Brazil & Southern Cone - September 2013 (ISSN 1741-4431)

Brazil’s Vale SA, the world’s third-largest mining company, said in August that its second-quarter profits had slumped by 84% year-on-year to reach US$424m, significantly below market expectations. But executives remain relatively optimistic.

The profit slump was attributed to lower revenue from iron ore production, and to big currency losses, triggered by the depreciation of the Brazilian Real against the US dollar – a fall of around 10% during the quarter. The company said it lost almost US$2bn on its net financial liabilities, plus further ‘one-off’ losses of US$814m in forward and swap derivatives. The weaker Real has pushed up the cost of servicing dollar-debts.

While the short-term impact is certainly painful, in the medium to long term a weak Brazilian currency may actually be a good thing for Vale’s profit margins. Company officials have explained that most of its big new projects are located in Brazil, and the effect of a weakening Real is to reduce capital costs in dollar terms. The project to expand the Carajás iron-ore mine in the Amazon, code-named S11D, is estimated to cost around US$19.7bn to 2018, based on an exchange rate of BRL2.00/US$. To the extent that the Real has weakened beyond that level (the currency stood at BRL3.30/US$ in early September, its weakest level in four years) the dollar-denominated capital cost of S11D reduces relative to the first estimate. Vale said Real-denominated expenditure represented around 90% of S11D, and the savings were not yet reflected in its capital expenditure numbers. Apart from a US$6.5bn coal and infrastructure project in Mozambique, most of the company’s future capex is in Brazil.

Currency problems aside, company executives do not seem too worried over the effects of slower growth in China, which according to some analysts is bringing the commodities and metals boom to an end. Vale said lower iron ore revenue was in part caused by softer prices, but also reflected a fall in production because of bad weather in Carajás. Iron ore output fell 6.5% y-o-y to 140.8m metric tons in the first half of 2013. But José Carlos Martins, executive director of ferrous and strategy, pointed out “in this third quarter it is going very well, and we are confident that we are going to arrive at the number we have project of 306m tons of iron ore this year”. Executives said that despite slower growth in China, market factors such as that country’s continuing urbanisation and related housing and construction activity indicated “strong support for prices at around US$110 a metric ton”. Chief Executive Murilo Ferreira noted: “Two years ago China produced 683m tons of steel, and this year everything indicates it will produce 780m tons. So once again, China has proven pessimists wrong.”

The ‘recovery’ remains volatile

The index of industrial production fell 2.0% month-on-month in July over June and rose a lower-than-expected 2.0% year-on-year over July 2012, according to latest data from the national statistics institute (Ibge). The Ibge revised up June’s result to show a 2.1% rise over May, up from a previously reported 1.9%, with the annualised figure lifted to 3.2% from 3.1% previously.

Industrial output rose 2.0% year-on-year in the first seven months, but it has been very volatile throughout. The fear is that an tentative rebound has been knocked back by the weakening Real, which though supportive of export sectors also lifts production costs for many manufacturers dependent on imported inputs. Of the 27 industrial sectors surveyed by Ibge, 15 declined in July from June, led by the key automotive sector (accounting for a fifth of the industrial base), pharmaceutical goods and rubber and plastic products. In terms of industrial categories, consumer goods fell 2.6% month-on-month in July, with intermediate goods down 0.7% and capital goods down 3.3%. Capital goods output was up 15.2% year-on-year nonetheless, indicating some restocking.

Brazil’s overall GDP surprised on the upside in the second quarter, with real annual growth of 1.5%, prompting the government to say that its latest measures to promote private sector activity were having the desired effect, but local economists caution that the economy remains vulnerable to external shocks. Nonetheless private sector sentiment appears to be improving: the private sector consensus forecast for real annual GDP growth in 2013 rose to 2.4%, up from 2.21% a month ago, according to the latest (13 September) Focus report compiled by the central bank. The forecast for industrial production growth rose to 2.12% in 2013, but dipped to 2.65% from 3.0% in 2014 respectively.

Likewise GDP forecasts for 2014 dipped slightly to 2.22%, from 2.5% a month previously. The consensus was for the benchmark Selic interest rate to end the year at 9.75% and stay there until end 2014, with the Real at R$2.35/US$ and R$2.40 at end-year 2013 and 2014 respectively; that should support an recovery in the trade surplus to US$10bn in 2014, from just US$2.0bn this year.

Femsa-Spaipa deal

The Mexico-based Coca-Cola Femsa, the largest soft drinks bottler in Latin America, has agreed to buy Brazil’s Spaipa SA Industria Brasileira de Bebidas in a US$1.86bn cash-based deal. If approved by Brazil’s anti-trust authority, the deal will raise Femsa’s share of the Brazilian Coca-Cola market to around 39%.

Femsa has been on a buying spree in recent years, acquiring various regional bottlers in its Mexican home market, one in Miami, and one as far afield as the Philippines. It has been present in Brazil for ten years, and it sees South America’s largest economy and most populous country as a strategic market. In July, it acquired a Rio de Janeiro regional Coca-Cola bottler. In this deal it will buy Spaipa’s existing franchise, which operates in more than half of São Paulo state, and also in Paraná. Spaipa has four bottling facilities and seven distribution centres, serving an estimated 17m consumers. The Brazilian company achieved net revenues of US$929m in 2013. A statement issued by Femsa described the Spaipa footprint as “a perfect geographic fit”. Femsa said the cash acquisition was being financed through bank loans, most of which were already in place.

• Femsa

According to Femsa CEO Carlos Salazar Lomelín, “we are privileged to serve as many consumers in Brazil as we do in Mexico, and our company will benefit from the talented and experienced employees of the Spaipa franchise.” He added that “building on our operating capabilities and solid financial position, we are confident that our company will be able to deleverage our balance sheet in a short period of time”.