Itaú BBA - Slowdown in consumption, investment better

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Slowdown in consumption, investment better

May 28, 2013

After a strong beginning of the year, many consumer good and service segments registered a deceleration in April and May.

With information through May 26, 2013

This report, published six times per year, summarizes anecdotal information on current economic conditions received from key business contacts, economists, market experts, and other sources outside Itaú. Apart from the “our view” section, it is not a commentary on the views of Itaú’s Macroeconomic Research team.

Contents

Consumption and Production of Goods and Services
After a strong beginning of the year, many consumer good and service segments registered a deceleration in April and May.

Investment
Investment is recovering. The speed and purpose of expenditures, however, differ across sectors.

Real Estate
The real estate sector continues to focus on reducing inventories. However, the gradual recovery in some regions suggests a greater number of launches in 2013.

Commodities
The agricultural sector has been posting good performance due to the record harvest this year. The outlook for the Steel and Mining sectors, on the other hand, is more challenging.

Labor Market, Production Costs and Prices
Higher production costs are still a significant cause of concern for most sectors. The labor market continues to be perceived as tight in many sectors, with few exceptions.

Our View
We believe the economy will continue to expand moderately throughout the rest of the year, but at a slower rate than in the first quarter.


Summary

After a strong beginning of the year, many consumer good and service segments registered a deceleration in April and May. Most retailers note increased consumer caution. In the vehicle sector, the solid pace of the beginning of the year has been sustained.

Investmentis recovering. The speed and purpose of expenditures, however, differ across sectors. One group (infrastructure- or agriculture-related sectors) is investing more heavily in production capacity expansion, while the other is gradually increasing investments to improve the already-installed capacity. In general, business confidence remains subdued.

The real estate sector continues to focus on reducing inventories. However, the gradual recovery in some regions suggests a greater number of launches in 2013, relative to the low level reported in 2012.

The agricultural sector has been posting good performance due to the record harvest this year. Crop sales have been good despite the logistical constraints and increased freight costs. The outlook for the steel and mining sectors, on the other hand, is more challenging. The still-modest activity and high idleness in local production reduce the investment prospects.

The higher production costs continue to be a significant cause for concern in almost all sectors, as rent and labor costs rise.

Our view:Although economic activity accelerated in the first quarter, the recovery is still not disseminated i.e., there may not be enough strength to sustain first quarter growth pace going forward. We believe the economy will continue to expand moderately throughout the rest of the year, but at a slower rate than in the first quarter.

Consumption and Production of Goods and Services

After a strong beginning of the year, many consumer good and service segments registered a deceleration in April and May; among them, supermarkets, textiles, personal accessories and restaurants. Some durable consumer goods producers report lower retail orders, while retailers have noticed a relative increase in inventories. The slower sales growth affects products targeted at all income classes. Among the regions, the deceleration seems clearer in the South and Southeast.

Retailers note increased consumer caution. Greater leverage (and its effects) and the recent increase in inflation are among the reasons cited for the recent consumer prudence. Although the hike in interest rates has yet to be felt by consumers, it is nevertheless a reason for concern during the second half of the year.

Despite the exchange-rate devaluation in 2012, many consumption segments continue to face import competition. Although more expensive, many imported products are either still cheaper (e.g. tires, clothing) or offer better quality than their domestic counterparts, which ensures a decent market share for such products.

The recent deceleration also hurt the service sector. Given its labor-intensive nature, the sector continues to suffer cost pressures. However, the pass-through to consumer prices has not been as trivial as in previous years. Segments such as restaurants, hotels, educational courses, IT and third-party labor providers have been working with narrower margins or lower demand. Notwithstanding the loss of momentum, the sector’s activity level can still be characterized as heated.

Meanwhile, the vehicle sector has sustained the solid pace registered at the beginning of the year. The extension of the IPI tax reduction and the gradual credit expansion have supported the high, albeit relatively volatile, sales level. The motorcycle segment finally started to react after a long downturn, but the sustainability of the recovery is still uncertain. The acceleration in the sector is also reflected in orders from suppliers. Auto-part producers posted strong sales up to April, though some slowdown was reported in May.

Investment

Business confidence reversed part of the improvement trend seen earlier in the year. Our business confidence indicator, which is based on a broad client survey, retreated in April and May, and returned to near the level reported at the beginning of the year. Higher production costs, inflation and tax volatility (which generate adjustment costs and future uncertainty) are among the current concerns. There is also the perception that the recovery is still excessively dependent on government stimulus.

Despite the subdued confidence levels, investment is recovering. The speed and purpose of expenditures, however, differ across sectors.

