Souza Cruz Bovespa-Beating Gain to End on Valuation

Source from:  Bloomberg 05/21/2010

Souza Cruz SA's climb to the most expensive level in more than two years is a signal to the majority of analysts covering Brazil's largest tobacco company that a five-month rally is poised to end. The unit of British American Tobacco Plc may fall 8.2 percent by Dec. 31 as investors seek shares that offer better growth prospects with the economy set to post the fastest expansion in two decades, according to Itau Unibanco Holding SA, Latin America's biggest bank by market value. Souza Cruz surged 18 percent this year, the biggest gain in the 66-stock Bovespa index, on speculation earnings will stay stable should the global recovery falter amid Europe's financial crisis. The increase pushed the stock's price to 15 times estimated profits compared with a ratio of 11 for the Bovespa and 12 for London-based BAT, data compiled by Bloomberg show. "It's a defensive stock for moments of stress like the one in Europe right now," said Rafael Burquim, an analyst at Sao Paulo-based Planner Corretora de Valores who has a "neutral" rating on the stock. "Souza Cruz has robust cash flow, but the question is growth." Founded 107 years ago, Rio de Janeiro-based Souza Cruz controls about 63 percent of Brazil's cigarette market through brands such as Free, Derby and Lucky Strike. About 14 percent of adults in Brazil smoke each day, compared with 17 percent in the U.S. and 31 percent in China, according to a World Health Organization report published last year. Stable Earnings Brazil's economic growth probably won't boost Souza Cruz's earnings this year, according to six analysts surveyed by Bloomberg, who on average estimate the company's net income will fall to 1.4 billion reais ($785 million), a 5.5 percent drop from last year. Stocks in the Bovespa will boost profit 17 percent this year, projections compiled by Bloomberg show. Two analysts recommend buying Souza Cruz, four recommend holding the stock and six advise selling it, according to Bloomberg data. "Souza Cruz's defensive prospects are fully priced in at current levels," Itau's Juliana Rozenbaum, the top-ranked Brazilian consumer goods analyst in Institutional Investor magazine's annual poll last year, wrote in a May 7 research report. She rates the shares "underperform." Bovespa Rebound At the same time, Itau predicts the Bovespa will rebound from an 8.3 percent drop this year through yesterday and rally 35 percent by yearend. Souza Cruz added 1.6 percent to 68.30 reais in Sao Paulo trading today as the Bovespa index tumbled 3.2 percent. Souza Cruz's rally is justified and the stock may keep rising as higher personal incomes for Brazilians spur smokers to boost purchases of its more expensive brands, Chief Financial Officer Luis Claudio Rapparini said in a telephone interview from Rio de Janeiro yesterday. "Souza Cruz will benefit from the population's higher wages and higher employment, from greater resources available in the economy," he said. "We won't necessarily have strong growth in volume, but we will have consumers migrating to more premium brands. Investors are going to look for other stocks that offer much higher possibilities for returns but which bring much higher risk as well. I don't think the market will punish Souza Cruz's shares." "Defensive" Haven The stock will keep leading the Bovespa because it provides a "defensive, dividend-paying safe haven" amid Europe's debt crisis, Marc Estigarribia, a Citigroup Inc. analyst, wrote in a May 7 note. He recommends buying the stock and said it will climb 5.4 percent in the next year. Souza Cruz has an indicated gross dividend yield of 5.5 percent, more than the 2.2 percent average for companies in the Bovespa and the ninth-highest in the measure, according to data compiled by Bloomberg. Latin America's largest economy will grow 6.3 percent this year, the most in 24 years, according to the median forecast of about 100 economists in a central bank survey published yesterday. The nation's retail sales increased the most on record in March, a report from the national statistics agency showed last week. The Bovespa tumbled this year after an 83 percent rally last year as China, Brazil's biggest trade partner, took steps to cool growth and on speculation Greece's debt crisis would spread. State-controlled oil company Petroleo Brasileiro SA, based in Rio de Janeiro, is down 20 percent this year while Sao Paulo-based JBS SA, the world's biggest beef producer, has fallen 25 percent. Economic Improvement Souza Cruz suffered less than most companies from Brazil's economic contraction last year. The shares dropped 8.5 percent in 2008, less than the 41 percent plunge in the Bovespa, while sales rose 9.4 percent as the expansion in gross domestic product slowed. Revenue increased in the first three quarters of 2009. "A person doesn't smoke more or less because of credit constraints or if GDP is growing seven or three percent," said Renato Prado, an analyst at Fator Corretora in Sao Paulo who rates the shares "underperform" based on their valuation. Itau, based in Sao Paulo, recommends buying companies whose sales will benefit more from Brazil's economic improvement, including airline Gol Linhas Aereas Inteligentes SA and homebuilder Cyrela Brazil Realty SA Empreendimentos e Participacoes. The companies, located in Sao Paulo, have dropped more than 14 percent this year and trade at lower valuations than Souza Cruz. Souza Cruz's profit tumbled about 24 percent to 335 million reais in the first quarter as volumes declined because of higher taxes on cigarettes, a factor that will continue to weigh on earnings, according to Planner Corretora's Burquim. "It's a really defensive option, but it's overbought," Fator Corretora's Prado said. "It's expensive. I see no reason for it to go up." Enditem