Brazil: Where Consumers Are All Keyed Up

Commodities have been good to Brazil. Thanks to high prices for the iron ore, steel, soybeans, and other products the country exports by the shipload, Brazil is set to post a $45 billion trade surplus this year. Some of its mining and metals companies are so cash-rich that they're snapping up rivals from Europe to Canada.

But investors looking for high returns in 2007 should skip commodities. A better bet would be companies that serve the 180 million consumers in Latin America's biggest country. Sure, nearly half of them are poor, but with inflation and interest rates dropping and wages rising, nearly everyone can afford to buy a cold beer, a mobile phone, or another shade of lipstick. "For the past four years, commodities were where the action was [in Brazil], but the easy money already has been made in those stocks," says Geoffrey Dennis, head of Latin America equity research for Citigroup (C ). "Now the focus is on consumption."

Fiscal discipline in Brasilia is fueling a buying binge. President Luiz Inácio Lula da Silva, a leftist former union leader, has pursued economic policies that have helped bring inflation down to just 3% from nearly 15% three years ago. Wages are up, and the government is making payments of as much as $60 a month to 11 million poor families that keep their children in school. Add them up, and these measures have reduced poverty and driven consumer spending. Although the economy is expected to expand just 2.9% this year, the consensus among economists is 3.5% for 2007. Growth has gotten a further boost from a decline in interest rates, which were 25% when Lula first took office in 2003. Today they stand at 13.25% and may well continue falling.

Lower rates mean more consumers are taking out mortgages. That's likely to add up to a big increase in consumer lending at Banco Itaú, now trading at 12.6 times 2007 earnings, and Unibanco, trading at 9.8 times. Another way to cash in on falling rates is with housing stocks such as Cyrela Brazil Realty, a big developer of high-end apartment complexes and office towers, where profits are expected to jump by a third in 2007. "The housing market in Brazil will tick up as interest rates come down," says Jeff Urbina, co-manager of the William Blair Emerging Markets Growth (BIEMX ) fund.

Stocks with a strong consumer focus should also get a lift as Brazilians feel a bit more flush. Low-cost airline Gol Linhas Aereas, which serves 55 destinations in Brazil and five abroad, could be a good bet. Latin America's largest bottler, Companhia Bebidas das Américas (AmBev), has consolidated the regional brewing market and will likely prosper as more Brazilians drink its Brahma and Skol beers. Strong demand for high-speed Internet and video services could give a boost to Telesp. The São Paulo fixed-line carrier is controlled by Spain's Telefónica and offers an attractive dividend yield of 10%.

Cosmetics maker Natura looks like a natural winner. The company, which makes skin-care products from herbs, plants, and native oils, saw its sales jump by 22% in the first three quarters of 2006. Natura sells its products via a network of more than a half-million independent agents. In 2005, Natura moved into France as well. The company's sales could grow by 21% in 2007, boosting profits by 19%, says Damian Fraser, head of Latin America research for UBS Pactual. "Natura," says Fraser, "is one of the best, fastest-growing companies in Latin America."

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