The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS

 
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
The Brazilian Infrastructure: It’s “Now or Never”
                                                From an Economic Growth Constraint to a Plethora of Opportunities
                                                July 29, 2013                          It’s “Now or Never.” If Brazil’s infrastructure bottlenecks were concerning before, they have only gotten
                                                Research Analysts                      worse. Over the past ten years, while the Brazilian economy enjoyed prominent growth leveraged by the
                                                                                       exhaustion of the model based on credit, consumption, and commodities (the "3 Cs"), transportation
                                                Bruno Savaris, CFA                     infrastructure investments accounted for just ~0.6% of GDP, i.e., less than half of what would be required
                                                55 11 3701.6332
                                                bruno.savaris@credit–suisse.com
                                                                                       to sustain annual economic growth of 4.5%. Now that the 3Cs economic model is running out of steam,
                                                                                       the Brazilian government has shifted towards addressing concerns about meager economic growth by laying
                                                Felipe Vinagre                         the groundwork to solve one of its biggest problems: the lack of adequate infrastructure.
                                                55 11 3701.6333
                                                felipe.vinagre@credit–suisse.com       Mindful Government but Ineffective Alone. While the federal government seems highly committed to
                                                                                       delivering on the ~R$240bn investment plan announced in 2H12, the execution challenge cannot be
                                                Daniel Magalhaes
                                                55 11 3701.6124
                                                                                       understated, as most projects are still in the analysis stage and execution of public investments has proven
                                                daniel.magalhaes@credit–suisse.com     inefficient, to say the least. Thus, the private sector has to be involved. Accordingly, the government has
                                                                                       implemented several changes to the regulatory framework for ports, railroads, highways, and urban mobility
                                                                                       to make the rules sufficiently clear to foster private investments. To put things into perspective, over the
                                                                                       past ten years some R$52bn in projects were granted to the private sector. In the next three years, the
                                                                                       government wants to auction an investment budget nearly six times larger. As the government targets
                                                                                       single–digit headline rates of return, at least a friendly regulatory framework has to be in place.
                                                                                       What’s in This Report? In this report, we address the (i) causes and consequences of the lack of
                                                                                       reasonable levels of infrastructure investments in the country and (ii) measures being implemented by the
                                                                                       government to narrow Brazil's R$1 trillion transportation infrastructure gap to more developed economies.
                                                                                       We discuss the idiosyncrasies of each mode of transportation (namely highways, railroads, ports, airports,
                                                                                       and urban mobility), evolution of the regulatory framework, and why we think that some of the potential
                                                                                       investment opportunities arising in the short–to–medium term have a greater likelihood of coming to fruition.
                                                DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do
                                                business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this
                                                report. Investors should consider this report as only a single factor in making their investment decision.

CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS                                                                                                                                                BEYOND INFORMATION®
                                                                                                                                                                         Client–Driven Solutions, Insights, and Access
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

Executive Summary (1/2)
Shifting Focus from 3C to Infrastructure Investments… Brazil’s past ten years of prominent macroeconomic fundamentals were built not only on its improved
economic predictability but also on the favorable global scenario. The latter, characterized by strong economic growth, mainly in China, led to a period of high
demand for commodities. This scenario was essential for the liquidity injection seen in Brazil and consequently for the boost in the domestic consumer market. The
economic growth model in place for the past ten years became known as the “credit, consumption and commodities” (3Cs) model. Yet, more recently, the 3Cs
started to lack stamina as households became more leveraged and credit availability got stricter. Now, the Brazilian economy is experiencing the unpleasant
dichotomy of low economic growth and high inflation. To reverse that, implementing the “Chinese recipe”, i.e. shifting the focus away from consumption to
infrastructure, seems appropriate to put Brazil on track to deliver greater growth rates.

 Underinvestment? Now, US$1 Trillion Gap. The current diagnosis of low economic growth and high inflation is explained by supply–side inefficiencies rather
than insufficient demand. According to Boston Consulting Group (BCG), 74%3 of Brazil’s GDP growth over the past decade was due to an expanded workforce and
only 26% due to productivity gains. Along with that, Brazil’s underinvestment in overall infrastructure, amounting to a meager ~2% of GDP, made the long–lasting
infrastructure bottleneck even more evident. This is half of the investment level needed to sustain economic growth at 4%. To put things into perspective, other
emerging economies such as China and India invested ~13% and ~5% of their GDP, respectively. As a consequence, Brazil holds a fairly ineffective infrastructure,
ranking1 107 out of 144 countries, well below its fellow BRIC countries. Putting it differently, Brazil has a 16% asset–to–GDP ratio2, namely infrastructure stock,
and is an underperformer outlier on a global scale, holding highly depreciated assets. The average infrastructure stock ratio stands at ~70%. In order to tap this gap,
US$1 trillion in infrastructure investments would be required, half of which in transportation alone.

What Has Been Wrong? Granting Brownfields but Lagging Behind in Greenfields. Before the 1990s investments relied mostly on public execution given
the very unstable macro backdrop and poor regulatory framework. In 1993, the Brazilian Government enacted two laws (8666/93 and 8987/95) that established
the general terms for concessions in Brazil between public and private entities. Since then, several assets have been granted to the private sector which essentially
overhauled depreciated brownfield assets while the public sector remained in charge of developing greenfield ones. In this context, while we observed improvements
in the granted brownfields, Brazil lagged behind in greenfield projects given (i) the government’s inefficient planning and execution and (ii) lack of regulatory support
for private investments. The result was: all the Brazilian transportation modes got overly constrained, especially airports, ports and railroads. The airport sector has
just started to undergo a privatization process (Feb-2012), and its dependence on public administration for a long time might explain its deterioration. The other two
modes (ports and railroads) didn’t have a robust regulatory framework, especially for greenfield projects.

It’s  “Now or Never”! Calling for Private Investments. It would be unfair to say that the Brazilian government isn’t mindful of the urgency of further
infrastructure investments. After attempting to fix the economy through micro–policies, it has shown a more pro-market stance towards long–term investments, i.e.
infrastructure. In our view, an ultimate improvement in Brazil’s infrastructure won’t come through greater public investments in the sector but rather by promoting a
friendlier environment to private investments.

(1) World Economic Forum ranking / (2) Mckinsey Study / (3) Productivity gains in China, India and Mexico accounted for 93%, 88% and 60% of GDP growth over the last 10 years / (4) PPP: Public-Private Partnerships 2
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

Executive Summary (2/2)
 Improving Regulation, and More. In order to attract private players, the government has been laying the groundwork to foster private investments in the country
  by (i) straightening the regulatory frameworks, (ii) tackling the limited availability of private funding, and (iii) streamlining the licensing process. To mention a few
  developments, we note the:

     – New Ports Law, which eliminates restrictions imposed on the development of greenfield private ports. Now, they can handle 100% of third–party cargo,
        directly competing against concession holders (within public ports);

     – New Railroad Model, the so-called “Open Access”, which should stimulate (i) competition between rolling stock operators and (ii) the development of
        greenfield stretches;

     – Updates on the Law for Public-Private Partnerships, which is key for urban mobility projects. Essentially, it brings more flexibility to government payments
        which now can happen also during construction phases.

 A Sizeable Pipeline of Identified Projects. Out of the R$1trillion investment gap in the Brazilian transportation infrastructure, we have identified ~R$334bn in
  potential private investment opportunities. We think that Brazil’s infrastructure gap now has a greater likelihood of being eventually narrowed given the
  government’s strong focus (ever) on (i) boosting investments in the sector and (ii) improving the regulatory framework for further private participation.

 What about Short–Term Opportunities? While there is a plethora of interesting projects, the execution challenge cannot be understated as (i) some projects
  are still in the feasibility analysis stage and (ii) the process for obtaining environmental licenses remains cumbersome. As such, our base case is that R$109bn
  (1/3) has significant chances of being auctioned in the next two years. Within this estimate, we attribute a greater probability to toll roads and airport projects as
  their request for proposal (RFP) processes are in a more advanced stage. For ports and railroads, although these projects account for 46% of the total identified
  opportunities, we attribute a lower probability for them to take place in the short term, as feasibility studies are still under early developments and environmental
  licensing tends to be more complex for these modes.

 At Least, Doubling Private Investment Levels! Even this more conservative scenario would be enough to double private investment levels in transportation to
  ~0.9% of GDP. If we also consider public expenditures and investments in the sector, it would reach ~1.4% of GDP for the next five years. Besides, we argue
  that the auctioning of 1/6 of this notable pipeline of R$334bn would already be equivalent to the projects granted to the private sector in the past ten years.

