Initiation of Coverage

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April 17, 2009 Equity Research

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PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 41 AND IMPORTANT DISCLOSURES, INCLUDING FOREIGN

AFFILIATE DISCLOSURES, BEGINNING ON PAGE41

.

Consumer

Latin America Cement and ConstructionBrazilian Housing DevelopersInitiation of Coverage

Fell and then Rose Sharply on Sentiment - Time to

Look at Fundamentals

Guilherme Vilazante

BBSA, Sao Paolo

+55 11 5509 3376

[email protected]

Edoardo Biancher

BBSA, Sao Paolo

+55 11 5509 3348

[email protected]

Sector View

New: 1-Positive

Old: 0-Not Rated

Summary

Fell and then rose sharply on sentiment: the steep downward motion of Brazilian housing stocks over the last 12 months wasdriven by a combination of a difficult credit environment, uncertainty about demand, lack of predictability, and cumbersome andever-changing accounting principles, together with a bearish global sector scenario. Since March 25th, when the governmentunveiled a housing package (which provided funding for production and improved affordability for low income units), the sectorhas risen sharply. On the way down, from peak to trough the sector has declined -79% (vs. -59% Ibovespa), and from lateMarch to today the sector has gone up by 65% (vs. 30% Ibovespa).

However, we believe sizable upside potential remains: even after this rally, blue-chip stocks (the focus of this report) seemfairly undervalued, in our view estimated upside potential varies from between 57% and 152%. Despite a healthy ROE andattractive growth prospects, only two companies trade above BVadj, and by a small margin. Thus, regardless of the past fewweeks upsurge, sizable upside potential remains, in our opinion.

Time to look at fundamentals: a special section of this report is dedicated to providing details on the DCF valuationmethodology from which we derive our target prices. We intend to challenge the consensus view that projecting cash flow forhousing companies is a complex task; instead, we believe it is possible to break down the valuation into a few simple blocks thatenhance visibility of where value comes from.

Government housing package and opportunities in the low income segment: we also discuss the government housingpackage and other factors that should help determine or limit growth in the next few years. Of the three growth determinants wesee for developers (3Cs: Client, Capital and Capacity), the government and companies have addressed the first two, Client andCapital, through the package and special credit lines. Now, execution capacity should determine the sectors winners and

laggards. We believe the challenges are higher than most investors realize and companies advertise, but so are the potentialpayoffs.

Our Top Picks are PDG, MRV and Rossi with a 1-Overweight rating: PDG and MRV on the back of a legacy position in thelow income segment combined with a likely boost in demand in the short term by the government package; and Rossi onvaluation (152% upside potential) - we see the discount as overdone given the companys credentials. We rate Cyrela andGafisa as a 3-Underweight, despite the attractive upside potential (57% for Cyrela and 89% for GFSA). We believe Cyrelashould take a few more quarters than expected to trade-down and collect the benefits of the additional demand for low incomehomes. As for Gafisa we believe short-term (operating) liquidity concerns relating to the Tenda acquisition will likely weigh onstock performance.


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Initiating on the Brazilian housing sector blue-chips

We are initiating coverage of the Brazilian housing sector with a 1-Positive rating. We believe valuations still offer attractiveupside potential, even before taking into account the new opportunities that the government housing package entails. In ourview, the potential upside ranges from 57% and 152%, assuming zero or negative growth in launches for the stocks we are

initiating on today.

In this report, we initiate coverage of the five largest and most liquid stocks within the housing sector: Cyrela, Rossi, Gafisa,PDG and MRV, which we will refer to as blue-chips. We are bullish on the sector, and based on our forecasts we believe thesestocks still offer upside potential of around 86% in the next 12 months (despite the impressive rally witnessed recently).

In this report, we also discuss the government housing package and other factors that should help determine or limit growth inthe next few years. Of the three growth determinants we see for developers (3Cs: Client, Capital and Capacity), the governmentby means of the recently announced package, has helped provide the first two, Client and Capital and therefore, executioncapacity is what should determine the sectors winners and laggards, in our view. We believe the challenges are higher thanmost investors realize and companies advertise, but so are the potential payoffs. Please refer to the section GovernmentHousing Package and the 3Cs approach for further details.

The section Valuation 101 Divide to conquer, which we consider the most important of this report, details the DCF valuationmethodology from which we derive our price targets. Further, we intend to challenge the consensus view that projecting cash

flow for Brazilian homebuilders is a complex task; instead, we believe it is possible to break down the valuation into a few simpleblocks that enhance visibility of where value comes from.

A more detailed account of the target price assessment (and DCF calculation) gains importance given the wide dispersion oftarget prices (TPs) in the street, which cannot be justified by differences in margins, Ke and growth assumptions, in our view.We believe that, despite the recent rally, no gain from the government housing package is priced in, and there is sizable upsidepotential under conservative assumptions. Therefore, we believe that allowing investors to walk through our valuationmethodology (and to see how conservative we have been) is a strong support to convey our positive view on the sector.

Finally, in the What can go wrong? section, we review the main points of concern of the investors that have driven stock pricesbelow their liquidation value during the most critical point of the crisis, of which we highlight the risk of banks pulling out ofongoing projects and the risk of a hike in discretionary return levels (sales cancellation). We also explain why we believe thatthese concerns are overdone.

We are rating MRV, PDG, and Rossi as 1-Overweight

We believe there is a high likelihood that demand for low income units exceed expectations in the next few quarters due to thegovernments housing package (significant advertisement + considerable gain in affordability; news flow already starting to showthis), and thus MRV and PDG, which boasts a legacy exposure to low income clients, in our view are to be the mainbeneficiaries in the next few quarters.

MRV is, in our opinion, the best prepared player to take advantage of the government package. We believe it is significantlyahead of its peers on the construction, logistics and procurement processes for affordable houses production. We believe it doesnot need to develop any additional skills to produce cheap, super standardized houses (government package focus).

Our 12-month TP for MRV is R$30/share (69% upside potential) and this is considering zero growth in launches from 2008levels. It is trading at 1.15 P/BVadj and 0.89 P/LV.

As for PDG, it could benefit from the potential upside from an acquisition of a smaller listed company, which we regard assomewhat likely to happen in the next 12 months, but not yet priced in. In our view, PDG has both funds (R$ 276mn BNDESloan for consolidation purposes) and potential targets (13 smaller listed companies that are about to enter the most cash-

consuming part of their construction cycle and are trading below 0.3x P/BVadj) to accomplish this undertaking.Regardless of the potential upside from acquisitions, the stock is trading barely above its BVAdj. Our 12-month TP isR$25/share (61% upside potential); it is currently trading at 1.03 P/BVadj and 1.1 P/LV.

Rossi is by far the most discounted player in our coverage universe, by our analysis. A string of relatively unimportant negativeevents, amplified by the lack of efficiency in communicating them, has weighed on stock performance since its IPO. At its currentprice, Rossi is significantly undervalued, in our view, although it is a leading, competitive, capitalized and healthy company, withno liquidity issues or any material issue to justify such a discount, in our opinion. Our 12-month TP is R$13/share (152% upsidepotential). It is trading at 0.53 P/BVadj (47% below its peers level) and 0.56 P/LV (33% below peers). The net present valuefrom projects launched before 2009 (which will be cashed in before 2011), minus the debt obligations, is still 38% higher thanRossis market cap, which we see as too strong a punishment for not communicating bad news effectively.


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We believe that, after its recent rally, the sector has come back into the spotlight. Therefore, investors are more likely to seek outthe fundamentals, and such a significant discount to peers and to the value of its own assets should narrow, in our view. (Forfurther information regarding TP methodology, please refer to the section Valuation Methodology).

and Cyrela and Gafisa as 3-Underweight

Cyrela has been adopting a conservative stance towards growth especially in the mid and high income segments (where it has acompetitive edge). As for the affordable segment, notwithstanding the sizable growth potential (and equally high pay-offs), andthe energy the company is devoting to developing this business unit, trading down can prove to be more challenging and time-consuming than the company and investors expect (please see the Government Housing Package and the 3Cs approachsection below for an in-depth discussion). These factors should cause the company to lag its peers in growth for now. Our 12-month TP for Cyrela is R$18/share (57% upside potential), trading at 1.13 P/BVadj and 0.78 P/LV.

For Gafisa, despite its attractive valuation (the company trades below its BVAdj and LV), we believe that short-term (operating)liquidity concerns could weigh on the stock performance. The acquisition of Tenda in 2008 (which we consider a rareopportunity) has brought operating volatility and hefty short-term construction obligations to Gafisa, thus we prefer not to ratethis stock differently until the company clarifies the way out for its short-term liquidity position.

