The turmoil in the emerging markets is not over yet. Brazil has decided to cut $18.5 billion from this year's budget in addition to lowering its GDP growth estimate to 2.5% from the 3.8% expected previously.
Why is this happening? Well, policymakers want to keep inflation under control and shore up fiscal management, which was raising concerns of a ratings downgrade. According to Finance Minister Guido Mantega, with these cuts, Brazil should be able to meet a primary surplus target of 1.9% of GDP.
So how will Brazilian ADRs perform?
In order to evaluate the impact, let's take a look a three companies -- two involved in retail and one bank.
First, here's the largest brewer in Latin America by sales volume and the fourth-largest in the world, AmBev (NYSE: ABEV). AmBev is also a Pepsi bottler in Brazil, Argentina, Bolivia, Uruguay, Peru, and the Dominican Republic.
Mitigating a volume decline of 3.1%, net revenue per hectoliter (the variable to look at in this industry) increased 7.3% in the third quarter. Volume was mostly affected by softness in Brazil, Canada, and, to a lesser extent, Argentina. However, the quarter brought top-line growth in nearly all divisions.
Despite the slowdown in the region, fundamentals remain strong for AmBev. The company retains dominant market share within Latin American countries: 68% in Brazil, 78% in Argentina, 97% in Bolivia, 90% in Paraguay, and 97% in Uruguay. This dominant share enables the firm to hold significant pricing power and operate its breweries more efficiently than its peers. Plus, its distribution system acts as an extra competitive advantage: AmBev delivers its products to almost 1 million points of sale throughout Brazil alone. This is very expensive and difficult to duplicate. In addition, AmBev's portfolio contains three of the world's top beer brands: Skol, Brahma, and Antarctica.
AmBev's Brazilian beer operations represent nearly 58% of sales, so the company is exposed to a slowdown. Plus, almost 90% of the company's revenue comes from South and Central America, which are also making GDP growth corrections. However, the World Cup should drive sales up this summer.
Second, here's Companhia Brasileira de Distribuicao (NYSE: CBD), a retail giant that operates four segments: food, self-service wholesale, home appliances, and e-commerce. It is the largest private employer in Brazil with more than 150,000 employees.
Fiscal 2013 brought good results for the company. Adjusted EBITDA increased 20.1%, and net profit reached almost $596.8 million -- up 20.7% in the year. In the fourth quarter, net income grew 27.5% year over year to $292.4 million, with same-store growth of 10.8% (9.8% in the food category and 11.5% in the non-food category). 2013 was an adverse scenario for retail in the country, marked by modest growth and interest rate hikes. Despite all this, Companhia Brasileira managed to perform well.
This company has some good fundamentals, as it has a strong market position and economies of scale. It holds 23.5% market share in the Brazilian food retail sector, and it expects to open 400 new stores by 2016 and 12 to 15 new Assai wholesale stores per year. The strategy will be to expand wholesale where the company already has a presence and focus on Brazil's fast-growing Northeast region. The company has a deep online presence as well, as it opened the first Brazilian online shopping mall in mid-2013.
However, Companhia Brasileira is highly exposed to Brazil, and a slowdown in consumer expenditure will probably affect more its home appliances retail position, as it is strongly tied to the disposable income of consumers. The company will probably find problems to keep prices down in the face of inflation and might witness some margin compression.
Good performance but tougher outlook
Finally, let's take a look at Itau Unibanco Holding (NYSE: ITUB), one of the biggest private banks in the country.
In the fourth quarter, Itau Unibanco reported net income of about $2 billion -- up 31% from $1.5 billion a year ago. The increase of its stake to 100% control of Redecard, the second-largest Brazilian credit card acquirer and payment processor, along with improvements in loan growth and operational efficiency, were the main drivers. In 2013, the bank performed well: It was able to control expenses and produce accelerated loan growth.
Itau Unibanco has a dominating presence with market leadership in several categories and diverse businesses that can drive return on equity above 18% as it did last quarter. The bank remains strong in credit cards, as last year, credit card income was the most positive contributor to noninterest income growth, growing 23% to $3.2 billion.
However, the context of higher interest rates and lower GDP growth should have some impact on Itau Unibanco, as this context usually doesn't help loan growth. In addition, three of the five largest Brazilian banks are government-controlled, and they have been increasing their lending, adding pressure to the bank's loan pricing and net interest margins.
Brazil has dealt with moderate growth in its economy for three consecutive years: 2.7% in 2011, 1% in 2012, and about 2% last year. The government's goal with these initiatives is to consolidate public accounts and cut inflation, which it wants to slow down to 5.3%. Although the goals are ambitious, they're achievable and will probably satisfy rating agencies. Let's not forget that this year's presidential elections are taking place in the country, and a ratings downgrade would be disastrous to Dilma Rousseff's current administration. For now, however, she remains the favorite.
AmBev depends on rising levels of GDP in South America, as they enable consumers to increase their per-capita consumption of beer. For now, it's hard to foresee this happening in the region.
As it did during 2013, Companhia Brasileira will have to face a weaker economy growth and some inflation pushing margins down. However, the company is solid and should be able to bring at least modest results this year.
As you probably know, banks are usually the first ones to make corrections when economies show weaknesses. Despite its good performance and great management, Itau Unibanco might not be the exception.
Play an Emerging Market the American Way
U.S. automakers boomed after WWII, but the coming boom in the Chinese auto market will put that surge to shame! As Chinese consumers grow richer, savvy investors can take advantage of this once-in-a-lifetime opportunity with the help from this brand-new Motley Fool report that identifies two automakers to buy for a surging Chinese market. It's completely free -- just click here to gain access.