3 Picks for the Brazilian Election - Analyst Blog

On Oct 5, the first round of Brazil's presidential elections threw up an unanticipated result. Aécio Neves, the candidate of the Brazilian Social Democratic Party (PSDB) received 34% of the vote, a substantial increase from the 20% indicated by polls held some days back. This raises the possibility of a change of regime in the country which might also lead to an alternative set of economic policies.

First Round Results Surprise

The surge in vote share received by Neves, the candidate of the primary right-of-center opposition party, significantly reduces the chances of the third candidate Marina Silva. The centrist candidate, who is also an environmentalist, was poised to defeat incumbent Dilma Rousseff. The current president now leads the race with 42% of the vote. However, this is the lowest percentage polled by any leading candidate since the reintroduction of direct elections in 1989.

Several observers have ignored the results of the polls, which indicate that Neves is steadily inching closer to the presidency. However, the results of two opinion polls released on Oct 9 have indicated that the second round on Oct 26 will see a stiff battle between Neves and Rousseff. Each of these polls shows that Neves will receive 46% of the vote share, once again a first, since polls indicate that the challenger has trumped the leading candidate.

It seems Marina Silva holds the keys to the President's office. Whoever she chooses to support in the second round of elections would hold a significant advantage. Silva and Rousseff have been colleagues in the past, when the environmentalist was part of the ruling PT (Workers' Party), but have disagreed strongly on policy matters.

Given Silva's attacks on the incumbent in the first round, it is unlikely she will offer support. There are some indications that she might support Neves. In fact, the most favorable outcome for the president would be a scenario where Silva refuses to support anyone at all.

Neves Markets' Favorite

Analysts have taken the view that a victory for Neves could usher in a period of prosperity for a country plagued by several economic problems. He is viewed as a pro-growth candidate and has even declared his choice for finance minister, clearly indicating who his economic decision makers will be.

Neves is expected to attack the economic policies of president Rousseff before the next round of elections. He will blame her administration for an inflation rate of 6.5%, low rate of growth and dismal levels of productivity. Additionally, he will showcase his success during two terms as governor of the prosperous state of Minas Gerais.

The economist credits himself with preventing the state from lapsing into bankruptcy by reducing government expenditure and increasing revenues. This program has been referred to as “management shock.”

He is also expected to critique the current administration for a number of scandals which has dented the reputation of the ruling Workers' Party. This includes allegations of rampant corruption and favoritism at government owned companies such as Petrobras (PBR).

Economic Indicators Improve

Despite these factors, Rousseff remains a frontrunner at this point. Since the restoration of democracy in 1989, no candidate who finished second in the first round has won the presidency. Despite sluggish growth and rising inflation, unemployment is at a record low of 4.9%, significantly lower than the 12.3% when the PT first won elections in 2003. The quality of employment has also increased with the percentage of workers in the informal sector declining to 13% from 22%.

According to data released last month, Brazil grew at 1.5% in July compared to June. This is the largest monthly increase in the last six years according to the country's central bank. The bank's gauge of economic activity, an indicator of GDP levels, increased in July after falling for two successive months.

Additionally, a survey conducted by the country's central bank revealed that analysts have revised their growth forecast for 2014 upward. The weekly survey of 100 respondents from private financial institutions indicated that the economy may grow at 0.28% compared with earlier expectations of an increase of 0.24%.

This was the first increase in the forecast for 2014 in 19 weeks. Government estimates for growth remain at 0.9%. Market watchers believe Brazil will grow at 1% in 2015 with an inflation rate of 6.3%.   

Policy Changes Ahead?

Rousseff has stated that she will reshuffle her cabinet, indicating that finance minister Mantega may be removed. Mantega initiated temporary policy measures to weaken the Brazil's currency and stimulate growth. These steps led to confusion among investors and could not control inflation. Ultimately, the central bank was forced to increase rates, reducing growth further.

Market watchers believe the incumbent will reverse several unpopular policy measures. She has also indicated that she will allow Brazilian real to appreciate. Rousseff will need a strong replacement for Mantega if she wishes to bolster her chances of re-election. Neves remains the market's favorite and is expected to radically change policy if he wins. But even a win for Rousseff could initiate changes in the country's economic policies.

Our Choices

Below we present three stocks which will gain from these trends, each of which also has a good Zacks rank.

Companhia Brasileira de Distribuicao (CBD) is a retailer of food, home appliances, clothing, drugs, fuel and other products. The company utilizes various store formats to distribute its products and owns several brand names. It has four major divisions, retail, cash and carry, e-commerce and home appliances.

Companhia Brasileira holds a Zacks Rank #1 (Strong Buy) and has expected earnings growth of 6.7%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 17.85.

Banco Bradesco S.A. (BBD) is a bank which offers a wide range of financial products and services targeted at individuals as well as corporate customers. Its range of operations includes investment and international banking. The bank operates within the country as well as in foreign nations and has several subsidiary companies.

The company currently holds a Zacks Rank #2 (Buy) and has expected earnings growth of 27.3%. It has a P/E (F1) of 10.64x.

Itau Unibanco Holding SA (ITUB) is a holding company whose primary operations are related to the banking sector. The company has four operating segments. These are commercial banking, consumer credit, market and corporation activity and Itau BBA. Through Itau BBA, the company provides business banking and investment banking services.

Apart from a Zacks Rank #2 (Buy), Itau has expected earnings growth of 27.4%. It has a P/E (F1) of 10.41x.

Economic issues are playing a crucial role in Brazil's election. Regardless of who wins, a change on the policy front is certain as the country looks to boost growth. Given these factors, adding these stocks to your portfolio would be a prudent choice.

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