Chapter 3
Brazil: The Soil Superpower
A man in a hurry will be miserable in Brazil.
—Peter Fleming, Brazilian Adventure
The best place to start exploring this agricultural wonder is the western part of Brazil, in an interior state called Mato Grosso do Sul. Its capital, Campo Grande, is a good-sized city with a population close to a million people.
I arrived at a small airport with a band of readers along for the journey, walked off the plane onto the tarmac, and met with 95-degree heat. It was also very dry and dusty. Seasonally, it was the end of what passes for winter in these parts.
I packed a handful of books on Brazil to help give my some perspective. One of the oldies is Roy Nash's The Conquest of Brazil, first published in 1926. On Campo Grande, Nash writes “Mud to the knees during the rains from October to February, and dust for the rest of the year.” Some things never change.
Nash is an interesting character, a former Army captain during World War I, he traveled widely in Brazil in the 1920s. He is good at putting together the pieces of Brazil's vast geography and history. We'll hear more from him in a bit.
The city has a slightly worn-down, yet energetic feel. People bustle about, and motorcycles are everywhere. There were the boxy, concrete buildings splashed with bright colors, a buttered-popcorn-yellow apartment building here, a melon-green body shop there. Our bus bounced along patchy roads to the hotel.
Campo Grande is nicknamed “the Brown City” (Cidade Morena) for the reddish-brown color of its soil. On the bus ride from the airport, we could see some new road construction and the rich turned-up earth, the color of red beans. Campo Grande has been growing smartly of late since opportunities abound here for investors in soil remediation, forestry, dairy, livestock, biofuels, and more.
The soil needs work before it can become productive farmland—that's the opportunity that attracted my small crew and me here in the first place. Investors can make a good return—doubling their capital in three years—by using a proven process that dates to the 1960s.
We endured the heat and some long bus rides to see farmland properties in the Cerrado, the vast grasslands of Brazil and the soil bank of the world.
The fly in the ointment is the political scene. Brazil has never been an easy place to do business, and it's tinkered with farm ownership rules, making it more difficult for foreigners. Nonetheless, over caipirinhas at the Bahamas Hotel, my contacts here told me there are a number of solutions to satisfy the new rules. Doing business in Brazil requires patience and a willingness to twist like a pretzel to meet the many rules in your way.
The Cerrado, full of scrub vegetation and grasses, covers some 22 percent of Brazil's land area. It's about eight times the size of the United Kingdom, and it has a good water supply. Water comes from nearby rivers and a huge underwater aquifer. There is a healthy amount of rain for about half of the year, and the land is also flat. Professionally managed, it becomes highly productive farmland.
It's also among the oldest soils in world and runs extremely deep, up to 65 feet in some places. Only here and in the plains of Africa do you find soil that has been undisturbed, in a geological sense, for so long. We're talking millions of years. The problem is that the soil is acidic, high in aluminum, and thus has low fertility. Luckily, this is where the opportunity comes in.
Turning this degraded pasture into good soil is an attractive investment proposition. It's a profitable arbitrage that takes place over three to four years and is largely self-funding. In the state of Mato Grosso do Sol, an investor could've bought scrubland for $3,000 per hectare. The next step is transforming this land into good productive soil by adding lime and fertilizer (chiefly phosphate), as well as planting restorative crops such as soy and crambe.
Soy helps fix the nitrogen deficiency, and crambe is a deep-rooted oils eed crop that brings nutrients closer to the soil. The cash earned from farming mostly pays for the transformation.
This is a proven strategy and quite straightforward. Over the years, much land has already been improved. In 1955, there were 200,000 hectares of land under cultivation in the Cerrado. Today, over 40 million hectares are under cultivation. That leaves over 80 million hectares still in play.
Once improved, the farmland is among the most productive in the world. Today, the Cerrado produces 54 percent of all the soybeans harvested in Brazil and 28 percent of the corn and 60 percent of the coffee. It also supports 55 percent of Brazil's beef cattle. The Cerrado also produces rice, sugar, cassava, and cotton.
Not surprisingly, this improved land is worth a lot more. Farmland prices chiefly reflect the productivity of the land measured in sacks of soybeans. In Mato Grosso, land sold for around $22.50 per 60-kilogram sack. Thus, land that produces 50 sacks per hectare, which is a reasonable target, would be worth $6,750/ha.
That, in a nutshell, is the story here. Invest $3,000 to get the land, improve it, and then sell it for $6,750, a 100 percent-plus return for a low-risk process that takes three to four years. After allowing for management costs, the project ought to return at least 37 percent annually for investors.
You might wonder why, if the economics are so good, more people aren't doing it. The answer is that many people are trying to do this. “There is a bit of a Klondike going on now,” one of my contacts told me, alluding to the Klondike gold rush of nineteenth century. “We've seen land in some places double in price, and it's still cheap,” given the returns you can get for improving the land.