 All  Companies to Benefit. Almost all companies under our transportation and capital goods coverage would directly or indirectly benefit from a boost in
  infrastructure investments in Brazil. Some key names are Mills, CCR, Ecorodovias, Arteris, Localiza, Marcopolo, Randon, Iochpe–Maxion and Mahle Metal Leve.
(1) World Economic Forum ranking / (2) Mckinsey Study / (3) Productivity gains in China, India and Mexico accounted for 93%, 88% and 60% of GDP growth over the last 10 years / (4) PPP: Public-Private Partnerships 3
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

Laying the Groundwork for Private Investments: Improving Regulation
                                        Main Discussions about the Current Model                                       Government Actions
                                                                                                                        The main change proposed relates to stricter capex requirements in
                                         The highway model is certainly the most mature and robust, with limited
                                                                                                                         terms of deadlines and penalties. The bulk of improvements should take
                       Toll Roads

 Better                                   room for surprises, in our view.
                                                                                                                         place within five years (duplication works).
                                         For the next auctions, the government will try to avoid the capex delays      The government is being more flexible to attract private investors, by
                                          seen in past auctions by addressing its causes and applying stricter rules
                                                                                                                         improving headline return rates (from 5.5% to 7.2%, real, unleveraged)
                                          and greater penalties.
                                                                                                                         and easing financing guarantees requested by public banks.

                                         Developed in 2H11, the recent regulatory framework for the privatization      The government increased technical qualification requirements to 35mn
                                          of airports attracted several bidders in a intense competitive bidding         pax/year (from 5mn pax/year) so that, at most,13 global operators can
                       Airports

                                          process.                                                                       participate in the auction, possibly implying less bidders in the next
                                                                                                                         auction.
                                         Yet, it seems that the government wasn’t satisfied with the fact that
                                          none of the largest global operators has won any bid.                         Another requirement is that the airport operator has to hold a minimum
                                                                                                                         stake of 25% in the formed consortiums.
 Private Investments

                                         Apparently, operational quality rules are not an issue, even though           Update of the PPP* Law. Law No. 12766, enacted in 2012, now
                       Urban Mobility
    Regulation of

                                                                                                                         permits government’s reimbursements during construction phases.
                                          feasibility usually depends on government reimbursements (PPP model).
                                         The challenge for PPPs is how to mitigate the government’s payment            Also, this new law increased the threshold for municipal tax revenues
                                                                                                                         that can be channeled to PPP payments from 3% to 5%.
                                          risk, which in these cases becomes a relevant source of revenues.
                                         Political Exposure is high as it deals with people not cargoes.               Government’s payment risk (main investors’ concern): guarantees and
                                                                                                                         collateral pools are still under discussion/being designed.
                                                                                                                        The government’s intention is to stimulate (i) private investments in new
                                         Government is unsatisfied with the current railroad monopoly model,            corridors (i.e. capacity increase) and (ii) competition between multimodal
                       Railroads

                                          which hasn’t stimulated investments in new stretches (greenfields).            operators (i.e. tariff decrease).
                                         Besides the measures announced in 2011 (challenging the monopoly of           Yet, (i) projects are still under preliminary studies and (ii) there are still
                                          current concessions), the government has launched a plan to grant 10           uncertainties regarding the new model such as (a) operational feasibility
                                          new stretches under a new railroad model (Open Access).                        and (b) collateral pools to secure Valec’s payment risk.

                                                                                                                        In 2013, the government launched the New Ports Law in order to
                                         Capacity additions in public ports has depended on the government’s            foster investments other than in public ports. The main innovation was
                                          planning and auctioning processes, which have been insufficient to
                                                                                                                         the authorization for private ports to handle third–party cargo.
                       Ports

                                          address the country’s port infrastructure needs.
                                                                                                                        While we welcome the elimination of that restriction, we think there are
 Worse                                   Private investments in greenfield projects outside of public ports have        still a few unclear terms such as for: renewals, auction criteria and
                                          been constrained by the lack of regulatory support.
                                                                                                                         different conditions for public and private ports.

Source: Credit Suisse Research / (*) PPP: Public-Private Partnerships                                                                                                                                     4
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

Table Of Contents
Macro Backdrop                                                                      6       … But Limited Capacity Addition                                                   42
   In the Last Decade, Economic Stability and Consequent Greater Predictability…    7       Encouraging Private Investments                                                   43
   … Improved Credit Availability and Boosted Consumption in Brazil                 8       Recent and Upcoming Auctions – Galeão Better than Confins…                        44
   The Commodities Boom and its Infrastructure-Intensive Profile                    9       Global Comparison on Regulatory Frameworks                                        45
   Demand for Transportation Infrastructure Spiked! What About Supply?             10       Details on the Privatization of Some Airports                                     47
   Underinvestment Led to Underperformance. Lagging Behind the BRIC League         11       Concession of Airports to Private Companies/Investors                             48
   After Golden 1970s, Investing Merely ~2% of GDP on Overall Infrastructure...    12   Urban Mobility                                                                        49
   … And Barely ~1% of GDP on Transportation Infrastructure                        13       Huge Urbanization and Wrong Incentives Behind Rising Mobility Constraints         50
   The Result: Mediocre Infrastructure Performance Across The Board …              14       While Middle Class Motorizes, Low Income Class Relies on Public Transport         51
   The Result: … On a Deteriorating Trend                                          15       Global Comparison of Subway Networks: Rio and São Paulo Far Behind                52
   The Result: Unbalanced Transportation Matrix And Inefficient Logistics          16       Government’s Plan: Over R$81bn of Investment Opportunities                        53
Governm ent Actions                                                                17       The Need for Subsidies through Public Private Partnerships (PPP)                  54
   A Mindful Government: Federal Investment Programs (PAC I and II)                18   Railroads: A New Model to Boost Private Investm ents in New Locations                 55
   But Ineffective Alone: Investing Far Below Brazil’s Transportation Needs        19       Brazilian Railroads: Increasing Demand, Flat Network Size, and …                  56
   Examples of Poor Government’s Execution: N–S Railroad & BR-163 Highway          20       … a Consequently Over–Constrained System                                          57
   Gradually Boosting Private Investments: R$52bn in the Past 10 Years             21       Brazil Lagging Behind On a Global Scale                                           58
   R$334bn on Identified Investment Opportunities to the Private Sector            22       Impacts on Brazil’s Competitiveness: The Soy Exports Example                      59
   Laying the Groundwork for Private Investments: Improving Regulation             23       Current Railroad Model Hasn’t Fostered Investments In New Lines                   60
   Can Financing Be a Constraint? Is BNDES Enough? Searching for Alternatives      24       The New Model (Open Access): Mitigating Risks to Boost Greenfields                61
Toll Roads                                                                         25       New vs. Current Framework: What Changes in Each Participant’s Role?               62
   From Dedicated to Spare Funding (1945–1988)                                     26       Comparison to Other Railroad Models: Innovative Solutions Despite Similarities    63
   Making Private Investments Viable (1990–2000)                                   27       Investment Opportunities: Projects still under Study Phases                       64
   Setting Single Digit Headline Return Standards (2001–2007)                      28    Ports: Addressing Regulation Barriers to Private Investm ents                        65
   Many São Paulo State Concessions, But Few Federal Ones (2008–2012)              29       Current Conditions: World’s Ninth Worst                                           66
   After Lack of Private Interest Comes a Pro-Market Stance (2013 onwards)         30       Current Conditions: Limited Draft, Limited Efficiency…                            67
   Private Toll Roads – A Snapshot Of The ~ 20 Years Of Regulatory Framework       31       Current Conditions: Awkward Customs Process                                       68
   Current Road Conditions: Only 14% Paved and Public Lagging Behind Private       32       Regulatory Story: Framework and Constraints                                       69
   R$54bn in Upcoming Auctions. Are They All Attractive? What About Risks?         33       The New Ports Law: What Has Changed? Open Doors for Private Ports                 72
   Government Showed Flexibility on Headline Returns. Will it Be Enough?           34       The New Ports Law: Asymmetries between Public and Private Ports                   74
   Upcoming Auction – Location & Potential Bidders                                 35       Investment Opportunities: R$54bn in Projects                                      75
   Amendments Pipeline (CCR, Arteris, Ecorodovias)                                 36       Complex Licensing Process – How Long Can It Take?                                 76
   Regulatory Improvement to speed-up Contract Amendments                          37   Com panies Mentioned                                                                  77
Airports                                                                           38   Im portant Global Disclosures                                                         78
   Twenty Airports For 90% of Passenger Flow                                       39   Im portant Regional Disclosures                                                       80
   ANAC, SAC, DAC… Fairly Regulated Sector                                         40   Disclaim ers                                                                          81
   Strong Demand Growth Fostered by Lower Yields…                                  41

