Download Brazil Infrastructure Paving the Way

May 5, 2010
MORGAN STANLEY BLUE PAPER
MORGAN STANLEY RESEARCH
GLOBAL
Economics
1
Marcelo Carvalho 
+55 11 3048-6272
1
Giuliana Pardelli 
+55 11 3048-6195
Strategy
2
Guilherme Paiva, CFA 
+1 (212) -761-8295
Equities
1
Subhojit Daripa, CFA 
+55 11 3048 6112
2
Carlos De Alba 
+1 (212) 761 4927
2
Javier Martinez de Olcoz Cerdan 
+1 (212) 761 4542
1
Brazil Infrastructure
Paving the Way
Nicolai Sebrell, CFA 
+55 11 3048 6133
1
2
Morgan Stanley C.T.V.M. S.A.+
Morgan Stanley & Co. Incorporated
Emerging economies have shown remarkable, resilient growth in recent years.
Indeed, Morgan Stanley expects strong secular forces to continue driving outperformance
in emerging vs. developed economies for some time to come.
For Brazil, low infrastructure investment could become the bottleneck to growth.
Other necessary steps include improving the business environment, rethinking fiscal
spending priorities, reforming the tax burden, and improving the current fiscal framework.
Brazil must double its infrastructure investment rate to live up to the expectations for
a BRIC member. Overall investment-to-GDP ratio averaged 17% in the past 5 years, vs.
China’s 44%, India’s 38%, and Russia’s 24%. To grow at 5% per year in the next decade,
infrastructure investment must double from the 2.1% of GDP average in recent years.
We believe Brazil will rise to the occasion and, over time, achieve our base case of
infrastructure spending at 4% of GDP. Scheduled projects include: 2014 World Cup, 2016
Olympics, pre-salt oil reserves, and government-backed Growth Acceleration Program.
We highlight two ways for investors to participate in infrastructure investment: 1)
our analysts’ top 10 picks (Cosan, Cosan Ltd., OSX, Lupatech, Gerdau, Usiminas, CCR,
ALL, Tractebel, CPFL) and 2) a basket of 20 related plays (bbg ticker: <MSBZINFR>).
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MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Table of Contents
Executive Summary ................................................................................................................................................................
3
Brazil Infrastructure: Paving the Way ......................................................................................................................................
5
Equity Investment Implications................................................................................................................................................
7
Infrastructure Investment Requirements .................................................................................................................................
10
Prospective Infrastructure Investment by Sector.....................................................................................................................
11
Challenges to Increased Infrastructure Investment .................................................................................................................
13
Current Situation: Not Good for Brazil’s Competitiveness .......................................................................................................
16
Macroeconomic Implications ...................................................................................................................................................
19
Equity Section
Agribusiness: An Infrastructure Play Via Rumo (Cosan SA, Cosan Ltd.).........................................................................
25
Basic Materials: Steel Is Our Favorite Way to Play Infrastructure in Brazil; Limited Benefits to Mining or Pulp & Paper
(Gerdau, Usiminas) ..........................................................................................................................................................
28
Oil, Gas & Petrochemicals: Pre-Salt and Local Content Boosting Local Development (OSX, Lupatech) ........................
33
Transportation Infrastructure: Highways and Rail: CCR and ALL Benefit from Accelerating Infrastructure Investment
(ALL, CCR) ......................................................................................................................................................................
37
Utilities/Electric and Water: In Support of Economic Growth (Tractebel, CPFL) ..............................................................
41
Appendix I: Infrastructure Across Sectors in Brazil .................................................................................................................
46
Appendix II: The Growth Acceleration Program (PAC)............................................................................................................
54
Appendix III: The 2014 World Cup and 2016 Olympic Games ................................................................................................
58
Appendix IV: Morgan Stanley Brazil Infrastructure Basket Constituents (Bloomberg ticker: <MSBZINFR>)...........................
60
Appendix V: Companies Leveraged to Infrastructure Investment ...........................................................................................
61
Morgan Stanley is acting as financial advisor to Braskem S.A. ("Braskem") in relation to the consolidation of the petrochemical interests held by
Odebrecht S.A ("ODB"), Odebrecht Servicos e Participacoes S.A. ("OSP" and, jointly with ODB, "Odebrecht"), Petroleo Brasileiro S.A. - Petrobras
("PTB") and Petrobras Quimica S.A. - Petroquisa ("Petroquisa" and, jointly with PTB, "Petrobras") as well as the acquisition by Braskem of the
interest held by Uniao de Industrias Petroquimicas S.A. ("Unipar") in Quattor Participações S.A., Unipar Comercial e Distribuidora S.A. and
Polibutenos S.A. Indústrias Químicas, as announced on January 22nd, 2010. The proposed consolidation and acquisitions are subject to approval
by Braskem's shareholders and other closing conditions, including anti-trust approvals. This report and the information provided herein is not
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including transaction fees that are subject to the consummation of the proposed transaction. Please refer to the notes at the end of this report.
2
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Executive Summary
Morgan Stanley & Co. Incorporated
Guilherme Paiva, CFA
[email protected]
Infrastructure spending in Brazil has been in a declining
trend over the past 40 years, averaging 5.4% of GDP during
the 1970s, 3.6% in the 1980s, 2.3% in the 1990s, and 2.1% in
the 2000s. Some studies suggest infrastructure investment of
2.0% of GDP is needed simply to sustain the current
infrastructure stock in Brazil.
For Brazil to grow at 5% per year over the next decade,
we think it must double its current infrastructure
investment rate to 4% of GDP. Brazil's overall investmentto-GDP ratio has averaged only 17% over the past 5 years,
well below the levels of China (44%), India (38%), and Russia
(24%) — the other BRIC economies — during the same
period.

Brazil must invest 4% of GDP (doubling its current
investment) for 20 years to catch up with Chile, the benchmark
in Latin America, according to our estimates.

To catch up with South Korea — the benchmark in Asia —
Brazil would need to invest 6–8% of GDP per year.
Our economist, Marcelo Carvalho, believes that Brazil will
rise to the occasion and, over time, achieve our base case
of infrastructure spending at 4% of GDP. There are four key
known drivers of higher infrastructure spending in the near
future: the 2014 World Cup, the 2016 Olympics, the
development of the pre-salt oil reserves, and the governmentsponsored Growth Acceleration Program (PAC).
Our equity analysts have selected the best companies
from five industries in Brazil to gain exposure to rising
infrastructure investment:

Agribusiness: Cosan (CSAN3.SA) and Cosan Ltd. (CZZ.N)

Oil services: OSX (OSXB3.SA) and Lupatech (LUPA3.SA)

Steel: Gerdau (GGB) and Usiminas (USIM5.SA)

Transportation: CCR (CCRO3.SA) and ALL (ALLL11.SA)

Utilities: Tractebel (TBLE3.SA) and CPFL (CPFE3.SA)
Investors can also gain exposure to the theme through our
Brazil Infrastructure basket 1 (Bloomberg ticker <MSBZINFR>;
1
The information contained herein has been prepared solely for informational purposes and
is not a solicitation of any offer to buy or sell any security or other financial instrument or to
participate in any trading strategy. Products and trades of this type may not be appropriate
for each investor. Please consult with your legal and tax advisors before making any
investment decision. Please contact your Morgan Stanley sales representative for more
details.
see Appendix IV for basket constituents). Finally, a broader list
of 42 Brazilian companies with direct or indirect leverage to
rising infrastructure investment can be found in Appendix V.
The Brazilian National Development Bank (BNDES)
estimates infrastructure investment could be R$274 billion
in 2010–13, or 37% higher than the R$199 billion disbursed in
2005–08. The figure is the result of a recent mapping of
infrastructure projects by sector planned for the current and the
next few years.

Electricity (R$92 billion, or 34% of expected spending):
new mega-hydroelectric plants such as Jirau, Santo Antonio,
and Belo Monte; upgrades of the Angra III nuclear plant; and
more than 70 new wind power projects.

Railways and Sanitation (R$69 billion, or 25%): in
railways, the construction of new lines and the expansion of
the current network (Transnordestina, Norte-Sul and
Ferronorte-Rondonopolis), besides plans to build a high-speed
train between Sao Paulo and Rio de Janeiro; in sanitation,
completion of the projects included in the PAC.

Telecommunication (R$67 billion, or 24%): network
expansion, and increase in capacity, including the introduction
of new technologies, should drive investment in the sector. The
main area of expansion will be broadband in both mobile and
fixed line.

Ports, Highways, and Airports (R$47 billion, or 17%): in
ports, the build-up of new facilities and upgrades to existing
ones now managed by the private sector; in highways,
maintenance of the current network and the grant of new
concessions to the private sector; in airports, required
upgrades to help ease congested terminals.
In general, we see the biggest opportunities in areas like
road, railway and port infrastructure. Investment in ports
and railways is already projected to expand an annualized
pace of 24.8% and 12.7%, respectively, even though a low
starting point means that the resulting volume of planned
investments in these sectors would remain relatively limited.
The R$274 billion in infrastructure investments estimated
for 2010–13 corresponds to only 2.2% of GDP — in line
with the average 2.1% of GDP spent in recent years. Over
the past 10 years, the private sector has accounted for almost
90% of total investment in Brazil, while the public sector was
responsible for the other 10%. In infrastructure investment,
however, the private and public sectors have shared the
burden (i.e., 50/50).
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MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Brazil faces four key challenges to greater infrastructure
investment, in our view:

Improving the business environment. Brazil needs a more
stable and credible regulatory environment to spur private
sector investment. The main issues are: 1) regulatory
bottlenecks and political uncertainties, 2) excessive
renegotiations of concessions, and 3) the lack of efficiency of
regulatory agencies.

Rethinking fiscal spending priorities. The government
needs to contain current spending growth and rethink priorities
by 1) addressing budget rigidities, 2) reducing mandatory
earmarking in the budget, and 3) revisiting structural
entitlements (i.e., social security reform).
We see interesting results from a simple analysis of return-onequity and Sharpe ratios (defined here as the average return
on equity divided by their standard error over the past 5 years)
for the 42 companies that we have identified.
For instance, the most profitable segments have been toll
roads (29% average ROE), followed closely by industrials
(28%) and oil services companies (25%). However, oil
services companies have delivered volatile results (1.2 Sharpe
ratio) over the past 5 years. Thus, when we adjust for risk,
utilities (with an average 15% ROE and 2.5 Sharpe ratio) look
more interesting. Meanwhile, the least profitable segments
have been ports (5%), building materials (6%), and
energy/logistics (8%) — all with Sharpe ratios below 0.5.
Exhibit 1
4.0
ROE
Sharpe Ratio (R.H.)
3.0
20%
2.0
10%
1.0
Ports
B. Materials
Energy/Logist.
Logistics
Airlines
Utilities*
Media
Auto parts
0.0
Metals
0%
Oil services*
The key risk could be complacency. Many hope that oil gains
can help finance fiscal needs and fund infrastructure spending
in the coming years; if nothing is done to support and
supplement that, then an infrastructure boom could peter out.
30%
Industrials

Improving the current fiscal framework. Brazil needs to
lay out a clear medium-term fiscal framework to restore
transparency to its fiscal accounts and targets — and to
address directly the quasi-fiscal transactions among public
sector financial entities (i.e., Treasury and BNDES).
Toll Roads, Industrials, and Utilities Have Delivered
the Best Risk-Adjusted ROEs (Sharpe Ratios)
Toll roads

Reforming the tax burden and system. The government
should limit its crowding-out effect and help improve the local
business environment. The government intake is close to 40%
of GDP, while companies spend on average 2,600 hours per
year to prepare, file, and pay their taxes. Both figures are
outliers by international standards.
*Oil services excludes OSX and Utilities excludes Eletrobras.
Source: Company data, Morgan Stanley Research
Finally, from an equity strategy point of view, we highlight
the discrepancy in profitability and growth prospects for
the many companies leveraged to infrastructure investment in
Brazil.
4
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Brazil Infrastructure: Paving the Way
Morgan Stanley C.T.V.M. S.A.+
Marcelo Carvalho
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
Brazil needs to double its infrastructure spending, to
4% of GDP, to sustain faster real GDP growth.
We estimate that infrastructure spending can reach 4%
of GDP over the next decade. Our bull case scenario is a
tripling of current spending, to 6% of GDP; our bear case is
2%, or flat.
Drivers of higher infrastructure spending are not
without risk:
 Known major drivers of infrastructure demand — the
World Cup (2014), Olympics (2016), investment in the presalt oil reserves, and PAC — illustrate prospects for
increased spending.

Less certain is Brazil’s ability to address fiscal
challenges that limit public spending on infrastructure.
Also, changes in the business environment could drive
private sector infrastructure investment.
Brazil’s infrastructure is poor by international standards,
but with large potential for improvement. In a World
Economic Forum survey, Brazil ranked 74th among countries
in infrastructure. In the same survey, it ranked 10th globally in
market size. Most countries with a market size comparable to
or larger than Brazil’s have better infrastructure — the notable
exception being India. We believe this disconnect between
infrastructure and market size illustrates the potential for
significant infrastructure growth in the coming years.
Whether Brazil increases infrastructure spending, and by
how much, will be an important determinant of GDP
growth, we think. The base case scenario we outline here —
less a forecast than a target, as it is over a 10-year horizon —
assumes real GDP growth of 5% per year, above the 4%
pace witnessed in recent years. We would expect Brazil’s
ability to grow GDP faster than the current average to be
jeopardized if infrastructure investment remained low for long,
as the economy could run an increasing risk of serious
constraints in logistics areas like ports and transportation.
To sustain faster growth, Brazil needs to double its annual
investment in infrastructure, to 4% of GDP, we estimate.
To achieve that, the country’s overall investment-to-GDP ratio
would need to increase markedly. There is a significant
correlation between infrastructure investment and overall
investment. Infrastructure investment in Brazil has averaged
2% of GDP in the past decade, while overall investment
averaged 17% of GDP. By contrast, when infrastructure
investment in Brazil was about 5% of GDP a few decades ago,
overall investment was 22% of GDP. If Brazil’s infrastructure
investment is to meaningfully increase, then the overall
investment-to-GDP ratio would likely exceed 20% of GDP.
Exhibit 2
Brazil Infrastructure Scenarios; Our Bear Case Is No
Change from Current Numbers (2011–20 average)
Infrastructure Spending Real GDP Public Debt
Bull
Base
Bear
FX Avg. Interest Rate
% of GDP
R$bn/yr.
%/yr.
% of GDP
R$/US$
Avg.% p.a.
6.0
4.0
2.0
188.6
125.7
62.9
6.0
5.0
4.0
62.9
52.9
42.9
1.56
1.74
1.94
7.7
8.4
9.0
Source: Morgan Stanley LatAm Economics
Known major drivers of demand illustrate prospects for
increased infrastructure spending in our base case… The
World Cup (Brazil is host in 2014), the Olympics (Rio de
Janeiro is host in 2016), increased pre-salt oil exploration, and
the growth acceleration program (PAC) all raise the prospects
for increased investment.
…but infrastructure investment plans fall short without
other drivers of investment, we think. Significant
infrastructure expansion will likely depend on addressing
fiscal challenges. In our view, the administration that
assumes power in 2011 will need to address the following:
1) spending priorities and mandatory earmarking, including
social security, probably the most important challenge facing
Brazil’s fiscal accounts over the long run; 2) the arcane tax
system (Brazil is a glaring outlier in international comparisons
in the amount of time firms are required to spend to comply
with tax rules); and 3) a medium-term fiscal framework that
restores transparency to the fiscal accounts and addresses
the issue of quasi-fiscal transactions through public sector
financial entities.
The task is doable, we think, although the path may prove
non-linear, with relatively limited progress in the near
term before reforms advance and infrastructure investment
picks up.
The key risk could be complacency: Many hope that oil
gains can help finance fiscal needs and fund infrastructure
spending in the coming years; if nothing is done to support
and supplement that, then an infrastructure boom could peter
out.
5
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
The Main Investment Opportunities in Infrastructure
Our Report at a Glance
Infrastructure investment looks likely to represent about
2.2% of GDP per year over the next four years, judging by
a mapping of investment plans by BNDES, the national
development bank. A recent survey 2 from BNDES indicates
that infrastructure investment should increase to R$274 billion
in 2010–13, from R$199 billion in 2005–08. That represents a
total increase of 37%, or annual growth of 6.5%. From these
numbers, we estimate that infrastructure investment in Brazil
would amount to about 2.2% of GDP per year over the next
four years, compared with about 2.0% on average in 2005–08.
Infrastructure investment requirements:
This level of investment is close to the average of recent
years, despite the potential for accelerated infrastructure
spending associated with the World Cup, the Olympics, and
potential future pre-salt oil benefits. Actual investments may
disappoint versus potential upside. However, to achieve
greater GDP growth, we believe Brazil will have to make
greater investments in infrastructure.
We see the biggest opportunities in areas like road,
railway and port infrastructure. Investment in ports and
railways is already projected to expand an annualized pace of
24.8% and 12.7%, respectively, even though a low starting
point means that the resulting volume of planned investments
in these sectors would remain relatively limited.
The bulk of total projected infrastructure investment
would still concentrate in the electricity sector, which is
expected to account for about one-third of total infrastructure
investments during the next four years. Telecommunications
come second, with a large share of 24.5% of the total,
followed by water and sewage with a share of 14.2%.
However, growth in infrastructure spending in
telecommunications is expected to be fairly modest, as it
seems largely related to maintaining structures already in
place.
Exhibit 3
Brazil: Infrastructure Investment Plans (2010–13)
Sectors
Electricity
Telecommunication
Sanitation
Railways
Highways
Ports
Infrastructure
R$ billion
92
67
39
29
33
14
274
% of total
33.6
24.5
14.2
10.6
12.0
5.1
100
% of GDP
per year
0.7%
0.5%
0.3%
0.2%
0.3%
0.1%
2.2%
Source: GT Investimento, APE/BNDES, Morgan Stanley LatAm Economics
2
“Perspectivas de investimento na Infraestrutura 2010-2013” in Visão do Desenvolvimento,
n. 77, BNDES, February 2010 - Gilberto Borça Jr and Pedro Quaresma.

Brazil’s infrastructure investment has slowed to 2.1% of
GDP in recent years, down from 3.6% in the 1980s.

Brazil would need to invest 6–8% of GDP per year to
catch up with South Korea in 20 years…

…and 4% of GDP per year to catch up with Chile.
Prospective infrastructure investment by sector:

Electricity tops the list in terms of total investment and
percentage of GDP.

Ports, starting low, should see most percentage increase.
Challenges to increased infrastructure investment:

Public sector infrastructure investment has been low, and
could grow over time if authorities can create fiscal space.

Challenges to increasing public sector infrastructure
investment: The tax burden is high and most of the budget is
earmarked for hard-to-curb expenditures.
 Challenges to increasing private sector investment:
the legal and regulatory framework.
Current situation not good for Brazil’s competitiveness:

In a WEF survey of global competitiveness, Brazil ranked
in the bottom half globally in infrastructure. Further, its
infrastructure score appears to offer the most room for
improvement of any category surveyed.

Brazil’s port and transportation infrastructure looks
particularly poor, with implications for agricultural
competitiveness and exports generally.

Infrastructure is likely to pose increasing problems for
doing business in Brazil. It can also affect an economy’s
ability to attract foreign direct investment. And infrastructure
also matters for sovereign ratings.
Macro implications:

Base case: Brazil doubles investment in infrastructure, to
4% of GDP; it moves ahead with some reforms; and real GDP
growth averages 5%.

Bull case: Investment in infrastructure triples, to 6% of
GDP; structural reforms are put in place; and real GDP growth
accelerates to 6% on average.

