Market has discussed need for rate hike in last weeks
08/28/2024
Igor Velecico — Foto: Silvia Costanti/Valor
The mounting uncertainty regarding the direction of monetary policy has been significant in recent weeks. The perception of an economy resistant to slowing down has joined the U.S. dollar’s appreciation against the real this year, supporting a growing view that the Central Bank will be forced to resume monetary tightening in September.
Alongside this perception is the recent communication from some Central Bank officials, particularly directors Gabriel Galípolo (monetary policy) and Diogo Guillen (economic policy).
Before the interest rate decision in July, few analysts projected new increases in the Selic policy interest rate, such as XP Asset Management and Novus Capital. After the policy meeting, the scenario gained significant supporters including Legacy Capital, Itaú Asset Management, and ASA. More recently, some sell-side players have also adopted this scenario, including XP and BTG Pactual.
However, there remains some uncertainty on the radar. Not by coincidence, although the interest rate curve and the COPOM digital options market continue to indicate a majority chance of the Selic tightening cycle beginning in September, the consensus in the Focus—Central Bank’s weekly survey with economists—still puts the policy rate at 10.5% per year, although the average of projections has increased.
In recent days, banks like Barclays, J.P. Morgan, and Morgan Stanley reaffirmed their projection that the Selic will remain at 10.5% per year.
The appreciation of the Brazilian real since the peak of stress, when the exchange rate reached R$5.86 per dollar, and the expected economic slowdown are cited by those who reject the view that an interest rate hike is necessary. Additionally, an imminent easing of the U.S. Federal Reserve’s policy would also factor into the equation.
Valor spoke with two market participants with differing views on the necessity of a process to raise the Selic starting in September, as has been priced in the market rates for some time now.
Igor Velecico, Genoa Capital’s chief economist, has adopted a scenario in which the Central Bank raises the policy interest rate by 25 basis points in September, reaching 12% per year by early 2025. According to him, the resumption of tightening is necessary, as the context encompasses an economy that is not in equilibrium. “And this generates inflation,” he said, projecting 12-month IPCA (Brazil’s official inflation index) at 4.3% this year and 4.2% in 2025.
“The Central Bank will gain credibility if it does the right thing. The right thing to do at the moment is to raise interest rates to address domestic imbalances and bring inflation closer to the target of 3%,” said the economist, who sees an “overheated” economic activity in the country.
On the opposite side, the chief strategist at Warren Investimentos, Sérgio Goldenstein, sees no need for an additional tightening of interest rates and projects the Selic to remain at 10.5% per year for a longer period.
“If the Central Bank promotes a cycle of a 150- to 200-basis-point increase [in the Selic], its model, over the relevant horizon, will point to an IPCA projection of 2.7%. Instead of initiating a tightening cycle only to soon have to start a cutting cycle, it seems much more coherent to keep the Selic stable, with a strong discourse,” argues the professional, who previously headed the monetary authority’s open market department.
High interest rates, resistant inflation hurt companies whose sales depend on credit
27/07/2022
Much higher interest rates, resistant inflation and reduced consumption power make up the scenario that has punished retail companies in the stock market for some months. But, more recently, the warning sound has also started to blare in the local corporate debt market, where a good number of these companies have been financing themselves, either to continue their expansion plans, or to reinforce their cash flow, thinking of going through the turbulence that may still come given the macroeconomic risks that lie ahead.
Analysts heard by Valor are unanimous in saying that, unlike what one might think when looking at large retailers traded on the stock market – Magazine Luiza, Americanas C&A, Centauro, Guararapes, Renner and Via –, which have seen losses of up to 88% in 12 months, the situation in the credit market is not dramatic. Most companies have a leverage situation under control and can access the market.
The point is that investors are becoming more demanding, not willing to pay any price, and not even willing to finance companies for any length of time. And at a time when the supply of securities is abundant, you can choose who you want to give money to. And this is already reflected both in the trading of shares in the secondary market and in new issuances.
“What we see is a dispersion of performance among companies, typical of times when uncertainty about the sector as a whole grows,” says Alexandre Muller, a partner at the asset management company JGP.
Two recent operations by large retailers illustrate this environment well. Americanas raised R$2 billion in June issuing 11-year bonds. The rate paid was 2.75% above the CDI (the interbank short-term rate), in an operation considered very successful, even with such a long term. Similarly, Centauro raised R$500 million by issuing 5-year bonds, paying 2.1% above the CDI, in a placement that was fully absorbed by the market.