From 2001 to 2009, the return on this land just from appreciation alone has been 26 percent annually, beating the stuffing out of the stock market and just about every commodity I can think of offhand.
There is also an energy tie-in here, which I'll touch on only briefly. Brazil is a hot spot for ethanol made from sugar cane. Sugar cane is more profitable than soybeans, so the investment dollars are starting to flow toward ethanol production and the Cerrado.
Petrobras, the giant Brazilian oil firm, and the Brazilian government were building a pipeline in northern Mato Grosso, right through the farmland we were visiting. This pipeline would make it possible to produce ethanol in this northern region for the first time. In the larger Mato Grosso region, there were 21 plants in operation—12 of them opened in 2010 alone. There are 43 more on the drawing board, with signed tax concessions from the government. Most will be up and running by 2015. It's quite the boom.
In any event, it's another reason to own farmland. The biofuel mandates around the world will push farmers to produce more feedstock for years to come. It will also prop up prices for farmland and crops. What's more, emerging scarcity issues with arable land and clean water aren't going away anytime soon. Rising populations, especially in the less-developed world, mean we'll need to produce a lot more food. Farmland is also an investment not tied to the vagaries of the stock market.
This land will help feed the growing global population. Brazil is a great beneficiary of that need and has become an agricultural power. It also has a lot of room to grow, as it has more usable arable land than any other country in the world.
We drove through some small towns, and you can see what that prosperity brings. Neat little houses stick out from the older, tired structures that remain from when people were poorer.
The power of its soil always saves Brazil.
—Stefan Zweig, Brazil: The Land of the Future
Brazil's place as an agricultural superpower is secure given its vast amounts of land, ample rainfall, and bountiful sunshine, so it's no surprise that Brazil has come to dominate certain aisles of the world's grocery store. For example, of the top 10 meat producers in the world, 3 are Brazilian, and they control about 40 percent of the global protein trade. The largest is JBS-Friboi, owned by the Batista family and led by Joesley Batista, “The King of Meat.” Batista's is a good story.
Joesley Batista started working at his father's butcher shop in the tropical highlands of Brazil before he was a teenager. His two brothers worked there, too. It was a small family-run affair. His father, who started the business in 1953, would carry slabs of meat on his back to walk them to the market. His was a typical working-class family, deep in the interior of Brazil.
The brothers stuck to the family business, through one crisis after another. Joesley Batista, in particular, showed a talent for business, and the family firm grew and grew and grew.
That family firm is JBS-Friboi, the largest meatpacking company in the world. JBs' sales have gone up nearly 2,000 percent from where it was in 2004. It is Brazil's second-largest privately-owned company, behind only Vale S.A., and most of its sales come from outside of Brazil.
The three brothers still run the show, and Joesley Batista, “the Meat King,” is its chairman. He is a billionaire now, one of the most successful of Brazil's entrepreneurs.
Batista, though, had an assist from Brazil's development bank, BNDES, which has helped bankroll the company's acquisitions. BNDES exists to promote the international expansion of Brazilian companies. Taxes fund its efforts. In 2007, BNDES bought 13 percent of JBS to help it acquire Swift, which was America's third-largest pork and beef processor.
In September 2009, JBS bought a 64 percent stake in another American icon, Pilgrim's Pride, pulling it out of bankruptcy. The Economist commented on the deal:
This will be a big test for the Batista brothers and for Brazil's tropical brand of capitalism, which mixes family control with traded stock, and finance from state-run banks with foreign acquisitions. Brazilian companies in other industries are watching how JBS gets on and plotting similar moves themselves.
We see more of this cocktail these days, this mixture of government support and private enterprise, but that is a philosophical topic to explore another day.
With this deal, JBS became the largest meat processor in the world, surpassing Tyson Foods. Now, it's not just that Brazil is raising the animals and growing crops. More and more, Brazilians are getting into the processing business, which brings greater profits.
This too is an interesting commentary on Brazil and its evolving role in food production. Batista is the poster boy of these big ambitions. He wants JBS to become a global power in milk and dairy products, too. This is another area where Brazilian firms plan to expand rapidly in the next several years. The company is public now (only in Brazil, unfortunately) and has other shareholders, but the Batista family controls it.
The third-largest player is Brasil Foods, which trades on the NYSE under the ticker BRFS. It has grand ambitions to become a great branded food company like Kellogg's, General Mills, or Nestlé. Besides being huge in Brazil, it is also the largest poultry exporter in the world and the second-largest meat exporter. It has 9 percent of the global protein trade by itself.
If we know one thing for sure, it is that the new consumers in these emerging markets will eat more processed meats, Brazilians included. Just to get to a level of poorer European countries, consumption would more than double. This bodes well for Brasil Foods' business.
There is also a somewhat surprising opportunity in dairy. “Brazilians are eating yogurt for the first time,” Renato Roscoe told us.