Bear case: Infrastructure spending remains stuck at 2%
of GDP, and average real GDP growth remains at 4%.
6
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Equity Investment Implications
Our stock ratings are on a 12- to 18-month view, while our investment recommendations in the context of a
Brazil infrastructure play are on a 10-year macro view.
ANALYST
INDUSTRY CALL
STOCK CALLS
Javier Martinez
Agribusiness
Brazil is a global leader in agribusiness
production and export. However,
improved logistics would help reduce
costs throughout the sector and provide
a boost to exports. We see opportunity
for leading players like Cosan and
private companies to benefit from
reducing logistics inefficiencies and play
a role in the agro-logistic business.
Cosan Limited (CZZ, Overweight), Cosan SA (CSAN3,
Overweight): new player in sugar logistics via Rumo.
Cosan was transformed by its recent joint venture with
Shell. Fuel distribution represents 45% of our valuation,
logistics 15%. The Rumo rail project, expected to start
operating this year, should transport 10 million tons of
sugar and elevate 18 million tons in its port terminal (as a
reference, Brazil exported 24 million tons last year). We
expect Rumo to generate EBITDA of R$400 million from
capex of R$1.3 billion, of which a large part is already
contracted.
Carlos de Alba
Basic Materials
The early-cycle nature of steel
consumption makes steel our favorite
way to play the infrastructure theme in
Brazil. Based on the scenarios outlined
by our economics team, we think it is
very likely that steel production capacity
will be sufficient to support future
infrastructure investments in Brazil.
Only in the bull case (6% GDP growth
over the next 10 years) would steel
capacity be insufficient to meet long
steel demand, and then only in 2019. In
that scenario, we would expect either a
stronger supply response by incumbent
local steelmakers (to avoid new
entrants) or an increase in steel imports
into Brazil.
Gerdau (GGBR4.SA, Equal-weight): Brazil’s leading
supplier of long steel products for civil construction.
Gerdau’s exposure to the US is priced in and recent
underperformance vs. peers is unlikely to continue, but it
is too early to buy. We think US commercial
construction will start to recover, following the residential
and industrial trend (see Fundamentals Bottoming,
Balanced Risk-Reward After Underperformance, April
22). Gerdau looks fairly priced after underperforming its
Brazilian steel peers by ~19 percentage points YTD.
The stock is trading at 6.7x 2011e EBITDA, in line with
the forward multiple we view as fair for long steel stocks.
Usiminas (USIM5.SA, Equal-weight): the sole
producer of heavy plates for the oil & gas industry.
Usiminas is also developing new product applications for
construction. Its businesses enjoy positive
fundamentals that are offset by fair valuation. We like its
exposure to the recovery of steel demand in Brazil
through a portfolio of high value-added products, and the
potential for unlocking value at the iron ore division.
Also, Usiminas offers the highest EBITDA growth (86%)
in our steel coverage (58%, on average) over the next
couple of years. But the stock has rallied 30% in the
past three months (USD) vs. 23% for its peers and 8%
for the Bovespa, and we see limited upside.
7
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Equity Investment Implications
Our stock ratings are on a 12- to 18-month view, while our investment recommendations in the context of a
Brazil infrastructure play are on a 10-year macro view.
ANALYST
INDUSTRY CALL
STOCK CALLS
Subhojit Daripa
Oil, Gas & Petrochemicals
Boosted by pre-salt oil prospects,
investments in the oil and gas sector
are expected to jump to R$295 billion in
the next four years, up 88.2% from
2005–08, or annual growth of 13.5%.
OSX (OSXB3, Overweight): offshore platform and rig
manufacturer. OSX has a contract to provide and
service all of OGX’s production infrastructure; it also
leases E&P units to oil and gas companies. OSX is
positioned to benefit from spending on the pre-salt. We
think it has an advantage over domestic and international
peers due to: 1) Brazil’s local content requirement; 2) its
potential $30 billion OGX order book; 3) its special
relationship with OGX, with guaranteed gross margins and
leasing ROE; 4) government-subsidized financing; and 5)
a partnership with ship manufacturer Hyundai.
Javier Martinez
Nicolai Sebrell
Lupatech (LUPA3, Overweight): only local vertically
integrated equipment manufacturer/service provider
with focus on oil & gas. With the equipment and services
segment of energy at the bottom of the capital investment
cycle, we see opportunities for Lupatech to gain clients,
both domestic companies and international oil companies
expanding in Brazil. Lupatech’s main competitive
advantages are its expertise in the manufacturing of
equipment for deep water oil production and its close
relationship with Petrobras helping to develop new
applications over many years. Also, Lupatech benefits
from laws requiring local content in E&P.
Transportation Infrastructure
We see government highway and rail
concessions as the way to play the
theme. The stark contrast in quality of
road conditions between efficient
privately administered and problematic
state-run highways, for instance, is a
compelling argument for further
concessions, in our view. Raising longterm infrastructure investment to 4.0%
of GDP, as our economist envisions,
would add significant value to the
industry. At the start of 2010, the
R$127 billion worth of work on
identifiable transportation infrastructure
projects over the next three years would
be R$40 million per year, or about 1.2%
of GDP — midway between our bear
case of 0.8% and base case of 1.6% of
GDP spent on transportation
infrastructure. Thus, our base case
represents attractive upside from the
government’s forecast.
CCR (CCRO3.SA, Overweight): significant value from
new concessions. CCR is one of LatAm’s largest toll
road operators, with 1,571 km of highways and other
concessions. It should gain value even with just a few
wins among the many upcoming projects. Synergies with
its existing network, such as the RodoAnel south tranche
in São Paulo, could drive further upside.
America Latina Logística (ALLL11, Equal-weight):
opportunity to grow with greater projects. ALL
specializes in rail and logistics, a focus of the government
due to lower transport costs over middle to long
distances. Part of the R$29 billion p.a. potentially
channeled to rail investment builds on projects already
ahead of ALL, including: 1) Sugar pipeline. In early 2009,
ALL signed an agreement with Rumo (a Cosan
subsidiary) to operate a new 400 km rail line (fully
financed by Rumo) transporting sugar from Ribeirão Preto
to the port of Santos. Over the next four years, ALL
expects its transported sugar volumes to grow by a factor
of 4 or more. The Rumo line would also drive ALL’s bulk
cargo share at Santos, which has nearly doubled in the
past three years. 2) Rondonopolis extension. ALL has a
project to build a 260 km railway extension from Alto
Araguaia to Rondonopolis in Mato Grosso, connecting it
to Santa Fe du Sul in São Paulo state. ALL expects to
move 500,000 tons on the completed track in 2011.
8
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Equity Investment Implications
Our stock ratings are on a 12- to 18-month view, while our investment recommendations in the context of a
Brazil infrastructure play are on a 10-year macro view.
ANALYST
INDUSTRY CALL
STOCK CALLS
Subhojit Daripa
Utilities
We do not expect electricity to be a
bottleneck to economic growth. Brazil
combines large generation potential
with what we view as a robust
regulatory framework that offers
adequate incentives to guarantee the
required investments in all segments
(generation, transmission, and
distribution). Brazil needs to increase
installed capacity by 5.0 GW per year,
on average, to meet expected annual
GDP growth of 5%. This will require
annual investment of R$17.0 billion in
generation through 2016, and of R$5.0
billion in transmission and distribution
segments. We think this is achievable.
Tractebel (TBLE3, Overweight): Long-term winners
will be the most efficient generation plays, like
Tractebel, in our view (see Poised for Growth, Catalyst
Expected; Upgrading to Overweight, April 23). We think
generation offers lower risk and higher potential return
than distribution. After flat earnings YoY in 2009, we
expect Tractebel to resume earnings growth of 13% and
EBITDA growth of 8% in 2009–15 (CAGR) due to:
 Additional capacity. The transfer of Estreito by GDF
Suez (Tractebel’s controlling shareholder) to Tractebel
should add 435MW of installed capacity by 2011e. The
complementary biomass plant Destilaria Andrade should
add 33MW of installed capacity in 2010.
 Higher generation prices. We expect strong volume
growth, led by industrials, to shave off part of the excess
capacity in the system, driving a recovery in generation
prices to industrial customers in the free market.
CPFL Energia (CPFE3, Equal-weight): also worth
highlighting. It is mostly a distribution play, and we
prefer generation; however, we believe CPFL is an
interesting vehicle to play long-term infrastructure
development in Brazil.
Why we are positive on CPFL:
 CPFL combines some of the key drivers of success
in consolidation, such as a strong management team,
material size (increasing potential bargain power with
suppliers), and operational efficiency.
 CPFL has growing exposure to the generation
segment. We expect the company to increase installed
capacity from 1,737 MW today to 2,765 MW by 2012,
based on projects under development. Management’s
target aims to reach 4,000 MW of installed capacity in
2014.
9
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Infrastructure Investment Requirements
Marcelo Carvalho
Morgan Stanley C.T.V.M. S.A.+
[email protected]
Giuliana Pardelli
Morgan Stanley C.T.V.M. S.A.+
[email protected]
Brazil’s infrastructure investment has slowed to
2.1% of GDP in recent years, down from 3.6% in the
1980s.
Brazil would need to invest 6–8% of GDP per year to
catch up with South Korea in 20 years…
…and 4% of GDP per year to catch up with Chile.
All of Latin America needs greater infrastructure
investment:

LatAm infrastructure investment was about 3.7% of GDP
in the early 1980s before slowing to 2.2% in the late 1990s.
current infrastructure stock (offsetting depreciation), and to
keep up with a growing population 4 .

Building on studies by the World Bank and the World
Economic Forum, we estimate that to sustain real GDP
growth of about 5% and catch up to infrastructure levels in
Chile, the Latin American infrastructure leader, Brazil would
need to invest 4% of GDP per year on infrastructure over 20
years, or about twice as much as in recent years.
Exhibit 4
Brazil: Infrastructure Investment
(as % of GDP)
6.0
Water and Sewage
5.0
Transport
Telecommunications
Electricity
4.0
3

One World Bank study estimates that an annual
infrastructure investment of 2.5% of GDP would be enough to
meet increasing demand, maintain existing infrastructure, and
ensure universal coverage in electricity, water, and sanitation.

The same study estimates that annual investment of
6–8% of GDP for 20 years would be needed for Latin America
as a region to reach levels of infrastructure per worker similar
to that of South Korea.
Brazil’s infrastructure needs are especially significant;
the bar is higher because the starting point is lower.

Infrastructure investment in Brazil has slowed to about
2.1% of GDP on average in recent years.

That is down from 5.4% in the 1970s, 3.6% in the 1980s,
and 2.3% in the 1990s. While the investment slowdown is
comparable to the one seen in the region, the resulting
infrastructure picture is worse in Brazil than elsewhere.

The World Bank study estimates that Brazil would need
infrastructure investment of 6–8% of GDP per year to catch
up with South Korea in 20 years. While ambitious, such
infrastructure investment levels were achieved by Korea,
China, Indonesia, and Malaysia from the late 1970s through
the late 1990s.

Some studies suggest that infrastructure investment of
about 2% of GDP per year is needed to simply maintain the
3
Fay M. and M. Morrison. 2005. Infrastructure in Latin America and the Caribbean: Recent
developments and key challenges. Report number 32640-LCR. The World Bank Finance,
Private Sector and Infrastructure Unit, Latin America and the Caribbean Region.
Washington: The World Bank.
3.0
2.0
1.0
0.0
1970s
1980s
1990s
2000s
Source: World Bank, IPEA, BNDES (see Bielchowsky 2002, Blyde, Castelar Pinheiro, Daude
and Fernandez-Arias 2007, and Frischtak 2007)
Exhibit 5
Investment Needed for Infrastructure Improvement*
Annual investment over 20 years to equal South Korea
(as % of GDP)
Argentina
Brazil
Chile
Colombia
Costa Rica
Mexico
Peru
Venezuela
Latin America
With all roads
3.0
6.0
4.0
6.0
2.0
2.0
7.0
3.0
4.0
With paved roads
4.0
8.0
5.0
9.0
3.0
2.0
11.0
4.0
6.0
How much would be needed for Latin American Countries to reach levels of infrastructure per
worker similar to those of Korea - Annual cost if spread over 20 years. First column indicates
investment needed when existing non-paved roads in Latin America count as “roads” too,
while the second column only counts as existing stock of roads those that are paved.
Source: Infrastructure in Latin America, 2005 – World Bank, Morgan Stanley LatAm
Economics
4
O Investimento em Infra-Estrutura no Brasil: histórico recente e perspectivas. Claudio R.
Frischtak. 4.o seminário ANBID de Mercado de Capitais, dezembro 2007.
10
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Prospective Infrastructure Investment by Sector
Morgan Stanley C.T.V.M. S.A.+
Marcelo Carvalho
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
Electricity tops the list in terms of total investment
and percentage of GDP.
Ports, though starting from a small base, should see
the greatest percentage increase.
In electricity, prospective investments are led by
hydroelectric plants. Total investment in the sector is
projected to be R$92 billion in 2010–13, or annualized growth
above 6% in this relatively consolidated sector. According to
BNDES, the main projects here are hydroelectric plants in the
context of the growth acceleration program (PAC). These
include Jirau and Santo Antônio along the Madeira River, with
a budget above R$23 billion, of which R$20 billion should
materialize within the next four years, besides investments of
about R$8 billion in the hydroelectric plant of Belo Monte and
investments in the nuclear plant of Angra III estimated at R$4
billion. Finally, more than 70 wind power projects should add
about R$8 billion over the next three years.
In telecommunications, investments appear to have
stabilized after a privatization-related expansion cycle in
1997–2001, as the sector now looks fairly consolidated, with
relatively few players. Investment drivers here are twofold,
according to BNDES.

Firms in the sector now appear inclined mainly to
maintain minimum investment as required by the regulator.

Telecom firms seem to compete for market share in
specific niches through the introduction of new technologies,
such as the third generation of mobile phones and digital TV.
In water and sewerage, investments could grow strongly
in 2010–13, although the regulatory framework could still
improve further. Besides projects in the growth acceleration
program (PAC), drivers here include strong penetration of the
private sector in this area, which is expected to account for
30% of new concession over the next 10 years, according to
BNDES.
As for railways, infrastructure investments are projected
at R$30 billion in 2010–13, or an average growth of 13% per
year. Drivers here include expansion of the network, with the
construction of new lines and expansion of existing railroads,
including the Transnordestina, Norte-Sul and FerronorteRondonópolis, besides the planned introduction of a highspeed train between the cities of Campinas and Rio de
Janeiro, going through São Paulo.
Planned investments in highways would add up to R$33
billion in 2010–13, for an average annual growth of 7.8%.
Highlights here would include new concessions in the existing
system, like the second stage of the federal program, and the
second stage of the program in the state of São Paulo, which
have already added 5,000 kilometers to the 15,000 kilometers
under concession. Desperately congested now, airports seem
to hold the promise for significant future investments, too,
depending on how the authorities handle the framework for
the sector in the next administration.
Finally, infrastructure investment in ports would triple in
2010–13, with an average annual growth of 25%, from a very
low starting point. The main drivers here include the
implementation of new ports administered by the private
sector, on the back of an improved regulatory environment
since late 2008, BNDES notes. While the global crisis and
resulting slower trade flows temporarily cooled pressures on
port utilization, port improvement and expansion remain a
pressing medium-term challenge. For instance, Brazil’s
national association of containers (Abratec) estimates that the
sector saw a volume decline of 14.3% in 2009 after 12 years
of uninterrupted growth, but now looks for a rebound of 18.3%
in 2010 as global trade recovers and the Brazilian economy
expands.
Exhibit 6
Brazil: Infrastructure Investment Plans
(R$ billion)
Sectors
Critical Factors
Ports and Highways
Regulation - Concession
Investment 2010-2013
Railways and Sanitation
Federal Budget
R$69 billion
Telecommunication
Competition
R$67 billion
Electrical Energy
Licenses
R$92 billion
R$47 billion
Source: APE/BNDES
Critical factors and prospects for infrastructure
investment across sectors in Brazil: BNDES highlights
that consolidation of the new regulatory framework for ports,
and increases in road concessions are key to attract
investments in these sectors. Stable sources of public and
private financing are important too for investment in railways
and in large sanitation projects. For telecommunications,
competition dynamics amid technological innovations seem a
key ingredient for investment prospects in the sector. As for
the electricity sector, regulatory and bureaucratic procedures,
11
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
including licenses, are important for implementation of large
hydroelectric projects in the north region, like Jirau, Santo
Antônio, and Belo Monte.
Exhibit 7
Brazil: Investment Prospects
(R$ billion, and % change)
R$ billion
Sectors
Infrastructure
Electricity
Growth
2005-2008
2010-2013
%
% a.r.
199
274
37.3
6.5
68
92
35.7
6.3
Telecommunication
66
67
0.8
0.2
Sanitation
22
39
77.1
12.1
Railways
16
29
81.7
12.7
Highways
23
33
45.4
7.8
5
14
203.0
24.8
311
499
60.2
9.9
156
295
88.2
13.5
Ports
Industry
Oil and Gas
Mining
53
52
-2.7
-0.6
Steel
28
44
58.7
9.7
Petrochemical
19
36
87.1
13.3
Automobile
23
32
40.8
7.1
Electric/Electronics
15
21
42.1
7.3
Pulp and Paper
Total
17
19
13.0
2.5
510
773
51.6
8.7
Source: GT Investimento, APE/BNDES, Morgan Stanley LatAm Economics
Investments in the oil sector: Beyond infrastructure,
BNDES also maps investment prospects in other areas,
including the oil sector and other industrial segments. The oil
sector already represented a large share of 30.6% of total
mapped investments in 2005–08, and is expected to jump to
38.2% of the total in 2010–13. Boosted by pre-salt oil
prospects, investments in the oil and gas sector are expected
to jump to R$295 billion during the next four years, up 88.2%
from 2005–08, or annual growth of 13.5%. Spillovers to other
sectors can prove relevant — most obviously to the
petrochemical sector, where investment is expected to
expand an annual rate of 13.3% in coming years. But
implications for other industrial sectors and for infrastructure
in particular are less clear.
In all, investment in the oil and gas sector would expand
at an annual pace of 13.5% per year in 2010–13, according
to BNDES, while other industrial areas would grow 5.6%, and
infrastructure investment would increase 6.5% during the
same period.
Exhibit 8
Brazil: Investment
(R$ billion)
350
2005-2008
2010-2013
300
250
200
150
100
50
0
Infrastructure
Oil and Gas
Other Industry
Source: GT Investimento, APE/BNDES, Morgan Stanley LatAm Economics
12
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Challenges to Increased Infrastructure Investment
Morgan Stanley C.T.V.M. S.A.+
Marcelo Carvalho
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
Public sector investment in infrastructure has been
low, and could grow over time if authorities manage to
create enough fiscal space.
Challenges to increasing public sector investment in
infrastructure: the tax burden is already high and most
of the budget is earmarked for hard-to-curb expenditures
like payroll expenses and social security outlays.
Challenges to increasing private sector investment
in infrastructure: the legal and regulatory framework.
Total investment in Brazil is not high by international
standards, and infrastructure investment in particular is low.
Total investment in Brazil has been about 17% of GDP on
average over the last decade, according to the national
accounts statistics. Investment in infrastructure on average
represents about 13% of total investment in Brazil, or about
2% of GDP (Exhibit 9).
…but in infrastructure, the role of public sector
investment is significantly larger. One study 5 estimates
that the public sector (essentially the federal government) has
accounted for about one-half of total infrastructure investment
in Brazil during the last decade.
Within the public sector, federal government investment
remains low. Despite Brazil’s rising overall public sector
spending over time, along with a steadily rising tax burden,
Brazil’s public sector spends relatively little on investment.
Investment accounted for just 6% of total federal spending
last year, lagging social security expenses (39%) and payrolls
(27%). And federal government investment in 2009 was only
about 1% of GDP — although it is not clear how much of that
goes to infrastructure specifically.
Exhibit 10
Brazil: Federal Government Spending
Federal spending on investment is just 6% of the
budget, or about 1% of GDP
(% of total, 2009)
Other
9.6%
Investment
6.0%
Exhibit 9
Brazil: Investment by Sector
Infrastructure represents ~13% of total investments
(as % of GDP)
Payroll
26.7%
20
Other
18
Social Security
39.1%
16
Industry
14
12
Current Expenses
18.7%
Housing
10
Mining
8
6
Oil and Gas
4
2
Infrastructure
0
2001
2002
2003
2004
2005
2006
2007
2008
Source: IBGE, BNDES, Morgan Stanley LatAm Economics
The bulk of total investment in Brazil is conducted by the
private sector… According to the national bureau of
statistics (IBGE), the private sector accounts for almost 90%
of total investment in Brazil, while the public sector accounts
for a bit above 10%.
Source: Tesouro Nacional, Morgan Stanley LatAm Economics
State-owned-enterprise (SOE) overall investment has
been growing. Overall investment by other public sector
entities, such as states and municipalities, has been relatively
stable over the years. But investment by federal SOEs has
been rising, although there is little clarity if any of that goes
into infrastructure. Petrobras, Brazil’s giant oil company,
plays an increasing role, investing about 2.1% of GDP in 2009
and outpacing total investment by the federal government
(Exhibit 11).
5
O Investimento em Infra-Estrutura no Brasil: histórico recente e perspectivas. Claudio R.
Frischtak. 4.o seminário ANBID de Mercado de Capitais, dezembro 2007.
13
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 11
Brazil: Public Sector Investment
SOEs play growing role in public sector investment, but
infrastructure investment concentrated at federal level
(as % of GDP)
6%
5%
Federal Stateowned
Enterprises
4%
Municipalities
3%
States
2%
1%
Federal
Government
0%
2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Tesouro Nacional. Min Planejamento. Site Contas Abertas, Morgan Stanley LatAm
Economics
Challenges to Increased Public Sector Investment
Public sector investment needs to increase, especially on
infrastructure, to sustain faster growth. A key challenge
facing Brazil is how to create fiscal room for increased public
sector investment in infrastructure, given Brazil’s already high
tax burden and its rigid budget, where the vast majority of
resources are channeled to hard-to-curb current expenditure
items like payroll expenses and social security outlays.
Structural reforms are needed to address Brazil’s long-term
fiscal constraints, open up room for increased public sector
investment in infrastructure, and encourage private sector
investment.
We think the administration that takes power in 2011 will
face three long-term fiscal challenges; see “Brazil: Longerterm Fiscal Challenges” in This Week in Latin America,
November 30, 2009:
international comparisons of the amount of time required of
firms to comply with complex tax rules.

Lay out a clear medium-term fiscal framework, restoring
transparency to the fiscal accounts and targets, and
addressing more explicitly the issue of quasi-fiscal
transactions through public sector financial entities. For
instance, let’s say the Treasury allocates resources via
BNDES to support the building by the private sector of a highspeed train system between São Paulo and Rio de Janeiro,
while the government also assumes the risks involved in the
project. While the headline net debt does not change, the
little-watched gross debt increases. And the current system
does not answer in a transparent way questions about implicit
contingent fiscal liabilities that could come back to haunt the
fiscal accounts.
Challenges to Increased Private Sector Investment
Within Latin America, Brazil ranks as an attractive market
for private sector investment in infrastructure, according to
an Infrastructure Private Investment Attractiveness index,
constructed by the WEF. The index measures the institutions,
factors, and policies that attract private investment in
infrastructure projects in a number of Latin American countries 6 .
It is composed of eight pillars (for a total of 62 variables),
including the macro environment, the legal framework, political
risk, ease of access to information, financial market enablers for
infrastructure financing, track record of private investment in
infrastructure, government and social indicators, and
government readiness to facilitate private investment. Among
the 12 LatAm countries surveyed, Brazil ranks second
according to this attractiveness index, just behind Chile.
Exhibit 12
Infrastructure: Private Investment Attractiveness
Brazil ranks as attractive, just behind Chile
(1-7 scale, higher value = higher competitiveness)
Score

Contain spending growth and rethink spending priorities.
Besides improving efficiency in the public sector in key areas
such as basic health and primary education, the fiscal
authorities will need to curb overall spending growth if they
seek to free resources to invest in infrastructure. That will
require addressing budget rigidities and mandatory
earmarking, as well as social security reform (probably the
most important challenge facing Brazil’s fiscal accounts over
the long run).

