Good behaviour sees rewards

Brazil has been confounding sceptics who doubted its economic robustness with a recent display of vigorous corporate life. Thanks to good economic policy and a dash of luck from its export exposure to commodity prices, the country, which was one of the last to plunge into recession, is now likely to be one of the first out.

Until recently, Brazilian corporate managers were treating the downturn as an opportunity to enhance productivity and contain cost, says Ivan Clark, partner at PwC in São Paulo. Such streamlining puts them in a stronger position as the recovery starts, he says.

The dominant business headline out of Brazil in recent months has been the pre-salt oil discovery, which is set to be as significant as the North Sea discoveries of the 1970s. Brazilian state-oil firm Petrobras is likely to benefit disproportionately from the finds, especially as the government looks inclined to make the company its preferred partner. There are plenty of other Brazilian institutions that will also benefit. They include names such as Lupatech, which supplies industrial valves, and engineering firm Grupo Schahin. “We are just discovering the full range of Brazilian companies involved in this sector,” says Jean-Marc Etlin at investment bank Itaú BBA.

Although overshadowed by the oil and gas sector, it is the financial sector that will act as the harbinger for a wider Brazilian corporate recovery. Fortunately, the legacy is positive: Brazilian banks are naturally timid and were hemmed in by Central Bank regulations so they never expanded leverage to the levels seen in the developed world. Moreover, as the recession progressed, the government was able to enforce measures to encourage banks to lend. It reduced compulsory reserves and pushed state-owned banks to reduce spreads and quickly approve credit.

There are already signs of a return to form in Brazilian credit markets, which were growing at rates of 25 to 30 per cent before the downturn. Regional bank Banrisul, one of this year’s best-performing bank stocks in Brazil, still expects to see 21 to 23 per cent growth in its credit portfolio this year and 25 per cent for 2010. Moreover, the bank has maintained substantial reserves and has the scope to nearly double lending from current levels of R$12bn (US$7bn), according to Ricardo Hingel, CFO – although he says that the bank is unlikely to do so.

The return of credit will help lubricate consumer spending and propel a new set of Brazilian retail companies on to the world stage. Companies such as cosmetics companies Natura and household goods retailer Hypermarcas are likely to step up foreign expansion plans. These retailers will complement the existing clutch of Brazilian multinationals, mostly drawn from the extractive sector, says Mr Etlin. Some eight to 12 established Brazilian multinationals, while not yet household names, are on the radars of investors worldwide, he notes. They include miner Vale, Petrobras, and steel companies such as Gerdau.

Mr Etlin predicts that as well as retailers the next five years will see the emergence of a new group of companies in natural resources. They will benefit from the wider global recovery and Brazil’s advantages in minerals as well as the sheer size of its fertile land. These companies will make themselves felt in sectors such as paper and pulp, sugar and ethanol, soy and coffee, he believes. Already, beef producers such as JBS Friboi are among leaders in their field.

Brazil is even defying naysayers who see the labour market and bureaucracy as inflexible and likely to crimp recovery. Aircraft manufacturer Embraer, which depends on funding from the state-owned National Development Bank, cut its 21,000 workforce by some 4,000 in the midst of the recession. Initially, that attracted tremendous political flak, but after meetings between politicians and executives, the fuss died down.

In spite of the good news, navigating the next few months will not be smooth sailing. In particular, companies harmed by derivatives exposure, such as pulp producer Aracruz and processed food maker Sadia, will suffer a long period of recuperation, says Mr Etlin. Still, Mr Clark points out that the crisis galvanised CVM, the market regulator, to insist on greater disclosure of exposure to financial instruments. That should bring some sunlight into what has been a murky area, he says.

Some sectors have been hurt by hubris. The sugar and ethanol sector drew in too much investment and some companies became heavily leveraged. That has proven to be a nasty legacy in the downturn and some companies are in the equivalent of bankruptcy court. Yet, even here, there are signs of improvement with sugar prices rising to the highest in nearly 30 years.

A final issue that could trip up corporate recovery is the presidential election, expected in October. It is bound to cause market uncertainty even though the two leading candidates are unlikely to change economic or industrial policy significantly.

In the past, the Brazilian economy and corporate sector were mauled by every passing global crisis. This time Brazil is escaping relatively unscathed.

That should have two positive effects. It should fundamentally alter the perception of risk, making investment cheaper, while also giving Brazilian companies a substantial headstart as the global recovery gains ground.