Renato is a soil expert and former Embrapa hand. (The latter is a government agribusiness research institute.) He holds a PhD in soil science and knows these lands well. He gave our group a good presentation before we embarked for our farmland tours. Sure enough, more than once on our trip, we heard people tell us that “Brazilians are eating yogurt!” Apparently, they didn't eat much before. Again, as part of this big bulging consumer class, some 30 million new consumers since 2005, people are starting to enjoy a more varied and complex diet. Brazilians consume only 2.5 liters of dairy per capita per year, versus nine in Argentina.
But the Brazilian dairy industry is gearing up for a lot more. It is forecast to grow by a third in the next decade. In the process, it will become a top exporter of milk and milk products. Why? Think Asia.
Per capita consumption of dairy is booming in Asia, too. For instance, in China, Vietnam, and Thailand, per capita consumption increased 206 percent, 91 percent, and 65 percent, respectively, since 2000. There is a lot of upside remaining. The typical Chinese citizen, for example, consumes less than a third of the dairy a typical EU citizen does. (I don't expect that gap will close completely, by the way, because the Chinese don't generally like cheese.)
Some of the fastest-growing importers are in markets where there are constraints to new production (such as a lack of available land). These include Thailand, the Philippines, Indonesia, and Malaysia, as well as North African states such as Algeria, Egypt, and the Middle East.
Brazil has no such constraints. There is plenty of pastureland and water. Production is low cost, so more and more of the world's dairy products will soon come from Brazil. Figure 3.1 shows you the opportunity unfolding in dairy.
When in Brazil, our crew visited a dairy project at Jaragua, a beautiful 3,000-hectare farm near Campo Grande. The farm is in a great location, right near a major road. It is also four kilometers from a new dairy factory under construction in a nearby township. We also drove by this site, which will produce 150,000 liters per day, expanding to 700,000 liters per day by 2014.
Vencedor, the firm building the plant, is an established dairy producer. “They are desperate for milk,” one of our contacts told us. He had signed agreements at very attractive rates to provide them with milk.
And remember forestry. I would guess most investors have little patience for forestry investing, so I won't cover it here except to relate a funny story one of our contacts told us. He was giving a presentation in New York to a group of prospective investors. He told them it was a 20- to 25-year investment, to allow the trees sufficient time to mature. An elderly lady told him afterward that she couldn't wait that long. “Hell, I'm so old I don't buy green bananas!”
Speaking of old, let's turn again to Roy Nash and his adventures in 1920s. Nash was a remarkable character who wrote a lot about these aspects of Brazil that interest us. He studied forestry at Yale and served in the Philippine Forest Service. He was a captain of artillery in World War I, then traveled far and wide in Brazil for three years and spent a summer in Portugal. During this time, Nash wrote The Conquest of Brazil. He continued his association with Brazil for the rest of his life. During World War II, he served in Brazil wearing various hats, including cultural attaché at the U.S. Embassy in Rio.
In his book, Nash talks about the great plains of Mato Grosso. The name “Mato Grosso,” he points out, means “thick forest.” Those forests are long gone. “When the world was young,” Nash writes, “the forests were as luxuriant as the whiskers of the barbarians.” After it was logged, beef farmers used great swaths of land as pasture.
Nash's book gave me a useful historical perspective on Brazil. It reminded me how some things never change. “Brazil is so predominantly an agricultural and pastoral country,” Nash observed then, “that no other facts can have quite such importance as the facts of the productive occupation of her soil.”
Everything is going to be all right in the end, and if everything is not yet all right, that's only because we haven't reached the end.
—Popular Brazilian saying
In one of our meetings, we met an economist who got everyone's attention when he started talking about Brazilian financial products and how he's averaged 25 percent a year in the past few years without doing any work (I'm suspicious). Asked how to get into these products, he said they are open only to Brazilian residents. Initially, he made his investments through his wife, who is Brazilian.
This led the reader to say, “I'm going to invest in a Brazilian wife.”
While that may not be a bad investment for some, there are other Brazilian opportunities beyond agriculture.
As I remarked earlier, there is a rapidly expanding middle class here (a familiar theme in many of the markets we cover in this book). Over the past six years, Brazil has added some 30 million middle-class consumers. They are only starting to enjoy products we take for granted, like yogurt. “We're happy because we are getting richer,” Renato said, unemployment being the lowest in his lifetime.
Not only is the middle class expanding, but Brazil is also minting millionaires. Only nine countries have more millionaires than Brazil, according to one study cited by Larry Rohter in his book Brazil on the Rise. “With about one-sixth the population of India, Brazil has more millionaires than India,” he writes.
Rohter goes on:
In a matter of a few years, Brazil has seen a new surge in entrepreneurs who have built fortunes from activities as diverse as airlines, cosmetics, slaughterhouses, shoes, toys and computers . . . . This phenomenon, particularly notable in sectors such as agriculture and ranching and oil and mining, was accompanied by a burst of spending on luxury items ranging from jewelry and designer clothing to private airplanes and yachts.