On the positive side, the company has a strong asset support for valuation (NPV of ongoing projects accounts for 110% of the

current market cap), and it has achieved a competitive edge in the low-income segment through Tendas acquisition. This recentacquisition had an impact on Gafisas short-term liquidity position, which we believe could cause the stock to underperform itspeers during the next few months.

Our 12-month TP for Gafisa is R$28/share (89% upside potential), trading at 0.81 P/BVadj and 0.81 P/LV (for further informationregarding TP methodology, please refer to the section Valuation Methodology).

Figure 1: Company comparison

CYRE GFSA MRV PDG RSIDMarket Cap (R$m) 4,091 1,962 2,407 2,263 984Rating 3-Underweight 3-Underweight 1-Overweight 1-Overweight 1-OverweightPrice (Apr 15, R$/sh) 11.50 14.80 17.70 15.50 5.16TP 12m (R$/sh)* 18.0 28.0 30.0 25.0 13.0Potential Upside (%) 57% 89% 69% 61% 152%Multipes

P/LV (2008) 0.74 0.81 0.79 1.03 0.52P/BVadj

2008 1.13 0.81 1.15 1.03 0.532009 0.98 0.73 1.03 0.92 0.502010 0.88 0.68 0.94 0.93 0.48

P/E2008 11.2 12.9 10.3 12.3 8.22009 9.8 15.4 4.5 4.5 4.32010 5.0 7.0 3.8 4.1 3.0

EV/EBITDA2008 11.0 17.3 11.3 12.0 10.02009 6.9 10.5 5.4 5.3 5.9

2010 4.9 4.1 3.4 4.6 3.7* For futher information regarding TP methodology, plase refer to the section "Valuation Methodology"

Source: Barclays Capital Research


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Government Housing Package and the 3Cs approach

A very useful approach, in our view, to assess the growth prospects of housing developers in Brazil was suggested by CarlosTerepins (EVENs CEO). According to Mr. Terepins, a company can only grow as long as three conditions are met: demand for

units, capital availability and execution capacity, which we have re-branded as the 3Cs approach, namely Client, Capital andCapacity. Right now, we consider that the government and companies have made timely moves to boost demand andfind alternative sources of funding despite the credit-scarce environment. It is on the execution capacity side where themost relevant bottlenecks reside, and where the sectors leaders and laggards should be determined, in our view. A briefdiscussion of each of these conditions is provided as follows.

A few words about the Government Housing Package

A lot has already been written on the government housing package, so we will spare the reader the details of each measure. It isfar from clear whether the government will accomplish its ambitious targets for housing supply in Brazil. However, we believe itis clear that, by making affordable houses profitable and assuming part of the credit risk, the government should significantlyenlarge the addressable market for homebuilders and unlock a pent-up demand that by far exceeds what companies are able todeliver (in our view, capital and execution capacity should become the restricting factors to growth in the foreseeable future).

To illustrate the magnitude of these changes, Brazil has 10 million households with income between five and ten minimum

wages. These families will almost certainly be brought to the housing market on the back of government measures (insurancegranting, subsidies, state-owned banks activism, etc.) that allow for a 5 MW household to buy a R$ 60K (US$ 27K) while onlyspending 20% of its income. Just as a reference, 10 million families will be added to the housing companies addressablemarket, while MRV, the largest low-income developer, launched no more than 25 thousand units in 2008.

The bottom line is that we believe it does not matter whether the government package will fall short of its rhetorical 1mn unittarget or whether developing for households below 3 MW is doable (the government believes so). Any improvement down theincome ladder is desirable. A quick look at the chart below shows it is no exaggeration to say that demand should not be arestriction to affordable housing growth during the next decade or so.

Figure 2: Minimum Wage Pyramid (million households)

30

11

7

3

7

57

5047

40

30

20

25

30

35

40

45

5055

60

3MW - 3-5MW 5-8MW 8-10MW 10MW+


The government has also approved measures to encourage demand for the mid- and mid-high income segments wherehomebuilders are more exposed so far. It has raised the ceiling for units eligible for subsidized SFH loans (mostly granted byretail banks, funded by savings accounts) from R$350K to R$500K. It has also allowed employees to withdraw their FGTS(unemployment severance fund) funds to buy apartments up to R$500K.

Many employees see their FGTS as non-refundable taxation, as it barely yields inflation and can only be withdrawn in case ofretirement (or unemployment). Under the new ceiling, many people are checking the balance and looking forward to using thismoney to purchase a decent apartment. Developers and banks are also working on new funding arrangements to attract thesewealthier, less risky and more profitable clients. Recently, newspapers have already displayed advertisements inviting clients tovisit showrooms and check the new funding conditions that the subsidized loans should entail.


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We believe it is also important to keep in mind that sizable demand remains for the mid- and high-income segments. Theaffordability obtained by mid-income families (lower interest and longer tenor), which triggered the impressive volume growthwitnessed since 2006, has not reversed. The retraction observed since October seems to be much more related to a drop inconfidence than to lack of purchasing power. After a murky December and January, demand for more expensive apartments hasbeen bouncing back since February. Although investors seem to have shrugged off the high-income measures, we believe they

should have stronger effects over the demand of wealthier clients than most expect.

Capital The main input for housing has already been taken care of

Another auspicious signal to housing companies is that the government seems to be aware that capital is probably the mostimportant and scarce input for building houses, and that listed companies have all their resources tied up in production. Thepackage foresees sizeable, attractive and comfortable funding support not only for construction, but also for land acquisition andmarketing expenses. So, capital deployment to enter the affordable segment should be much more modest and lessburdensome when compared to less subsidized wealthier clients.

The government is also working to provide production loans under favorable conditions that are not necessarily tied tolower income segments. In March, Tenda announced a R$ 600mn debenture issuance to be fully acquired by CaixaEconmica (state-owned savings and loans bank) to fund production under quite favorable terms (funding 80% of expenses withland + construction + marketing, at TR+8%, or 9.5% interest). We believe other companies will likely announce similar creditlines shortly, which not only gives way to working capital relief, but also puts pressure on private banks to improve funding

conditions.

It is important to note that Brazil is about to cross the 10% basic interest threshold, after which other countries (such as Mexico,Chile and Spain) have experienced a boom in mortgage lending. Apart from the importance of reaching that mark, it is natural toexpect that as interest rates come down, additional resources (aside from the compulsory or public lines) should be channeledto mortgage funding.

Finally, we believe blue-chip companies, which IPOed first (Cyrela, Rossi and Gafisa) or have a shorter cycle (MRV and PDG)are about to enter the cash positive period and begin to enjoy the benefits of the remarkable growth observed from 2006 to2008, a period in which the companies posted record high volumes and sales speed. When looking at homebuilders as aportfolio of projects (at the end of the day, this is what they really are), we find that proceeds from legacy projects account forroughly 70% of the current market cap. Further, we estimate that blue-chips should become net cash generators by the end of2009, and the bulk of the proceeds should be cashed in before 2011, in stark contrast with the common wisdom thathomebuilders are growth assets whose pay-offs lie in the perpetuity.

Just to illustrate, we carried out a simple exercise with the five largest blue-chip companies (Cyrela, Gafisa, PDG, MRV andRossi). If we could represent everything launched by the blue-chips through a single project, it would be a R$ 26 billion projectlaunched in Nov. 07.

Launch Profile 5 Largest Homebuilder Launches

(R$ m)

2006-2008 Launches Representative Cash Flow Profile

(R$ m)

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

mar/06

jun/06

set/0

6

dez/06

mar/07

jun/07

set/0

7

dez/07

mar/08

jun/08

set/0

8

dez/08

Total Lauches Volume

R$ 26 Billion

(3,000.0)

(2,000.0)

(1,000.0)

-

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0

nov/07

fev/08

mai/08

ago/08

nov/08

fev/09

mai/09

ago/09

nov/09

fev/10

mai/10

ago/10

nov/10

fev/11

mai/11

ago/11

nov/11

Source: Barclays Capital Research Source: Barclays Capital Research


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Taking into account the evolution of our representative project, we are almost 1.5 year prior to key delivery, and a few months toreach the turning point when the project becomes cash positive, resulting in a free cash flow of R$ 10.8 billion (70% of thecurrent market cap) by mid 2011. If the companies use these proceeds to prepay 100% of corporate debt (totaling R$ 3.9billion), R$ 6.9 billion would still remain, which would be available to distribute, buy back shares, sponsor additional growth, buyassets, prepay corporate debt or, (hopefully not), simply retain.

