In February I took my first trip to Brazil since before the Covid-19 pandemic began. A lot has happened in the last two years and, especially in an election year, there was much to discuss.
As with the rest of the world, I have kept in touch with clients, companies, colleagues, and others via video calls. These are great, but there are many benefits to visiting in person.
The benefits of visiting in person
In the pandemic era, video calls are the new norm. They work well and are an effective and efficient means to communicate. But there are aspects you miss out.
For example, the ten minutes before a meeting is scheduled to start often provides the opportunity to chat informally to other participants, and to understand them and their lives better. Often this means gaining a more local perspective, or simply more anecdotal experiences of what is really going on. These tidbits of information are important in building relationships, and in some instances can help our thinking as investors.
Meetings themselves also allow us to interpret other elements such as body language, facial expressions, and eye contact. These are much harder to assess on a video call. Company management teams also come across as more open and natural when meeting face to face.
Meeting companies and clients in person is really key to building relationships, trust, and understanding. This is especially the case when it comes to engaging with companies on ESG-related issues.
On this trip I met business leaders with whom I had, unknowingly, worked at a previous employer. Another had worked in Mexico City, where I grew up, for another company in our Latin America investment universe.
One interesting contrast was the approach which different employers took to flexible working. The extent to which the return to the office is playing out was also observable. Meeting business leaders in their offices, it was sometimes clear that there were relatively few employees working from their headquarters. This is of course only one part of the picture, but for many industries, flow of information is important. Understanding how this works was therefore an area of interest in some cases.
While in Brazil, I often shared a taxi with locally-based colleagues to visit companies or clients. Sitting in Sao Paulo’s traffic jams provided the opportunity to catch up, and share thoughts and ideas. And it also enabled a debrief afterwards; back in London, this usually required an additional call.
Talking about traffic jams, these were actually less acute than before the pandemic. This is a function of working from home policies. These could well aid productivity as Sao Paulo was famed for its traffic delays; people would talk of spending between one and four hours per day stuck in traffic.
What did I learn?
It seemed clear that Brazil’s economic recovery has been K-shaped; there are winners and losers.
Inflation, which reached 10.5% in February, together with higher interest rates, is now impacting the domestic economy. Lower to middle income earners are the hardest hit, as they typically spend a relatively larger amount of their disposable income on food and transportation costs.
Rising food prices have been in the headlines globally, given the implications of Russia’s invasion of Ukraine. In Brazil, the impact of drought in January of this year has already put upward pressure on some food prices. With food export prices now rising, this will undoubtedly exacerbate existing domestic food price inflation.
Chatting to shopkeepers dovetailed with these points, and domestic companies we met reported weak demand as disposable incomes are pressured by inflation. Many of these companies are also facing higher raw material and/or labour costs, which will only add to pressure on profit margins.
Anecdotally, we heard car prices are up around 30-40% over the past 12 months. House prices have increased by as much as 40-50% in the last couple of years, and so asset owners are rich, even if their salaries lag inflation. Those with investment portfolios are likely to have benefitted in recent years. Despite a weak 2021 for Brazilian equities, Brazil’s financial sector in general has enjoyed a strong period in recent years. More than 45 companies listed on B3, the country’s main stock exchange, in 2021, raising $11.9 billion. That is the highest count of annual listings since 2007.
We also visited clients and companies in Rio de Janeiro, which to some extent gave us the chance to compare the two cities. Rio has many dilapidated buildings in need of refurbishment; by contrast this process is well underway in Sao Paulo and there is construction almost right across the skyline. That said, there was a new air of hope in Rio de Janeiro state more broadly, as the acceleration in oil investment starts to feed into the broader economy. Ahead of the Carnival festivities, our hotel in Rio was also unusually packed, possibly due to the cheap Brazilian real, and high demand for post-pandemic travel from North America and Europe.
This information and the various observations are useful on a number of levels. Ultimately we came back to London with a more bearish outlook for consumption and the view that inflation won’t peak as soon as we previously had expected.
Even the local office had changed
Schroders has operated in Brazil for over 27 years and I’ve been visiting our local office for more than ten years. But this time around I had to find a new address. The office has moved to the centre of the business district, near to Avenida Brigadeiro Faria Lima, Brazil’s equivalent of Wall Street.
Rather than concerns about downsizing due to a shift to working from home, the office has actually increased in size. The move reflects the growth in the size of the Schroders team in Brazil over recent years, with about 30 people now based in Sao Paulo.
This rise has been in tandem with a increase in assets under management. Schroders is now among the top five independent managers investing in B3, the main stock exchange, according to data from ANBIMA, as at end February 2022.
It’s good to be back, but the world has changed
I have never been more conscious of the impact that travel has on the planet. Schroders has committed to becoming carbon neutral across our operations, and investors like myself have a key role in this. While taking anything other than a plane to visit Brazil is not an option, the last two years have demonstrated what can be achieved with technology. So while I emphasise the benefits of in person meetings, I do so while also acknowledging that the world has changed. We must all play our role in achieving net zero, and I will be doing fewer business trips than in the past.
This trip was a reminder though of the value of a hybrid approach. During my week in Brazil, I met with 24 companies across a range of sectors. Gauging their views and outlooks in person was incredibly beneficial. There was much that I learned that would never have come across via the screen on a video call from London.
Company management teams were also unusually generous with their time; in many cases senior management spent well over an hour with us. Several people mentioned we were the first investor they met in two years, and that included locally based investors. We even had time to discuss 19th century asset price bubbles with one CEO, and hear their views on the Metaverse from another.
My key takeaways on Brazil
1. K-shaped recovery - The economic recovery has not been equal, with low to middle income earners hardest hit. This could have implications for the outcome of October’s presidential election, and future policy.
2. Inflation and rates will be higher for longer – This will put pressure on disposable incomes and the domestic economy, but should support the currency, and help to keep inflation expectations stable if not lower.
3. Economic growth could surprise on the upside - We’re starting the year with very low expectations for economic growth – there is scope for a positive surprise, but those surprises are likely to initially come from the exporting sector.
4. Individual company outlooks vary considerably - From an equity market perspective – exporters are better placed this year than domestic-focused companies.
a. The problem with many “growth stocks” is not just higher interest rates. High returns and low interest rates have in recent years attracted excess capital to sectors such as ecommerce, fintech and real estate. New entrants, many with deep pockets, are here to stay. Increased competition has put pressure on company returns.
b. Incumbent banks have been prudently managed through the pandemic, have not yet seen material competition in lending from fintech players, and are seeing a favourable environment of higher rates and better spreads.
c. To some extent there has been a “revenge of the old economy” effect, driven by the materials sector and banking stocks. These sectors had been out of favour for some time. Brazil is a low cost producer of many commodities, and also has an energy mix that is majority hydro. As a result, the materials sector is benefiting from higher prices and a competitive cost structure, aided by a weak Brazilian real.
d. IPOs have been a minefield as most have underperformed. That said, the flood of listings in recent years, followed by the recent stampede out of stocks by local investors, will leave some well managed smaller capitalisation companies mis-priced and overlooked. While the current environment does favour large companies with strong balance sheets, we met a select few smaller companies whose outlook is actually improving. Valuations have materially fallen for some of these stocks, and opportunities are opening up.