One such builder of fortune, Eike Batista happens to sit at number eight on Forbes's global rich list. He was worth about $30 billion at last count, on the back of Brazil's oil, gas, and mining assets (a field we'll explore later). He's also keen on the growing middle class: “China is putting more than 20 million new consumers into the world each year, add to that the two million we're adding in Brazil, and the 3 million from India . . .—it's clear we're living in a cycle,” he told a BBC reporter from his office overlooking Rio's Sugarloaf Mountain.
In fact, Brazil's richest man believes that the outlook for Brazil is especially good. “We have our own oil, we've got natural resources—I believe we're living in a cycle of growth like the United States lived in the 1960s.”
Given that context, you can understand some of the success companies are having in Brazil. Whirlpool is one example. According to the company, one in six Brazilians already has at least one of its appliances. In agriculture, AGCO, a maker of farm equipment, saw sales in South America surge, thanks mostly to Brazilian farmers. Owens-Illinois, the glass container company, finds its fastest-growing market in Brazil. And Brookfield Asset Management enjoys high growth rates in its Brazilian residential businesses.
Buy the One Thing Brazil Needs
Brazil is blessed with enormous reserves of the metals and minerals essential to modern manufacturing . . . . Coal may be the only substance vital to industrial production that is in short supply.
—Larry Rohter, Brazil on the Rise: The Story of a Country Transformed
In São Paulo, I gave a short presentation to a group of readers about a few attractive Brazilian investment themes. My favorite was the case for hard coking coal, also known as met coal.
Steelmakers use hard coking coal for steel making. The big emerging markets are short of the stuff. China, India, and Brazil all import it.
The southern coast of Brazil bristles with steel expansion projects. Its need for coking coal will more than double over the next decade. The same kind of situation exists in China and India.
I made the case that Mozambique, Africa, is where the world will get a good chunk of the coking coal it needs. The play here was Riversdale Mining, which owned a heaping pile of it in the Moatize Basin.
The day after my presentation, the Brazilian mining giant Vale said it bought a 51 percent stake in a logistics firm in Mozambique. Vale has a coal project in the Moatize Basin, too. It had already invested approximately $1 billion there before this latest move. I look at it as further validation of the idea of investing in coking coal and also in the mining of the commodity in Mozambique. This firm Vale bought, SDCN, owns railway concessions that will carry Vale's coal to the port at Beira.
(About three months after I recommended Riversdale to my readers, it too, got a buyout offer for a 60 percent premium.)
Miner Vale, meanwhile, wants to become one of the world's largest fertilizer companies. It wants to boost potash output tenfold by 2017 and triple its output of phosphates. Acquisitions and investments in its own mines will make that happen. It sees the opportunity to serve farmers in its own backyard.
Vale has significant fertilizer assets in Vale Fertilizantes. This is a relatively new fertilizer company that will hold all of Vale's fertilizer assets. It was the second-biggest revenue generator for Vale after its more famous iron ore mines. Vale Fertilizantes has many of Brazil's best fertilizer assets, which is key, because Brazil also imports most of its fertilizer needs. See Figure 3.2.
You can see that Brazil depends on the rest of the world for its fertilizer needs, which keep its mighty agricultural production humming. In particular, note the lack of domestic potash, with 93 percent of Brazil's needs coming from outside of the country.
In a bigger-picture sense, this adds to the broader theory that you will do well to invest in the commodities that the big emerging markets are short of. China, India, and Brazil import both hard coking coal and potash, and it looks likely they will import a lot more over the next decade.
São Paulo: The Economic Heart of Brazil
São Paulo, a mind-boggling immense sprawl of a city, sits at the economic heart of Brazil. The state of São Paulo has 45 million people and makes up nearly a third of Brazil's economic output. Half of the country's tax base is here. If it were its own economy, São Paulo state would be the second-largest in South America, behind only Brazil and ahead of Argentina and Colombia. It is also home to Brazil's stock market, the fourth-largest in the world by market cap.
The city of São Paulo is Brazil's New York City. Someone once said it was as if Los Angeles threw up on New York. It's a bustling, congested city of 11 million people, with another 9 million in the suburbs. Author Larry Rohter calls it, “Ground zero for [the] explosion of conspicuous consumption.” São Paulo is the third-largest urban center in the world, behind only Tokyo and Mexico City as ranked by the United Nations.
For many, it's an ugly city, but I loved it right away. While gloom and doom hover over the economies of the United States and Europe, it is impossible to maintain a sense of pessimism in São Paulo—or Brazil, for that matter. It's a showcase for the kind of changes sweeping over the emerging markets.
São Paulo had a humble beginning. Jesuits founded it on the banks of the little Tietê River in the sixteenth century. For hundreds of years, it was an insignificant settlement. Even as late as the 1870s, only 26,000 inhabitants were cobbled around its narrow streets.
