Toll Roads and Airport Projects As Their Request for Proposal (RFP) Processes Are in a More Advanced Stage
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The Brazilian Infrastructure: It’s “Now or Never” From an Economic Growth Constraint to a Plethora of Opportunities July 29, 2013 It’s “Now or Never.” If Brazil’s infrastructure bottlenecks were concerning before, they have only gotten Research Analysts worse. Over the past ten years, while the Brazilian economy enjoyed prominent growth leveraged by the exhaustion of the model based on credit, consumption, and commodities (the "3 Cs"), transportation Bruno Savaris, CFA infrastructure investments accounted for just ~0.6% of GDP, i.e., less than half of what would be required 55 11 3701.6332 bruno.savaris@credit–suisse.com to sustain annual economic growth of 4.5%. Now that the 3Cs economic model is running out of steam, the Brazilian government has shifted towards addressing concerns about meager economic growth by laying Felipe Vinagre the groundwork to solve one of its biggest problems: the lack of adequate infrastructure. 55 11 3701.6333 felipe.vinagre@credit–suisse.com Mindful Government but Ineffective Alone. While the federal government seems highly committed to delivering on the ~R$240bn investment plan announced in 2H12, the execution challenge cannot be Daniel Magalhaes 55 11 3701.6124 understated, as most projects are still in the analysis stage and execution of public investments has proven daniel.magalhaes@credit–suisse.com inefficient, to say the least. Thus, the private sector has to be involved. Accordingly, the government has implemented several changes to the regulatory framework for ports, railroads, highways, and urban mobility to make the rules sufficiently clear to foster private investments. To put things into perspective, over the past ten years some R$52bn in projects were granted to the private sector. In the next three years, the government wants to auction an investment budget nearly six times larger. As the government targets single–digit headline rates of return, at least a friendly regulatory framework has to be in place. What’s in This Report? In this report, we address the (i) causes and consequences of the lack of reasonable levels of infrastructure investments in the country and (ii) measures being implemented by the government to narrow Brazil's R$1 trillion transportation infrastructure gap to more developed economies. We discuss the idiosyncrasies of each mode of transportation (namely highways, railroads, ports, airports, and urban mobility), evolution of the regulatory framework, and why we think that some of the potential investment opportunities arising in the short–to–medium term have a greater likelihood of coming to fruition. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. 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 consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client–Driven Solutions, Insights, and Access 29 July 2013 Executive Summary (1/2) .Shifting Focus from 3C to Infrastructure Investments… Brazil’s past ten years of prominent macroeconomic fundamentals were built not only on its improved economic predictability but also on the favorable global scenario. The latter, characterized by strong economic growth, mainly in China, led to a period of high demand for commodities. This scenario was essential for the liquidity injection seen in Brazil and consequently for the boost in the domestic consumer market. The economic growth model in place for the past ten years became known as the “credit, consumption and commodities” (3Cs) model. Yet, more recently, the 3Cs started to lack stamina as households became more leveraged and credit availability got stricter. Now, the Brazilian economy is experiencing the unpleasant dichotomy of low economic growth and high inflation. To reverse that, implementing the “Chinese recipe”, i.e. shifting the focus away from consumption to infrastructure, seems appropriate to put Brazil on track to deliver greater growth rates. Underinvestment? Now, US$1 Trillion Gap. The current diagnosis of low economic growth and high inflation is explained by supply–side inefficiencies rather than insufficient demand. According to Boston Consulting Group (BCG), 74%3 of Brazil’s GDP growth over the past decade was due to an expanded workforce and only 26% due to productivity gains. Along with that, Brazil’s underinvestment in overall infrastructure, amounting to a meager ~2% of GDP, made the long–lasting infrastructure bottleneck even more evident. This is half of the investment level needed to sustain economic growth at 4%. To put things into perspective, other emerging economies such as China and India invested ~13% and ~5% of their GDP, respectively. As a consequence, Brazil holds a fairly ineffective infrastructure, ranking1 107 out of 144 countries, well below its fellow BRIC countries. Putting it differently, Brazil has a 16% asset–to–GDP ratio2, namely infrastructure stock, and is an underperformer outlier on a global scale, holding highly depreciated assets. The average infrastructure stock ratio stands at ~70%. In order to tap this gap, US$1 trillion in infrastructure investments would be required, half of which in transportation alone. .What Has Been Wrong? Granting Brownfields but Lagging Behind in Greenfields. Before the 1990s investments relied mostly on public execution given the very unstable macro backdrop and poor regulatory framework. In 1993, the Brazilian Government enacted two laws (8666/93 and 8987/95) that established the general terms for concessions in Brazil between public and private entities. Since then, several assets have been granted to the private sector which essentially overhauled depreciated brownfield assets while the public sector remained in charge of developing greenfield ones. In this context, while we observed improvements in the granted brownfields, Brazil lagged behind in greenfield projects given (i) the government’s inefficient planning and execution and (ii) lack of regulatory support for private investments. The result was: all the Brazilian transportation modes got overly constrained, especially airports, ports and railroads. The airport sector has just started to undergo a privatization process (Feb-2012), and its dependence on public administration for a long time might explain its deterioration. The other two modes (ports and railroads) didn’t have a robust regulatory framework, especially for greenfield projects. .It’s “Now or Never”! Calling for Private Investments. It would be unfair to say that the Brazilian government isn’t mindful of the urgency of further infrastructure investments. After attempting to fix the economy through micro–policies, it has shown a more pro-market stance towards long–term investments, i.e. infrastructure. In our view, an ultimate improvement in Brazil’s infrastructure won’t come through greater public investments in the sector but rather by promoting a friendlier environment to private investments. (1) World Economic Forum ranking / (2) Mckinsey Study / (3) Productivity gains in China, India and Mexico accounted for 93%, 88% and 60% of GDP growth over the last 10 years / (4) PPP: Public-Private Partnerships 2 29 July 2013 Executive Summary (2/2) . Improving Regulation, and More. In order to attract private players, the government has been laying the groundwork to foster private investments in the country by (i) straightening the regulatory frameworks, (ii) tackling the limited availability of private funding, and (iii) streamlining the licensing process. To mention a few developments, we note the: – New Ports Law, which eliminates restrictions imposed on the development of greenfield private ports. Now, they can handle 100% of third–party cargo, directly competing against concession holders (within public ports); – New Railroad Model, the so-called “Open Access”, which should stimulate (i) competition between rolling stock operators and (ii) the development of greenfield stretches; – Updates on the Law for Public-Private Partnerships, which is key for urban mobility projects. Essentially, it brings more flexibility to government payments which now can happen also during construction phases. A Sizeable Pipeline of Identified Projects. Out of the R$1trillion investment gap in the Brazilian transportation infrastructure, we have identified ~R$334bn in potential private investment opportunities. We think that Brazil’s infrastructure gap now has a greater likelihood of being eventually narrowed given the government’s strong focus (ever) on (i) boosting investments in the sector and (ii) improving the regulatory framework for further private participation. What about Short–Term Opportunities? While there is a plethora of interesting projects, the execution challenge cannot be understated as (i) some projects are still in the feasibility analysis stage and (ii) the process for obtaining environmental licenses remains cumbersome. As such, our base case is that R$109bn (1/3) has significant chances of being auctioned in the next two years. Within this estimate, we attribute a greater probability to toll roads and airport projects as their request for proposal (RFP) processes are in a more advanced stage. For ports and railroads, although these projects account for 46% of the total identified opportunities, we attribute a lower probability for