Brazil Equity Strategy Playing Low Rates, GDP Acceleration...

| 1 |

Brazil Equity Strategy – Playing Low Rates, GDP Acceleration,

and Macro Adjustment

Marina Valle

[email protected]

+55 (11) 3847 9403

Andre Carvalho

[email protected]

+55 (11) 3847 9327

October 2019

| 2 |

Post-Pension Reform Agenda

| 3 |

What is the growth agenda?

Source: Bradesco BBI

Improvement in business conditions:

Tax reform

Bill changing regulatory framework for the sanitation sector

Bill changing the telecom sector’s regulatory framework (PLC 79/16) - APPROVED

Bill to change the gas industry

Bill making it easier to do business in Brazil (MP 881/19) - APPROVED

Import tariff cuts

Privatizations, concessions, and asset sales:

BNDESPar to sell its equity portfolio (~R$120bn)

Concessions of oil fields and transportation services (e.g. airports, toll roads, railroads)

IPO of some financial services (e.g. Caixa insurance, credit card business, lottery)

Bill to privatize Eletrobras

Bill to allow foreigners to buy more land in Brazil

Reduction in cost of capital:

Monetary easing

Bill on Central Bank autonomy

| 4 |

Brazilian tax reform - Summary

Note: (*) voluntary participation by states and municipalities. Source: Bradesco DEPEC, Bradesco BBI

Goods &

Services

Federal VAT (Cofins,

PIS, IPI)

or

Dual VAT* = Federal

VAT + (ICMS, ISS)

Income &

Profits

Reduce Corporate

Tax (IRPJ & CSLL)

Reduce Personal

Income Tax (IRPF)

Remove/Limit Tax

Deductions

Tax Dividends

| 5 |

Multi-Year Earnings and GDP Growth Cycle

| 6 |

Brazil GDP’s pace of recovery after a recession is the slowest since 1980

Source: AC Pastore, Bradesco BBI

Pace of GDP growth after recessions

1981

1987

1989

1995

1998

2001

2003

2008

Current

BBI Est.

98

100

102

104

106

108

110

0 1 2 3 4 5 6 7 8 9 10 11 12 13

| 7 |

In real terms, government spending is actually declining YoY

Source: STN, Bradesco DEPEC, Bradesco BBI

Central Government Real Spending (% annual)

-5%

0%

5%

10%

15%

20%

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19

-0.20

6.13

| 8 |

Real wage bill (wages + employment) provides cushion for household consumption growth

Source: IBGE, Bradesco BBI

Real Wage Bill (YoY)

Aug-17 Aug-18Aug-16 Aug-19Aug-15

-5.4%

-1.2%

2.0%

3.9%3.0%

1.8%

2.8%

| 9 |

Unemployment remains high


Employment growth (YoY %) and unemployment rate (%)

Unemployment rate, seasonally adjusted - RHS

Aug-17 Aug-18

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

-2.4

-2.1

Employment growth (YoY)

13.1

12.0

-1.5

-0.6

0.3

1.1 1.2

Aug-16 Aug-19

1.0

2.11.9

1.4 1.5

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1.8

2.1

Aug-17 Aug-18 Aug-19

2.4

2.0

| 10 |

Employment growth mostly driven by informal job creation


Employment growth breakdown (YoY)

Informal Jobs – Private Sector Not RegisteredFormal Jobs

Informal Jobs – Own Business

Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19 Aug-19

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

Total

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Bank Lending Accelerating

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Bank lending growth on an upward trend since early 2017

Source: BCB, Bradesco BBI

Bank lending growth in nominal terms (%)

8.4%

34.2%

14.6%

21.0%

10.9%

-3.8%

5.4%

-10%

0%

10%

20%

30%

40%

Aug-03 Aug-05 Aug-07 Aug-09 Aug-11 Aug-13 Aug-15 Aug-17 Aug-19

| 13 |

Private-sector banks to continue gaining market share in 2019


Bank lending growth (YoY, %) and market share in Aug. 2019

Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Aug-19

Public-sector banks

Private-sector banks

-5%

0%

5%

10%

20%Private-sector,

national banks

51%

Aug. 2019

Weight (% of total)

Public-sector

49%

-15

-5

5

15

25

35

Aug-13

14.2%

-2.4%

| 14 |

Bank lending still better for individuals than for companies


Quarterly Growth of Loans (%)

-9.5

Corporate loans (growth - YoY)

1Q-11 1Q-12 1Q-13 1Q-14 1Q-15 1Q-16 1Q-17 1Q-18

Personal loans (growth - YoY)

