Latin America may be an unintended beneficiary of Brexit, the U.K.’s planned withdrawal from the European Union. Many market observers believe the referendum’s surprising outcome could prompt the U.S. Federal Reserve to delay its next rate increase, and that’s good news for emerging markets reliant on low borrowing costs. However, the region is unlikely to escape unscathed, as the U.K.’s decision is expected to have an adverse effect on global economic expansion.
“We expect Brexit to have a limited impact on Latin America, as the direct trade linkages with the U.K. are relatively small,” contends Maurício Fernandes, director of Latin America equity research at Bank of America Merrill Lynch in São Paulo. “However, the two indirect channels that are relevant for Latin America are the foreign exchange and commodities channels, as the negative externalities of Brexit on global trade and the wave of protectionism can have an impact on risk aversion, which can lead to weaker Latin American currencies versus the dollar and lower commodities prices.”
Carlos Constantini, Itaú BBA’s São Paulo–based head of research, says his economists and strategists hold a similar view. “Our macro team believes the U.K. exit from the EU means lower global growth, which tends to affect Latin America, but they expect financial contagion to remain contained due to accommodative monetary policy abroad,” he reports. “Exchange rates in Latin America have been volatile since the Brexit vote but without a clear trend. And Brexit might open up new trade opportunities for the region.”
“Latin America is not at the epicenter of the shock,” adds Pedro Martins Jr., who oversees Latin American equity research at J.P. Morgan in São Paulo. “Downward growth revisions to the U.K.-euro area are coming through, but the direct impact of those on Latin America should be limited.” His firm stands behind its pre-Brexit forecast of a 0.8 percent regional contraction this year followed by 1.8 percent real gross domestic product growth in 2017.
Of course, the situation is still very volatile, and any number of issues could undermine even the most well-considered projections. Keeping abreast of the latest developments is essential in such an environment, and the firm whose analysts the buy side most relies on is Itaú, which tops Institutional Investor’s Latin America Research Team for a second consecutive year. It captures 22 positions, one fewer than in 2015.
BofA Merrill and J.P. Morgan, which shared the winner’s circle with Itaú last year, slip to second place, with 21 spots. BTG Pactual repeats at No. 4, with 18 positions — down one from last year — while Credit Suisse holds steady at No. 5, with 14 positions. Fourteen research providers are represented on this year’s team, including two that did not appear in 2015: Credicorp Capital and Raymond James Argentina.
The Leaders link in the navigation table at right provides access to the full list of firms, while the Best Analysts of the Year identifies the top teams in each of the survey’s 25 sectors. (Please note: Information about crews in second and third place, plus runners-up, is available to subscribers only.)
Constantini, who guides his Itaú crew to first place for coverage of Brazil for the fourth time in five years, notes that regional growth figures are being dragged down by recession in its largest economy.
“Brazil is the clear underperformer. We expect a GDP decline of 3.5 percent this year, as economic activity remains weak,” he says. “However, reforms and lower interest rates should allow for moderate growth of around 1 percent next year — though still below the region’s average.”
Peru is the place to be, with a projected GDP growth rate of 3.9 percent this year and next, he adds. “We believe the economy will continue to benefit from mining sector expansion and that private investment will pick up, lifted by greater business confidence and infrastructure spending,” Constantini affirms.
BofA Merrill is even more upbeat on that nation’s prospects, forecasting expansion of 4 percent this year and 4.5 percent in 2017 driven by strong mining investment and a market-friendly government, according to Fernandes, who also co-leads (with Rodrigo Villanueva) the No. 2 team in Technology, Media & Telecommunications.
“We like the fundamental story in Peru — it should be the fastest-growing economy in Latin America in 2016 and 2017,” concurs Morgan Stanley’s Guilherme Paiva, captain of the winning crew in Equity Strategy for a fifth year running. “The acceleration in the Peruvian economy is broadening beyond primary sectors. In other words, mid-double-digit growth points in mining are now being met with robust figures in financial intermediation and a smaller drag in construction. Further, the recent increase in domestic confidence should help consolidate a recovery in services and investment.”