                                                                                                                                                                               5
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

Macro Backdrop

                                                                                        FOTO

Exhaustion of the 3Cs Model…                                                                          Now, It’s about Restoring the Great Legacy – Shifting to Infrastructure
Brazil’s past ten years of prominent macroeconomic fundamentals were built on observance              Unfortunately, Brazil’s noticeable economic development wasn’t followed by adequate
of three main pillars, namely (1) inflation targeting, (2) a floating exchange rate, and (3) fiscal   infrastructure investments to tap the growing demand. Over the past ten years, the country’s
responsibility, which improved Brazil’s economic predictability. At the same time, the                transportation system became overloaded, resulting in clogged ports, congested roads and
favorable global scenario characterized by strong economic growth, mainly in China and, to            airports, obsolete railroads, and inadequate transportation matrix. Brazil’s underinvestment in
some extend, in the developed regions, led to a period of high demand for commodities. This           overall infrastructure, amounting to a meager ~2% of GDP, made the long–lasting
scenario was essential for liquidity in Brazil and consequently for the boost in the domestic         infrastructure bottleneck even more evident. This is half of the investment level needed to
consumer market. The economic growth model in place for the past ten years is known as                sustain economic growth at 4%.
the “credit, consumption and commodities” (3Cs) model.                                                To put things into perspective, other emerging economies such as China and India invested
Yet, more recently, due to government inaction, the Brazilian economy started to experience           ~13% and ~5% of their GDP, respectively. Looking at the World Economic Forum ranking,
the unpleasant dichotomy of low economic growth and high inflation. Also, with more                   Brazil’s overall infrastructure ranked 107 of 144 countries, well below its fellow BRIC
leveraged households, with a debt–service ratio of ~22% of disposable income, up from                 countries, with India ranking 87th and China, 69th, and nearly on par with Russia, which is
~16% in 2005, the 3Cs model is lacking in stamina. Thus, the adoption of the “Chinese                 101st. Among the BRIC countries, Brazil has the worst airport, port, and railroad systems.
recipe“, i.e. shifting the focus away from consumption to infrastructure, seems appropriate to        Now, its about restoring the great legacy. According to McKinsey, Brazil has a 16% asset–
put Brazil on track to deliver greater growth rates and keep its emerging market status.              to–GDP ratio, namely infrastructure stock, and is seen as an outlier on a global scale,
The current diagnosis of low economic growth and high inflation is explained by supply–side           holding highly depreciated assets. The average ratio stands at ~70%. To help tapping this
inefficiencies rather than insufficient demand. About 74% of Brazil’s GDP growth over the             gap, US$1 trillion of infrastructure investments would be required, being half of that in the
past decade was due to an expanded workforce and only 26% due to productivity gains.                  transportation sector.
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

In the Last Decade, Economic Stability and Consequent Greater Predictability…
   Brazil’s prominent prospects can be credited to the “Real Plan,” instituted back in                GDP Growth (%) vs. Inflation (IPCA %)
    1994, almost 19 years ago, which led to a rapid reduction in monthly inflation, from
    50% to 1%. Then, in 1999, the Brazilian government adopted an economic policy                                 12.5                                                                 Real GDP growth (%)
    based on three main pillars, namely (1) inflation targeting, (2) floating exchange rate,                                                                                           IPCA inflation (%)
    and (3) the adoption of a fiscal responsibility law.                                                                   9.3
   Observance of these policies for over ten years has improved Brazil’s economic                          7.7                    7.6
                                                                                                                                                                                7.5     6.5
    predictability and contributed to a significant improvement in Brazil’s macroeconomic                                                  5.7                   5.9                           5.8     6.0      5.8
                                                                                                                                   5.7                    6.1
    fundamentals. From 2003 to 2011, the government kept inflation relatively low,                                                                               5.2    4.3     5.9
    redeemed all sovereign debt originated from the 1990s debt renegotiation, improved                                                            4.0     4.5
                                                                                                                  2.7                      3.2                                                                  3.0
    the risk profile of its sovereign securities, posted primary surpluses, and substantially                                                     3.1                                   2.7            2.0
    increased its level of international reserves.                                                          1.3            1.1
                                                                                                                                                                                               0.9
                                                                                                                                                                       –0.3
   Despite the recent macro challenges, consisting of “high” inflation and low GDP                     2001 2002 2003 2004 2005 2006 2007 2008                                2010 2011 2012 2013e 2014e
    growth, the current scenario is far better than in the past.                                                                                                       2009

Brazil’s Historical Inflation and Interest Rate Levels, Almost 20 Years of Economic Stability
7,000

                                                   160                                                20
6,000                                                       Real Plan     Russian
                                                                          crisis and                  15
                                                                          abolishment                                                                      Selic basic interest rate
5,000                                              120                    of the fixed FX
                                                                                                      10
                                                                          rate regime                                    Lowest interest
                                                                                                                         rate in decades
                                                                                                       5
4,000                                               80                                                                                                                        IPCA
                                                                            Introduction of the        0
                                                                          floating FX rate and        Feb-05         Feb-06      Feb-07    Feb-08       Feb-09   Feb-10       Feb-11     Feb-12       Apr-13
                                                                             inflation–targeting
3,000                                                                                   regimes
                                                    40
                             SELIC
2,000
                                                     0
                                                     May-95         Aug-97            Nov-99                Feb-02            May-04             Aug-06           Nov-08              Feb-11           Apr-13
1,000
                             IPCA
      0
      Jan-90        Jan-92           Jan-94      Jan-96         Jan-98         Jan-00              Jan-02            Jan-04          Jan-06             Jan-08         Jan-10           Jan-12           Jan-13

Source: Central Bank; Credit Suisse Research.                            Source: Central Bank of Brazil, Brazilian Statistics Bureau (IBGE), Credit Suisse Economics Team                                             7
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

… Improved Credit Availability and Boosted Consumption in Brazil
   Brazil’s sound macroeconomic policies helped to stabilize financial inflows and make             Household Income and Breakdown of Income Groups in Brazil
    investors less concerned about the safety of their investments. Accordingly, the                     Total Household Income from                Breakdown of Income Groups in Brazil
    greater economic predictability was essential to foster a substantial improvement in                     all Sources of Income                           (millions of people)
                                                                                                                  (US$/month)
    credit availability in the country.                                                                                                                  2002                    2009               2014

   While some people may look at credit availability and disposable income through                                                    Class “A”   7.2                     9.6                   13.4
    different lenses, we note that both are closely linked and extremely important factors                 Class “A”
    for any credit transaction. Thus, the combination of credit availability improvements
                                                                                                                                       Class “B”   7.3                     10.4                  15.7
    and greater disposable income leveraged the domestic consumer market. Through                                         5.010
    2009, the purchasing power of about ~30mn people had improved. By 2014, about                          Class “B”
    60% of Brazil’s population, or ~50mn people, will have enjoyed an improvement in                                                   Class “C”                67.5                     95.0                118.0
                                                                                                                          3.843
    their purchasing power.
                                                                                                                                       Class “D”          46.1                    44.5              32.1
   Back in 2008/2009, the fear of increasing delinquency rates led financial institutions
                                                                                                           Class “C”
    to implement a stricter credit approach, decelerating the growth pace of their loan
    portfolios, which once boomed. Going forward, it seems that it will be increasingly                                                Class “E”          46.6              28.9                 16.8
    hard to see a rise in buyers’ purchasing power, at least not at the same pace                                         891
                                                                                                           Class “D”      558
    observed until 2010.                                                                                                                   Total     175mn                   188mn                 196mn
                                                                                                           Class “E”
                                                                                                                          0

