Strong Devaluation in Emerging Markets: How Will It Impact These ADRs?

What's the outlook for Telecom Argentina SA, Petrobras, and YPF SA?

Feb 5, 2014 at 12:24PM

Last week's strong devaluation of the Argentine peso, which dropped about 12%, has raised panic in other emerging markets. The Turkish lira and the South African rand were also feeling the pressure, and their respective central banks have taken serious action to offset the impact of investors selling local currency and seeking refuge in dollar-denominated assets.

That's why India, South Africa, and Turkey have raised their interest rates to support their currencies. Why? Higher rates would act as an incentive for investors to stay in those currencies instead of going to the dollar, which pays much less interest when deposited. The Turkish rate, for example, went from 7.75% to 12% in a few days, while the Turkish lira dropped 25% since May.

How will all of this turmoil affect companies that operate in the emerging markets? Let's take a look at three ADRs.

Pricing policy versus depreciation
First, let's take a look at the state-run Brazilian energy giant Petroleo Brasileiro (NYSE:PBR). Also known as Petrobras, it is the largest publicly traded Latin American oil company.

The company is now enjoying the benefits of a new domestic pricing policy that will lead to an automatic adjustment of gasoline and diesel local prices. The recent increase in pump fuel prices should boost Petrobras' margins in the near term.

From a medium-term perspective, however, the company's growth potential might be restrained. Petrobras is showing a declining production trend, and exploiting its offshore discoveries will require a tremendous amount of capital. It's important to take into consideration that the company is the only Brazilian fuel-importer willing to take a loss on imports.

There's currently an extra local event adding volatility to the stock. Presidential and legislature elections will take place in the country in October. Investors worry that if President Dilma Rousseff is re-elected, government intervention will continue, damaging the company's profitability. Rousseff remains the country's favorite, but the other two contestants, Aecio Neves and Eduardo Campos, could grow in popularity if the economy worsens. These two candidates are seen as more market-friendly, and they still have a chance. We'll have to see how things go, but until then, the stock price will certainly feel the pressure with every update in the polls.

Argentina's petroleum company, YPF SA (NYSE:YPF), shares some issues with Petrobras.

The company has to deal with strong devaluation pressures on the Argentine peso, along with higher energy imports. Last year, Argentina imported more than $13 billion in energy -- most of this was subsidized fuel. Argentina, along with Venezuela, is facing very high inflation rates -- unofficially around 25% annually. The official exchange rate, pegged slightly above 10% for last year, is being questioned locally and by the IMF.

YPF must also find a settlement agreement with Repsol, the Spanish oil company that used to own YPF until the Argentine government unilaterally decided to nationalize 51% of YPF's stock. Negotiations are taking course, and we will probably see an agreement later this year. Repsol still owns about 15% of YPF's stock and has a few directors managing the company.

Will prices match inflation?
Finally, here's a leading telecommunications operator in Argentina: Telecom Argentina SA (NYSE:TEO).

Some metrics for Telecom Argentina are solid, especially for those considering a value investment. Its forward price-to-earnings ratio is 5.9, and its trailing 12-month price-to-sales ratio is around 0.54. The company also offers a decent dividend yield of 4.6%. With these factors, investors have to pay a relatively low price for each dollar of earnings. And this company has been showing impressive earnings levels.

Here's the rub, though: This sector is highly regulated, and the company has to deal with price caps and is forced to negotiate with the government when it needs to increase prices. And, given growing inflation and restrictions on imports in the country, the company could face a scenario of flat peso-denominated income and increasing costs (labor, maintenance, and technology imports).

Final thoughts
As you probably know, the depreciation of currencies although it makes the economies more competitive for some time, it also fuels inflation as imports become more expensive in local currency. A rise in interest rates will probably ease the pressure on currencies but will likely cool down the economy, which affects sales levels. As a result, this cocktail is not good for companies operating in this region unless they are primarily focused on exports.

So long as Petrobras manages to keep costs low and/or transfer the increase in costs to final prices, the company will remain profitable. We'll have to see what final level the Brazilian real and interest rates reach and how the general economy evolves. Elections are coming up!

YPF is in a similar condition, but the local government has set a state priority to make the company profitable. Local fuel prices will continue to adjust as they have already, and all of the necessary subsidized imports will be made. Profitability should not be significantly damaged, though.

Regarding Telecom Argentina, although profitability looks good, it will be key to monitor whether the company will be in a position to increase prices to at least match the growing inflation rate.

Louie Grint has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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