FLBR: Exceptional Value Threatened By Lula’s Long Arm (NYSEARCA:FLBR)

The Franklin FTSE Brazil ETF (NYSEARCA:FLBR) is designed to track the performance of the FTSE Brazil RIC Capped Index, providing exposure to Brazilian large- and mid-cap stocks. It has $161M in assets as of writing. It offers value, along with a fantastic yield profile. It also appears attractive versus a key competitor. However, large question marks remain around the government’s hostility toward key constituents in the fund, as well as its willingness to intervene in both private sector corporate governance, as well Brazil’s central bank. I currently rate FLBR as a hold.

Uneven growth story tempting interventionist policy

Brazil is Latin America’s largest economy and has had an uneven growth trajectory over the last decade. Brazil emerged from a deep recession in 2017 and was setback once more with the onset of COVID-19. The economy rebounded in both 2021 and 2022. The International Monetary Fund (IMF) projects GDP growth to amount to 3.1% in 2023, and decline back down to 1.5% in 2024.

Interest rates have remained high and are currently 11.25%, down from 13.75% since August when the central bank began its easing cycle. Headline inflation is currently 4.50%, which is higher than projected estimates of 4.44%. This has drawn direct criticism from Brazil’s President Luiz Inácio Lula da Silva or “Lula”, and in turn raised eyebrows about the president’s commitment to upholding norms around the central bank’s independence.

Large allocations to commodities

As of March 2024, FLBR’s sector allocation is heavily tilted toward financials (24%), energy (21%), and basic materials (18%).

Brazil’s materials sector is dominated by mining and metals companies and has been a key driver of Brazil’s export-oriented economy. The longstanding relationship between Brazil and its key trading partner China will influence the outlook for the sector. President Lula has made an overt effort to communicate its commitment to the relationship, despite escalating tensions between the US and China.

FLBR is decently diversified from an individual holdings’ perspective. It has 85 individual stocks, with 53% of the assets in the top 10 holdings. The largest allocation is the materials company Vale S.A. (VALE). The second-largest holding is the energy conglomerate Petróleo Brasileiro S.A. – Petrobras (PBR).

Valuation

FLBR has strong value, currently trading at 1.5x book value, while its earnings are currently 8x. FLBR also has an exceptional dividend profile. It averaged a yield of 9.33% in 2023. Looking at its 5-year history, we see that the fund, while not always offering consistent growth, has provided roughly 10% TTM average yield since 2022.

Distinct differences vs. EWZ

I don’t often see the necessity for 1:1 comparisons for single-country ETFs, given the limited breadth of single-country equity markets, there isn’t often much daylight between offerings. Brazil is the exception. FLBR’s main competitor is the iShares MSCI Brazil ETF (EWZ). It is more concentrated (57 holdings vs. FLBR’s 85). While it offers a similar valuation profile, its TTM yield is quite a bit lower, currently offering 6.22% vs. FLBR’s 9.33%. When looking at performance over the last 5 years (FLBR has only been around since 2017), we see that FLBR has outperformed, which brings me to my last point of comparison: cost. The expense ratio is not my favorite data point when evaluating an ETF. However, FLBR’s notably cheaper price tag (0.19%) vs. EWZ (0.59%) coupled with the disparities in income generation for the fund can contribute to meaningful differences in total return. Of course, there are counters to FLBR relative to EWZ as well, its bid-ask spread is wider, but for a buy and hold play, FLBR seems more attractive than EWZ.

Abundant risks still loom

As mentioned above, there are key risks that would impact both FLBR or EWZ. Sluggish growth in Brazil appears to be the reality for the near to medium-term. Increased interventionism on behalf of President Lula is a real fear, that could throw sand in the gears of critical sectors in the Brazilian economy. An interest rate reduction could be a boon for export sectors, but could also commensurately negatively impact the financials sector in FLBR. Additionally, Brazil’s economy is heavily reliant on China’s cooperation as a key trading partner, which is not a certitude.

Closing thoughts

Brazil’s growth story is not compelling at the moment, and that is coupled with a head of state that could become increasingly hostile to free-market principles; Brazil’s equity market is not exactly fertile ground. However, I acknowledge that given the country’s export-oriented economy, the domestic macro situation could be less relevant to this assessment. Even still, the boom and bust reality of commodities infuses a level of risk into FLBR that exceeds my current appetite. Despite both the relative attractiveness vs. EWZ and its overall value profile, the precarity of FLBR’s juice is not worth the squeeze and I currently rate the fund as a hold.