Real Growth in Average Wages and Unemployment Rate                                                   Improving Credit Availability (%)
                                                                                                         60                                                                                                      9
                         14.1%                                 Real Increase in Minimum Wage                                                                           Credit–to–GDP
                                                               Unemployment Rate                                                Delinquency Rate                          (%, LHS)
                                                                                                         50                         (%, RHS)                                                                     8
    12%
           12%
                                                                                                         40                                                                                                      7
                  10%    10%
                                 9%
                  7.0%                           8%
                                                                       7.5%                              30                                                                                                      6
                                         8%
                                 6.0%                    7%
                                                7.2%             6%                                                                    Debt–to–Income
                                                                        6%                               20                               (%, LHS)                                                               5
           3.7%                                         5.3%                    5%
                                        3.1%                                            4%
                                                                                                         10                                                                                                      4
    0.7%                                                                       2.7% 0.9%
                                                                0.1%
                                                                                                          0                                                                                                      3
    2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013e 2014e                                        Jan-05        May-06      Sep-07          Jan-09          May-10               Sep-11          Jan-13

Source: FGV, Central Bank of Brazil, Brazilian Statistics Bureau (IBGE), Credit Suisse Economics Team.                                                                                                           8
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

The Commodities Boom and its Infrastructure–Intensive Profile
   The share of commodities in exports rose from 49.7% in 2000 to 70.0% in the 12–month period ended in April 2013. The most significant increases have been in iron ore, oil,
    soybeans, and sugar attributable mainly to a rise in the international commodity prices. The mining industry alone accounts for ~4% of GDP and ~20% of Brazil’s exports. While
    the Brazilian government put a lot of effort in trying to reduce its dependence on commodities, minerals and agriculture, they are still very significant to the economy.
   The booming commodities cycle also made evident one of the country’s major structural problems: the lack of proper infrastructure. As the most important agricultural and mineral
    areas are located far from the country’s export gates, it would be reasonable to assume that railroads meet most of the transportation demand. In fact, that isn’t the case.
    Highways account for ~60% of agricultural commodities transportation. In the case of minerals (mainly iron ore), as railroads are used as cost centers by miners, most of the iron
    ore flows through railroads. An example of Brazil’s logistics bottlenecks we note the usual ~10–mile line of trucks awaiting at the ports’ gates to unload the crop and the ~200
    ships awaiting to load cargo as well.

Brazilian Landscape: Producing Areas Away from the Coast                                               Boom in Commodity Prices Drove Exports Up
                                                                                                                        Volume Exported (tons) Index 2002 =100
                                                        AP
                                                                                                       800

                                                                               Ponta da Madeira Port   600
                                      Santarem Port               900
                                                                                                                                                                                   Corn
                             AM                         PA                                             400
                                                                        MA
                                                        Carajás                                                                                                                             Soy
                                                1,500
                                                                                                       200
                                RO                                TO            BA                                                                             Iron Ore                   Sugar
                                                                                                         0
                                               MT                                                         2002   2003   2004      2005    2006    2007   2008     2009      2010    2011     2012
                              Lucas do Rio Verde
          Capitals                                                                                                      US$ FOB / tons Exported Index 2002 =100
                                                             GO
          Railroads
                                                         2,000                MG                       800
          Distance (km)                       MS
          Ports                                                                      700
                                                                                                       600
                                                                                       Tubarão Port                                                             Iron Ore
    Producing Zones                                     1,000                RJ                                                                                                     Sugar
                                                                   SP         Santos Port              400
          Soy/Corn                                                  Paranaguá Port
                                                                                                       200
          Sugar
                                                                                                                                                         Soy                Corn
          Iron Ore                                                                                       0
                                                                                                             2002   2003   2004    2005    2006   2007   2008    2009      2010    2011    2012

Source: Aliceweb, Credit Suisse Research. (*) FOB value in the Brazilian Ports/Exported tons 2002=100)                                                                                            9
The Brazilian Infrastructure: It's "Now or Never" - Credit Suisse | PLUS
29 July 2013

 Demand for Transportation Infrastructure Spiked! What about Supply?
   Unfortunately, Brazil’s noticeable economic development wasn’t followed by greater infrastructure investments to tap the growing demand. Over the past ten years the country’s
    transportation system was overloaded, resulting in clogged ports, congested roads and airports, obsolete railroads, and inadequate transportation modes. About 300Mt have been
    added to foreign trade flows, led by iron ore and agricultural commodities exports. Light vehicle sales are 2.5x higher than ten years ago, increasing highway infrastructure needs
    and deteriorating urban traffic. Yet, investments in transportation infrastructure have not kept the same pace of economic development.
   Reportedly, the inefficiencies created by infrastructure bottlenecks subtract 10%–15% from the country’s GDP.
Growing Demand across the Board (Services, Manufacturing Industry and Agriculture): How About Processing Capacity?
                  Infrastructure                  Distance to Ports       Demand                      Demand                                              Growth in Past Ten Years
                  Demand Drivers                        (km)              in 2002                     in 2012                               Delta         (%, 2002–2012)

                  Air Passenger Traffic
                  (mn passenger/year)                     NA                 71.2*                            193.1                         121.9                                             171

                  Light Vehicle Sales
                  (mn units/year)                         NA               1.6                         4.0                                   2.4                                             147

                  Agricultural** Exports
                  (Mt/year)                           500 – 3000            32                           77                                  45                                           140

                  Container Flow at Ports
                  (mn TEUs/year)                       70 – 150            3.5                         8.2                                   4.7                                        132

                  Iron Ore Exports
                  (Mt/year)                           500 – 1000                 167                                327                      160                                 96

                  Foreign Trade***
                  (Mt/year)                               NA                           387                                  688              301                            78

                  Household Consumption
                  (R$bn)                                  NA                               1,825                               2,744         919                      50

                  ABCR Index
                  (Paved Highway Traffic)                 NA                   111                            163                            NA                      48

                  Petrobras Offshore
                  Production (mn bpd)                     NA                             1,257                               1,768           511                    41

Source: INFRAERO, Anfavea, Aliceweb, Brazilian Water Transportation Agency (Antaq), ABCR, Petrobras, CS Research // (*) 2003 Figures. (**) Soy, corn and sugar. (***) Exports and imports.         10
29 July 2013

Underinvestment Led to Underperformance. Lagging behind the BRIC League
                          Brazil has invested, on average, ~17.5% of its GDP, much less than China (42%),                BRIC’s Gross Fixed Capital Formation (% of GDP)
                           India (30%), and Singapore (25%). Among the BRIC countries, Brazil stands out for
                                                                                                                          50
                           having the lowest level of investments for the past ~ten years.
                          On average, for the past ten years GDP growth in these countries has been virtually                                                                                  China
                           proportional to the level of investments, with Brazil growing ~4%, China 11%, India            40
                           8.2%, and Singapore 6.5%. South Korea and Mexico are heading into the right
                           direction to boost growth. Needleless to say, the lower investment levels in Brazil
                           were not able to sustain its growth rates at 4% for longer.                                    30
                                                                                                                                                                                     India
                                                                                                                                                                                                      Russia
Fixed Capital Formation vs. GDP Growth (Last Ten Years)
                                                                                                                          20
                                           45
                                                                                                             China
                                                                                                                                                                  Brazil
                                                                                                                          10
                                           40                                                                                      1963     1969    1975   1981   1987     1993         1999     2005        2011
Gross fixed capital formation (annual %)

                                                                                                                          Breakdown into Public and Private: Brazil’s Fixed Capital
                                           35                                                                             Formation (% of GDP)
                                                                                                                               Private    Public                    19.1          19.5 19.3
                                                                                                India                                                                      18.1                18.1 18.2 18.5
                                                                                                                                                             17.4
                                           30                                                                             16.8 17.1 16.4
                                                                                                                                              16.1 16.0 16.4      4.2             5.2    4.5
                                                                      S. Korea                                             2.6 2.9
                                                                                                                                         15.3                 3.6          4.8                 4.7     4.7    5.0
                                                                                                                                     3.2       3.0 3.1 3.4
                                                                                                                                          2.8
                                           25
                                                    Japan            Chile            Singapore
                                                                               Hong Kong
                                           20                                                                             14.2 14.2 13.2                     13.8 14.9 13.3 14.3 14.8 13.4 13.5 13.5
                                                            Mexico                                                                       12.5 13.1 12.9 13.0
                                                                        Russia
                                                       US             Brazil
                                           15
                                                0           2        4         6            8           10           12
                                                                      GDP growth (annual %)                               2000           2002      2004    2006    2008           2010         2012          2014e
Source: Central Bank; World Bank, Credit Suisse Research.                                                                                                                                                      11
29 July 2013

