In focus

Brazil: new economy powers new listings resurgence

Sometimes in investing, it can pay to look where you haven’t been looking for a while. And if you looked at Brazil now, you’d find something striking: a lot of companies are listing on the stock market.

The numbers tell one part of this remarkable story. More than 40 companies have said they plan to list (also known as initial public offering or IPO) this year on the local exchange, B3. This is an exchange that already notched up 28 IPOs in 2020 — the highest number since 2007.

Such activity may seem surprising, given that Brazil is the largest economy in a region that has been among the hardest hit by the coronavirus pandemic.

Concerns over the sustainability of public finances, a sharp rise in inflation which caused the central bank to change tack and raise interest rates, and uncertainty related to next year’s general elections, have weighed on Brazilian financial markets recently. 

Against this backdrop, it is an encouraging sign that capital markets continue to function well; both in terms of equity issuance and the availability of credit funding.  

New economy, new corporate agenda

Yet the other part of the story is what’s happening with regards to the long term picture. The type of companies planning to go public highlights a theme independent of broader economic performance.

Disruptive new economy companies are setting a new corporate agenda through renewables, e-commerce and fintech, leaving old economy sectors such as commodities behind. This is a trend we identified last year.

Some of these areas are benefiting from changing consumer behaviour as a result of the pandemic.

Our conviction in the new economy has been strengthened as we’ve seen the emergence of increasing numbers of more nimble, new economy groups. For example Aeris, the largest producer of wind turbine blades in Latin America; Mobly, a home decor and furniture retailer that combines digital with physical stores in an omnichannel approach; and Mosaico, a price comparison website. All three conducted IPOs in the last six months.

The risks around IPOs should not be understated. The majority of companies which listed in Brazil last year underperformed the local Ibovespa market, in particular house builders. And as always, valuation is key. Good companies don’t always make good investments.

Examples of new economy companies coming to market

Aeris, founded in 2010 by former employees of Embraer, the Brazilian aircraft manufacturer, has developed commercial relationships with the largest wind turbine producers globally. These include Vestas and General Electric, as well as with WEG, a Brazilian producer. It should benefit not only from the growth of wind-driven power as globally-installed capacity increases, but also from the outsourcing of blade production by larger turbine groups.

Mobly’s largest shareholder is German home furniture e-commerce company Home24 — itself listed on the Frankfurt Stock Exchange — and has been profitable since 2019. The company’s scale gives it significant bargaining power with retailers and the company has managed to generate high-margin growth in recent years. Almost 70% of its sales are online.

Mosaico was founded in 2010 by three internet entrepreneurs and runs two price-comparison brands in Brazil: Zoom, a product review platform, and Buscapé e Bondfaro. It recently entered into a partnership with BTG Pactual, the Brazilian investment bank, to operate a digital wallet. This will allow participation in the growth of digital payments, one of the biggest trends globally, accelerated by Covid-19 as societies have moved increasingly away from the use of cash.

Retail investors almost double in size

A second structural element is a marked increase in the participation in the Brazilian market by domestic retail investors, illustrated in the chart below, which has helped to fuel the IPO boom.

A survey published in December by B3 found that in the 10 months to October 2020, the number of individual investor accounts rose by 88% to 3.2 million, compared with the total in 2019.

601211_SC_Brazil_webchart_V2.png

This is not just a local phenomenon, but a wider trend we are seeing in other markets, including the US, where equity markets have been in the spotlight after an upsurge in retail investor trading linked to short-selling of certain stocks.

In Brazil, social media influencers have been noticeable in driving retail investor enthusiasm for certain stocks and IPOs. But it was particularly interesting to us that B3’s survey showed retail investors — average age 32, employed, no family — to be less interested in short-term volatility related trading, and more interested in holding investments.

Finally, we would add one other trend that’s been building in Brazil over the last 18-24 months and which we see as supportive of market participation: a proliferation of new asset managers in equities.

In many cases these groups are being established by former executives from large, established institutions who have left to set up partnerships, taking advantage of favourable tax benefits in relation to such organisations.   

Attractive market valuations

In terms of valuation, there are reasons to think that the Brazilian market has some support. Brazilian equities, as measured by the MSCI Brazil Index, underperformed the broader emerging markets, as measured by the MSCI Emerging Markets Index, by over 37% last year. And year-to-date, as at 5 May, Brazil lags by more than 6%. A major contributor to underperformance has been weakness in the currency, the Brazilian real; it fell -22% against the dollar in 2020 and has depreciated by more than -3% so far this year.  

At the same time, we’ve seen a big re-rating of emerging markets as a whole recently, with forward price-to-earnings multiple at over 15 times the next 12 months’ earnings, compared with a historical level of 10-12 times. This valuation measure takes the market value of the stock and divides by forecast earnings per share over the next 12 months – a low number represents better value. While Brazil has historically traded in line with the emerging markets benchmark, it is now trading at below 10 times forward earnings. We think this makes the market relatively cheap.

What is the outlook?

In addition to the cohort of new economy stocks we referred to earlier, we are optimistic about further potential IPO activity around state-owned enterprises. The government’s stated commitment to relinquish control makes those assets potentially more attractive. Caixa Seguridade, the insurance arm of development bank Caixa Economica, listed on B3 at the end of April, raising close to US$890m in a secondary offering.

We also think there are some ”value” stocks that have been over-sold, and which offer upside as the economy recovers. In particular shopping malls, whose sales are mostly derived not from sales of goods, but from services like beauty parlours, cinemas and restaurants. China’s economic recovery is also flowing through to opportunities in iron ore and steel.

The outlook is of course not all blue skies, and there are some clouds on the horizon. Pandemic-related government spending last year worth 17% of gross domestic product (GDP) resulted in a high budget deficit, taking gross debt to almost 100% of GDP, excluding US dollar reserves, based on IMF figures.

The latest wave of Covid-19 and the new strain have weighed on the pace of economic recovery. However, infection rates are now easing, and the pace of vaccinations is set to accelerate sharply in the next few months. That said, with general elections due in 2022, a delicate balancing act between  conventional fiscal policy and political expediency when it comes to opening the spending taps once more may be needed.

The successful distribution of vaccines appears to be key to economic recovery. But looking beyond the pandemic, a new structural story looks to be emerging in Brazilian equities.

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