Presidential Elections in Brazil: Which ADRs to Watch

Adding to the uncertainty that most emerging markets are experiencing, a local event is stirring up volatility in Brazilian stocks. Presidential and legislature elections will take place in the country in October, and three candidates have real chances of taking office. The favorite is current President Dilma Rousseff, who is running for re-election, and then we have Aecio Neves and Eduardo Campos.

How does this matter to Brazilian ADRs?
A key point here is the degree of government intervention. Investors sense that if President Dilma Rousseff is re-elected, government intervention will continue, damaging companies' profitability level. The other two candidates are seen as more market-friendly, and they still have a chance, especially with the current slowdown in the economy. So let's see how three ADRs are performing.

Low exposure
First, here's a Brazilian forestry leader and the world's largest producer of hardwood market pulp, Fibria Celulose (NYSE: FBR  ) . It has an annual production capacity of approximately 5.3 million tons.

To begin with, you should know that fundamentals are on Fibria's side. The company operates with near-perfect growing conditions to produce bleached eucalyptus kraft pulp. Its Brazilian forests allow a six-year average eucalyptus harvest cycle, whereas the cycle for most hardwood growing regions is 25 to 70 years. Brazilian eucalyptus output in relation to land use is higher, averaging 45 cubic meters per hectare a year, where in other producing regions you can get around 25 cubic meters a year. Thus the company has a clear cost advantage, well below the industry average. Plus, Fibria's pulp production is more focused toward the higher-growth tissue markets, where it also has long-term sales contracts (normally at least three years) in place.

So the results of the election will probably not generate volatility within this stock. However, any new policies regarding forestry or foreign exchange appreciation would probably raise concerns. For example, Campos' party has a popular new ally, Marina Silva, who comes from the Green Party. If Campos makes it to the presidency, chances are that stricter regulation would be applied..

Focused
Second, here is Brazilian aircraft company Embraer (NYSE: ERJ  ) . It is the leading manufacturer of regional 30- to 120-seat jets.

Recent news about Embraer shows that the commercial and executive segments have already met their fiscal 2013 delivery targets, and the company will likely reach its 2013 revenue goal. This demonstrates the current recovery in demand for regional aircraft.

Embraer has held leading regional mid-jet market share since the 2000s, and with its recently launched E2 commercial aircraft, it's expected to gain share in the 70- to 130-seat jet market. In fact, in June of last year SkyWest signed orders for 100 E175-E2s with purchase rights to get 100 more, while American Airlines just placed a $2.5 billion list-price order for 60 of these jets with an option to add another 90. But why is Embraer selling more? The company's strategy focuses on low cost, fuel efficiency, and spacious cabins. These qualities allowed Embraer to gain share of more than 70% in this category in 2013.

You have to understand that the Brazilian government and banks are strong supporters of Embraer, as they help its customers with lending and other financing programs. So changes in interest rates and stricter monetary policies coming from the new administration could affect the company's sales and profitability. The company has tight ties with Rousseff's PT party, and a re-election would probably be the best scenario for Embraer.

Facing costs
Finally, there's the largest low-cost airline in Latin America, Gol Linhas Aereas (NYSE: GOL  ) .

Third-quarter results were disappointing for Gol, as they showed a net loss per share of $0.31 despite improving from the prior-year loss of $0.57. In short, this owes to higher costs. The increase of aircraft rent and traffic service fees, along with higher maintenance costs and promotional expenses, are behind the results.

Cost-wise, Gol is planning to maintain its 2013 domestic supply for 2014, but it will sell assets and reduce its staff to try to cut some expenses. Unfortunately, there's a highly competitive scenario in the area where Gol operates: Other regional airlines want a piece of Gol's market and are increasing supply, pushing ticket prices down.. This, along with imbalances between supply and demand, is affecting profitability. Nonetheless, the FIFA World Cup taking place soon should boost regional sales. In fact, the company is working toward maximizing this opportunity by providing flexibility and competitive rates.

The election scenario could impact Gol, given the Brazilian government's propensity to intervene in the domestic fuel market; fuel is critical within the cost structure of airlines. If Ms. Rousseff is re-elected, chances are that prices will be more protected from international volatility through direct and indirect subsidies.

Bottom line
Rousseff remains the country's favorite, but the other two candidates could grow in popularity if the economy worsens. Nonetheless, a re-election would provide more certainty, as investors could expect a continuation of the current policies and have a better idea of what's coming up.

Embraer's growing demand for regional aircraft is generating an inflow of fresh contracts. The company remains well-positioned, and it's likely that the next administration will preserve this company's profitability like the previous ones.

Gol's pursuit for lower costs and better margins is not over. Stay tuned and watch how sales perform during the World Cup this summer.

Regarding Fibria, the company is a good long-term investment regardless of the reigning administration, as its fundamentals are strong.

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