After Golden 1970s, Investing Merely ~2% of GDP in Overall Infrastructure ….
   Looking at Brazil’s historical investments in the infrastructure sector, the highest investment levels occurred during President Juscelino Kubitschek’s administration and in the
    following decade (1970s). During the 1980s Brazil faced strong fiscal issues and started to significantly reduce its expenditures. Before the 1990s investments relied mostly on
    public execution in view of the very unstable macro backdrop and poor regulatory framework for private investments.
   It would be unfair to say that the Brazilian government wasn’t mindful of the urgency of further infrastructure investments. Looking at the R$250bn of federal investments
    disbursed in the past 12 years, ~85% has been disbursed over the past five years, during the booming economic cycle. Transportation was the category with the greatest number
    of investment initiatives (~25% of the total) and the greatest volume of disbursements (~R$76 billion) in the period.
   Annual federal investments in transportation have corresponded to ~0.2%–0.3% of GDP since 2010. In our view, an ultimate improvement in Brazil’s infrastructure won’t come
    through greater public investments in the sector but rather by promoting a friendlier environment to private investments.
Brazil’s Investments in Infrastructure* (as a % of GDP)
                   5.42                                         Brazil’s Investments in Infrastructure (as a % of GDP)                       Investments Breakdown (% of total)
         Waste     0.46                                           3.1
     and Water                                                                            Transportation     Telecom     Power & Utilities                                             Federal
                                                                                                                                             12.9 11.6 14.8                     11.2
                                                                                                                                                                  18.7 16.1            Government

                                                                  0.8
                                                                                                             2.5   2.5
                   2.13                                                                                                  2.4
         Power                 3.62                                                                                                                                                    Public–Owned
                                                                                                                                     2.2            33.3                        36.2
                               0.24                                                                                                          37.1                                      Companies
                                                                                           2.0   2.0                           2.1                                       36.1
                                                                        2.0                                  0.9                                           44.8
                                                                                                       1.9         1.0                                            42.1
                                                                                    1.8
                                                                                                                         1.0
                               1.47                                                                                                  0.8
                                                                                           0.8                                 0.8
                   0.80                    2.29                         0.8   1.4                0.9
      Telecom                              0.15     2.16          1.7               0.7                0.8
                                                    0.19                                                           0.6
                                           0.76                                                              0.8         0.4
                               0.43                                           0.6
                                                    0.67                                                                       0.5   0.6
                                                                                           0.7                                                      55.0                               Private–Sector
                                                                        0.7                      0.5   0.5                                   50.5                               51.5
                                                                                    0.7                                                                                  47.3          Companies
                   2.03                    0.73     0.64                                                                                                   40.8 39.1
Transportation                                                                0.5
                               1.48                                                                                1.0   1.0
                                                                                                             0.8               0.8   0.7
                                           0.63     0.62          0.6   0.5                0.5   0.6   0.6
                                                                              0.4   0.4
                 1971–80 1981–89 1990–00 2001–10                 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*                2007 2008 2009 2010 2011 2012*
 (*) Includes both private and public investments
Source: Inter. B Consultoria / Castelar Pinheiro and Giambiagi (2012) and Frischtak (2012)                                                                                                        12
29 July 2013

… And Barely ~1% of GDP in Transportation Infrastructure
                     Total Investments (R$bn)                                                                Breakdown of                                             Investment as % of GDP
 45                                                                                   1.2%
                                                                                                    Total Investments 2002 – 20012                     1.2%                                                       0.8%
                                                                                                                                                                                                                  0.7%
 40                                                                                                                                                    1.0%
                                                                                      1.0%                      Subway
 35                                                                                                                                                                                                               0.6%
                                                                                                         Airports                                      0.8%
 30                                                                                   0.8%                            8%                                                                                          0.5%
 25                                                                                                               3%
                                                                                      0.6%                                                             0.6%                                                       0.4%
 20                                                                                                Waterways
                                                                                                              12%                                                                                                 0.3%
 15                                                                                   0.4%                                                             0.4%
                                                                                                                                                                                                                  0.2%
 10
                                                                                      0.2%                                                             0.2%
  5                                                                                                                                                                                                               0.1%
                                                                                                    railroads   19%             58%
  0                                                                                   0.0%                                                             0.0%                                                        0.0%
                                                                                                                                                           2002       2004         2006    2008      2010       2012
       2002

              2003

                     2004

                            2005

                                   2006

                                          2007

                                                 2008

                                                        2009

                                                               2010

                                                                      2011

                                                                             2012

                                                                                                                                      Highways                                                      Subway
                                                                                                                                                          Highways     railroads      Waterways                 Airports
                Public                     Private                     % of GDP                                                                                          Public (RHS)      Private (RHS)

              Airports Investments                                                   Highway Investments                        railroad Investments                                  Waterway/Ports Investments
              (R$bn)                                                                 (R$bn)                                     (R$bn)                                                (R$bn)
 2.5                                                     90%                 18                                  60%        7                                 100%           3.5                                   120%
                                                         80%                 16                                                                               90%
                                                                                                                 50%        6                                                3.0                                   100%
 2.0                                                     70%                 14                                                                               80%
                                                                                                                            5                                 70%            2.5
                                                         60%                 12                                  40%                                                                                               80%
 1.5                                                                                                                        4                                 60%            2.0
                                                         50%                 10
                                                                                                                 30%                                          50%                                                  60%
                                                         40%                 8                                              3                                                1.5
 1.0                                                                                                                                                          40%
                                                         30%                 6                                   20%                                          30%                                                  40%
                                                                                                                            2                                                1.0
 0.5                                                     20%                 4                                                                                20%
                                                                                                                 10%        1                                                0.5                                   20%
                                                         10%                 2                                                                                10%
 0.0                                                     0%                  0                                   0%         0                                 0%             0.0                                   0%
       2003
       2004
       2005
       2006
       2007
       2008
       2009
       2010
       2011
       2012

                                                                                    2002
                                                                                    2003
                                                                                    2004
                                                                                    2005
                                                                                    2006
                                                                                    2007
                                                                                    2008
                                                                                    2009
                                                                                    2010
                                                                                    2011
                                                                                    2012

                                                                                                                                2002
                                                                                                                                2003
                                                                                                                                2004
                                                                                                                                2005
                                                                                                                                2006
                                                                                                                                2007
                                                                                                                                2008
                                                                                                                                2009
                                                                                                                                2010
                                                                                                                                2011
                                                                                                                                2012

                                                                                                                                                                                   2002
                                                                                                                                                                                   2003
                                                                                                                                                                                   2004
                                                                                                                                                                                   2005
                                                                                                                                                                                   2006
                                                                                                                                                                                   2007
                                                                                                                                                                                   2008
                                                                                                                                                                                   2009
                                                                                                                                                                                   2010
                                                                                                                                                                                   2011
                                                                                                                                                                                   2012
                                                                                    Private                            Public                             % Private

Source: Orçamento Fiscal (SIGA BRASIL /SIAFI), ABCR, DEST/Docas, ANTF, Infraero, BNDES, IPEA / (*) Public Investments (based on SIAFI & DEST–MPOG)                                                                      13
29 July 2013

The Result: Mediocre Infrastructure Performance across the Board …
   Looking at the World Economic Forum ranking, Brazil’s overall infrastructure ranked                      Investments in Infrastructure, 2011 (as a % of GDP)
    107 of 144 countries. Among the BRIC countries, Brazil has the worst airport, port,
                                                                                                                  China                                                                                       13.4
    and railroad systems. The only mode in which Brazil isn’t as bad (relatively to BRICs)
    is highway transportation. Perhaps that has to do with the fact that the regulatory                        Vietnam                                                                             11.4
    framework seems to be relatively more robust.                                                                  Chile                                                6.2
   As mentioned in the previous slides, Brazil’s Achilles’ heel is its infrastructure, which                 Colombia                                                 5.8
    is the clear result of its meager infrastructure expenditures for the last several years.                      India                                     4.5
    Relative to other developing economies, Brazil invested only ~2% of its GDP in                           Philippines                               3.6
    infrastructure, versus ~4.5% in India and an astonishing ~13% in China.                                       Brazil                      2.1

Global Ranking of Quality of Infrastructure (1= Best performer, 144= Worst performer)
                       Airports         1 (Best performer)                                                                                                                                  144 (Worst performer)
                                                       15                                                       68 70                                        104                              134

                                                                                                                                                                                                   Brazil
                                                    S. Africa                                                 India China                                 Russia

                       Ports            1 (Best performer)                                                                                                                                  144 (Worst performer)
                                                                                            52       59                     80                 93                                             135