However, it would go on to make perhaps the greatest population growth curve of any major city in human experience (as the Fernand Braudel Institute maintains). A great coffee boom in the ninteenth century was the spark that kindled São Paulo's growth. A great deal of wealth jelled in São Paulo and expanded into other businesses. Thus, São Paulo quickly became Brazil's most industrious city.
Ambitious people of all kinds took root here over time, and today, São Paulo has an intriguing mix of people. It has more people of
Japanese descent than any city outside of Japan.
Syrian-Lebanese descent than any city outside of the Middle East.
Italian descent than any city outside of Italy.
Each of these migrations happened at different times and for different reasons. For example, the big Japanese wave came in 1908 as the transition from feudalism caused much poverty in Japan, forcing many to look abroad for a better life. At the same time, Brazil desperately needed workers for its coffee plantations around São Paulo. Hence, the migration of Japanese to Brazil.
Those kinds of incidents fascinate me, as they bring together different, distant cultures. After all, I don't think most people realize there are so many people of Japanese, Syrian-Lebanese, or Italian descent, for that matter, in São Paulo.
São Paulo did not grow up slowly around a center, as did the cities of Europe. Rather, it grew hastily and in an improvised manner. You can see the consequences of that process today. Traffic is horrendous. It can take more than an hour to move only a handful of blocks. The subway system is not up to the task of serving the entire city, and record car sales overwhelm the construction of new roads.
Furthermore, an acute housing shortage provides an interesting investment opportunity. There are a lot of ways to show the data on housing. One common way to measure housing shortages is to look at how many families have three people per bedroom. This measure shows about 13 percent of families live in substandard housing. Expressed as a number of units, Brazil needs nearly 6 million new homes.
That's really not surprising when you think of the swelling ranks of the middle class. Millions of people have become consumers in the last decade, yet housing has not caught up with that demand. By some estimates, Brazil needs to build about 1.6 million homes every year just to keep up with new families entering the market.
In São Paulo, you can see the shortage in the price of homes. New construction often takes three years. People now taking delivery for housing units bought three years ago find that the value of their dwellings have doubled.
All this frothiness has some people worried about a housing bubble. Brazil's mortgage market, too, is in hyper-growth mode. Take a look at the total loans to homebuilders and buyers in Figure 3.3.
It looks impressive, but the starting base was very low. Brazil's home lending market is still only a fraction of that found in other Latin American countries, such as Mexico or Chile. Brazilians also have much more equity invested in their homes. Typically, loan-to-value ratio is 70 to 75 percent.
Eventually, supply will catch up with demand, and maybe even exceed it. Then you'll have a correction. For now, the easiest way to cash in on Brazil's housing boom is to buy Gafisa (GFA), the only Brazilian real estate company trading on the NYSE.
Gafisa has built and sold nearly 1,000 developments and more than 11 million square meters of housing in its 55-year run. Traditionally focused on the high-end market, Gafisa recently bought Tenda to tackle the low end of the housing market.
Gafisa has a good track record and nationally recognized brand names. It looks like a good speculation on the long-term demand for housing in Brazil.
Another surefire long-term demand is oil, and we met someone who knows perhaps more than anyone about that.
What can one say about Rio, except that it's all true.
—Anthony Bourdain, The Nasty Bits
Rio de Janeiro is as great a city as everyone says it is. There are the pretty beaches, the verdant mountains, and the signature 130-foot-tall soapstone statue of Christ the Redeemer on a rocky crest 2,300 feet above the sea overlooking the city. There are the street-side cafes and the infectious, easygoing lifestyle of the Cariocas (which is what you call people from Rio).
One pleasant morning, a small crew of readers and I left our hotel at Ipanema beach to go on a short ride to nearby Copacabana. The main office for HRT Oil & Gas looks out over the storied beach. Here we visited with CEO Marcio Mello, which was one of the highlights of the trip.
Mello, aka “Mr. Go-Deeper” is full of energy. He had us mesmerized as he described the hunt for oil and gas in Brazil and off the coast of West Africa.
Petrobras, Brazil's giant oil firm, as you may know, found billions of barrels of oil in the deep waters of Brazil. Mello, an old Petrobras hand, wrote a book more than 20 years ago that predicted those discoveries. Today, he has another theory about oil off the coast of Namibia. Millions of years ago, Africa and South America were one big landmass. Following those clues, Mello found the geology of the coast of Namibia was similar to where the big oil finds were in Brazil. The idea is that the same kinds of discoveries exist in the waters off Namibia, where the continents once joined together.
I can't do justice to the whole story here, but suffice it to say Mello and his crew are on the cutting edge of oil exploration. We visited their lab in Botafogo and got a tour of the kind of work they do. It's incredibly high-tech and makes you appreciate just how difficult the oil business is.
Mello himself is a kind of magic man in the oil and gas industry. His company raised more than $1 billion by selling a third of the company in an IPO. His pre-IPO investors already made more than 10 times their money.
