How Will Brazil's Economic Slump Affect These 3 Stocks?

Bad news is coming from Brazil. Its GDP decreased 1.9% this quarter versus the year-ago quarter. Considering that this has been the worst quarterly performance of Latin America's biggest economy since the beginning of the global financial crisis in early 2009, it is a troubling sign that's worth paying close attention to. According to Nomura Securities, Brazil is expected to grow just 2.1% this year; this is way below its BRIC peers India and China. Factor in a 6% annual inflation, and the outlook is not the best.

Given these circumstances, how will these Brazilian American depositary receipts perform?

Not affected
First, we will take a look at Gerdau (NYSE: GGB  ) , a leading steel-producer that operates in the Americas, Europe, and Asia.

This company is clearly showing no signs of a recession. Gerdau's net earnings grew 57% in local currency year over year. Its revenue also increased by 7%, driven by a healthy performance both in the country and in Latin America. The domestic market is booming for the company, more than offsetting the decline in its exports. The reason? Many infrastructure investments are needed for next year's FIFA World Cup and the 2016 Rio Olympic games, both of which are pushing demand.

Another positive for Gerdau is that it is investing heavily in mineral resources and logistics, moves that will increase its competitiveness. Its Acominas investment increased Gerdau's annual iron-ore production capacity to 11.5 million tons, and this will reach 18 million tons in 2016 following an incremental $210 million investment.

Amazing performance
Following Gerdau comes Companhia Siderurgica Nacional (NYSE: SID  ) , another vertically integrated steelmaker with the capacity to produce 5 million tons of crude steel per year.

Performance has been impressive for CSN, with net earnings growing 216% in local currency. The company also reported a record net revenue, increasing 15% sequentially to $2 billion. Its consolidated EBITDA margin expanded to 31% as well. These results are very encouraging.

The company is profiting from the infrastructure demand that Brazil is experiencing, especially with its exposure to iron-ore mining and cement. In fact, mining sales contribute more than a quarter of revenue. Taking into account the fact that CSN's mining sector is likely to produce 89 million tons of iron ore in 2014, the company's stock looks very promising. CSN takes its own investments seriously as well, as 71% of its total capital spending will be used for expansion plans (including $420 million on Transnordestina logistics.)

Bad fuel-pricing policy
Finally, we have the largest publicly traded Latin American oil company: state-run energy giant Petroleo Brasileiro (NYSE: PBR  ) , also known as Petrobras.

The recent news on Petrobras regarding its fuel-pricing policy is not encouraging. Its board approved a policy that will have the company not automatically adjusting its prices in relation to international levels. In the third quarter, the company's diesel was 20.1% below world prices, and its domestic gasoline was priced 18.9% below. Under the new pricing scheme, we will not see a major correction, either, as the company refused to announce when future price changes would be made or how they would be calculated.

Considering the company's declining production trend and the fact that it's the only Brazilian fuel importer willing to take a loss on imports, the main issue here is how Petrobras will earn the revenue needed to finance its ambitious expansion plans. We do not have that answer yet, and until then, it would be a wise idea to wait and see.

Bottom line
Gerdau and CSN look like they will not be affected by a worsening of the Brazilian economy. Infrastructure projects are likely to continue despite short-term and mid-term challenges. However, it would be wise to keep an eye on sales contracts and margins anyway.

Petrobras' growth potential is expected to be restrained, given the substantial investments that it requires and its new pricing policy. In this case, the company's prospects hinge on factors beyond the contraction of the Brazilian GDP.


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