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Brazilians' Millions: General Electric's South American Headache

By John Bromels – Sep 26, 2016 at 11:54AM

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Brazil has problems. And thanks to General Electric's investments in Brazil, some of those problems are now GE's. Should investors be concerned?

Not only Brazil's corn crop but also its economy and its politics are in turmoil. Image source: Getty Images.

The 2016 Rio games in Brazil were great for the U.S. Olympic Team, which won more medals than any other country. But beyond the Games, Brazil hasn't been great for U.S. businesses such as General Electric (GE -2.68%)Monsanto (MON), and DuPont (DD), which have fallen victim to some of Brazil's many problems. 

Are these problems just minor issues, or should they make investors reevaluate their positions in the stocks?

Your guide to Brazilian scandals

There's been no shortage of political scandals in Brazil recently. Many have swirled around the government of now ex-President Dilma Rousseff, leading to her eventual impeachment and removal from office in August. But new President Michel Temer has had his share of scandals, too, including violation of campaign finance limits and secret recordings that revealed plans to quash corruption investigations.

The particular scandal that's causing problems for GE -- among other U.S. companies -- has been dubbed the "Carwash" scandal, named after the gas station in Brazil's capital that black-market banker Alberto Youssef used to launder money. 

While being interrogated about the money laundering, Youssef revealed a massive kickback and corruption scheme involving state-run oil giant Petrobras and several construction companies, including conglomerate Odebrecht.

According to Brazilian prosecutors, the construction companies formed cartels and gave kickbacks to Petrobras execs and politicians in order to win inflated contracts with Petrobras. http://www.bloomberg.com/news/articles/2016-05-31/quicktake-q-a-brazil-s-carwash-is-more-trouble-for-ruling-party Unfortunately for GE, it counts both Petrobras and Odebrecht as "key customers."

The fallout for GE

Besides Petrobras and Odebrecht, one of the companies caught up in Operation Carwash was the construction arm of Brazilian conglomerate Queiroz Galvao SA. Citing two unnamed sources, Bloomberg News reported that Queiroz Galvao owes GE about $150 million that it can't pay because of the ongoing probe.

Things sound pretty serious for Queiroz Galvao: In June, police raided the offices of one of its joint ventures, saying they found evidence of overbilling and false receipts. In August, the former president of its construction unit, Ildefonso Colares Filho, was arrested on several charges, including corruption and money laundering.

And if all that wasn't bad enough, Queiroz Galvao's energy unit recently purchased wind turbines from GE, expecting to pay for them with a loan from BNDES, Brazil's development bank. But that financing, unsurprisingly, has been put on hold pending the outcome of the Carwash investigation. 

With no end in sight to the Carwash investigation and allegations of corruption swirling around numerous other elected officials, it's unclear how soon Queiroz Galvao might be able to come up with a payment for GE, although Bloomberg reports that the two companies are currently in negotiations. It's also unclear how other Brazilian companies might be affected in the future. 

Where the money goes

Corruption is only one of Brazil's many problems. The country's economy -- the world's ninth largest -- is undergoing its worst two years in more than a century. Issues include a massive recession, soaring inflation, and collapsing commodities prices.

That has made it difficult for companies to access funding. It has also led to a slowing of support for renewable energy. According to Jerome Pecresse, the president and CEO of GE Renewable Energy, slowing wind turbine demand in Brazil risks collapsing the supply chain, and many of the company's Brazilian clients are in arrears. That's bad for GE, a major supplier of wind turbines.

It's not just energy

Other areas of the economy are being hit as well. Brazil's agriculture sector has been affected in several ways. First, a plunging currency made foreign seeds and pesticides more expensive, hurting the fortunes of U.S. companies such as DuPont and Monsanto, which derived 5.6% and 11.5% of their 2015 sales, respectively, from Brazilian customers. By contrast, GE derived only about 5.7% of its revenue from all of Latin America in 2013, the last year for which they provided a regional estimate. 

The cheap currency caused a surge of corn exports, which -- accompanied by a poor corn harvest -- caused feed prices to rise, hurting Brazil's pork and poultry farms. Some experts have gone so far as to suggest Brazil could run out of corn by 2017.And even if it doesn't, the ongoing credit crunch is causing growers to delay purchases. 

The Foolish bottom line

Ultimately, $150 million is just a drop in the bucket for GE, whose annual revenue tops $116 billion. So in and of itself, it's not likely to affect the company's bottom line. However, it's just one example of why investors should be concerned about the precarious situation in Brazil. Although the overall share of GE's revenue that comes from Brazil is small, if big clients like Petrobras or the Brazilian wind industry start cutting back on their purchases, the company could start feeling the pinch. 

For DuPont and Monsanto investors, though, Brazil's ongoing economic and agricultural woes are a more pressing concern. Wise investors will keep an eye on how things shape up in Brazil's agricultural sector. It's possible that the corn shortage will actually benefit DuPont and Monsanto as rising prices benefit corn producers and short supplies necessitate U.S. imports.

There are some signs that the worst may be over in Brazil. Retail sales and industrial output have improved in recent weeks, and economists expect the country to return to growth by the end of the year. But smart investors shouldn't take it for granted. At least, not yet. 

John Bromels has no position in any stocks mentioned. The Motley Fool owns shares of General Electric. 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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Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
GE
$62.73 (-2.68%) $-1.73
Monsanto Company Stock Quote
Monsanto Company
MON
E. I. du Pont de Nemours and Company Stock Quote
E. I. du Pont de Nemours and Company
DD
Petroleo Brasileiro S.A. - Petrobras Stock Quote
Petroleo Brasileiro S.A. - Petrobras
PBR
$12.14 (-0.98%) $0.12

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