4 sectors (and 9 stocks) to take advantage of the booming opportunity in this asset class
As we wind up our trip across Latin America, we take a look at the opportunities in a key part of our universe - transportation stocks.
Across planes, trains, ships and automobiles, we managed to explore the opportunity set across the Brazilian transport space and came away strengthened in our conviction of the fundamental opportunity in each. We'll go through all four modes of transport and the stocks we like in the following wire - the last in our series exploring the opportunity set in Latin America.
Rail
Brazil’s agricultural theme is an exciting one - for the national economy, agricultural producers and infrastructure operators alike. None is more leveraged to this theme than monopoly rail operator, Rumo (BVMF: RAIL3), whose network is the backbone for the distribution of all soft commodities out of the Mato Grosso region.Over the short, medium and long term, the theme supports the Rumo strategy and we returned very comfortably in the fundamental investment.
Volumes
Unfortunately, short-term crop outlooks can create volatility in the Rumo share price, despite take or pay contracts and a very attractive long-term dynamic. Thankfully, the current outlook is for solid crop volumes into 2025, albeit with some risk from evolving weather patterns.The company reiterated a fully contracted model, noting that it gives surety of earnings and also operational ease in planning terminal operations. They are expecting that by year-end they will be 70% contracted for 2025 (95% for crop 1 and 50% for crop 2), largely de-risking the 2025 crop story.
Importantly, by 2030, the grain production in Mato Grosso (a Brazilian state in the country's central west) is expected to grow over 30% and exports from the Mato Grosso region are expected to grow 60% adding over 30 million tonnes to today’s 55 million base.
As such, the supply/demand balance for logistics is favouring Rumo’s monopoly rail network, supporting its contract strategy as well as pricing. While global commodity prices can impact the attractiveness of expanding planted areas, Mato Grosso is not the marginal supplier, particularly of soybean, so planting will remain robust even during periods of commodity price softness. However, with demand for food sources outpacing supply, commodity pricing should be well supported over the long term.
Pricing
The company is negotiating forward 2025 contracts in an environment with a strong volume outlook. However, trucks have become increasingly competitive this year and producers have been slower to lock in rail capacity.As such, while the company is not expecting the exceptional price uptick achieved in 2024 of +25%, it is not looking to lower pricing to contract faster and is forecasting an above-inflation uptick of up to 10% for 2025, still ahead of market expectations. Producers ultimately need to commit, or risk having limited means to transport volumes.
And, given the ongoing competitiveness of rail over trucks, Rumo should be the first to contract its capacity:
- Rail pricing – R$150-160 per 1000 km
- Truck pricing – R$250 per 1000 km.
Expansion
A key theme for Rumo is the much-anticipated network extension north to Lucas do Rio Verde (LRV) which is due to be completed in phases from 2026 with a CAPEX investment of over R$15 billion (real terms). The LRV extension takes the rail network into the heart of Mato Grosso State increasing the agricultural competitiveness of the region and Rumo’s ability to capture export market share.The first phase of the project, a 160km stretch to Rondonopolis is expected to be operational in 2026. Disappointingly, the company recently revised up the CAPEX profile for this stretch, as more advanced engineering works showed a need to move more land than originally anticipated, hiking CAPEX/km by 20%.
Upon discussions with the company, they remain confident in the return profile of this stretch and overall project as although CAPEX has increased, so too has the margin per km (due to yield expansion) and as the latter has outpaced the former, the expected return has improved.
The first phase will add 10 million capacity to the network, with the option to expand this by a further 10 million on the same site with the expectation that this capacity will be absorbed very quickly.We have revised our forecasts and timelines for the project, and are confident that it remains value accretive and will cement Rumo’s competitiveness as the core logistic artery for Mato Grosso grain exports.
CAPEX will be elevated for the coming decade throughout the execution of the extension, but the balance sheet remains comfortable as the phased opening boosts cash flows.
Competitiveness
Rumo’s competitiveness for agriculture logistics is clear to the south and is improving against the trucks as the network drives north, both in terms of pricing and in terms of operational flexibility and efficiency.There has been some suggestion that expansion of the Northern Arch and northern road networks could reduce their long-term competitiveness for Mato Grosso exports. However, we believe the growth in the Port of Santos (versus northern port capacity) and operational efficiency and pricing dynamics of rail over road continue to support market share gains for Rumo over other forms of transportation in either direction.
