By Asher Levine
SAO PAULO | Thu Jul 18, 2013 9:37am EDT
(Reuters) – Brazilian homebuilders are trying to convince investors they are set to rebound from a long period of disappointing results, but it may be too early to bet on a comeback as the nation’s economy takes a turn for the worse.
Builders such as Gafisa SA (GFSA3.SA), PDG Realty SA (PDGR3.SA), Brookfield Incorporações SA (BISA3.SA) and MRV Engenharia SA (MRVE3.SA) have struggled with losses over the past two years despite favorable economic conditions for homebuyers. Results have suffered from poorly managed expansion plans that led to project delays, higher sales cancellations and hefty cost overruns.
Most homebuilders’ shares are now trading below book value, meaning investors perceive them as worth less than the companies’ assets. An index of the stocks .IMOB on Brazil’s Sao Paulo stock exchange is down more than 22 percent for this year alone.
The major homebuilders have taken pains to persuade the market that the worst is over as they cut costs and narrow their focus to major cities. Still, they are about to face another set of challenges as Brazil’s economy shows signs of a deeper and more prolonged slowdown.
“While valuations might seem attractive at this point, we do not expect homebuilders to outperform until the macroeconomic fog lifts,” Citigroup analysts Paola Mello and Dan McGoey wrote in an investor note last week.
Brazil’s high wages, expanded mortgage credit and recent record-low unemployment and interest rates have helped homebuilders to escape the economic forces that have been holding back the country’s manufacturers.
Recent data suggests the outlook may not remain rosy for long, though. Real wages have plateaued, unemployment is no longer hitting record lows every month and job creation has slowed to a trickle, all against the backdrop of mounting inflation pressures and steadily-rising interest rates.
Economists have responded by slashing forecasts for Brazil’s economy, which has been stuck in a rut for the last two years. A central bank poll showed expectations for growth of just 2.31 percent this year, down from a 3.3 percent estimate in early January, with interest rates hitting 9.25 percent by the end of the year.
But perhaps even more troubling for homebuilders is that ordinary Brazilians, not just economists, are beginning to worry more about the future, evidenced by scores of mass street protests throughout the country in recent weeks. Consumer confidence has dropped in eight of the last nine months and fell to its lowest level in more than three years in June.
That begs the question: If builders managed to lose money while the outlook for homebuying was strong, what happens when Brazilians start to think twice about purchasing new homes?
“The consumer’s feeling about their future job prospects, about their salary, are going to have a big impact on their decision to buy,” said economist Claudia Oshiro of Sao Paulo consulting firm Tendencias. “As we are undergoing a very turbulent economic moment, we think there will be a negative effect going forward.”
Demand for homes in Brazil remains robust due to a large shortage, but that does not mean Brazilians will keep up the pace of buying. Low down-payment requirements make backing out of a purchase relatively painless in many cases.
“The moment someone start to feel financially insecure, he won’t give up his plans to buy a home, but he will probably delay those plans,” said João da Rocha Lima Jr., head of real estate studies at the University of Sao Paulo. “That’s when we are going to see the problem of higher cancellations and unsold inventories.”
Homebuilders have already felt some of that impact as sales cancellations soared last quarter, driving Gafisa, PDG and Brookfield to losses.
The second-quarter earnings season for Brazil’s builders kicks off on August 7.
“With a deterioration in macro, this sales cancellation rate could increase,” said analyst Eduardo Silveira of Espirito Santo Investment Bank in Sao Paulo. “This would be a big risk for companies because they are counting on those receivables being turned into cash.”
Making things worse, inflation fears have boosted the likelihood of higher interest rates through this year and next, which would put more pressure on more heavily leveraged builders such as PDG, Brookfield and Gafisa.
One exception, however, may be Cyrela Brazil Realty SA (CYRE3.SA), whose focus on scaling down and generating cash has helped reduced debt to less than 40 percent of shareholder equity.
“(Homebuilders) learned the hard way that scale isn’t better and size doesn’t matter,” Silveira said. “Cyrela for example … has a very strong cushion to face this storm that might be coming. This is a good lesson the companies are learning.”