The New York–based strategist, who also directs squads that earn runner-up spots for their insights into Brazil and Argentina (with Cesar Medina), holds a constructive view on the latter economy. “The local equity market has benefited from political change in 2015 and a reduction in country risk in 2016 as President [Mauricio] Macri reinserted the country in the international capital markets,” Paiva explains. “Looking forward, further gains for domestic stocks will depend upon the new government’s ability to reduce fiscal subsidies and consequently the fiscal deficit, which should help bring down inflation and ignite sustainable economic growth.”
Money managers are excited by the possibilities, reports Itaú’s Ricardo Cavanagh, leader of the team deemed the best at covering Argentina for the fourth time since 2012. “I just came back from a two-week road show throughout the U.S. and Europe and frankly was impressed by the high level of interest in Argentina,” says the Buenos Aires-based analyst, who also manages crews that earn top honors for coverage of Chile and a runner-up spot for North Andean Countries. “Investors are extremely impressed about the political change that is taking place in the country. Many comment that there are very few places in the emerging-markets world with such potential for positive change.”
And Argentina’s markets hold much promise. “During the past few years, equity prices were propelled by sovereign spread compression. We became pickier in 2016, considering the trade largely played out,” Cavanagh explains. “Now looking onto 2017 we believe prices will be driven upward by the expectations of economic growth.”
Two sectors in particular stand out. “The first one is the banks,” he says. “Private loans are only 14 percent of GDP and could double in five years. Banks are reasonably capitalized, asset quality is strong and ready to grow.”
The second is energy. “Over the past 15 years, electricity and natural gas tariffs were artificially kept low. Investment in the electricity sector has been well below what was required to sustain minimum quality levels, less so to support growth,” he observes. “Aided by low prices, natural gas consumption skyrocketed — during winter people opened the windows to reduce the heat!”
Argentina imports 20 to 30 percent of the natural gas it consumes even though it sits on one of the largest unconventional natural gas resources in the world, he notes. “There is a phenomenal potential for investment, growth and rising profit margins,” Cavanagh insists.
On the fixed-income side, “sovereign yields are still substantial,” the team leader says. “Bonds yield 3 percent in dollars for a three-month duration note and 6 to 8 percent for durations between three and ten years.”
Predictability is in high demand in times of economic uncertainty. “Post-Brexit there was a grab for duration in emerging markets, including Latin America. The key driver was a push out of Fed hiking expectations,” observes Dirk Willer, who guides his Citi team from runner-up all the way to first place in Local Markets Strategy. “Even with the renewed stronger data flow out of the U.S., we think that a Fed hike is unlikely before December, keeping duration supported. Latin America is well positioned on the duration front because it is the region that has seen some aggressive hiking cycles, which will have to be unwound.”
Willer and his associates are directing clients toward markets where monetary easing is likely to begin. “We recommend therefore to be long bonds in Brazil and are also overweight duration in Colombia,” the New York–based strategist says. “We continue to dislike Mexico. Additional weakness of the Mexican peso is likely going into the U.S. election, and this will likely trigger more hikes.”
And that could have a positive impact on Mexican banks, according to Domingos Falavina, who directs the J.P. Morgan squads that celebrate a fourth straight year in first place in Financials/Banks and a second successive victory in Financials/Nonbanks.
“Fears of rising inflation in certain countries, or actual inflationary pressure in others — usually as result of currency depreciation — are the main drivers of Latin America’s high rates when compared to historical averages,” he says. “Banks in Mexico benefit the most from higher rates, in our view.”
Recommended names include Grupo Financiero Banorte and Grupo Financiero Santander México, on the belief that the central bank’s rate increases over the past year should be supportive of earnings.
In addition, “we recommend investors keep an eye in Brazil, as minor signs of macroeconomic improvement could ease concerns about asset quality and drive shares to outperform,” the São Paulo–based analyst says. “We believe Itaú Unibanco to be a good alternative to benefit from a potential decrease in provisioning levels while not taking excessive capital adequacy risks associated with Basel III implementation.”
Stocks to avoid include Bancolombia, owing to “recent fast growth potentially hurting asset quality and the overall fiscal situation in Colombia, as result of the decrease in oil prices,” Falavina cautions, and Chilean banks in general, as decreasing inflation is likely to create headwinds on net interest income growth.
Rising prices and lackluster demand have prompted the J.P. Morgan squad helmed by newcomer Pedro Leduc and Andrea Teixeira, which rises from second place to first in Food & Beverages, to turn cautious on the sector.