Curb the tax burden and simplify the arcane tax system
to limit the public sector’s crowding-out effect and improve the
local business environment. Brazil’s tax burden is high by
international standards, once adjusted for the country’s per
capita income. And the tax system is a glaring outlier in
2
3
4
5
4.3
4.2
Peru
Mexico
4.0
Uruguay
4.0
4.0
El Salvador
3.6
Guatemala
Argentina
7
4.4
Brazil
Colombia
Venezuela
6
5.4
Chile
3.4
3.4
Bolivia
3.3
Dominican Rep.
3.3
Source: World Economic Forum, Morgan Stanley LatAm Economics
6
See Benchmarking National Attractiveness for Private Investment in Latin American
Infrastructure, by Irene Mia, Julio Estrada and Thierry Geiger – 2007 World Economic
Forum.
14
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
The legal and regulatory framework is a key challenge to
private sector investment into infrastructure in Brazil.
According to the WEF survey, Brazil’s legal framework scores
poorly — in fact, the distinction between Brazil and Chile is
the largest in this factor (see Exhibit 13). Brazil ranks 9th out
of the 12 LatAm countries in the quality of its legal framework,
mainly because of inefficiencies in the regulatory framework
and poor public ethics. The business community shows little
trust in politicians and doubts their impartiality. Diversion of
public funds and, to a lesser extent, issues regarding the
awarding of public contracts are widespread, according to the
WEF survey. In addition, given the importance of the judiciary
system in determining investment attractiveness, Brazil’s poor
ranking (ahead of only Venezuela in the survey) raises a
flag. 7
Exhibit 13
Infrastructure Attractiveness Index: Brazil vs. Chile
Brazil lags most in legal and regulatory framework
(1-7 scale, the farther from the center the better)
Brazil
0
1
2
3
4
5
6
Chile
7
8
Brazil needs a stable, credible regulatory environment to
spur private sector infrastructure investment, according to
a World Bank study. 8 The report highlights the need to:
1) eliminate regulatory bottlenecks and remaining political
uncertainties in certain sectors; 2) plan infrastructure
concessions to avoid excessive renegotiations; and 3)
improve the functioning of regulatory agencies.
Among factors that attract private sector investment,
Brazil does well in terms of investor access to
information, scoring close to Chile on the WEF survey. This
includes aspects such as the quality of statistical information,
transparency, and openness of the dialogue and decisionmaking process. Elsewhere, there is clear room for
improvement, ranging from financial market enablers and
government readiness for private sector investments to
political risk and the macro environment. In particular, while
Brazil gets high marks for the soundness of its financial
system, the WEF survey indicates that investors express
concern about the poor quality of Brazil’s educational system
and the difficulty in hiring skilled labor.
Government readiness for private
investments
Government and society
Private investment track records
Financial markets enablers
Access to information
Political risk
Legal framework
Macro environment
Source: World Economic Forum, Morgan Stanley LatAm Economics
7
For a survey among Brazilian judges on their perceptions about economic issues, see also
- Pinheiro, Armando Castelar. “Judiciário, reforma e economia: a visão dos magistrados”.
July 2003. Texto para discussão 966 – IPEA – Instituto de Pesquisa Econômica Aplicada.
8
Como Revitalizar os Investimentos em Infraestrutura no Brasil: Políticas Públicas para
uma Melhor Participação do Setor Privado. Relatório no. 36624-BR, Novembro 2007,
Departamento de Finanças, Setor Privado e Infra-estrutura, Banco Mundial.
15
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Current Situation: Not Good for Brazil’s Competitiveness
Morgan Stanley C.T.V.M. S.A.+
Marcelo Carvalho
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
In a survey of global competitiveness, Brazil ranked
in the bottom half globally in infrastructure. Further,
its infrastructure score appears to offer the most room for
improvement of any category surveyed.
Brazil’s port and transportation infrastructure looks
particularly poor, with implications for agricultural
competitiveness and exports generally.
Infrastructure is likely to pose increasing problems
for doing business in Brazil. It can also affect an
economy’s ability to attract foreign direct investment.
And infrastructure also matters for sovereign ratings.
Brazil’s infrastructure ranks 74th out of 133 countries,
even though its overall economy ranks 56th, according to a
World Economic Forum (WEF) survey 9 that asked firms to
rank global competitiveness. Among the BRIC economies,
Brazil’s infrastructure ranks similar to India’s (76) and Russia’s
(71), but it lags China’s (46). Within Latin America, Brazil’s
infrastructure ranking is near Mexico’s (69) and is significantly
better than Venezuela’s (106), but it is far behind Chile’s (30);
see Exhibit 14.
Infrastructure is crucial to strong GDP growth. One
study 10 estimates that Brazil could boost real GDP growth to
5–6% if its infrastructure caught up with regional leader Chile.
And it could boost real GDP growth to as much as 7% —
above even our bull case scenario — if its infrastructure
caught up with that seen in East Asian countries like South
Korea.
Brazil’s port and transportation infrastructure looks
particularly poor, with implications for logistics costs and
trade competitiveness. Among 133 countries in the WEF
survey, Brazil ranked 127th in the quality of its ports. Only six
countries ranked lower in port infrastructure — and two of
them are landlocked. Brazil’s international rankings in other
infrastructure areas are also generally poor, including quality
of overall infrastructure (81), air transport (89), railroads (86),
and roads (106); see Exhibit 15. In contrast, Brazil’s
electricity supply ranked higher at 55.
9
Exhibit 14
Global Competitiveness Index: Infrastructure
Brazil ranks in the bottom half globally
(1-7 scale, higher indicates greater competitiveness)
Score
2
3
4
5
6
17
Korea, South
30
Chile
South Africa
45
China
46
69
Mexico
71
Russia
Brazil
74
India
76
Ranking out of 133 countries
83
Colombia
88
Argentina
97
Peru
Venezuela
7
8
US
106
Source: World Economic Forum, Morgan Stanley LatAm Economics
Exhibit 15
Brazil: Global Competitiveness Index
Infrastructure offers most upside to a high score
(1-7 scale, higher indicates greater competitiveness)
Score (1-7)
3
4
5
6
10
Market Size
79
Health
32
Business Sophistication
51
Financial Market Sophistication
80
Labor Market
58
Education
46
Technological Readiness
91
Basic Requirements
Brazil's
ranking out
of 133 countries
109
Macro Stability
99
Market Efficiency
Innovation
43
INFRASTRUCTURE
74
Institutions
93
Source: World Economic Forum, Morgan Stanley LatAm Economics
See “The Global Competitiveness Report: 2009-2010,” World Economic Forum).
10
Calderon, Calderón and Servén, Luis, 2004. The Effects of Infrastructure Development on
Growth and Income Distribution. World Bank Policy Research Paper, WPS 3400.
Washington: The World Bank.
16
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 16
Market Size vs. Infrastructure
Brazil: advantage in market size, lags on infrastructure.
(Bottom-left: small markets with poor infrastructure.
Top-right: large economies with advanced infrastructure)
7
Infrastructure
(Score)
Germany
Iceland
6
U.
South Korea
Barbados
5
Chile
China
Italy
4
Brazil: Farmers’ Cost Structure
Mato Grosso (MT) contributes 7% of global soybean
production, but poor roads result in high logistics costs
(R$ per ton, and % share)
India
Brazil
Zimbab
Exhibit 18
Russia
Mexic
3
Brunei
2
agribusiness team 11 estimates that logistics costs represent
32% of total costs for soybean exports from Mato Grosso,
given the long distances along poor roads that trucks have to
travel to reach the Santos port (see Exhibit 18). Further, the
poor roads are particularly vulnerable to weather conditions.
In the latest harvest — a record for Brazil — heavy rains
interrupted traffic in the region, causing soybeans to be stuck
at the point of origin. Some studies indicate that soybean
transport costs in Brazil can be up to 7 times higher than in
the US. 12
Timor-Leste
MT
Market Size (Score)
1
2
3
4
5
6
7
Scale is 1-7 , with 7 being the best. Source: World Economic Forum, Morgan Stanley LatAm
Economics
Exhibit 17
Brazil: Infrastructure by Sector
Brazil lags in port facilities but excels in electricity supply
(1-7 scale, and ranking among 133 countries)
Score (1-7)
0
1
2
3
4
5
55
electricity supply
air transport
infrastructure
89
PR
R$/ton % share
R$/ton % share
Total Cost
601
100%
576
100%
515
Production cost*
407
68%
487
85%
452
100%
88%
Logistics cost**
194
32%
89
15%
63
12%
*Includes fertilizers, chemicals, seeds, process, etc. ** Includes transportation and ports
MT=Mato Grosso; MAPITO=Maranhão, Piauí and Tocantins; PR=Paraná. Source: MS LatAm
Agribusiness Report, Agrianual, Conab, Morgan Stanley LatAm Economics
Brazil’s freight costs to export to the US are higher than
for countries in Europe or the East Asia, including China
(Exhibit 19). This is remarkable, given the distances involved.
Brazil and Latin America as a whole spend nearly twice as
much in freight costs per ton to import goods as does the
United States (see “The Age of Productivity” in Development
in the Americas, Inter-American Development Bank, 2010.)
81
overall infrastructure
106
roads
Brazil's ranking out
of 133 countries
127
port infrastructure
railroad infrastructure
6
MAPITO
R$/ton % share
1
86
Source: World Economic Forum, Morgan Stanley LatAm Economics
Poor infrastructure is a hindrance to Brazil’s agricultural
competitiveness. For instance, Brazil is a major producer
and exporter of soybeans, and the world’s second-largest
exporter of soybean oilseed, after the United States.
Soybeans represent about 11% of Brazil’s total exports. The
state of Mato Grosso alone contributes about 7% of global
soybean production. The state has the lowest production
costs in Brazil, but its logistics costs are very high. Our LatAm
11
See “Farmers Update: Nearing the Bottom of the Cycle” in LatAm Agribusiness, March 2,
2010, by Javier Martinez de Olcoz Cerdan, Alessandro P Baldoni and Jeremy R Friesen.
12
See “Desafios de logística nas exportações brasileiras do complexo agronegocial da
soja” in Observatorio de la Economía Latinoamericana, Revista académica de economia,
n. 71, December 2006, by Cristhyan Carozo Nunoz and Eduardo Mauch Palmeira.
17
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 19
Global: Freight Expenditures to the US
Costs more to ship from Brazil than from distant markets
(as % of total exports to the US, 2006)
0
1
2
3
4
5
6
7
8
9
Exhibit 20
Brazil: Most Problematic Factors for Doing Business
Recent rapid growth with limited infrastructure
investment so far could drive infrastructure up the list
(% of responses)
0
European Union-12
East Asia
Oceania
Mexico
Access to financing
Inadequate supply of INFRASTRUCTURE
Corruption
Costa Rica
Inadequately educated workforce
Brazil
Policy instability
Ecuador
Inflation
Uruguay
Foreign currency regulations
Panama
Poor work ethic in national labor force
Chile
Crime and theft
Argentina
Poor public health
Infrastructure could pose increasing problems for doing
business in Brazil, if left unchanged. A global survey 13
asked executives of large global companies to rank the
factors that pose difficulties for doing business in different
countries. Infrastructure was not the top concern for Brazil.
(It ranked sixth, after Brazil’s arcane tax system, heavy tax
burden, restrictive labor regulations, inefficient bureaucracy,
and access to financing.) However, if Brazil grows rapidly
amid limited infrastructure investment, we would not be
surprised if infrastructure moves up the list in the coming
years.
20
Inefficient government bureaucracy
Colombia
Source: IDB, Morgan Stanley LatAm Economics
15
Restrictive labor regulations
Venezuela
Peru
10
Tax rates
China
Bolivia
5
Tax regulations
Government instability/coups
Source: World Economic Forum, Morgan Stanley LatAm Economics
Infrastructure can also affect an economy’s ability to
attract foreign direct investment (FDI). A survey 14
conducted by the United Nations Conference on Trade and
Development (UNCTAD) finds that Brazil does well in
international comparisons of market size and growth rate, but
lags global average in the quality of infrastructure and
government effectiveness. Importantly, the object of the
survey was to gauge the prospects for FDI in Brazil.
And infrastructure matters for sovereign ratings. When
Standard & Poor’s reviews Brazil’s sovereign rating (currently
a foreign currency rating of BBB- and stable outlook), it
typically identifies the country’s insufficient and inefficient
infrastructure as a factor limiting sustainable growth (see “As
Brazil Heads for the World Stage, It Looks to Bolster
Infrastructure” in Global Credit Portal, Standard & Poor’s,
February 24, 2010).
14
13
See the 2009 WEF’s Executive Opinion Survey.
See “World Investment Prospects Survey 2009-2011”, United Nations Conference on
Trade and Development (UNCTAD), July 2009.
18
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Macroeconomic Implications
Morgan Stanley C.T.V.M. S.A.+
Marcelo Carvalho
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
Base case: Brazil doubles investment in infrastructure,
to 4% of GDP; it moves ahead with some reforms; and
real GDP growth averages 5%.
Bull case: Investment in infrastructure triples, to 6% of
GDP; structural reforms are put in place; and real GDP
growth accelerates to 6% on average.
Bear case: Infrastructure spending remains stuck at a
low level of 2% of GDP, and average real GDP growth
does not exceed the recent average of 4%.
Assuming Brazil increases infrastructure investment,
what would the economy look like in the next decade?

Bull case: Investment in infrastructure jumps to 6% of
GDP, structural reforms are put in place, and real GDP growth
accelerates to 6% on average. The currency appreciates
further than in our base case, in both nominal and real terms,
and interest rates fall at a faster pace.

Base case: Brazil manages to double its investment in
infrastructure, to 4% of GDP, it moves ahead with some
reforms, and real GDP growth averages 5%. The currency
appreciates in purchasing power parity (PPP) terms, although
inflation differentials work against much nominal appreciation.
Policy interest rates continue to decline over time, gradually
converging to international standards. For its part, the fiscal
outlook depends on how the authorities choose to fund
increased infrastructure investment. All else equal, an annual
increase in public sector spending on infrastructure of 1% of
GDP would mean that the debt stock ends up 10% of GDP
higher than otherwise over the course of a decade, under a
simplifying illustrative assumption that the authorities resort to
increased indebtedness to fund additional spending.
And if Brazil does not increase infrastructure investment?

Bear case: Infrastructure spending remains stuck at a
low level of 2% of GDP, and average real GDP growth does
not exceed the average 4% pace seen in recent years. The
currency remains roughly stable in real terms, and interest
rates still fall further, but converge at a slower pace. While
such outcome may not seem bad, a 4% growth ceiling would
frustrate those that may have become used to the notion that
Brazil is a faster-growing economy. And average
infrastructure investment numbers mask tighter constraints in
specific areas. Brazil’s ability to grow fast over time might
come under question if infrastructure investment remains low
for long, as Brazil could run an increasing risk of facing
serious constraints in logistics areas like ports and
transportation. There is precedent for complacency or
inaction: Limited progress on structural reforms during the
abundance years since 2003 inspires some caution about
proactive policy action.
Exhibit 21
Brazil Infrastructure Scenarios; Our Bear Case Is No
Change from Current Numbers (2011–20 average)
Infrastructure Spending
% of GDP
Bull
Base
Bear
6.0
4.0
2.0
Real GDP Public Debt
R$bn/yr.
188.6
125.7
62.9
FX Avg. Interest Rate
%/yr.
% of GDP
R$/US$
Avg.% p.a.
6.0
5.0
4.0
62.9
52.9
42.9
1.56
1.74
1.94
7.7
8.4
9.0
Source: Morgan Stanley LatAm Economics
These scenarios look at simple averages over the next
decade; reality will be much more complex and non-linear.
Take the base case scenario of success, for instance.
Infrastructure investment is unlikely to suddenly double
overnight. Instead, it may well remain relatively low in the
near term, before it picks up more significantly later on. The
outlook in part also depends on the willingness and ability of
the administration that takes power in 2011 to move forward
with reforms and infrastructure investment. Besides actual
infrastructure investment, signposts in coming years to gauge
which scenario is playing out include progress on reforms,
especially on the fiscal front.
Other macroeconomic variables under a base scenario of
success: Brazil’s overall investment-to-GDP ratio would
need to increase markedly. After all, there is a significant
correlation between infrastructure investment in particular and
overall investment. Infrastructure investment in Brazil has
averaged about 2% of GDP in the latest decade, while overall
investment averaged about 17% of GDP. By contrast, when
infrastructure investment in Brazil was about 5% of GDP a
few decades ago, overall investment was 22% of GDP (see
Exhibit 22). If Brazil’s infrastructure investment is to
meaningfully increase, then the overall investment-to-GDP
ratio would likely exceed 20% of GDP.
In fact, Brazil’s overall investment-to-GDP ratio is too
small. Brazil’s average investment-to-GDP ratio of about
17% stands well below the median ratio of 25% for
comparable investment-grade peers which Standard and
Poor’s rate as BBB. Brazil’s overall investment ratio also
stands below regional investment-grade peers like Mexico
(23%) and Peru (24%). And Brazil’s investment ratio lags well
19
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
behind other BRIC economies, India (38%), Russia (24%),
and China (44%); see Exhibit 23.
Prospective oil-related investment helps, but cannot
alone save the day. A BNDES mapping of prospective
investments in oil and gas suggests that annual investments
in this sector could increase from 1.5% of GDP on average in
2005–08 to 2.3% in 2010–13. The resulting investment gain
of 0.8% of GDP would be welcome, but insufficient by itself to
dramatically change Brazil’s overall macroeconomic
investment picture.
Exhibit 22
Brazil: Overall and Infrastructure Investment
Overall and infrastructure investment are co-related
(as % of GDP)
30
25
20
15
Overall Investment
10
Infrastructure Investment
5
0
1980
1984
1988
1992
1996
2000
2004
2008
Source: BCB, PAC, Morgan Stanley LatAm Economics
Exhibit 23
Gross Domestic Investment
Brazil’s investment-to-GDP ratio is well below peers’
(as % of GDP)
50
Increasing infrastructure investment is tied to increasing
overall investment in the economy. As the national
accounts dictate, total investment must equal total savings.
Higher investment requires higher savings. In turn, an
increase in total savings comes from higher domestic savings,
higher external savings, or a combination of the two.
Higher overall investment would likely require increased
external savings, in the form of a wider current account
deficit. There is a significant historical correlation between
investment and the current account in Brazil; see Exhibit 24.
A scenario where infrastructure and overall investment
increase significantly amid faster domestic demand growth
would likely mean that Brazil’s current account deficit could
widen, perhaps to 3–5% of GDP for several years — at least
until increased domestic oil production and a better oil export
mix eventually boost total exports more significantly. As a
reference, Brazil’s current account deficit has been almost 2%
of GDP on average since the 1980s, but averaged close to
4% in the 1970s, when the economy was growing much faster.
Most of Brazil’s current account deficit should be covered
by foreign direct investment, if all goes well, although
portfolio flows will play a role, too. Our previous work has
highlighted that Brazil’s market size and growth outlook help
attract FDI flows, but its infrastructure and public sector
efficiency remain challenging (see “Brazil: What Is the FDI
Outlook?” in Latin America This Week, September 21, 2009).
Improved infrastructure, if combined with increased public
sector efficiency, could go a long way toward supporting FDI
inflows. If Brazil were to recover the market share of 3.5% of
global FDI flows it enjoyed back in 1980, for instance, annual
FDI flows into Brazil could reach 3% of GDP.
2004-2008 average
45
2009e
40
2010f-2011f average
35
30
25
20
15
10
5
0
Brazil
'BBB'
median
Mexico
Peru
India
Russia
China
Source: Standard and Poor’s, Morgan Stanley LatAm Economics *E = Estimate, F = Forecast
20
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 24
Brazil: Investment versus Current Account
If infrastructure and overall investment grow
significantly amid faster domestic demand growth,
Brazil’s current account deficit could widen, perhaps to
3–5% of GDP
(% ∆ y-o-y, and absolute ∆ in US$ y-o-y)
25%
20%
8
Investment (real, % change y-o-y, LHS)
Current Account (US$ billion, absolute change y-o-y, RHS)
6
4
15%
Exhibit 25
Brazil: Micro Radar
In survey on local business conditions, Brazil ranked
129th out of 183 countries, and particularly low in ease
of starting a business and the tax system
(Benchmark: EM Average=0)
-2
-1
0
0
5%
4
5
6
Getting Credit: Legal
Rights Index
Getting Credit: Credit
Information Index
Shareholder Rights
Index
-4
-5%
-6
-10%
-15%
-20%
Mar-97
3
Starting a Business
(Days)
-2
0%
2
Employing Workers:
Rigidity of Employment
Index
2
10%
1
-8
Taxes: Time (Hours)
-10
Taxes: Total Payable
(% of gross profit)
-12
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
Investor Protection
Index
Mar-09
Source: BCB, Morgan Stanley LatAm Economics
Higher investment could also come in part from
increased domestic savings, private and/or public.
Boosting private sector investment would likely depend on
improving Brazil’s business environment. Brazil ranks poorly
on microeconomic indicators, according to an annual survey
conducted by the World Bank (“Doing Business”). In the
latest edition of this survey on local business conditions
(2009), Brazil ranks 129th out of 183 countries under
consideration; see Exhibit 25.
Contract Enforcement:
Time (Days)
Contract Enforcement:
Cost (% of debt)
Bankruptcy: Recovery
Rate (cents on the
dollar)
Source: Morgan Stanley LatAm Economics * The higher the number, the worse the situation
To foster private sector investment, we think Brazil will
need to contain its tax burden and simplify its tax system.
Brazil’s high tax burden and complex tax system are
important hurdles to doing business in the country. According
to, again, the World Bank survey, Brazil ranks very low in
terms of the amount of taxes and mandatory contributions on
labor paid by businesses as a percentage of commercial
profits; the average corporate tax rate in Brazil is 69%, but
only 41% in the median country in the survey. The situation is
even worse when it comes to the time it takes to prepare, file,
and pay (or withhold) corporate income tax, VAT and social
security contributions. Brazil ranks dead last in the survey.
21
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 26
Brazil: Tax Burden Indicators
It takes companies in Brazil 2,600 hrs/yr. to prepare and
pay taxes vs. a median of 224 hrs in other countries
Total Tax Rate**
(% of profits)
100
90
80
Brazil
70
60
50
40
30
20
10
0
0
500
1000
1500
2000
2500
3000
Time* (hours per year)
Source: World Bank, Morgan Stanley LatAm Economics; * Time it takes to prepare, file and
pay (or withhold) corporate income tax, VAT and social security contributions (in hours per
year); ** Amount of taxes and mandatory contributions on labor paid by the business as a
percentage of commercial profits.
Brazil’s tax burden has been climbing steadily over the
years, and is simply too high by international standards, once
adjusted by Brazil’s per capita income; see Exhibit 27. The
concern is that a high and rising tax burden can be bad for
growth, as it crowds out the private sector and can hurt
private sector investment.
Exhibit 27
Brazil: Tax Burden Over Time
Brazil’s tax burden has been rising steadily for decades
(as % of GDP)
40
the authorities may need to reassess the role of BNDES over
time, for micro and macro reasons.

From a microeconomic perspective, local capital markets
need to develop to provide diversified sources of long-term
financing for private sector investment plans.

From a macroeconomic point of view, subsidized BNDES
lending carries fiscal implications as well, if not always
explicitly. For instance, when the Treasury issues debt in
order to help fund BNDES subsidized operations — as it did
last year — the federal government’s gross debt goes up but
the net debt does not change immediately, although there is
an implicit negative carry over time. While most observers
seem to focus on Brazil’s net debt (42.9% of GDP at year-end
2009) as the main benchmark indicator, Brazil’s public sector
gross debt is significantly higher (62.9% of GDP at end-2009);
see Exhibit 28. A strategy of funding infrastructure investment
through Treasury-based BNDES subsidized lending could
further widen the gap between gross and net debt statistics,
before any considerations about liquidity and asset quality of
the BNDES lending portfolio.
Exhibit 28
Brazil: Gross and Net Fiscal Debt
(as % of GDP)
80
75
70
65
60
55
50
35
30
25
20
45
40
Net Public Sector Debt
35
Gross General Government Debt
30
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
15
Source: BCB, Morgan Stanley LatAm Economics
10
As for spurring private sector savings, structural reforms
like pension reform could prove important, too. Brazil’s
current pay-as-you-go pension system, and its many
distortions, provides little incentive for higher long-term
household savings. Here, Chile’s experience with pension
reform and savings might provide useful lessons.
5
0
1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009
Source: Morgan Stanley LatAm Economics
Another factor to support private sector investment in
infrastructure is the development of local capital markets.
BNDES has played a crucial role in providing subsidized
financing for long-term projects like infrastructure. However,
Commodity wealth can help, but it is no guarantee of
increased infrastructure spending. One channel through
which the pre-salt oil exploration could indirectly help
infrastructure prospects is through the fiscal accounts. In
22
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
principle, rising fiscal revenues from the oil sector could
enhance the government’s ability to spend more in
infrastructure. Payments from Petrobras to the public coffers
(mainly royalties, but also taxes and special participation
contribution, besides dividends) were 0.9% of GDP last year,
or about 6% of federal government revenues.
Two caveats on prospects for oil-related fiscal gains:

The timeframe and magnitude of prospective oil gains.
While capacity expansion plans by Brazil’s giant oil company
are impressive (above US$ 200 billion in 2010–14), it will take
time before new oil output runs at full speed; see Exhibit 29.
And only about a third of oil dividends get transferred to the
government, given the ownership structure of Brazil’s main oil
company. Our sector equity analysts estimate that total oilrelated payments to the government would increase to about
1.2% of GDP by 2014, or a gain of about 0.3% of GDP
relative to 2009. Numbers would grow over time, as oil
production ramps up. Under certain assumptions, annual
fiscal earnings from oil could eventually increase by almost
1% of GDP relative to 2009, to reach about 2% of GDP by
2020 - although our sector analysts believe there are upside
risks to potential oil reserves.
In other words, it will probably take several years before
the authorities can rely on a significant fiscal boost from
oil revenues, assuming all goes well. It is worth keeping in
mind, too, that international oil prices can prove highly volatile,
adding uncertainty to prospective fiscal gains from oil.
Exhibit 29
Brazil: Oil Production
Oil output will not provide a major fiscal boost for years
(million barrels of oil equivalent per day)
7.0
Gas international
6.0
5.0
Oil - international
4.0
3.0
Gas - domestic

Uncertainty about how the authorities would handle future
oil-related fiscal gains. Discussions in congress suggest that
there are already many ideas about how to spend future oil
gains, and not necessarily on infrastructure projects. The
experience with commodity gains in other countries in the
region can provide useful lessons for Brazil. Oil-rich
Venezuela provides a cautionary tale: The country ranks low
in international infrastructure surveys, illustrating how windfall
oil wealth does not necessarily translate into better
infrastructure. At the other end of the spectrum, Chile’s fiscal
experience in handling gains from copper is often cited as a
model of prudence to be followed. And Chile ranks high in
cross-country infrastructure surveys.
Further, there is not even a strong positive correlation
between natural resource wealth and economic growth;
see “The Natural Resource Curse: A Survey”, NBER working
paper, March 2010, by Jeffrey Frankel:

Commodity prices can decline over time.

Natural resource sectors can crowd out manufacturing, a
concern if the sector offers positive spillovers for growth.

International commodity prices are notoriously volatile.