On our assessment, the risk/reward favours the operator at these levels with an anticipated EBITDA CAGR of over 15% for the next 10 years.
Ports
Whilst in Brazil, media reports suggested that the government was looking to revisit the auction of a new container terminal, STS10, in the Port of Santos. The shares of Santos Brasil suffered from threats of increased competition in their home terminal. As such, the catch-up with Santos Brasil (BVMF: STBP3) and industry experts was very timely.Competitive threat
Fundamental to the Santos Brasil investment story, is its competitive positioning in the Port of Santos as capacity constraints offer the incumbent operators significant pricing power over shippers. This has been reflected in a rapidly growing revenue per TEU over the past two years.The Port of Santos is currently operating at about 90% utilisation (close to optimal), with the demand outlook for capacity robust. Both incumbent operators, Santos and BTP, have fast-tracked capacity expansions with Santos Brasil expected to add 1 million TEUs (20-foot equivalent units) by 2026/27 which will support the near-term volume growth outlook.
However, the relief will be short-lived, with demand projections forecasting that a second wave of expansion at the port will be needed by the early part of the next decade. This is where the authorities are looking at all options for expansion including STS10.
According to Santos Brasil, under consideration are the:
- Release of additional land to incumbents BTP and Santos to further optimise and expand capacity by around 1-1.5 million TEUs [20-foot equivalent units] each. This would require the removal of those currently illegally occupying the land which is always difficult. This is the option that Santos Brasil (and BTP) favours as it would see them control and capitalise on the capacity expansion needs.
- Auctioning STS 10 which would occupy the space of the current Ecorporto cargo terminal, whose concession will not be renewed. Should this occur, the need for Santos and BTP to expand capacity in the early parts of the decade would be mitigated. To date, the project remains undefined and vague in terms of capacity, timing, cost, who can participate in the auction etc.
- If the project moves ahead, bids are expected next year at the earliest with a build period of 5+ years, seeing it operational in the early part of the next decade when capacity is expected to be squeezed again.
Organic upside
Strong demand recovery and a 90% port utilisation rate have seen strong revenue expansionand margin upside for Santos Brasil this year and the outlook for 2025 remains robust.
Absent global shocks, top-line growth should be at least double digits for the foreseeable future as they capitalise on the tight capacity. With a 65-70% fixed cost base, absolute EBITDA growth and margin expansion are impressive underpinning a very strong valuation dynamic.
Capital allocation
For many years, Santos Brasil has had a balance sheet that would be considered sub-optimal in the Western world, including net cash at times. They are currently executing on a strong CAPEX pipeline while working within an ‘optimal’ leverage structure of 1-1.5x net debt/EBITDA, which, while very low, they believe insulates them from any global shocks and volume volatility.At the same time, they are maintaining a 100% dividend payout and utilising other forms of capital return where possible. However, even with this as a target, the very strong FCF growth sees them deleveraging fast and without future expansion needs, we could see cash trapped.
They have no further profit reserves so can’t pay specials and cap the payout to 100%. The recently announced capital reduction of >10% share capital provided a means to improve shareholder returns and help optimise the balance sheet.
However, this is not a sustainable strategy. The company did suggest that should their expansion potential slow (STS10), they would look to M&A within the port space for future growth – they have had mixed results with M&A, so too much cash remains my one source of concern – but this is a story for 2027+.
Alternatively, as it becomes a cash cow it becomes a target for unlisted investors and shippers alike. In the meantime, I remain a buyer of the story.
Roads & urban transport
The two dominant listed transport operators in Brazil, CCR (BVMF: CCRO3) and Ecorodovias (BVMF: ECOR3), were impressed with their positive organic growth outlook coupled with a huge and targeted potential M&A pipeline. How they fund this was the one market concern, but an increasingly disciplined approach to capital management is expected to position them well for the future.Organic
While the majority of the discussion was on future growth, it’s worth highlighting that organic growth on existing assets remains strong and much better than expected. This is a function of the stronger economic environment discussed above, the growing agricultural industry and an expanding middle class. Further, these operators have an explicit inflation hedge and a high margin so also capitalise on this economic dynamic. Full-year and 2025 earnings have been upgraded supporting valuations.
