Brazil Orange Book Monday, July 07, 2014 Weak Consumption, Production falls With information through July 3, 2014 This report, published six times per year, summarizes anecdotal information on current economic conditions received from key business contacts, economists, market experts, and other sources outside Itaú. Apart from the our view section, it is not a commentary on the views of Itaú s Macroeconomic Research team Contents Consumption and Production of Goods and Services The weakening of consumption is becoming more widespread and more intense. Inventories are high throughout the different consumer-related production chains Investment Business confidence retreated significantly during 2Q14. Due to global and domestic uncertainties, major investment decisions are being postponed. Real Estate The residential real estate sector has seen a clear slowdown in sales in recent months, particularly in June. In the commercial segment, the drop in activity is more pronounced. Commodities Hot and dry weather continues to affect Brazilian agricultural production. The outlook for prices is less favorable, due to the large U.S. harvest. Labor Market, Production Costs and Prices Faced with low growth, the appetite for hiring is low, and more sectors are announcing forced vacations. Our View Indicators for recent months point to a slowdown in domestic demand, which are likely to lead to negative growth in 2Q14. Low confidence suggests that activity will remain weak in the coming months. Summary The decline in consumption is becoming more widespread and more intense in Brazil. The durable goods segment continues to post weak sales as retailers accumulate inventories, while the nondurable goods and services segments, which had been holding steady, have started to lose steam. Inventories are high throughout the different consumer-related production chains, and many segments are announcing forced vacations. Business confidence retreated significantly during 2Q14. Due to global and domestic uncertainties, major investment decisions are being postponed. Low growth and fear of future stagnation are factors leading to caution. Supply-side factors, such as high costs and tax complexity, also cause entrepreneurs to shy away from plans to expand capacity. Sales remain weak in the heavy vehicles sector (trucks and agricultural machinery), dropping further in June. As for infrastructure investment, the tone is more positive, given the favorable outlook for concession programs, among other factors. The residential real estate sector has seen a clear slowdown in sales in recent months, particularly in June. The inventory of residential properties for sale remains above the desired level. In the commercial segment, the drop in activity is even more pronounced. Sales are considered weak, and vacancies are high. As for commodities, the hot, dry weather continues to affect Brazilian agricultural production. The grain crop as a whole is still considered good but falls short of initial expectations. The outlook for Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.
prices is less favorable, due to the large U.S. harvest. The drought has markedly affected the sugar & ethanol sector, while the drop in coffee prices will likely be lower than expected. The scenario is much more favorable in the meat sector, with heated domestic and external demand. Labor costs continue to be a major point of concern among different sectors of the Brazilian economy. Faced with low growth, the appetite for hiring is low, and more sectors are announcing forced vacations. Wage negotiations are tougher than last year and have resulted in small real gains on average. By contrast, some costs began to drop as a result of the economic downturn. The highlight is the decline in freight costs, which has a major impact on industrial activity. Our View: The 1Q14 GDP results and indicators for recent months point to a slowdown in domestic demand, which are likely to lead to negative growth in 2Q14. Indicators of business and consumer confidence are falling sharply, suggesting that activity will remain weak in the coming months. We believe that this decline is partly temporary, due to expectation of fewer working days because of the World Cup, but also driven by the recent dynamics of economic fundamentals (higher interest rates, inflation under pressure, low and volatile growth). The labor market is beginning to reflect the weakening economy and appears to have lost momentum, although the unemployment rate remains at historically low levels. Consumption and production of goods and services The weakening of consumption is becoming more widespread and more intense. The durable goods segment continues to post weak sales as retailers accumulate inventories, while the non-durable goods and services segments, which had been holding steady, have now started to lose steam. In general, growth remains positive, but it is in decline. And the effort to maintain sales is stepping up. Some sectors more closely related to disposable income and basic necessities, such as medicine and cosmetics, are still seeing robust demand. Higher interest rates, inflationary pressures, a higher debt-to-income ratio and fear of a slowdown in the labor market continue to justify a more cautious approach to demand expectations. The recent drop in consumer confidence accentuates the fear that demand will continue to slacken in the coming months. Sales of durable goods related to the World Cup (especially televisions) were good, but at the expense of aggressive promotions from retailers. Among the sectors related to consumption, the auto industry remains one of the most affected by the current scenario. Automakers report high inventories and have been announcing forced vacations. Automakers have relied on sales to fleets, at tighter margins, in order to reduce inventories and maintain activity. Sector suppliers (of auto parts and tires) are also experiencing stagnant production and small order volumes. Producers of intermediate goods, such as chemicals, plastics and resins, confirm the weak demand. May and June were the worst months of the year for production and sales. The industry expects a drop in production compared with last year. A similar situation occurs in those segments connected to household items. Sectors such as furniture, sanitary ware and heavy appliances posted a decline in orders, and many are announcing forced vacations. Some companies in these sectors allegedly stopped investing in advertising, believing that demand will not be able to react in the short term. On the more positive side, producers of consumer goods and semi-durable and non-durable goods such as cleaning products, medicines and food still report heated activity, though decelerating. Supermarkets report that consumers are increasingly selective, trying to buy only the essential items. The same picture can be seen in the services sector, which continues the slowdown observed throughout 2013. The apparent stabilization reported in the latest edition of the Orange Book was not confirmed. On the more positive side, services connected to the World Cup (hotels, tour operators, event production, media and executive transport) are going strong, as expected, and the FIES (governmental funding for higher education) continues to boost some segments of the education industry. Page 2