Interestingly, the IPO happened first on Brazil's stock exchange. I asked Mello why he didn't aim to list in the United States or London. His simple answer: “Speed.” Mello doesn't like delays. “I was born in seven months,” he says. “No joke. That is true. I couldn't wait.” And so it has been his whole life. He says HRT will list in the United States, but the process takes longer. “And time is money,” Mello said. “One day is a lot of money in the oil and gas business.” The sooner HRT gets to production, the better.
So, the reason for the IPO was plain. “We know where the oil is,” he said. “What we need is money.” The money raised will go toward sinking wells and producing oil. It's an expensive proposition.
You might be curious as to where Mello is putting his money, beyond HRT. “I put all my money in oil and iron,” he said. Mello is a shareholder of Petrobras and Vale, the giant mining outfit.
As to the government's rough treatment of these companies, which some call a “renationalization”? Mello is undeterred. “Just close your eyes and buy it,” he says of Petrobras. “You'll never lose over the long term. It has so much value even government incompetence can't destroy it.”
Mello may well be right. It makes me a bit nervous, though, having the government as such a big (and overbearing) partner. Plus, Petrobras has to spend hundreds of billions of dollars developing big offshore discoveries, which is risky. The final costs could be much higher than today's estimates. Still, Petrobras owns a huge amount of oil and is one of the largest producers in the world.
I'll end with one other anecdote about Mello. Over a fabulous lunch of melt-in-your-mouth pasta and fresh fish at a small Italian restaurant around the corner from his office, he shared some of his thoughts on life and business. Mello, as I've found with many successful businesspeople and investors, doesn't dwell on the negatives. As one of my readers put it, “You seldom find an Eeyore at the top of the heap,” referring to the gloomy character of Winnie-the-Pooh fame.
Instead, Mello cheerfully makes the most of whatever cards life deals. He is passionate about his business and focused on opportunities and figuring out how to exploit them. “There are no problems,” he says. “There are only opportunities.” That could be the tag line of my own ceaseless combing of the globe for ideas. I've come to appreciate how an apparent (or potential) crisis, whether about food, water, or whatever, is the handmaiden of opportunity. Mello, for instance, turned the world's unquenchable thirst for oil into a fortune.
Florianopolis: Flip-Flops on the Ground
We were received with a hospitality hardly to be equaled . . . for [Brazil] asks neither who you are nor whence you come, but opens its doors to every wayfarer.
—Louis Agassiz and Elizabeth Cabot Cary Agassiz, A Journey in Brazil (1879)
The southernmost part of our tour took in Florianopolis, the capital of the state of Santa Catarina, in southern Brazil. “Floripa,” as it is known, is on the landward side of an island, where it can shelter ships from the brunt of the Atlantic Ocean's powers. (It boasts warmer water off its beaches, which pleases the growing number of local and international tourists.) The Portuguese colonists settled here in the seventeenth century, looking for gold.
They didn't find gold, but Floripa has become a favorite spot for wealthy Brazilians. I stayed at a resort on Jurerê Beach, which is one of 42 beaches on this 200-square-mile island. Jurerê is the best one, apparently, having won a number of awards. Jurerê is where the rich stay when they come, and I saw some monster houses that looked like beached cruise ships, one even had a helipad.
I came to Floripa to look at a new project by a group called Txai (pronounced “chai,” like the tea). It is a spectacular piece of property. This project will be open to individuals to buy bungalows, lofts, and more.
I enjoy exploring these little nooks of the world unknown to most Americans, although on Sunday night, we took a break from the Brazilian cuisine and found an English pub that had the Dolphins-Jets game on TV. There we met an American who had lived on the island for 20 years. He is an old Mets and Jets fan from New York and had come to watch the game.
In my four-city tour of Brazil, what can I say about the experiences to sum up so far?
I can say the caipirinhas, Brazil's national drink, is a potent cocktail. Brazilian meats are very salty. Brazilian desserts are very sweet. This taste for the extremes of the flavor spectrum extends to Brazil's monetary brand, as well.
The Brazilian currency is the real. The Brazilians pronounce “real” something like “hey-ALL.” In plural form, it sounds like “hey-EYES.” So we're all saying it wrong when we say “RAY-all”.
The Brazilian real has been strong (and the dollar is weak). While I was there, it hit a 10–month high against the U.S. dollar. Since 2008, the Brazilian real gained 45 percent against the dollar, which means U.S. assets are cheap to Brazilians. This is why many are buying property in South Florida.
In the Miami area, Brazilians bought more homes and apartments than any other group of international buyers. According to International Sales Group, Brazilians bought about half of the Miami condos sold to foreigners for more than $500,000. Brazilians accounted for half the sales of condos bought for over $1 million.
Even so, the Brazilian finance minister frets and threatened to weaken the real. What he feared was that the strong real will hurt Brazil's export goods by making Brazilian goods more expensive, hence weakening the Brazilian economy. It is a tired line of reasoning. This idea that a country gets rich by destroying the value of its currency is a weed that won't go away no matter how many times you pull it from the soil.