Much abundance can undermine institutions, especially if
it fosters rent-seeking.
In addition, natural resource wealth can be a doubleedged sword, as swings in commodity prices can entail
macro instability, through the real exchange rate and
government spending, imposing unnecessary costs. The
international literature suggests that oil booms typically entail
higher government spending on two main budget items: public
sector investment and government wage bill. Infrastructure
investment is surely welcome if well designed and
implemented within a long-term framework — as opposed to a
surge in white elephant projects which later on end up
unfinished or strapped for maintenance funds when
commodity prices go down. As for increased spending on the
public sector wage bill, as has already been the case in Brazil
in recent years, a key concern is the asymmetric nature of
such spending, which is very hard to cut back when needed.
2.0
1.0
Oil - domestic
0.0
2007
2008
2009
2010
2011
2012
2013
2015
2020
Source: Company data, Morgan Stanley LatAm Economics
23
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Equity Section
24
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Agribusiness
An Infrastructure Play Via Rumo
Javier Martinez de Olcoz Cerdan
Morgan Stanley & Co. Incorporated
[email protected]
Alessandro P Baldoni
Morgan Stanley C.T.V.M. S.A.+
[email protected]
We see Cosan as an infrastructure play. Following
Cosan’s joint venture with Shell (see sidebar), Cosan is not
just a sugar and ethanol play anymore. We estimate that fuel
retail business now represents 45% of our price target of
R$29, and Rumo (Logistics) and other businesses represent
22% (see Exhibit 30). After the deal is finalized, Cosan is
expected to have a market share of 24%, 30% and 39% in
gasoline, ethanol, and aviation fuel retailing, respectively, and
transport 10 million tons of sugar by railway and 18 million
tons through its Port Terminal. As a reference, Brazil
exported 24 million tons last year.
Exhibit 30
Cosan Price Target Breakdown (BR$/share)
40.0
2.1
35.0
4.3
30.0
13.1
-5.5
29.0
1.5
25.0
20.0
15.0
What is the Cosan/Shell JV?
In 2008 Cosan acquired Exxon Mobil’s fuel retail assets
in Brazil. In February 2009 it announced a MOU to form
a joint venture with Shell combining its operations with
Shell Brasil. There are to be two JVs, one for the sugar
& ethanol assets (including cogeneration), and the other
for fuel retail assets (combining Esso and Shell
distributions in Brazil). Cosan’s Rumo, land, and
lubricant business will remain outside the JV. Cosan
and Shell are to have shared control of both JVs.
Rumo
Rumo Logistica, owned 93% by Cosan, is a company
that specializes in sugar and grain logistics. Cosan
originally had a Port Terminal in Santos with partnership
with Nova America group. In 2009 Cosan acquired Nova
America and become the sole owner of the terminal.
Then it began to broaden its logistics business (now
Rumo) which included the expansion of the terminal and
a partnership with America Latina Logistica (ALL) for
sugar railway transportation. Given ALL had the
concession, but not the capacity to transport all of
Rumo’s expected volume, Rumo will invest ~R$1.3
billion to expand ALL’s rail transport capacity in the
sugarcane area of SP state and will hire ALL to provide
the transport services up to its Port Terminal. We expect
Rumo to generate an EBITDA of R$400 million in 2013.
13.5
10.0
5.0
-
S&E +
Cogen
Fuel Retail
Business
Lubs
Rumo
Other
Net Debt
Total
Source: Morgan Stanley Research
Shell JV plays a relevant role in this call. We have never
been fans of vertical integration in the sugar and ethanol
sector, but believe that the Shell JV will add a lot of value,
especially due to potential synergies with Esso assets
(acquired by Cosan in 2008).

First, the JV, in our view, will allow Cosan to gain critical
mass, which is the main profitability driver in fuel retailing. We
expect NPV of synergies to be R$1.5 billion as we see
EBITDA /cubic meter increasing from R$40 today to R$54 in
two years, in line with that of Ultrapar, the second player in
the market, as Cosan closes the market share (and EBITDA)
gap with Ultrapar (covered by Subhojit Daripa)

Second, we expect the JV will deleverage Cosan, likely:
i) allowing it to participate in M&A transactions at a good time
(i.e., when sugar is in the middle of a down-cycle), and
ii) increasing the viability of the Rumo logistic project. (See
our note of April 12, 2010, Buy CZZ and CSAN Despite Sugar
Prices; JV Adds Value, for more details).
Shell JV also has positive implications for Rumo. Last
year, Cosan was searching for private investors to acquire a
stake in Rumo and help finance its capex needs. After the
Shell JV, Cosan’s leverage would be significantly reduced. In
anticipation of that, the private placement for Rumo was put
on hold until the closing of Shell deal. With the lower leverage
Cosan should have greater bargaining power in the
negotiations, or even the option to finance the project alone.
25
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 31
Rumo’s Expected Volumes and Capex
2010e
2011e
2012e
Volumes ('000 tonnes)
Railroad
5,313
6,513
7,717
Port
11,000
12,000
15,000
Capex (R$ mn)
Railcars and Locomotives
290
78
68
Permanent Way
0
524
0
Transshipment Warehouses
121
117
71
and Port Terminal
Total Capex
411
719
139
Source: Company data, Morgan Stanley Research estimates
2013e
2014e
10,662
15,000
10,875
18,000
-
-
-
-
We think the stock is attractively valued. We arrive at
our price target (R$29.0 for CSAN and US$14.8 for CZZ)
using a DCF model in which we include all of Cosan’s
businesses (fuel retail, logistics, etc.). Our sum-of-the-parts
methodology generates a similar valuation, R$28.6 for
CSAN. We use a WACC of 11.95% for CZZ and 12.7% for
Cosan SA, based on equity risk premium of 5.5% and a 4%
real terminal growth rate in year 2019.
multiples, and is now trading at US$55/ton, which is below
historical multiples, below peers (SMTO trades at
US$83/ton) and below M&A transactions in the sector,
which have recently ranged from US$77–110/ton.
Exhibit 32
Cosan’s Multiples Got Cheap After Shell Deal
(EV/tn)
200
180
160
140
120
100
80
60
40
CSAN3 post Shell deal
20
Sugar business is trading at a large discount, and is
attractive even in a down cycle. Analyzing the implicit
EV/ton multiple for the sugar and ethanol business after the
deal with Shell shows us that the stock is cheap in terms of
0
Jul-07
Jan-08
CSAN3
Jul-08
Jan-09
SMTO3
Jul-09
Jan-10
CSAN3 post Shell
Source: Company data, Morgan Stanley Research
26
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Cosan: Play Both Vehicles
Cosan Limited is the holding company that controls Cosan SA. Therefore, our scenario analyses are identical for the two stocks.
The difference in upside reflects our view of the holding company discount.
Cosan SA (CSAN3, R$22.1, Overweight, PT R$29.0)
Cosan Ltd (CZZ, US$10.6, Overweight, PT US$14.8)
$ 20
R$ 40
18
R$35.48 (+61%)
35
$17.30 (+63%)
16
30
R$28.99 (+31% )
25
$14.76 (+39% )
14
22.1
12
10.62
10
20
R$16.40 (-26%)
15
$8.14 (-23%)
8
6
10
4
5
2
0
Price Target (Apr-11)
Apr-08
Oct-08
Historical StockOct-09
Performance
Apr-09
Apr-10
WARNINGDONOTEDIT_RRS4RL~CSAN3.SA~
Source: FactSet (historical chart data), Morgan Stanley Research estimates
CSAN3
CZZ
Price Tgt
R$29.0
Price Tgt
US$14.8
Historical StockOct-09
Performance
Apr-09
Apr-10
CurrentOct-10
Stock Price
WARNIN GDONOTED IT_RRS4RL~CZZ.N~
Source: FactSet (historical chart data), Morgan Stanley Research estimates
Investment Thesis
Scenarios Apply to
Both Stocks
 After the JV with Shell and the investments in Rumo, Cosan has
diversified into businesses that can generate synergies, in our view.
Derived from our base case scenario.
Current share price does not appear to reflect the value of all these
Bull Case
R$35.5
Bull Case
US$17.3
3.5x 2011
EV/EBITDA
3.9x 2011
EV/EBITDA
Base Case
R$29.0
Base Case
US$14.8
4.0x 2011
EV/EBITDA
4.3x 2011
EV/EBITDA
Bear Case
R$16.4
Bear Case
US$8.1
5.2x 2011
EV/EBITDA
5.5x 2011
EV/EBITDA
Sugar prices are in US$0.184/lb for
2010/11. FX is at 1.8 for YE10. Shell
and Esso deal generates more
synergies than expected. Rumo
increases further than current
guidance.
Sugar prices are in US$0.18/lb for
2010/11. FX is at 1.7 for YE10. Shell
and Esso deal generates expected
synergies. Rumo delivers its
guidance.
Sugar prices are in US$0.162/lb for
2010/11. FX is at 1.6 for YE10. Shell
and Esso deal gets less than
expected synergies. Rumo does not
deliver full guidance.
CSAN3: Bull to Bear
businesses.
 The valuation gap between CZZ and CSAN3 has been reduced
significantly in the last months, and is now below the historical average.
We see conditions under which the current CZZ structure could be
ended, improving corporate governance and potentially bringing the
discount to zero.
Potential Catalysts
 Closing of the Shell/Esso JV. Official guidance is early August, but we
believe the deal could be closed in early June. For CZZ, the main
catalyst would be the announcement of an operation to end the CZZ
shareholder structure, bringing all minorities to CSAN3 and reducing the
gap to zero.
Risks
 Delays in or failure to close the Shell JV. Failure to deliver on guidance
from Rumo. No changes in CZZ current structure. Market concerns
during the down part of the commodity cycle.
CZZ: Bull to Bear
40.0
20.0
Price Target: $29.0
35.0
30.0
18.0
$4.5
35.5
29.0
$1.8
$4.3
12.0
$1.8
15.0
$0.7
14.0
$10.8
20.0
Price Target: $14.76
16.0
$2.0
25.0
10.0
0
Price Target (Apr-11)
Apr-08
Oct-08
CurrentOct-10
Stock Price
10.0
$2.3
8.0
17.3
14.8
6.0
16.4
4.0
5.0
8.1
2.0
-
Bear
Case
International
prices
Other
Source: Morgan Stanley Research estimates
Base
Case
International
prices
Other
Bull
Case
Bear
Case
International
prices
Other
Base
Case
International
prices
Other
Bull
Case
Source: Morgan Stanley Research estimates
27
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Basic Materials
Steel Is Our Favorite Way to Play
Infrastructure in Brazil; Limited
Benefits to Mining or Pulp & Paper
Morgan Stanley & Co. Incorporated
Carlos De Alba
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Bruno Montanari
[email protected]
The early-cycle nature of steel consumption makes steel
our favorite way to play the infrastructure theme in Brazil…
Infrastructure investments seem likely to drive stronger GDP
growth over the next 5–10 years. Brazil’s hosting of the World
Cup (2014) and the Olympics (2016), as well as development
of the pre-salt oil reserves, should drive higher steel
consumption in just the next couple of years, ahead of many
other industrial sectors in the country.
…while paper and mining should see little benefit from
investment-led GDP growth, in our view. We view paper
demand as the second derivative to an accelerated growth
driven by infrastructure, which would generate increased
consumption, particularly during the World Cup and Olympics.
However, we believe it is too early for this second derivative
to be a catalyst for equities. As for mining stocks, they should
see limited benefits from higher steel demand as steel mills
are highly vertically integrated into iron ore.
Steel production capacity in Brazil is not a concern for
accelerated growth from infrastructure. Based on the
scenarios outlined by our economics team, we think it is very
likely that steel production capacity will be sufficient to support
future infrastructure investments in Brazil. Only in the bull case
(6.0% GDP growth over the next 10 years) would steel capacity
be insufficient to meet long steel demand, and then only in
2019. In that scenario, we would expect either a stronger
supply response by incumbent local steelmakers (to avoid new
entrants) or an increase in steel imports into Brazil.
We also do not rule out investments necessary to meet
specific demand from a pickup in infrastructure expenditures.
For instance, Brazil does not produce railway tracks, but if
demand from this segment starts to intensify, we believe local
steel producers will invest in rail rolling mills to meet future
domestic requirements. Investments in steel rolling and
finishing capacity are not as capital intensive as those in
crude steel expansions. They are also easier to execute,
which lessens concerns with steel shortage in the domestic
market.
Exhibit 33
Planned Flat Steel Capacity Expansions More than
Enough to Accommodate Future Demand…
FLAT STEEL - DOMESTIC SURPLUS (M TONNES)
20
18
16
14
12
10
8
6
4
2
0
2006
2008
2010E
2012E
Bear Case
2014E
2016E
Base Case
2018E
2020E
Bull Case
Source: IABr, Morgan Stanley Research estimates
Exhibit 34
…While Limited Growth in Long Steel Supply Would
Result in Supply Deficits in Our Bull Case Scenario
LONG STEEL - DOMESTIC SURPLUS (M TONNES)
10
8
6
4
2
0
-2
2006
2008
2010E
2012E
Bear Case
2014E
2016E
Base Case
2018E
2020E
Bull Case
Source: IABr, Morgan Stanley Research estimates
Steel Industry Investment Case
We expect event-driven investments to boost Brazilian
steel consumption by 4% in the next seven years. Steel is
consumed by a large array of economic segments, from basic
utilities (electricity and sanitation) to industrial applications
(automotive and oil industries).
Four events should generate 8.0 million tonnes of
incremental steel consumption in Brazil (see Exhibit 35).
Steel historically has shown a strong correlation with GDP
(0.77), with its steel consumption expanding 1.7–2.0x real
GDP growth over the past 35 years, depending on product
grade. However, we believe that major events in Brazil in the
coming years will intensify steel consumption:

Minha Casa, Minha Vida housing programs

World Cup

Olympics

Oil & gas investments
28
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 35
We See 8.0Mt Incremental Steel Demand in Brazil
Driven by Specific Events in the Next Seven Years
Minha Casa, Minha Vida I
Minha Casa, Minha Vida II
World Cup
Olympic Games
Oil & Gas (mainly Pre-Salt)
Total
Steel Demand (2010-16)
Increase in Demand
Steel Demand
(K tonnes)
450
900
2,000
2,000
2,700
Main
Segment
Long
Long
Long / Flat
Long / Flat
Flat
Time
Horizon
2009-11
2011-14
2010-14
2010-16
2010-16
8,050
197,326
4.1%
Fundamentals Bottoming, Balanced Risk-Reward After
Underperformance, April 22). Gerdau looks fairly priced after
having underperformed its Brazilian steel peers by ~19
percentage points YTD. It is trading at 6.7x 2011e EBITDA, in
line with the forward multiple that we view as fair for long steel
stocks.
Exhibit 37
Long Steel Is Leveraged to Construction, but Brazil
Represented Only 38% of Gerdau’s Volumes in 2009
Gerdau Sales Volume - 2009
Segment Exposure
Source: IABr, Ministry of Sports, Morgan Stanley Research
We see an attractive market for both long and flat steel
products. The incremental steel consumption implied by most
of the major events we highlight above suggests increasing
exposure to long steel producers. Based on technology in use
today, the elasticity of long steel demand to GDP growth is
~15% higher than that of flat steel demand. However,
steelmakers are developing flat steel solutions for civil
construction, including housing and stadiums, which should
allow flat products to exhibit a higher correlation to economic
activity in the coming years. Furthermore, incremental steel
demand arising from oil & gas investments will be
concentrated in heavy plates, a type of flat steel product.
Exhibit 36
New Applications of Flat Steel in Civil Construction
Will Likely Increase Its Elasticity to GDP Growth
Elasticity of Steel Demand to Real GDP Growth
2.0x
NEW UTILIZATION
1.7x
Agriculture
Construction
1%
50%
LatAm
14%
Brazil
38%
North America
35%
Industrial
49%
Specialty
13%
Source: Company data, Morgan Stanley Research
Usiminas (Equal-weight): the sole producer of heavy
plates for the oil & gas industry. Usiminas is also developing
new product applications for construction. The company’s
businesses enjoy positive fundamentals that are offset by a fair
valuation. We like its exposure to the recovery of steel demand
in Brazil through a portfolio of high value-added products,
including heavy plates, and the potential for unlocking value at
the iron ore division. Further, Usiminas offers the highest
EBITDA growth (86%) in our steel coverage universe (58%, on
average) over the next couple of years. However, the stock
has rallied 30% in the last three months (USD) vs. 23% for its
peers and 8% for the Bovespa, and we see limited upside.
Exhibit 38
Usiminas: 25–30% of Mix Exposed to Infrastructure
Infrastructure Product Mix
Long Steel
Flat Steel
35%
Source: IABr, Morgan Stanley Research
30%
Stock Picking: Wait for a Better Entry Point
25%
Gerdau and Usiminas offer leverage to infrastructure
growth, but valuation is not compelling. Steel price
increases beyond what we model could make the stocks less
expensive, but still not attractive, in our view.
20%
Gerdau (Equal-weight): the leading supplier of long steel
products for civil construction in Brazil. Gerdau’s exposure
to the US is priced in and recent underperformance relative to
its peers is unlikely to continue, but it is too early to buy, we
believe. We think US commercial construction will start to
recover, following the residential and industrial trend (see
0%
15%
10%
5%
1Q03
2Q05
3Q07
4Q09
1Q12
2Q14
3Q16
Source: Company data, Morgan Stanley Research
Note: infrastructure product mix: heavy plates and processed structures
29
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Risks to our ratings, price targets, and earnings
estimates include political and macro risks in emerging
markets, a sharp slowdown in the global economy driven by
China, slower than expected demand for metals, abrupt
decline in metal prices, increases in raw material costs, failure
to deliver growth plans, long-lasting strikes, changes in mining
and environmental regulations in countries where companies
operates, other unforeseeable operating disruptions and
adverse litigation outcomes.
Capacity & Demand Evolution in Brazil –
Base Case Scenario
Exhibit 39
Flat Steel: Capacity vs. Demand (M tonnes)
Capacity
Consumption
Surplus
40
35
30
25
20
15
10
5
0
2006
2008
2010E
2012E
2014E
2016E
2018E
2020E
Source: IABr, Morgan Stanley Research estimates
Exhibit 40
Long Steel: Capacity vs. Demand (M tonnes)
Capacity
Consumption
Surplus
25
20
15
10
5
0
2006
2008
2010E
2012E
2014E
2016E
2018E
2020E
Source: IABr, Morgan Stanley Research estimates
30
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Gerdau (GGBR4.SA, R$28, Equal-weight, Price Target R$32)
Gerdau Currently Offers a Balanced Risk-Reward Proposition
Investment Thesis
R$45
R$41 (+44%)
40
35
R$ 28.45
30
R$32.00 (+12%)
25
R$24 (-16%)
20
15
10
5
0
Apr-08
Oct-08
Apr-09
Price Target (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
Source: FactSet (historical chart data), Morgan Stanley Research estimates
Price Target R$32
Our year-end 2010 price target is determined by our DCF model,
using a WACC of 9.6%.
Bull
Case
R$41
6.5x
2011e
EV/EBITDA
Growth surprises to the upside. Global growth reaccelerates;
and industry discipline allows coordinated price increases,
sustaining healthy metal spreads. Vertical integration with more
iron ore own energy generation energy boosts profitability.
Base
Case
R$32
6.4x
2011e
EV/EBITDA
Slow recovery in North American volumes; Brazilian
operations recovering. Non-residential construction in the US
slowly returns to pre-crisis levels over 2–3 years as US
government incentive is applied to low structural steel intensive
use. Brazilian demand proves resilient and continues to grow, but
threat of imports reduces pricing power.
Bear
Case
R$24
7.4x
2011e
EV/EBITDA
Imports come to Brazil sooner; lower operating rates.
Capacity utilization remains depressed among Gerdau
operations;, imports continue to gain market share in Brazil,
compressing metallic spreads and EBITDA/t.
Bear to Bull: Pricing Power and Operating Rates Driving Value
45
40
35
30
25
20
15
10
5
0
all values in R$
6.00
price target: 32
3.00
2.50
2.00
3.50
41.0
< Premium
on Brazilian
Rebar
< Pricing
Power
ex-Brazil
Source: Morgan Stanley Research estimates
Lower
Operating
Rates
Base
Case
Key Value Drivers
 Operating flexibility provided by
combination of low-cost electric arc
furnace (EAF) facilities and an
integrated plant provides strong
leverage to steel prices in Brazil.
 Relative low fixed costs in N. Amer.
operations results in high sensitivity
to operating rates in the region.
Potential Catalysts
 Positive: commercial construction
indicators continue to improve.
 Negative: long steel imports
continue to rise in Brazil into 2Q10.
Where We Could Be Wrong
32.0
24.0
Bear
Case
 We see a more balanced risk-reward
on GGBR4 that makes the stock’s
YTD underperformance relative to
its peers unlikely to continue.
Further, EV/EBITDA multiple has
contracted 16% YTD.
 We believe commercial construction
in the US has bottomed, which
eases the main concern behind our
previous Underweight rating. We
also think that Gerdau’s exposure to
this segment is now well understood
by the market, and it should no
longer be a negative catalyst for the
stock.
 In Brazil, although the domestic
price premium has closed to 29%
from 50% recently, we believe
Gerdau will wait to assess the
sustainability of these levels before
implementing price increases.
Faster
Volume
Recovery
> Pricing
Power
Bull
Case
 We continue to forecast flat long
steel prices in Brazil this year, but
our sensitivity analysis shows higher
prices in Brazil would bring
meaningful upside to our estimates.
 Gerdau succeeds in curbing
Brazilian rebar imports by tightening
its control over the distribution chain
and customer loyalty.
31
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Usiminas (USIM5.SA, R$56, Equal-weight, Price Target R$62.50)
Exposure to Solid Industry Fundamentals, but Entry Point Not Attractive
R$100
90
R$90 (+60%)
80
70
R$ 56.11
60
R$62.50 (+11%)
50
R$44 (-22%)
40
30
20
10
0
Apr-08
Oct-08
Apr-09
Price Target (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
Price Target R$62.50
Determined by sum-of-the-parts valuation based on multiples to
our 2011e EBITDA (6.0x for steel and 7.5x for iron ore)
Bull
Case
R$90
Expansions resumed. Emerging markets growth reaccelerates,
allowing stronger price increases in 2010/2011. Usiminas
delivers the greenfield Santana do Paraíso plant, increasing crude
steel capacity by 5.0m tonnes. Efficient port logistics for mining
expansion is found, allowing the mine to be expanded to 29Mtpy.
Base
Case
R$59
6.7x
2011e
EV/EBITDA
Steel prices recovering; trimming iron ore expansion. The
improvement in Brazilian steel consumption and raw materials
cost hikes allows mills to implement a 13% price increase YoY in
2010. Iron ore output reaches just the first phase of 13Mtpy, as
logistics solution for the project are still uncertain at this point.
Bear
Case
R$44
10.3x
2011e
EV/EBITDA
Overhangs prevail. Global economy decelerates again, causing
weakness in international steel prices and another period of poor
demand and low steel prices in Brazil. Usiminas cancels the
Santana do Paraíso Project and faces capex inflation on existing
projects.
Bear to Bull: Steel Market Profitability and Expansions Driving Value
100
R$10.0
80
60
R$90
R$12.0
R$59
R$3.0
40
R$7.0
R$14.0
Price Target:
R$62.50
 We like Usiminas’s exposure to the
strong rebound expected for the
Brazilian economy and local steel
consumption.
 Potential to unlock value at its iron
ore division will likely drive the stock
in coming months; we see a
possible 31% upside if the market
were to pay peak multiples for iron
ore.
 However, USIM5 shares are trading
at 6.2x 2011E EBITDA, in line with
our fair multiple for the company on
our sum-of-the-parts valuation.
Key Value Drivers
Source: FactSet (historical chart data), Morgan Stanley Research estimates
5.6x
2011e
EV/EBITDA
Investment Thesis
R$44
 World-class steel operating
practices and growing iron ore
integration allow the company to
achieve a lowest cost structure.
 Efficiency has supported strong
EBITDA margins over prior cycles.
Potential Catalysts
 Positive: delivery of higher product
mix in the domestic market.
 Positive: capital goods industry
growth (steel intensive) catches up
to overall IP growth in Brazil
 Negative: Imports of flat steel
continue to grow in absolute terms
during the coming months.
Where We Could Be Wrong
 Steel imports in Brazil continue to
increase into 2Q10, which could
jeopardize mills attempt to increase
domestic prices in Brazil.
 Usiminas finds a strategic partner to
help it develop its iron ore assets,
and the stock continues to rally off a
high base.
20
0
Bear
Case
Capex
Inflation
(5%)
Source: Morgan Stanley Research estimates
Operating
Margin
Squeeze
Base
Case
Stronger
Steel
Markets
J.Mendes @
29Mtpy
Santana
do Paraiso
@ 5.0mtpy
Bull
Case
Bear-to-bull estimates base on our DCF model
32
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Oil, Gas & Petrochemicals
Pre-Salt and Local Content
Boosting Local Development
Morgan Stanley C.T.V.M. S.A.+
Subhojit Daripa, CFA
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Miguel F. Rodrigues
[email protected]
Exhibit 41
Main Prospects Indicate 7.2 bn boe Net for PBR
Reserve estimates (Bln. Boe)
Recoverable factor (%)
Petrobras Working Interest (%)
Net Reserves
(Bln Boe @mid point of range)
Consortium
Tupi
5-8
25%
65%
Iara
3-4
25%
65%
Guara
1.1 - 2
25%
45%
4.2
BG (25%);
GALP (10%)
2.3
BG (25%);
GALP (10%)
0.7
BG (30%);
Repsol (25%)
Source: Company data, Morgan Stanley Research
Exhibit 42
We expect investment in the pre-salt oil reserves to
be a major driver of infrastructure demand. Petrobras
Assuming Recoverable Factor of 40%, PBR
Reserves Could Increase to 16.4 bn boe
has impressive plans to expand capacity by spending over
US$200 billion in 2010–14. Per BNDES, investment in the
oil and gas sector should expand 13.5% p.a. in 2010–13.
Adjusted recoverable factor (%)
Adjusted reserve estimates (BlnBoe)
Petrobras Working Interest (%)
Net Reserves
(Bln Boe @mid point of range)
Despite focus on the upstream segment, Petrobras also
plans to expand its refinery park. In Petrobras’s
announced 2010–14 plan, downstream investments
represent 38% of total investments, up from 25% in its
previous plan (2009–13). In the event of insufficient funding,
we think Petrobras would defer downstream investments
and prioritize the upstream business. Petrobras’s
downstream investments are concentrated today in the
development of four refineries: Abreu de Lima, with capacity
of 230 Kbpd; Comperj, 150 Kbpd; Premium I, 600 Kbpd; and
Premium II, 300 Kbpd.
Source: Company data, Morgan Stanley Research
Also, we expect prospective oil gains to fill government
coffers, allowing infrastructure spending elsewhere. Only
about one-third of oil dividends are transferred to the
government, given the ownership structure of Brazil’s main oil
company. Still, we estimate that total oil-related payments to
the government will increase to about 1.2% of GDP by 2014,
or a gain of about 0.3% of GDP relative to 2009. Numbers
would grow over time, as oil production ramps up.
Iara
40%
4.8 - 6.4
65%
Guara
40%
1.8 - 3.3
45%
8.3
5.6
2.5
Local content requirements:

We think these requirements will delay development of
the pre-salt, but not as much as the market expects. ANP
(Brazil’s regulatory agency for oil and gas) has been
increasing the minimum local content in the exploration and
development of Brazilian oil and natural segment. In the
development stage, the minimum local content for platforms is
~70%. We expect this to delay development somewhat by
limiting the use of global resources; however, it will be a key
driver of local industry development. Our conversations with
ANP left us convinced that, forced to choose between
delaying production or limiting domestic fabrication, it would
choose the latter.
Exhibit 43
Minimum Local Content Requirement Evolution
86%
89%
84%
81%
77%
86%
Pre-salt reserve estimates look conservative:

We think the estimates may be underestimated by at
least 40%. Based on our conversations with managements of
Petrobras and Repsol, among others, we are convinced that
Petrobras’s estimates of the pre-salt prospects are on the
conservative side due to recovery factor and absolute volume.
Tupi
40%
12.8
65%
79%
48%
79%
74%
54%
69%
40%
42%
27%
25%
1R
39%
28%
2R
3R
Exploratory Phase
4R
5R
6R
7R
8R
9R
10R
Production Phase
Source: Company data, Morgan Stanley Research
33
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
According to Petrobras, in most areas where the company
requires service, the local industry already has a high level of
local content. One except is the maritime space, particularly
related to the shipyard for offshore construction.

OSX should benefit. We expect newly formed offshore
platform and rig manufacturer OSX to benefit significantly
from the local content requirement. As a short-term example,
Petrobras announced a tender for the construction of 28 rigs
in early May. The rigs (semi-submersible or drillships) will
have a combination of owned and chartered rigs to Petrobras
and will be built in Brazil. Based on our conversations with
industry players, we think Petrobras is likely to award
7+7+1+1 to virtual yards and the remaining 12 rigs to charter
players. OSX will likely not take part in the initial batch of
owned rigs as its yard had not received the preliminary
environmental permit by the time of the invitation letter (now
the yard obtained the preliminary permit, but it awaiting the
installation permit). However, it is looking to make a JV with
an international company to participate.
We recently initiated coverage of OSX with an Overweight
rating (see our report dated April 28). OSX, which IPOed in
February, is a manufacturer of offshore platforms and rigs (it
has a contract to provide and service all of OGX’s production
infrastructure requirements); it also leases E&P units to oil and
gas companies and services the units. We think the company
may emerge as a world leader over the next five years and
eventually grab the lion’s share of domestic orders, although we
are not including that in our base case, which considers only
the announced demand for offshore units from sister company
OGX.
Five pillars of our OSX investment case:

Local content requirements leads OGX to contract its
equipment s in Brazil. In light of local content rules, OGX has
little option but to purchase equipment fabricated in Brazil. In
the early years of delivery, we think OSX will be a quasi offbalance sheet company to OGX whereby its margins and
profitability will be defined ex-ante.

Size: Potential order book of $25 billion from OGX. OGX
is the E&P company of the EBX group, which has 22 offshore
blocks spanning across 4 offshore basins. According to
DeGolyer & MacNaughton (D&M), OGX has 6.8 billion boe of
net prospective resources, which will require 48 units,
amounting to a potential backlog of $30 billion. As per the
agreement between OGX and OSX, the former will fabricate
all but two of the units required by OGX. Should all the 48
units be built, we estimate that OSX will be fully occupied until
2017, at least.

Attractive commercial relationship with OGX. According
to the contract between OGX and OSX, an open book
approach will guarantee an equivalent of 15% gross margin
for the shipyard, a 15% ROE for the leasing unit, and a 5%
gross margin for the service unit. We think this relationship is
vital for the yard and a key advantage in relation to other
yards as potential cost overruns will be passed on to OGX.

Attractive financing from government-subsidized funds.
OSX will ask for financing to FMM (Fundo de Marinha
Mercante), a naval-type fund to build the shipyard. FMM can
provide up to 90% financing at attractive cost of funding (2.0–
4.5% in USD). In addition, the shipyard may access funds
from FGCN (Fundo Garantidor de Construcao Naval) to tap a
potential cash shortfall stemming from cost overruns. The
federal government has put R$15 billion in the FMM and R$5
billion in the FGCN and it is a key initiative of the federal
government to foster naval construction.

Partnership with Hyundai in the shipyard. OSX has
entered into a technology partnership with Hyundai, the
world’s largest shipbuilder, to acquire state-of-the-art
technology and gain expertise for OSX’s own shipyard. OSX
will have access to expertise from Hyundai, which will supply
technical advice, staff training, technology and engineering
know-how on the shipbuilding industry. Hyundai will have a
10% ownership in the yard.
Risks to our view:

Execution risks are evident at this stage of development
as producing platforms/rigs require high standards of welding
systems and skilled workforce. As the shipyard is slated to
become the biggest in the Americas, there are risks related to
construction of the plant.

Cost overruns could defer the earnings stream. Although
the agreement made with OGX calls for an open book
approach, the company could face delays in the delivery of
the units, of which in this case its earnings and cash flow
stream will be deferred throughout the time of the delay.

OGX may not prove up its reserves and OSX may loose
its main customer. At this point, OGX did not finalize all the
steps to certify its reserves, remaining under the category of
net prospective resources.

Environmental risks could lead to a delay in the start-up
of the shipyard, slated to begin operation in 4Q10. So far, the
EBX group has secured the land and applied for the
environmental permit with IBAMA. The company expects to
receive the permit in time to begin operations this year but
delays could undermine this schedule, putting at risk the initial
start of the operations in 2011.
34
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
OSX (OSXB3, R$557, Overweight, Price Target R$960)
Risk-Reward View: Base Case Is Centered on OGX Backlog Only
Investment Thesis
R$1,800
1,600
R$1600 (+187%)
1,400
1,200
1,000
R$960.00 (+72%)
800
R$ 556.99
600
R$430 (-23%)
400
200
0
Apr-08
Oct-08
Apr-09
Price Target (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Apr-11
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~OSXB3.SA~
Source: FactSet (historical chart data), Morgan Stanley Research estimates
Price Target R$960
Based on DCF using a cost of equity of 10% in real terms
Bull
Case
R$1,600
Turning 18: Order intake based on OGX announced units plus
Petrobras drillships and FPSOs to third parties, for a total of 76 units, or
$50 billion of potential backlog. Each FPSO takes on average 4 years of
fabrication.
Base
Case
R$960
Fully Leveraged to OGX: Order intake based on OGX announced
units (48); first 20 units take on average 5 years to be built, whereas the
remaining units take on average 4 years.
Bear
Case
R$430
OGX announced discoveries only: Order intake based only on
discoveries announced by OGX so far (~3.4 billion boe), equivalent to
25 units, or $12 billion of potential backlog. Environmental permit delays
shipyard start-up in 11/2 year. We assume each FPSO takes on
average 6 years of fabrication. Each of the 4 DPs made to Petrobras
loses $500 million. (Value destruction considered only in the bear case,
if OSX wins Petrobras DPs tender)
OSX Bear to Bull Cases (R$ per share)
2,500
2,000
550
60
1,500
1,000
1600
price target: 960
30
500
30
330
960
170
0
Permit delay DP Value
Destruction
Source: Morgan Stanley Research estimates
Our investment case is based on:
 Protected environment. Commercial
relationship with OGX based on an
open book approach and local
content requirements.
 High earnings visibility. Potential
backlog with OGX amounts to an
estimated $30 billion and would run
trough 2019.
 Macro environment. Fabrication
market is bottoming out, potentially
leading to a tight supply/demand
balance in the near future.
Key Value Drivers
 Backlog. Large part of the backlog
comes from sister company OGX,
with further potential from other
players in the Brazilian offshore.
 Fabrication time, delays in
construction. Although the
agreement made with OGX calls for
an open book approach, the
company could face delays in the
environmental permit and delivery of
the units, deferring cash flow.
Potential Catalysts
 Environmental permit is granted to
OSX shipyard by the end of the
year.
 Winning four drillships from the
upcoming PBR tender on May 20.
 Review of the D&M appraisal report,
increasing OGX’s net prospective
resources to ~9 billion boe from 6.8
billion boe.
Where We Could Be Wrong
430
Bear
Case
OSX could become a global player in
the offshore fabrication market as it
gains high-efficiency expertise
levered by its relationship with
Hyundai and OGX.
Backlog
Base
Case
4 DP
Petrobras
Backlog
Delays in
construction
Bull
Case
 Execution risks
 Cost overruns
 OGX may not prove up its reserves
Environmental risks
35
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Lupatech (LUPA3.SA, R$24, Overweight, PT R$34); covered by Javier Martinez
Risk-Reward View: The Opportunity to Play Brazil Oil Services Boom
R$70
60
50
R$45 (+89%)
40
R$34 (+43%)
30
R$ 23.85
R$22 (-8%)
20
10
0
Apr-08
Oct-08
Apr-09
Base Case (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~LUPA3.SA~
Source: FactSet, Morgan Stanley Research
Price Target R$34
Based on DCF model derived from our base-case scenario.
10% average WACC (2010-2030), 4.0% perpetuity growth.
Bull
Case
R$45
13x
Bull Case
2010e
EBITDA
International player: Lupatech is able to grow top line faster by
expanding outside Brazil. Expansion comes at a price with
margins on average 200bps lower than in base case.
Base
Case
R$34
11x
Base Case
2010e
EBITDA
Strong competitor: Lupatech remains mainly a local player with
Petrobras as its main customer. We assume the company stays
competitive despite competitive pressures but ultimately sees
margins falling to industry averages.
Bear
Case
R$22
9x
Bear Case
2010e
EBITDA
Loosing ground: Lupatech remains an important player locally
but loses some ground to new entrants. Revenue grows given
the boom in the industry locally but Lupatech has a smaller share
of a larger pie. Margins are also hurt as international competitors
establish a stronger presence in Brazil, though not as much as in
the bull case.
Lupatech’s - Bear to Bull
60
R$9
Price Target: R$34
R$(6)
R$8
45
R$45
R$4
R$8
30
15
R$34
R$22
0
Bear
Case
Platforms
Compressors
Source: Company data, Morgan Stanley Research
Base
Case
Platforms
Compressors
/ Other
Margins
Bull
Case
Why Overweight?
 Local player: Only local player with
a strong long-standing relationship
with Petrobras and with a growing
product portfolio that includes both
oil and gas E&P, transportation and
refining.
 Expanding client base in Brazil:
As other oil companies expand
operations in Brazil, Lupatech could
gain new clients.
 Opportunity to expand
internationally: Deep-water
exploration is also growing in other
regions of the world and Lupatech
could export its Brazilian experience
and know-how.
 Capital investment cycle: The
equipment and services segment is
at the bottom of the capital
investment cycle.
Key Value Drivers
 Oil macro fundamentals signal a
tightening of supply. New
exploration in deep-water should
trigger capital investments in the
region.
 E&P capex increasing in Brazil as
PBR accelerates production or as
other players start exploration.
Potential Catalysts
 Movement in the backlog should
be the first signal that Lupatech wins
new contracts.
 PBR’s capital increase could
accelerate the capital investment
process.
 New projects outside Brazil would
indicate success in becoming an
international player.
 Joint Ventures with independent
players would allow Lupatech to
expand product portfolio.
Risks
 Competition: PBR’s announced
investment over the next decade will
bring more competition to Lupatech.
36
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Transportation Infrastructure: Highways and Rail
CCR and ALL Benefit from
Accelerating Infrastructure
Investment
Morgan Stanley C.T.V.M. S.A.+
Nicolai Sebrell
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Augusto Ensiki
21% in 2001, to 25% by 2007 (latest available data), which
shows steady progress. Growth in volume during that period,
despite two downturns, has averaged over 10% for ALL.
CCR has experienced similar success with tolled traffic
growing over 2.0x GDP for much of the decade, due to capex
spent on road improvements and network expansion. This
year, CCR should again exhibit healthy growth as high as
12%, or about 2x GDP.
[email protected]
Government focus on transportation infrastructure is
best played through CCR (CCR) and America Latina
Logística (ALL). Strong established operations, scale,
geography, established ties with the BNDES, and close
relations with the regulatory authorities set CCR and ALL
apart from peers.
Creating value in infrastructure investment depends on
winning and executing government projects at an acceptable
price and a sufficient rate of return for stakeholders. Both
CCR and ALL have deep experience in such projects. CCR
specializes in toll highway and light rail projects, while ALL
focuses on rail and logistics. CCR in particular has shown
discipline when bidding for new projects with respect to
returns and risk. ALL successfully acquired and rehabilitated
first the formerly national-run rail concession in the states
south of São Paulo and later acquired and turned around the
concession covering São Paulo state and northwest, including
Mato Grosso.
Valuations for both are reasonable relative to history and
peers, in our view. ALL trades at 10.1x 2010e EBITDA and
CCR at 9.2x. These multiples are consistent with an
infrastructure investment scenario above the bear case but
below the base case in our economist’s forecast, making both
potentially interesting investments, in our view.
CCR and ALL have capacity to invest more. CCR has
ample balance sheet capacity to fund new projects, about
R$6 billion over the near term when taking into account cash
on the balance sheet (R$2 billion) and additional debt (raising
net debt to EBITDA from 1.5, to 3.0x by year-end 2010)
without returning to the market for additional equity. ALL has
roughly R$2.5 billion in cash on its balance sheet.
ALL, CCR, and other smaller concession companies have
already shown their value in improving Brazil transport
infrastructure and operations. Since the start of the decade,
volume transported has almost doubled. Railroads’ share of
total cargo transported in the country has risen from about
The stark contrast in quality of road conditions between
privately administered and state-run highways (shown in
Exhibit 51) argues for further concessions to improve Brazil’s
highway infrastructure, in our view.
Raising long-term infrastructure investment to 4.0% of
GDP would add significant value to the industry. There is
a difference between the current concession flow announced
by the government and that laid out in this report. At the start
of 2010, there was at least R$127 billion worth of work on
identifiable transportation infrastructure projects, including
airports, railway, waterway, ports, roads, and subways, the
majority of which are to be completed over the next three
years. That averages about R$40 million per year, or about
1.2% of GDP per year, in between the bear case of 0.8% and
base case of 1.6% of GDP spent on transportation
infrastructure in this report. Thus, the base case represents
upside from the current scenario laid out by the government
from a bottoms-up perspective.
The government already has a significant amount of
concessions planned for auction. Exhibit 44 shows those
concessions and PPPs planned for the next two or so years,
with a focus on the kinds of projects that CCR and similar
companies would bid on. Excluding the bullet train,
investments for these projects total about R$30 billion,
indicating more than ample opportunity for all concession
operators if auction momentum accelerates.
Exhibit 44
Large Number of New Projects Expected
Concessions Coming to Market
Authority
Second RodoAnel tranche
São Paulo
GRU Airport express train
São Paulo
Third Sao Paulo state hwy auction
São Paulo
Minas Gerais state hwy acution
M. Gerais
Fed stage III Minas hwy auction
Federal
SP-RJ bullet train
Federal
Brasilia metro project
Federal
Belo Horizonte metro project
M. Gerais
Undisclosed city metro project
State TBD
Source: Company data, Morgan Stanley Research
Est Length of
Concession, Yrs
30
35
30
25
25
25
25
25
25
Capex
R$ Bn
4.5
1.8
3.8
9.0
8.2
40.0
0.8
0.8
0.8
37
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
CCR should capture significant value from new
concessions. CCR is among Latin America’s largest toll
road operators, with a current portfolio of 1,571 km of
highways and other concessions and operations. With the
large number of upcoming new projects, bolstered by the
renewed PAC funding, CCR should gain additional value even
if it were to win just a few. Further upside exists should CCR
win projects that would lead to synergies with their existing
network, such as the RodoAnel south tranche in São Paulo.
cargo transit. CCR is a larger company and we do not expect
traffic on its roads to grow faster due to greater infrastructure
spending. After all, the point of greater road investment is to
reduce congestion. Instead, CCR benefits from new projects
to bid on which further add scale and value to the business.
ALL’s opportunity to grow extends with greater projects.
Though highway transportation is dominant in Brazil, rail
logistics are a focus for the government due to lower transport
costs over medium to long distances (Exhibit 50). Part of the
R$29 bn per year potentially channeled to rail investment
builds on the projects that ALL already has ahead of it. Two
of the most important are:
We value CCR as a package of current road and metro
concessions. To adjust for the change in potential project
flow in each scenario, we adjust the value of future projects
that the company has not yet won. In our bull case, the
company’s upside potential becomes limited by execution and
financing capacity. In general, we believe the capex intensity
of the industry would make it difficult for management to grow
CCR significantly above 15-20% on a sustained basis in
terms of new project flow. This does not include traffic growth
in current projects, which require little incremental operational
attention.

Sugar pipeline. In early 2009, ALL signed an agreement
with Rumo (a Cosan subsidiary) to operate a new 400 km rail
line (fully financed by Rumo) transporting sugar from Ribeirão
Preto to the port of Santos. Over the next four years, ALL
expects its transported sugar volumes to grow by a factor of 4
or more. This would also increase ALL’s bulk cargo share at
Santos, which has nearly doubled over the past three years.
For ALL, we take a slightly different approach. With
additional investment in new projects fostered by the
government, the company’s growth profile should extend
beyond the current three to four years. As well, additional
value should be added through new projects as yet
unidentified. We model this by extending the DCF to beyond
the current concession termination date.

