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Latin America Equity Research Overview July 2012
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Latin America overview
Latin Am
erica Equity Research
Overview
July 2012
2
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c Latin America sector by sector Sector
Energy Materials Industrials
Consumer Discretionary
Consumer Staples Health Care Financials
Information Technology
Telecommunication Services
Utilities
Weight in MSCI Latam 13% 20% 5% 4% 16% 1% 21% 2% 9% 8% Key sub-sectors Integrated Oil & Gas
(87%) Steel (57%) Industrial Congloms
(33%)Broadcasting (33%) Brewers (30%) Managed Heatlh
Care (63%)Diversified Banks
(81%)Data Processing &
Outsourced Services (87%)
Wireless Telecommunication
Services (82%)
Electric Utilities (57%)
Oil & Gas Storage & Transportation (8%)
Diversified Metals & Mining (14%)
Highways & Railtracks (25%)
Department Stores (29%)
Hypermarkets & Supercenters (22%)
Health Care Services (37%)
Specialized Finance (6%)
Systems Software (13%)
Integrated TelecomsServices (18%)
IPP & Energy (31%)
Oil & Gas E&P (5%)
Construction Materials (8%)
Airlines (17%) Home Building (17%)
Soft Drinks (21%) n/a Real Estate Oper Companies (4%)
n/a n/a Water Utilities (12%)
Three largest stocks Petrobras (9.41%) Vale (8.69%) Lan (0.99%) Televisa (1.43%) Ambev (3.87%) DASA (0.22%) ItauUnibanco
(4.41%)Cielo (1.12%) AMX (6.84%) Cemig (1.16%)
Ecopetrol (1.98%) GMexico (1.45%) CCR Rodovias(0.94%)
Falabella (0.61%) Femsa (2.23%) Odontoprev (0.18%) Bradesco (3.88%) Redecard On (0.75%)
Telef Brasil (0.97%) Endesa (0.74%)
Ultrapar Partp (0.96%)
Cia. Minas Buenaventura ADR
(0.99%)
Copec (0.91%) Lojas Renner(0.48%)
Walmex (1.83%) Amil (0.17%) Itausa (1.48%) Totvs (0.28%) Tim Part (0.61%) Enersis (0.64%)
Trading data Free float mkt cap (USDbn) 95 158 40 34 123 4 170 16 71 57 ADTV (5 year) (USDm) 566 796 129 242 219 17 687 5 221 194 Perf in last 10 years * Absolute 710% 738% 343% 216% 638% 158% 878% -78% 481% 711% Relative to MSCI Latam 16% 20% -36% -55% 6% -63% 40% -97% -17% 16% Correlations of sector MSCI index returns (5 year) with
MSCI Latam 0.90 0.94 0.88 0.88 0.91 0.22 0.93 0.41 0.92 0.80 Nominal GDP (Latam area) 0.81 0.89 0.86 0.87 0.88 0.11 0.93 0.26 0.86 0.82 US ISM 0.31 0.50 0.47 0.41 0.39 -0.10 0.33 0.21 0.30 0.24 Key sector stats 12m forward sales growth 8% 6% 10% 11% 12% 12% 20% 12% 8% 2% 12m forward EPS growth 10% -1% 21% 16% 12% 23% 11% 7% 16% 10% Long-term avg 12m fwd PE 7.7 8.7 13.8 15.1 16.0 25.3 10.3 14.5 11.8 14.9 12-month forward PE 8.2 8.3 17.7 13.4 21.1 19.6 9.8 15.7 11.6 11.5 Long-term average PB 1.9 1.8 1.8 2.8 2.6 3.9 2.0 10.0 2.5 0.8 Current PB 1.1 1.5 2.7 2.4 3.6 2.9 1.7 16.3 2.5 1.3 Long-term average ROE (%) 22% 19% 11% 15% 13% 8% 19% 142% 19% 7% Current ROE 10% 15% 8% 17% 13% 9% 15% 84% 17% 10% *Including dividends. Priced as at 30 June 2012 Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S
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Latin America Equity Research Overview July 2012
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Introduction Latin America experienced significant economic growth in the last decade, an improvement from the
1980s, the so-called “lost decade”, characterized by defaults, currency crises, high inflation, and the
economic stagnation that ensued. Transitions from authoritarian political regimes to democracies took
place in many countries, but it was not until the implementation of structural reforms, including
privatizations, trade liberalization and the adoption of transparent and stable economic policy regimes in
the 1990s, that the region subsequently achieved above-average growth.
