Zell Sees Bargain in Brazil Property on Strong Growth

May 31, 2010, 5:14 PM EDT

By Alexander Ragir

May 31 (Bloomberg) -- Gafisa SA, Brazil's second-biggest homebuilder by revenue, is trading at the lowest level relative to earnings in 14 months after the shares slid 24 percent this year. Guilherme Reboucas, a money manager at Itau Unibanco Holding SA, said the stock is too cheap to pass up.

"There have been times when you had to look at the smaller homebuilders to find value, but now you can basically buy anything in the sector -- Gafisa, Cyrela -- anything," said Reboucas, who helps manage the equivalent of $10.5 billion in stocks at Sao Paulo-based Itau, Brazil's second-largest asset manager after Banco do Brasil SA's fund unit. "They're cheap across the board."

Gafisa, PDG Realty SA Empreendimentos e Participacoes, the third-biggest, and MRV Engenharia e Participacoes SA may gain as much as 69 percent by yearend as revenue climbs an average of 33 percent, JPMorgan Chase & Co. said in a May 20 report. The prospect that Latin America's largest economy may grow at the fastest pace in 24 years outweighs concerns that rising interest rates will curb demand, said Eduardo Favrin, the head of equity for HSBC Global Asset Management's Brazil unit in Sao Paulo.

The BM&FBovespa Real Estate Index declined 12 percent this year through last week, pushing the average price for its companies to 10.3 times reported earnings, as the central bank boosted rates for the first time since September 2008 to curb inflation. Gafisa slumped to 13 times reported profits, the lowest since March 2009.

Zell's Plans

The real estate index rose 0.4 percent today. Gafisa gained 2.3 percent to 11 reais, MRV increased 0.6 percent to 11.82 reais and PDG lost 1.9 percent to 15.31 reais. Markets in the U.S. and U.K. were closed today.

Property firms may benefit as billionaire Sam Zell raises $500 million to invest in Brazilian real estate companies and as former central banker Arminio Fraga's private equity and hedge fund, Gavea Investimentos Ltda., moves into the industry after buying a stake in the real-estate division of construction company Odebrecht SA.

PDG Realty dropped 10 percent from Jan. 1 through last week and trades at 13 times reported earnings, while MRV has tumbled 17 percent and has a ratio of 11.9, according to data compiled by Bloomberg. Only three of the stocks in the 16-member BM&FBovespa property measure have gained this year.

Industry Outlook

Zell, 68, reported selling part of his stake in Sao Paulo- based Gafisa on May 13 and his firm now plans to expand in Brazil, Equity International Chief Executive Officer Gary Garrabrant said in a May 20 interview.

The share declines in the past month were "mainly" caused by large investors trimming stakes for reasons unrelated to the industry's outlook, JPMorgan said. In the past eight months, large holders sold $4 billion worth of builder shares, the New York-based bank said.

Housing developers aren't the best value in the market, said Claudio Andrade, co-founder of Polo Capital Gestao de Fundos Ltda.

"Valuations are far from distressed," said Andrade, whose Polo Fund jumped 165 percent last year after snapping up homebuilders that had plunged during the global financial crisis in 2008. "It makes sense that they would fall more than the market because of expectations for higher rates, and homebuilders are one of the most sensitive sectors to credit."

Economic Growth

Investors are overlooking the strength of Brazil's housing industry, Reboucas said. President Luiz Inacio Lula da Silva's government plans to finance the construction of 2 million homes.

Residential construction companies increased earnings per share an average of 63 percent in the past year, according to data compiled by Bloomberg.

Brazil's economy will expand 6.5 percent this year, the fastest pace in more than two decades, after contracting last year, according to a central bank survey of 100 economists published today.
Gains in GDP are stoking inflation and prompted policy makers to raise the benchmark Selic rate to 9.5 percent in April from a record low 8.75 percent. The rate will likely increase another 2.25 percentage points by the end of 2010, according to the central bank survey.

Home prices continue to rise in Brazil, with the average cost of a new apartment in Sao Paulo up 22 percent to 2,432 reais ($1,336) a square meter in the first four months of 2010 from a year earlier and 51 percent from four years ago, according to a report by Sao Paulo-based Brazilian Company of Property Studies, known as Embraesp.

Brazil Mortgages

Increased borrowing costs aren't a risk for the housing market in Brazil because mortgages are pegged to the nation's reference rate not the overnight Selic, Favrin said in an interview. For each 1 percentage point increase in the Selic, the reference rate, known as the TR, changes about 0.16 percentage point, Credit Suisse Group AG of Zurich estimates. If the central bank raises the Selic 2.5 percentage points, the TR may rise 0.4 percentage point, according to Credit Suisse.
"These are long-term loans so a short-term interest rate hike isn't going to affect them that much," said Regis Abreu, who oversees the equivalent of $1.6 billion as executive director at Mercatto Gestao de Recursos, Rio de Janeiro-based hedge fund. "It is a clear buying opportunity."

Cyrela Brazil Realty SA Empreendimentos e Participacoes, Brazil's biggest builder by revenue, still is twice as expensive than it was in 2008, when it sank to 5.5 times earnings in November, as the global economic crisis intensified, seizing-up credit markets and stalling the Brazilian economy.

‘No Constraints'

As builder shares fall, Zell's Equity International sees "no constraints to growth for the homebuilding sector," Garrabrant said. Gavea, which bought an 11.7 percent stake of Brazilian retailer Lojas Americanas SA in December 2008, is expanding its strategy to invest in companies that benefit from rising incomes. Fraga declined to comment for this story.

Brazil's jobless rate fell in April to the lowest since the series began in 2001, excluding the months of December and January when companies hire temporary workers to meet demand by holiday shoppers, the statistics agency said on May 27.

"What really determines someone's readiness to buy a house is income, jobs and consumer confidence," said Favrin, who oversees $2.5 billion in Brazilian stocks. "The market's reaction is wrong because financing costs aren't based on the Selic rate."