Also, both operators are executing very well on an optimisation strategy, which should see substantial margin expansion over the next three to five years. This is a function of scale, a transition of the network to a free-flow system and a restructuring of the holding structures to remove obsolescence.
Both have reported visible success to date and are very confident in their longer-term goals, which for Ecorodovias includes an 80% margin target which would see them a standout in the global toll road sector.
M&A
2024, particularly the second half, is expected to be a very busy period in the transport auction market, with new roads and metro assets and re-concession assets at a federal and state level, as well as amendments to existing assets all set to hit the market. Both operators are being very selective and sitting out auctions that don’t offer the best capital allocation return, seeing neither winning a bid this year yet.In roads alone, over the next three years, 10,000 kilometres of new roads with investment requirements of >R$125 billion are expected to hit the market. In urban mobility, four new concessions and five amendments with a total investment opportunity of R$69 billion are also expected to be auctioned.
CCR identified a suite of nine projects in roads and urban mobility across new, re-auctioned and amendments that were on their focus list. CCR is targeting at least two wins, with a benchmark return unchanged at cost of capital +200-300bps in real terms. It reiterated yet again that they bid conservatively so do not expect to win all it participates in. However, if it is more successful than expected it would consider other funding mechanisms including equity, bringing in a partner and/or an asset rotation strategy with its airport portfolio already identified as a source of capital and a willingness to exit certain regions such as Rio de Janeiro.
That is, it won’t bid if they find an attractive use of capital. Interestingly, the biggest concern for the company was not the funding thereof but the ability to execute on the CAPEX embedded therein – today CCR is tracking at around 85-90% of CAPEX planned, and wouldn’t want this to change by taking on too big a load.
Ecorodovias conveyed a similar story of potential. However, its capacity is more restricted given recent wins and ongoing execution of what is a substantial CAPEX profile. Again, it doesanticipate some delays to CAPEX deployment which will help smooth the peaks and reduce
near-term demands on the balance sheet. In terms of new wins, its focus was very much on
potential amendments (three under discussion), as well as core auctions in areas with synergies to its existing network as well as in Sao Paulo which is considered the national artery.
While its leverage is actually tracking better than originally anticipated due to better operational performance, any new wins will require alternative funding mechanisms as discussed below.
The overall competitive dynamic remains robust, with existing players and new private equity and international operators (Vinci) participating. However, with the quantum that needs to be done, the operators believe they can be targeted and conservative in bids and still win a solid pipeline of future growth in assets well suited to their existing portfolio. They certainly have proven to be disciplined year to date and now we wait for execution.Capital allocation
Considering the huge potential growth pipeline, it’s worth touching briefly on the capital
allocation priorities of the two players.
allocation priorities of the two players.
CCR currently has the capacity in its balance sheet to participate in new growth with leverage below its cap of 3.5x net debt/EBITDA. Importantly, some of the potential wins would be EBITDA accretive immediately, so limited disruption to the leverage dynamic.
However, should opportunities present in more greenfield assets, it could (doesn’t wish to) push leverage above 3.5x for a brief period. Also, it has the potential to bring in partners or adopt an asset recycling strategy that could realise around R$5-10 billion over time.
Importantly though, if leverage moves above 3.5x it would trigger a cut in the dividend payout from the 50% today to 25%, where it would stay until leverage returned to sub-3.5x. I think its capital allocation strategy is well thought out and limits the risk of over-extension in pursuit of future growth. It’s known to be conservative and I don’t see any risk of this changing.Ecorodovias: The recent wins with associated Capex deployment will see leverage peak around 4.5x in 2027/28, and the company is unwilling to go above this. While it continues to look and will participate in auctions it sees as offering a strong risk/reward dynamic, its balance sheet has significantly less capacity.
As such, future wins are likely to trigger further equity raises or alternative financing structures such as partnerships and an asset disposal strategy. I am not against equity issuance if the proposition offers better value than existing trading metrics, which the company is convinced it can achieve and will need to be very clear in disclosure. I continue to like both names with risk/reward dynamics supporting a position in both at current prices.