Capacity (Execution Capacity) How hard will it be to trade down?

Being competitive in producing affordable houses is a completely different game, almost the opposite of being profitable sellinghouses for wealthier clients. The super-customized, client-oriented business model, where the key is to win the buyers heartand convey a sense of exclusivity that comes down to sales speed and higher margins, works well when focusing on the top ofthe pyramid, where clients are willing to pay a premium to buy a special place to live.

When you go down the income ladder, premium for exclusivity is replaced with price sensitivity. Low installments become thebest advertisement. Investments in reducing costs often have a better payoff than a trendy decorated apartment. When movingdown-market, housing development becomes more similar to the retail business, where scale, distribution capacity,standardization, focus on product (as opposed to focus on client) and procurement/logistics efficiency are the key successfactors.

Right now, companies are in different stages of development in their affordable business. Despite the undisputable high payoff,

trading down is usually more complex than the companies advertise. So far, large companies forays into the affordable segmenthave been quite disappointing. For example, it has been more than two years since Cyrela unveiled its plans for the low-incomesegment, and so far units below R$ 80K have represented only 8% of 2008 launches.

Gafisas track record (before the Tenda acquisition) has not been much better, in our view. Its low-income spin-off never took offand a largely heralded low-income JV named Bairro-Novo was quietly left to its partner (Odebrecht) during the fourth quarter of2008. As for Tenda, whose acquisition (closed in 2008) we consider a rare opportunity for Gafisa to acquire a premium large lowincome operator, it has developed a strong brand and a differentiated distribution chain in the affordable segment. However,important improvements are needed on the execution side, in our view. Currently, it subcontracts roughly all the construction,letting go sizable gains that scale and procurement should entail.

Even PDG, which has a legacy low-income exposure through its full subsidiary Goldfarb, is not as affordable as it seems.Seventy percent of its launches during 4Q08 were tagged as low-income; however, the breakdown of these projects shows thatthe average unit price has been R$167K (please note that the government housing package benefits house prices up to R$130K), and only two low-income projects (out of 15 totaling 5% of 4Q08 launches) had average unit prices below R$ 100K.

The fact that the companies are not that exposed to the low-income segment is not bad, in our view. This is just an indicationthat until now the companies have not had to go that far from their comfort zone to profitably deploy their scarce resources. Andthis is the very expected behavior: companies tend to focus on the wealthiest clients available until another limiting factor(usually capital or execution capacity) restricts growth.

This setting is about to change as the government has been improving the gains to downtrade. In our view, the challenges arehigher than most realize, and so are the potential payoffs. From now on, we believe execution capacity out of the comfort zone(where companies have been allowed to remain so far) should be the key factor in determining the real beneficiaries of thispackage.


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Valuation 101 Dividing to Conquer

DCF Sector fell and then rose sharply on sentiment time to look at fundamentals

We have already described our top-down bullish view of the sector (client & capital available, capacity is the key to success);now lets take a look from a bottom-up approach. In our view, this is the most important section of the report, where we describein detail the DCF valuation methodology from which we derive our target prices. Further, we challenge the consensus view thatprojecting the sectors cash flow is a complex task; instead, we believe it is possible to break down the valuation into a fewsimple blocks that enhance visibility of where value comes from.

A more detailed account of the target price assessment and DCF calculation gains importance given the dispersion of targetprices in the street, which can not be justified by differences in margins, Ke and growth assumptions, in our view. We estimatethat, despite the recent rally, no gain from the government housing package is priced in. We find sizable upside potential withvery conservative margin, growth and Ke assumptions (see numbers below). Therefore, we believe that allowing investors towalk through our valuation methodology (and to see how conservative we have been) is a strong support to convey our positiveview on the sector.

Valuation 101 Dividing to conquer

One of the most interesting things when modeling the Brazilian housing sector is the stark contrast betweensimplicity/straightforwardness in forecasting a developers cash flow and the complexity involved in breaking this cash flow intoaccount records that usually drive valuation models (net income/working capital change). Housing sector accounting has alwaysbeen challenging, and addressing this matter can be so cumbersome that many throw in the towel and mark the sector as toocomplicated to look at.

At the end of the day, a homebuilder is a portfolio of existing projects whose cash flow parameters are somewhat easy to obtain(notes to financial statements and earnings releases). So, the first step is to calculate what we call Present Value of LegacyProjects (PVLP), detailed below.

The second step is to gauge the present value from future projects (PVFP). Here we need to make a few assumptions about thecash flow profile of a typical project such as margins, and the speed of sales, construction development and cash inflow. We willbriefly explain each of these blocks below and then provide an example. The valuation comes from the sum of the parts of thevalue from legacy and future projects (PVLP + PVFP) adjusted for other obligations and liabilities, such as landbank needs and

net debt.In the subsequent sections, we will disclose the breakdown for each company under our coverage, along with the parametersused to calculate the value of each block.

Step I: Calculating the PVLP (Present Value of Legacy Projects)

The nominal value of receivables, net of the remaining obligation to finish these units, can be easily drawn from earningsreleases. We will divide the PVLP in two blocks: cash from sold units (also known as backlog units) and cash from unitslaunched and not sold. For the sake of simplicity, we will deduct net debt from the PVLP value in order to segregate oldcompany (legacy - net debt) from new company (future projects).


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Figure 3: Present Value of Legacy Projects (PDG Example)

Value Duration Ke (US$) Present Value Description

Accounts

Receivable

2,808 1.50 16% 2,307

Extracted from the accounts receivables on theearnings release (including the both the on-balance

and off-balance portions).Cost to beincurred

(1,020) 1.50 16% (838)Earnings release: from the Results to be Recognized

breakdown (off balance).

Market value ofthe inventory

1,286 1.50 16% 1,056Earnings release: extracted from the AccountsReceivables, including all the reciavables from soldunits (both the on-balance and off-balance portions)

Remaining Cost (391) 1.50 16% (321)

Remaining cost=Total Cost-Cost Disbursed

Total Cost=(1-Backlog Mg)xMk val of inventory

Backlog margin: earnings release

Cost disbursed: Inventory breakdown on earningsrelease

Mk val of inventory: line above.

Total 2,683 2,204

(-) Net Debt (518)

PVLP (present value of lagacy projects) 1,686

Sold Units

Unsold

Units


It is worth mentioning that we are using the same Ke (16% in US$, 14% in real terms) of our full DCF model for PDG, and thatthe 1.5 year duration is a simplification. A project takes 30 months between launch and key delivery, so this duration shouldrange between 1 and 2 years (so we adopted 1.5 years to simplify). Regardless of the Ke we adopt, given the short duration ofthis cash flow, the PVLP amount should not vary more than 10% on the back of differences in Ke, so it can be considered asomewhat stable support for valuation.

Step II: Calculating the PVFP (Present Value of Future Projects) How much is each billion launched worth?

To provide a good account of value added by future projects, one should be able to calculate an important parameter of thevaluation model: the value added, at the date of the launch, of each unit launched. From now on, this number stands for NetPresent Value equivalent, or NPVe. For each set of assumptions of margins, speeds (sales, disbursement and cash inflow) andKe, a ratio between launches and value added can be defined. For example, if the cash flow from a project with a sales value ofR$ 100mn comes down to a R$ 15mn present value, we say that the NPVe for this project is 0.15. So if a company launchesone billion reais each year, from the cash-flow standpoint, it is as if it generates R$ 150mn for the shareholder yearly.

Coming back to the PDG example, below we show the parameters for a typical project and the resulting cash flow. With our 16%Ke (in US$, 14% in real terms), a R$ 1 billion project should come down to a value added (at the date of the launch) of R$153mn, so our NPVe is 0.153. G&A must also be deducted from the generated cash flow. We assume that G&A costs amount toan additional 5% of the launched value each year (this is another very stable parameter across the industry). As a result, eachbillion PDG launches is worth R$ 103mn (R$ 153 of NPVe less 5% of R$ 1bn of G&A).


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Figure 4: Typical Launch Parameters (for PDG)

Margin Assumptions (%VGV)Construction + Land 64.0%Taxes 6.8%Sales Expenses 6.5%

% of Construction Financed 60%NPVe 0.153x

Year 1 Year 2 Year 3 Year 4+Sales Speed 63% 38% 0% 0%

Cash Received 16% 44% 0% 0%Disbursment Speed 39% 61% 0% 0%

Cash flow* -139.9 285.3 46.3 0.0% of PSV** -14.0% 28.5% 4.6% 0.0%* For a project with sales value of R$1000.