-0.91Q-19

Aug-19

22.2

17.0

14.3

9.7

12.2

9.8

8.2 6.6

19.4

21.1

17.218.6

8.2 9.2

10.7

4.53.2

8.7 4.7

| 15 |

Main investment themes

I. Global factors: Global economy in soft landing, Chinese domestic

demand to stabilize & recover, US politics

II. Brazil macro policy adjustment

III.Low interest rates on multi-year basis

IV.Multi-year GDP growth cycle

V.Privatization, concessions, asset sales & turnaround of SOEs

October 2019

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Sector recommendations

Overweight

Consumer Discretionary, Exchanges, Healthcare, Utilities

Neutral

Energy

Underweight

Cons. Staples, Banks, Industrials, Insurance, Materials, Real Estate, Telecom

October 2019

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LatAm Equities

| 18 |

LatAm equities are inexpensive

Source: Thomson Reuters Datastream, Bradesco BBI

MSCI LatAm - Consensus 12-month forward P/E (through Oct. 16, 2019)

Oct-13 Oct-15 Oct-17 Oct-19

+1 standard deviation

-1 standard deviation

12.8

13.9

11.9

7-year average

Oct-11

15.1

8

16

10

12

14

Oct-09

13.8

12.4

| 19 | Source: Bradesco BBI

We are OW Brazil and Mexico and UW Andeans and Argentina

Brazil (Overweight). The Brazilian equity market looks cheap, considering the current long-

term real interest rate and BBI’s forecast for EPS growth. We sees low risk of political fatigue

regarding the current economic agenda. Our 2019 Ibovespa target is 122,000 points.

Mexico (Overweight). We see upside risks from more orthodox policymaking. This policy

optionality, coupled with low investor sentiment, makes us comfortable in having an OW on the

country.

Chile (Neutral). Although Chile has an attractive valuation, the country is exposed to China’s

economic performance.

Peru (Underweight). Disappointing economic activity figures, increasing political uncertainty,

and high sensitivity to commodities & China support a more cautious view.

Colombia (Underweight). Despite Colombian equities’ attractive valuations and high risk

premiums, it is difficult to find appealing bottom-up stories.

Argentina (Underweight). The challenges are mounting and we have no visibility on the

country’s post-election macro policy. Also, BBI’s economics team forecasts a deep recession in

2020 and a sharp currency depreciation, supporting our OW.

| 20 |Note: The MSCI weighting for Petrobras considers the two classes within the Index. Source: Thomson Reuters Datastream,

Bloomberg, Bradesco BBI

Local MSCI Portfolio Mkt. Cap P/E Div. Yld FundamentalCompany

Ticker Weight Weight (US$ mn) 20E (%) 19-20E AnalystPriceRatingBradesco BBI Last

Bradesco BBI’s LatAm Model Portfolio

Through Oct. 16, 2019

Banco do Brasil BBAS3 1.5% 6.0% Neutral 30,984 45.00 6.8 5.6% Victor Schabbel

Itau Unibanco ITUB4 6.1% 10.0% Neutral 76,216 34.86 10.8 6.2% Victor Schabbel

B3 B3SA3 3.5% 6.5% Outperform 22,365 45.20 24.0 4.2% Rafael Frade

CVC CVCB3 0.0% 6.0% Outperform 1,899 53.00 19.5 1.2% Richard CathcartLojas Renner LREN3 1.5% 7.0% Outperform 9,904 51.83 26.7 1.7% Richard Cathcart

Energisa ENGI11 0.3% 6.0% Outperform 4,451 47.80 17.9 1.7% Francisco Navarrete

CPFL CPFE3 0.0% 5.2% Outperform 8,819 31.85 12.4 3.9% Francisco Navarrete

Rumo RAIL3 1.0% 6.2% Outperform 9,792 23.47 29.4 0.4% Victor Mizusaki

Vale VALE3 5.8% 6.0% Outperform 59,427 46.80 6.2 7.3% Thiago Lofiego

Petrobras PN PETR4 7.6% 9.0% Outperform 92,125 27.93 11.6 3.9% Vicente Falanga

Mexico 21.2% 21.8% Overweight

Banorte GFNORTEO 2.3% 4.3% Outperform 16,288 108.43 8.1 5.8% Rafael Frade

Bolsa Mexicana BOLSAA 0.0% 3.0% Outperform 1,143 36.99 14.6 5.1% Rafael Frade

Coca-Cola FEMSA KOF 0.5% 4.0% Outperform 13,021 61.98 16.9 3.3% Leandro Fontanesi