Brazilian utilities
Hydrology concerns increasingDue to weak rainfall, water levels in reservoirs are falling, reducing hydroelectric power generation capacity. To compensate, Brazil is using more thermoelectric power, leading to higher energy tariffs. Generators with un-contracted capacity should be able to benefit through year-end into 2025, as spot pricing peaks offering a near-term earnings tailwind.
However, for the system as a whole, reservoir levels heading towards 40% will see increased risks of restrictions again – the trajectory is not as bad as 2018-2020 at this stage but certainly deserves monitoring.
CurtailmentEnergy curtailment is the deliberate reduction in electricity generation to maintain the balance between supply and demand in electric power systems and/or reduce stress on the grid. It’s becoming an issue for the Brazilian system and was a key topic of conversation for the utility sector and arguably the biggest sector concern coming out of the visits.
While many argued that it was a short-lived issue, rectified by the build-out of much-needed transmission lines, others indicated that the issue is more structural.
- Short-lived – curtailment to date has largely been to support the grid and operators like Serena (BVMF: SRNA3) believe that a large part of the curtailment will be mitigated by new transmission lines entering the system. This is certainly one cause and increased transmission investment will help – it’s also a reason we favour transmission investments over generation in Brazil at the moment.
- Structural – others believe the curtailment issues are structural given the exponential increase of distributed generation as a result of government subsidies. CPFL Energia (BVMF: CPFE3) forecasts that there is currently a 20% overcapacity in the system, while Engie Brasil (BVMF: EGIE3) estimates a long-term structural curtailment of 5% of wind and 10% of solar.
What is clear to us from the integrated players is that further investment in renewable assets was taking a back seat to investments in distribution and transmission. I think it’s a medium-term overhang for the pure-play renewables in the country, with many operators already factoring in ongoing curtailment to their forecasts.
Importantly, it’s also a message to the rest of the world: renewables without supporting grid investments will lead to curtailment of the generation and an inefficient energy system in general. It is also the reason we believe grid investments are the most attractive way to gain exposure to the energy transition theme at the moment.
Energy tariffsA strong consensus view is that the structure of the electricity bill in Brazil needs to be redesigned to facilitate energy investment in the country. While Brazil continues to have one of the lowest costs of power generation globally, increasing subsidies to distributed generation and the shift of large consumers to the free market have increased the burden of the grid on a smaller pool of customers, largely retail.
This must be addressed as they move into a cycle of large grid investment, particularly in light of investment thematics such as data centres.
Importantly, the Undersecretary for Economic and Regulatory Affairs of the MME, Mr Gustavo Estrella, recognised the issue and commented that the “MME is working on redistributing sector costs and a new policy could be presented soon”.He also noted that the new contract will give ANEEL the power to improve tariff structures and potentially charge different tariffs across the customer base.
Distribution renewals
The renewal of the distribution concessions is one of the most under-appreciated stories within the Brazilian utility space this year. A decision has been long awaited and the conclusion to move forward with the concession renewal without additional cost to the distributors was very positive for both the operators and the system, as it looks to keep up with demand, quality of service issues and the potential of new technologies.The new contracts require significantly increased levels of investment (much like networks globally) with associated tougher consumer satisfaction metrics. Importantly, the potential ability to incorporate investments into RAB [regulatory asset base] annually helps incentivise and accelerate the needed growth as companies are remunerated very quickly.The signature of the new contracts is expected within the first half of 2025, removing a key overhang for the sector (albeit I think very little residual risk) and anticipate revised investment programs throughout 2025 with impressive RAB growth expectations. The one ongoing overhang is, as discussed above, who and how this grid investment is supported by bills in the regulated market.
Water
There’s a lot of buzz around the successful privatisation of Sao Paulo’s water utility, Sabesp (BVMF: SBSP3). The sector has had a strong run this year, with a regulatory framework finally in place, paving the way for the entry of strategic investors, Equatorial, and the ultimate sell-down by the government. The story is now about execution, with the company responsible for a significant investment pipeline as well as delivering on promised efficiencies.We are positive on the thematic that is water and sanitation in Brazil, and had good meetings with both Sabesp and Equatorial (BVMF: EQTL3) with consideration now to be given to how best to gain exposure.
