Southern Comfort : ategist Cabrera Sees Much to Like in Trends for Latin America’s Economies

Eduardo M. Cabrera, a Wall Street analyst for 10 years, joined Merrill Lynch & Co. in 1992 and became its chief Latin America stock strategist two years later. He is a University of Florida engineering graduate with a Harvard MBA and has lived in Cuba, Mexico, Venezuela and Spain.

In a recent conversation with Times staff writer Thomas S. Mulligan in New York, Cabrera made the case for continued strength in 1997 in Latin American stocks. And 1996 wasn’t half bad, with Mexico’s Bolsa index up 21%, Brazil’s Bovespa up 64% and Argentina’s Merval up 25%. U.S. investors remain cautious, however, because many were burned by a disastrous first quarter of 1995, when stock indexes throughout the region tumbled 20% or more after the devaluation of the Mexican peso.

Times: What’s ahead for the Latin American economies in 1997?

Cabrera: We see an acceleration of growth. After the difficult 1995, when Mexico had a depression, Argentina had a recession and Brazil had a slowdown, 1996 was a rebound year when the countries continued to reform and put into place a foundation for sustainable growth.

In 1996, the average [real] growth of the seven major economies of Latin America was about 3%. For this year, we’re projecting closer to 4% real GDP [gross domestic product] growth for the region.

Unemployment in the region has been high. Now we expect that [to] . . . begin to come down again, which should have an added benefit for the economy.

Across the board you’re seeing fairly dramatic declines in inflation, which is always very positive. In 1997 we expect inflation in the seven major [Latin] economies to average around 13%, versus 23% in 1996.

The currencies in 1996 were fairly stable. We expect that to continue. We expect the trade balance in many of these countries to remain close to balanced because of their focus on exports. Mexico, Argentina, Brazil all showed double-digit export growth in 1996, and we would expect fairly close to that type of growth for 1997.

Times: Moderate inflation, good growth, stable currencies--isn’t that a scenario for another good year in Latin American bonds? Why don’t I just stick with dollar-denominated Latin “Brady” bonds in 1997 instead of taking risks with equities?

Cabrera: The debt market in 1995 and 1996 clearly outperformed the equities market by a large gap. We think that the equity markets should rally and play catch-up to the bond markets. Eventually the contraction of [interest-rate] spreads that we’ve seen in the bond market will have an impact on earnings because companies will be able to finance themselves more cheaply.

Times: Mexico isn’t Peru, of course, but are you concerned about the markets being upset by some unforeseen political event?

Cabrera: There really are three risks to our scenario for Latin America. U.S. interest rates is one. Obviously, if the U.S. economy continues to accelerate and the Fed moves to tighten monetary policy, it’ll have a significant impact on the Latin American markets.

The second factor is what’s happening in Japan. If the banks in Japan, which have huge investments in the Japanese stock market, run into problems because of the stock meltdown, they might begin to repatriate a lot of the capital that they’ve sent abroad. That would have a tremendous impact on global liquidity and, obviously, on Latin America.

The third factor is political risk. You have important elections coming up in two of the major economies of Latin America. In Mexico in July, you have the midterm congressional elections. This could be the first time in modern history that the PRI party [Institutional Revolutionary Party] loses control of congress. We’re in the camp that says while the PRI will lose seats, they will be able to retain control of congress. It is a scare, but it also reflects a very important fact, which is that Mexico is moving toward a two-party system, and that’s positive.

In Brazil, you have a [proposed] constitutional amendment that would permit politicians to run for a second term. If it is approved, we believe that [President Fernando Henrique] Cardoso becomes the likely winner of the 1998 presidential election, which would give him another term to implement reforms.

Times: You like the Latin American economies in general. Which sectors are you focusing on?

Cabrera: When you look at what’s going to drive GDP growth in 1997, it is not the consumer, it’s not government, it’s business investment. In Mexico, we like cement, we like construction, we like some of the steel companies that can convert export capacity into local markets.

A lot of these industries were running at very low capacity utilization in 1995-1996. In the case of cement, in Mexico capacity utilization is running at 70%. That’s a high fixed-cost business. Your variable cost to add another ton of cement is not that expensive, so what happens when you go from 70% capacity to 80% is your margins explode and your earnings explode.

Times: Don’t be afraid to name names.

Cabrera: In Mexico, there are two construction companies we like very much that are expanding into the rest of Latin America: Empresas ICA and Bufete Industrial. We also like Cemex, the second-largest cement company in the world. They are taking advantage of infrastructure building throughout Latin America. And we like Grupo Televisa, which is the largest and most important entertainment company in the region. They are basically a manufacturer of stars. They have their own talent school, and they create stars from musicians to actors, and they provide the publicity and the promotion--and they generate the profits.

In Argentina, we like [oil giant] YPF very much. It’s undergoing a dramatic restructuring, and oil prices should maintain their strength. As the economy accelerates in Argentina, they’ll be able to sell more in the local markets.

In Brazil, the country is going to institute the largest privatization program in the history of Latin America, privatizing probably close to $15 billion worth of enterprises just this year, everything from mining to electric utilities to phone companies. In fact, they’ve already begun the process with the phone companies. Our favorite stock in all of Latin America is Telebras, the phone monopoly in Brazil. Brazil has one of the lowest penetrations of phones in the emerging markets, and Telebras is one of the cheapest phone companies in the world in terms of enterprise value and access lines. The potential growth rate is 30% a year.

Also in Brazil, there’s Cemig [Companhia Energetica de Minas Gerais]. This is one of the major electric utility properties in the world, and it’s being sold. There are several U.S. and Canadian utilities that want to buy the controlling stake that the government is selling.

Brazil is one of the largest economies in the world--155 million people. Multinationals have to be in Brazil, and they’re going to pay a premium for it. In our analysis, the Brazilian stock market is the cheapest in Latin America and one of the cheapest in the world on a cash-flow basis, on a price-to-earnings basis--any way you want to look at it.

Times: What other sectors do you like?

Cabrera: One of the things we look at is barriers to entry, the leverage companies have against competition. The kind of sector that you buy and keep in Latin America is the food companies. The reason for that is that they have huge distribution systems. Distribution in Latin America is so important. You have to be able to move your product on roads and in trains that don’t function as well as they do in the U.S. We’re seeing companies like Mavesa, which has a huge distribution system in Venezuela, going out and finding products to funnel through their system. These might be foreign products, or they buy out a competitor in a local market and just pump those products through the system.

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Regional Favorites

Here are specifics on some of the Latin American stocks that Merrill Lynch’s Eduardo M. Cabrera currently favors. These stocks trade either on the New York Stock Exchange or over the counter, and track movement of the shares in their native markets.

Mexico

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52-week Monday Company (market) high/low close Empresas ICA (NYSE) $16.38/$11.13 $16.13 Bufete Industrial (NYSE) 23.75/15.13 23.63 Cemex (OTC) 8.38/6.25 7.44 Grupo Televisa (NYSE) 34.63/22.38 27.63

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Brazil

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52-week Monday Company (market) high/low close Telebras (NYSE) $86.00/$47.00 $85.88 Cemig (OTC) 43.00/23.14 41.50

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Argentina

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Company 52-week Mon. (market) high/low close YPF (NYSE) $29.38/$19.25 $28.13

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Venezuela

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Company 52-week Mon. (market) high/low close Mavesa (NYSE) $7.13/$6.50 $6.75

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