Banco Itau: Cashing In on Brazil's Growth

Last week, I wrote about Petrobras (NYSE: PBR  ) , recommending that investors take a long look at the Brazilian energy behemoth because -- among other things -- the company stands to benefit from the strong growth of the Brazilian economy, an economy that's expected to expand by around 3.7% this year and a further 4.5% to 5% in 2007.

Yes, that wasn't a misprint ... in the face of rising global interest rates, high oil prices, and concerns about a global economic slowdown, Brazil's economy is powering ahead. In a situation that financial pundits must feel is right out of Lewis Carroll's Alice's Adventures in Wonderland, Brazil is benefiting from two positive economic developments that run completely counter to global trends: declining domestic interest rates and slowing inflation.

That's why I believe that investors should increase their exposure to this revitalized emerging market and take a gander at Brazilian banking giant BancoItau (NYSE: ITU  ) , a company that stands to profit nicely as the overall strength of the Brazilian marketplace generates robust demand for credit.

Before jumping into Banco Itau's specifics, let's first take a look at the Brazilian economy in general.

Brazil's economy
As I stated previously, the Brazilian economy has had some beneficial tailwinds propelling it. Of course, it goes without saying that these improvements are all relative. After all, Brazil remains an emerging market and a country that hasn't exactly been known for its economic or political stability. (Remember the devaluation of the real in 1999 or the endemic corruption scandals?)

Take interest rates, for example. The Brazilian Central Bank has cut rates by a whopping 500 basis points over the past 14 months, yet that has brought overnight rates down to only 14.75% -- still a mind-bogglingly high number but the lowest levels in more than two decades.

Similarly, inflation has been slowing markedly with the Broad Consumer Price Index (IPCA) growing at an annualized rate of 4% in June -- a rate that would turn Fed Chairman Ben Bernanke's hair white -- but down from more than a 7.6% clip back in 2004, and at the lowest pace since 1998.

I know, I know ... these numbers seem frightening to U.S. investors fretting about the possibility of domestic interest rates hitting 5.5%, but Brazil's consumers, for one, certainly see it differently. According to a recent report by Brazil's National Federation of Industry (CNI), consumer demand is expected to grow by 4.5% in 2006 and by more than 5% in 2007.

Other snapshots of the economy paint an equally rosy picture. The government just reported that exports hit a record $13.6 billion in July, bringing the year-to-date trade surplus to more than $25 billion. Foreign direct investment (FDI) also is robust, as Brazil is expected to receive inflows of approximately $17 billion in 2006, up from a mere $10.1 billion in 2003. The country's currency -- the real -- remains stable and the nation's debt burden is actually starting to shrink -- albeit from high levels.

Hmmm, increasing consumer demand, rising exports (and hence the need for companies to expand capacity), growing foreign investment, and a stable currency ... sounds like a banker's paradise, right?

BancoItau
Banco Itau, formally known as Banco Itau Holdings Financeira, is the second largest private bank in Brazil with roughly $77 billion in assets (after the BankBoston acquisition), trailing only archrival BancoBradesco (NYSE: BBD  ) .

The company primarily operates through three divisions: Banco Itau BBA in corporate banking, Itaubanco in traditional retail banking, and Itaucred, which targets the low-income consumer. The combined businesses boasted a domestic client base of more than 12 million active customers at the end of 2005, serviced by close to 2,400 branches and more than 22,000 ATMs. According to Banco Itau, 85% of its branches are located in the country's relatively affluent southeastern region, an area that accounted for 55% of Brazil's GDP in 2005.

Banco Itau's traditional strength has been its leadership position in corporate banking and wealth management, a position it further strengthened with its recent agreement to acquire Bank of America's (NYSE: BAC  ) Brazilian operations in an all-share deal worth about $2.2 billion. In simple terms, Banco Itau gets a business -- focused on high-net-worth individuals and corporate clients -- with $11 billion in assets and a fund management portfolio valued at $12.4 billion, and Bank of America gets a 5.8% stake in the enlarged company.

Not a bad deal in my book, especially since Banco Itau expects the acquisition to be accretive to earnings starting in the second half of this year, has exclusive rights to acquire Bank of America's operations in Chile and Uruguay, and now has a strategic investor (there's a three year lock-up on the issued shares) with some serious financial muscle.

While this acquisition is certainly going to be a key driver of growth in the future, Banco Itau should also benefit from continued strength coming from other parts of its operations. For example, the company continues to see rapid growth from its joint-venture with CRB -- Brazil's largest retailer -- which offers financial services through CRB's stores to low-income consumers. Automobile loans and financing are another area of strength, with Banco Itau reporting that vehicle loans jumped 72% in the most recent quarter and that it now had a 21% share of that rapidly growing market.

Did I mention that Banco Itau is now the leading issuer of credit cards in Brazil, with 12.8 million cards outstanding and roughly $7 billion in billings as of June, 2006? That ties in rather nicely with the company's purchase of Orbitall, Brazil's leading credit card processor, back in late 2004.

I could go on, but you get the point. Banco Itau has many irons in the fire, and all are shaping up nicely. Of course, rapid growth doesn't always equal sustained profitability, but one look at Banco Itau's metrics proves that the company is keeping its house in order. In the most recent quarter ended June 30, 2006, Banco Itau reported a return on equity of 35% -- marking its 15th consecutive quarter with an ROE in excess of 30% -- as well as a return on assets of 3.6% and an efficiency ratio (non-interest expense as a percentage of revenue) of 43.5%. All of these numbers compare very favorably with the company's Brazilian banking peers and illustrate why Banco Itau is one of the most profitable banks in Latin America.

Shares in Banco Itau, trading at 10 times consensus 2007 estimates, aren't exactly cheap by emerging-market standards. That said, I believe that the company's organic growth prospects, the potential upside from its BankBoston acquisition, and its proven operational excellence make it an attractive play for risk-tolerant, long-term investors interested in cashing in on Brazil's growth.

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Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than, reading The Financial Times, rooting for the New York Giants, or pondering the vagaries of life (pretty unsuccessfully up to this point). He welcomes your feedback. Will does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.


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