Asset prices soared to reflect this growth, as can be seen in chart 1, which shows the MSCI Latin America
index jumping tenfold from 2002 until the 2008 crisis. Even when the region’s financial market volatility
resurfaced during the 2008 crisis, and equities fell back c60%, strong economic foundations and strong
policy responses allowed for a relatively quick recovery from the lows. Market structure Latin America’s largest companies are shown in table 2. The consumer staples (AmBev, FEMSA and
Walmart de Mexico) and financials (Itaú Unibanco, Itaúsa and Bradesco) sectors each contribute three
companies. The energy sector (Petrobras and Ecopetrol) is represented by two companies. A telecom
(America Movil) and a materials company (Vale do Rio Doce) complete the list. Combined, these 10
stocks accounted for 44.6% of the total market capitalization as of June 2012.
Latin America overview
Alexandre Gartner* Equity Strategist HSBC Bank Brasil SA + 55 11 3371 8181 [email protected]
Francisco Machado,* CFA Equity Strategist HSBC Bank Brasil SA + 55 11 3371 8191 [email protected]
Andre Loes Chief Economist HSBC Bank Brasil SA + 55 11 3371 8184 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations
1. MSCI Latam price index (USD)* 2. Largest stocks in MSCI Latam
-
2,000
4,000
6,000
8,000
10,000
02 03 04 05 06 07 08 09 10 11 12
Stock rank Stock name Index weight
PETROBRAS 9.4% VALE 8.7% AMX 'L' 6.8% ITAUUNIBANCO PN 4.4% BRADESCO PN 3.9% Top 5 33.2% AMBEV PN 3.9% FEMSA 'UBD' 2.2% ECOPETROL 2.0% WALMEX 'V' 1.8% ITAUSA PN 1.5% Top 10 44.6% Source: HSBC, Thomson Reuters Datastream, MSCI
* Index with gross dividends reinvested in local currency Source: HSBC, Thomson Reuters Datastream
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Latin America Equity Research Overview July 2012
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The largest sector in Latin America is financials, with a 21% weight in the index, as of June 2012. The
commodities group is also well represented and combined materials (20%) and energy (13%) account for
33% of MSCI Latam. Consumer staples (16%) and telecommunications (9%) follow behind.
The most important market by far is Brazil, with a 60% weighting in June 2012, followed by Mexico with
22%. The other three countries rank as follows: Chile (9%), Colombia (6%) and Peru (3%).
All markets are highly concentrated, led by Peru where only four stocks make up for the whole index. In
Colombia, the top five stocks represent 70% of the country index, followed by Mexico (64%), Chile
(44%) and Brazil (38%) (table 3).
Overall liquidity in Latin American stock markets is very low outside Brazil and Mexico. Peru is the most
illiquid market, with only USD14m daily average turnover for the last five years, followed by Chile with
USD149m and Colombia with USD154m. Brazil ranks as the most liquid with USD2.5bn daily average
volume in the last five years, followed by Mexico with USD432m.
Higher liquidity, deeper markets and more investor participation has translated into higher market
volatility for Brazil. Indeed, in volatile market conditions, Brazil is used also to hedge exposure to the
region as a whole, on both the long and short side. The country index ranks first in annualized volatility in
both a five- and 10-year window (table 4). Next in line are Peru, the most concentrated market with only
four stocks components, followed by Colombia and Mexico. Chile is the least volatile market in both time
frames, benefiting from c25% weighting of the more stable utilities sector.
The volatility of earnings is not necessarily correlated to market volatility in Latin America. Earnings in
Brazil have been the most stable in the region over the last ten years, despite having the highest equity
market volatility. Chile ranks second in terms of low earnings volatility in-line with its less volatile
market, followed by Mexico. Colombia and Peru have the most volatile earnings profiles as they are more
concentrated in fewer company results.
