Our trip to Brazil spotlights the improving and underappreciated investment landscape.
For many of our EM clients, Brazil is the largest relative overweight country position, with the two biggest constituents typically being holdings in Petrobras, the energy major, and Mercadolibre, the Latin American e-commerce and fintech platform. Beyond these, Brazil has been the subject of many recent team discussions as we debate the merits of a range of ideas, from NuBank in fintech to Natura in cosmetics, through to Eletrobras, the largest power company in the country.
Michelle Brown, our senior ESG analyst, recently returned from a week and a half of visiting around 20 companies and conducting site visits, ranging from fuelling facilities to ethanol plants. She has been sharing her reflections with the team.
Capital at risk.
The economic backdrop is relatively buoyant today and has been improving in recent months, as one of our key macro research providers has pointed out, with credit activity, durable spending and import demand all having picked up sharply. Improving economic activity has helped stabilize the budget position, though there is clearly still a large fiscal gap that the government needs to gradually resolve.
Michelle noted that there are many reasons to be optimistic about opportunities for Brazilian businesses. There is a lot that could go right for Brazil, but the country is still full of extremes, for example, in income and energy inequality. Despite the volatility of politics, the country has good institutions. It's also clear that the country has some excellent research universities and a very well-educated tier within society. A relatively free press helps with accountability. Corruption has improved (dropping 15 per cent between 2013 and 2023 on the Corruption Perception Index) but remains a challenge. Poverty has decreased (the number in extreme poverty dropped 40 per cent in 2023).
Her trip had a bias towards companies in and around the energy sector and served as a very useful complement to recent research in the team on the likes of Petrobras, Raizen and Eletrobras. Energy in Brazil cuts to the core of many environmental, social, and governance topics that we believe will impact the long-term profitability of a range of companies and also have a macro-level influence on Brazil. The country has one of the lowest carbon grids and wants the money from selling oil/gas to support broader development. This has been a key consideration in the Petrobras investment case: the royalties paid by the company to the government have a much wider social importance.
Energy and sustainability in Brazil
Brazil is also keen to develop industries that can benefit from its abundant renewable energy. Michelle noted that it is making sure it's known to be 'open for business': for example, Chinese companies are investing heavily in electricity generation in Brazil, transmission, and of course, electric and hybrid car manufacturing. There is interest from data centres too, but relatively high electricity prices for customers may push investment elsewhere.
Electricity prices have gone from extreme highs to extreme lows, to highs again as a severe drought affects the country. Most of Brazil has access to electricity, but electricity bills do not yet reflect low generation costs. This is important for us to monitor, well beyond just energy and electricity, because it directly impacts disposable income, which will influence consumer choices across a range of portfolio companies. This has implications for holdings such as Natura, a relatively recent purchase in the cosmetics industry, Mercadolibre and the banks.
On the former, both Michelle and Alex Summers (one of the investment managers in the team) have had company meetings with Natura in recent weeks. We are mindful that it is early days for this holding but are carefully monitoring the brand strength and the company's commitment to building it.
Elsewhere, we have been debating Eletrobras, the state power company. While on the face of it, this doesn't feel like a typical Baillie Gifford investment, the case here would rely on the company making material improvements from a somewhat messy and complicated base. There is a potential turnaround story as Eletrobras is going through a transformation following its privatization in 2022. The company has restructured its governance model to streamline decision-making processes across its subsidiaries. Several in the team are yet to be convinced of the investment merits here, but Michelle has been very impressed by their head of sustainability, Camila Araujo.
There is still a lot to digest from the trip, but perhaps one of the key takeaways was the fact that there were about a dozen companies in which Michelle highlighted that further work would be worthwhile, as leadership in sustainability and governance could be a key growth driver over the next years. We have often said that commodities matter more than politics to the long-term outlook for Brazil, and beyond oil, we should also note that the country is endowed with great resources – including copper, cobalt, nickel, rare earths, lithium, graphite and renewable energy. Wider macro concerns about government meddling and high tax burdens are causing some negativity among local investors, but the scope for improvement is significant, which may well lead to stronger investment returns from here.
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