Differentiating sources of value when the macro story is so strong
Q. As a Brazilian company, how important is it to help our investors distinguish between the macroeconomic and the company-specific when Brazil’s big picture is such a strong story in its own right?
A. Macroeconomic realities and sovereign financial health have always been important to the equity valuation of Brazilian companies. In the days of hyper-inflation, before liberalization and the establishment of current standards of financial discipline, Brazilian companies’ ability to raise debt was limited by the ‘sovereign ceiling’: no company could achieve a higher credit rating than the country. Money was therefore expensive, limiting virtually every kind of business option.
Brazilian companies have also often been penalized because of the ‘Brazil discount’: the perception that inadequate infrastructure adds significantly to corporate expense. While there have been vast improvements, the infrastructure drag on economic activity persists, due in no small part to surging economic growth.
The good news is that there is no longer a meaningful sovereign ceiling on debt ratings. Today strong commodity prices, new mineral and energy discoveries and rising demand from China and elsewhere have created capital inflows that give Brazil a public financial profile that is admired globally. Corporate equity valuations have benefited enormously in this benign environment.
But every responsible investor knows that a strong financial and macroeconomic background can mask holes in corporate performance that become evident only when the macro-cycle reverses. Brazilian companies seeking to help investors distinguish between macro-based and company-specific performance factors should first undertake a serious study of the matter for themselves. Whether or not they initiate this discussion with the market, it is critical that they arrive at the best and most realistic picture of the sources of their financial results.
Managements that confuse the quality of their own performance with the benefits they reap from what we might now call the ‘Brazil premium’ will inevitably face exposure, just as weaknesses in US and European financial institutions came to light at the advent of the current crisis there.
In exploring the relationship between macro and company-specific factors, one can hardly avoid the special case of those large Brazilian resource companies in which the government holds a significant equity stake. While benefiting from Brazil’s amazing wealth under the ground and sea, and from enormous global demand, these companies are also influenced by the government’s interest in assuring that society as a whole benefits from the country’s ‘patrimony’. Investors are therefore compelled to undertake an unusual calculus in deciding the degree to which such influences on executive strategy affect customary valuation models.
These companies – for reasons of scale, available resources and global demand for their products – remain immensely attractive to international investors despite their particular governance characteristics. As a consequence, the challenges to investor relations groups within these companies are unique, and there is little question they have important insights to teach the rest of the IR profession.
Peter Firestein is president of Global Strategic Communications (www.firesteinco.com) in New York
This article appeared in the July print edition of IR magazine.
