Friday, August 30, 2013

A Major Gafisa

As recently discussed by a broker who has been reformed, the Brazilian market has been absolutely rocked as of late. Its PE10 sits at a dreamy 10, likely offering up a bunch of value opportunities.

Just the other day, the benefits of volatility (to value investors) were discussed on this site, and there are several volatile names on the Brazilian market that may be offering great opportunities at the current time.

I've been looking rather closely at Brazilian home builder Gafisa. The company's cash flow turned negative for a while as it struggled to complete projects on budget. As a result, the market started to worry about its ability to pay off its substantial debts.

In response, management has been shrinking operationally. It has agreed to sell 70% of its best-performing unit (the one that sells high-end homes) at a valuation of more than 3 times book value! It is also reducing its inventory in what it has identified as areas where its profits are sub-par (anywhere outside of San Paulo or Rio). In a move that is perhaps more symbolic than anything, it has also transferred its headquarters to a new spot where operating costs are some 45% lower.

As a result, Gafisa's debt situation looks rather manageable; if/when the major sale goes through (currently planned for October) and the money is applied towards debt (also the plan), Gafisa's debt to equity ratio will be just 54%, whereas it is currently almost 100%. Management has stated its debt to equity target is approximately 60%.

But despite the company's much safer circumstances, the market price has hardly responded. Gafisa trades for barely half of its book value! Book value is likely understated as well, as Brazil's inflation rate is generally higher than it is here, ensuring that inventory stated at historical cost is almost always a conservative estimate.

Such an investment is not without risks, however, both macro and micro. The company's remaining two operations (assuming the sale of 70% of Alphaville goes through) are losing money. The losses are on the decline as management appears confident that it has identified the problem areas and the negative impact of these will decline as they continue to be run off.

One of the company's remaining two units will be heavily reliant on a government program to supply houses for the poor. So far, it appears the program is popular and enjoys support and so is likely to continue, but who knows if/when that can change.

Finally, that aforementioned inflation (which suggests inventory at market is higher than inventory at cost) can be a problem for foreign investors. As an emerging market, Brazil's currency could depreciate, leaving outside investors holding the bag. To minimize this risk, investors in Brazil may wish to focus more on exporters, who have a natural hedge against this sort of problem.

Do you have any favourites in Brazil?

Disclosure: No position


Anonymous said...

Oibr good mgmt, debt reduction

Anonymous said...

You're making investing way harder than it is. You don't need to pump out one idea every 24 hours to beat the S&P. I would recommend a less feverish approach.

Filipe said...

I bought MRV Engenharia a couple of years ago. Its been up quite nicely and then gave it all back (and the some)

The company focuses on the lower segment, so it is a way to play the growing middle class (middle-lower)

Really like the company and its dynamics... and it is really really cheap with little competition

It is possible to buy it in the pink-sheets, but liquidity is low

Saj Karsan said...

Thanks, Anon1. I have a hard time getting comfortable with their debt, though, particularly as much of it is denominated in foreign currency.

Thanks, Filipe, it looks interesting. Why is there little competition?

Anonymous said...

Not sure I would be placing too much money on housing/property stocks in Brazil at the minute. Spent a lot of time in Brazil last year as I am married to a Brazilian and there appears, at least to someone who lived through the US/UK/Irish housing bubbles of the past few years, as though Brazilians are going through something very similar. House prices there - particularly SP and Rio but all over Brazil - have simply gone through the roof in the past 5 years. Anecdotally, an apartment that a friend bought for $100k five years ago is now worth $600k! The work being done by builders is slaphazard and, by US standards, substandard. Builders, including Gafisa, are racing to finish one project and start others "while the music plays," a la the one-time Citibank CEO. Every Brazilian I met while living in SP last year is talking about buying as many properties as they possibly can to get on the bandwagon. My feel is there is a lot of speculation going on at this time - particularly with the World Cup and Olympics coming to Brazil in the next few years. I wold be very careful of Brazilian builders at tis time. Just my few cents! Good luck nonetheless.