Q2 earnings set to show impacts from sluggish Brazilian economy

. Jul 16, 2019
q2 earnings

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 </span><b>The Brazilian Report</b><span style="font-weight: 400;">.</span></p> <p><span style="font-weight: 400;">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 </span><a href="https://brazilian.report/money/2019/07/11/pension-reform-markets-reactions-bovespa/"><span style="font-weight: 400;">trading at record levels</span></a><span style="font-weight: 400;">. Even after the peak on 106,000 points, there are investors, like AZ Quest’s Walter Maciel Neto, who </span><a href="https://exame.abril.com.br/mercados/falar-que-a-bolsa-vai-a-200-mil-nao-e-maluquice-diz-ceo-da-az-quest/"><span style="font-weight: 400;">believe it could reach 200,000 points</span></a><span style="font-weight: 400;"> within just three years.</span></p> <p><span style="font-weight: 400;">This is because, as usual, markets are pricing-in a future scenario with higher margins, as Mr. Maciel explained to </span><i><span style="font-weight: 400;">Exame</span></i><span style="font-weight: 400;"> magazine. The rationale is that with lower interest rates, the cost of a company&#8217;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.</span></p> <div class="flourish-embed" data-src="visualisation/507206"></div> <p><script src="https://public.flourish.studio/resources/embed.js"></script></p> <p><span style="font-weight: 400;">In other words, markets are cashing in future expectations, rather than present sluggish results. As Terra Investimentos analyst Régis </span><span style="font-weight: 400;">Chinchila concludes, “I don’t see these earnings reports giving another boost to the Brazilian stock market.”</span></p> <p><span style="font-weight: 400;">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.”</span></p> <p><span style="font-weight: 400;">One example is that of </span><a href="https://brazilian.report/money/2019/06/17/petrobras-major-gas-discovery-energy-costs-brazil/"><span style="font-weight: 400;">Petrobras</span></a><span style="font-weight: 400;">. 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.</span></p> <h2>Case-by-case basis</h2> <p><span style="font-weight: 400;">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 </span><a href="https://brazilian.report/money/2019/04/20/china-swine-fever-brazil-beef/"><span style="font-weight: 400;">African swine fever outbreak in China</span></a><span style="font-weight: 400;">, thus increasing export volumes. For Mr. </span><span style="font-weight: 400;">Chinchila, JBS may be one of the best performers, due to the increase in cattle prices and impacts from the supply crisis in China.</span></p> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">“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.</span></p> <h2>Closer look</h2> <p><span style="font-weight: 400;">Mining and steelmaking is a sector that will require closer attention. </span><span style="font-weight: 400;">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. </span></p> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">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 </span><a href="https://brazilian.report/money/2019/07/03/brumadinho-investigation-murder-charge-vale-execs/"><span style="font-weight: 400;">other expenses related to the Brumadinho disaster</span></a><span style="font-weight: 400;">.</span></p> <div class="flourish-embed" data-src="visualisation/507185"></div> <p><script src="https://public.flourish.studio/resources/embed.js"></script></p> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">“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.</span></p> <h2>Long-term bets</h2> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">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.</span></p> <p><span style="font-weight: 400;">Now </span><a href="https://brazilian.report/money/2019/06/04/luxury-homes-brazil-millionaires/"><span style="font-weight: 400;">these companies are starting to react</span></a><span style="font-weight: 400;">. 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.</span></p> <p><span style="font-weight: 400;">“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 </span><a href="https://brazilian.report/newsletters/weekly-report/2019/05/25/e-commerce-shopping-malls/"><span style="font-weight: 400;">shopping mall-related stocks</span></a><span style="font-weight: 400;"> as interesting picks for a lower interest rate scenario.</span></p> <p><span style="font-weight: 400;">For Mr. Arbetman, the sectors that underperform now may also be a good bet if you’re looking at a longer investment horizon. </span><span style="font-weight: 400;">“We believe that sectors like cellulose and energy, although showing a sluggish second trimester, have consolidated companies (&#8230;) that could be considered for a longer-term foray.”</span></p> <p><span style="font-weight: 400;">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 </span><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"><span style="font-weight: 400;">largest profits since 2015</span></a><span style="font-weight: 400;">, at BRL 20 billion.</span></p> <p><span style="font-weight: 400;">“As bank specialists always warn, the </span><a href="https://brazilian.report/power/2019/05/13/brazil-hotspot-fintechs/"><span style="font-weight: 400;">competition with fintechs</span></a><span style="font-weight: 400;"> 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.

 
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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