It has been a challenging year for Brazil, both from a societal perspective with the pandemic, and from an investment angle with a sharp fall in the currency compounding stock market weakness.
It can be an unnerving place to invest amid such volatility and uncertainty. But behind the headlines, Brazil is changing and we are seeing a new wave of companies reshaping the established order.
As a reminder, Brazil is the world’s 9th largest economy with a population of more than 210 million people, and a median average age of 33. The addressable market is therefore significant, while propensity to adopt new technology and embrace digitalisation is high.
New economy versus old economy
Investing in Brazil today is about so much more than the financials and old economy commodities sectors that dominate the index and investors’ perceptions of the country. Materials and energy are exposed to global macroeconomic factors and face important ESG challenges, while the performance of banks is closely tied to the domestic Brazilian economy, and they are not immune to disruption.
There are numerous examples of new economy companies disrupting the status quo across a range of sectors. Some are in widely followed indices such as the MSCI Emerging Markets Latin America Index, while others are not, which is where the flexibility of an active manager’s approach can help. What’s more, in many cases, these are companies with potential long-term secular growth stories, that is their fortunes are independent of overall economic growth. Indeed, some are seeing an acceleration in demand due to the pandemic.
E-commerce and fintech
Brazil has one of the most dynamic e-commerce and fintech sectors in emerging markets. E-commerce represented just 7% of total retail sales in Brazil in 2019. This compares to 27% in China and South Korea, and 15% in the US; but Brazil’s e-commerce share is expected to double over the next five years.
Lockdowns in response to Covid-19 have accelerated the adoption of online consumption. With stores closed or openings disrupted by lockdowns, many consumers have turned to online retailers. We think that some of this change in consumption patterns will be permanent.
At present, the main listed operators in the e-commerce space are Magazine Luiza, Via Varejo, Lojas Americanas, and B2W. All four companies retail directly to online buyers, known as first-party or 1p relationships. They also act as third party sellers - so-called 3p relationships - enabling others to sell their products via an online market place. With the exception of B2W, all of these companies also operate bricks and mortar stores. In addition, there is Mercado Libre, a pan-Latin American online marketplace and payments provider listed on the Nasdaq.
Along with global peers, many of these companies saw demand surge during lockdowns. But it also led to adaption from retailers. For example. with its stores forced to close during lockdown, Via Varejo took measures such as “text me on WhatsApp” tool, whereby store sales people utilised social media to provide advice and push sales, effectively integrating online and offline. Its physical stores saw first quarter sales fall by 7% compared to the same quarter of 2019; online sales were up 48.6%.
One thing worth noting is that, while these models exist elsewhere in the world, it tends to be hard to get it right in Brazil. Local knowledge and talented management are key. Amazon, for example, has been in Brazil for years with limited market share in e-commerce.
Fintech too has seen an acceleration during the crisis. For example Mercado Libre reported that its fintech business saw total payment volumes increase by 155.6% year-on-year in the first quarter of the year.
Other fintech companies include payments solutions providers Pagseguro Digital and StoneCo. Regulatory changes in Brazil’s payments segment have removed barriers to entry and increased competition. Meanwhile, the share of cash as a mode of transaction, which was in excess of 40% in 2018, is falling amid increased use of cards and digital payments. So Pagseguro, which initially focused on micro merchants that had been cash only businesses, and Stone have taken market share in a growing industry. Investment manager and broker XP Inc, currently the only listed digital platform, is another disruptor in the fintech sector. Historically, individuals and funds invested via banks. But the market is becoming de-centralised and XP, with its digital investment platform, has gained market share. Furthermore, the sector itself, with increased digital offerings is also growing by attracting new clients.
Locaweb and Linx, meanwhile, are enablers of e-commerce. Locaweb provides small and medium- sized businesses with web hosting and online marketing services. It has seen a surge in demand during the pandemic, as the importance of having an online presence was brought to the fore. Linx is a software developer which provides integrated business management systems for retailers, as well as tools for the e-commerce sector more broadly.
Healthcare and education
Healthcare and education are two sectors which have seen the highest rates of inflation over the past 20 years. The chart below uses the US to illustrate this point, but the trend has been a global phenomenon, driven by inefficiencies which stem from multiple conflicts of interest, and a lack of innovation.
Companies such as Hapvida and Notre Dame Intermedica Saude are disrupting the healthcare sector in Brazil. By integrating insurance and private healthcare, significant agency problems can be eliminated, improving efficiency and reducing costs. One approach has been to offer a discount to insurance clients who receive treatment in the companies’ own hospitals – where cost control is typically better, the use of A&E is more rational - but without a loss of service quality. The net result is a more affordable product for customers and the private healthcare market is growing.
In relation to the pandemic, one area which has seen an acceleration in adoption has been telemedicine. This is in early stage use, but it is growing fast. Telemedicine enables patients to see a doctor via video link, without the need for physical contact. In addition to being safer at times like the present, it is offered at a much lower cost and can reduce the number of visits to A&E. There are other benefits too. For those living in more isolated areas, access is improved. Meanwhile, those seeking a specific specialist can be more selective in who they see. This can also assist in bringing down medical inflation.
The education sector too has seen a chronic lack of innovation. For many people, evolution in the learning experience has been limited and is similar to that of the grandparents: studying using text books in school under the direction of a teacher and with homework for the evening.
A number of companies such as Arco Platform, Cogna and Santillana (the subsidiary of Spanish listed company Prisa) are driving change in the sector. The companies provide learning systems for K-12 levels (primary and secondary school), substituting text books for a combination of printed and digital material. The systems include features such as interactive exercises, pre-recorded video classes, live classes, revision tools and online assessment. Exams are also provided by the companies and graded online, saving teachers time. Meanwhile, students, parents and the school are able to see comparable performance data to focus on areas for improvement, for both students and teachers, on a timely basis, enabling more targeted learning plans.
A major improvement in the way educational material is consumed is underway. The learning systems are more cost effective, and the curriculum is standardised across Brazil. During the pandemic, schools which were already accustomed to using the learning systems were able to adapt very quickly to studying from home.
A number of the companies in the sectors discussed are not yet in widely-used indices such as the MSCI Brazil. Active fund mangers, in contrast to most index tracking products, are free to invest at a time of their choosing. However, there are a range of considerations when it comes to making investment decisions and, while these companies may have a strong growth outlook, we have not discussed valuation, for example. As a reminder, investing in emerging markets is higher risk and past performance is not a guide to future performance.
New economy versus old economy; existing trends are set to accelerate
While the global health emergency may be contributing to changes in consumption patterns, many of these disruptive trends were already well underway. What we are seeing today is a dichotomy of new economy versus old economy. The balance of index weights is likely to shift away from the old economy in the coming years towards the new economy. We noted at the outset that these are testing times. And investing responsibly, supporting high quality, sustainable businesses which face difficulty as a result of the pandemic, is an important task. As long term investors we continue to look beyond Covid-19 and how life will evolve. In Brazil we think that understanding the new economy dynamic will be a key part of the puzzle.
Any references to securities, sectors, regions and/or countries are for illustrative purposes only and not a recommendation to buy and/or sell.
Reliance should not be placed on any information contained within the article when taking individual investment and/or strategic decisions.