What's curious about this is that you'd think a Brazilian would appreciate the dangers of weakening a currency more than most. Brazil has had a habit of blowing up its currency over the past 60 years.
From 1942 to the present, Brazil went through eight different currencies:
1. Mil Reis, 1833–1942
2. Cruzeiro, 1942–1967
3. Cruzeiro Novo, 1967–1986
4. Cruzado, 1986–1989
5. Cruzado Novo, 1989–1990
6. Cruzeiro, 1990–1993
7. Cruzeiro Real, 1993–1994
8. Real, 1994– ?
The present-day real is but a teenager, a mere youth sprung from a bad family. Yet it was among the world's strongest currencies in recent years, bolstered by the commodity wealth and strong growth rate of Brazil's economy.
Say what you will about the U.S. dollar, which has been a poor currency as far as retaining its purchasing power over time, but it's never gotten so bad that the United States had to start over, at least not yet. Brazil's experience makes the dollar look like a gold standard. It was not that long ago that Brazil's inflation rate hit 2,700 percent. It happened in one 12-month period from 1989 to 1990.
Even as late as 1999, Brazil was a financial basket case. In 1998 and 1999, its finances were such a mess that Brazil got the biggest IMF rescue package in history up to that point, $41.5 billion.
During the twentieth century as a whole, Brazil had a cumulative inflation rate of more than a quadrillion percent. If you were a net saver in Brazil and kept that money in Brazil's currency, you lost big. You might as well have set the money on fire.
Today, Brazil is in a different position. The currency is so strong, its politicians fret. American travelers find no bargains in the shops of São Paulo or Rio. Brazil, too, has huge currency reserves and is now a net creditor, not a debtor. Brazil is even accumulating gold, the real thing. An economist I met on my trip told me Brazil's central bank had 5 percent of its reserves in gold, and it's been buying more.
Today, U.S. investors go out of their way to buy products that give them exposure to Brazilian reals, instead of U.S. dollars. It's incredible when you think how much things have changed in just the past 10 years.
Brazil could screw it up again.
There are some worrisome signs. The new president is Dilma Rousseff. She is a former Marxist guerrilla. Hers is a quite a tale. Suffice to say, she has since mellowed out, supposedly. Most people see her as simply continuing the policies pursued under President Lula. But we'll see.
Some of her opening moves were not encouraging. She had been highly critical of foreigners buying Brazilian land during her campaign. “Brazilian land for Brazilians” was the chant. I mentioned how the Brazilian government restricted foreign ownership of Brazilian land. Worse, the legal rules were so unclear that all such acquisitions since 1988 could've been made null and void, in theory, with the land returned to nationals. Some political groups were saying this is exactly what should be done.
The mainstream papers seemed to treat this latter possibility as unlikely. I can tell you from talking to people down there that local businesspeople did not dismiss that possibility.
There have been a lot of foreigners buying. As I wrote above, the economics of turning the Cerrado to productive farmland is compelling. You get a 100 percent-plus return in three to four years without leverage using a proven 40-year-old process. Other folks started to figure this out, too. A group in Hong Kong, backed by Jacob Rothschild and a pair of Hong Kong tycoons, raised $179 million to do just what I described. Others are following suit, raising large piles of money in public markets to invest in Brazilian farmland.
In theory, the country could double the amount of land under cultivation—something no other large country could plausibly do. The land is also cheap and potentially very productive. Brazilians can harvest two crops a year, for instance. All these investors are doing the same math. Buy the land, improve the land, and boom: big returns only a few years later.
Many foreigners are already there. By some estimates, foreigners own or control about 20 percent of Brazil's cane production. Estimates for some other crops are even higher. Good estimates are tough to come by because many do business through a Brazilian company, even though foreigners own and control it. The government tried to close this loophole with its tinkering.
In any event, rule changes and uncertainty freeze agricultural investment in Brazil every time they strike. This is big news for global food markets because Brazil was such a key part of the equation. Brazil, as I've pointed out, is the world's arable-land bank. This is where we can get the added food supply the world needs.
As Reuters points out, “Brazil's essential role as a provider of food for the world's expanding population is at risk . . . . There are simply no large-scale alternatives to Brazil's unique agriculture potential.”
However, Brazil can't do it alone. Getting the arable land to production is a process that takes significant investment and time. Foreigners brought the needed capital. Between 2002 and 2008, foreign investors poured nearly $2.5 billion into land alone.
Foreign money also brought the expertise of large-scale and modern farming techniques. Their investments create jobs for Brazilians. They pay taxes. They raise the value of Brazilian lands. A recent study said that farmland values had increased 54 to 70 percent over the last three years in frontier regions.
Of course, foreign money brought more food to the world. What did Brazilians do with Brazilian land before? Not much. It mostly sat there while the country was poor and backward.