                                                                                                                                                                                                   Brazil
                                                                                         S. Africa China                    India             Russia

                       Railroads        1 (Best performer)                                                                                                                                  144 (Worst performer)
                                                         22     27 30               46                                                                 100

                                                                                                                                                              Brazil
                                                       China India Russia       S. Africa

                                        1 (Best performer)                                                                                                                                  144 (Worst performer)
                       Highways
                                                                               42             54                                     86                                               123       136

                                                                                                                                                                             Brazil
                                                                            S. Africa       China                                   India                                                     Russia

                       Overall          1 (Best performer)                                                                                                                                  144 (Worst performer)
                       Infrastructure                                                               58            69                   87               101     107

                                                                                                                                                                        Brazil
                                                                                                 S. Africa      China                 India            Russia

Source: World Economic Forum, Credit Suisse Research                                                                                                                                                             14
29 July 2013

The Result: … On a Deteriorating Trend
    For the past five years Brazil has consistently witnessed a deterioration in all of its                 Total Infrastructure Stock*, 2012 (% of GDP)
     transportation modes. The deterioration is mostly pronounced in airports, ports and
                                                                                                                                                                                                            179
     railroads. The airport sector has just started to undergo a privatization process
     (February 2012), thus the dependence on public investments for a long time might
     explain its deterioration. The other two modes of transportation just don’t have a                          Average, excluding outliers,
                                                                                                                 Brazil and Japan 71%                                      76    80     82        87
     robust regulatory framework in place, which hinders private investments.                                                                            71           73

    According to McKinsey, Brazil has a 16% asset–to–GDP ratio, namely infrastructure                                   57       58       58   64
                                                                                                                16
     stock, and is seen as an outlier on a global scale. The average ratio stands at ~70%
     which would imply that Brazil needs US$ 1 trillion in infrastructure investments to
     narrow the gap.                                                                                          Brazil    UK     Canada India     US Germany Spain China Poland Italy S. Africa Japan

Global Ranking of Quality of Infrastructure (1= best performer, 144= worst performer)

    Airports                             Ports                                        Railroads                                    Highways                                 Overall Infrastructure

         2008       2010          2012         2008      2010            2012              2008       2010      2012                     2008      2010          2012            2008        2010           2012
    60                                     0                                    116   0                                  75        40                                       50
                     India                                                      118                                                                           China
    70                                                                                5
                                          20                                                                             80                                                 60
                 China                                                          120                                                60
    80
                                                                                122   10                                                                                                            China
                                          40                                                                             85                                                 70
    90                                                                          124                          Brazil                80
                                                                China                 15                     (RHS)                               India
100                                       60                                    126                                      90                                                 80
                                                                                              India
                                                                                      20                                                                                                            India
110
                             Russia                                             128                                               100
                                          80            India                                                            95                                                 90
                                                                                130   25          China
120                                                                                                                                             Russia        Brazil
                                                                                                                                                                                        Russia
                                                      Russia                    132                                      100      120
                         Brazil          100                                          30                                                                                   100
130                                                             Brazil                       Russia
                                                                                134
                                                                (RHS)                                                                                                                            Brazil
140                                      120                                    136   35                                 105      140                                      110

Source: World Economic Forum, McKinsey Global Institute Analysis, IHS Global Insight, Credit Suisse Research                                                                                                  15
29 July 2013

The Result: Unbalanced Transportation Matrix and Inefficient Logistics
   When measuring logistics costs, there are essentially a few components that impact the final freight rate, namely (i) distance; (ii) volumes; (iii) storage capacity; and (iv) specific product
    characteristics, such as its density. By far, the two most important components are distance and volumes, especially when the cargo is mostly of low value added and cost dilution becomes
    essential.
   Taking into account Brazil’s geographical landscape (area) and export profile, it is noticeable that the country has an unbalanced mix of transportation modes, heavily concentrated in
    highways. Roughly 60% of cargo in Brazil flows through highways, of which only 14% is paved. Considering Brazil’s area, a greater proportion of railroad transportation would make more
    sense, especially in view of its competitive advantage in the production/extraction of commodities (mineral and agricultural), which are low value–added cargo. Due to their size, the USA,
    Canada, Australia, China, and Russia rely heavily on railroad transportation.
                                                                                                     AREA                   Highways             Railroads          Paved Roads   Railroad Density
Transportation Matrix                                                                                (mn km²)               (mn km)              (000’ km)          (%)           (km/000’km²)

                      Transportation Matrix                                                                         Transportation Matrix
         9.0                                                                                          16.4
                                 Waterways                                                                                             Waterways
         1.0                                                                                           1.0      Railroads
                               11 Highways                                                                                        11
                                           8
         58.3                     % of                                                                85.3                     % of                     Russia
                                  Total                Canada                                                          46      Total
                                  RTKs                                                                                         RTKs
         n.a.                                                                                          n.a.                             43
                               81
         6.47                                                                                          5.2                                Highways
                   Railroads

         9.1         Transportation Matrix                                                             9.3          Transportation Matrix
                                           Waterways                                                                                   Waterways
         6.5     Railroads                                                                             4.0      Railroads
                                          25                                                                                      13
                                  % of
                                                       USA                                                              37 % of                         China
        228.5           43                                                                            66.2
                                  Total                                                                                        Total
                                  RTKs                                                                                         RTKs
        100%                                                                                         53.5%                              50
                                          32
         25.0                              Highways                                                    7.1                                Highways

                     Transportation Matrix                                                                          Transportation Matrix
         8.5                                                                                           7.6
                                           Waterways                                                                             Waterways
         1.7     Railroads                                                                             0.8      Railroads
                             25       17                                                                                         4
                                  % of                 Brazil                                                                                           Australia
         29.8                                                                                         8.65                     % of
                                  Total                                                                                43
                                  RTKs                                                                                         Total
        13.5%                                                                                        43.5%                     RTKs      53
                                     58
         3.5                                                                                          1.13                                   Highways
                                           Highways

Source: World Bank, Credit Suisse Research                                                                                                                                                     16
29 July 2013

Government Actions

                                                                                    FOTO

Mindful Government but Ineffective Alone                                                          It’s “Now or Never”! Calling for Private Investments
Before the 1990s, investments relied mostly on public execution given the very unstable           In our view, an ultimate improvement in Brazil’s infrastructure won’t come through greater
macro backdrop and poor regulatory framework. In 1993, owing to the fast deterioration of         public investments in the sector but rather by promoting a friendlier environment to private
highways, the Brazilian government enacted two laws (8666/93 and 8987/95) that                    investments. In this sense, the government has been laying the groundwork for further
established the general terms for concessions in Brazil between public and private entities.      private investments in the country by (i) straightening the regulatory framework, (ii) tackling
Later, several assets were granted to the private sector, which became responsible for            the limited availability of private funding, and (iii) easing the environmental licensing process.
overhauling depreciated brownfield assets while the public sector remained in charge of           We think that Brazil’s infrastructure gap now has a greater likelihood of being eventually
developing greenfield ones. Yet, given its inefficient execution, there aren’t good examples      narrowed given the government’s strong focus (ever) on (i) boosting private investments and
of successful greenfield projects. In fact, there are two emblematic projects that exemplify      (ii) improving the regulatory framework. In this sense, of the R$1trillion gap, we have
the government’s inefficiency, namely the North–South railroad and the BR-163 highway,            identified ~R$334bn in potential private investment opportunities. Yet, the execution
which have been under development for over 30 years, with delays and cost overruns.               challenge cannot be understated as (i) some projects are still in the analysis stage and (ii)
However, it would be unfair to say that the Brazilian government wasn’t mindful of the            the process for obtaining environmental licenses remains cumbersome. As such, we believe
urgency of further infrastructure investments. Back in 2007, it launched the Growth               that R$109bn (1/3) has significant chances of being auctioned in the next two years.
Acceleration Program (PAC), a stimulus program to boost investments in the country. Since         Even this more conservative scenario would be enough to double private investment levels in
then, about R$101bn have been deployed in the transportation sector. While helpful, this          transportation to ~0.9% of GDP. Adding public expenditures, investments in the sector
amount accounts for only 53% of the planned budget and ~10% of Brazil’s R$1 trillion              would reach ~1.4% of GDP for the next five years. Besides, we argue that the auctioning of
transportation infrastructure gap. Putting it differently, public investments in transportation   1/6 of this notable pipeline would already be equivalent to the projects granted to the private
have corresponded to only ~0.5% of GDP since 2007, which is far from adequate levels.             sector in the past ten years.
29 July 2013

