Not financial advice, full disclaimer available here.
Brazil is the 12th largest economy in the world, the 4th in emerging market (EM) and the 1st in Latin America.1 Yet, the MSCI All Country World Index only has a 0.56% allocation to the country.2 So it’s really easy to overweight Brazil in a portfolio if you are bullish.
For EM investors, the benchmark has a 5.05% exposure to Brazil.3 That’s much higher. But do you really want to mirror the index? I don’t, because it has 20% invested in information technology and 32% in China. Taiwan Semi and Samsung are great companies, but the market knows that and other sectors are likely to outperform.
10 years ago, energy accounted for 10.7% of the world’s total stock market cap.4 In 2022, the sector made up 4.4% of the index. It has lost even more investment dollars in emerging markets, since they have underperformed for the last decade. Brazil’s Petrobras, a leading integrated oil supermajor, used to be one of the most valuable companies in the world!
The table below shows the 10 largest companies by market cap, back when EM and commodities were all the rage:
Petrobras currently has a market cap of ~$62bn and clearly is not one of the “top dogs”, as Research Affiliates puts it. Brazil is out of favor, so is China and its largest oil company.
However, Petrobras earned $36bn in net profits in 2022. That’s more money than Amazon or Nvidia ever made in a year (2 of the top dogs right now, with valuations in the hundreds of billions). So the market’s perception differs from fundamentals. Tech remains overly popular while investors’ sentiment is very pessimistic when it comes to Brazil and Petrobras.
Here are the sector weights for Brazil:
That’s a much more attractive mix than other indices for the 2020s. Energy is 16.61% of the Brazilian stock basket versus 5.13% for the world and 4.71% for emerging markets.5 Materials is 25.28% against 5.4% for the world and 8.78% for EM. Plus, investors get virtually no tech exposure and very little consumer discretionary (the first thing people cut in inflationary times).
Brazil has 2 national champions which drive sector performance for energy and materials: Petrobras and Vale. So you’d expect to find these companies in global ETFs such as FILL (energy) and MXI (materials). They are in there. But even if you put 25% of your portfolio in each one, your exposure to PBR and VALE would be immaterial.
How about investing 5% of a portfolio in the country ETF? In this case, the weight of PBR would be 0.62% and Vale 0.94%.6 That's more than the sector ETFs but these are still small positions. Long-term options are available on both stocks to increase exposure as the investor sees fit. The downside is that you forgo dividends, which are massive in the case of Petrobras.
Is the dividend safe? The reason PBR is so cheap is because of political risk. Investors worry about their property rights, government stability and taxation. These are legitimate concerns. Brazil just experienced a change in government which has led to significant conflict and could negatively impact the country’s economy.
My question to western investors is this: how is that different than what’s going on at home? For example:
Bolsonaro contested the results of the elections, leading to huge protests. Sounds a lot like the US, doesn’t it?
The Brazilian government keeps changing the leadership at Petrobras. How many times has the UK changed prime minister recently?
Lula wants Petrobras to invest in renewables. The EU has been pouring money into uneconomic ESG projects for years.
Brazil has not picked a side in the Ukraine war. Switzerland has.
So political risk is everywhere. Maybe having a few chips in Brazil is not such a bad idea after all. In fact, it’s a way to diversify.
The investment community generally prefers to see the right in power than the left (capitalism over socialism). But western world leaders wanted to Lula to win. Macron and others were quick to congratulate Lula after he became president once again. The mainstream media also portray Bolsonaro as the bad guy.
This is good news if you hold a western passport because it means that your government gets along with that of Brazil. Can’t say the same thing about Russia. Besides, investing in a cheap socialist market (Brazil) can be more profitable than an expensive capitalist one (US).
It’s a question of rate of change as well. The west is arguably moving left faster than the rest of the world because it’s starting from a lower base. Relatively speaking, Brazil is not getting worse. Yet, it is pricing in much more political risk than other stock markets. Check out this post for a discussion on expected returns.
Lula is in office now and state-controlled Petrobras is still paying dividends, despite the president complaining about it. Investors forget that politicians in emerging countries face constraints too. Brazil has a senate and a congress, it’s not north Korea! Brazil was under dictatorship until 1985; should Lula or another get crazy, the people won’t take it.
Politics aside, the dividend payout is extremely high. Petrobras paid $37.7bn to shareholders in 2022! That’s 75% of operating cash flows and 3.9 times CapEx. If the dividend gets cut by 80%, it is still a nice yield. The next ex-dividend date is April 28th and the amount is R$ 2.75 per share, which is more than a 40% annualized yield for common (R$ 26.36) and preferred shares (R$ 23.31). See footnotes for more details.7
The stock is basically priced for ruin in the next 3 years. This is not happening unless the government goes full-on retard, which is improbable. So I like Petrobras and I believe my portfolio is better off with Brazil than without.
MSCI: emerging market index
MSCI: ACWI all cap index
Data based on Blackrock's ETF which tracks the MSCI Brazil index. Ticker: EWZ 0.00%↑ | FLBR 0.00%↑ from Franklin Templeton has lower management fees and tracks the FTSE Brazil Capped Index
Petrobras trades in New York under the tickers PBR and PBR.A for common and preferred shares, respectively. Here is the shareholding structure:
And the earnings per share for the last 3 years:
PBR 0.00%↑ closed the week at $9.99 and PBR.A at $8.83 on March 17th, 2023.
Click here for more information on the upcoming dividend, and here for the dividend policy.
Good write up, and spot on about any cut to the dividend. Even if forced to spend more on renewable and ESG boondoggles, plus cur the dividend by 70% and you're STILL in double digit yield.