Rondónopolis extension. ALL has a concurrent project
estimated at R$400 million to build a 260 km railway
extension from Alto Araguaia to Rondónopolis in the state of
Mato Grosso, connecting it to Santa Fe du Sul in the state of
São Paulo. The company expects to be moving upwards of
500 thousand tons on the completed track in 2011.
The bull, base, and bear cases for both ALL and CCR are
detailed in their respective risk-reward pages.
Scenario Discussion
Base and bull cases mean more investment opportunity
and longer horizon for substantial growth for both CCR
and ALL. In our bull case, where the government accelerates
infrastructure investment to 6.0% of GDP, ALL’s stock exhibits
slightly more upside potential (60% vs. 53% for CCR),
although within the accuracy of this exercise the difference is
not material, in our view. The slightly greater upside potential
for ALL comes from the greater importance of increasing
traffic growth through the end of the current concessions and
then extending their time horizon, which is in line with the
government’s goal to increase rail’s utilization and share of
Price Target Discussion
Our R$47 mid-year 2011 price target for CCR is based on
a DCF that values the company’s concessions as finite
projects. There is a small terminal value due to businesses
such as STP that are ongoing concerns. In our view the finite
project assumption is potentially conservative as the company
has shown in the past that granting authorities will often
extend concession maturities in exchange for additional capex
or operating changes. In exchange for the additional capex or
costs, the granting authority extends the life of the concession
to preserve the original contract return. We use a BRLequivalent WACC of 11% (cost of equity of 14%). Past 2015,
highway traffic is assumed to grow at 4%, or about 1.1x GDP
until the maturity of each concession. This valuation is
equivalent to a forward EV/EBITDA multiple of 8.7x, in line
with the long-term average.
38
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
America Latina Logística (ALLL11.SA, R$16, Equal-weight)
14% Upside in Base Case Infrastructure Investment Scenario: 4% of GDP
R$25
R$22 (+39%)
20
R$18 (+14%)
R$ 15.82
15
R$14 (-12%)
10
Investment Thesis
 After a difficult year in 2009, we see
accelerating growth in 2010, with
upside risk to our estimates
 ALL’s EV/EBITDA multiple looks
reasonable on a forward basis
relative to peers, despite higher
sustained growth of low doubledigits
Drivers
 Agricultural exports should grow in
excess of 20%
5
0
Apr-08
Oct-08
Apr-09
Base Case (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
Source: FactSet, Morgan Stanley Research
Bull
Case
R$22
11x
Bull Case
2011e
EBITDA of
R$1,800 mn
Government provides visibility to infrastructure investment not
seen since the early 1970s. Strong 2010 performance of 15%
volume growth and 20% revenue growth is followed by solid growth
in 2011 (13% volume and 14% revenue). More importantly, longterm visibility to intense government facilitation of future rail and
related projects adds significant value to the stock with improving
sentiment.
Base
Case
R$18
10x
Base Case
2011e
EBITDA of
R$1,722 mn
Gradual improvement in long-term outlook; in line medium
term results. ALL makes good on 13.5% volume growth this year,
with revenue growth at 18%. 2011 volume slows back to the longterm 10-12% range with equivalent revenue growth. Sentiment on
the stock improves with greater visibility to long-term infrastructure
investment, though newly identified projects remain few.
9x
Bear Case
2011e
EBITDA of
R$1,600 mn
2010 meets guidance. ALL’s volume grows only 12%, with 16%
revenue growth due to slower economic growth in the second half
and less new market share than expected. Infrastructure
investment looks likely to slow, but does not affect sentiment
meaningfully.
Bear
Case
R$14
Note: These scenarios are based on the infrastructure outlook scenarios of this report; Base Case is based on DCF fair value
estimate.
LatAm Infrastructure Comparables – Best Value to Growth Relationship
30-Apr-10
Company
ALL
CCR
OHL Brasil
IDEAL
Zhejiang Expway
Union Pacific
CSX
Guangshen RR
Ticker
Rating
ALLL11.SA
E
CCRO3.SA
O
OHLB3.SA
E
IDEALB1.MX
U
0576.HK
O
UNP.N
O
CSX.N
O
0525.HK
O
Price
Local
15.82
40.24
40.99
15.53
7.35
75.66
56.05
3.05
Mrkt Cap Daily Vol
US$ Mn US$ Mn
6,467
22.8
10,262
22.9
1,632
2.9
3,804
0.8
4,112
7.3
38,292
274.1
22,224
194.6
2,783
2.2
Median
2009
325.0x
26.2x
16.1x
498x
15.3x
16.6x
14.6x
14.5x
16.3x
P/E
2010e
67.4x
18.9x
11.6x
245x
14.5x
14.8x
14.1x
14.6x
14.7x
2011e
39.5x
15.9x
10.1x
71.1x
14.1x
12.3x
11.8x
13.7x
13.9x
EV / EBITDA
2009
2010e
2011e
13.6x
10.1x
9.1x
10.4x
9.2x
8.0x
8.4x
6.2x
5.9x
33.7x
23.9x
21.2x
8.1x
7.3x
6.6x
8.5x
6.9x
5.9x
8.9x
7.7x
6.6x
7.2x
7.0x
6.2x
8.7x
7.5x
6.6x
 Brazilian industrial production
should grow in excess of 10%, after
contracting in 2010
 Rondónopolis and Rumo projects
add visibility to growth outlook
 Corumbá mine and similar longdated opportunities add potential
upside to long-term outlook
Risks/Concerns
 Valuation looks expensive
compared to the market and peers
on a P/E basis
 Company has not yet reached
positive cash flow; break-even
expected some time next year
 Market saturation on the agriculture
side could occur within the next
three years unless operational
region expands (possible through
new government concessions or
projects such as the Rondónopolis
extension)
0576.HK and 0525.HK covered by Andy Meng; CSX.N and UNP.N covered by William Greene
Source: Morgan Stanley, FactSet
e = Morgan Stanley Research estimates
O = Overweight E = Equal-weight U = Underweight
39
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
CCR (CCRO3.SA, R$40, Overweight, Price Target R$47)
17% Upside in the Base Case Infrastructure Investment Scenario: 4% of GDP
R$ 60
R$56 (+39%)
50
R$47.00 (+17%)
R$ 40.24
40
R$35 (-13%)
30
0
4/30/2008
10/30/2008
4/30/2009
Price Target (Apr-11)
10/30/2009
4/30/2010
Historical Stock Performance
10/30/2010
 Rodoanel auction expected in June
is a potential catalyst.
Current Stock Price
Source: FactSet, Morgan Stanley Research
Price Target $47
Our YE2010 target equates to 9.0x 2010e EV/EBITDA, based on
DCF with 12.6% WACC in BRL terms, LT growth (until concession
termination) of 4% real, 65% EBITDA margin, 11% capex/sales.
Bull Case
R$56
Better than expected 2010 carries over to 2011; Rodoanel
auction win. CCR wins the Rodoanel auction as part of a
consortium. Traffic grows at 12% and 10% in 2011. Multiple
expands on expectations for more auctions in 2011 and 2012.
10x
Bull Case
2011e
EBITDA of
R$2,900
Base Case 9x
R$47
Base Case
2011e
EBITDA of
R$2,723
Double-digit traffic growth. Low double digit growth in traffic in
2010, partially offset by competition in Nova Dutra. Rodoanel West
continues strong growth as South stretch opens. Controlar and
Linha 4 also add revenue growth.
Bear Case
R$35
No auction wins and weak traffic. Traffic grows in mid-single
digits, driven by cannibalization in Nova Dutra and little positive
effect from Rodoanel South. No auctions won during the year, and
a change in strategic direction that makes future auctions unlikely.
8x
Bear Case
2011e
EBITDA of
R$2,450
Note: These scenarios are based on the infrastructure outlook scenarios of this report; Base Case is based on DCF fair value estimate.
Progression from Bear Case to Bull Case
60
4.00
price target: R$47
50
6.00
45
1.50
4.50
40
1.50
3.50
 Secondary market opportunities for
existing concessions could add
value, e.g., CCR’s Renovias
purchase, in keeping with
company’s stated strategy on uses
of cash
Risks/Concerns
 Timing of Rodoanel South and East
auction(s) could slip; financing of the
Rodoanel project will require
multiple solutions (e.g., BNDES
combined with Brazilian banks and
potentially foreign investors)
 Ayrton Senna impact on Nova Dutra
looks to be negligible so far, but
could increase
 Elections could shift focus away
from infrastructure progress as year
end approaches
65
30
Drivers
 Robust project pipeline should
generate important business
opportunities further down the road
10
35
 Traffic growth, new businesses, a
large potential auction win, inflation
protected tariffs, and a reasonable
valuation support our Overweight
rating.
 Double digit top-line growth driven
by strong traffic growth, tariff
increases, and new businesses
20
55
Investment Thesis
56
47
all values in R$
35
25
Bear
Case
Weak Traffic* Auctions NovaDutra
Delayed Cannibalization
Indefinitely
Base
Case
Sustained Rodoanel
Normal
Traffic Auction Win NovaDutra
Strength*
Growth
Bull
Case
* Base case traffic grows 15% 2010, 8% 2011; Bear 10% and 4%; Bull 18% and 2%; Source: Morgan Stanley Research estimates
40
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Utilities/Electric and Water: In Support of Economic Growth
Morgan Stanley C.T.V.M. S.A.+
Subhojit Daripa, CFA
[email protected]
Morgan Stanley C.T.V.M. S.A.+
Miguel F. Rodrigues
[email protected]
We do not expect electricity to be a bottleneck to economic
growth. Brazil combines large generation potential with what
we view as a robust regulatory framework in the sector that
offers adequate incentives to guarantee the required
investments in all segments (generation, transmission, and
distribution).
Industry can make investments needed to meet expected
GDP growth. Brazil needs to increase installed capacity by
5.0 GW per year, on average, to meet expected annual GDP
growth of 5.0% (base case). 15 This will require annual
investment of R$17.0 billion in generation through 2016, and
of R$5.0 billion in transmission and distribution segments. 16
We think this is achievable.
The auction model encourages private sector participation.
For many years, generation companies had their prices set at
artificially low levels, which caused them to earn below
required rates of return. As a result, investment in the industry
declined significantly in the past two decades, increasing the
risk of rationing, which finally took place in 2001. Since then,
the Lula administration has implemented a new electricity
model aimed at increasing capacity in the system.
The model fosters private player participation through
electricity auctions. These were somewhat disappointing
when they began in 2005: Generation prices were set at
lower-than-expected levels, and there was significant
participation by state-owned companies, particularly
Eletrobras, which pushed prices down further. However,
prices have been trending up since then due to a tighter
supply-demand balance and less interference from stateowned companies.
Public (non-state-owned) operators see attractive returns,
we believe. Several public companies are exploring generation
opportunities in Brazil, including Tractebel (GDF SUEZ group),
Energias do Brasil (EDP group), AES Tiete (AES group), MPX
(EBX group), and CPFL (Camargo Correa group). This
supports the view that these operators are still finding attractive
return rates in the Brazilian market. We believe that generation
15
16
Generation requirements based on our supply-demand model
Investments in the transmission and distribution segments based on “Plano Decenal de
Energia 2008-2017” (EPE / Ministerio de Minas e Energia)
companies will increasingly enhance their returns as current
contracts are renewed at expected higher generation prices.
Brazil’s current electricity oversupply should become
tighter in the coming years, but this is not a risk to supply,
in our view. Assuming electricity demand sensitivity to GDP
growth of 1.2x, we estimate that additional capacity can meet
our economists’ bull, base, or bear case growth scenarios.
(Note that we are assuming that the plants facing no or low
restrictions come on stream; we are not considering plants
with serious restrictions, according to ANEEL criteria.)
Exhibit 45
Electricity Oversupply Should Become Tighter in
the Coming Years, but This Is Not a Risk to Supply
Average MW
80
6.0%
75
5.0%
70
4.0%
65
60
55
50
45
Only Plants w/o restrictions
40
35
2003
2005
2007
2009E
2011E
2013E
2015E
Average MW
80
6.0%
75
5.0%
70
4.0%
65
60
55
50
45
Including plants with restrictions
40
35
2003
2005
2007
2009E
2011E
2013E
2015E
Source: Morgan Stanley Research estimates
Brazil’s generation potential is very large, combining
hydro, thermal, wind, biomass, and nuclear. PAC II (the
government’s economic growth acceleration program)
41
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
identified 48 GW of additional capacity (hydropower only) to
be installed over the next years. The whole program expects
to invest R$113 billion in generation and R$27 billion in
transmission through 2014. However, given the
disappointment with the previous program (PAC I), we are not
counting on the full implementation of this program.
We do not see water and sewerage investments as a
bottleneck to economic growth, as such investments are
more a matter of social policy than are electricity investments.
complementary biomass plant Destilaria Andrade should add
33MW of installed capacity in 2010.

Higher generation prices. We expect strong volume
growth, led by industrials, to shave off part of the excess
capacity in the system, prompting a recovery in generation
prices to industrial customers in the free market.
Risks to our Tractebel investment thesis:

Lower-than-expected long-term generation prices.
The largest portion of investment in water and sewerage still
comes from government funds (FGTS). Furthermore, water
and sewerage compete with electricity projects for
government funds. However, we believe electricity projects
will be prioritized because they are critical to economic growth.

New projects with lower than required return on equity.
Return on investment remains an uncertainty in water and
sewerage. The regulatory framework in the space is
improving toward a more robust framework, as in the electric
distribution industry; however, challenges remain. Both in Sao
Paulo and Minas Gerais, regulators are working on the
development of a ROA-based rate review methodology.

Exposure to spot electricity prices. Tractebel’s ability to
forecast spot prices during the year is critical to reduce the
impact of its 375MW exposure to the spot market.
We prefer to maintain our Equal-weight rating in both Copasa
and Sabesp until we have more visibility on the methodology
of the new rate review to be adopted in these regions, and on
its implementation. The critical value driver is whether the
upcoming investments will be remunerated properly or not.
Likely Beneficiaries from Long-Term Outlook
Two key drivers of the generation segment that we think
make it compelling to investors:

Growth through the expected increase in generation
prices and addition of capacity and

Fewer uncertainties on the regulatory front.
In our view, the long-term winners will be the most
efficient generation plays, like Tractebel (Overweight).
We believe the generation segment offers both lower risk and
higher potential return than the distribution segment. (See our
note Poised for Growth, Catalyst Expected; Upgrading to
Overweight, April 23.)

Transfer of assets to Tractebel. As Jirau was won by
Suez and is likely to be transferred to Tractebel, investors
want to know when and at what price the transfer of assets
will be made.
We also highlight CPFL (Equal-weight). Although it is
mostly a distribution play (and we believe the winners are in
the generation side), we believe CPFL is an interesting
vehicle to play long-term infrastructure development in Brazil.
We are positive on CPFL as a consolidator in distribution
and due to growing exposure to generation:

We remain positive on value creation opportunities
through consolidation, with CPFL as one of the best
positioned to benefit from it. The company combines some of
the key drivers of success in consolidation, such as a strong
management team, material size (increasing potential bargain
power with suppliers), and operational efficiency.

We have a positive view on CPFL’s increasing exposure
to the generation segment. We expect the company to
increase its installed capacity from 1,737 MW today to 2,765
MW in 2012, based on projects under development.
Management targets 4,000 MW of installed capacity in 2014.
After flat earnings year-over-year in 2009, we expect
Tractebel to resume earnings growth of 13% and EBITDA
growth of 8% in 2009–15 (CAGR) due to:

Additional capacity. The transfer of Estreito by GDF
Suez (Tractebel’s controlling shareholder) to Tractebel should
add 435MW of installed capacity by 2011e. The
42
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 46
CPFL Expects to Double Its Generation Capacity by
2014, Becoming the 2nd-Largest Private Player…
Installed Capacity Generation (MW)
0
1000
2000
3000
4000
Our Equal-weight rating is based on a 12-month view, on the
back of a rich valuation. The stock’s trading multiples are in
line with historical levels, and we see companies with more
compelling upside in our coverage universe.
5000
Risks to our investment thesis and price target:
2009

Increase in generation capacity. We are assuming a
growth in assured energy of 40% year-end 2010 to year-end
2009, based on two new projects (Foz do Chapeco HPP and
EPASA TPPs) expected to enter on stream at 3Q10. If one or
both of these projects is delayed, it could reduce the
generation segment revenue.
2012e
2014e
Source: Company data, Morgan Stanley Research estimates
On the distribution side, CPFL’s distribution segment plans to
invest R$4.6 billion in 2010–14, doubling its current market
share of 13% to over 25% through the acquisition of strategic
assets and cooperatives.
…and to Double Its Market Share in Distribution
Distribution Market Share
5%
10%
15%
20%
25%

Next rate cycle. Should regulatory WACC for the
distribution companies turn out to be lower than our estimate
of 8.9%, we might review our valuation.

Share overhang. If Bradespar confirms its intention to
sell its shares, or even maintain signals in this direction, stock
overhang could prevail.
Exhibit 47
0%

Dividend policy. The company’s policy defines a
minimum payout of 50%, although the company has
historically distributed its dividends at 94%. If CPFL reduces
its payout, it might reduce its premium to the peer group.
30%
2009
2012e
2014e
Source: Company data, Morgan Stanley Research estimates
43
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Tractebel (TBLE3, R$22, Overweight, Price Target R$28)
Risk-Reward View: Limited Downside and Generation Repricing
Investment Thesis
R$35
R$30.00 (+35%)
30
R$28.00 (+26%)
25
R$ 22.15
R$20.00 (-10%)
20
15
10
5
0
Apr-08
Oct-08
Apr-09
Price Target (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
Source: FactSet (historical chart data), Morgan Stanley Research estimates
Price Target R$28
Derived from base case DCF analysis. Ke in nominal R$ of 14.0% p.a.
Bull Case
R$30
Pricing Power. Tractebel’s uncontracted generation capacity is
renewed at R$145/MWh in the free market. We assume spot prices at
R$16/MWh. We do not include additional capacity from Jirau.
14x
2011e
EPS
Base Case 13x
R$28
2011e
EPS
Higher generation prices. Bilateral contracts are maintained under
current generation prices (over 83% of average MW until 2013) and the
remaining amount is renewed at R$130 per MWh (real terms). We do
not include additional capacity from Jirau. Assume spot prices at
R$50/MWh
Bear Case
R$20
Late recovery / Oversupply. Tractebel reprices generation contracts to
R$90/MWh. Exposure to the spot market of 375MW and spot prices at
R$115, closer to the levels at which the most efficient plants would be
dispatched. We do not include additional capacity from Jirau, but a
negative impact from its transfer to Tractebel of R$750 million.
9x
2011e
EPS
Tractebel – Bear to Bull Cases (R$ per share)
35
30
price target: 28
15
1.00
1.00
3.00
25
20
4.00
1.00
30
28
20
10
5
 Tractebel should be seen as a stock
with low volatility, as its cash flows
are secured by long-term contracts.
We view management as high
quality, and shareholder returns are
the key focus of the company.
 The long-term winners in the electric
utilities sector will be the most
efficient generation players, like
Tractebel. The generation segment
offers both lower risk and higher
potential return than the distribution
segment. We expect Tractebel to
resume earnings growth of 10% and
EBITDA growth of 6% in 2009–15
(CAGR) due to additional capacity
and higher generation prices.
Key Value Drivers
 Generation prices: Every
R$10/MWh move in generation
prices moves our PT by R$1.
 Spot prices: Tractebel has a
375MW exposure to spot prices.
Every R$30 move in spot prices
reduces our target price by R$1.00/
share
Potential Catalysts
 Jirau’s transfer price: GDF Suez’s
stake in Jirau may be transferred to
Tractebel at a price to be defined
during 2011. Even considering a
less favorable goodwill scenario, the
impact on share price is marginal.
For each 15% of goodwill (as
percentage of total capex), our fair
value decreases by R$1.00/share.
 Generation prices: We expect the
company to disclose higher implied
free market generation prices during
the next quarters.
0
Bear
Case
Spot Prices Generation
Losses
Prices
from Jirau
Transfer
Base
Case
Spot Prices Generation
Prices
Bull
Case
Source: Morgan Stanley Research
44
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
CPFL (CPFE3, R$36, Equal-weight, Price Target R$40)
Risk-Reward View: Waiting for a Better Entry Point
Investment Thesis
R$60
50
R$48.00 (+35%)
40
R$40.00 (+12%)
R$ 35.60
R$31.00 (-13%)
30
20
10
0
Apr-08
Oct-08
Apr-09
Price Target (Apr-11)
Oct-09
Apr-10
Historical Stock Performance
Oct-10
Current Stock Price
Source: FactSet (historical chart data), Morgan Stanley Research estimates
Price Target R$40
Based on DCF using a cost of equity of 14% in nominal R$.
Bull Case
R$48
Successful growth strategy. We assume cash flows are reinvested at
a rate of return 400 bps above the cost of equity. We assume 5%
annual growth and higher margins in the trading arm. Finally, we
assume a more favorable rate review process (equivalent to maintaining
regulatory WACC at current levels).
Base Case
R$40
Status quo. From the 3rd cycle onwards, we assume regulatory
WACC should be reduced to 8.95% from 9.95%. We assume additional
capacity of 40% to YE2010 from YE2009 in the generation arm. Trading
arm maintains results in line with 2009e.
Bear Case
R$31
Lower return on investments. We assume a more severe rate
review, equivalent to reducing regulatory WACC to 7.00% from 9.95%.
We assume cash flows are reinvested 400 bps below the cost of equity.
In addition, we assume 5% annual decrease and lower margins in the
trading arm.
CPFL – Bear to Bull Cases (R$ per share)
60
50
40
30
price target: 40
2.00
4.00
3.00
3.00
4.00
1.00
48
40
31
20
10
0
Bear
Case
Regulatory CFs Re- Trading
WACC investment
Arm
Source: Morgan Stanley Research
Base
Case
Trading Arm CFs Re- Favorable
investmentRate review
Bull
Case
 We believe CPFL is an interesting
long-term play to benefit from
investment in infrastructure in Brazil;
however, we do not see the stock
outperforming the index in the next
12 months. It is trading in line with
historical multiples levels and
maintains a premium over its peers.
 Professional management: We think
CPFL trades at a premium due to its
management — one of the best in
the industry, in our view, with solid
expertise and comprehension of
investors’ needs.
 Increasingly exposure to the
generation segment: The company
should increase its generation
capacity by 60% until 2012 and
plans to more than double its
current capacity by 2014.
 The company is leveraged to volume
growth and should benefit from
industrial volume recovery in 2010.
 We remain positive on value
creation opportunities through
industry consolidation, with CPFL as
one of the best positioned to benefit.
Key Value Drivers
 Rate review: The conditions for the
3rd rate review cycle to be defined.
Every 100 bps reduction in
regulatory WACC reduces our fair
value by R$1.0/share.
 Return on investments: Rate of
return from additional projects.
Every 100 bps of value creation /
destruction = R$1.0 / share.
Potential Catalysts
 Growth plan: We see CPFL as a
consolidator in the sector with a
good track record of acquisitions. A
new acquisition could be a trigger.
 Rate review: announcement on
conditions of 3rd cycle rate review.
 Overhang: Bradespar could decide
to sell its shares.
45
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Appendix I: Infrastructure Across Sectors in Brazil
Exhibit 49
Brazil: Infrastructure – Assessment Across Sectors
Giuliana Pardelli
Morgan Stanley C.T.V.M. S.A.+
A
[email protected]
Transportation Sector 17
Strong growth in Brazil’s economy and exports since
2003 is endangered by high logistics costs. These costs
are estimated to be about 20 percent of gross domestic
product, or about twice as high as in OECD countries. The
global trend toward integrated logistics solutions in contract
logistics can also be seen in Brazil. For instance, just-in-time
solutions are frequently sought by the automotive industry,
prompting many service providers to offer them. But the
efficient and cost-effective implementation of these solutions
is often hindered by bureaucratic hurdles. The transport
sector was once strongly fragmented, although it has become
more consolidated since the late 1990s.
The highway network plays a leading role in Brazil.
Highways are cheaper to build initially, but much more
expensive to maintain over time. Despite a slight decline in its
share in recent years, highways are still used for around 60%
of Brazil’s total freight transportation, a much higher ratio than
in other countries, especially those with a territorial size
equivalent to Brazil’s. Indeed, countries that rely significantly
on highways typically have a smaller territory, like France or
Germany, for instance. Countries as large as Brazil, like the
United States or Russia, rely relatively more on railways and
less on highways than Brazil does.
Exhibit 48
Freight Transportation Structure (% of total)
0%
20%
40%
60%
80%
100%
France
Brazil
Mexico
Australia
Austria
Highway
Railway
Other
Canada
Germany
U.S.
Russia
Source: ANTT (2005), Morgan Stanley LatAm Economics
17
B
C
D
E
F
=
Energy Sector
This appendix is largely based on “Anuário Exame 2009-2010 – Infraestrutura”, in Revista
Exame, Editora Abril, 2009.
Generation
=
=
=
=
Transmission
=
=
=
=
Distribution
=
Telecommunication Sector
=
=
Land Lines
=
=
=
=
Mobile Lines
=
=
=
=
Internet
=
=
Airports
=
=
=
Railways
=
=
=
=
=
=
=
=
Transportation Sector
Hydro ways
Ports
=
State-run Highways
=
Concession Highways
=
=
=
=
=
=
=
=
Source: Anuario de Infraestrutura 2009 Revista Exame, Morgan Stanley LatAm Economics
A = General Assessment; B = Regulatory Framework; C = Legal Issues; D = Taxes; E =
Institutional Issues; F = Investment. Thumb up means there are no problems or issues
preventing normal services delivery or investment. Thumb down means there are serious
problems or issues preventing normal services delivery or investment. Equal sign means
there may be problems or issues preventing normal services delivery or investment.
Brazil’s transport infrastructure is characterized by sharp
regional differences. Several well-built highways are available
in the economically developed Southwest and South. But the
picture is completely different in the Amazon region in the
North, where opportunities are very limited — both in terms of
much thinner population density and in terms of the
availability of various means of transport. As a result of the
difficult terrain, transport infrastructure in the rain-forest region
of the north is poorly developed. Rain forests in the lowlands
of the Amazon in the north, plateaus and mountains in the
south, and the Andes toward the west shape Brazil’s
geography.
Brazil’s transport system is heavily dependent on the highway
network. This applies especially to economically advanced
regions, even though other means of transport are available
there — particularly in the state of São Paulo. One major
challenge is the long-term shift away from relying so heavily
on road traffic. This would become possible after a sufficient
number of inter-modular distribution centers have been set up.
46
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
In railway transportation, Brazil lags behind by American
or European standards in terms of quality and density.
Brazil’s 29,000 kilometer long rail network is poorly developed,
and parts of it are in bad condition. It is primarily based in the
states of São Paulo, Minas Gerais, Rio de Janeiro and Rio
Grande do Sul. Another problem is the different track widths
used in parts of Brazil.
As for ports, fees charged by Brazil’s harbors are high by
international standards. Many ports have tremendous
problems as well. Some lack handling capacities, ships face
restrictions because of low navigational channel depths, while
highway and rail connections are inadequate. In addition,
personnel is often poorly trained and a there is a shortage of
parking for trucks.
Exhibit 50
Brazil: Freight Transportation Costs
(US$/TKU*, 2006)
0
100
200
300
400
500
600
700
800
Air
Highway
Pipeline
Waterway
Railroad
Highway Transportation
Brazil’s paved highway system extends over 212,442 km
and is distributed very unevenly among regions. The
South and Southeast regions contain more than 50% of
Brazil’s highways, even though they represent only 18% of
the national territory. Opting to build highways was largely due
to the lower initial implementation cost compared to railroad
transportation. It also served as an incentive for the
development of the Brazilian automobile industry. Despite the
lower cost of implementation, the operational cost of highway
transportation is about six times higher than for railroad
transportation, which contributes to the high average costs for
transportation in Brazil.
The main problem affecting freight transportation in
Brazil is the structural distortion in its composition. While
countries of great territorial dimensions, as the US, Canada,
China and Russia use primarily railroad and waterway
systems, in Brazil the exact opposite occurs, with an absolute
dominance of the highway system. In Brazil about 60% of
freight transportation is based on the highway system, while in
the Unite States this proportion stands at 26%, in Australia at
24%, and in China 8%. Observers say that the lack of
appropriate regulation for the entrance of new companies in
the highway system in Brazil creates competition distortions
with other modes of transportation, inhibiting investment in the
modes which involve higher fixed costs, as the railroad
system. The reduced scale of other modes makes it difficult to
dilute fixed costs.
Source: Coppead *TKU=tons transported times km traveled
Another significant problem is serious deterioration
because of weather conditions and heavy usage. The
government's investment in highway maintenance often falls
short of the necessary amounts, resulting in the lack of
maintenance of thousands of kilometers of federal highways,
especially the minor ones. Transportation infrastructure
investment in Brazil is in the early stages, and significant
additional spending is required for the country to remain
competitive. The so-called growth acceleration program
(PAC) is expected to invest R$ 58.3 billion in the logistics and
transportation sector by the end of 2010. However, experts
suggest that investment needed in the sector would be at
least twice this amount.
Maintenance costs are also high and, given the large
portion of highways under public sector management, this
also results in poor conservation, which further raises the
operational cost of highway transportation versus other
means of transportation.
The public sector is responsible for managing around
93% of Brazil’s paved highway system, especially the
federal and local state governments. The sections under
private-sector concession total around 14,328 km, close to
7% of the total system. Most of the highways under
concession are located in the Southeast and South regions,
especially in São Paulo, Rio Grande do Sul and Paraná. Over
the next few years, observers expect a significant rise in the
percentage of the highway system under concession. For
2010, more than 2055 km of federal highways are scheduled
to go under concession.
47
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Exhibit 51
Brazil: Highways Conservation (2009)
(% of responses)
Public
22.4
49.4
28.2
Excellent/Good
Regular
Bad/Very Bad
Private
76.5
21.7
1.9
Source: Confederacao National do Transporte (CNT), Morgan Stanley LatAm Economics
Despite the generally poor conservation of Brazilian highways,
there is a major difference between the highways managed by
the public and private sectors. A 2009 survey by the National
Transportation Confederation (CNT) showed that more than
30% of Brazil’s paved highways are in bad or very bad
condition. However, within the highways under concession,
76.5% are in a good or very good state of conservation, a
percentage that drops to 22.4% for the highways run by the
public sector. Of the 30 best highway sections, 24 are
managed by the private sector.
Railway Transportation
The railroad system accounts for 21% of all freight
transportation in Brazil (around 426.5 million tons) and
consists of 29,426 Km of track, which is quite limited in
comparison to other countries, especially considering Brazil’s
vast territory. For instance, railways account for 38% of the
transportation system in the United States.
Exhibit 52
Transportation Structure: Brazil versus US
(% of total, and relative prices)
Participation (% of total)
0%
10%
Brazil
20%
30%
40%
Highway
70%
114%
Waterway
Air
US
60%
36%
Railroad
Pipeline
50%
180%
Prices in Brazil
as % of US prices
(per 1,000 ton km)
111%
141%
Source: Coppead (2001), Morgan Stanley LatAm Economics
The government has not announced so far any major new
railroad concessions, after it made concessions for all existing
tracks in the mid-1990s. Unlike the highway system, the
private sector administers around 96% of the 29,426 km of
railroad track in operation. The system’s privatization began in
1996 and was completed in 1998. Currently, there are 12
railroad concessions in Brazil, operated by five private groups
and two state-owned corporations. Railroad concessions have
successfully preserved existing assets, but not all
concessions have kept pace with modernization. Since then,
companies have invested around R$18.8 billion in the
transportation system, and another R$2.4 billion was
expected for 2009. From 2007 to 2010, the growth
acceleration program (PAC) is expected to invest R$7.9 billion
in 14 new tracks, totaling 2,500 km. In October 2009, the
government had concluded 356 km and invested R$1.2 billion.
The total volume of transported freight increased 95% in the
first 11 years of concession, since the 1990s. However, the
railroad track extension stagnated at the 29,426 km mark.
According to the ANFT (National Association for Railroad
Transport), the ideal would be around 52,000 km. The
government estimates that railroads have reached their
transportation limit, and more investment has to be made in
order to increase capacity. According to the National Plan for
Logistics and Transportation, an investment of R$245 billion is
needed by 2023, in order to support railroad competitiveness.
Exhibit 53
Brazil: Railroads
Land Area
(km²)
Brazil
Chile
Mexico
Argentina
India
U.S.
U.K.
Belgium
Rail Length
(Km)
Rail per area
(km/1000km²)
29,295
6,585
17,665
31,902
63,221
226,612
16,567
3,536
3.5
8.8
9.2
11.7
21.3
24.7
68.6
116.8
8,456,510
748,800
1,923,040
2,736,690
2,973,190
9,161,923
241,590
30,278
Source: Central Intelligence Agency (2009), Morgan Stanley LatAm Economics
In the past, insufficient funds have been the main hurdle to
improving road and rail networks. To an extent, this remains a
problem. But some observers argue this hurdle could be
greatly reduced by leveraging the private sector for much of
the needed investment.
Waterway System and Ports
Waterways account for only a small share — around 14%
— of total freight transportation in Brazil. According to the
National Agency for Waterway Transportation, the total freight
volume carried in 2000 was 25.2 million tons, of which 58% is
concentrated in the Amazonas region. Brazil has
approximately 8,500 Km of ocean coast and approximately
42,000 km of navigable inland waterways, of which only
10,000 km are actually used for freight transportation. This is
considered to be the most underdeveloped sector in Brazil’s
transportation system. Besides environmental constrains that
complicate the completion of a number of projects, most of
48
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Brazil Infrastructure
these also suffer with the scarcity of resources, since
waterways are rarely in the priority list of investment plans. Of
the R$400 billion amount suggested by the National Plan for
Logistics and Transportation for the improvement of
infrastructure in Brazil until 2023, only 4% are allocated to
waterways (R$17 billion). Until 2011, R$6 billion should be
invested. However, in 2007 alone, the Transport Ministry
spent only R$354 million in the waterway system (including
ports), which represent less than half of the revenues for the
sector.
The Brazilian port system is composed by 40 ports, 37 of
which are run by the public sector. There are also 125 port
terminals, divided between privately-owned terminals and
mixed-use terminals. In privately-owned terminals, the owner
is authorized by the government to install and operate a port
terminal only for movement of self-owned cargo. In mixed-use
terminals, the concession holder can deal with third-party
cargos, besides moving its own cargo.
Furthermore, the private sector also participates in the
operations of some government-owned ports. Public-sector
entities can transfer the operation of the public ports to private
companies, through a concession involving a public bidding
process. In this case, the successful bidder is responsible for
equipping the terminal and for loading and unloading
operations at the port.
Public-sector entities are in charge of inspecting and
maintaining the port infrastructure, including roadways
connecting the port to the highway and the dredging of the
access canals to the terminals.
The Special Secretariat for Ports has earmarked investments
of $2.7 billion from the federal government's Growth
Acceleration Program (PAC) specifically aimed at
infrastructure work in ports, from 2007 to 2010. The National
Plan for Logistics and Transportation estimates that at least
R$40.6 billion are needed in the sector by 2023.
The waterway transportation system can be divided into
three main types:

Long-distance transportation. International trade of
goods. Long-haul transportation accounts for around 90% of
Brazil’s foreign trade flows.

Coastal: Transportation of goods along Brazil’s coast
and the Amazon River, considered an extension of maritime
shipping since it can handle big vessels. This segment is
dominated by private shippers and ferries between São Paulo
and Manaus. Most cargo, however, consists of coal/charcoal,
wheat, corn, fertilizers, salt and iron ore.

Inland marine transportation: Transport via rivers or
lakes using low-tonnage vessels. Despite the vast length of
navigable waterways in Brazil, only some 23.8% of its total
potential is actually used for navigation.
The system is used mostly for international trade; inland
marine and cabotage shipping represent only 26% of total
waterway freight transportation. Cargo movement through
Brazil’s main ports is divided in bulk solids (59.5% in terms of
volume), bulk liquids (25.5%), and general cargo (15.0%).
As with railroads, the main limitation to waterway system
expansion is the high cost of infrastructure building,
especially for inland marine transportation, On the other hand,
operational costs are nearly four times lower than those of
road transportation. The cost of freight movement through
Brazilian ports is very high, significantly higher than in many
developed countries or emerging markets. Sector
development has been hindered by the dreadful state of the
ports, whose services and storage facilities are generally
much more expensive — and considerably less efficient —
than those of their international counterparts. According to a
World Bank survey, out of 183 countries, Brazil ranks poorly
at 100th when it comes to the logistics of trading across the
borders.
Air Transportation
The Brazilian airport system has 34 international airports
and 31 domestic airports. There are other 2,498 smaller
airports, whose capacity cannot accommodate larger aircraft.
The administration and operation of the 65 main airports in
Brazil are under the responsibility of Infraero, a state-run
company controlled by the federal government. The airport
system is used mainly for passenger transportation. In 2008,
airports operated by Infraero served 113.2 million passengers
(arrivals and departures), 54% of them at Brazil’s five largest
airports — São Paulo (GRU); São Paulo (CGH); Rio de
Janeiro (GIG); Brasília; and Salvador.
Only 0.4% of all freight transportation is made by air in
Brazil. Total air freight in 2008 was 1.27 million tons at the
five main freight shipping airports, São Paulo (GRU);
Campinas; Manaus; Rio de Janeiro (GIG) and Recife,
representing around 73% of the total. If it were not for its
relatively high cost, perhaps more freight would be sent by air.
The cost of air transportation in Brazil is around 38 times
higher than that of railroad transportation and about six times
the cost of highway transportation. Although Brazil’s airport
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Brazil Infrastructure
infrastructure is managed by the state, there is no stateowned airline in operation. Currently, 17 Brazilian airlines run
regular domestic flights and six operate international routes.
restriction programs (e.g., as the one introduced in Brazil in
2001), which would be an obstacle for economic growth.
Electricity
Despite its numerous negative effects, the 2008/2009
financial crisis did have its positive side, especially for the
electric sector in Brazil. Indeed, from January through
September 2009, average energy consumption in Brazil fell
by 2.3% compared to the previous year. The drop was mainly
due to the slowdown in the industrial sector, whose average
consumption declined 9.9% in the same comparison. This
environment allowed energy supply and demand to invert the
dangerous disequilibrium trend seen since the first half of
2008.
Organization of Energy Sector and Current Situation
Exhibit 54
The Brazilian air traffic has climbed at an average pace of 9%
y-o-y, and some market estimates expect air transportation to
increase three times above GDP growth in the next 15 to 20
years. The growth acceleration program (PAC) investment in
airports expansion and modernization was expected to reach
around R$3 billion by 2010. However, by August 2009, the
government invested R$ 221 million in five airports.
Until the first half of the 1990s, most activities in the energy
sector in Brazil were controlled by government-owned (federal
and state) corporations, which handled generation,
transmission and distribution. In the late 1990s, the energy
sector went through a series of privatizations and
deregulations, with the creation of a new sector regulatory
framework and various agencies to regulate and supervise
the industry, including the National Electric Energy Agency
(Aneel). The seven main bodies of the Brazilian electricity
sector are: National Council of Energy Policy; Ministry of
Mines and Energy; Electricity Sector Monitoring Committee;
Energy Research Company; Electric Power
Commercialization Chamber; Electric System National
Operator; and the Brazilian Electricity Regulatory Agency.
Despite the privatizations, the participation of governmentcontrolled companies in the energy sector remains significant,
especially for energy generation and transmission.
The good news is that, currently, almost half of Brazilian
energy, 44%, comes from renewable sources. Such figure is
much higher than the world average of 14%. While deep
water offshore exploration of petroleum and gas advances,
Brazil also has also seen investments in the construction of
hydroelectric plants and in the production of bio-fuels, with
emphasis on sugar cane biomass for the generation of
electricity.
In terms of electricity, ~90% of the energy generated
comes from non-fossil sources, primarily hydroelectric.
There are many opportunities. Although hydroelectric plants
are responsible for 80% of the country’s energy generation,
only 27% of Brazil’s hydroelectric potential has been explored.
The electricity sector is important not only because there
exists many challenges in the sector’s policy development,
but also because electricity shortages may imply consumption
Brazil: Energy Sector
(% of total)
Electricity Generation
State-owned
Private
Electricity Transmission
State-owned
Private
Energy Distribution
State-owned
Private
72
28
84
16
34
66
Source: Aneel, (2008) Morgan Stanley LatAm Economics
Generation
After the license auction of the hydroelectric plants of Santo
Antônio (with an estimated capacity of 3,150MW ) and Jirau
(generation capacity of 3,300 MW), as well as the Belo
Monte’s contract — which is expected to take place in the first
half of 2010 — the Amazon River basin region should
continue to account for the largest part of Brazil’s new
generation capacity. The Energy Research Company (EPE)
estimates that, in coming quarters, a number of projects
should be concluded and together would generate 32,950
megawatts, distributed in 10 different plants. Such increase
would represent almost 30% of Brazil’s current energy
generation capacity.
However, difficulties in obtaining environmental permits
usually delay the construction schedule. Indeed, there are 10
plants whose licenses were auctioned before 2002, and
whose constructions have not started yet.
Although the 2008/2009 financial crisis did affect investments,
investors have shown interest in the country’s new projects.
Besides, even if the private sector resources are scarce, the
National Development Bank (BNDES) seems willing to cover
a large part of the R$14.2 billion investment amount which is
expected for the next few years.
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Transmission
Exhibit 55
Brazil: Generation Segment Growth
(annual increase in MW)
0
1,000
2,000
3,000
4,000
5,000
2000
2001
2002
2003
2004
According to sector specialists, among all energy segments,
the transmission is in best shape, relatively speaking.
However, the blackout that affected 18 Brazilian states on
November 10th last year highlighted the fact that, despite
recent investments, the net still has some vulnerability.
Exhibit 56
Brazil: Annual Increase in Transmission Lines
(Km installed per year)
0
1,000
2,000
3,000
4,000
5,000
6,000
2005
1999
2006
2007
2008
Source: Aneel, Morgan Stanley LatAm Economics
In 2009, according to the National Agency for Electrical
Energy, the country’s installed generating capacity stood at
113,360 MW. Total consumption amounted to 392,900 GWh
(in 2007), of which 24.1% is residential, 45.8% industrial,
15.8% commercial and 14.3% for other purposes.
In November 2008, there were 1,768 energy generation
companies operating in Brazil, with an aggregate installed
capacity of 104.8 GWh. Among them, 159 units were
medium- and large scale hydroelectric plants, 320 were small
hydroelectric plants and 1,042 were thermoelectric plants fired
by various energy sources (natural gas, diesel oil, fuel oil and
biomass). Brazil has the largest hydro power potential in the
world - a total of 260GW. Of this amount, only about 30%
(77GW) is being exploited by existing plants. The hydro power
potential yet to be exploited totals some 126GW, of which
70% lies in the basins of the Amazon and Tocantins/Araguaia
regions.
3,077
2000
2001
2,080
1,150
2002
2,438
2003
4,980
2004
2,314
2005
3,036
2006
2007
2008
3,198
995
3,318
Source: Aneel (2009), Morgan Stanley LatAm Economics
Imperfections in the system’s maintenance and management
are supposedly the source of most problems. This suggests
that the modernization of the system has not followed the
pace of expansion of the transmission system, which has
been around 2,500 km per year.
The segment receives R$3.5–3.9 billion in investment per
year. Specialists believe this amount is adequate to keep
pace with intended system expansion.
Most of Brazil’s existing large hydro power plants are located
in the basins of the Paraná and São Francisco rivers, in the
South, Southeast and Northeast regions, despite the
existence of important energy plants in the North region.
Nearly 100% of the hydro power capacity in the South,
Southeast and Northeast regions is being exploited (or
subject to environmental restrictions). Efforts to expand
Brazil’s hydro power capacity would therefore need to focus
on the country’s North region.
Since the largest hydro power potential is located far from the
main centers of consumption, Brazil’s energy grid is highly
interconnected in a vast transmission network. Small isolated
systems represent only 3.4% of Brazil’s total hydro power
generation.
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Distribution and Consumption
This segment has been working without major difficulties
over the past years. As of today, the distribution companies
already have contracts to sell all the energy which is
necessary for its markets until 2012. Due to the decline in
energy consumption during the 2008/2009 financial crisis,
revenues of distribution companies fell temporarily but the
situation has normalized since then.
Exhibit 57
Brazil: Service Disruptions
(hours per year, and times per year)
0.0
0.5
1.0
1.5
2.0
2.5
2002
Domestic consumption totaled 412.2 GWh in 2007, of which
80% comes from hydro power. After Brazil’s energy rationing
in 2001, the government granted incentives to boost energy
generation capacity using thermoelectric energy plants. These
plants aimed to turn Brazil less vulnerable to rainfall
conditions. Indeed, Brazil is unique in its dependence on
hydro power, hydro energy consumption as a percentage of
total energy consumption in Brazil is the second highest in the
world, only trailing Norway (98%). In the rest of the world, only
16% of domestic consumption, on average, is generated by
hydro power.
Exhibit 58
Brazil: Electric Power Sources
(As % of total, 2008)
0%
2003
Hydropower
2004
Natural Gas
2005
2006
2007
20%
Durtion of disruption
(hours/year)
Frequency of disruption
(times/year)
Nuclear
Mineral Coal
40%
60%
80%
100%
80.0%
6.6%
3.1%
1.6%
2008
Biomass
5.3%
Source: ONS (2009), Morgan Stanley LatAm Economics
Brazil has over 64 million consumer points of electricity
connection, covering 98.6% of Brazilian households. Of this
total, 85% are residential consumers and 15% are industrial,
commercial and/or rural users.
Of the total electricity consumed in Brazil, 88% is produced
domestically and 12% is imported, mainly from the Itaipu
hydroelectric plant, which is a bi-national venture between
Brazil and Paraguay. The Itaipu power plant in the Paraná
River on the Brazil-Paraguay border currently is the second
largest hydroelectricity producer in the world. With 20
generator units and 14,000 MW of installed capacity, in 2008
the Itaipu power plant reached a new record for electricity
production by generating 94.68 terawatt-hours (340,800 TJ).
Oil derivatives
3.3%
Source: Empresa de Políticas Energéticas (EPE), Morgan Stanley LatAm Economics
The 10-year Energy Extension Plan, by the Ministry of Mines
in Energy for 2008 to 2017, expects an increase in electricity
demand at an annual pace of 5.4% over the next 10 years,
and the addition of around 54,000 MW of installed capacity in
Brazil.
The cost of energy production at hydro power plants is around
four times lower than the cost of production at thermo plants
fueled by diesel oil, and three times lower than the cost of
plants fueled by fuel oil. However, the final average energy
price in Brazil is one of the highest in the world, for both
industrial and residential users. Higher costs of transmission
(6% of total cost), distribution (29%), and especially taxes
(around 33%) raise the price of energy for final consumers.
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Fuels
Exhibit 59
Global: Electricity Prices
(US$/Kilowatt Hour)
0%
5% 10% 15% 20% 25% 30%
Jamaica
Italy
Germany
Barbados
Petroleum and Gas
Cuba
Ireland
Brazil is at the technological vanguard of deep-water
production and exploration of petroleum and natural gas
reserves. 2008 was marked by large deposits discoveries,
known as pre-salt and located in sedimentary basins, around
6,000 meters beneath the surface of the ocean. Some
estimates suggest the volume of reserves in the deep sea
pre-salt layer to be around at least 50 billion barrels, four
times the number of current reserves. Such volume would
place Brazilian reserves among the ten largest in the world.
Investment plans in the sector are substantial, north of $200
billion over the next five years, focusing on exploration and
production.
Brazil
United Kingdom
Portugal
Japan
Austria
Nicaragua
Spain
Uruguay
Norway
El Salvador
Hungary
Bio-fuels
France
Brazil is the largest exporter of ethanol in the world, and
produces fuel from sugarcane. The largest portion of
sugarcane cultivation is concentrated in the southeast region
of Brazil, far away from the Amazon region. In all, 90% of the
sugarcane production for ethanol is located in the Southeast,
Central and South regions of Brazil.
Singapore
Chile
New Zealand
Poland
Switzerland
Panama
Production of Brazilian ethanol reached 27 billion liters in
2008, a 17.9% increase over the previous year, and the
Brazilian Ministry of Agriculture calculates that this could rise
to 37 billion liters in 2015, without a significant increase in the
sugarcane planted area. There is large demand for bio-fuel in
the domestic market, due to the development of “flex fuel”
technology, launched in 2003, which allows cars to run on gas
and ethanol in any proportion.
Peru
Czech Republic
Guatemala
Turkey
United States 3
Mexico
Argentina
Colombia
Korea, South
Honduras
Costa Rica
Bolivia
South Africa
Petrobras plans to raise production from 2.5 million
barrels of petroleum (boe) a day to 2.7 million by 2013 (in
Brazil and abroad), and ultimately reach 3.9 million by 2020.
The pilot system for the Tupi field starts production in 2010,
followed by other fields, such as the Guará and Iara fields.
Projections for output from the pre-salt layer look for a gradual
increase in the production of oil over the years.
Household
Industry
The productivity of ethanol per hectare is 6,800 liters for
sugarcane, 5,400 liters for beets and 3,100 liters for corn.
Brazil is the third largest producer and consumer of biodiesel
in the world. The National Program for the Production and
Use of Biodiesel (PNPB), established in 2004, provides a
mandatory and gradual addition of alternative fuels to diesel.
Venezuela
Dominican Republic
Source: EIA, Morgan Stanley LatAm Economics
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Appendix II: The Growth Acceleration Program (PAC)
Morgan Stanley C.T.V.M. S.A.+
Giuliana Pardelli
[email protected]
The Context
Brazilian industrial activities are highly concentrated in a few
urban settlements, and living standards vary significantly
between these metropolitan areas and the vast rural regions.
In this context, the authorities have identified the need to
promote an efficient and extensive infrastructure network, to
assure that all Brazilian regions have the opportunity to
participate in the country’s development. As a result, in early
2007, the federal government launched the “Growth
Acceleration Program” (PAC in the Portuguese acronym),
which organized and defined guidelines for investment in
logistics, energy, social and urban infrastructure projects.
The initial plan estimated investments of R$504 billion
(US$ 220 billion) in 2007–10. More than half of that total
(R$275 billion) was earmarked for energy projects, R$171
billion for housing and sanitation, and R$58 billion for logistics.
State-owned firms, including the giant oil company, would be
responsible for a large share of the total investment, while the
federal budget should contribute directly with only R$70 billion.
Furthermore, the stated investment plan goal is to construct,
modify, duplicate and recuperate 45,000 kilometers of
highways in four years, and 2,518 kilometers of railways;
expand and improve 12 ports and 20 airports; generate more
than 12,386 MW of electricity; construct 13,826 kilometers of
transmission lines; install four new refinery or petrochemical
units; construct 4,526 kilometers of gas pipelines and install
46 new biodiesel plants and 77 ethanol plants.
Exhibit 61
Brazil: Investment*
(As % of GDP)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
2003
2004
Exhibit 60
Brazil: PAC Investments
(R$ billion)
Sectors
Logistics
Energy
Social and Urban
Total
Investments under the PAC are divided into three
categories: logistical infrastructure, which includes the
construction and expansion of highways, railways, ports,
airports and waterways; energy infrastructure, which includes
generation and transmission of electricity, as well as the
production, exploration and shipping of petroleum, natural gas
and renewable fuels; and social and urban infrastructure,
which covers sanitation, housing, subways and urban trains.
Old 2007-2010
58.3
274.8
170.8
503.9
Federal Government
Petrobras
2005
New 2007-2010
96.0
295.0
255.0
646.0
2011-2017
36.2
464.0
2.0
502.2
Total
132.2
759.0
257.0
1148.2
Source: PAC, Morgan Stanley LatAm Economics
In February 2009, the federal government increased the
total planned amount by 26%, to R$646 billion (US$ 301
billion), to be used by 2010 as an additional tool for supporting
the economy and countering the negative effects of the
international financial crisis.
Besides infrastructure investments, the overall program also
includes other measures, such as tax breaks and incentives
(particularly for construction, and for technological
development), regulatory changes, special transactions with
the national development bank (BNDES), new regulation on
small and medium-sized enterprises, minimum wages
increases, and the creation of a new R$ 5 billion Infrastructure
Fund — using part of workers’ compulsory savings (Fundo de
Garantia por Tempo de Serviço, or FGTS).
2006
2007
2008
2009
* 2009 = Government estimates. Source: PAC, Morgan Stanley LatAm Economics
The PAC also includes investments by the giant oil company,
which is expected to invest more than US$ 200 billion through
2013 in the oil and gas exploration, and in the construction of
new refineries, among other projects.
In all, PAC investments stated aim is “to boost technological
modernization, accelerate growth in already developed areas,
and to foster growth in depressed areas, increasing
competitiveness and integrating Brazil with neighboring
countries and with the world.”
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PAC: An Overview 1
Energy Generation
Between the 1990s and 2006, federal government investment
in Brazil represented less than 0.5% of GDP, on average.
With complex infrastructure projects, the PAC package was
conceived as a new model for planning and managing public
investment. It is focused on articulating infrastructure projects
to accelerate growth, together with providing better social and
urban conditions, mainly within the most important Brazilian
metropolitan areas. PAC does not, however, consist only of
new projects. Indeed, most of the included projects had been
studied and designed since the 1980s.
The PAC projects place strong emphasis in the energy sector.
In fact, despite impressive growth in bio-fuel production, Brazil
remains dependent on foreign oil and gas supplies, and
exposed to potential electricity shortfall.
Exhibit 62

