Trip report: Brazil
Recent history in Brazil has seen a push towards identifying and weeding out the linkages between corporate and political networks that have intertwined over decades to breed a culture of impunity.Download PDF version
The ongoing investigations under Operation Lava Jato continue to uncover steadily the scale of the kickbacks and fraudulent nature of numerous corporate contracts across sectors, with federal prosecutors seeking to recover approximately USD12 billion from those implicated.
These attempts at justice and reform, however, are still very much in their infancy in the long road to truly addressing a political and corporate nexus where systemic corruption has become endemic. This was the backdrop to a trip to the country in August 2019, where meetings with management teams repeatedly reiterated the crucial nature of investing alongside stewards who demonstrate competence, integrity and humility.
As a team, we constantly try to challenge our conceptions about franchises and their stewards and as such, we spent some time during this trip with a few companies that we have not met in some years, revisiting our views about them.
"If there is a lack of machines, you can buy them; if there is no money, you can borrow some; but people you can neither buy nor borrow, and motivated people are the basis of success."
Eggon João da Silva, co-founder of WEG
A couple of the companies we met looked quite attractive on paper, with little debt on the balance sheet, growing fast, and with decent profit margins. However, further research into the founders of these businesses revealed quite a different story. We came across a regulated business whose founding family also owned a media and publishing entity in the North East of Brazil, where the links between political influence and business can sometimes be even more explicit than the rest of the country. Another example we came across was a company with dominant market share in their sector that has been found to be channel stuffing1 twice in the past five years, and whose founder-Chairman and the former CEO have both recently resigned as part of an investigation into bribery charges.
These instances highlight the simple but essential fact that every founding family is not made equal, and emphasize the need to continue to be extremely rigorous where we look to invest clients’ capital. We continue to believe that management teams and founders that build franchises through political connections, those that do not treat all stakeholders appropriately, or demonstrate large risk-taking appetites might, at some point, disadvantage minority shareholders as well.
In today’s world of casino capitalism2, having a patient steward at the helm gives companies the tangible advantage of being able to withstand short-term pressure from aggressive competitors funded by deep pockets.
We came across this in Brazil during our meeting with Raia Drogasil, the leading drugstore chain in the country. The company was formed through the merger of Droga Raia and Drogasil, two strong brands who have a century of history and experience behind them, with the founding families continuing to own close to 32% of the company.3
Over the years, management have proved themselves time and again to be able to execute just the right balance between growth, via new store openings, and consistent profitability. Attracted to a profitable, consolidating industry, recent years saw a number of risk-happy competitors entering the market and rapidly opening new stores. However, with neither the history nor the experience of what running drugstores entails, the most exuberant of these new entrants are now heavily debt-laden, loss-making, closing stores, and looking for opportunities to exit the business.
During two years of aggressive competition, the stewards at Raia demonstrated the ability to unwaveringly stick to a strategy that has served them well for a century, taking slower short-term growth in their market share rather than sacrificing their solid balance sheet to match the risk appetites of their competitors. They are now picking up the fruits of this long termism, with a range of consolidation opportunities to choose from as competitors depart and market shares gradually shift their way.
Another example where the patience and long-term vision of the stewards has been essential to the business is WEG. Set up in the 1960s, WEG, named after the initials of the founders – Werner Voigt, Eggon da Silva and Geraldo Werninghaus – produces electric motors. They are one of the few globally competitive industrial companies to come out of Brazil, challenging the likes of ABB, Siemens and Emerson across the world.
The vision of these stewards to take an evolutionary approach to building out the business internationally has seen the company go from a predominantly domestic business in the 1980s to 34% of products being exported in the 2000s to 30% of products now being produced and sold abroad, with another 30% being exported from Brazil. Slow but steady vertical integration is one of their main advantages, allowing them to maintain both flexibility and a competitive cost structure by setting up manufacturing much closer to customers. Above all else, they have shown a consistent adherence to their mission of continuous and sustainable growth while maintaining simplicity. This continues to be seen in their core focus on a business they have proved themselves in over the decades, a conservative balance sheet maintained to take advantage of opportunities when competitors suffer and disciplined capital allocation.
Having a family behind a company is no automatic guarantee of returns, and trying to find and back true family stewards is a key part of our jobs as active investors. We believe that these stewards provide long-term competitive advantages in the form of the patience to build sound businesses over decades, the resilience to overcome short-term setbacks and the institutional memories not to get carried away, both in times of elation or gloom. In a world where corporate time horizons continue to shrink, we remain on the lookout for these stewards managing durable franchises with structural growth tailwinds.