In July, Via concluded the issuance of R$400 million in five-year and seven-year Certificate of Real Estate Receivables (CRI). But given the low demand for the security, of only R$134 million, the banks that coordinated the offering had to keep a portion of R$266 million.
In this case, the assessment of the managers is that the term was too long given the risk of the company, which deals with macroeconomic issues but also operational and governance issues. It is enough to remember that during the book-building process, a disagreement between the partners about the company’s compensation plan became public.
Similarly, C&A tapped the market to raise R$600 million through bond issuance in April. At the time, Fitch had changed the company’s rating outlook to negative. The banks also had to exercise the firm commitment and were left with 69% and 28.65% of the two lots, maturing in 2025 and 2028, respectively.
When one looks at the secondary market, there are also some movements drawing attention. Magalu’s bond, which was issued last year at a rate of 1.25% above the CDI, for example, is now traded at 1.75%. In contrast, Guararapes’s bond maturing in 2024, which was issued with a spread of 2.95% above the CDI, had a reference rate of 2.0295%.
“There is a change in conditions for these companies, and the credit world also perceives this,” says Mr. Muller. He notes that, although the negative effect is not as intense as the one seen in 2020, when the pandemic strongly impacted some sectors, such as restaurants or tourism, investors now seem even more cautious.
“In 2020, it was easier to have a projection for the companies’ recovery because we knew things would normalize. Now, the call is more complex, because nobody knows when the interest rate will stop rising and not even for how long it will remain high,” he explains. In this context, says Mr. Muller, the fiscal scenario has an even greater weight on the market, once the definition of the fiscal framework for the next government will have a great influence on the interest rate projections.
Vivian Lee — Foto: Carol Carquejeiro/Valor
Vivian Lee, a partner at Ibiúna Investimentos, says that the macroeconomic scenario of high interest rates and inflation affects income and cools consumption. And this has a direct impact on the companies’ revenues and especially punishes those who have a financial arm. Not to mention the immediate effect of the rise in the Selic policy interest rate on the debt, which, for the most part, is pegged to the CDI. “We haven’t seen any impact of the financial cost on the earning reports when looking at the 12-month horizon yet, but in the second half of the year this will start to appear,” she says.
What analysts observe, however, is that the impact of interest rates will have a different magnitude in each retail segment. The most sensitive is the white goods segment – represented by Via and Magalu – which has already benefited a lot during the pandemic, a period in which consumers directed their funds to this type of product.
On the other hand, fashion retail ends up gaining space at this moment. But for those who have a financial arm, the rise in interest rates has a double negative effect: on consumption and on portfolio default. This is the case with C&A, Renner, and Guararapes (owner of Riachuelo).
The need for working capital, the profile of the consumer public, and the level of leverage are also variables that are being closely observed by investors.
“Those who depend on the upper classes end up benefiting. Those who work more with the lower classes will lose more because inflation weighs more for these consumers,” says Luiz Sedrani, BV Asset’s chief investment officer. “The government’s [consumption stimulus] package tends to stimulate the economy, but we have to keep an eye on default rates.”
The market has observed since March a repricing of the shares, a movement that has not yet reached all the companies, says Ms. Lee, with Ibiúna. “How much this scenario will be reflected in the fees paid by the companies is hard to say, but it is clear that there will be a price correction, and this time it will be due to credit risk,” she says. This environment is likely to overlap the flow of investments, which remains strong for the corporate debt market. This has contributed to balancing the rates paid by companies. “Even if you have an appetite for corporate debt, investors will separate the wheat from the chaff, and at some point, prices will adjust.”
Leonardo Ono, Legacy’s corporate debt manager, says that many retailers are impacted because of factoring of receivables, an operation whose cost increased with the higher Selic. But, for him, this is not an exclusive situation for retail, but for companies that depend on the local economy. A good part of these companies are prepared to go through turbulent periods. “I don’t see an explosive situation,” he says.
In a note, Magalu said it ended the first quarter with an adjusted net cash flow of R$1.6 billion and a total cash flow of R$8.5 billion, considering cash and financial investments of R$2 billion and available credit card receivables of R$6.5 billion. Guararapes, Americanas, Renner and C&A declined to comment. Centauro and Via declined to comment, citing a quiet period before the release of their earnings reports.
The production of household appliances faces a deep decline in 2022 due to rising inflation and interest rates. The segment had already been struggling to receive inputs and saw costs soar amid a disrupted production chain and higher commodity prices brought by the pandemic. Now, consumers’ tight budgets – eroded by higher spending on food, electricity and fuel – are taking a toll on manufacturers.