Correlations Latin American markets in general have a high correlation to the region index led by Brazil with an
almost one-to-one relationship.
The Mexican index is the most correlated to US economic conditions, as measured by the ISM index,
which makes sense as both countries share borders and have a high interconnectedness. Next are Brazil
and Colombia with 77% and 73% respective correlations in the last five years. All countries indexes but
3. MSCI Latam: Country weights of top five stocks, June 2012 4. MSCI Latam: Earnings and index volatility
Top 5
Peru 100% Colombia 70% Mexico 64% Chile 44% Brazil 38% Source: HSBC, Thomson Reuters Datastream
__Trailing earnings vol _ _ Market volatility* __ 5 years 10 years 5 years 10 years
Brazil 16% 15% 45% 39% Chile 13% 25% 27% 24% Colombia 30% 53% 33% 33% Mexico 18% 23% 35% 28% Peru 49% 79% 41% 33% Latam 14% 19% 39% 32% Source: HSBC, Thomson Reuters Datastream. Note: *calculated as the annualised standard deviation of monthly changes for USD MSCI country indexes (ex-dividends)
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Latin America Equity Research Overview July 2012
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Peru are well correlated to each country economic conditions, as measured by GDP.
Global growth is also important, as measured by the correlation of stock market performance to country
exports. Chile, Mexico and Peru are very open economies with a high percentage of imports and exports
to GDP and therefore a high correlation between exports and stock market performance was to be
expected. Colombia and Brazil, on the other hand, are considered more closed economies and therefore
the impacts of trade flows on growth are lower.
The key takeaway is that among Latin American countries, Chile, Mexico and Peru are sensitive to global
economic growth conditions, with Mexico particularly sensitive to the US, while Brazil and Colombia
correlate more to domestic economic growth.
Earnings and ratings Latin American earnings boomed during the last 10 years’ expansion cycle, benefiting from ample global
growth, liquidity and high commodities prices. Since the 2008 crisis, earnings have gone sideways and
are situated below all-time highs and their 10-year trend (chart 5).
In the last 10 years, Latin American earnings have grown on average by 18.1% annually. The countries
that have recorded the highest compounded earnings growth were Peru (28%), Colombia (23%), Chile
(13%) and Mexico (12%). Brazil trails the list with 11% growth registered in this period.
If we look at how accurate analysts have been in forecasting earnings growth it becomes apparent that
until 2008 they have tended to be too pessimistic. Since the 2008 crisis, the trend reversed and analysts
overestimated earnings growth. The average miss to the 12-month forward EPS expectations (between
2003 and mid-2012) has been 6.2%.
Earnings momentum (measured as the six-month rate-of-change in 12-month forward EPS) and market
performance has a close historical correlation (chart 7). During the 2003-2007 expansion phase, positive
earnings momentum correlated with positive Latin American market performance. Analysts missed the
magnitude of the crisis and its impact on earnings performance and had to play catch-up in 2008. Since then
both series have been moving in tandem, first to the upside, as Latin America rebounded, and then downwards,
as dismal earnings followed. The conclusion we draw is that earnings momentum can have explanatory power
for equity performance in Latin America, but analysts are not good at anticipating the next crisis.
5. MSCI Latin America: Actual vs 10-year trend earnings 6. MSCI Latin America: 10-year annual EPS growth CAGR
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50
100
150
200
250
300
350
400
02 03 04 05 06 07 08 09 10 11 12
12-month Trailing EPS EPS linear trend
-
5
10
15
20
25
30
Peru Colombia EM Latam Chile Mex ico Brazil
Source: HSBC, Thomson Reuters Datastream Source: HSBC, Thomson Reuters Datastream
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Latin America Equity Research Overview July 2012
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Valuations In the last decade the Latin American market has traded on an average 10.1x PE. The most expensive
market was Chile with c15x PE, followed by Mexico, Colombia and Peru with c12x PE. Brazil has
historically traded at a discount with an average PE of 8x. Sector composition is the reason behind the
Brazil discount, as c40% of the index is composed of energy and materials companies that historically
trade at cheaper multiples.
