Q2 earnings set to show impacts from sluggish Brazilian economy

Natália Scalzaretto . Jul 16, 2019

We are half-way through 2019 and, for companies and investors, it is time to assess earnings once again. But, with official estimates projecting a 0.81 percent growth for the year, the picture of a strong economic recovery painted in January seems a distant memory. And this grim perspective will probably be starkly exemplified in Q2 earnings.

According to Pedro Galdi, stocks analyst at Mirae Asset, the next earnings season in Brazil is set to show “a very similar trend to Q1, with lackluster results due to the overall scenario.

The economy is still stalling and you can’t expect companies dependent on the domestic market to perform so well, even if there will be some exceptions here and there,” he told The Brazilian Report. The signals about the real economy differ substantially from the optimism seen in the markets over the past few weeks. With the expected passing of pension reform, more balanced public accounts are on the horizon. The Ibovespa stock market index has been <a href="https://brazilian.report/money/2019/07/11/pension-reform-markets-reactions-bovespa/">trading at record levels</a>. Even after the peak on 106,000 points, there are investors, like AZ Quest’s Walter Maciel Neto, who <a href="https://exame.abril.com.br/mercados/falar-que-a-bolsa-vai-a-200-mil-nao-e-maluquice-diz-ceo-da-az-quest/">believe it could reach 200,000 points</a> within just three years. This is because, as usual, markets are pricing-in a future scenario with higher margins, as Mr. Maciel explained to Exame magazine. The rationale is that with lower interest rates, the cost of a company’s debts will fall; and since many enterprises went bankrupt in the 2015-2016 recession, there’s less competition. The remaining companies are leaner, more resilient and ready to profit. <div class="flourish-embed" data-src="visualisation/507206"></div> <script src="https://public.flourish.studio/resources/embed.js"></script> In other words, markets are cashing in future expectations, rather than present sluggish results. As Terra Investimentos analyst Régis Chinchila concludes, “I don’t see these earnings reports giving another boost to the Brazilian stock market.” Ilan Arbetman, an analyst with Ativa Investimentos, echoes this vision, adding that, for this period, investor’s eyes will be turned toward future moves. “Players will analyze companies’ strategies, mostly focusing on cash flow and inventories, for late Q3 and early Q4 when the market may be more active.” One example is that of <a href="https://brazilian.report/money/2019/06/17/petrobras-major-gas-discovery-energy-costs-brazil/">Petrobras</a>. Both Mr. Galdi and Mr. Chinchila see slightly positive results, but the highlights mostly concern the continuity in the company’s strategy. “We are waiting to see more about asset selling and debt reduction, which has been gradual, and maybe a little slow,” said Mr. Chinchila. <h2>Case-by-case basis</h2> As Mr. Galdi explains, not every sector will have slowed down in the second quarter. Meatpackers, for example, might have felt the influence of the <a href="https://brazilian.report/money/2019/04/20/china-swine-fever-brazil-beef/">African swine fever outbreak in China</a>, thus increasing export volumes. For Mr. Chinchila, JBS may be one of the best performers, due to the increase in cattle prices and impacts from the supply crisis in China. However, both analysts see other commodities suffering from the impacts of the global slowdown. Among the sectors that may feel the blow are paper and cellulose. For retail, which is very connected to domestic consumption, the projections are soft to neutral, though analysts believe that better-positioned players may show satisfactory performances. “We are seeing Via Varejo’s recovery. Their 2019 first quarter was already better than 2018’s fourth quarter and I believe it will continue into the second quarter. We also back the top players, like Lojas Renner and Magazine Luiza,” says Mr. Arbetman. <h2>Closer look</h2> Mining and steelmaking is a sector that will require closer attention. After the January 25 Brumadinho disaster affected Vale’s production, the global benchmark iron ore prices jumped 61 percent, due to reduced supply by the world’s largest iron ore mining company. For steelmakers—like Usiminas—the surge in their basic inputs price is bad news; the company is also very dependent on the local market and may suffer from the sluggish domestic economy. On the other hand, CSN, Brazil’s second-biggest ore exporter, is surfing the iron ore rally; the company’s stocks have risen 85 percent in 2019. Analysts believe the positive momentum will be reflected in the earnings report. Vale itself is a tricky case. Mr. Galdi believes that operational results may be strong, due to iron ore prices, but the actual earnings will be a surprise, depending on penalties and <a href="https://brazilian.report/money/2019/07/03/brumadinho-investigation-murder-charge-vale-execs/">other expenses related to the Brumadinho disaster</a>. <div class="flourish-embed" data-src="visualisation/507185"></div> <script src="https://public.flourish.studio/resources/embed.js"></script> This uncertainty is also taking a toll on the stocks. Though they are positive on the year, many believe the jump in iron ore prices is not yet cashed in. Mr. Chinchila thinks that this discount reflects eventual risks still connected to the disaster. “Vale should be trading at higher prices if you consider iron ore only, but the market has priced in other risks, like further penalties. It is an opportunity, but you have to be aware that there may be volatility depending on the news,” he said. <h2>Long-term bets</h2> One of the hottest sectors in the Brazilian stock market is real state. Imob, a B3 index focused on the sector, has already risen 30 percent this year, while Ibovespa, the benchmark, is up 14 percent in 2019. This is because the construction business, one of the hardest-hit areas during the recession years, is slowly, though consistently, recovering. While government housing programs like Minha Casa Minha Vida have helped lower-income players, such as MRV, middle-income homebuilders, like Cyrela and Even are more reliant on middle-class consumption, which had stalled. Now <a href="https://brazilian.report/money/2019/06/04/luxury-homes-brazil-millionaires/">these companies are starting to react</a>. For example, Even has reported a 20 percent Sales Over Supply (VSO) ratio in their Q2 preview, the best since 2013. But better may be yet to come: middle-income homebuilders have lower property inventories and lower interest rates on the radar. “Perhaps this sector will show the best results of the season. Some stocks are already showing good results, as operational data are set to be strong”, explains Mr. Chinchila, who also sees <a href="https://brazilian.report/newsletters/weekly-report/2019/05/25/e-commerce-shopping-malls/">shopping mall-related stocks</a> as interesting picks for a lower interest rate scenario. For Mr. Arbetman, the sectors that underperform now may also be a good bet if you’re looking at a longer investment horizon. “We believe that sectors like cellulose and energy, although showing a sluggish second trimester, have consolidated companies (…) that could be considered for a longer-term foray.” On the other hand, the banks—some of Ibovespa’s strongest blue chips—may show some early signs of increasing competition after an overwhelmingly good Q1. Together, Itaú Unibanco, Bradesco, Banco do Brasil and Santander Brasil had their <a href="https://g1.globo.com/economia/noticia/2019/05/09/lucro-dos-maiores-bancos-do-brasil-cresce-22percent-no-1o-trimestre-e-soma-r-20-bilhoes.ghtml">largest profits since 2015</a>, at BRL 20 billion. “As bank specialists always warn, the <a href="https://brazilian.report/power/2019/05/13/brazil-hotspot-fintechs/">competition with fintechs</a> is not something to worry about right now, but I do see some competition effects showing up in this quarter already. They will have to respond to it,” projects Mr. Chinchila.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Most recently, worked as an Editor for Trading News, the information division from TradersClub investor community.

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Natália Scalzaretto