Itaú BBA - Moderate activity, focus on efficiency gains

OrangeBook

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Moderate activity, focus on efficiency gains

abril 24, 2014

The divergence in trends between the durable and non-durable consumer goods sectors has continued in recent months

With information through April 23, 2014

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                                    
The divergence in trends between the durable and non-durable consumer goods sectors has continued in recent months.  

Investment                                                                                              
Business confidence remains subdued. The focus is on efficiency gains.                                               

Real estate                                                                                             
The residential real estate sector is reporting a sales pace that is largely seen as good. In the commercial segment, however, there is less optimism.

Commodities
Hot and dry weather has affected Brazilian agricultural production.

Labor market, production costs and prices                                                 
Labor costs still worry several sectors of the economy.
                                                                                                                                                           
Our view
We maintain our expectation of moderate activity this year.


Summary:

The divergence in trends between the durable and non-durable consumer goods sectors has continued in recent months. While durable consumer goods have seen a sharp slowdown, the pace of non-durable goods has remained relatively strong, albeit weaker than last year.

For the services sector as a whole, the slowdown observed throughout 2013 has continued into this year. However, the pace of growth seems to be stabilizing, supported by the labor market. Services related to the FIFA World Cup are reporting an acceleration, as expected.

On the investment side, business confidence remains subdued. 2014 is still seen as a year of global and domestic uncertainties, which is leading companies to postpone large-scale investment decisions. In general, throughout the country’s sectors and regions, managers have been increasingly focused on higher efficiency in cost management and the allocation of available resources.

The residential real estate sector is reporting a sales pace that is largely seen as good, depending on project location and characteristics. In the commercial segment, however, there is less optimism. In some regions, especially the South and Southeast, the oversupply is worrisome.

Hot and dry weather has affected Brazilian agricultural production. The grain crop is still considered good, but it has been short of initial expectations. Prices have been reacting to lower supply. The bright spot is the sizable increase in coffee prices, which has been livening up the sector. The acceleration in food inflation has had a negative side effect in the sugar and ethanol industry, as it is reducing the probability of hikes in gasoline prices in the short term.

Labor costs still worry several sectors of the economy. Some sectors indicate that it has become a bit easier to hire, but wages remain under pressure. Other rising costs, such as food and transportation expenses, and the possibility of upward readjustments in electricity and fuel prices add to the concern. Thus, inflationary pressures in the economy are persisting, even the restrictive demand is restraining the ability to pass through increases.

Our view: The economy grew more than we expected in the first two months of the year. However, there are signs of undesired inventory accumulation, and business confidence indicators remains low. Thus, we maintain our expectation of moderate activity this year. In structural terms, we still see infrastructure and productivity bottlenecks weighing down the potential of the Brazilian economy.

Consumption and Production of Goods and Services

The divergence in trends between the durable and non-durable consumer goods sectors has continued in recent months. While durable consumer goods have seen a sharp slowdown, the pace of non-durable goods has remained relatively strong, albeit weaker than last year. Some durable goods segments posted a pick-up in production and sales during the first quarter, but this movement is not perceived as sustainable.

Producers of durable consumer goods continue to report high inventories at retailers and increasingly restrictive demand. Interest rate hikes, higher prices, higher income commitments and fears of a slowdown in the labor market are among the factors that, for those sectors, justify the more cautious demand. The recent exchange rate appreciation would appear to be a positive factor, but the perception in many segments is that this movement will be temporary. Sales of durable goods connected to the World Cup (especially televisions) have not yet taken off.

The auto industry continues to face a particularly challenging scenario. Automakers report high inventories, and industry suppliers (parts, tires) are posting practically stagnant production and orders. The still-reduced IPI tax rate is no longer perceived by the industry as a stimulus, so its extension does not promise to be a catalyst for improvement in the second half of the year.

Producers of semi-durable and non-durable consumer goods – items such as cleaning products, medication and food – are reporting stronger activity, though activity remains lower than in 2013. Supermarkets have posted solid sales numbers, especially in regions where temperatures remain high. Segments related to education (stationery, bookshops, publishers) reported a strong start to the school year, although the changes in the calendar due to the World Cup affected planning. The still-heated labor market and the reduction in durable goods spending remain the main determinants of sales for non-durable goods segments in general. The hike in food inflation, which reduces real disposable income, is a further concern in some sectors.

In the services sector as a whole, the slowdown observed throughout 2013 has continued. However, the pace of growth seems to be stabilizing, supported by the labor market. Services related to the World Cup (hotels, tourism operators, event production, media and executive transportation) are reporting an acceleration, as expected. The FIES program (a government student-loan initiative) is boosting some segments in the education sector.

Investment

Business confidence remains subdued, with additional decreases in the margin. Our indicator, which is based on a broad client survey, retreated again in April, maintaining the downward trend of recent months. The current level is about 10% below the average for the fourth quarter of 2013 and significantly below the levels posted between 2010 and 2011.