The production of appliances plummeted 25.3% year over year, a survey by statistics agency IBGE shows, the third consecutive quarter of decline. A double-digit contraction is also clear in segments like white goods (refrigerator, stove, washing machine), brown goods (TV and stereo) and portable appliances. At the same time, the prices of appliances and equipment rose 7.46% in the same period, up 20.43% in the 12 months through March, according to data from IBGE and the Extended Consumer Price Index (IPCA), reflecting the higher production costs in the industry.
The war in Ukraine and the new outbreak of Covid-19 in China further aggravate a situation considered “challenging” by executives, who want to avoid a negative tone. The Asian country is shutting down plants due to lockdowns, especially in Shanghai, which impacts some companies.
Some companies are already seeking new suppliers of inputs – dual sourcing has expanded because of problems faced during the pandemic – and also air freight to shorten travel times for some products, while others are adopting a wait-and-see approach. Officially, all companies rule out the possibility of interrupting lines, but part of the market may face this risk.
Sergei Epof — Foto: Divulgação
“The drop in the first quarter is very much related to the consumer’s cash flow. Inflation has risen sharply and default rates too. The money available among Brazilian consumers for buying home appliances has been used for food, electricity and gasoline,” said Sergei Epof, Panasonic’s vice president of appliances in Brasil. His team focuses mainly on the white line, since the company halted the production of the brown line in the country last year, following a global strategy.
The Brazilian market is experiencing a combination of weaker demand, more expensive goods – as higher costs are passed on to prices – and more expensive credit, he said. Given the high interest rates, the consumer has been paying more for loans and default rates are on the rise.
“Demand has fallen and the price of appliances has risen. We had a lot of cost increase, which includes international freight, because of oil, the foreign exchange rate, which remains high despite the small recent drop, and inputs such as steel, resin and semiconductors,” Mr. Epof said. Part of the cost was passed on to consumers, he added.
As a result of inflation of inputs and falling purchasing power, “demand virtually disappeared,” said Marcelo Campos, managing director at Esmaltec. The company, which makes household appliances for Ceará-based Edson Queiroz group, has seen disappointing results since the middle of last year, especially in the last quarter of the year, typically a good time for durable goods sales due to Black Friday and the holidays. This happened after a surge in demand for appliances after the initial months of the pandemic, as people stayed at home.
The higher cost of components especially impact companies like Esmaltec, which works with the so-called entry-level products – those with lower prices, Mr. Campos said. Steel rose 163% in 2021, according to him, and is up 20% this year. This affects items such as compressors, evaporators and condensers for refrigerators. “Part of the cost has been passed on to consumers, but there is also a great effort to review negotiations with suppliers and processes to hold on some of the pressure,” he said.
The worsening of Covid-19 cases in China brought back the concern of shutdown factories at a time when the supply of inputs was already normalized, said Silvia Tamai, head of marketing for Latin America at Philips Walita, the company’s division of portable appliances.
“The situation of delays and lack of inputs had already been very much reduced. Our prospect in January was very positive as we had returned to a normal level. But the situation started to concern again around a month and a half ago.” Despite that, she still expects higher sales volumes in 2022 than last year.
The problems affect both the inputs used directly in the plant in Varginha, Minas Gerais, and the portion of products imported directly from other units, such as some models of coffee makers that come from Europe. Most of the inputs and products are produced in Brazil, she said, but even so the imported ones impact the production flow.
“There is a filter that goes into the espresso machine that comes from China. We bring the product from Europe, but they also depend on some component that comes from China,” she said.
Electrolux said in its global first-quarter financial report that falling sales in Latin America are linked to the decline in demand in Brazil, since inflation and high interest rates affected consumers’ purchasing power.
Whirpool, owner of Brastemp and Consul brands, did not mention the situation in Brazil in its first-quarter report, but predicted a decline in the household appliance industry as a whole in Latin America, Europe, Middle East and Africa this year.
The companies that tapped the capital markets to issue debt in 2021 taking advantage of the very low Selic rate will see their costs with interest expenses almost double in 2022. This is because, of the R$250 billion of funds raised last year through bond issues, 76% are pegged to the interbank deposit rate (CDI).
This higher cost does not yet bring to the fore a solvency risk for those companies that, in most cases, still require low leverage. But it will certainly affect profitability, with a direct effect on profit and, consequently, on growth capacity in the medium term.