**Potential Sales Value (see glossary for further explanation)

Source: Barclays Capital

We assume PDG will post launches of R$2.5bn in 2009, with no real growth after that (a conservative growth assumption, in ourview). So, the value added to the shareholder each year will be R$2.5bn x (NPVe G&A Burden) = 2.5bn x (0.153 5%) =R$258m. Therefore, the present value, with a real Ke of 14% (16% in US$ nominal 2% inflation) and g=0, amounts toR$2.097bn (from the perpetuity formula 258 x (1+14%)/14%).

Landbank build up: we treat landbank as a working capital need, which varies in tandem with next years launches. As in ourbase case scenario PDG will not post any real growth in launches, land expense will not affect valuation. But as a reference, weassume landbank net exposure (book value of land accounts payable from land acquisition) represents 12% of next yearsVGV (in line with historical levels). So if PDG raise its launches in 2009 by R$1bn, we estimate that it will need to deployapproximately R$120mn (12% of R$1bn) in land.

Interestingly, this sum of the parts valuation, with all the parameters disclosed came down to practically the same result as thefull DCF model (table below). It is worth mentioning that all the parameters used to carry out PDGs simple valuation we havejust gone through were the same used for our full model.

Figure 5: PDGs Sum of The Parts Model (SOTP)

Equity (R$m)

L: Legacy Projects 1,686

L1 Sold Units NPV 1,469

L2 Units Launched and not sold 735

L3. (-) Net Debt + Other Assets NPV (518)

F: Future Projects 2,097

F1. New Launches NPV 3,115

F2. G&A Burden (1,018)

F3. Landbank Burden -S: Sum of the Parts Valuation (S+F) 3,745

Other Adjustments not captured on the SOTP 40

D: DCF Valuation (Full Model) 3,785

Difference % 1.1%


Better yet, for all the stocks on which we have initiated, the difference between the full DCF model (from where we derive ourtarget prices) and the above-mentioned simple model approach has not exceeded 10% (see table below). As we stated in thebeginning of this section, it is possible to model the sector with very clear, understandable, available and straightforwardparameters and still reach a result very similar to the full model, which is exceedingly time consuming.


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Figure 6: SOTP vs. Full DCF

R$ millions MRV RSID GFSA CYREL: Legacy Projects 1,618 1,357 2,285 2,252

L1 Sold Units NPV 1,223 1,288 2,403 2,557

L2 Units Launched and not sold 671 644 1,129 856

L3. (-) Net Debt + Other Assets NPV (277) (575) (1,247) (1,161)

F: Future Projects 2,101 612 1,135 2,814

F1. New Launches NPV 3,064 1,437 2,216 4,091F2. G&A Burden (1,065) (634) (1,069) (1,362)

F3. Landbank Burden 101 (190) (13) 85

S: Sum of the Parts Valuation (S+F) 3,718 1,969 3,419 5,065

Other Adjustments not captured on the SOTP (157) 192 (97) 506

D: DCF Valuation (Full Model) 3,562 2,161 3,322 5,571

Difference % -4.4% 8.9% -2.9% 9.1%



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Multiples and Accounting Principles

Moving from earnings multiples to net-worth multiples

Accounting principles have always been one of the most challenging issues to deal with when analyzing Brazilian homebuilders.

The combination of backward-looking revenues recognition (percentage of completion), long production cycles (three years),expensing of marketing costs, discretion to record financial expenses as COGS and ever-changing accounting practices,combined in a setting of outsized growth (2006-2008), has made earnings and margins simply unpredictable and oftenincomparable among companies.

Worse yet, after 2010, Brazilian companies will adhere to the IFRS (International Financing Reporting Standards) principles,which, for the sake of conservativeness, state that revenues can only be recognized after the entity has passed control of thegoods or other assets to the buyer. This implies that revenues will be recognized 30 months after a project is launched. Thoughit is a noble principle, it brings even more volatility to earnings. Further, it makes the income statement a poor gauge ofcompanies economic performance. A two-year delay between sales and revenues recognition, with SG&A and part of financialexpenses weighing on the results as expensed, has eroded EBITDA and earnings (along with their respective multiples) asreferences of cash flow generation for the housing sector. As a reference, we show below how Cyrelas 2008 results wouldappear under different GAAPs:

Figure 7: GAAP Sensibility Table

R$ millions Current IFRS Sales Based

Revenue Recogition Percentage of projectevolution

After project completion Fully recognized at themoment of sale.

Revenues 2008 2,667 1,044 3,067Gross Profit 1,071 419 1,231

Mg 40.1% 40.1% 40.1%Earnings 366 -172 499

Mg 13.7% -16.4% 16.3%Implied P/E (2008) 11.0 NA 8.1


In our opinion, the adoption of the IFRS principles should give way to the retirement of P/E and EV/EBITDA as credible metricsto compare assets in the real estate sector. And the market should increasingly seek net worth multiples to support investmentdecisions.

Net Worth Multiples (P/Liquidation Value, P/Adjusted BV and P/BV)

In the previous section of this report, we mentioned that an important part of the value of housing companies comes from legacyassets (with a somewhat short duration). Therefore, it is important to develop metrics to gauge the Net Worth for housingcompanies. We define Net Worth generically as what remains for shareholders after assets and receivables are cashed in andobligations are cashed out. Net Worth-based multiples become even more valuable now that uncertainty about volumes andmargins, combined with a backward-looking GAAP, deteriorates earnings predictability and the widely used multiples such asP/E and EV/EBITDA.

We will calculate and display below three of the most broadly used Net Worth multiples: P/BV, P/Adjusted BV and P/LV. For ahealthy sector, Net Worth consists in an important lower bound for valuation. Trading below such benchmark should be theoutcome for companies/sectors with low profitability (below Ke) or negative growth prospects. Housing companies are at theopposite spectrum with healthy IRRs at the project level (above 20% unleveraged, real, after tax) and strong growth prospects(given the sizable pent-up demand for housing in Brazil).

Under the current valuation levels, many premium companies are trading below or in line with Net Worth (in spite of the recentrally), which seems to be more a distortion from dislocated markets, moved by sentiment, than an adjustment to deterioration ingrowth prospects. Above the BVAdj floor, margins, leverage and asset turnover are the dominant factors to determine relativevaluation among companies.


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We also believe that Liquidation Value is superior to the other metrics not only because it encompasses obligations related tothe completion (and receivables) from projects launched to date but also because it allows for very interesting sensitivityanalysis. We plan to shortly release a note with an in-depth discussion about multiples for Brazilian housing companies.

Figure 8: Liquidation Value Breakdown (R$ millions)

Cyrela Gafisa MRV PDG Rossi

Receivables from Sold Units 7,162 4,663 1,921 2,808 2,814

(-) Obligations from Sold Units (3,217) (1,594) (454) (1,020) (1,183)

Market Value of Units for Sale 2,061 2,577 1,592 1,286 1,544

(-) Construction Obligations (641) (708) (593) (391) (688)

Book Value of Land 2,152 673 1,199 606 317

(-) Payables from land acquisition (423) (365) (263) (321) (344)

Other Assets - - - - -

(-) Other liabilities - - - - -

(-) Net Debt (1,244) (1,269) (277) (610) (575)

(-) Minority Shareholders (289) (471) (83) (169) -

Liquidation Value 5,562 3,506 3,042 2,189 1,886

P/LV 0.74 0.56 0.79 1.03 0.52

BV Adjusted 3,616 2,424 2,089 2,203 1,845

BV 2,121 1,612 1,552 1,476 1,238

Deferred Income 1,869 1,015 538 727 607

Avg Stake 80% 80% 100% 100% 100%

P/BVAdj 1.13 0.81 1.15 1.03 0.53

P/BV 1.93 1.22 1.55 1.53 0.79

Market Cap 4,091 1,962 2,407 2,263 984

# of shares 356 133 136 146 191

Closing price 11.50 14.8 17.70 15.50 5.16



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What can go wrong?

Naturally, in such an uncertain environment, it pays to inquire as to what can go wrong. In this section, we will discuss two verycritical events that could place the sector in a difficult situation and that could change our positive stance towards the sector:banking pulling out of ongoing projects or a hike in discretionary cancellations. We believe that much of the stocks

underperformance, especially at the height of the crisis, has been driven by these concerns. This section contains a detailedexplanation of these risks and why we regard them as overdone.

