Corporate bond issuers in Brazil face a shifting backdrop and careful bottom-up selection is becoming increasingly key. However, opportunities abound for active investors, not least in the field of green commodities, according to Alan Siow, Co-Head of EM Corporate Debt, and Kevan Flynt Salisbury, Analyst at Ninety One, as they outline in the following analysis.
The Brazilian corporate credit market is one of the largest in the world, and the biggest in Latin America. Despite its well-developed nature, this is an increasingly diverse investment universe. A recent field trip confirmed the importance of active selection in this market, especially in the context of dynamics that are reshaping the corporate landscape and that, in time, will result in clear differentiation between winners and losers. As a result, a rigorous assessment of underlying fundamentals remains a clear imperative. Here are four key themes to look out for.
Theme 1: The varied impact of tariffs on corporate profitability
One issue that was raised by several companies, particularly commodity exporters, was the negative impact of subsidised manufacturing exports from China. For instance, the ‘dumping’ of cheap steel supply is clearly denting some Brazilian companies’ profitability, prompting calls for an increase in tariffs on Chinese imports. Brazil’s authorities appear reluctant to take any action that may put upward pressure on local inflation, but some companies have been more successful than others at pleading their case, e.g., petrochemical company Braskem. Braskem expects the recently announced increase on tariffs on resin imports (back up to 20%) to meaningfully increase EBITDA, leading to a significant deleveraging at the company.
Theme 2: Cheap local financing is reshaping the market
Brazil’s local currency debt market is in high demand from local investors, thanks to the current perception of benign domestic fundamentals. As a result, large, blue-chip companies have been able to get significantly cheaper financing in local currency compared to global dollar markets on a FX-hedged (i.e. Brazilian real-equivalent) basis. The upshot: US dollar-denominated issuance has fallen, and we expect issuers in this market to be increasingly bifurcated into two categories: large companies with US dollar-denominated revenues looking for size or duration that local markets cannot absorb; and potentially vulnerable companies that locals have been unwilling to fund. This polarisation in credit quality of issuers emphasises the need for strong credit underwriting and selectivity when considering the new issue pipeline from Brazilian corporates.
Theme 3: Concerns around government intervention
In a year of municipal elections, there has been growing concern among locals that President Lula da Silva’s administration may once again look to apply political pressure, with state-owned oil company Petrobras considered a likely vehicle for this. Given Petrobras’ huge market presence, it will be important to monitor the situation closely given the potential for second-order effects on other issuers in the sector. With the government discussing a potential increase in its stake of both public and private companies in other key sectors, investors should seek to identify investment opportunities that are not reliant on domestic industries at risk of political interference, or those that could potentially benefit from the government’s support.
Theme 4: The potential to be a sustainability hub
A confluence of factors has helped Brazil to establish itself as the world’s largest and lowest cost sugar producer. Consequently, it is also one of the world’s largest and lowest cost ethanol producer, making Brazil a key producer of sustainable fuels. With hydroelectricity representing a significant portion of Brazil’s grid, Brazilian corporates benefit from a high share of sustainable power generation to power their activities.
Discussions with company management reaffirmed our view that Brazil has the potential to be the hub for the next generation of green commodities. Raizen Fuels is an example of a company that looks set to benefit from this theme given its position as the largest cellulosic ethanol producer globally. Raizen’s ethanol production via its cutting-edge E2G process (second generation ethanol made from sugar cane waste) has reached commercial scale, with its second plant opening earlier in 2024. Over the next four years, Raizen will scale up to producing nearly 700k cubic metres of E2G ethanol, all of which can be sold at a premium as a 100% green biofuel.
A further theme that was discussed during this trip was the export of lithium – an essential component in batteries for electric vehicles (EVs). Since restrictions on exports were removed in 2022, mining companies have been able to increase exploration and lithium production has risen. Crucially, lithium production costs in Brazil are highly competitive on the global stage and the quality of the ore in Brazil potentially avoids the need for chemicals and tailings that other methods rely on and can create environmental concerns for investors. For example, Brazil’s South-Eastern state of Minas Gerais potentially offers one of the highest quality deposits of lithium ore on the planet. The Brazilian lithium opportunity set currently represents one of the few possibilities for integration into global supply chains outside of China, and as such there is significant Western demand.
Conclusion
As bottom-up fundamentally based investors, field research and regular on the ground visits are a key element of our analysis and underwriting of investments. Our recent visit to Brazil underscored the importance of understanding the dynamics of local markets when assessing the future prospects of domestic corporates. Current considerations vary from the impact of tariffs on the profitability of companies, the potential for government interference or support, and the demand for green commodities produced in the country in the context of global supply-chain shifts. There will be winners and losers, and a rigorous assessment of underlying fundamentals is imperative.