Boosting and modernizing oil refining, increasing
Brazilian participation in the processing chain, and improving
quality of byproducts;
Brazil: PAC Investment by Sector
(% of total)
Sectors
Logistics
Energy
Social and Urban
Total
2007/2010
14.9
45.7
39.5
100.0
After 2010
7.2
92.4
0.4
100.0
Total
11.5
66.1
22.4
100.0
Source: PAC, Morgan Stanley LatAm Economics
During the 1990s, the federal government conducted research
on the transportation corridors in Brazil, and launched an
infrastructure program called “Brasil em Ação” (Brazil in
Action), focusing on transport projects. However, the Brasil
em Ação program did not reach its objectives due to drastic
cuts in public spending in the context of fiscal adjustment
amid the several crisis of the 1990s. The lack of infrastructure
investment culminated in the 2001 energy blackout.
The PAC was launched in 2007 with a sense of urgency
for investment in infrastructure, with these objectives:

• To consolidate the most important infrastructure
projects realized in the last 30 years;

• To build a program that would include not only transport,
but also energy, oil and gas, and social and urban projects;

• To unify investment plans under the umbrella of a single
set of projects, protected from economic instabilities—so that
it would became strategic to the government; and

• To adopt a different managing model, in order to
improve control and accelerate results.
The PAC also includes a series of policies intended to
decrease regulatory risks, improve the framework for private
participation in infrastructure, and develop risk mitigation
mechanisms. The PAC aims to improve coverage and quality
of infrastructure as well as better access to water and
sanitation, electricity, transport, and energy.
1
See also “Brazil Competitiveness Report 2009”, section 2.1 - Will PAC really accelerate
growth, in World Economic Forum, 2009.
The PAC stated energy goals include:

Assuring Brazil's long-term self-sufficiency in oil, with
production at least 20% above Brazil's internal consumption, a
minimum 15-year reserve/production ratio, and larger
production of light oil;

Increasing domestic supply of natural gas;

Assuring Brazilian leadership in bio-fuels.
Exhibit 63
Brazil: PAC Investment in the Energy Sector
(% share)
Sector
Energy
Oil and Gas
Other
2007/2010
100.0
65.1
34.9
Source: PAC, Morgan Stanley LatAm Economics
Energy Distribution
Some studies indicate that Brazil would need another 34,072
kilometers of energy distribution lines (in addition to the
current 86,229 kilometers). The new lines would cost
approximately US$10 billion, according to the authorities.
Expansion under PAC projects would add 7,120 kilometers,
which are not enough to fully meet growing demand, although
the private sector has also expanded projects in energy
distribution lines.
The Oil Factor
About 65% of energy infrastructure projects under the
PAC involve oil and gas. Most of this investment would be
concentrated in the Southeast and include the following:

The Rio de Janeiro State Petrochemical Complex
(Comperj), a R$21 billion project, which, once concluded, is
expected to process 150,000 bbl/d of heavy oil to produce
diesel and several other petrochemical materials.

The Abreu e Lima Refinery in the state of Pernambuco, a
R$10 billion project that once finished in 2012 should process
200,000 bbl/d of heavy oil and produce diesel, coke, naphtha,
and gas;
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MORGAN STANLEY RESEARCH
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
Two bio-fuel export pipelines - one just for ethanol from
Goiás state to the São Sebastião port in São Paulo; the other
for both ethanol and biodiesel, to run from Cuiaba (in Mato
Grosso) to Paranagua (in Paraná);

The Gas Production Anticipation Plan (Plangás), a R$25
billion investment to increase natural gas production to 55
million cubic meters by end-2010.

In addition to Plangás, the PAC envisions to build about
4,526 kilometers of new gas pipelines.
Bio-fuels
As for bio-fuels, the PAC envisaged some 120 new
projects for 2007–10, to raise the country's ethanol output to
23.3 billion liters by 2010 and biodiesel production to 3.3
billion liters. The projects included:

Ethanol: 77 new plants producing about 40% more
ethanol;

Biodiesel: 46 new plants to quadruple production by
2010;

H-bio: the state oil company would invest some R$150
million (about US$71 million) in four refineries in Minas Gerais,
São Paulo, Paraná and Rio Grande do Sul to produce "H-bio",
a blend of vegetable oil and diesel.
Hydroelectric Dams
As for hydroelectric dams, the PAC envisions across the
main regions of Brazil:

North: 10 regular hydroelectric plants

Northeast: seven foreseen sometime after 2010;

Southeast: 12 plants — five under development, four
foreseen after 2010;

South: 8 plants under development, seven envisioned
after 2010;

Center-West: 10 under development, 10 more foreseen
after 2010.
All these projects must undergo environmental impact
assessment, public hearings and licensing.
Power Lines
The PAC estimated an investment of R$12.5 billion in
building 13,826 kilometers of high-tension power lines
(and substations) across the Brazilian territory. The regional
breakdown is as follows: North, 4,721 km; Northeast, 2,276
km; Southeast, 2,900 km; South, 2,078 km; Center-West,
1,851 km.
Transport
The authorities recognize that the current deteriorated
transport system is responsible for large economic losses and
high statistics on road accidents, also hurting competitiveness.
The PAC has in its budget a total of US$ 20 billion earmarked
for transport projects.
Highways. Given Brazil’s high dependence on highway
transportation, 70 percent of the PAC total transport budget is
dedicated to highway improvements. According to the
National Association for Cargo Transport Users (ANUT), the
increasing deterioration of the highway system is a particular
area of concern. Back in 2004, ANUT estimated that
approximately US$ 5 billion would be needed to restore the
highway system. The PAC has estimated approximately
US$ 14 billion for investment in highways. However,
according to some sector experts, the country would need to
invest more than US$25 billion in the sector.
Ports. After highways, ports are the second priority in the
PAC for reducing main logistics bottlenecks and reducing
operational transport costs in Brazil. Brazil’s current port
structure shows several critical weaknesses, including
equipment obsolescence, inefficiencies in labor organization
and allocation, lack of capacity in harbors, and inadequacies
in port administration.
In Brazil, only seven ports are able to handle large, capesize
ships, which required ports with minimum water depth of 16 to
18 meters. The port system is one of the most important
logistical bottlenecks in Brazil, given its impact on
international and national logistics efficiency. The Port
Modernization Enactment of 1993 opened port operations to
private companies that took responsibility for the operations of
6 out of the 10 major ports in the country. However, in 2005,
the National Agency for Waterway Transport (ANTAQ)
enacted two controversial resolutions (resolutions 55 and 517)
that changed the rules of port operations and private terminal
capacity improvements, analysts argue. Concession periods,
for example, were reduced from a 25-year-period to a
precarious one-year authorization that could be revoked at
any moment. These resolutions discouraged private
investment from taking place on a larger scale. A new
regulatory framework seeks to address these issues. The
PAC port projects include a total of US$5 billion, including
ship construction.
Other modes of transport. One recurring issue in logistics
discussions in Brazil has to do with the lack of balance in the
Brazilian transport matrix, which is heavily biased towards
highways. Incentives to use transport modes other than
56
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
highways should be a trend already consolidated in the
country, experts note.
Approximately US$12 billion of the PAC budget is earmarked
for investment in railroads, inland waterways, and air transport.
Some sector experts believe that the country needs
investments about twice as large (or a total of US$25 billion)
to balance its transport structure.
Exhibit 64
Brazil: Main Infrastructure Investment Projects
(R$ billion)
Projects
High-speed train, between SP and RJ
Belo Monte Hydroelectric Plant
Santo Antonio Hydroelectric Plant
Jirau Hydroelectric Plant
Angra 3 Nuclear Plant
P-57 Platform
North-South Railway, South Section
Energy Connection Line Madeira-Araraquara
Highway Arch - Rio de Janeiro
Guarulhos Airport Lane
Investment
34.6
16.0
13.5
9.3
8.6
5.1
4.8
3.3
1.1
0.3
Source: Anuário de Infraestrutura 2009 Revista Exame, Morgan Stanley LatAm Economics
57
MORGAN STANLEY RESEARCH
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Appendix III: The 2014 World Cup and 2016 Olympic Games
Giuliana Pardelli
Morgan Stanley C.T.V.M. S.A.+
[email protected]
1
As an IMF study argues, hosting a large sporting event can
offer both direct and indirect economic benefits. While direct
benefits include capital and infrastructure construction related
to the event, long term benefits include lower transportation
costs thanks to an improved road or rail network, and
spending by tourists who travel from out of town to attend the
games. Indirect benefits may include advertising effects that
showcase the host city or country as a potential tourist
destination or business location in the future and an increase
in civic pride, local sense of community, and the perceived
stature of the host city or country. But there is also a potential
downside, resulting from possible cost overruns, poor land
use, inadequate planning, and underutilized facilities.
Potential Benefits and Costs
Economists tend to be skeptical about the economic benefits
of hosting “mega-events” such as the Olympic Games or the
World Cup, since such activities have considerable cost and
seem to yield few tangible benefits. The academic literature
on the impact of hosting sports mega-events on economic
growth is scarce. However, some evidence suggests that
these events can have a positive impact on growth over time.
2
According to one study , the Olympic Games are able to raise
the GDP per capita growth rate, especially in the years that
precede the event. However, for the World Cup, there is no
strong evidence that this occurs. One possible reason for this
result would be that the International Olympic Committee
(COI) chooses, for the hosting of Games, economies with a
high growth potential. Another possible explanation would be
that infrastructure investments, increased tourism, and higher
consumer and business confidence have a positive impact on
GDP growth.
Hosting a mega event like the Olympic Games often
requires increased infrastructure to move the participants,
officials, and fans to and from the venues. In previous
episodes, most transportation infrastructure construction has
been on roads. But host cities and regions have also spent
considerable sums on airport construction as well as on the
renovation and construction of public transportation systems.
In less-developed cities, building modern telecommunications
capacity also represents a substantial investment. The
1
This appendix draws heavily from an IMF survey - “Is It Worth It?”, by Andrew Zimbalist, in
Finance and Development, The International Monetary Fund, March 2010.
“Growth Impact of Major Sporting Events”, by Elmer Sterken, in European Sport
Management Quarterly, December 2006.
2
construction of such infrastructure generates appreciable
economic activity in the local host community. Many
construction workers must be hired and large quantities of
construction materials must be purchased and transported.
Beyond the construction period, sports-event-generated
infrastructure can provide the host metropolitan area or region
with a continuing stream of economic benefits. The venues
built for these events can be used for years or decades
afterward. More important, upgrades to the transportation
infrastructure can provide a significant boost to the local and
regional economy.
Critics argue that while some expenditures improve
infrastructure, some spending is on white elephants. That
is the case when facilities built especially for the games go
underutilized after the few weeks of the competition itself,
require large sums to maintain, and occupy increasingly
scarce real estate.
Within the direct economic benefits generated by mega
sporting events, tourist spending is probably the most highly
publicized. On average, 5.1 million tickets were sold for the
past six Summer Olympic Games, and an average of 1.3
million tickets for the past five Winter Olympics. A sporting
event of this size and scope has the potential to attract a
significant number of visitors from outside the host city. These
visitors may spend considerable time in the host area,
generating substantial spending in the lodging and food and
beverage sectors.
However, additional visitors for the games are likely to be at
least partially offset by fewer visitors for other purposes
(tourism or business), as the latter seek to avoid the higher
prices and congestion associated with the Olympics. Further,
even if hotel occupancy rates and room prices rise during the
games, the extra revenue often leaves the local economy as
hotel profits are transferred to the company’s home office.
Since the benefits accrue to non-local capital owners leading
to higher than normal leakages of income, the money
generated from these events is unlikely to re-circulate through
the economy, and any multipliers applied are therefore
3
probably inflated .
Another positive impact can be found on trade numbers.
4
Indeed, using a variety of trade models, one study shows
3
“Economic Multipliers and Mega-Event Analysis”, by Victor A. Matheson, College of the
Holy Cross, department of economics, faculty research series, working paper no. 04-02,
June 2004.
4
See “The Olympic Effect”, by Rose, A. e Spiegel, M. (2009), NBER, Working Paper No.
14854.
58
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
that hosting a mega-event like the Olympics has a positive
impact on national exports. This effect is statistically robust,
permanent, and large; trade is around 30% higher for
countries that have hosted the Olympics. Interestingly
however, the study also finds that unsuccessful bids to host
the Olympics have a similar positive impact on exports,
therefore concluding that the Olympic effect on trade is
attributable to the signal a country sends when bidding to host
the games, rather than the act of actually holding a megaevent.
Brazil’s Ministry of Sports estimates that R$28.8 billion would
be spent in the 2016 Olympic games, considering both the
Organizing Committee expenses and infrastructure
investment. A government-sponsored study estimates that,
through 2027, such investment would generate US$ 51.1
billion worth of economic transactions in various sectors, 120
thousand jobs per year (during the preparation period and
during the games), and 130 thousand jobs in the subsequent
years. The official report argues that one of the direct benefits
from the Olympic Games would be additional revenues
equivalent to 97% of the total invested amount, which would
benefit not only the 12 cities where games would take place,
but also state and federal coffers.
Academic studies typically offer less upbeat conclusions than
official estimates. Some academic studies indicate that,
although a modest number of jobs may be created as a result
of hosting the games, there appears to be no detectable effect
on income, suggesting that existing workers do not benefit
(Hagn and Maennig, 2009; and Matheson, 2009). Moreover,
the impact of hosting the games depends on the overall labor
market response to the new jobs created by the games and
might not be positive (Humphreys and Zimbalist, 2008). The
economic impact of hosting the World Cup appears, if
anything, to be even smaller (Hagn and Maennig, 2008 and
5
2009) .
lasting economic benefits. Reality, however, often departs
from theory. Academic researches suggest that “in cold hard
terms it’s actually hard in international experience to
determine if there has been a positive, lasting impact on
tourism from having that brief burst of exposure” (Burton,
6
2003 ). And if accompanied by bad weather, pollution,
unsavory politics, or terrorist acts, the games may actually
damage a location’s reputation.
Finally, initially publicized budgets invariably understate
the ultimate cost of staging the games. Between the time a
host city puts in its bid for an event and the time it takes place,
construction costs and land values may increase significantly.
Projected budgets are never enough to cover actual costs.
Athens initially projected that its games would cost $1.6 billion,
but they ended up costing closer to $16 billion (including
facility and infrastructure costs). Beijing projected costs of
$1.6 billion (the operating cost budget of the Beijing OCOG),
but the final price tag was $40 billion, including facility and
infrastructure expenditures such as expansion of the Beijing
subway system. London expected its 2012 Games to cost
less than $4 billion, but they are now projected to cost $19
billion (Sports Business Daily, 2009). If there is an economic
benefit from hosting the Olympic Games, it is unlikely to come
in the form of improving the budgets of local governments,
which raises the question of whether there are broader,
longer-term, or less tangible economic gains.
Indirect economic benefits of mega sporting events are
potentially more important than the direct benefits, but are
also more difficult to quantify. One possible indirect benefit is
the advertising effect of such events. Many Olympic host
metropolitan areas and regions view the Olympics as a way to
raise their profile on the world stage. In this sense, the intense
media coverage before and during the Olympic Games or
other big events is a form of advertising, possibly attracting
tourists who would not have otherwise considered the city or
region, and who may generate significant, broad, and long5
See “Employment Effects of the Football World Cup 1974 in Germany” in Labor
Economics, vol 15, no. 5, 2008, and “Large Sport events and Unemployment: The Case of
the Soccer World Cup in Germany”, Applied Economics Vol 41, No 25, 2009, by Florian
Hagn and Wolfgang Maennig. See also “Caught under a Mountain of Olympic Debt”, The
Boston Globe, August 22, 2008, and “Economic Multipliers and Mega-Event Analysis”,
International Journal of Sport Finance, Vol 4, No. 1, 2009, by Victor Matheson.
6
“Olympic Games Host City Marketing: An Exploration of Expectations and Outcomes”, by
Rick Burton, in Sport Marketing Quarterly, Vol. 12, No 1, 2003.
59
MORGAN STANLEY RESEARCH
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Brazil Infrastructure
Appendix IV: Morgan Stanley Brazil Infrastructure Basket
Constituents (Bloomberg ticker: <MSBZINFR>)
Our Brazil infrastructure basket contains 20 stocks in the industries with the highest ROEs and Sharpe ratios greater than 1: Toll
Roads, Industrials, Metals, Auto Parts and Utilities. Liquidity constraints were applied, and for balance Utilities, Metals, and a
combination of the other industries are each equally weighted (1/3 each), with the stocks in each grouping weighted by market
capitalization. The basket is denominated in USD.
Company
Gerdau
Usiminas Siderurgicas de Minas Gerais
Metalurgica Gerdau
Ferbasa-Ferro Ligas da Bahia
CPFL Energia
Tractebel Energia
EDP - Energias do Brasil
Light
Cia Paranaense de Energia
Cia de Transmissao de Energia
AES Tiete
Eletropaulo Metropolitana
Cia de Saneamento de Minas Gerais
Equatorial Energia
Cia Energetica do Ceara
Cia de Concessoes Rodoviarias
Randon Participacoes
Lochpe-Maxion
Marcopolo
Plascar Participacoes Industriais
Ticker
GGBR4
USIM5
GOAU4
FESA4
CPFE3
TBLE3
ENBR3
LIGT3
CPLE6
TRPL4
GETI4
ELPL6
CSMG3
EQTL3
COCE5
CCRO3
RAPT4
MYPK3
POMO4
PLAS3
Sector
Metals
Metals
Metals
Metals
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Utilities
Toll Roads
Auto parts
Auto parts
Auto parts
Auto parts
Weight
15.5%
11.8%
5.5%
0.5%
7.3%
6.2%
2.3%
2.0%
4.1%
3.1%
2.9%
2.4%
1.2%
0.7%
1.0%
24.7%
3.3%
2.1%
2.5%
0.8%
Source: Morgan Stanley Research
60
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Appendix V: Companies Leveraged to Infrastructure Investment
Sector
Company name
Ticker*
Price
Analyst Name
Airline
Airline
Auto parts
Auto parts
Auto parts
Auto parts
B. Materials
B. Materials
B. Materials
Energy/Logistics
Energy/Logistics
Energy/Logistics
Industrial machinery
Logistics
Logistics
Media/Cable
Metals
Metals
Metals
Metals
Oil services
Oil services
Oil services
Port
Toll Roads
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Utility
Gol Linhas Aereas Inteligentes
Tam
Iochpe-Maxion
Marcopolo
Plascar Participacoes Industriais
Randon Participacoes
Eucatex Industria e Comercio
Kepler Weber
Magnesita Refratarios
Cosan Ltd
Cosan Industria e Comercio
Ultrapar Participacoes
Weg
ALL America Latina Logistica
LLX Logistica
NET Servicos de Comunicacao
Ferbasa-Ferro Ligas da Bahia
Gerdau
Metalurgica Gerdau
Usiminas Siderurgicas de Minas Gerais
Confab Industrial
Lupatech
OSX Brasil
Santos Brasil Participacoes
Cia de Concessoes Rodoviarias
AES Tiete
Centrais Eletricas Brasileiras
Cia de Gas de Sao Paulo
Cia de Saneamento Basico de Sao Paulo
Cia de Saneamento de Minas Gerais
Cia de Transmissao de Energia
Cia Energetica de Sao Paulo
Cia Energetica do Ceara
Cia Paranaense de Energia
CPFL Energia
EDP - Energias do Brasil
Eletropaulo Metropolitana
Equatorial Energia
Light
MPX Energia
Tractebel Energia
Transmissora Alianca de Energia
GOLL4
TAMM4
MYPK3
POMO4
PLAS3
RAPT4
EUCA4
KEPL3
MAGG3
CZZ.N
CSAN3
UGP.N
WEGE3
ALLL11
LLXL3
NETC4
FESA4
GGBR4
GOAU4
USIM5
CNFB4
LUPA3
OSXB3
STBP11
CCRO3
GETI4
ELET6
CGAS5
SBSP3
CSMG3
TRPL4
CESP6
COCE5
CPLE6
CPFE3
ENBR3
ELPL6
EQTL3
LIGT3
MPXE3
TBLE3
TRNA11
R$ 23.00
R$ 30.10
R$ 16.05
R$ 8.36
R$ 3.60
R$ 9.63
R$ 5.60
R$ 0.45
R$ 12.64
$10.62
R$ 22.10
$47.13
R$ 17.75
R$ 15.82
R$ 8.25
R$ 20.50
R$ 12.59
R$ 28.45
R$ 34.04
R$ 56.11
R$ 4.44
R$ 23.85
R$ 593.99
R$ 16.75
R$ 40.24
R$ 19.41
R$ 28.52
R$ 33.40
R$ 33.38
R$ 25.23
R$ 46.24
R$ 25.18
R$ 26.18
R$ 35.40
R$ 35.60
R$ 33.35
R$ 38.40
R$ 15.60
R$ 23.50
R$ 21.49
R$ 22.15
R$ 38.60
Nicolai Sebrell
Nicolai Sebrell
Nicolai Sebrell
NC
NC
Nicolai Sebrell
NC
NC
NC
Javier Martinez
Javier Martinez
Subhojit Daripa
Nicolai Sebrell
Nicolai Sebrell
NC
Vera Rossi
NC
Carlos de Alba
NC
Carlos de Alba
NC
Javier Martinez
Subhojit Daripa
Nicolai Sebrell
Nicolai Sebrell
Subhojit Daripa
Subhojit Daripa
NC
Subhojit Daripa
Subhojit Daripa
NC
Subhojit Daripa
NC
Subhojit Daripa
Subhojit Daripa
Subhojit Daripa
Subhojit Daripa
Subhojit Daripa
Subhojit Daripa
NC
Subhojit Daripa
NC
NC = Not covered.
* Brazil equity, except where noted.
Source: Morgan Stanley Research
61
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
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62
MORGAN STANLEY RESEARCH
May 5, 2010
Brazil Infrastructure
Stock Rating Category
Coverage Universe
Investment Banking Clients (IBC)
% of
% of % of Rating
Count
Count Total IBC Category
Total
Overweight/Buy
Equal-weight/Hold
Not-Rated/Hold
Underweight/Sell
Total
1065
1118
14
366
2,563
42%
44%
1%
14%
328
357
4
88
777
42%
46%
1%
11%
31%
32%
29%
24%
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual
circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan
Stanley received investment banking compensation in the last 12 months.
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Brazil Infrastructure
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