Doubts over doing business in Brazil have started to ramp up over the last year or so. Last year, the country's GDP growth came in at an underwhelming 0.1 per cent, compared with 2.4 per cent in 2013. Industrial production is down, employment rates and retail sales are in decline, although inflation is actually rising. Interest rates are also on the up and are expected to hit around 14 per cent by the end of the year.
Corruption scandals are also marring Brazil's once-glittering appeal as an alternative fast-growth market. A multi-billion dollar bribery scandal at Petrobras (see box below) has undermined the ruling Workers' party and former president Lula da Silva. In March, Augusto Ribeiro de Mendonça Neto, a former board member of oil and gas services company Toyo Setal, claimed he paid bribes to the ruling centre-left Workers' party between 2010 and 2013 in exchange for winning contracts with the state-controlled oil group. One London-listed company to lose out from the scandal is steam trap and pump maker Spirax-Sarco (SPX). Spirax's steam traps help Petrobras meet its process quality and efficiency parameters, but the UK supplier is now faced with deteriorating trading conditions in South America - specifically Brazil - in the wake of the corruption debacle.
Scandals aside, the business environment in Brazil has become less favourable in general. But there is the odd victory story. "Problems with Brazil's economy have been good to us in terms of currency, as our costs are in reals," says Horizonte Minerals' (HZM) chief executive, Jeremy Martin. "Doing business here is as smooth as anywhere I've worked. This year we've been in discussions to build a financing package, and the Brazilian banks are prepared to lend at very competitive rates." Similarly, Serabi Gold (SRB), a Brazilian-focused mining group, says a 13 per cent devaluation in the Brazilian real during the first quarter will lead to significant cost benefits in the current financial year. However, the continued slump in bulk and industrial metals has also weighed heavily on growth prospects for the domestic economy. Brazilian multinational Vale SA is the world's third biggest miner, the leading iron ore producer and one of the largest logistics operators in the country. Over the last fiscal year, iron ore accounted for 62 per cent of group revenues and upwards of 80 per cent of cash profits, so the mining giant's continued underperformance is hardly surprising.
Some large-scale global institutions, such as HSBC (HSBA), are trying to cut their losses completely. The banking behemoth wants to sell its Brazilian unit entirely - possibly to Santander's Brazilian arm. In February, HSBC identified its Brazilian division as one of "four problem businesses" along with those located in Mexico, Turkey and the US - all of which it said needed to be restructured or sold. Last year, it lost $247m in Brazil compared with a $1.12bn profit in 2012 and a $351m profit in 2013. By comparison, profits from the Mexican arm dropped from $699m to $117m, then to $51m through 2012-14.
With a marked slowdown hitting the wider economy, it's to be expected that the recruitment industry is also hurting. Without as many Brazil-based jobs up for grabs, Hays (HAS) reported a 14 per cent drop in local net fee income during the third quarter. Meanwhile, Aggreko's (AGK) local trading operations, which generate revenues from self-operating hire equipment, admitted to problems in Brazil last year. Coupled with a drop off in US military contracts, the company's trading profit for the Americas was down 4 per cent to £141m in 2014. Even the weather isn't helping: drinks can manufacturer Rexam (REX) has expressed concerns over the ongoing drought in Brazil, home to some of its major manufacturing operations. As things stand the group's electricity bill could rise by £15m this year as the drought has increased the price of hydroelectrically-generated power.
But it's the depressed oil price that has put the most pressure on various London-listed companies' Brazilian operations. As multiple junior oil and gas explorers cut back on investment in response to the plummeting price of Brent crude, this has had a knock-on effect on companies servicing oil and gas clients in Brazil. Software company Aveva (AVV) blamed a 7 per cent squeeze in last year' underlying sales on tepid spending among its oil and gas clients, patchy demand across South America and the strong pound. Similarly, maritime services group Ocean Wilsons (OCN) said sluggish growth in 2014 was the result of a falling oil price and tough economic conditions in Brazil. Management said trading in the country stalled in the fourth quarter, and the weaker Brazilian real contributed to a 4 per cent dip in full-year revenues. A moribund oil price ultimately hurts Brazilian-based oil and gas explorers hardest.
IC VIEW: In February, Forbes described Brazil as a "hot mess" for investors wanting exposure to emerging markets. Like Rio de Janeiro itself, investing in Brazil had become "pretty but deadly". Until now, it has also been difficult to quantify just how many companies and sectors are affected by the economic meltdown. For now, tread extremely carefully, and seek out those businesses with diverse geographic spread or conservative management who might realise the need for medium-term cost-saving programmes.