A Mindful Government: Federal Investment Programs (PAC I and II)
   Back in 2007, the Brazilian government announced the national Growth Acceleration                    Federal Government Investments (% of GDP)
    Program (PAC I), a stimulus package aiming at investing R$646bn in logistics, energy,
    and social and urban development. By 2010, R$444bn had been deployed (49% of it in                  1.4                                                       PAC Execution (RHS)               90
    the “Minha Casa, Minha Vida” housing program and only 15% in logistics.)                                                                  Average since                                         80
                                                                                                        1.2                                           2007
   In 2010, in an arguably political move, the Brazilian government launched the second                                                                                                            70
    phase of this stimulus program, the so-called PAC II. It encompasses R$955bn in                     1.0                                            1.0
    investments to be deployed during 2011–2014. So far, ~40% of that has been invested.                                                                                                            60
    It is important to note that a great portion of PAC’s transportation infrastructure projects        0.8                                                                                         50
    had their first feasibility studies back in 1980.
                                                                                                        0.6                                                       Investments ex PAC (LHS)          40
   During the 2007–2012 period, the PAC stimulus program was able to boost federal                            Execution (RHS)
    investments to ~1% of GDP, from ~0.4%. Still, infrastructure expenditures would have to                                                                                                         30
                                                                                                        0.4
    reach ~4%–5% of GDP to sustain economic growth rates of 4% or so. Thus, private                                                                                                                 20
    enterprise has to be on board.                                                                      0.2
                                                                                                                                                                                   PAC (LHS)        10
   Moreover, not only quantity but also quality of deployed investments is key. Public–sector
    investments have questionable execution and often experience cost overruns.                         0.0                                                         0
                                                                                                          2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

                        PAC 1                                                           PAC 2
                                                                      955                                  955                     Urban Mobility & Sanitation, 55.90   Public Service Improvement,
                                                                                                                                                                          22.56
                                                                                                                                                                             Housing Program, 53.80
                                                                     278.2     Housing Program                                                                               Water & Electricity,
                                                                                                                                                                             27.20
     657.4                    657.4                                            Public Service                        Remaining
                                          Part to be Invested         23.0                                566.4                           Energy, 335.30                    Transportation, 71.60
                                                                               Improvement                           investments
                              115.6       Post–2010
     275.7                                Uncompleted
                              97.8
                                                                     461.6     Energy                                              Urban Mobility & Sanitation, 1.2 Public Service Improvement, 0.4
                              230.1       Social & Urban
                                                                                                                                            Energy, 126.3
     300.1                                                                                                           Total
                                                                      30.6    Water & Electricity         388.6
                              148.5       Energy                                                                     Invested
                                                                      57.1    Urban Mobility &
                                                                              Sanitation                                                                                     Housing Program, 224.4
      81.6                    65.4        Logistics                 104.5     Transportation                                          Transportation, 32.9
2007 Announced (*)        2010 Invested                         2011 Announced                      April 2013 Invested                Water & Electricity, 3.4

Source: Brazilian Government, Credit Suisse Equity & Macroeconomics Research / (*) Updated from R$504bn in Jan 2007 to R$657bn in Jan 2009                                                          18
29 July 2013

But Ineffective Alone: Investing Far Below Brazil’s Transportation Needs
      Taking a deeper look at the government’s PAC investments, about R$190bn were planned to be channeled to the transportation sector. Roughly 48% of that would be deployed in the
       highway sector, followed by 36% in the railroads. Looking at the past six years, i.e. since PAC’s inception, only 53% of the planned budget has been disbursed and perhaps less than that
       has been delivered in terms of physical execution. Even when 100% completed, the planned PAC would address only ~20% of the country’s infrastructure needs.

PAC Planned & Executed Investments vs. Brazil’s Infrastructure Needs (R$ billion)
                          PAC Investments                                               Infrastructure Investment Need                              Breakdown of Investments

                                            50.4        91.8                                                            1,110
                                                                   75.3
    Highways

                                                                                                                                                                        Construction of 2nd
                                                                                                                                   Construction & Pavement              Lane & Recovery
                                41.4                                                                                                                  69.6              803.7

                                                                                                                                            Landside Access
                                                                                                                                                                        Dredging and Demolition
                                                                                                                                                       18.6
                                                                                                                        873.3                                           3.0

                                                                                        Investment Gap
    Ports

                                             9.9        23.9                                                                                                             Ports Infrastructure
                                14.0                                                                                                            Expansion,
                                                                   8.0                                                                                                   2.5
                                                                                                                                   Construction & Recovery
                                                                                                                                                     22.0

                                                                                                                                                                       Smaller Improvements
                                            46.0        68.9                                                                                                           0.5
    Railroads

                                                                                                                                                Expansion               Recovery
                                                                                                                                                   129.6                10.5
                                22.9                                                                                     46.1
                                                                  14.2
                                                                             PAC Planned
                                                                              Investments

                                                                                                             101        140.7      New (less than 500K pax)             Expansion
                                                                                                                                                        5.5             of 20 Largest Airports
    Airports

                                                                                    Highways                 75.3
                                             2.7         5.7       3.8                                                               New (500K–1mn pax)                 20.5
                                 3.0                                               Waterways                 8.0
                                                                                    Railroads                14.2 3.8     49.5                      8.0
                               PAC 1       PAC 2        PAC Executed*                 Airports
                                                                                                         PAC Executed Est. Req.         New (Over 1mn pax)             Expansion of Other Airports
                                                        Total (Apr-13)
                                                                                                           (Apr-13)   Investment                     12.0              3.5

Source: ILOS, FIPE, McKinsey, Credit Suisse Research / (*) PAC Investments until April 2013                                                                                                     19
29 July 2013

Examples of Poor Government Execution: N–S Railroad & BR-163 Highway
   The 3,700km of the 26-year old North–South railroad project and the improvements in             North–South Connections (Railroad & Highway)
    the BR-163 highway are clear examples of the questionable execution quality of public
    investments in the country. These projects are taking 2x longer to be completed and are
    at least 3x more expensive than originally forecasted .
                                                                                                                                               Tirios
   The infamous North–South railroad has been stuck due to political disputes and
    bureaucratic imbroglio for decades. The railroad started to be built in 1987 and its fist
                                                                                                                                                              Santarem Port
    phase, a 215km stretch from Açailândia (State of Maranhão) to Porto Franco (State of
                                                                                                                                                                                            Ponta da Madeira Port
    Maranhão), was inaugurated with a nine-year delay.                                                                                                                          Barcarena
                                                                                                                                             Santarém
   A later attempt to complete the railroad was carried out by former President Lula in 2007.
    The former president promised to deliver the entire railroad by October 2010 and                                                                                               Açailândia
                                                                                                                                                               PA
    deposited R$4.2bn into Valec’s coffers in order to attain its objective.                                                                                                        MA
   The project, whose original contract was amended more than 17 times, was mismanaged
    and postponed once again. In October 2007, the 722km stretch between Açailândia                                                        Cachimbó
                                                                                                                                                                           TO
    (State of Maranhão) and Palmas (State of Tocantins) was transferred to the private sector                                                                                    Palmas
    through a competitive bid won by Vale, which paid a concession fee of R$1.48bn. At that                                                   Sinop           MT                                BA
    time, only the 361km stretch between Açailândia (State of Maranhão) and Araguaína                                           Lucas do Rio Verde
                                                                                                                                                                    Uruaçu
    (State of Tocantins) had been completed. The proceeds from the auction process would                                                  Cuiabá
                                                                                                                                                              Ouro Verde
    be used to construct the remaining stretch.
                                                                                                            Cities                                                              Anápolis
                                                                                                                                                                   GO
   Going further south, the ~855km stretch between Palmas (State of Tocantins) and                         Ports                                   MS                                      MG
    Anápolis (State of Goiás) has only 155km with reasonable quality while the remainder                                                                                 Estrela d'Oeste
                                                                                                            Current railroads
    enjoys a questionable quality of rail tracks imported steel from China. About R$5.1bn
    have been deployed in this stretch alone which implies a cost of US$3.6mn per km,                  BR-163 Road                          Dourados
    reportedly requiring further ~R$0.5bn to be concluded.                                                 Paved                                                    Panorama     SP         Rio de Janeiro Port
                                                                                                            Undergoing paving                                                         Santos Port
   Another legendary project is the 3,500km BR-163 highway project, launched in 1976                                                              Cascavel
                                                                                                       North–South Railroad                                                       Paranaguá Port
    (37 years ago). About 1,300km are still unpaved. BR-163 is the primary highway to
    transport agricultural commodities out of the producing area of Sinop, Sorriso and Lucas                Operating                                               Chapecó

    do Rio Verde to the ports in the South and Southeast regions. The 1,780km stretch                       Constructed                                             RS
    between Cuiabá (State of Mato Grosso) and Santarém (State of Pará) needs a sharp                        Under construction
    revamp (construction of a second lane and pavement) and could demand another                                                                                   Rio Grande
                                                                                                            EVTEA concluded
    ~R$1.5bn at least. Once completed, it will be possible to export commodities through the
                                                                                                            Future projects
    ports in the north region (Santarém Port) instead of using the ports in the
    south/southeast.
Source: Valec, Brazilian Department of Transportation Infrastructure (DNIT), Amazonia Org, Credit Suisse Research                                                                                              20
29 July 2013

