How to profit from Brazil’s infrastructure splurge

It's all gone wrong for the Brics.

Brazil, Russia, India and China were meant to dominate the global economy in the near future. As it stands, Russia remains hopelessly dependent on oil, India can't get its act together at all, and China is suffering a hard landing.

As for Brazil, falling commodity prices (a knock-on impact of China's landing) are likely to hit growth this year. The country is also suffering a major credit bubble. My colleague Merryn Somerset Webb thinks that property in Brazil is overdue a fall.

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But while we're bearish on the market overall, there are still some pockets of opportunity in Brazil here's why

Brazil's transport networks are in dire need of an upgrade

To say that Brazil has completely neglected its infrastructure would be unfair. The nation unlike Venezuela, for example has used at least some of the money from the commodities boom to upgrade its roads, ports and rail.

Trouble is, it hasn't spent anywhere near enough.

Brazil's roads are dire. Over 85% of them are unpaved. In fact, out of 142 countries around the world, Brazil comes 118th when it comes to the quality of its road network, reckons the World Economic Forum. That's worse than is worse than Yemen, Burundi, or Bangladesh.

As for the air transport system, it comes in at 122. And the ports do even worse. They are among the worst in the world, languishing in 130th place.

This is a serious handicap. Brazil relies on commodity exports. But it's a massive country. Just to get its commodities from where they're initially dug up or harvested to a port may involve a journey of hundreds or even thousands of miles.

Better infrastructure could cut both the time and the cost of getting to market. It could also enable the development of projects that were previously thought of as too remote. All of this would go some way to offsetting the impact of lower prices.

The Brazilian government is starting to wake up to the problem. As The Economist reports, it is trying to cut regulations that slow down or stop projects. More importantly for the short term, it is starting to give both direct and indirect help to the sector. Tax-free infrastructure bonds, which will cut funding costs, are starting to be issued. The country also plans to spend 1% of GDP a year on upgrading transport networks, up until at least 2014.

But the biggest impact may come from Brazil's newly-announced $66bn stimulus programme. Past measures focused on getting consumers to buy more goods. However, with credit at dangerously high levels, the government has changed tack.

Instead, it plans to focus on investment, aiming to build 8,000 km of new roads and the same distance of railways. Although supported by the government, these will be run and operated by private firms. The long-term aim is to make them self-sufficient through tolls and charges.

$66bn may not be enough

This all looks impressive. However, it could be just the tip of the iceberg.

Two years ago, Morgan Stanley predicted that Brazil would need to increase investment from 2% to 4% of GDP it wanted to maintain its strong growth. However, even at this rate it would take two decades to catch up with Chile. More ambitious targets will need a bigger increase. To catch up with South Korea, it would have need to invest 6-8% of GDP.

This may seem over the top. But in the 1970s, spending on infrastructure was as high as 5.4% of GDP. Indeed, the current level of 2% of GDP is the lowest it has ever been.

And of course, as well as investment in energy and transport, the World Cup in 2014 and the 2016 Olympics will also be good news for companies working on Brazilian infrastructure. All those new stadiums and facilities will require cash to build, and they'll almost certainly cost more than anyone plans.

Indeed, Oxford academics Bent Flyvbjerg and Allison Stewart have found that from 1968 onwards, the average Olympic Games went over budget by 179% in real terms. Given that Brazil will have to build many facilities from scratch, its over-spending may be even higher.

That's bad news for Brazilian taxpayers. But it means more profits for the construction sector and anyone invested in it.

How to invest in Brazil's building boom

It's a pain in the neck for a British investor to buy stock listed on Brazil's market. To do so, you'll have to register with a broker in Brazil and complete various bits of paperwork.

The good news is you don't have to. You could instead look at an exchange-traded fund. One US-listed fund focuses specifically on infrastructure (with stakes in transport, infrastructure and utility companies) and pays a decent dividend yield.

Alternatively you could invest in power company CPFL Energia SA (NYSE: CPL). All those new railways, ports and airports will need electricity. While it trades on 12.2x earnings, it has a high dividend yield of 5.5%.

A third option is to buy the shares of firms doing business in Brazil. The US design and engineering firm AECOM (NYSE: ACM) is taking full advantage of the Brazilian infrastructure boom. It has already used its role in London 2012 to get a major contract to help with Rio 2016. Trading at a price/earnings ratio of 8.7, it looks good value.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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