Investment Business confidence significantly retreated during the 2Q14. Our indicator, built from a broad customer base, was stable in May and June, following a sharp drop in April. The current level is 9% below the 1Q14 average, and 18% below the 2Q13. Despite the lower volatility of financial markets, the second half still brings global and domestic uncertainties, leading to postponement of more relevant investment decisions. Low growth and fear of future stagnation are factors reinforcing caution. Supply-side factors, such as high costs and tax complexity also lead entrepreneurs to shy away from production capacity expansion. Sales continue to be weak in the heavy-vehicle sectors (trucks and agricultural machinery), dropping further in June. In addition to the low propensity to invest, the anticipation of sales in recent years and the lack of manpower (drivers) are also among the factors that limit the demand for trucks. In this environment, heavy-vehicle production will likely remain contained. On the infrastructure investment side, the tone is more positive. Companies in the transport and logistics business are facing a more favorable environment for their projects. This fact reflects the Brazilian society s growing awareness that this area is a priority for the country s development. The increase in public spending and a number of government actions, including the extension of the PSI program from BNDES and the return of the Reintegra program, are also helping marginally. As mentioned in the most recent editions of the Orange Book, despite the cautious mood, interest in investing in Brazil still remains. The size of the consumer market and the potential of commodities production make Brazil structurally attractive. Infrastructure projects offered by the government through the concession programs have return potential and could help relieve production bottlenecks. Real Estate The residential real estate sector has experienced a clear slowdown in sales in recent months, particularly in June. Part of this may be related to the World Cup, as a larger volume of sales is usually closed on weekends, which are now preferably spent by consumers watching the games. But much of the loss of momentum had already been observed before the World Cup, and it may be connected to rate hikes and falling consumer confidence. The inventory of residential properties for sale remains above the desired level. Despite the weaker pace, prices have remained relatively stable. In general, the industry prefers to adjust quantity instead of prices. But in regions where falling prices are observed, demand has responded elastically, which indicates that this practice may begin to spread in the coming months. In the commercial segment, the decrease in activity is more pronounced, especially in capitals such as São Paulo, Belo Horizonte and Rio de Janeiro. Sales are considered weak, and the vacancy level is high, especially if we take into account the releases scheduled for the coming quarters. In the shopping mall segment, the indication is that investment will be limited over the next two to three years. Activity in existing malls is still relatively good, but there are doubts about the demand for new ventures. In this environment, retailers willingness to invest is less than in recent years. Commodities The hot, dry weather has affected Brazilian agricultural production. The grain crop as a whole is still considered good, but it will fall short of initial expectations. At the same time, the strong crop in the U.S. leads to a less favorable outlook for prices, especially corn and soy, a movement that has not been offset by a depreciation of the Brazilian exchange rate. Thus, the sector will likely see more moderate yields in the second half. The drought in São Paulo has affected the sugar & ethanol sector more strongly, reducing the Page 3
outlook for cane harvest in the second half. The scenario for ethanol remains worrisome, also due to the uncertainty around adjustments of gasoline prices in the domestic market. The outlook is more positive for sugar, with prices improving in the international market. In the case of coffee, however, the crop reduction was smaller than initially projected, and prices have remained at relatively favorable levels. Thus, the sector will likely sustain good remuneration levels over the coming months. The scenario is much more favorable in the meat sector. The international demand for Brazilian meat continues to be strong, and domestic sales are particularly heated because of the World Cup. On the production side, the drop in corn prices reduces the cost of livestock feed. The exchange rate (at levels perceived as appreciated) limits metal and mining exports. On the domestic demand side, the acceleration expected for infrastructure concessions helps, but the drop in production of consumer durables, especially cars and heavy appliances, is cause for concern. Labor market, production costs and prices Labor costs continue to be a major point of concern among different sectors of the economy. Faced with low growth, the appetite for hiring is low, and more sectors are announcing forced vacations. Wage negotiations are tougher than last year, and they have resulted in small real gains on average. The possibility of increases in electricity and fuel prices ahead also generates concern. Thus, inflationary pressures remain, although constrained demand limits the ability to pass through the costs of inflation. By contrast, some costs began to drop as a result of the economic downturn. The highlight is the decline in freight costs, which has a major impact on industrial activity. The recent accommodation of the exchange rate also helps to ease inflationary pressures. Our view The 1Q14 GDP results and indicators for recent months point to a slowdown in domestic demand, which is likely to lead to negative growth in 2Q14. Indicators of business and consumer confidence are falling sharply, suggesting that activity will remain weak in the coming months. We believe that this decline is partly temporary, due to expectation of fewer working days because of the World Cup, but other part is due to the recent dynamics of economic fundamentals (higher interest rates, inflation under pressure, low and volatile growth). The labor market is beginning to feel the weakening economy and appears to be losing momentum, although the unemployment rate remains at historically low levels. Macro Research Itaú Ilan Goldfajn Chief Economist Tel: +5511 3708-2696 Click here to visit our digital research library. Page 4
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