We remain committed to selective growth in Latin America
The short-term, global macro scenario is full of challenges (a trade war between the United States and the rest of the world, a general slowdown in manufacturing activity, a possible recession in the United States, Brexit, etc.) that have recently prompted downward revisions in expectations for corporate profit growth on most markets.
Therefore, the investment community is committed to those markets that offer higher growth potential, like Latin America, where there are also loft expectations about the upcoming approval of a new pension system in Brazil, which would mean considerable tax savings and would facilitate the persistence of low rates, as well as the possibility of dedicating greater resources to structural investments in order to boost economic activity. It is an element that translates into net investment inflows and turnover toward equity assets.
As a result, 2019 has been a good year for equity markets in Latin America. In the specific case of our EDM Latin American Equity fund, cumulative returns as of the July close totalled +xx.x% and +x.x% for the USD and EUR classes, respectively, relative to a +xx.x% return for the MSCI EM Latin America index, expressed only in USD. Despite the figures, we believe the vehicle continues to maintain an attractive valuation and offers an interesting “expected return” in relation to the “assumed risk.”
Nevertheless, EDM remains focused on micro, with our investment philosophy intact. Therefore, we only approach investments through the selection of interesting, financially sound, well-managed businesses with attractive valuations.
As an example, take the recent addition to our fund of Atacadao, a leader in Brazil in the low-cost supermarket segment through different channels (physical stores and online sales). After visiting one of its establishments in Sao Paulo and meeting with current CEO, Marco Oliveira, we obtained a better understanding of the favourable historical evolution of its income statement, high margins, enormous cash generation, and financial strength.
It is a story of local growth, fuelled by a capacity to adapt to any type of demand from end consumers or small retailers. The format of its stores is highly functional and tidy, offering one of the widest selections of products on the market, with an outstanding price/quality ratio. Another competitive advantage is its purchasing power, allowing the brand to offer prices that are, on average, 15% lower than those of the competition. In addition, the company continually focuses on improving operational efficiency through reduced logistics and advertising costs. As a result of the foregoing, Atacadao achieves one of the highest ROICs (return on invested capital) in the sector. Last but not least, despite already being the largest company of its format, with more than 160 stores, it maintains tremendous future growth potential, capable of opening 20 establishments per year in the medium term owing to the broader expected penetration of its concept.
With regard to the fund’s characteristics, there is currently a selection of 26 companies, each—in our view—dedicated to quality businesses, from which we expect to obtain a 2019 aggregate profit growth rate above 13%, and above 11% in the next five years. Also notable, the portfolio’s aggregate return on equity (ROE) is near 16% and its net debt/EBITDA ratio is less than 1x. In other words, these are businesses that grow, while being profitable and financially sound at the same time.
In terms of valuation, the fund’s earnings multiplier stands at 14x expected NTM profits. Likewise, despite its cumulative YTD appreciation, we expect its upside potential to remain attractive since, at the current price, the portfolio trades at roughly 15% below what we consider its adequate or fair valuation.
In short, our EDM Latin American Equity fund offers an ample safety margin for investors who, thinking in the long term, want equity exposure in Latin America—one of the most economically dynamic regions—through a conservative selection of quality businesses.
Financial Analyst & Fund Manager