Fibra Danhos DANHOS13 0.0% 3.7% Outperform 2,152 28.85 10.6 8.9% Victor Tapia

GAP PAC 0.6% 3.7% Outperform 5,650 100.72 17.6 4.7% Rodolfo Ramos

Cemex CX 0.9% 3.3% Outperform 6,189 4.13 9.5 1.7% Rodolfo Ramos

Chile 8.2% 8.2% Neutral

Copec COPEC 0.6% 3.9% Outperform 13,080 7,214 24.3 2.2% Thiago Lofiego

Enel Chile ENELCHIL 0.4% 4.3% Neutral 6,765 70.12 10.6 6.0% Francisco Navarrete

Peru 3.1% 2.1% Underweight

Credicorp BAP 2.2% 2.1% Neutral 16,692 209.28 11.1 3.4% Rafael Frade

Colombia 3.4% 0.0% Underweight

Argentina 1.6% 0.0% Underweight

Brazil 62.4% 67.8% Overweight

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Brazilian Equities Outlook

| 22 |

MSCI Brazil multiples should be at 13.5x to reflect lower long-term rates

Source: Thomson Reuters Datastream, Bradesco BBI

MSCI Brazil - Consensus 12-month forward P/E (through Oct. 16, 2019)

Oct-17Oct-11 Oct-13 Oct-15 Oct-19Oct-09

13.5

7-year average 11.2

+1 standard deviation

14.0

11.9

10.0-1 standard deviation

12.4

13.9

10

14

4

6

8

12

| 23 |

MSCI Brazil embeds high equity risk premium (ERP)

Source: BCB, Bloomberg, Thompson Reuters Datastream, Bradesco BBI

Equity risk premium (ERP) and its historical average (p.p.) (through Oct. 16, 2019)

Oct-11 Oct-13 Oct-15 Oct-17 Oct-19Oct-09

1.8

9.2

-0.7

9.4

Historical average ERP

6.3

7.4

0.4

4.7

4.7

-0.1

7.0

Oct-07

-2

0

2

4

6

8

10

Oct-06

| 24 |

Long-term real rates have decreased by 3 p.p. in the past year

Note: The index provides a weighted average yield of NTN-B bonds (IPCA inflation linked) issued by the Brazilian National Treasury

with a remaining life of 7-10 years. The weights are given by the amount outstanding of each bond included in the basket. Source:

Bloomberg, Bradesco BBI

NTN-B inflation-linked bonds’ real yields (7-10 years*, %, through Oct. 16, 2019)

