Latin American Stocks Offer Elevated Risk, Enhanced Return (VALE, SQM, BVN, GGB, TSU, EEM)
Joseph Hogue: While investment in regional funds and country-specific ETFs can help investors gain exposure to the strong growth drivers in Latin America, a selection of individual equities will further enhance portfolio return.
Many Latin American countries allow foreign investors to establish accounts and directly purchase locally listed shares, though here we will restrict the analysis to the universe of American Depository Receipts (ADRs) or foreign shares that trade on the American exchanges.
These shares are typically of much larger companies and the increased regulatory requirements for listing in the U.S. provide another layer of protection for investors. Stocks with ADRs often have an advantage over other local companies because they have greater access to world capital markets for cheaper funding.
Screening and selecting foreign companies listed on the U.S. exchanges is only marginally different than selecting securities of U.S. companies.
However, political cycles influence stocks more in Latin America than in developed markets. Investors should hedge this by investing in the stocks of several countries and only in those with relatively stable and business-friendly political-environments.
Of the most active markets in Latin America; Chile, Colombia and Mexico have the most investor-friendly political climates while Argentina, Brazil and Peru present varying levels of political risk.
The share price of ADRs will be affected by exchange rates of the underlying currencies. This can be hedged in the currency markets, but is usually not necessary for most investors. Including shares of companies based in various currencies will partially offset the currency volatility experienced from any one country.
Additionally, exposure to emerging market currencies will reduce the effects of the long-term downward trend in the U.S. dollar, and help to protect the purchasing power of the investor.
A few of the most liquid names to consider:
TIM Participacoes (NYSE:TSU) is a mobile telecom provider with a theoretical reach of 94% of the urban population in Brazil.
The company is the market leader through large sections of the country with a market share of 25.5%, providing 100% digital services in TDMA and GSM technologies. The twelve-month trailing price-to-earnings is lower than competitors at 7.2 and the stock pays a dividend yield of 2.9%.
Though EBITDA growth is expected to decline to around 12% going forward, extent of coverage across the country gives the company cost advantages over competitors. Overall mobile subscriber growth stood at 17% in 2011 from a year ago but may slow in the future as the market approaches saturation. The primary risk to the investment is through increased competition from fixed communications providers as consolidation between the fixed and mobile markets continues.
Gerdau (NYSE:GGB) is a Brazilian-based producer of long rolled steel with mills in Brazil, India, Mexico, Guatemala and the United States.
Industry and market weakness this year have left the stock with a price-to-earnings ratio of 11.1 and a price-to-book just over par. Brazil has a relatively protective steel industry so Gerdau should benefit from the increased infrastructure spending leading up to the World Cup and the Olympics. Revenues are exposed to the sluggish commercial real estate market in the U.S. but will benefit from the eventual rebound.
Vale (NYSE:VALE) is a Brazilian mining company with operations in 38 countries and logistics operations like railroads and ports in Brazil.
The company derives about half of its value from iron ore, with another fifth from nickel and the remainder from other minerals and metals. Revenues in the last quarter increased 16% as production rose, though depreciation in the Brazilian real caused net profits to fall. The company has lower production costs and above average operating margins relative to the industry.
Down almost 26% since July, operational profitability should help it rebound strongly when the global economy strengthens. Vale trades for just 5.1 times price-to-earnings and pays a dividend yield of 1.6%. China accounts for 35.4% of revenue, so while it should benefit from higher emerging market growth, it is also closely tied to the already overheating Chinese real estate space.
Sociedad Quimica Y Minera de Chile (NYSE:SQM) is a Chilean chemicals manufacturer operating in four segments: specialty plant nutrients and fertilizers, iodine derivatives, lithium and industrial chemicals.
The company has operations in every continent and its products are distributed in more than 110 countries. Though its current price-to-earnings ratio of 33 makes it the most expensive in the industry, the company controls its expenses better than its peers and has a net profit margin of 22.5% and a return on equity of 26.7%.
The company is a leader in fertilizers and industrial chemicals and should benefit from the strong growth in agricultural products going forward. Risks lie in volatility of prices for core products such as fertilizers.
Minas Buenaventura (NYSE:BVN) is a Peru-based mining company operating mostly in the gold and silver segment.
The stock has been volatile this year, first falling 18.8% on the election of leftist President Humala, then rising 32% on strong gold prices before coming down with the rest of the market.
Though Humala has proven to be more market-friendly than feared, mining is a large share of the Peruvian economy and the risk of increased royalties is possible. A positive outlook for the Peruvian economy should dilute fears somewhat and increased demand for gold as investment and jewelry will drive revenue.
The stock currently trades for 13.2 times price to earnings, lower than 72% of its competitors, and has a net profit margin of 67%.
Though the selection of stocks above produce different products, exposure is largely in two industries: basic materials and telecommunications. These industries should do well going forward but investors should also seek to take advantage of growth in consumer demand as well.
Financial stocks should do well as Latin American consumers become more accustomed to using credit and other financial products. A strategic investment in diversified regional funds should comprise the bulk of an investor’s Latin American exposure with a few well-placed picks of individual companies.
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