Up until 2006 MSCI Latin America traded in a range of 8-10x PE coinciding with the period we analyzed
previously when analysts consistently underestimated earnings growth potential. A re-rating occurred in
2007-2008, with multiples reaching c13x. This was followed by depressed valuations at the depth of the
2008-2009 crisis of c6x PE. The rebound that followed was strong and valuations reached new highs of
c14x PE in December 2009 and since then a de-rating has occurred bringing PE multiples closer to the
historical average.
Today, Colombia trades with the most significant discount compared to ten-year average multiples
followed by Peru and Chile (table 8). PE multiples in Brazil are 9% above average compared to 34% for
Mexico. As a whole, Latin American equities are trading almost in-line with historical average c10x PE.
Compared to GEMs, Latam average valuations in the last ten years were similar but today the global
emerging market index is trading at a higher discount of -11%.
There is a wide difference in market valuations between the two most important markets in Latam in June
2012. Brazil trades at 9x PE compared to 16x for Mexico. The Mexican premium reflects its status as a
more defensive market due to its close relationship to the US economy, a stronger sovereign, lower
inflation and interest rates, and the large weighting that the service sector has in its index. Specifically,
telcos, consumer staples, financials and consumer discretionary accounted for 78% of the MSCI Mexico
index today compared to 51% for MSCI Brazil. These sectors command higher multiples than materials
and energy which have a higher representation in Brazil than Mexico (34% and 17%, respectively).
Long-run average Latin American ROEs range from 10% in Chile and Colombia to 25% in Peru. In Latin
America, current ROE is 14%, below the 17% historical ROE delivered. Today, both Brazil and Mexico have
ROEs below the historical average, while Colombia is in line, and Chile and Peru are marginally above.
7. MSCI Latin America: 12-month earnings momentum and market return
8. MSCI Latin America: 12-month-forward PE by country
(100)
(50)
-
50
100
150
03 04 05 06 07 08 09 10 11 12
MSCI Latin America Earnings momentum
PE now Long-term PE % diff.
Brazil 8.9 8.1 9% Chile 15.0 15.3 -2% Colombia 11.6 12.4 -6% Mexico 16.0 11.9 34% Peru 11.0 11.6 -5% Latin America 10.3 10.1 2% GEMs 9.5 10.7 -11% Source: HSBC, Thomson Reuters Datastream
Source: HSBC, Thomson Reuters Datastream
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Latin America Equity Research Overview July 2012
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Valuations are not very useful for calling short- and mid-term market direction but extreme levels (6-14x
for Latam) can often help identify good entry and exit points for long-term investors.
On a price-to-book value basis Latin America has been on a de-rating trend since mid-2008. From 2005-
2008, higher ROEs c20% commanded more dear valuations with higher P/BV multiples c3x. As ROEs
descended to below 15%, valuations moved in tandem, to c2x (chart 9).
Fund flows/holdings In the last decade, Latam and individual country dedicated equity funds received USD12.6bn inflows.
Significant inflows started in 2005 as the multi-year above average growth cycle in the region was in full
force and lasted until the onset of the 2008 crisis. The pattern of redemptions and new flows that took
place after the crisis is a mirror image of the MSCI Latam price index that significantly retreated at first to
recover most of the losses afterwards. Cumulative flows peaked in early 2011 at USD26.3bn together
with global growth expectations reinforcing the perception that Latam equities are very cyclical and
growth sensitive.
9. MSCI Latin America: PBV vs ROE 10. Cumulative fund flows into equities for individual country and Latam regional dedicated funds (USDm)
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1
2
3
4
05 06 07 08 09 10 11 12
P/BV
5
10
15
20
25
ROE(
%)
P/BV ROE
(5,000)
-
5,000
10,000
15,000
20,000
25,000
30,000
02 03 04 05 06 07 08 09 10 11 12
Source: HSBC, Thomson Reuters Datastream Source: HSBC, EPFR