1. Banks could exit the projects they are sponsoring

Banks play a key role in Brazilian homebuilders business models, being responsible for the funding of up to 80% of constructionexpenses through SFH (Sistema Financeiro da Habitao). After a project is delivered, banks are also decisive on thesecuritization of receivables. Loans for housing (for both construction and mortgage) enjoy a secure source of funding, as banksare required to channel at least 65% of their savings account balances to real estate related loans.

We believe it is not unreasonable to state that this is funding that homebuilders mostly take for granted and, if it ceases in such amoney-scarce environment, many companies would be driven into insolvency or be forced to sell inventories with discount.Construction loans drastically reduce the equity tied in each project (from 20-27% of the construction cost to 40%-50%, as perthe chart below), thereby providing an important and necessary source of cash flow relief.

Figure 9: Typical project cash flow profile (with and without funding) - % of PSV

-23%-21%

-26%-23%

-9%

20%

-17%-6%

-20%-21%

-28%

-40%

-45%-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

-2 Half -1 Half Launch 2nd Half 3rd Half 4th Half 5th Half 6th Half 7th Half

Accrued Cash Flow Accrued Cash Flwo Ex-Debt


It is worth mentioning that, even if banks wished to pull out (and they dont, with falling interest rates and no signs ofdelinquency), it would be rather costly. Each project is sponsored by a single bank, whose logo shows up on the billboard as apartner and co-sponsor of the project; the partnership with a large bank is seen as compelling proxy of security by potentialbuyers, who take their decision to buy counting on the promise of a mortgage on key delivery.

The terms of the loan, and the requirements that the developer and the buyer of a project must satisfy to receive the

construction funding, along with a non-binding guarantee to finance buyers after key delivery (three years after the launch), arestated in a commitment letter signed between banks and developers. As this letter must be signed before launching, fundingconditions for everything launched so far has already been set. So there is no naked or unfunded project that is launched.

Besides the contractual restriction and the reputational issue, banks could additionally face regulatory questioning. Asmentioned, in Brazil banks are required to channel 65% of their savings account balances to housing related loans. Interestinglythe Central Bank allows banks to take into account all the future funding commitments to reach this regulatory target, providedthe commitment letter is signed. So, if banks decide not to release the construction loans previously agreed with developers,they would be to failing comply with the 65% minimum requirement, thereby providing maneuvering room for the monetaryauthority to pull the strings and prevent any major disruption in the housing sector.


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As for the cancellation clauses established in the contract, the project must reach a minimum level of sold units (usually 50%)and a minimum equity commitment (usually 20% or 30% of the total construction cost) to access the funding. However, a poorlyperforming project will rarely reach the point of being rebuffed by the sponsor bank, as homebuilders are allowed to cancel theproject until six months after launching, which prevents companies from carrying out poorly sold projects that could be ineligible.

Additionally, the government is also working to provide production of new credit lines under favorable conditions that arenot necessarily tied to lower income segments. In March, Tenda announced a R$ 600mn debenture issuance to be fullyacquired by Caixa Econmica (state-owned savings and loans bank) to fund production under quite favorable terms (funding80% of expenses with land + construction + marketing, at TR+8%, or 9.5% interest). We believe other companies will likelyannounce similar credit lines shortly, which not only gives way to working capital relief, but also puts pressure on private banksto improve funding conditions.

Given that 1) the terms for both construction funding and mortgage concession are pre-defined by contract for all the projectslaunched before 2009, 2) it is rather costly to banks to pull out of a project owing to contractual, reputational and regulatoryconstraints, 3) housing related spreads are becoming increasingly attractive in an environment of one digit interest rates (andthere appears to be no hike in delinquencies on the horizon), we believe that neither funding for construction nor ability tosecuritize buyers receivables should be a constraint for the successful conclusion of a project.

Return of Units (discretionary sales cancellations)

First of all, it is important to state that, differently from other countries, buyers are not allowed to cancel a purchase intentionally.A unit can only be returned if the client is in delinquency. Naturally if a client is really willing to pull out, he can suspendpayments and become delinquent, and technically return the unit. So the gains from 2007/2008 launches should not be taken forgranted as buyers could decide (or be forced by economic constraints) to return units across the board.

Not least because such an outcome would be negative for the industry, and detrimental to the business model, the contracts areset to make it difficult to return the unit. The conditions are rather punitive for buyers; the standard contract states that in casedelinquency triggers the cancellation of the contract before key delivery (units cannot be returned after key delivery), the buyerwill have to deduct from the amount returned:

1. Approximately 4% of brokerage commission (this amount was already paid to the broker, and is non-refundable).

2. 7% of the total amount paid until the date of the cancellation (nonrefundable taxes)

3. Up to 15% of the total sales price of the unit (limited to the amount paid).

A typical client who is willing to return a unit will lose 60% of the amount paid, and companies normally work with a cancellationrate below 5% total sales (10% for lower income segments); sales figures are reported net of cancellations. Further, most unitsare returned within the very few months after the unit acquisition by virtue of lack of payment. So far, despite the deterioration inthe economic environment, companies have not detected any discernable increase in cancellation levels.

Companies usually adopt a friendly approach to the client on cancellation; they rarely retain the 15% of the total unit value thatthey are allowed to, not least because the hesitant buyer is by and large the less creditworthy, who will likely have difficulties inbeing accepted by the banks on key delivery. It is worth mentioning that this is a rather draconian clause, which allows thedeveloper to retain virtually 100% of the down payment until cancellation date and, therefore, if adopted, could entail judicialissues across the board. However, if the trend changes and the level of cancellations rises so as to worsen solvency, thecompanies will likely be more strict in order to curb any sharp rise in cancellations.

In the 10 years leading up to 2003, Brazil experienced a number of economic slumps (the country had economic downturns in1992, 1996, 1997, 1998, 2001 and 2002); according to developers that witnessed (and survived) such a bumpy period,cancellation has never exceeded 10%, which consists in sensible anecdotal evidence that concerns about a severe hike incancellation levels seem overdone.

The main takeaway from this discussion is that, despite a challenging outlook for the industry, a scenario of a hike incancellations of pre-sold units is not next door, buyers remain quite committed, and sales speeds have bounced back sinceFebruary, which bodes well for the profitability of units in inventory. So, despite the uncertainty about the future margins andvolumes, we believe the projects launched to date should be considered a good and trustworthy support for valuation.


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Valuation Methodology

PDG: Our R$25.0/share 12-month price target is derived through our DCF model in which we discount PDG's cash flows up to2017 with a Cost of Equity of 16.0% (in US$ nominal, 14% real) and 2% perpetuity growth (in US$ nominal, 0% real). This pricetarget translates into 2009E EV/EBITDA of 7.7x EBITDA of R$ 602.0mn and P/E of 7.5x applied to 2009 EPS of R$2.95.

Rossi: Our R$13.0/share 12-month price target is derived through our DCF model in which we discount Rossi's cash flows up to2017 with a Cost of Equity of 17.0% (in US$ nominal, 15% real) and 2% perpetuity growth (in US$ nominal, 0% real ). This pricetarget translates into 2009E EV/EBITDA of 11.2x EBITDA of R$ 275.5mn and P/E of 10.8 applied to 2009 EPS of R$ 1.20.

Cyrela: Our R$18.0/share 12-month price target is derived through our DCF model in which we discount Cyrela's cash flows upto 2017 with a Cost of Equity of 16.0% (in US$ nominal, 14% real) and 2% perpetuity growth (in US$ nominal, 0% real ). Thisprice target translates into 2009E EV/EBITDA of 10.7 EBITDA of R$ 590.2mn and P/E of 15.1x applied to 2009 EPS of R$1.17.

Gafisa: Our R$28.0/share 12-month price target is derived through our DCF model in which we discount Gafisas cash flows upto 2017 with a cost of equity of 17.0% (in US$ nominal, 15% real) and 2% perpetuity growth (in US$ nominal, 0% real). Thisprice target translates into 2009E EV/EBITDA of 18.3x EBITDA of R$ 256.2 mn and P/E of 29.0 applied to 2009 EPS of R$ 0.96

MRV: Our R$30.0/share 12-month price target is derived through our DCF model in which we discount MRV's cash flows up to2017 with a Cost of Equity of 16.0% (in US$ nominal, 14% real) and 2% perpetuity growth (in US$ nominal, 0% real ). This pricetarget translates into 2009E EV/EBITDA of 8.2x EBITDA of R$ 587.6mn and P/E of 7.5 applied to 2009 EPS of R$ 3.94.


