Brazil is hot right now. Aside from having the most beautiful beaches/women in the world, selling tons of natural resources, getting an upgrade form the S&P to investment grade and boasting an emerging middle class, the country also had the foresight to make a very insightful move way back in the 70’s. In 1973 when OPEC decided it wanted to use oil as a weapon in the Yom Kippur War, Brazil decided it no longer wanted to be at the mercy of the fundamentalist oil kingdoms of the Middle East. Instead the Brazilian government decided to take action to wean itself off foreign oil. The project was called “Proalcool” (pro-alcohol), and made use of Brazil’s ability to produce tons of sugar cane. Because of this great insight, Brazil today is far less dependent on foreign oil and may be a net exporter of oil in the future if the offshore oil finds turn out to be as good as Petrobras hopes. The lack of dependence on foreign oil, plethora of natural resources(not just hard commodities like ore but also agricultural products like soybeans), and emergence on internal demand make Brazil a great investment opportunity.

Historically Brazil, and the whole Latin American region for that matter, has been a highly cyclical, highly volatile region characterized by runaway inflation and unstable governments. But much has changed in the recent past and the recent commodity and agriculture boom has given the BRIC country with Latin flavor a chance to become an economic powerhouse.

In the past Brazil has been associated with a very large gap between the rich and the poor. It has one of the worst Gini coefficients (57) of any nation on the planet. (The Gini coefficient essentially measure the gap between the rich and poor – for reference the greedy capitalists of the US score a 40.8, Russia comes in at 39.9, and Mexico gets a 46.1) And although this is still largely true, the commodity boom has given Brazil an emerging middle class which translates to internal demand. That is, demand for better infrastructure, airports, buildings, consumer goods- you get the picture – better everything. Sounds familiar? It should - tt’s the emerging markets story – it’s the BRIC story – an infrastructure boom coupled with emerging internal demand.

I want to ride this infrastructure wave Brazilian style, so I am recommending SID. Companhia Siderurgica Nacional S.A (SID) is a fully integrated Brazilian Steel company that no one produces steel, but also owns ore mines(ore is the man input for steel), railroads/seaports(to ship the ore and steel around), and has investments in power supply companies. SID sells its products in 72 countries around the world and exports about 40% of its products.

The Numbers

SID has a strong market cap of 32 billion with 5.23 billion in debt and 2.17 billion in cash. The company sports a healthy current ratio of 1.363 – so no short term liquidity problems here. The F P/E of 9.61(yahoo finance, other sources vary greatly and have much higher p/e’s) is attractive and so is the 24.42% profit margin (from a 30.39% operating margin). The company hit a high of 52.46 back in mid-late May and has pulled back a bit to 42.70 today. The company also pays a sporadic dividend which equal about 4.5%, but I would not invest in this stock based on its current sporadic yield.

Qualitatively

It’s all about demand for SID’s products created by the global infrastructure boom. More to the point, SID is a vertically integrated monopoly and does not have to worry about rising ore/transport costs that plague most steel makers (Rio Tinto just raised ore prices on China by 80%). Icing on the cake for me is the prospect of growing internal demand for SID’s products which would come from the emerging Brazilian middle class demanding copious amounts of steel.

Warning

I once heard it said that the institutions think of L. America as a trade not an investment. Since the big boys set the prices, and L. America has run up a lot already, there may be some profit taking. But in spite of this vexing fact I am still bullish on SID as a play on the global infrastructure boom.

Why is it undervalued?

This is the most important question. Firstly, I would say there is some information asymmetry with this stock. Investment conversations about Brazil always seem to lead to two stocks (all be them great stocks) CVRD (RIO) and Petrobras (PBR). SID does not get the attention I think it deserves. Furthermore, I think SID is undervalued because the big institutions are wary of L. American – they have been burned (recently in the early 2000’s) on the volatile region before and they are very wary of a possible bubble this time around.

Conclusion

I like SID for a number of reasons- the infrastructure boom, the rising internal demand, the vertically integrated monopoly- but the stock is a bit of a speculative play. This is not a stock for widows and orphans – if you are super risk averse see my article about Phillip Morris International below.

If you have any questions/comments/just want to tell me to go to hell – feel free to e-mail me at domenic@domenicstrazzulla.com

Also – never invest on someone else’s advice – do you own research.

Disclosure – not long SID yet but plan to be and already long several global infrastructure companies.

Companhia Siderurgica Nacional (SID)