“The higher interest rate causes a redistribution of results, which used to go to shareholders and now also go to creditors,” said Alexandre Muller, JGP’s managing partner. In order to estimate the impact of the higher Selic policy interest rate, which started 2021 at 2%, the analyst looked at the evolution of the debt of the companies that make up IDEX-CDI, an index created by JGP that includes CDI-linked, liquid bonds. Considering an average CDI of 4.46% last year, the effective interest cost of these companies will be R$6.68 billion in 2021. If the Selic increases to 12%, as predicted by the market, the average CDI this year would increase to 12.31%, raising the cost of this group of companies by 84% in 2022, to R$12.31 billion.
Mr. Muller explains that one indicator tracked by JGP is the return on invested capital (ROIC). A given company whose operations generate an 8.9% ROIC creates value when the cost of capital is 6.5%. The point is that when the cost of capital goes up, smaller, less profitable companies suffer. “Interest rate changes cause more market concentration, because larger companies, which have the power to adjust prices, can survive, while smaller ones have a harder time.”
But higher interest rates are not the only factor making companies’ debt more expensive. Vivian Lee, a partner at Ibiúna Investimentos, recalled that the spread, which is the rate paid above the CDI for the bonds, can also go up again in the coming months. She recalled that in 2021, as investors migrated to fixed income assets from the stock market, there was a strong flow to corporate debt funds, which reduced the spread substantially, to nearly 1.4%. The companies took advantage of the favorable moment and accelerated issuance between October and November. At the same time, faced with a more uncertain environment of rising interest rates, corporate debt funds became more selective at the end of the year.
With a more balanced demand and a flood of offerings, the spread rose to around 1.8%. “The market was busy at the end of the year, showing that even with the migration to fixed income, investors will not support such low spreads,” he said. The point, he said, is that issuers who need to roll over their doubts or even strengthen their cash reserve this year have to do so in the first half of the year, because from then on investors’ willingness to take risk is likely to decrease due to the presidential election. In other words, there may be a new concentration of offerings in the coming months and, therefore, a repricing of securities. “Whoever needs to go back to the market may have to pay a higher spread, besides a much higher CDI,” he said.
For Laurence Mello, head of corporate debt strategy at AZ Quest, the landscape for companies will worsen with the interest rate hike, “but won’t necessarily be bad,” especially when looking at the “high grade” companies, those with good risk ratings. These are companies that have already made adjustments and are now in good liquidity conditions. “Looking at the structure of their balance sheets, the companies are able to pay debts,” he said. Even so, financial costs will rise, impacting profitability and these companies’ performance in the stock market.
The consequence will be, in his view, a setback in the dynamics of the debt market, which went through a period of lengthening terms and reducing spreads. “Companies will need more leverage, more equity, and will make shorter term issues,” Mr. Mello said, adding that this dynamic may affect the speed of growth of these companies.
The impact of the increased cost of debt is likely to be different depending on the company’s profile, said Artur Nehmi, head of fixed income at Sparta. Sectors that offer basic public services, whose capital has natural protection from the rise in inflation, will have fewer problems, he said. This is the case of companies in the energy, infrastructure or sanitation industries, which are important issuers of bonds. But cyclical companies will have a harder time, as their revenues will drop due to the economic slowdown, while financial expenses will increase with higher interest rates.
Another company profile that may be more affected by the increase in interest rates are those that exchanged IPOs for debt offerings as a way of strengthening cash reserve. “Some of these companies had room on their balance sheets to issue equity, but not necessarily to issue debt,” he said.
For Ricardo Carvalho, an analyst at Fitch, higher interest rates will pressure the companies’ financial expenses. But the perverse effect for companies will come from demand. “Interest rates rise because inflation is high, and this combination impacts income and has a restrictive effect for companies,” he said. He points out that companies’ leverage ratios are still low – their net debt-to-EBITDA ratios are at 1.5%, according to Central Bank data, compared with 3.5% in 2019. This means that balance sheets are likely to remain well, even as credit cost conditions worsen. “The question mark now is how long interest rates will stay high. But companies did their homework, lengthened their liabilities and are more prepared to face this more adverse scenario,” he said. “Results will be weaker in terms of revenues and interest rates, but this is not a risk that concerns us.” Given this, Mr. Carvalho believes that there will be a smaller number of upgrades of companies’ ratings. “Yet we don’t expect a material number of downgrades either.”
For Yuri Ramos, head of investment banking at BV, the Selic and the cost of debt is likely to have an accounting impact for companies. But, according to him, most of them were already planning for a higher interest rate level, which may indicate a milder effect on these companies. Even with this interest rate increase underway, he said, the capital market is likely to remain heated this year, propped up by infrastructure companies, for example. He recalled that there were several concessions in this sector last year, such as that of Rio’s sanitation company Cedae, and companies will seek long-term financing to make the necessary investments viable.
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