Skip to Content
Stock Strategist

In Latin America, Slow and Steady Wins the Race

Why investors should consider Brazil over Argentina.

Mentioned: , , , , , ,

With its Olympic soccer win over Brazil, Argentina has scored the latest victory in a longstanding rivalry. Brazilians are surely suffering in their defeat. But on the economic front, at least, we expect they will yet emerge the winners.

A scenario in which Brazil's growth overtakes Argentina's will have important long-term implications for regional business, and in turn, the portfolios of Latin America-oriented investors. In this piece, we'll highlight some of those firms that stand to benefit (or suffer) from these countries' fast-diverging economic paths.

To Samba or Tango?
From a passion for soccer to a devotedly red-meat diet, Brazil and Argentina are not culturally dissimilar. Economically, though, they are a study in contrasts. In recent years, Brazil has floated its currency, embraced foreign investment, and followed a conservative monetary policy. The fruits of this disciplined approach have so far shown up in the form of steady, if not blistering, mid-single-digit expansion. Inflation has fallen fivefold in a few years, and president Luiz Inacio Lula da Silva's government seems determined to keep it at its present level of around 5%--even if it means sacrificing growth.

Brazil's southern neighbor, on the other hand, has essentially thrown out the rule book. Argentina's free-spending government has set exchange rates, fixed prices, and doled out massive subsidies. So far, this strategy has helped support a racy 8% growth. But where Brazil's rate of inflation has been reined in, Argentina's has been set loose. The official rate sits around 9% (a government statistician who thought this was low was recently fired), but independent estimates pin it closer to 25%--and rising--as shown in the graph below.

There are more tangible signs, too, that Argentina's economy may no longer be the contrarian wonder touted by its populist masters. Public unrest is mounting, and support for the current administration is in free-fall. The recent performance of  Edenor (EDN), a major Argentine utility, also points to trouble. Edenor's electricity volumes increased 3.3% in the second quarter--hardly what you would expect in an economy that is purportedly growing at more than twice this rate (sales to industrial customers fell a worrisome 9%). Operating expenses, meanwhile, leapt 31%--lending weight to unofficial inflation estimates.

Argentina's swift recovery following its 2002 financial crisis has made Brazil's steady-eddy pace appear dull by comparison. But like the hare that starts out at a sprint, we think Argentina may have set it itself up for disappointment. As long-term investors, we're betting on the tortoise.

Three Brazilian Firms Worth Considering
While Brazil has plenty of room to improve, it seems clear that its economy is better positioned for the long term than Argentina's. So how does this translate into individual stock picks?

Quite simply, we're inclined to steer investors away from Argentine equities altogether. Of the nine Argentine firms we cover, just one earns a greater-than three-star rating, and all have been awarded a fair value uncertainty rating of either high, very high, or extreme. These include above-mentioned Edenor, as well as  BBVA Banco Frances (BFR) and  Telecom Argentina (TEO). Some Argentine firms would otherwise be fine businesses to own. But for now, given the macroeconomic red flags that are currently popping up, it's hard to envision a rewarding future for their shareholders.

In contrast, at the right price we would heartily recommend several of the 29 Brazilian firms we cover. In a previous Stock Strategist article, we described two such companies. Below, we highlight three more. Not only are these attractive businesses of their own merit, but we think the broader economic environment taking shape in Brazil bodes well for their success.

 Gafisa (GFA)
Real estate developer Gafisa has a front-row seat to Brazil's ongoing economic transformation. With interest rates at historical lows, banks in Brazil are able to offer fixed-rate home loans for the first time. This macroeconomic trend has played nicely into Gafisa's recent shift in strategy. Although the company had traditionally focused on high-end homebuyers in Sao Paulo and Rio de Janeiro, acquisitions have established a geographic footprint in smaller urban centers throughout the country. This has given the company exposure to precisely the segment that is benefiting most from a drop in rates: lower-income customers looking for affordable entry-level homes.

Gafisa stands to profit from three additional long-term trends: population growth, increased urbanization, and rising incomes. This latter trend will be particularly key, in our view. Home ownership is a first-choice investment for many Brazilians, and as incomes rise, we think consumers will funnel more of their savings into real estate.

 Petrobras (PBR)
Brazil's economic expansion will necessitate energy, and though competition is entering the market, Petrobras' home-court advantage and extensive reserves should make the firm the go-to source for years to come. We also like that the company derives most of its operating profit from upstream operations--a link in the supply chain that offers strong long-term profit potential (OPEC uses its heft to influence global oil supplies, promoting the health of nearly all upstream producers). In addition to its incumbent position and potential for serious production growth, Petrobras has significant deep-water expertise. Given Brazil's vast undersea deposits, we think this know-how constitutes an important competitive advantage.

Several caveats--including state meddling in energy markets and the government's majority ownership stake--temper our enthusiasm. On balance, however, we think this energy titan would be worth investors' consideration if the stock fell below our Consider Buying price.

 American Beverage (ABV)
As Brazilians' prosperity rises, so should their thirst for beer and soft drinks. Ready and waiting is AmBev--far and away one of the world's most profitable beverage makers. Ruthless efficiency, vast scale, and powerful brands allow the firm to ring in operating margins a good 15 percentage points above industry rivals'. These strengths help provide the firm competitive advantages, in our opinion. In addition to its absolute dominance of the Brazilian beer market (the world's fourth-largest), AmBev has selectively expanded abroad. The firm complements its brewing operations with carbonated soft drinks. It owns bottlers that fabricate and distribute  PepsiCo (PEP) products as well as proprietary brands. By possessing two classes of beverage products, the company is better able to leverage its distribution infrastructure. During the next five years, we expect revenues to increase at robust double-digit rates.

AmBev has many qualities we love, but it does not come without uncertainty. The firm's sales are concentrated in Latin America, where economic and political risk is relatively high. Many of the firm's input costs, as well as about $3.5 billion of debt, are denominated in U.S. dollars. Should the Brazilian real depreciate, these payments could become dangerously expensive. On the other hand, if the real remains strong, AmBev's leveraged cost structure could entail handsome rewards.

Ryan McLean does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.