It seems that for many British investors Latin America is like marmite – you either love it or you hate it. Whenever I write about investing in Latin America reader responses generally fall into one of two camps: they either think I’m nuts, or they think it’s a great idea. Of course regular New World readers will know what camp I’m in. In previous articles I’ve tried to explain why some of the most commonly held fears MoneyWeek readers have about Latin America are misplaced.
Today I want to tackle another myth – that Latin American firms don’t pay dividends. Oddly enough, even some of my buddies in the ‘pro Latin America camp’ believe this one. There’s a general perception among readers that while you may find safe, reliable, dividend-paying blue chips in Britain, Europe or the US, places like Latin America just have volatile growth stocks. The type of companies, as one friendly reader put it to me, that “are worth a punt but not betting the house on”. Now, I wouldn’t recommend betting the house on anything, regardless of what country it’s based in. But I think investors that ignore Latin America’s heavy hitting dividend payers are missing a trick. So today I’m going to point out some of the best ways to earn income in the region.
First up is an Argentinian landowner.
One third of the world’s unused farmland is here
One of the major themes that I’m really interested in is Latin American agriculture. It’s no secret that growing populations and increasing wealth – which leads to more diverse diets – have put a strain on global food supplies. Prices for ‘soft commodities’ such as sugar have repeatedly set new records in the last ten years. Less widely appreciated is that Latin America is uniquely well placed to serve this growing demand.
As anyone who has ever been there will know, most of the region is pretty fertile. Over the past decade I’ve travelled all over rural Latin America – from Argentina’s sprawling pampas to Guatemala’s banana plantations. I’ve lost count of how many different people in different countries have proudly boasted that all they have to do is throw a seed to the floor for it to grow.
Of course, Latin America isn’t the only place in the world with good farming conditions. The US, Eastern Europe, and Australasia are all major food exporters that help keep more densely populated areas – ie Asia – well stocked with food. But Latin America has the most ability to crank up production.
The UN’s Food and Agriculture Organisation reckons that Brazil has the most ‘spare farmland’ in the world. The country has 350 million hectares of potential arable land which isn’t currently being used to produce food. In total, the World Bank estimates that about a third of the world’s spare farmland is in Latin America. Putting all that into production won’t be easy, but the region has the necessary resources to do it. For example, Latin America has just under a third of the world’s freshwater resources; more than any other region.
So how can investors benefit? Well one of the major players is Argentinian landowner Cresud (NASDAQ: CRESY). The firm’s holdings in Paraguay, Brazil and Argentina give it exposure to the wider regional story. Of course the stock is not without risk, after all President Kirchner likes to pick fights with farmers. It also has a big stake in a local real estate company, which is likely to struggle as the Argentinian economy slows down. But fortunately a lot of those problems are now in the price – the stock is now pretty cheap having fallen 30% since last year. Moreover, it also has a very generous 5.8% dividend yield.
For my next play, we move onto Colombia and its natural resources.
Earn steady income from Colombian oil
It’s no secret that Latin America has lots of oil and gas – but it’s normally Brazil, with its huge offshore finds, that gets most of the attention. However, I’m a lot keener on Colombia.
About ten years ago the Colombian oil and gas sector was in a terrible way. Production had fallen to 500,000 barrels of oil equivalent per day (boe/d) from 800,000 boe/d just five years earlier.
It wasn’t that Colombia didn’t have oil. In fact, geologists told the Colombian government that more oil would probably be found in the unexplored mountains. The problem was that poor security and unhelpful regulations meant few companies wanted to explore.
That’s all changed now. Thanks to some shrewd government policy and a fair bit of luck, oil production is now almost at a million boe/d, and predicted to hit 1.5 million by 2020.
So what’s changed?
One smart move was to reorganise the oil and gas sector and change the rules to allow explorers to keep more of the income from any oil they found. Another was to allow producers to charge a fair price for the oil in Colombia – many other Latin American countries fix the price of domestic oil, meaning that local producers are often forced to sell to locals for well below the going rate, hurting profit margins.
Security has also improved. Colombia’s murder rate has dropped while the strength of FARC, the country’s oldest and largest insurgent group, has been reduced by a series of military strikes. Indeed, the government is currently holding peace talks with FARC in Cuba.
As a result, the profits and share prices of several Colombian oil producers have soared. However, the party’s not over yet. The government is implementing a massive transport infrastructure plan that should help bring down costs for producers. The country also still has plenty of exploration potential. If you want to earn a steady income from the Colombian oil story then Ecopetrol (NYSE:EC) looks a good bet. When I first wrote about this company I felt it was too expensive. But since then, it’s fallen 25% and now looks more fairly valued. Thanks to the price drop, and the board’s commitment to keep payments high, it now yields 6%.
An infrastructure boom is happening across the region
I sometimes get accused of having a rose-tinted view of Latin America. So now, I’m going to talk about one of its weak points – infrastructure. Getting around South America, especially when you go anywhere near the Andes, can be a nightmare. There are not many excellent road tunnels like those the Swiss, French and Italians have blasted through the Alps. No European-style fully-integrated railway system either. Indeed in many countries the remaining fragments of British-built railways are more tourist attractions than transport systems.
But many governments in the region are now trying to remedy this. The Peruvians and Colombians have launched multi-billion dollar projects to lay new roads, railways and airports across their countries. Colombia has a $100bn infrastructure plan that, in addition to improving transport, will also build new cities for the millions of people displaced by violence in the 80s and 90s.
As for Peru, it has set aside $20bn for infrastructure spending between 2011 and 2016. $11bn will go towards upgrading transport routes across the jungle and mountain regions. Meanwhile, $8.3bn will be spent on railways linking towns in the mountains to ports on the country’s Pacific coast, and on a new commuter line in the capital, Lima. There will also be money for new airports, telecommunications systems and river management.
Brazil is also spending heavily on infrastructure. One reason is that it too has the combination of challenging geography and rubbish roads, railways, ports and airports. Policymakers there have recognised that a commodity exporting powerhouse like Brazil needs better infrastructure. They also see improved transport as a way to reduce the ‘Custo Brasil’ – the Brazil cost – which makes everything in the country so expensive. Of course the added incentive for Brazil is that it’s hosting the World Cup and Olympics in 2014 and 2016. In total, in partnership with the private sector, the Brazilian government is planning to roll out $470bn of infrastructure projects over the next decade.
Even Mexico, which has invested more heavily in infrastructure than its southern peers, is planning to boost spending. The government is expected to unveil a new infrastructure plan shortly, but early estimates reckon that it will see public and private infrastructure spend increase by about 50% to $70bn per year.
So what’s the best way to earn income from the sector? One of my long-term favourites is steel-maker Ternium (NYSE:TX). It has a major presence throughout the region and yields a decent 3.5%.
Three areas to assess how safe the yield is
Of course just because a firm is offering an attractive yield now doesn’t mean that it will always do so. The dividend is, in effect, a promise from the managers to shareholders. And, as we all know, promises can be broken. While it’s impossible to second-guess management’s actions, investors can at least check a company’s financial ability to pay. Three areas worth looking at are a company’s size, levels of debt and free cash flow (the cash left over from operating activities once certain commitments such as tax have been met). Judged by those three criteria Ecopetrol’s yield looks the safest, followed by Ternium’s, while Cresud’s is the most risky.
But you don’t have to just stick to those companies. With an average dividend yield of more than 3.5% Latin America companies are more generous than companies in Asia (ex Japan) or America. So there is plenty of income to be had in this region.
• This article is taken from The New World, MoneyWeek’s FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.