Sometimes I think Brazilian politicians pine for the old days. Governments are “pathologically stupid,” as my friend Doug Casey likes to say. So perhaps this shouldn't be a surprise. Nonetheless, I am always amazed at how readily politicians are so quick to kill the golden geese. (The U.S. government is, sadly, no different.)
We may not feel the effects immediately, but Brazil's hostile turn toward foreign investment helps plant the seed for a future food crisis. Brazil forgets there is a larger world out there. If Brazil is not careful, the money will just go elsewhere, and Brazil will be the poorer for it.
In the four-month period beginning on December 20, 1994, the Mexican peso lost 50 percent of its value. Some wag dubbed it the Tequila Crisis. The name stuck. I don't think anything so severe will happen in Brazil, but there are warning signs that Brazil's boom needs a breather. A caipirinhas crisis, perhaps.
For all that there is to like about Brazil from an investment point of view, it has problems, too, some of which might surprise you.
For instance, Brazil's boom has been fueled in part by the free flow of credit, which is a warning sign all its own. Its major banks had all reported loan growth of more than 20 percent. As the Financial Times reports: “Brazil's economy has been riding a consumer credit boom as millions of new middle-class consumers borrow money at high interest rates to pay for everything from liposuction to cars.”
Overall debt numbers as a percentage of the economy are still low, but the debt service burden on consumers is already very heavy. Brazilians pay high interest rates. And per capita incomes are still low, lower than in Mexico, Peru, and Venezuela. So, debt service as a percentage of disposable income is high at 24 percent, according to fund managers Paul Marshall and Amit Rajpal, who published their research in the Financial Times. The U.S. mortgage bubble blew up when that number hit 14 percent.
Prices were also rising. When I was there, I was surprised how expensive things were. The dollar did not go far there, that's for sure. At some point, the comparisons become a little absurd. You could stay at a Marriott Renaissance hotel in São Paulo, and it cost you 50 percent more than if you stayed at a Marriott Renaissance in Manhattan. As the Wall Street Journal pointed out, a Honda Civic EX-L cost $38,800 in São Paulo and $21,425 in New York City. A Starbuck's Grande café latte cost $5.40 in São Paul and $4.30 in NYC.
Brazilians are starting to feel the pinch, but Brazil's politicians made sure they won't get left behind. Brazil's Congress gave itself a 62 percent raise in December of 2010 to $210,000 per year. As is, Brazilian workers earn salaries more comparable to developed countries even though doing business in Brazil is more expensive as firms contend with bad roads, power outages, congested ports, high crime, and heavy taxes.
‘People don’t appreciate how difficult it is to do business in Brazil. In the “ease of doing business” World Bank survey, Brazil ranks 127 out of 183 countries. Rwanda and Belarus score better than Brazil. The survey points out, for instance, that it takes 120 days and the completion of 15 procedures to start a business in Brazil, compared to 56 days and 5 procedures in the rest of Latin America.
I have firsthand experience with this, given my involvement with a Brazilian farmland project. I can tell you it is a long process to get anything done in Brazil. Months rolled by as we waited for approvals of one kind or another as the rules changed or were applied differently in different offices. The place is thick with bureaucratic webbing.
Still, having said all that, the Brazilian market was among the cheapest of the big emerging markets in 2011. The price-to-earnings ratio based on earnings forecast for the next 12 months sank to only 9.5 times, and the Brazilian market has traded sideways for almost two years. A Caipirinhas Crisis would likely make them all cheaper still.
Brazil clearly offers numerous opportunities over the long haul. But one thing we have to realize is that none of these places will grow uninterrupted. There are always booms and busts.
So, while I am raising a caution flag on Brazil, I see the long-term as bright. The world right side up describes a multi-decade process that may halt for stretches, or even seem to go backwards, but over the long haul that gap between the emerging markets and the developed markets will continue to narrow.
Brazil has made tremendous leaps ahead in just the last decade. I don't think it's finished just yet.
Five Key Takeaways
One of the best opportunities in Brazil is to invest in agriculture or the things Brazil's ag producers need. Potash is one. The big names are Potash Corp and Mosaic, but better values can be had among the smaller players and miners. MBAC Fertilizers is a small Brazilian player trying to become an integrated producer of potash and phosphate in Brazil.
Meat: Brasil Foods (BRFS:NYSE) is the champion here. It's a good long-term play on Brazil continuing its dominance of the protein trade.
Gafisa (GFA:NYSE) builds residential homes. Long-term this is another likely good play, though I expect short-term turbulence as Brazil works through what might be a credit crisis.
Met coal: This brand of high-grade coal is being snapped up the world over. Riversdale, mentioned above, has a huge deposit. Quality met coal deposits are hard to find and hence valuable investment properties.
Larry Rother's Brazil on the Rise is one of the better books on Brazil's recent renaissance. For the historically minded, you may enjoy Roy Nash's Conquest of Brazil.