LatinFinance - July/August 2017 - 21

Management, the political environment
in Brazil is worse than it was at the end
of Rousseff's administration. "You have
to look at politics versus policy, and the
politics is more of the same," he says. "The
problem is, the government is now in paralysis, and you question whether they can
execute their stated objectives."
Reforms in question
A critical reform, in the eyes of investors,
involves overhauling Brazil's public pension
system. Temer's administration has proposed lifting the minimum age to qualify for
a state pension from an average of 54, to 65
for men and 62 for women. Such changes
are imperative to address the country's fiscal deficit, says Bruno Saraiva, the head of
equity capital markets for Brazil at Bank of
America Merrill Lynch.
"Every year, the social security deficit
has been in the billions and it has been increasing," he says. "The Brazilian structure
is old. People now live longer, so we need
to adjust."
Now, investors worry that the latest bribery allegations could postpone the process.
A Senate committee rejected the reform
bill in mid-May, raising the specter that the
proposals could stall in Congress.
Some argue that the market dip and prospect of better growth will combine to spur
lawmakers into action. Knudsen argues that
the country's leaders have "no choice" but
to pass the reforms if they want economic
growth to continue. The stock market
sell-off in May, he says, "put pressure on the
politicians. You must pass these reforms or
you are going to see a continued sell-off."
With presidential elections scheduled
next year, politicians will be keen to get the
economy moving, he adds. "If the stock
market craters again, interest rates will have
to go back up, putting more pressure on the
economy," Knudsen says.
Taking advantage of momentum
Despite the snarl-ups in the administration,
the rise in the equity market, lower interest
rates and good first-quarter earnings reports have managed to keep investors fairly
optimistic, BAML's Saraiva says.
Azul, for example, posted net revenues
of 1.87 billion reais in the first quarter this
year, up 12.3% on the same quarter last
year. The retail chain Lojas Renner also
registered a strong first quarter, with net
revenues from merchandise sales reaching
1.24 billion reais, up 14.7% year-on-year.
"There is earnings momentum in Brazil,"

CHUCK KNUDSEN, T. ROWE PRICE

"IF THE STOCK
MARKET CRATERS
AGAIN, THAT MEANS
INTEREST RATES WILL
HAVE TO GO BACK
UP, PUTTING MORE
PRESSURE ON THE
ECONOMY"

Saraiva says. "The momentum comes on
the back of reduced interest rates and it
has brought earnings power to companies
in Brazil."
Knudsen says stock buyers can find good
opportunities in sectors such as real estate,
retail, consumer goods and financial institutions. "Lojas Renner and Raia Drogasil, for
example, have been able to take on market
share," he says. "These are companies that
can weather the tough times."
And despite the latest allegations, conditions are still solid, say some.
"Even after the sell-off [in May], the market went from probably overpriced to fair
value," says Taylor at Aberdeen.
"If I am a company owner, or a banker advising them, I'm telling them it would have
been even better to come to market [before
the Temer recordings]. But right now is not
bad timing either."
BAML's Saraiva expects some companies
to capitalize on the open market window,
rather than face potentially further political

uncertainty next year. "All those companies that have capex plans or M&A opportunities see the inflows and want to get
ready," he says. "Some don't want to wait
until 2018 and are trying to anticipate their
new investment plans."
The same is true for shareholders wanting to divest. Qatar Investment Authority,
for example, sold shares in Santander
Brasil in April, reducing its stake to 3.4%
from 5.5% and raising 2 billion reais in the
process. The sovereign wealth fund capitalized on a rally in the bank's American
depositary shares, which had climbed
from as low as $5.06 in June 2016 to peak at
$11.61 in February.
Roderick Greenlees, the global head
of investment banking at Itaú BBA, says
liquidity was buoyed by financial sponsors
that had invested in companies years ago.
"It was time for them to monetize, at least
in part," he says.
Fair value
The rebound in corporate earnings,
lower interest rates and the all-important
reforms drove Brazilian stock prices above
where they should have been earlier
this year, given the uncertainty ahead,
argues Taylor.
"If you believe in these pillars, then you
would think the valuations are now fair,"
he says. "If any of those pillars fall away,
then equities are certainly not cheap here."
The surge in stock prices earlier in the
year came as fund managers shifted their
weightings on the country, moving from
underweight allocations to more bullish
stances, says Greenlees. Now, growth expectations alone are "more than enough"
reason to reconsider Brazilian stocks, he
says. "The markets have been responsive
and we should have a busy second half
of 2017."
Lawmakers' progress at pushing
through reforms will likely determine how
busy Brazil's equity market is for the rest
of the year and into next. Investors understand that the changes may not take effect
until 2018 - but progress on implementation alone can fuel fund inflows and spur
demand for new transactions.
"You have a country that is marching
towards better economic policies," says
Knudsen from T. Rowe Price. "The end
goal does not change. The reforms must
get passed, maybe in 2019, maybe sooner."
But Brazil, he says, is exhibiting a welcome
political will "to keep the momentum
going". LF

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