Four out of their ten picks are from Brazil. Although there is nothing superb nor creative about MS’ stock picks, we thought it would still be valuable to discuss them. Here we present their ten LatAm stock picks, and we will look into the four Brazilian stocks in more detail.
• Brazil: Banco do Brasil, Telefonica Brasil, Cemig and Vale (our comment: we disagree on Vale, which is a pure-China play, and Banco do Brasil, which is geared into the housing bubble like no one else… but we will leave this comment for another post)
• Mexico: Televisa
• Chile: Falabella
• Andean: Ecopetrol and Buenaventura
• Others: Arcos Dorados and Copa Airlines
• We remain Equal-weight Brazilian banks; given the risks to global growth, commodity prices could come under pressure going forward, which flow-wise should benefit Brazilian
• Nonetheless, we see fundamental risks to earnings, as the Brazilian economy decelerates further and interest rates come down.
• We prefer exposure to the sector through stocks with internal catalysts or discounted valuations. Banco do Brasil trades at an attractive discount to private sector peers of around 40% on a P/BV basis and of around 30% on a 12-month forward P/E basis. Both are wider than historical averages.
Key Value Drivers:
• Loan growth;
• Lending spreads;
• Asset quality;
• Cost control.
• A sharp deterioration in the outlook for commodity prices could result in more
flows to Brazilian bank stocks;
• Improvements in the outlook for growth, interest rates, and asset quality.
• Risk of political intervention as the bank is government-owned;
• Spread compression due to high cost of debt service in Brazil;
• High leverage of Brazilian consumers that could lead to slower pace of loan growth and asset quality deterioration.
• Investors may be underestimating the fiscal benefits of the merger with Vivo. Tax-deductible Interest on Own Capital (IOC) could increase 4x in 2012, enhancing after-tax earnings, cash flow and dividend distributions;
• Vivo leads in mobile data with a 48% (and growing) share of the market. This confirms Vivo’s brand strength and network quality, which should help sustain above-average growth in mobile services;
• The current 2012 P/E of 8.5x and dividend yield of 8.7% are compelling on an absolute basis and relative to local and global telecom peers;
• Given parent company cash needs, we expect a dividend payout near the 95% legal maximum. Our projected 8.7% dividend yield is the highest among Latam telcos, which should reduce downside risks for the stock under adverse market conditions.
• Auditors should clarify before YE10 the extent of the merger-related fiscal savings.
• Look for IOC distribution of BRL0.6-0.8bn before YE, implying a 1-2% yield.
• Anatel plans to auction 4G spectrum in the 2.6GHz band will shed light on the fact that VIV already owns this spectrum in some cities via its TVA subsidiary. Thus, VIV is likely to spend
less than peers in the next auction. Rules are due out early 2012 with the auction slated for April 2012.
Risks to Our Price Target:
• Competition is set to intensify in fixed line in 2012, as GVT enters Sao Paulo
and as Atimus shifts its client focus from wholesale to retail.
• Relative valuation is attractive in light of 6% earnings CAGR through 2012. Healthy earnings growth outlook, relatively attractive valuation, and limited downside risk make Cemig one of the few names in the Brazil electric utility space where we still see fundamental upside;
• Strong track record bodes well in times of uncertainty. Part of our preference for Cemig
is driven by the fact that we don’t have to take any “leaps of faith” or bet on any “turnaround”
stories to see earnings growth in coming years. Additionally, while M&A; could certainly
continue to be part of this story, we do expect management to practice a certain level return
• Improvements at Light, particularly from the loss combat program. Light’s bull case adds
BRL2.0/share to Cemig;
• Re-pricing of the generation portfolio. We forecast significant upside potential from 2014 on, when auction commitments will start expiring, permitting more energy allocation to
the free market, with significantly higher prices. Every BRL10/MWh move in generation prices (for the un-contracted capacity) moves our price target by BRL1.0/share;
• Distribution Rate Review: Every 50bp variation in the regulatory WACC changes
intrinsic value by BRL1.0/share.
• Conclusion of the tariff review cycle;
• New transmission and generation auctions;
• Potential acquisitions;
• New PPAs.
Risks to Our Price Target:
• New investments or acquisitions;
• Rate review cycle;
• Government involvement.
• EW based purely on our view that the market multiple will remain depressed until the macro environment improves;
• We also expect the overhangs related to rising mining royalties in Brazil and pending tax issues to continue;
• After announcing an attractive USD12bn proposed capital program, we fail to see any company specific catalysts that would cause the stock to outperform;
• However, the stock trades at 5.3x 2012e EPS, ~35% below its historical average and below the 10x multiple at which global miners usually trade on peak commodity prices;
• Given that we remain constructive on iron ore fundamentals, we would expect to turn more positive on the stock when macro conditions improve, all else equal.
• Vale benefits from a low production cost relative to the industry. This supports above-average operating margins and cash flow generation, especially in iron ore and nickel;
• Attractive growth projects will support future earnings growth and cash flows.
• Positive: China shifts economic policy to promote growth vs. reduce inflation;
• Positive: Vale obtains environmental licenses for its flagship iron ore growth
projects (Serra Sul, Apolo, etc) and breaks ground on construction work;
• Negative: World’s economy goes into a new recession or global financial crisis;
• Negative: Vale intensifies investments in steelmaking capacity in Brazil.
• China reduces iron ore imports, by ramping-up domestic production;
• European fiscal issues result in lower steel production and iron ore demand;
• Commodity pricing profiles significantly lower than our base case.
Source: Morgan Stanley