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16

MRV Engenharia e Participacoes SA (MRVE3.SA)Initiation of Coverage

Consume

Latin America Cement and Construction

The Only Full-Fledged Low Income Player Guilherme VilazanteBBSA, Sao Paolo

+55 11 5509 [email protected]

Edoardo Biancher

BBSA, Sao Paolo


Stock Rating Price Target

New: 1-Overweight New: BRL 30.0

Old: 0-Not Rated Old: BRL N/A

Sector View: 1-Positive Price (15 Apr 2009): BRL 16.90

Fiscal Year End: DEC 52-Week Range: 40.49 - 6.45

Stock Overview Chart EPS (BRL)

MRV Engenhari a e Particip acoes SA

May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Source: LehmanLive

5

15

25

35

Volume

0

2M

4M

6M

2008 2009 2010 2011

Actual Old New Old New Old New

EPS 1.71A NA 3.94E NA 4.71E NA 3.10E

Source: Barclays Capital Estimates

Investment Conclusion

We are initiating MRV with a 1-Overweight rating and a 12-month price target of R$30.0 (US$13.8). In 2009, MRV addressedwhat we believe were the main drawbacks weighing on the stock performance, namely sluggish sales speed and rapid cash-burn pace. The improvement has been obvious as the stock has been the sectors best performer YTD, rising 72% vs. + 21% forthe Ibovespa. In spite of the stocks strong performance, we believe that current prices are still lagging fundamentals. Even if we

use a conservative assumption for volume growth (we froze forecast launches on 2008 levels from 2010 on, with a dip in 2009 of-12% growth), we still find an attractive 70% upside potential for MRV.

We believe there is a high likelihood that demand for low income units exceed expectations in the next months due to thegovernments housing package (significant advertisement + considerable gain in affordability; news flow already starting to showthis), and thus MRV and PDG, which boasts a legacy exposure to low income clients, are to be the main beneficiaries in the nextfew quarters.

MRV is, in our opinion, the best prepared player to take advantage of the government package. We believe it issignificantly ahead of its peers on the construction, logistics and procurement processes for affordable houses production. Webelieve it does not need to develop any additional skills to produce cheap, super standardized houses (government packagefocus).

We would like to point out that all numbers in this report were derived using a zero growth assumption, as was the 70% upsidepotential. If we were to factor in some growth during the upcoming years (which we believe would be a reasonable assumption

given the aforementioned advantage that should cause the company to benefit from the governments package), this potentialupside would go up accordingly. Therefore, we believe MRV could be a good option not only for a value play (70% potentialupside with zero growth) but also a way to play the sectors growth (please refer to the section, Government Housing Packageand the 3Cs approach in our industry note, titled Brazilian Housing Developers: Fell and then Rose Sharply on Sentiment Time to Look at Fundamentals, for discussion).

One possible reason for the stock trading at this discount to liquidation value (0.89x LV) could be general market concernsaround MVRs short-term liquidity, given its current cash availability of R$150mn and a track-record of cash outflows of around


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R$200mn during the last few quarters. However, we do not see this as a major concern given that MRVs projects are nowmoving into the cash-positive part of the cycle, additionally it has issued a R$100mn debentures during 1Q09 (with a programopen to raise additional R$200m).

Company Profile

MRV is Brazils largest real estate developer and builder in the low-income segment in terms of number of units developed andcities served. MRV has 29 years of experience in the low-income segment and in all cities in which it operates it offers threedifferent products through a highly standardized production line. This experience and operating model generally allows MRV toachieve industrial scale (in the construction of its developments) at low production costs and with high quality advantages.During this period, it has also been the only company in Brazil fully focused in the low-income segment and thus we believe itwill be in a premium position to benefit, in the near future, from forecast high demand (amplified by government package) in thesegment. Additionally, the company has a long track record in accessing the special financing programs of the Caixa EconmicaFederal, the main conduit for government mortgage funding.

Investments Positives

We believe the companys focus on the low income segment and vast experience in mass low-cost production makes itthe No. 1 candidate to benefit from governments package.

MRV is the only company that already has a scalable construction, logistics and procurement processes in place to

produce super standardized affordable units with strict cost control. Already owns a sizeable landbank on the segment that the government package aims at. Strong relationship with Caixa Economica Federal, the primary source of financing for the low income segment.

Risks and Concerns

Recent problems in raising cash from credit lines. Currently has cash availability of R$150mn for new projects andinvestments (last year it had net cash outflow of R$200mn per quarter). However, projects are already going into thecash inflow part of the cycle, the company has low leverage and recently issued R$100mn debenture program (that cango up to R$300mn).

Unexpectedly low sales volume in 08; however, it has been signaling a strong rebound during 1Q09.

Valuation

Our R$30.0/share 12-month price target is derived through our DCF model in which we discount MRVs cash flows up to 2017with a forecast Cost of Equity of 16.0% (in US$ nominal, 14% real) and 2% perpetuity growth (in US$ nominal, 0% real) from2010 on (in 2009 decreased growth by 12% bringing back to 2008 levels in 2010).

We are also breaking down the valuation into blocks to provide more transparency on the source of the value, along with theassumptions that underpin each valuation part. For a more in-depth discussion about this methodology, please refer to thesection titled Valuation 101 Dividing to Conquer in our industry piece.


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Key Assumptions

As for the present value of future project (PVFP) we adopted very conservative assumptions for growth (-12% for 2009, thengoing back to 2008 levels, zero growth after that), combined with parameters for a typical launch that come down to NPVe of0.160x (see assumptions below).

Figure 1: Launches and Valuation Assumptions Figure 2: Typical Project Cashflow Profile (% of PSV)

Launches

2008A 2,533

2009E 2,222

CAGR 09-12 7.7%

Perpetuity Growth 0.0%

Ke (US$ nominal) 16%

PVLP** (R$m) 1,618

*Expected Net Present Value**Present Value of Launched Project

(see glossary for further explanation)

13% 16%

24% 24%24%

-25% -25%

17%

26% 26% 26%

-60%

-40%

-20%

0%

20%

40%

1st Half 2nd Half 3rd Half 4th Half 5th Half 6th Half 7th Half

Cash Flow Cash Flow before funding


Figure 3: Typical Launch Parameter



Year 1 Year 2 Year 3 Year 4+Sales Speed 80% 20% 0% 0%Cash Received 22% 69% 0% 0%Disbursment Speed 91% 9% 0% 0%




These parameters are based in the profile of MRV's typical project, we assume a gross margin at project level of 35.7% (versuspeers' average of 34.6%) and a sales speed (duration) of 9 months (versus peers' average of 12 months) that reflects MRV'sexposure to low income segment. It is worth mentioning that these parameters are somewhat stable across each incomesegment.

Price Target Derivation and Forecasts

As a consequence of the parameters stated above, with a cost of equity of 16% in US$ and a forecast growth in perpetuity of 2%(in US$, zero in real terms) after 2010, we reach an equity value of R$3.56bn (TP Spot of R$26/Share, 12m of R$30/share).Please find below the valuation breakdown, main metrics and multiples along with our forecast for Income Statement andBalance Sheet.


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Figure 4:Where Value Comes From? Figure 5: Valuation BreakdownEquity (R$m)



L2 Units Launched and not sold 671L3. (-) Net Debt + Other Assets NPV (277)

F: Future Projects 2,101F1. New Launches NPV 3,064

F2. G&A Burden (1,065)

F3. Landbank Burden 101

S: Sum of the Parts Valuation (S+F) 3,718Other Adjustments not captured on the SOTP (157)


Difference % -4.4%

# of shares 136TP Spot 26

TP 12m 30

3,562

1,944

1,618

2407

0

1,000

2,000

3,000

4,000

L ega cy NPV F uture Projects Equi ty Ta rget

(R$millions)

Market Cap Line --------


Figure 6: Estimates and Valuation Ratios

(R$ Millions) 2008 2009E 2010E

Launches (% Consolidated) 2,533 2,222 2,615Sales (% Consolidated) 1,544 2,261 3,068Other Key Variables

