When it comes to investing in emerging markets, Brazil is often mentioned as one of the most appealing countries. This is for good reason -- its population of more than 200 million represents one of the world's largest markets. Better yet, years of economic growth under the rule of president Luiz Inacio Lula da Silva have brought an estimated 20 million citizens out of poverty and millions more into a middle class.
Economic growth is driving an emerging class of consumers that buy goods and open bank accounts. Brazil is also rich in natural resources and many of its companies have grown into global leadership positions as they export oil and precious metals to other fast-growing emerging markets.
Given these themes, here are three stocks that offer a compelling mixture of operational savvy and reasonable valuations for investors to profit.
1. Petrobras (NYSE: PBR)
Business: Integrated Energy Giant
Energy behemoth Petrobras is arguably Brazil's preeminent blue chip company. Petrobras is effectively controlled by the government, as it is the largest shareholder. This relationship has provided Petrobras with an essentially limitless capital capacity that allows it to fund oil exploration activities and the construction of large oil production and refinery facilities. Its existing four-year plan calls for almost $175 billion in infrastructure investment.
An investment in Petrobras looks compelling right now. Global uncertainty and volatile oil prices have pushed the shares toward their lows for the year. At current levels, the forward price-to-earnings (P/E) ratio is only about eight and is well below the low double-digit levels of the past couple years. This is a very reasonable entry point for investors, given the ambitious growth targets. It's also worth noting that Petrobras is the largest firm in Brazil, and as such it drives much of the value of Brazilian stock indexes. This makes it a must-own in the country -- at the right price.
2. Vale S.A. (Nasdaq: VALE)
Business: Basic Metals Mining
Vale is another national champion and bills itself as the second-largest mining firm and largest iron ore miner in the world. Growth in emerging markets, which includes its Brazilian home as well as rapidly-growing countries such as China, is the main driver of Vale's fortunes and means extremely ample profit opportunities.
Vale is one of the 30 largest public companies in the world. The company operates primarily in Brazil but also has sizable operations in Canada. It has long-life and low cost assets in the ground that it exports across the globe -- 50% of sales stem from Asia, while about 20% of the top line stems from Europe and South America. International diversification helps stabilize operations, though demand for its products does fluctuate with global construction activity.
Shares of Vale are bumping up against their highs for the year but still trade for a reasonable forward P/E below 11. The current dividend yield is respectable at 1.4%, but investors should be interested in Vale's ability to grow along with emerging markets for many years to come.
3. Banco Itau (NYSE: ITUB)
The final pick is a play on domestic Brazilian demand. Banco Itau, along with Banco Bradesco (NYSE: BBD), are the two largest banks in Brazil. After years of dealing with hyperinflation in the economy before the country found a path to stable growth, Brazilian banks have developed some of the most sophisticated technology systems on the planet. This coupled with a growing consumer market for bank loans, checking accounts, and related financial services activities makes the industry very compelling overall.
Headquartered in Sao Paulo, Banco Itau provides commercial and corporate banking services to individuals and businesses throughout Brazil. Recent returns on equity (ROE), an important measure of banking efficiency and profitability, have been stellar at around 20%. This qualifies it as one of the country's most profitable banks. Size matters in banking as well, and this favors Banco Itau, as it can transact business at lower price points to keep earnings coming in.
Again, Banco Itau's forward P/E is reasonable at below 14. This may be higher than U.S.-based investors may be accustomed to paying for banks, but they don't have to worry about things like the U.S. housing bust in Brazil. Banco Itau is also growing rapidly -- during the past three years sales have grown more than +30% annually, while earnings have grown nearly +20% in each of these years. This growth is worth paying up for, especially if it continues at a similar pace.
Action to Take ---> Emerging markets are safest when focusing on the largest players in the space. As with Petrobras, Vale and Banco Itau, size has its advantages. In the first two cases, the firms have been able to dominant Brazilian positions into global leadership roles in their respective industries. Banco Itau will continue to benefit from domestic growth as more Brazilians are lifted up out of poverty and into the middle class. Shares of any of these companies should be considered a compelling buy.