 1.54 percent this year.

“These apparent expensive multiples are caused by weak results, and with the economic recovery, profits will grow significantly,” Carlos Firetti, the head of equity research at Bradesco BBI in Sao Paulo, said in a phone interview on Nov. 5. “Considering the stimulus the economy got -- on the fiscal and monetary sides, interest rate reduction, credit expansion -- I think it would be hard not to see the economy getting stronger, and that is a driver for stocks.”

Earnings per share in the Bovespa will probably jump 30 percent in 2013, led by companies tied to the local economy, Firetti said.

Rousseff’s efforts to increase Brazilians’ spending power have helped boost earnings at consumer-related companies.

Relative Value

Lojas Renner SA, Brazil’s biggest clothing retailer, posted a 20 percent profit increase last quarter and analysts surveyed by Bloomberg predict earnings at the Porto Alegre-based company will climb more than 20 percent next year.

A 30 percent earnings increase for companies in the Bovespa index still wouldn’t be enough to reduce the gauge’s price-earnings ratio to its historical mean. The 68-stock Bovespa trades at a 39 percent premium versus its five-year average multiple of 14, according to data compiled by Bloomberg.

The Bovespa was valued at a 29 percent premium versus the MSCI All-Country World index on Nov. 9. The gap hit a nine-year high of 36 percent on Oct. 15.

The Brazilian index’s multiple of 19 times trailing earnings compares with 16 for the BSE India Sensitive Index, 11 for the Shanghai Composite Index and 5.8 for Russia’s Micex Index, according to data compiled by Bloomberg. Brazilian equity valuations are higher than all the world’s biggest markets except for Japan and Switzerland.

Petrobras Earnings

“Profitability has deteriorated quite significantly in comparison to other emerging markets,” Jonathan Garner, the chief Asia and emerging-market strategist at Morgan Stanley in Hong Kong, said in an Oct. 29 phone interview. Garner said he prefers shares in China and Russia to those in Brazil.

Earnings have declined during the past year for all 10 Brazilian industry gauges compiled by MSCI Inc. except for technology companies as economic growth slowed to a 0.5 percent annual pace in the second quarter from 3.3 percent a year earlier. Profits at energy companies sank 68 percent for the biggest drop.

More than 60 percent of companies in the Bovespa index that reported quarterly earnings since the end of September have trailed analysts’ estimates, the biggest proportion among benchmark equity gauges in the world’s biggest markets after India’s Sensex, according to data compiled by Bloomberg. Third-quarter profits at Bovespa companies have declined 19 percent, versus a 1.9 percent increase in the MSCI All-Country index, the data show.

Political Influence

Petrobras, as the Rio de Janeiro-based oil producer is known, posted its first quarterly loss since 1999 in the three months ended June and reported third-quarter earnings that trailed analysts’ estimates. The company sells imported fuel at a loss because the government sets domestic prices artificially low and local refineries can’t meet demand.

Petrobras is valued at 15 times reported earnings, a 36 percent premium over the MSCI All-Country World Energy Index, according to data compiled by Bloomberg. The stock has traded at an average discount of 27 percent during the past decade.

“Their recent results were horrible,” Jim Chanos, who oversees about $6 billion as the founder and president at Kynikos Associates Ltd., said in an interview at Bloomberg headquarters in New York on Nov. 2. “Prices are kept low for the consumers. That is a political decision that is hurting the company’s shareholders.”

Chanos, the short seller known for betting against Enron Corp. before the company collapsed in 2001, said he’s wagering on declines in shares of both Petrobras and Vale.

‘Civil Levels’

Eletrobras, as South America’s largest generator is known, has tumbled 27 percent in Sao Paulo trading since Rousseff unveiled measures to cut power rates by as much as 28 percent. Analysts have reduced 2013 earnings estimates for the Rio de Janeiro-based company by about 28 percent since the announcement and now expect profits to fall 13 percent from this year’s level.

Banco do Brasil has lowered consumer borrowing costs and fees, steps that Rousseff said in September would reduce lenders’ profits to “civil levels.”

Brazilian consumers paid an average of 35.6 percent on loans annually in August, down from 46.2 percent a year earlier, according to data compiled by the central bank. Consumer rates in the U.S. declined to 8.06 percent in August from 11.39 percent a year earlier, according to

Banco do Brasil’s adjusted return on equity, a measure of profitability, declined to 18.1 percent in the third quarter from 20 percent a year earlier, the company said in a Nov. 8 statement. Shares of the Brasilia-based lender have dropped 12 percent this year.

“Investors have become much more wary of the impact of state intervention on equity returns,” John-Paul Smith, a London-based emerging market strategist at Deutsche Bank AG, wrote in a Nov. 2 research report. “The big issue for investors is the extent to which the state factor is priced in.”

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