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Brazil's Hot, But This Stock's a Short

October 08, 2009 – Comments (2) | RELATED TICKERS: GFA , HXM

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SHORT Gafisa SA (NYSE: GFA) 
Since bottoming late last October, the Brazilian market has been booming. The BOVESPA is up 112% while S&P 500 has only risen 19%. Part of the explanation for Brazil’s ability to come through the financial crisis relatively unscathed has been its strong domestic market. According to the numbers released by the Brazilian Institute of Geography and Statistics (IBGE), domestic consumption makes up around 60% of Brazil’s GDP. This means the recent dramatic drop in demand for oil, metals, etc. that everyone loves about Brazil’s long-term prospects didn’t have nearly the effect falling export demand had on China, Singapore, et al. 

Thesis:
While the domestic consumption market in Brazil is very intriguing, and the housing market has a shortage of some 7 million homes, Gafisa appears to be benefiting from the fact that it is the only Brazilian homebuilder on a major American exchange. After tripling so far this year, the market has more than priced in the growth prospects for what appears to be a second tier operator.

Company Description:
Gafisa is the fourth largest public homebuilder in Brazil by market cap, and is about half the size of the country’s largest homebuilder, Cyrela. Gafisa initially focused on the upper-end housing development, but with the recent 60% acquisition of Tenda, has moved into low-priced, entry homes. The company is almost 20% owned by an investment vehicle of Sam Zell, a billionaire real-estate mogul, who is also tied into Mexico’s Homex (NYSE: HXM). 

Valuation:
Currently trading at 29x earnings, the market is looking for some serious growth in this stock, and management’s expected 59%-88% sales growth for this year delivers. However, the Tenda acquisition is providing the bulk of this growth and analysts are looking for a tamer 35% growth next year. Even if you like these growth numbers, my beef is on a relative basis. Gafisa has averaged an EBITDA margin of 12.6% over the past five years, and will see a boost this year thanks to the one-time benefits of the sale of division, but something in the range of 10-11% seems realistic going forward, especially as Tenda becomes a larger part of the business (the low-cost houses are the best sellers right now).

Using these numbers with management’s sales expectations, Gafisa is trading at an EV/EBITDA ratio of 16. Compare that to 11.5 for Cyrela, a company with twice the sales and an EBITDA margin almost 10 percentage points higher than Gafisa. Gafisa is riding the Brazil boom right now, but if we see any rough patches in the coming twelve months, Gafisa, with its sub-optimal operations, is primed to fall. The company’s presence on the NYSE can only prop it up for so long. Give it a red thumb and get out on top.