Revenues 1,075 2,288 3,184EBITDA 237.7 587.6 765.9

Margin 22.1% 25.7% 24.1%Net Income Adj 232.9 536.3 640.8

Net Margin 21.7% 23.4% 20.1%EPS 1.71 3.94 4.71Multiples

P/LV 0.89 N/A N/AP/BVAdj 1.15 1.03 0.94P/E 10.3 4.5 3.8EV/EBITDA 11.3 5.4 3.4


Financial Statements

Figure 7: Income Statement

(R$ Millions) 2008 2009E 2010E

Net Revenue 1,075 2,288 3,184

(-) Cost of Sold Units (643) (1,419) (2,145)Gross Profit 432 869 1,039(-) SG&A (176) (195) (253)

Operating Profit 256 674 785Financial Results 41 17 46

Net Income (reported) 233 581 720(+) Other Adusts 0 (45) (79)

Net Income (adjusted) 233 536 641



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Figure 8: Balance Sheet

(R$ Millions) 2008 2009E 2010E

ASSETS

Cash and near cash 150 447 734

Accounts receivable from clients 701 1,175 1,158Inventories 1,176 1,493 1,412Others 70 70 70

Total Current Assets 2,097 3,185 3,374Accounts receivable from clients 449 659 549Others 62 62 62

Total Long Term Assets 511 721 611Investments & Other 11 11 11PP&E 50 52 54Deferred 13 10 8

Total Permanent Assets 74 73 72TOTAL ASSETS 2,682 3,978 4,057

Liabilities

Debt 68 196 144Accounts payable for site acquisition 199 199 199

Advances from Clients (ST/LT) 82 82 82Others 200 242 264

Total Current Liabilities 549 720 690Debt 359 1,040 764Accounts payable to sites acquisition 63 63 63Others 69 69 69

Total Long Term Liabilities 491 1,172 896Minority Interests 83 174 199Deferred Income 7 7 7

Shareholders' Equity 1,552 1,988 2,347Others - - -

TOTAL LIABILITIES 2,682 4,061 4,139



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21

PDG Realty SA Empreendimentos e Participacoes(PDGR3.SA)Initiation of Coverage

Consume


Significant Upside Potential; M&A Call Not Priced Guilherme VilazanteBBSA, Sao Paolo

+55 11 5509 3376

[email protected]

Edoardo Biancher

BBSA, Sao Paolo

+55 11 5509 3348

[email protected]







PDG Realty SA Empreendim entos e Partici pacoes


Source: LehmanLive

8

12

16

20

24

28

Volume

02M4M6M8M

10M

2008 2009 2010 2011


EPS 1.09A NA 2.95E NA 3.25E NA 1.94E



We are initiating coverage of PDG with a 1-Overweight rating and a 12-month target price of R$25.0 (US$ 11.5).Notwithstanding the recent rally (+133% from bottom in Nov 08, vs. +48% Ibov), we consider that the valuation is not yet

reflecting any growth: even though we assume the company will keep its 2008 launches level long-term, we believe there is stillupside potential of 61% from current levels.

Additionally, we regard the likelihood that the company succeeds in acquiring smaller listed companies during the next 12months as high and believe that this upside potential is not duly priced in. We believe that it has both the resources (R$276mnBNDES loan for consolidation purposes) and potential targets (13 smaller listed companies that are about to enter into the mostcash-consuming part of their construction cycle and are trading below 0.3x P/BVadj) to accomplish this.

Company Profile

PDG Realty is a leading developer that operates on all different income segments through six subsidiaries. The company, whichstemmed from the merger of several different subsidiaries, continued to grow through acquisitions after its IPO. PDG boasts adistinguished position on the low income segment through its subsidiary Goldfarb as well as a significant exposure to the mid-and mid-high income segment through other subsidiaries. The companys strong M&A track record combined with itscomfortable cash position places the company as a natural consolidator in the sector, in our view.

Investment Positives

PDG has the potential to profit from the government package (please refer to the section, Government Housing Package andthe 3Cs approach in our industry note, titled Brazilian Housing Developers: Fell and then Rose Sharply on Sentiment Time to Look at Fundamentals, for discussion)through Goldfarb, one of the largest low-income operators and the largestclient from the Caixa Economica mortgage business.


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PDG (which was already in an enviably comfortable leverage situation) has raised R$ 276mn while its peers are short of cashand the market is all but closed, therefore positioning itself as a natural consolidator (with BNDES support), in our view. Justas a reference of the potential gains from acquisitions, the 13 smallest listed homebuilders are trading at an average of 0.3xBVadj and 0.2x LV and are about to enter the most critical (and cash consuming) part of the cycle.

The company boasts a distinguished operating performance since its IPO; it has been posting record sales speed quarterafter quarter, while keeping margins at healthy levels. Surprisingly, even after the credit crisis became known, the companyhas managed to keep its pace of launches and posted superior sales speed.

Seasoned management with financial market and private equity experience whose compensation is highly variable and linkedto the companys performance.

Risks and Concerns

CHL and Goldfarb, which together are responsible for more than 70% of PDG launches, are somewhat dependent on theirformer controllers. PDG has been very successful in incorporating new businesses and is possibly addressing thesuccession issue in its subsidiaries; however, we believe this dependence is still a source of risk.

We believe PDG still has work to do in order to profit from its edge in the affordable segment. So far it is still veryconcentrated in large cities, focusing on clients that are far wealthier than the government housing packages target. Forexample, in 4Q08 its low-income projects had an average price of R$167k (remember that government package benefits

house prices up to R$130k), and only two low-income projects out of 15 (totaling 5% of 4Q08 launches) had average unitspriced below R$100k.

Valuation

Our R$25.0/share 12-month price target is derived through our DCF model in which we discount PDG's cash flows up to 2017with a cost of equity of 16.0% (in US$ nominal, 14% real) and 2% perpetuity growth (in US$ nominal, 0% real).

We are also breaking down the valuation into blocks to provide more transparency on the source of the value, along with theassumptions that underpin each valuation part. For a more in-depth discussion about this methodology, please refer to thesection Valuation 101 Dividing to Conquer in todays industry note titled Fell and Then Rose Sharply on Sentiment Time toLook at Fundamentals.

Key Assumptions

As for the present value of future projects (PVFP) we adopted very conservative assumptions for growth (-4% launches growthYoY in 2009, zero growth after that), combined with parameters for a typical launch that come down to NPVe of 0.153x (seeassumptions below).


Launches

2008A 2,611

2009E 2,500

CAGR 09-12 0.0%

Perpetuity Growth 0.0%

Ke (US$ nominal) 16%

PVLP** (R$m) 1,648

*Expected Net Present Value**Present Value of Launched Project

(see glossary for further explanation)

-13%

15%19%

-14%

-4%

19%

50%

23%23%23%

-15%

-40%

-20%

0%

20%

40%

60%



Source: Barclays Capital Source: Barclays Capital


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Figure 3: Typical Launch Parameters







These parameters are based on the profile of PDG's typical project; we assume a gross margin at project level of 33.6% (versuspeers' average of 34.6%) and a sales speed (duration) of 10.7 months (versus peers' average of 12 months) that reflects PDG'sexposure to low-income segment with focus in larger cities. It is worth mentioning that these parameters are somewhat stableacross each income segment.

Target Price Derivation and Forecasts

As a consequence of the parameters stated above, with a cost of equity of 16% in US$ and a growth in perpetuity of 2% (inUS$, zero in real terms), we reach an equity value of R$3.79bn (TP Spot of R$22/Share, 12m of R$25/share). Please find belowthe valuation breakdown, main metrics and multiples along with our forecast for Income Statement and Balance Sheet.

