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Surging Brazilian stocks await privatisation booster

Surging Brazilian stocks await privatisation booster

October 12
12:11 2017


When Fernando Coelho Filho, Brazil’s minister for mines and energy, was asked on television this month about privatising Petrobras, the state-controlled oil producer, he could not have known the stir he was about to cause. 

The minister said he expects the further privatisation of Petrobras, the dominant energy company in which the government and state entities hold a voting stake of more than 60 per cent, in the longer term. 

The remarks sent Petrobras, a bellwether stock, up nearly 4 per cent the next day, forcing the government to backtrack. Officials said the politically sensitive sale of a company that is a source of national pride was not on the agenda.

However, the episode was a reminder of the popularity in markets of a programme to sell state assets launched by the government of Michel Temer, the centre-right president, this year. Plagued by corruption scandals, the government is proving unable to deliver fiscal reforms to plug a near 10 per cent budget deficit, such as changes to the over-generous pensions system. So it is promising privatisations

“Instead of generating lower expenses or more revenues from the [fiscal] reforms, they will try to get more revenues, albeit non-recurring ones, from privatisation, so this has helped market sentiment a lot,” says Ronaldo Patah, chief investment officer for Brazil at UBS Wealth Management, 

The government’s promises to privatise a range of state assets, from Eletrobras, the electricity producer, to roads, airports, ports and railways, come as the market is riding high on strong macroeconomic numbers. The Bovespa has surged 27 per cent this year, with a pronounced climb since June putting it in record territory. In contrast, shares in Petrobas are only up 8 per cent.

Brazil is finally emerging from two years of deep recession, and the economy is forecast to expand 0.7 per cent this year and 2.4 per cent next, according to a survey of economists by the central bank. Some banks, such as UBS, predict growth as high as 3.1 per cent next year. 

Inflation has fallen faster than expected to 2.5 per cent year-on-year in September — below the central bank’s target range of 4.5 per cent plus or minus 1.5 per cent.

Rapidly improving economic fundamentals have partly compensated for disappointment with the Temer government’s ability to deliver promised reforms, analysts say. Mr Temer was able to phase out subsidised loans for the corporate sector, introduce more flexible labour laws and liberalise the oil sector. 

But congressional support for his benchmark reform, raising the average retirement age to the mid-60s from the mid-50s, has been sapped by allegations in May from Joesley Batista, a billionaire businessman, that he had discussed bribes with the president.

“We don’t see as embedded in market prices the assumption of a pension reform this year,” says Luiz Cherman, head of Brazil equity strategy at Itaú BBA. 

Instead stocks are being supported by corporate news, with profits beginning to surprise, exceeding estimates in the first and second quarters, adds Mr Cherman. Lower interest rates were also reducing financial costs. The country’s benchmark 10-year yield has eased to 4.65 per cent from a level of 5.40 per cent at the start of January.

“Companies over the past two years, because of the long recession, have cut costs massively and now is the time to benefit,” says Mr Cherman. 

Valuations are not cheap at 13.8 times for 12-month forward earnings compared with a historical average of 10.9 times. But with the recovery just starting, earnings per share growth is expected to be a robust 66 per cent in dollar terms for Brazil stocks included in the MSCI index this year. 

There was also potential for an influx of new money, with global funds and emerging market specialist funds underweight on Brazil. Domestic pension funds were also significantly underweight on equities following the period of economic contraction. 

Analysts say privatisation will only add a fillip to these larger macro themes. So far, the government has been able to auction some oilfield exploration blocks and electricity hydropower dams. But in terms of listed assets, it was unlikely to be able to sell more than a stake in Eletrobras before the next election in October 2018. 

“They will try to do the Eletrobras privatisation before the election,” says Mr Patah of UBS. “It is going to be a tight schedule.” 

In the meantime, he says the market would be focusing on cyclical stocks, such as consumer companies and financial institutions, with lending expected to pick up again. 

“Equities are not cheap but not expensive as well if our economic forecast is correct and if the market is correct in the assumption that the next president will keep doing reforms, no matter who it is,” adds Mr Patah. 

If those reforms eventually include the further privatisation of Petrobras, as promised by Mr Coelho Filho, then the market could be in for a stronger rally than most expect.



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