“Food inflation is likely to continue picking up as processors try to pass through commodities- and forex-driven higher costs,” affirms Teixeira, who also leads the No. 1 team in Health Care (with Joseph Giordano) and the No. 2 team in Retailing. “The impact on listed food stocks varies according to demand conditions in their specific countries, as well as industry specifics — brand strength, market share, competition rivalry, product profiles.”In Brazil, for example, food prices have not kept pace with cost increases thanks to an adverse demand scenario, she says, so companies have been facing margin losses for almost a year. In Mexico, however, there is adequate demand to absorb higher prices, but the analysts are increasingly cautious going into the second half of 2016. Top picks include Gruma, a maker of corn flour and tortillas, and poultry producer Industrias Bachoco.
“We urge investors to avoid bottlers,” the New York–based leader adds. “A negative theme in beverages is the potential tax increase on sugary drinks, as happened three years ago, and the risk of a concentrate price increase for Coca-Cola bottlers ahead of the ten-year anniversary of the concentrate negotiation.”
Another industry undergoing change is telecommunications, according to Gregorio Tomassi, who with Susana Salaru manages the Itaú troupe that vaults from runner-up to reclaim the top spot in Technology, Media & Telecommunications.
Telecom names are “poised to recover from a recent profitability trough,” Tomassi believes. In recent years regulation has been a key driver of increased competition, he says, but “we believe the pressure going forward will not be as strong as it has been.” A regulatory-driven drop in mobile termination rates is already having an impact, the Mexico City–based analyst notes, by lowering competitive barriers built on disproportionately large mobile traffic shares. “It also forced both smaller and larger players to redirect commercial strategies, as some traditional segment-specific service models became unprofitable overnight,” says Tomassi, who also oversees crews that earn runner-up spots in Equity Strategy and Mexico. “Additional measures introduced in countries such as Mexico, Chile, Colombia and Peru eliminated what had been traditional revenue streams and also boosted competition, including opening the door for new entrants.”
Stocks to watch include Chile’s Empresa Nacional de Telecomunicaciones, or Entel, and Telefônica Brasil.
The latter outfit “has been capturing a roughly 50 percent share of mobile-postpaid growth while pricing its plans at a premium, and we expect that its reputation as a superior-quality data-service provider will be bolstered by the support of [broadband provider] Global Village Telecom’s network,” says Salaru, who also works out of Mexico City. “Despite our current neutral recommendation, we believe that Telefônica Brasil could benefit from optionalities that include an eventual update to fixed-line regulations and a more supportive competitive landscape, which could arise from market consolidation.”
Entel “is aiming to grab a sustainable share of the Peruvian mobile market,” Tomassi says. “This bold step outside its home market forced us — analysts and investors — to extend the forecast horizon when developing an opinion on the company’s valuation.”
The range of scenarios is much wider than for companies in more organic growth stages, he adds, and the more positive ones — which the researchers believe are likely to materialize — are not priced in yet. “While the challenges are still considerable, the rewards for investing in Entel can also be high,” he attests.
The same can be said about buying shares of Latin American power companies, according to Maria Carolina Carneiro, leader of the Santander team that rockets from runner-up to first place in Electric & Other Utilities. “We see new auctions with reasonable returns taking place in the next quarters, assets for sale — mergers and acquisitions — in the region and a better trend for volumes and prices in Brazil,” the São Paulo–based crew captain says. Recommended names include power generators AES Tietê Energia (formerly Cia. Brasiliana de Energia) and Cia. Energética de Minas Gerais, both of which are headquartered in Brazil, and Argentina’s Pampa Energía, an electricity distributor. All three should benefit from cost-cutting initiatives as well as falling interest rates, she advises.
On the other hand, “we believe some Chilean names like Colbún are more exposed to uncertainty regarding price trends, and we see downward pressure as a result of high competition and lower demand growth,” Carneiro adds. Brazil’s Tractebel Energia “is a good company with a sound balance sheet, but we believe its current valuation implies limited upside.”
The 2016 Latin America Research Team reflects the opinions of more than 900 buy-side analysts and money managers at some 450 institutions that oversee an estimated $337 billion in Latin American equities and approximately $304 billion in Latin American debt.
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