3.1

7.06.7

7.6

5.5

6.2

2.8

4.6

Oct-11 Oct-13 Oct-15 Oct-17 Oct-19Oct-09

6

8

7

9

2

3

4

5

5.8

| 25 |

Brazil’s long-term rates converging to international peers’ levels

Source: Bloomberg, Bradesco DEPEC, Bradesco BBI

Nominal Interest Rates - 10 Years

2008 2010 2015 2018 2019 CPI Target

Brazil 12.5 12.3 13.7 10.3 7.2 3.8

South Africa 9.1 8.5 8.2 8.7 9.0 4.5

Russia 7.9 7.8 11.3 7.8 7.2 4.0

Chile 6.7 4.8 4.5 4.2 2.7 3.0

Colombia 10.8 4.9 7.5 6.6 6.0 3.0

Peru 7.3 5.9 6.4 5.6 4.2 2.0

Mexico 8.4 7.0 6.0 7.2 7.0 3.0

Average (ex-Brazil) 8.9 7.7 8.2 7.2 6.2 3.3

| 26 |

Yield curve pricing in Selic at 4.0-4.5% soon, then low rates for long

Source: Bloomberg, Bradesco BBI

Brazil’s yield curve31-O

ct-

19

12-D

ec-1

9

06-F

eb-2

0

4.9

4.2

5.4

6.0

7.2 7.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

19-M

ar-

20

07-M

ay-2

0

18-J

un-2

0

06-A

ug-2

0

17-S

ep-2

0

29-O

ct-

20

10-D

ec-2

028-J

an-2

1

11-M

ar-

21

29-A

pr-

21

10-J

un-2

127-J

ul-21

09-S

ep-2

128-O

ct-

21

09-D

ec-2

127-J

an-2

2

10-M

ar-

22

28-A

pr-

22

09-J

un-2

228-J

ul-22

08-S

ep-2

227-O

ct-

22

08-D

ec-2

226-J

an-2

3

09-M

ar-

23

27-A

pr-

23

08-J

un-2

327-J

ul-23

07-S

ep-2

326-O

ct-

23

07-D

ec-2

325-J

an-2

4

07-M

ar-

24

25-A

pr-

24

06-J

un-2

425-J

ul-24

05-S

ep-2

424-O

ct-

24

05-D

ec-2

423-J

an-2

5

| 27 |

Yield curve slope still above historical average…

Source: Bradesco DEPEC, Bradesco BBI

Yield Curve Slope (bps) - Difference between 5-year and 1-year yields

11 12 13 14 15 16 17 18 19

Slope

Average

-124

316

173

375

85

10

313

-200

-100

0

100

200

300

400

09

| 28 |

…also above what fundamentals suggest due to fiscal uncertainty

Source: Bradesco DEPEC, Bradesco BBI

Yield Curve Slope - Breakdown

Neutral Interest Rate Level InflationGlobal Interest Rate

Country Risk + Constant ModelEffective Slope

173

8

-400

-300

-200

-100

0

100

200

300

400

500

09 10 11 12 13 14 15 16 17 18 19

| 29 |

Corporate credit spreads already reflecting much better macro in Brazil

Source: Thomson Reuters Datastream, Bloomberg, Bradesco BBI

Spread between corporate and sovereign credit yields (through Oct. 16, 2019)

Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19

-0.5

0.5

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Oct-12

| 30 |

Bradesco BBI’s Brazil Model Portfolio

* Note: The MSCI weight for Petrobras considers both ON and PN classes. Source: Bloomberg, Bradesco BBI

Through Oct. 16, 2019

Local MSCI Portfolio Mkt. Cap PE Div. Yld FundamentalCompany Ticker Weight Weight (US$ mn) 20E (%) 19-20E AnalystPriceRating

Bradesco Last(USS mn)

ADTV

Banco do Brasil BBAS3 2.3% 8.0% Neutral 30,984 116.3 45.00 6.8 5.6% Victor Schabbel

Santander Brasil SANB11 1.1% 15.0% Outperform 42,177 18.0 46.37 10.3 5.1% Victor Schabbel

B3 B3SA3 5.6% 10.0% Outperform 22,365 94.7 45.20 24.0 4.2% Rafael Frade

CVC CVCB3 0.0% 10.0% Outperform 1,899 22.7 53.00 19.5 1.2% Richard Cathcart

Lojas Renner LREN3 2.4% 8.0% Outperform 9,904 46.4 51.83 26.7 1.7% Richard Cathcart

Hapvida HAPV3 0.0% 8.0% Outperform 10,065 25.4 57.09 31.7 0.9% Fred Mendes

CPFL Energia CPFE3 0.0% 10.0% Outperform 8,819 23.4 31.85 12.4 3.9% Francisco Navarrete

Sabesp SBSP3 1.0% 10.0% Neutral 8,481 32.6 51.64 10.6 2.1% Francisco Navarrete

VALE VALE3 9.2% 8.0% Outperform 59,239 53.4 46.80 6.2 7.3% Thiago Lofiego

Petrobras PN * PETR4 12.1% 13.0% Outperform 92,125 285.5 27.93 11.6 3.9% Vicente Falanga

| 31 |

Fiscal Adjustment

| 32 |

BRL Trading at a Premium

| 33 |

The BRL has depreciated much more than other EM currencies

Note: BRL accumulated change vs. median of 22 emerging market currenciesSource: Bloomberg, Bradesco DEPEC, Bradesco BBI

BRL vs. 22 Emerging Markets’ Currencies

3.68

4.11

3.00

3.20

3.40

3.60

3.80

4.00

4.20

4.40

Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19

BRL Median 90% 75% 25%

| 34 |

Net external liabilities suggest fair value for BRL close to R$4.00/US$


Breakdown of external liabilities (%)

Others

Loans

Fixed

Income

Equities

Foreign

Direct

Investment

2003 2005 2007 2009 2011 2013 2015 2017 1Q-192001

33 33 37 34 37 47

48 50 50 50

108

17

4022

3524 20

12 21 2131

28

22

16 17 16 18

18

14 13

24 13 10 1319

1415

51

21

13

14

Aug-19

15

13

22

51

| 35 | Source: Bradesco BBI

Risks to Brazil’s equity markets in 2019 and 2020

XxxxxxxxxxxPositive risks

Congress to approve meaningful

fiscal adjustment measures after

passing the Pension Reform.

Average Selic rate below 6% in

2019-2022 with Brazil’s GDP

accelerating.

Earnings growth above

consensus in 2020 and beyond.

Deeper SOE turnarounds (e.g.

privatization).

International commodity prices

rising with China’s domestic

demand recovering.

Global risk appetite increasing.

Negative risks

Brazil’s GDP growth remaining

around 1%.

Hard landing by global

economy.

Global geopolitical risk

deteriorating materially.

Significant decline in

international investors’ risk

appetite, material slowdown in

China, and sharp drop in

commodity prices.

Brazil Equity Strategy Playing Low Rates, GDP Acceleration...

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