No Drought for South American Stock

04/19/2013 7:45 am EST

Focus: GLOBAL

Despite some recent troubles in Brazil, this company is expanding, rewarding its shareholders with a stock split and a nice dividend, says Genia Turanova of Leeb Market Forecast.

As one member of a growing international “middle income” club of nations, Brazil is something of an international economic powerhouse.

With the Western Hemisphere’s second-largest gross domestic product and the world’s sixth largest, Brazil boasts a Development Bank (distinct from its Central Bank) three times larger than the World Bank. Its Ministry of Development company features an equity investment arm, a London arm to raise Brazil’s international profile, a capital goods financing unit, and a new export-import credit agency.

As a result, Brazil no longer needs to worry about such things as US or international opposition to dam construction in the Amazon, writes environmental health professor John Briscoe, chief of the Harvard Water Security Initiative, in the winter issue of the university’s quarterly ReVista journal.

Brazil’s export-driven growth in the last dozen years fueled healthy, enviable 2.5% average annual increases in per-capita income, and catapulted its economy to the largest in Latin America—and one of the world’s fastest growing.

In 2012, Brazil’s economic miracle seemed to hit a wall. Annual growth slowed to only 1%. The government kept its fiscal surplus at its baseline—3.1% of GDP—only by cutting infrastructure expenses, prematurely advancing state-owned corporate dividends, and invading the sovereign wealth-fund established in 2008.

Worse, inflation far outpaced economic growth. Prices rose nearly 6%, far more than expected, and near the top of the Central Bank’s target range. And only fuel price caps and local sales tax holidays on cars held inflation even to that level.

President Dilma Rousseff, elected with much fanfare in 2010, shrugged off the criticism. Brazil still grew faster than Europe, she noted. But since growth in other Latin American economies now exceed that of Brazil, she boasts of a relatively unimportant achievement.

Meanwhile, several corruption cases have rocked confidence in the Workers’ Party. Officials very close to former president Luiz Inácio Lula da Silva, Rousseff’s mentor, were arrested in a bribery case that ended with prison sentences.

Rousseff moved quickly last November to dismiss alleged members of an influence-peddling ring. However, those implicated included Lula’s personal secretary since 2005 in the president’s Sao Paulo
regional office—speaking poorly of the party.

SABESP (SBS), Brazil’s largest water company (and the world’s fifth largest), has been very strong. The company provides water and sewage service to São Paolo and more than 360 municipalities in that state, and looks ripe for further growth. Half-owned by the São Paulo State Finance Department, SABESP sits in Brazil’s water-rich southeastern economic heart.
 
Here, regulations have been favorable for the company’s financial performance and long-term growth. New beneficial regulations have been in place since the beginning of the year.

Importantly, São Paulo still has a way to go with water treatment, and SABESP, as the leading water utility, will benefit from its current 81% sewage coverage rate and 75% sewage treatment rate.

A new tariff reset is expected. The tariff hike proposed in November is likely to end up being further increased by regulators. The new tariff is going to be in effect by September 2013. If the increase is indeed implemented, the stock has further upside from here.

Even without this expected additional increase, the proposed hike represents a healthy one, and implies strong earnings growth for the company. Note the recent (January 2013) 2:1 stock split, which also reflects the strong performance of the company and its stock.

While income paid by SABESP has been irregular, it did amount to a nice yield, now exceeding 2.5%. SABESP remains a buy.

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