Infrastructure concessions – and greater recognition of the need to relieve supply bottlenecks – continue to provide some grounds for optimism for the construction industry and producers of machinery and equipment. In contrast, the World Cup and specific government programs (to finance machinery and equipment for municipalities) are gradually ceasing to support demand. The recent appreciation of the BRL is worrisome, although, as with sectors related to consumption, the perception is that this movement will be temporary.

Despite the lower volatility of the financial markets, 2014 is still seen as likely to be a year of global and domestic uncertainties, which is leading to the postponement of large-scale investment decisions. The assessment that macroeconomic adjustments will have to be made ​​in 2015 (interest rates, taxes, administered prices) is reinforcing this caution and holding down demand for investment. Supply-side factors, such as high production costs (labor, transportation, rent, land) and tax complexity, also discourage entrepreneurs from expanding productive capacity. Construction companies report weak production of warehouses and logistics centers this year.

In general, throughout the country’s sectors and regions, managers have been increasingly focused on increasing efficiency in cost management and the allocation of available resources.

As highlighted in our previous Orange Book, despite the cautious mood, there is still interest in investing in the country. The size of the consumer market and the country’s commodities-production potential make Brazil structurally attractive. The infrastructure projects offered by the government through the concessions program have return potential and are helping to tighten production bottlenecks.

In the heavy vehicle industry – trucks and agricultural machinery – production improved at the beginning of this year, but sales have lagged behind. Thus, the industry expects a correction in production in the coming months. The sector is experiencing a decline in demand following the changes in the credit conditions of the investment support program (PSI) funded by BNDES. A lack of skilled labor (drivers) is another factor restraining demand. In contrast, sales for the agricultural sector have been sustaining the industry.

Real Estate

The residential real estate sector is reporting a sales pace that is largely seen as good, depending on project location and characteristics. The more restrictive demand reflects higher prices and rising interest rates, which affect not only credit conditions but also the opportunity cost of acquiring a real estate property. Still, sector participants believe that this year will be better than 2013.

In the commercial segment, however, there is less optimism. In some regions, especially the South and Southeast, the oversupply is worrisome. Vacancy rates are already considered high, and there are launches of both commercial spaces and shopping malls scheduled for the coming months.

In the shopping malls segment, signs are pointing to low investment over the next two to three years. Customer movement in shopping malls is still high, but retailers’ willingness to invest is lower than in recent years.

Commodities

Hot and dry weather has affected Brazilian agricultural production. The grain crop as a whole is still considered good, but it has been short of initial expectations. The soybean and cotton crops will probably be higher than last year, but the corn and coffee crops are likely to be smaller. Prices have been responding to the lower supply. The bright spot is the notable increase in coffee prices, which has been livening up the sector (as many producers still hold inventories from the previous crop).

The acceleration in food inflation has had a negative side effect in the sugar and ethanol industry, as it is reducing the probability of hikes in gasoline prices in the short term. Restricted fuel prices in the domestic market and an oversupply of sugar in the international market have reduced investment incentives. The industry is seeking to diversify by investing in power generation from sugarcane bagasse.

In the steel and mining sectors, the recent FX appreciation is a disturbance. The current exchange rate level is still favorable to exports but does not encourage more tangible investment plans. On the domestic demand side, the first months of the year were heated, but expectations are subdued. The production of durable consumer goods, especially passenger cars and household appliances, will likely be restrained by high inventories and more modest growth in consumer spending.

Labor Market, Production Costs and Prices

Labor costs still worry several sectors of the economy. Some sectors indicate that it has become a bit easier to hire, but wages remain under pressure. Wage negotiations, while tougher than last year, are often resulting in real wage gains.

Other rising costs such as food and transportation expenses, and the possibility of increases in electricity and fuel prices add to the concern. Thus, inflationary pressures in the economy are persisting, even as the restrictive demand is restraining the ability to pass through increases. The recent accommodation of the exchange rate has helped ease these inflationary pressures, although some segments indicate that prices have yet to fully reflect the exchange rate depreciation of the past two years.

In this environment, many sectors are determined to reduce costs by avoiding new hires and automating processes.

Our View

Brazil’s economy grew faster than we expected in the first two months of the year. However, there are signs of excessive accumulation of inventories in industry, and business confidence remains low, indicating that the surprise in production earlier this year was not followed by an improvement of industry fundamentals. On the retail side, interest rate hikes, lower growth in the wage bill and declining consumer confidence point to moderate growth in sales ahead. Thus, we maintain our expectation of moderate activity this year.

In structural terms, we still see infrastructure and productivity bottlenecks weighing down the potential of the Brazilian economy. The acceleration of concessions to the private sector may help, although the impact will likely be felt more clearly from 2015 onwards.



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