Global Strategist Jacek Dzierwa has just returned from another research trip to Latin America where he visited Peru, Chile and Brazil. Travel is important for our tacit knowledge because many of the world’s best opportunities aren’t discovered behind a Bloomberg terminal or an earnings report. We venture to visit as many companies as possible before investing in them.
This was Jacek’s first trip to Peru and the country “surprised to the upside.” Another beneficiary of higher commodity prices, Peru has seen a massive improvement in its standard of living in recent years.
The poverty level has declined from a staggering 55 percent in 2001 to 35 percent this year and is expected to fall to 25 percent by 2015. However, there is still much progress to be made. Roughly 71 percent of Peru’s population works in an informal economy, which means they pay no taxes, have no bank accounts and have no access to credit. The size of this informal economy is second only to Bolivia (80 percent) in Latin America.
Peru’s progress is on display in Lima, the country’s capital and largest city. The bustling metropolitan city is home to South America’s main Pacific port (Port of Callao) and several thousand factories and manufacturing plants. Recent growth has pushed the greater Lima’s population over 9 million people.
One annoying side effect of this progress is heavy traffic. According to some estimates, the number of vehicles in Peru today is five times greater than it was a decade ago. That means that there are now 10 cars vying for space on the same roadways where there used to be two. Numerous Asian manufacturers from Korea and China have been big beneficiaries of this growth in demand for cars.
But there is relief on the way. The Peruvian government recently announced a $24 billion infrastructure overhaul over the next three years that should help the country meet its rapidly growing demand. One beneficiary of this infrastructure spending is likely to be Grana y Montero, a Peru-based construction and engineering company that Jacek uncovered during the trip. The firm is highly profitable with its EBITDA (earnings before interest, taxes, depreciation and amortization) margin in the last three years ranging from 16-20 percent. This is way above average for construction projects where EBITDA margins of 6-8 percent are considered good.
Just like in the U.S., it is the busy season for retail shopping in Latin America. Much of Peru’s retail market is dominated by Chilean-owned companies such as Cencosud, which purchased the popular Wong (pictured) chain of stores back in 2008. The Wong family started the company, which is a supermarket grocery story, in their garage and developed it into a great retail business. Many Chinese emigrated from Macau as laborers in the 19th Century and today Peru boasts a 1 million Chinese population (total country population of 28 million) that has been active in its entrepreneurial efforts such as the Wong family.
In Santiago, Jacek met with Chilean-based large retailers Falabella and Cencosud. Both companies operate at higher profit margins than their U.S. counterparts, which partly explain their current hefty valuations. Cencosud aims to have checkout lines no more than three deep–one outlet Jacek visited had 67 cash registers open and each was busy.
Over in Brazil, Jacek made his third trip to the country in the past 12 months. Unfortunately, Jacek’s experience at São Paulo’s Guarulhos Airport was similar to the one we detailed a year ago—On the Ground in Brazil.
The unconfirmed word on the street is that FIFA has warned Brazil that they need to get their act together and improve the country’s infrastructure before the 2014 World Cup or the games will be moved somewhere else. Just a rumor at this point, but it may be the motivation Brazil needs to get going.
Brazil’s equity market has been a major underperformer this year. One reason is the large number of equity offerings coming out of the country, with the largest being the recent $25 billion offering from state-oil company Petrobras.
Brazil also faces an overvalued currency, which puts exporters at a disadvantage. Jacek snapped this photo as an example of how the overvalued Brazilian real affects retailers. Even after a 60 percent discount, this off-brand shirt costs the equivalent of $43, more than what one would pay in the U.S. for some name brands.
On the other hand, Brazilian retailers that sell a wide variety of imported goods can benefit from a stronger currency. In particular, we’re optimistic about Lojas Renner (pictured).
Renner, which is similar to a Macy’s in the U.S., has developed a cutting-edge “Enchantment” policy that asks each customer to take a satisfaction survey before they leave the store. Customers do so by pressing a simple button labeled unsatisfied, satisfied or enchanted. If a customer chooses unsatisfied, an associate immediately engages them to correct their experience.
In 2009, 16.6 million of the 17.2 million customers surveyed selected either satisfied or enchanted. We think this unique customer feedback loop gives the company a competitive advantage over other retailers.
Another thing to keep an eye on is the proposed integration of the Chile, Peru and Colombia stock exchanges to create a joint equities platform. Known as Mila, the joint exchange is currently in a beta testing phase. If approved, Mila could be the capital creation platform Latin America needs to take the next step in development.
We understand that the integration still requires some issues to be resolved before investors can reap the benefits of a larger trading platform. The companies which stand to benefit the most from a higher profile are those that currently fly under the radar of most investors, particularly those in Peru and Colombia.
The following securities mentioned in the article were held by one or more of U.S. Global Investors family of funds as of September 30, 2010: Lojas Renner. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
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