Postcard
- High interest rates and uncertainty over the government’s tax and spending plans have created a challenging backdrop for Brazilian companies.
- But as I saw on a research trip to my home country, some businesses are using adversity to catalyse innovation, strengthening their business models through operational efficiencies and digitisation.
Ninety One Sustainable Equity team
Eduardo Gomes, Research Analyst
The past year has been testing for companies in Brazil, where higher-for-longer interest rates and fiscal uncertainty have weighed on sentiment. But on a recent research trip back to my home country, I saw how some Brazilian businesses are using these headwinds to catalyse innovation. The industry leaders I visited have doubled down on operational efficiencies and digitisation to build more resilient business models.
Their response to external challenges underscores why we think emerging markets require an investment approach tailored to their distinctive character – specifically, one designed to capture the structural advantages these economies have vs. the developed world, while leaning into businesses best able to withstand cyclical challenges1.
Structural growth in EMs
With the US equity market appearing priced for perfection, this is an interesting time to consider emerging markets. The price-earnings ratio on the national stock index, the BOVESPA, is just 8x, vs. 27x for the S&P 500 Index2.
We see significant structural growth potential for leading companies that are leveraged to emerging markets’ economic transformation, and in our view some quality EM businesses are now trading at a steep discount. But Brazil’s recent cyclical headwinds show why focusing on companies with durable competitive advantages is important for those seeking to access this growth opportunity.
On site with WEG
Source: Ninety One.
Meeting WEG
One quality Brazilian business that we believe has long-term growth potential is WEG3, which I visited on my research trip. A leading manufacturer of electrical equipment in Latin America, the company is benefiting from structural tailwinds linked to decarbonisation.
WEG is a sizeable player in low-voltage industrial motors, gaining market share by offering high-efficiency products. It also supplies critical grid infrastructure in the Americas – a business that is growing due to supply constraints and rising electrification – and is well positioned in its domestic market across solar, wind, transmission, distribution and electric mobility.
The value of vertical integration
Through vertical integration – i.e., owning multiple stages in a supply or production chain – WEG is optimising costs and enabling rapid customisation, helping it sustain market leadership. This is increasingly critical as global competition intensifies, yet we believe the advantage WEG gains from these efforts is underappreciated by the equity market.
Despite the challenging macro backdrop in Brazil, in September 2024 WEG announced a five-year US$115 million additional investment in the vertical integration of its transformer and electric motor businesses. Projects involve the expansion of factories, acquisition of machinery and plant modernisation.
At WEG’s site in Jaragua do Sul in southeastern Brazil, I saw how the company’s vertical integration works in practice. The industrial complex occupies a huge site, equivalent to 140 football pitches, where it manufactures virtually every component of a low-voltage motor. Few competitors can do the same.
By bringing everything in-house, WEG can achieve higher levels of product customisation than its peers – at Jaragua do Sul, it employs almost 500 people on machines for bespoke production. It can also innovate faster to meet customer needs, as decision-making is more streamlined. During the COVID-19 pandemic, the company’s vertical integration was particularly advantageous, minimising production disruptions and helping WEG win new business as competitors failed to deliver.
The benefits of its approach are being felt on the bottom line. WEG’s revenues grew by 31% annually during 2020-2022, with its return on invested capital reaching the high ‘20s’ in percentage terms. The average ROIC of the Bovespa was about one-third that level in the same period. Following its success in Brazil, WEG is looking to replicate its vertical integration strategy in other key markets, including Mexico and China.
On site with WEG
Source: Ninety One.
On-the-ground observations
On site, you get a strong sense of the company’s culture, which emphasises return generation. Key performance indicators for cost savings and profitability are shown to all employees, and I observed that workers at all levels feel individual accountability for these metrics. In fact, WEG uses them to determine compensation for all workers, not just senior management.
WEG’s approach to recycling steel is testament to its cost-conscious culture. Excess steel in the production of motors is melted on site and used to produce different parts of the motor, delivering cost reductions and a more sustainable manufacturing model.
WEG also made a point of showcasing internal promotions and development opportunities for employees. Internal promotions are the most common way roles are filled in the company and have been a key driver of employee longevity in the business, many of whom started as interns and have worked their way up. Every CEO since the founders has risen through the company in this way, from intern all the way to the top of the management team.
While we have long believed in WEG’s business model and competitive advantages, the combination of these attributes with a remarkable culture has strengthened my conviction in the company’s prospects. In more challenging environments, like the present, it helps make WEG more resilient. Just as importantly, it enables the business to better align itself with the long-term growth opportunity as the structure of the Brazilian economy continues to evolve.
And thanks to the investments WEG is making now, we expect the company to be even further ahead of its competitors when the macro backdrop in Brazil turns positive again.
1 For further information on investment process, please see the Important information section.
2For further information on indices, please see the Important information section.
3Stock selected as an example of a company visited during a research trip that showed characteristics of investing to improve resilience.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Emerging markets (including China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic, or other systems. Sustainable Strategies: Sustainable, impact or other sustainability-focused portfolios consider specific factors related to their strategies in assessing and selecting investments. As a result, they will exclude certain industries and companies that do not meet their criteria. This may result in their portfolios being substantially different from broader benchmarks or investment universes, which could in turn result in relative investment performance deviating significantly from the performance of the broader market.
