Brazil: BM&F Bovespa’s room for recovery in question
Exchange already ‘toppish’, valuations suggest; Bovespa argues internationalisation adds differentiation.
The BM&F Bovespa is predicting that its own performance will improve strongly with the expected Brazilian recovery, but analysts question if the market is expecting too much upside and think its current valuation may already capture the likely growth in revenues from an increase in flows on the exchange.
Roberto Belchior, BM&F Bovespa managing director Latin America market development, says: “We gain from the enhancement in the economic situation, and when the political scene clears out the whole system will gain, including ourselves [because] our correlation with the macro situation is very high.”
There is also a widespread belief that lower interest rates (the market is pricing in at least one rate cut before the end of 2016) will boost equity volumes, both primary and secondary, given the inherent obstacles to equities in the current market environment.
“The risk-free rate is so high and, with the tax-free investments related to agriculture and real estate, investors can get more than the risk-free rate with no credit or liquidity risk,” says Caio Weil Villares, president of Ancord – the Brazilian association of stockbrokers. “So you don’t have a benchmark that is beatable – it’s very hard in nominal terms to generate alpha, but in risk-adjusted returns it’s impossible.”
Belchior also believes that a reduction of the 14.25% Selic (short-term interest) rate will be an opportunity to increase the Bovespa’s equities business, as will the low penetration of smaller firms on the index (the number of listed companies has fallen in recent years).
“Of course the equity market tends to suffer from a high interest rate policy but we are full service – we have fixed income and interest rate derivatives products,” he says. “There is also unlocked potential as it relates to small caps and mid caps – that’s clearly a function of the economy. There is even far more potential for large caps, we haven’t seen an IPO for a while and we will eventually have to turn that page and see good times again.”
However, analysis from UBS, led by Frederic de Mariz, questions whether lower interest rates and a more equity-friendly environment will benefit the Bovespa, especially as it is already trading at high valuations.
Brazilian markets do have room to grow from an EM perspective but they are in line from a Latin American viewpoint, UBS says. The Bovespa has a market depth of 43% (market-cap-to-GDP), which is the average for the region but well below the EM average of 81%. Moreover, turnover at 71% (trading/market cap) is well above the Latam and EM averages of 23% and 32% respectively, suggesting to UBS that equities turnover will not necessarily pick up strongly.
This year the exchange has been averaging about R$7 billion ($2.15 billion) in daily volumes, up 4.5% from 2015. Equities represent about one third of the revenues, which means that even if volumes do increase a lot, to around R$10 billion a day by 2018, the upside to earnings-per-share is limited.
We think markets overestimate the relevance of equities on earnings, as the BM&F Bovespa derives 43% of earnings from derivatives. - Frederic de Mariz, UBS
“We think markets overestimate the relevance of equities on earnings, as the BM&F Bovespa derives 43% of earnings from derivatives,” says de Mariz, who also advises caution as some equity analysts see outperformance as likely to be driven by the low current depth of equities market capitalization in Brazil.
He argues that the 43% market cap/GDP ratio will not automatically lead to catch-up. “[Some markets have] neither optimal banking intermediation nor deep capital markets and we would categorize Brazil or Latin American markets in [this] category,” he says. “In fact, Brazil reports a loan-to-GDP ratio of 51%. In terms of depth of capital markets, Brazil’s depth is above the average of Latin American markets, where market cap to GDP ranges from 14% in Argentina to 90% in Chile.”
The high turnover ratio of 71%, compared with 60% globally and just 23% in Latin America, also leads to questions about upside.
However, Belchior is keen to point to the Bovespa’s international programme as a potential source of growth for the company. In recent years, the exchange has disinvested its stake in the Chicago Mercantile Exchange to fund the acquisition of Cetip. The plan has been to invest up to the maximum amount possible before triggering regulatory approval and now has 9.9% of the Colombian exchange, 4.1% of the Mexican exchange and 10.4% in Chile.
Belchior says the strategy is to cooperate with those exchanges, particularly on technology.
“They view us as colleagues and friends and not only as a shareholder,” he says. “We didn’t buy a single stock in those exchanges before making visits and meeting with the regulators. There were rumours we wanted to buy control but we don’t. We want to be a meaningful minority partner – we want a seat at the table, but as a minority shareholder because we think it is important to have skin in the game.”
One equity analyst, who declined to be named, believes the international programme is not about maximising international revenues, but rather it is a ploy to prevent those exchanges aligning in a way that would hurt the BM&F Bovespa.
“I see the regional strategy as defensive,” he says. “They want to have a say in what is going on – they want a finger in all the pies.”