The first group of sectors is stepping up investments in an attempt to expand production capacity. Among these are the agribusiness-related sectors that benefited from the recent record crop and the infrastructure-works-related sectors, influenced by the upcoming FIFA World Cup™ and the election year (2014). In this first group are sectors such as heavy vehicles (trucks and agricultural machinery), fertilizers and construction inputs.

The second group, which represents a more diverse range of sectors, has been investing more cautiously and focusing on improving the already-installed capacity. The focus has been on the operation – to improve productivity and lower costs – rather than growth. In some cases, investment in a new plant (e.g., more modern, better location) is aimed at replacing an older plant.

Companies in general are also reporting greater investments in machinery and equipment in order to address the shortage of manpower. All in all, the perception for most sectors is that the acceleration in aggregate investment in the first quarter will continue throughout the year, but at lower rates.

Real Estate

Real estate builders and developers remain focused on inventory reduction. The gradual activity recovery in the sector, however, suggests a greater number of releases in 2013, relative to the low level reported in 2012.

The sector's performance differs among the country’s regions. On the one hand, companies in Salvador, Curitiba, Brasília and Manaus continue to report high inventories and low demand and production. On the other hand, São Paulo and Rio de Janeiro post good sales in most real estate projects. Small property sales (around 50 m²) have been notable, partly reflecting the lower interest rate stimulus for real estate investment.

Despite the still-moderate and heterogeneous recovery in new launches this year, the accelerated pace of production and sales in the past few years (particularly 2011) continues to generate a positive impact for sector suppliers. The finishing materials segment, for example, continues to experience strong demand, especially in the North and Northeast regions.

Companies that operate in the low-income segment, both builders and input suppliers, continue to benefit from the effects of the Minha Casa Minha Vida housing program.

Commodities

Most segments connected with the agricultural sector have been posting good performances as a result of the year’s record harvest. Crop sales have been good despite the logistical constraints and increased freight costs caused by the new labor regulation for truck drivers. Exports benefit from ports operating 24 hours per day.

Temperature and rainfall remained favorable for the second corn crop, and productivity was high in most regions, with the exception of the North and Northeast regions affected by drought.

Well-capitalized producers delayed their crop sales in anticipation of more favorable prices. However, some prices, including sugar and coffee, have fallen as a result of the high supply (in Brazil and the world) and storage issues. Lower prices affect the profit outlook and reduce the appetite for investment, which may be a risk for future harvests (particularly from 2015 onward).

The good agricultural production has boosted demand for fertilizers and pesticides, while the increase in sales has been supplied by imports, which grew close to 50% between April and May, compared with last year. Local production, on the other hand, is lower than in 2012.

The outlook for the steel and mining sector is more challenging. Protective measures against imports, including a weaker exchange-rate and local-content requirements, and the acceleration in automobile production benefit the steel industry. Meanwhile, external demand is moderating, particularly due to the lower growth in China, and the sustainability of the domestic recovery remains uncertain. The modest activity in both mining and steel, coupled with the relatively high idleness in local production, reduce the sector’s investment prospects.

Labor Market, Production Costs and Prices

Higher production costs are still a significant cause of concern for most sectors. Rent and labor costs continue to rise, while energy costs decreased due to recent tax cuts, albeit at a lower-than-expected magnitude. The partial replacement of the payroll tax by revenue benefited many sectors, but also burdened other less labor-intensive ones. The persistent tax changes in recent years, which have increased the need for management professionals such as lawyers and accountants, have also pressured costs.

The labor market continues to be perceived as tight in many sectors, with few exceptions. Wages have been adjusted above inflation, although the real gains are lower than in previous years.

And, while there are no signs of layoffs, the willingness to hire or accept wage increases above inflation is waning. Many prefer to reduce production or, in the case of very labor-intensive sectors, abandon their expansion plans.

Investments in training and automation are accelerating. The search for private labor sources, such as foreigners and former convicts, has been proving to be a good strategy. However, the bureaucratic issues involved in hiring foreign professionals are often cited.

Our View

Economic growth in Brazil accelerated in the first quarter, driven by investment on the demand side and by the agricultural sector on the supply side. However, we continue to see growth not disseminated; i.e., there is insufficient strength to sustain the first quarter growth pace going forward. In fact, the expansion in the first three months of the year was probably heavily dependent on agriculture, which is expected to slow in the coming quarters. The indicators for the second quarter already suggest a moderation in economic growth.

We believe the economy will continue to expand throughout the rest of the year, but at a slower rate than that observed in the first quarter.



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