Figure 4: Where Does Value Come From? Figure 5: Valuation Breakdown

Equity (R$m)


L1 Sold Units NPV 1,536L2 Units Launched and not sold 630

L3. (-) Net Debt + Other Assets NPV (518)

F: Future Projects 2,178

F1. New Launches NPV 3,233

F2. G&A Burden (1,055)F3. Landbank Burden 1

S: Sum of the Parts Valuation (S+F) 3,826Other Adjustments not captured on the SOTP (41)


Difference % -1.1%# of shares (fully dilluted) 169

TP Spot 22

TP 12m 25

3,785

2,137

1,648

2613

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Legacy NPV Fut ure Proj ect s Equi ty Target

(R$millions)

Market Cap Line --------



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(R$ Millions) 2008 2009E 2010E

Launches (% Consolidated) 2,611 2,500 2,615Sales (% Consolidated) 1,812 1,963 2,746

Other Key VariablesRevenues 1,210 2,182 2,734EBITDA 240.4 602.0 690.1







(R$ Millions) 2008 2009E 2010E

Net Revenue 1,210 2,182 2,734(-) Cost of Sold Units (738) (1,384) (1,828)

Gross Profit 472 798 906(-) SG&A (212) (257) (276)

Operating Profit 260 541 629Financial Results 9 28 49

Net Income (reported) 212 558 618(+) Other Adusts (29) (60) (71)




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(R$ Millions) 2008 2009E 2010E

ASSETS


Accounts receivable from clients 517 827 857Inventories 1,056 1,050 992Others 136 136 136

Total Current Assets 1,965 2,672 2,869Accounts receivable from clients 747 1,196 1,239Others 161 161 161

Total Long Term Assets 908 1,356 1,400Investments & Other - - -PP&E 76 76 77Deferred 297 238 178


Liabilities



Total Current Liabilities 783 941 962Debt 647 1,168 1,328Accounts payable to sites acquisition 82 82 82Others 89 89 89

Total Long Term Liabilities 818 1,338 1,499Minority Interests 169 169 169Deferred Income - - -





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26

Rossi Residencial SA (RSID3.SA)Initiation of Coverage

Consume


Overdone Penalty for Miscommunication Guilherme VilazanteBBSA, Sao Paolo


Edoardo Biancher

BBSA, Sao Paolo








Rossi Residencial SA


Source: LehmanLive

2

6

10

14

18

Volume

5M

2008 2009 2010 2011


EPS 0.63A NA 1.20E NA 1.73E NA 1.84E



We are initiating Rossi Residencial with a 1-Overweight rating and a 12-month TP of R$13 (US$6.0), a potential upside of 152%from current levels. Among stocks in the industry, Rossis share price decline appears to be one of the steepest, having fallen92% since its highs in Nov 07 (vs. -56% Ibov). We find that, to a significant degree, it is the most discounted stock among the

blue-chip housing developers in Brazil.In the past, Rossi had been recommended by many analysts. The company is considered a leading and competitive developerby its both competitors and partners, with a competitive edge (especially in certain regions of So Paulos countryside). It is apreferred partner for banks for its conservative credit concession policy; it has built a sizeable landbank, and it is in a rathercomfortable liquidity position, in our view (after an R$150mn rights issue sponsored by the controller in 2009).

Rossis main drawback, in our opinion, revolves around what is considered its negative track record involving communicationswith the market, which tends to bring an unnecessary volatility to the stock. It also creates what we believe is an unfairperception that Rossi is a poor operator. In the past, a string of relatively unimportant negative events was amplified by a lack ofefficiency in properly conveying them. However, we are confident that there is no fundamental reason for such a discount. Webelieve Rossi is a leading, competitive, capitalized and healthy company, with no solvency concerns or any material issue thatprovides a fundamental basis for the paper to be trading at current levels. Additionally, the management is aware of this situationand seems to be focused on improving communications with the market.

Notwithstanding Rossis communication deficiency, we believe it is unduly undervalued, currently trading at 0.53 P/BVadj (47%

below the level of its peers) and 0.56x LV (33% below its peers). The net present value from projects launched before 2009(which will be cashed in before 2011), minus the debt obligations, is still 38% higher than Rossis market cap, which we see astoo strong a punishment for not communicating effectively.

We believe that, following the current rally, the sector has come back to the spotlight. Therefore, investors should become moreprone to take into account fundamentals, and such a degenerated discount to peers (and to the value of assets the companyowns) should narrow.


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Company Profile

Rossi Residencial is among the three largest residential homebuilders in Brazil, operating with a highly vertical integratedhomebuilding business model, both as a developer and contractor, and with a dispersed geographical distribution. Establishedin 1961, with a focus on the residential development since 1980, Rossi is one of the largest and most diversified (geographically

and by income segment) companies in the sector.

Investments Positives

Leading operator in Brazilian housing market. The company is considered one of the best operators in the mid-incomesegment.

An R$150mn rights issue sponsored by the controller in late 2008, combined with a reduction in launches in the sameyear, has left the company in a comfortable cash position. It has a Debt/Equity of 0.46x.

No challenging obligations in the short term: we do not see the need for any additional capitalization to keep the currentlevel of launches. Rossi has a cash position of R$303mn and receivables from sold units of R$3bn (32% for 2009). Weestimate short-term construction obligations of R$940mn, with relief to come from construction funding (whose termswere defined with banks before projects were launched).

Risks and Concerns

Negative track record of communication with the market. The company also has lagged its peers on the operating side, with mediocre sales speeds and margins; a lot can be

explained by the decision to keep launches pace in 4Q08 when sales speeds were already slowing down.

Valuation

Our R$13.0/share 12-month price target is derived through our DCF model in which we discount Rossi's cash flows up to 2017,with a Cost of Equity of 17.0% (in US$ nominal, 15% real) and 2% perpetuity growth (in US$ nominal, 0% real).

We are also breaking down the valuation into blocks to provide more transparency on the source of the value, along with theassumptions that underpin each valuation part. For a more in-depth discussion about this methodology, please refer to thesection Valuation 100 Dividing to Conquer in our industry piece titled Brazilian Housing Developers: Fell and then RoseSharply on Sentiment Time to Look at Fundamentals.

Key Assumptions

As for the present value of future project (PVFP), we adopted very conservative assumptions for growth (-27% launches gr YoYin 2009, zero growth after that), combined with parameters for a typical launch that come down to NPVe of 0.125x (seeassumptions below).


Launches2008A 2,0452009E 1,500CAGR 09-12 0.0%Perpetuity Growth 0.0%

Ke (US$ nominal) 17%PVLP** (R$m) 1,357*Expected Net Present Value**Present Value of Launched Project(see glossary for further explanation)

-8%-4%

7% 6%

21%

-9% -11%

-33%

-23%

10%

25%

-40%

-20%

0%

20%

40%





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Figure 3: Typical Launch Parameters

Margin Assumptions (%VGV)Construction + Land 63.0%

Taxes 6.8%Sales Expenses 5.5%






These parameters are based in the profile of Rossi's typical project, we assume a gross margin at project level of 34.6% (in linepeers' average) and a sales speed (duration) of 14.6 months (versus peers' average of 12 months) that reflects Rossi'sexposure to mid income segment. It is worth mentioning that these parameters are somewhat stable across each incomesegment.

Target Price Derivation and Forecasts

As a consequence of the parameters stated above, with a cost of equity of 17% in US$ and a growth in perpetuity of 2% (inUS$, zero in real terms), we reach an equity value of R$2.16bn (TP Spot of R$11/Share, 12m of R$13/share). Please find belowthe valuation breakdown, main metrics and multiples, along with our forecasts for Income Statement and Balance Sheet.

Figure 4: Where Value Comes From? Figure 5: Valuation Breakdown

Equity (R$m)



L2 Units Launched and not sold 644L3. (-) Net Debt + Other Assets NPV (575)

F: Future Projects 612F1. New Launches NPV 1,437

F2. G&A Burden (634)

F3. Landbank Burden (190)

S: Sum of the Parts Valuation (S+F) 1,969Other Adjustments not captured on the SOTP 192


Difference % 8.9%# of shares 191TP Spot 11

TP 12m 13

2,161

804

1,357984

0

500

1,000

1,500

2,000

2,500

Legacy NPV Future Projects Equity Target

(R$millions)

Market Cap Line ---------



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(R$ Millions) 2008 2009E 2010E

Launches (% Consolidated) 2,045 1,500 1,569Sales (% Consolidated) 1,661 1,301 1,684

Other Key VariablesRevenues 1,233 1,602 1,940EBITDA 156.2 275.5 408.8




Source: Company reports, Barclays Capital



(R$ Millions) 2008 2009E 2010E

Net Revenue 1,233 1,602 1,940(-) Cost of Sold Units (814) (1,149) (1,376)

Gross Profit 419 453 565(-) SG&A (274) (179) (158)

Operating Profit 145 274 407Financial Results (10) 46 47

Net Income (reported) 119 307 416(+) Other Adusts 1 (78) (86)




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(R$ Millions) 2008 2009E 2010E

ASSETS


Accounts receivable from clients 396 448 464Inventories 1,008 989 1,079Others 174 174 174

Total Current Assets 1,881 2,036 2,469Accounts receivable from clients 909 975 961Others 36 36 36

Total Long Term Assets 945 1,011 997Investments & Other 3 3 3PP&E 33 34 35Deferred 4 3 2


Liabilities



Total Current Liabilities 649 488 533Debt 729 882 1,047Accounts payable to sites acquisition 193 193 193Others 57 57 57

Total Long Term Liabilities 978 1,131 1,296Minority Interests - - -Deferred Income - - -





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