Other
To comment on a few of the opportunities that were raised when in Brazil, which I think are worthy of monitoring and will be discussed in greater detail in future articles:
- State of Para – Para is set to host Cop30 in 2025 and showcase Brazil’s strategy for decarbonisation. The current governor spoke at length about the national opportunity set, but I wanted to flag one unique state initiative.
- The state is set to auction a ‘reforestation’ concession, which will provide a 30-year concession to reforest illegally deforested sections of the Amazon. In exchange for this reforestation, the owner of the concession will receive credits for nine million tonnes of carbon. For those looking to offset carbon emissions, this could present a unique and simple way of capturing carbon.
- Offshore wind – there’s legislation in parliament to set the framework for decarbonisation goals including the future of offshore wind in Brazil. The federal environmental regulator is currently considering close to 100 projects with a capacity of over 230 GW [gigawatts]. An initial auction could be in play as early as 2025, with capacity online by 2030.
- Data centres – private equity funds have been investing heavily in the Brazilian data centre opportunity, given the country’s potential to provide clean and abundant energy. Brazil sees the opportunity to establish itself as a data centre hub and is working to design the energy system and security of water supply to support future growth.
- Climate investment – the floods in Rio Grande do Sul (RGS) earlier this year, and the recent Sao Paulo fires, have highlighted the growing climate risk from the increasing frequency of extreme weather events. Impressively, RGS has done an exceptional job in recovering operations, including infrastructure (roads cleared in 10 days, airports to be operational in October). However, it has also opened the door for increased investment to strengthen core infrastructure and prepare for future weather-related events – so-called adaptation and prevention initiatives. This is not as yet quantifiable but the rebuild of RGS will certainly provide a benchmark for the opportunity set for all states.
Portfolio positions
Despite ongoing political and economic headwinds across the region and the globe, this trip sees us reaffirm our investment in Latin America. We have factored in the risk and believe the value proposition of the quality infrastructure names continues to be very attractive.
In summary:- Mexican airports: We remain exposed to the Mexican airport operators. Having factored in increased country risk, we believe the risk/return trade-off favours the operators, who we believe should be largely insulated from the political and economic overhangs – all offering value but continuing to favour ASUR and GAP.
- Brazilian toll roads: There’s strong organic momentum coupled with a huge pipeline of growth with companies exhibiting capital discipline in bids. Valuations are offering significant upside without growth incorporated, and we believe risk/return on bids is to the upside. We maintain positions in both.
- Brazilian rail: This is strongly leveraged to a key Brazilian and global growth dynamic being the expansion of the agricultural industry to meet global food demand. Significant near-term competitive advantages and long-term growth drivers reaffirm our investment in the core logistic provider supporting this theme, Rumo.
- Brazilian ports: Santos Brasil is supported by near-term competitive advantages and mid-term expansion opportunities. Valuation is further underpinned by an improved capital structure and attractive shareholder return strategy. One concern over the longer term is the cash trap, but doesn’t dissuade us from our core position at these levels.
- Brazilian utilities: A mix of positive and negative discussion points here. Of concern was increasing hydrology risk as well as ongoing system curtailment which sees us less favourable in the generation sector. By contrast, a strong upside coming from the distribution concession renewals and a significant ramp-up of investment in grids to see us increasingly positive on the integrated regulated names as well as pure-play transmission & distribution operators, both of which are undervalued at the moment.
- Other: There are significant interesting infrastructure opportunities to explore in greater detail moving forward, including unique climate concessions, Brazil’s preparation ahead of 2025 COP30 and the potential of nearshoring and data centre growth across the region.
As always, we maintain a diversified portfolio of high-quality infrastructure names globally, and at the moment, believe parts of LatAm are offering an attractive mix of quality and value.
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Sarah has almost 30 years of experience across financial services, including 20 years focused on global listed infrastructure. She is an experienced portfolio manager, having successfully launched and managed several listed infrastructure funds including being involved in the build-out of two start-up listed infrastructure capabilities.
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Sarah has almost 30 years of experience across financial services, including 20 years focused on global listed infrastructure. She is an experienced portfolio manager, having successfully launched and managed several listed infrastructure funds...
Expertise
Sarah has almost 30 years of experience across financial services, including 20 years focused on global listed infrastructure. She is an experienced portfolio manager, having successfully launched and managed several listed infrastructure funds...
Expertise
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