View our list of investment terms to help you understand the terminology within this document.
Subscribe to our updates
To get regular updates and content from Stewart Investors, please register here.
This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should conduct your own due diligence and consider your individual investment needs, objectives and financial situation and read the relevant offering documents for details including the risk factors disclosure. Any person who acts upon, or changes their investment position in reliance on, the information contained in these materials does so entirely at their own risk.
We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication but the information contained in the material may be subject to change thereafter without notice. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material.
To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at First Sentier Investors.
Past performance is not indicative of future performance. All investment involves risks and the value of investments and the income from them may go down as well as up and you may not get back your original investment. Actual outcomes or results may differ materially from those discussed. Readers must not place undue reliance on forward-looking statements as there is no certainty that conditions current at the time of publication will continue.
References to specific securities (if any) are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. Any securities referenced may or may not form part of the holdings of First Sentier Investors' portfolios at a certain point in time, and the holdings may change over time.
References to comparative benchmarks or indices (if any) are for illustrative and comparison purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the funds managed by First Sentier Investors.
Not all First Sentier Investors products are available in all jurisdictions.
This material is neither directed at nor intended to be accessed by persons resident in, or citizens of any country, or types or categories of individual where to allow such access would be unlawful or where it would require any registration, filing, application for any licence or approval or other steps to be taken by First Sentier Investors in order to comply with local laws or regulatory requirements in such country.
This material is intended for ‘professional clients’ (as defined by the UK Financial Conduct Authority, or under MiFID II), ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) or Financial Markets Conduct Act 2013 (New Zealand) and ‘professional’ and ‘institutional’ investors as may be defined in the jurisdiction in which the material is received, including Hong Kong, Singapore, Japan and the United States, and should not be relied upon by or be passed to other persons.
The First Sentier Investors funds referenced in these materials are not registered for sale in the United States and this document is not an offer for sale of funds to US persons (as such term is used in Regulation S promulgated under the 1933 Act). Fund-specific information has been provided to illustrate First Sentier Investors’ expertise in the strategy. Differences between fund-specific constraints or fees and those of a similarly managed mandate would affect performance results.
About First Sentier Investors
References to ‘we’, ‘us’ or ‘our’ are references to First Sentier Investors, a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG). Our investment team operates under the trading name of Stewart Investors which is part of the First Sentier Investors Group.
This material may not be copied or reproduced in whole or in part, and in any form or by any means circulated without the prior written consent of First Sentier Investors.
We communicate and conduct business through different legal entities in different locations. This material is communicated in:
- Australia and New Zealand by First Sentier Investors (Australia) IM Ltd, authorised and regulated in Australia by the Australian Securities and Investments Commission (AFSL 289017; ABN 89 114 194311)
- the European Economic Area by First Sentier Investors (Ireland) Limited, authorised and regulated in Ireland by the Central Bank of Ireland (CBI ref no. C182306; Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland; Company no. 629188).
- Hong Kong by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. First Sentier Investors and Stewart Investors are business names of First Sentier Investors (Hong Kong) Limited.
- Singapore by First Sentier Investors (Singapore) (Company no. 196900420D) and this advertisement or material has not been reviewed by the Monetary Authority of Singapore. First Sentier Investors (registration number 53236800B) and Stewart Investors (registration number 53310114W) are business divisions of First Sentier Investors (Singapore).
- Japan by First Sentier Investors (Japan) Limited, authorised and regulated by the Financial Service Agency (Director of Kanto Local Finance Bureau (Registered Financial Institutions) No.2611).
- the United Kingdom by First Sentier Investors (UK) Funds Limited, authorised and regulated by the Financial Conduct Authority (FCA ref no. 143359; Registered office: Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB; Company no. 2294743).
- the United States by First Sentier Investors (US) LLC, authorised and regulated by the Securities Exchange Commission (RIA 801-93167).
- other jurisdictions, where this document may lawfully be issued, by First Sentier Investors International IM Limited, authorised and regulated in the UK by the Financial Conduct Authority (FCA ref no. 122512; Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB; Company no. SC079063).
To the extent permitted by law, MUFG and its subsidiaries are not liable for any loss or damage as a result of reliance on any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment products referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.
© First Sentier Investors Group