Cannondale Bikes Show Real Drop Helps Industry: Corporate Brazil

The drop in the real, the worst-perfoming major currency over the past six months, is reviving interest in Brazil’s industry after a half-decade slump.

Montreal-based Dorel Industries Inc., the maker of Cannondale bicycles, on Aug. 22 said it was acquiring a 70 percent stake in Caloi, the country’s oldest and largest bike manufacturer, for an undisclosed amount. While the deal was in the works before the real’s recent slide, a weaker currency made it more attractive and could help pave the way for Caloi’s factory in Manaus, a duty-free zone in the Amazon, to become a hub for exports, said Dorel Chief Executive Officer Martin Schwartz.

Government officials and manufacturers have been cheering the real’s 15 percent decline since March as a chance to win back market share lost to China after the currency rallied to a 12-year high in 2011. The slide will help boost competitiveness that’s also been hurt by red tape and poor infrastructure. The World Bank last year ranked Latin America’s biggest economy 130th in the world for ease of doing business.

“The logical thing right now is to manufacture locally,” Schwartz, whose company has been manufacturing child car-seats in Brazil since 2009, said in an Aug. 26 phone interview from Montreal. “I’m sure some factories will come back online if they’re efficient enough to compete. It’s not just the exchange rate.”

Manufacturers in Brazil have long complained that a commodities-fueled export boom over the past decade masked the threat to blue-collar jobs posed by a stronger currency. In the past six months, the real has fallen more than all 16 major currencies tracked by Bloomberg.

Manufacturing Deficit

Brazil’s industry shrank to 13.3 percent of gross domestic product last year, its lowest level in 50 years and half of what it was in the 1980s, according to Fiesp, the Sao Paulo Industry Federation. At the same time, imports have surged, creating a record deficit in manufacturing goods last year of more than $50 billion, Fiesp says.

More recently companies are starting to see a light at the end of the tunnel. Manufacturing exports rose 6 percent in the second quarter over a year ago, reversing an 8 percent contraction in the first quarter. Former Trade Secretary Welber Barral estimates that almost 50 percent of Brazil’s competitiveness gap in recent years was the result of an overvalued currency.

“When the dollar was cheap everyone complained that industry was hurting. Now they’re going to keep complaining?,” Trade and Industry Minister Fernando Pimentel told reporters in Brasilia on Aug. 21, when the real touched a near five-year low of 2.45 reais per dollar. “The exchange rate is excellent. We’re getting close to the ideal level.”

The real declined 0.4 percent to 2.2852 per U.S. dollar at 3:12 p.m. local time.

Bus Exports

One company seeking to benefit from a weaker real is Marcopolo SA. Brazil’s biggest bus maker is intensifying its sales efforts in places where it has recently lost ground, such as the Middle East, said Ricardo Portolan, the Caxias do Sul-based company’s foreign sales manager. At the current exchange rate, exports, which have fallen from a peak of 42 percent of sales in 2009, can rise by as much as 10 percent next year, helping offset a slowdown in Brazil, he said.

Rising Costs

Partly eroding the trade advantage are similar currency declines around the world as the Federal Reserve prepares to scale back its stimulus, leading investors to pull out of emerging markets that benefited from abundant global liquidity since 2008.

“The dollar is gaining everywhere in proportions similar to Brazil,” Portolan said in a phone interview. “This doesn’t immediately make us more competitive.”

A stronger dollar can also raise costs. As supply chains have globalized, companies have grown more dependent on foreign-made parts, especially the electronics industry, so prices of some goods will increase with a weaker real, said Barral.

“The dollar at 2.40 obligates industry to seek out local suppliers,” Barral, who now advises companies on trade matters, said in an interview in Rio de Janeiro. “The problem is they’re not going to find them, or supplies are stretched, so inflation will worsen.”

The central bank said last week that the currency declines “in the near term” can pressure inflation that has been running above the government’s 4.5 percent target since 2010. Prices jumped 6.09 percent in August from a year ago.

A report today by the Getulio Vargas Foundation showed that the weak real is already pushing up the price of imported components and commodities Brazil exports like soy and iron ore, which are priced in dollars. The IGP-M index, which is 60 percent weighted in wholesale prices, rose 1.02 percent in the last 10 days of August from the same period a month earlier, more than economists forecast

A weaker currency also does nothing to reduce bureaucracy and a complicated tax system, the so-called “Brazil Cost” that Fiesp estimates adds an average 25 percent to the price of locally-made goods compared to their imported equivalent.

Steeper Declines

That’s why some manufacturers are holding out for even steeper declines. The real needs to fall to around 2.7 per dollar to stem a surge in imports that have risen to 66 percent of sales of capital goods last year, from 52 percent in 2007, according to Luiz Aubert Neto, president of the Brazilian Association of Machines and Equipment Manufacturers.

“A dollar at 2.40 helps a little but it’s far from a level that resolves our problems,” he told journalists Aug. 28 in Sao Paulo.

Vicunha Textil SA, for example, last month closed a half-century-old nylon production facility in Sao Paulo state and laid off 300 workers, blaming competition from China, according to a union representing the workers. The company didn’t respond to e-mail requests for comment.

Plant Relocation

Another company that has struggled, and which Barral says stands to benefit from a more favorable exchange rate, is shoemaker Vulcabras Azaleia SA, which in 2011 shifted part of its production to India. The company has trimmed payrolls in Brazil by 29 percent over the past year, to 21,457 workers, according to its second quarter earnings statement. The company declined to comment.

Marcopolo rose 5.7 percent in 2013 through yesterday, compared to a 42 percent rise for Vicunha, a 46 percent drop in Vulcabras and a 11 percent drop in the Ibovespa benchmark index. Dorel has risen 0.1 percent.

Dorel, with $2.5 billion in annual sales, was drawn to Caloi by its vast distribution network in the world’s fifth-largest bike market by sales. Its first focus is on introducing higher-end brands like Cannondale that are currently priced out of competition by high tariffs, Schwartz said. Those duties were raised to 35 percent from 20 percent in 2011 after manufacturers complained about a flood of imports from China, part of a broader protectionist push sparked by the global financial crisis.

Amazon Factory

Caloi became a household name in the 1970s thanks to a TV cartoon ad in which a child drives his parents crazy ahead of Christmas by leaving notes around the house saying “Don’t forget my Caloi.” Today, the company’s factory in Manaus, a duty-free industrial zone in the Amazon, produces more than 700,000 units per year.

More than a century after Italian immigrant Luigi Caloi began importing bikes from Europe, Schwartz said that the company may one day be able to reverse that journey. That’s thanks to the European Union’s recent extension until 2018 of a 20-year-old anti-dumping levy on bikes from China, producer of 70 percent of the world’s two-wheelers.

“There’s not much low-cost manufacturing left outside of Asia,” Schwartz said, citing the benefits enjoyed by Caloi’s factory in Manaus. “In some cases, just the difference on duties is enough to make it competitive.”

Before it's here, it's on the Bloomberg Terminal.