Gradually Boosting Private Investments: R$52bn Auctioned in the Past 10 Years
         Below we outline the main transportation investments unveiled over the past nine years in Brazil. About R$52bn in investments were granted to the private sector, averaging close to
          R$6bn/year. This figure was boosted by planned investments in the three recently auctioned airports (~R$17.8bn). Excluding the airports, investments would total R$3.8bn/year. Going
          forward, the government wants to auction ~R$170bn in one or two years, taking into account only the federal investment plan for toll roads, railroads, and two airports. About 40% of that
          seems reasonable to be auctioned within this timeframe, which wouldn’t be bad at all if we take into perspective the historical level of investments.

Timeline of Most Recent Toll–Road Projects Auctioned in Brazil and Project Execution
                                  2004                     2006                          2007                                 2008                          2009                    2010                      2011                         2012                        2013

                                                                                                                                                                                                                                       21,315
                                                                                      11,253                                                                                                                                                                         9,800
                                                                                                                            7,900                                                   5,800
                                  975                     1,053                                                                                         2,100                                                 900
    Auctioned Projects

                         MG–050           975      Subway –SP Line 4 1,053   Autopista Planalto       Sul   1,559    CART               1,750    ViaBahia          2,100   BA–093            800     ASGA Airport       600    BR-101/ES/BA         1,700    VLT Rio de Janeiro 1,100
                                                                             Autopista Litoral   Sul        1,962    ViaRondon          1,350                              Rodoanel South            MT 130 / PE–060    300    Guarulhos Airport    5,200    Galeão Airport      5,200
                                                                                                                                                                                            5,000
                                                                                                                                                                           & East
                                                                             Autopista Régis     B.         2,364    Rodovia do Tiete   1,600                                                                                  Viracopos Airport    9,900    Confins Airport     3,500
                                                                             Autopista Fernão     Dias      2,456    Ecopistas           900                                                                                   Brasilia Airport     2,715
                                                                             Autopista Fluminense           1,672    Rota das Bandeiras 1,500                                                                                  Transolimpica        1,800
                                                                             Transbrasiliana                  716    RodoAnel            800
                                                                             Rodovia do Aço                   524

                           2003           2005            2007          2009                2011                    2013             2015         2017             2019         2021          2023            2025            2027                2029        2031             2033
                         6000

                         5000

                         4000
    Capex Execution

                         3000

                         2000

                         1000

                            0
                            VLT Rio de Janeiro               Transolimpica                                  Brasilia Airport                    Viracopos Airport                Guarulhos Airport                  BR-101/ES/BA                         MT 130 / PE-060
                            ASGA Airport                     Rodoanel South & East                          BA-093                              ViaBahia                         RodoAnel                           Rota das Bandeiras                   Ecopistas
                            Rodovia do Tiete                 ViaRondon                                      CART                                Rodovia do Aço                   Transbrasiliana                    Autopista Fluminense                 Autopista Fernão Dias
                            Autopista Régis Bittencourt      Autopista Litoral Sul                          Autopista Planalto Sul              Subway -SP Line 4                MG-050

Source: ANTT, ARTESP, ANAC, Credit Suisse Research.                                                                                                                                                                                                                                      21
29 July 2013

R$334bn in Identified Investment Opportunities to the Private Sector

     Highways Program
                                                                                                        Urban Mobility
      9 federal highways,                                                                               Urban Mobility Growth
       covering over 7,500km
                                                                                                          Acceleration Program (federal
                                                                                                          investments)
                                                                                54                       São Paulo Subway Program
                                                                                            81.5         Urban mobility in Rio de Janeiro
     Airports Program*
      Galeão Airport
                                                                 16.2
      Confins Airport
                                                                                 R$334bn                        High–Speed Train
                                                                                                                 Rio de Janeiro
                                                                                 Pipeline          30
                                                                                                                  to Campinas
                                                                                                                  (through São Paulo)

                                                                       98

                                                                                       54.1
                                                                                                            Ports Program
     Railroads Program
      10 railroads, covering                                                                                Investment in 16 states,
                                                                                                              covering public port
       over 12,000Km
                                                                                                              concessions, private port
                                                                                                              authorizations, and the
                                                                                                              dredging plan

Source: Credit Suisse Research. * Includes both concession fees and expected capex.                                                       22
29 July 2013

Laying the Groundwork for Private Investments: Improving Regulation
                                        Main Discussions about the Current Model                                       Government Actions
                                                                                                                        The main change proposed relates to stricter capex requirements in
                                         The highway model is certainly the most mature and robust, with limited
                                                                                                                         terms of deadlines and penalties. The bulk of improvements should take
                       Toll Roads

 Better                                   room for surprises, in our view.
                                                                                                                         place within five years (duplication works).
                                         For the next auctions, the government will try to avoid the capex delays      The government is being more flexible to attract private investors, by
                                          seen in past auctions by addressing its causes and applying stricter rules
                                                                                                                         improving headline return rates (from 5.5% to 7.2%, real, unleveraged)
                                          and greater penalties.
                                                                                                                         and easing financing guarantees requested by public banks.

                                         Developed in 2H11, the recent regulatory framework for the privatization      The government increased technical qualification requirements to 35mn
                                          of airports attracted several bidders in a intense competitive bidding         pax/year (from 5mn pax/year) so that, at most,13 global operators can
                       Airports

                                          process.                                                                       participate in the auction, possibly implying less bidders in the next
                                                                                                                         auction.
                                         Yet, it seems that the government wasn’t satisfied with the fact that
                                          none of the largest global operators has won any bid.                         Another requirement is that the airport operator has to hold a minimum
                                                                                                                         stake of 25% in the formed consortiums.
 Private Investments

                                         Apparently, operational quality rules are not an issue, even though           Update of the PPP* Law. Law No. 12766, enacted in 2012, now
                       Urban Mobility
    Regulation of

                                                                                                                         permits government’s reimbursements during construction phases.
                                          feasibility usually depends on government reimbursements (PPP model).
                                         The challenge for PPPs is how to mitigate the government’s payment            Also, this new law increased the threshold for municipal tax revenues
                                                                                                                         that can be channeled to PPP payments from 3% to 5%.
                                          risk, which in these cases becomes a relevant source of revenues.
                                         Political Exposure is high as it deals with people not cargoes.               Government’s payment risk (main investors’ concern): guarantees and
                                                                                                                         collateral pools are still under discussion/being designed.
                                                                                                                        The government’s intention is to stimulate (i) private investments in new
                                         Government is unsatisfied with the current railroad monopoly model,            corridors (i.e. capacity increase) and (ii) competition between multimodal
                       Railroads

                                          which hasn’t stimulated investments in new stretches (greenfields).            operators (i.e. tariff decrease).
                                         Besides the measures announced in 2011 (challenging the monopoly of           Yet, (i) projects are still under preliminary studies and (ii) there are still
                                          current concessions), the government has launched a plan to grant 10           uncertainties regarding the new model such as (a) operational feasibility
                                          new stretches under a new railroad model (Open Access).                        and (b) collateral pools to secure Valec’s payment risk.

                                                                                                                        In 2013, the government launched the New Ports Law in order to
                                         Capacity additions in public ports has depended on the government’s            foster investments other than in public ports. The main innovation was
                                          planning and auctioning processes, which have been insufficient to
                                                                                                                         the authorization for private ports to handle third–party cargo.
                       Ports

                                          address the country’s port infrastructure needs.
                                                                                                                        While we welcome the elimination of that restriction, we think there are
 Worse                                   Private investments in greenfield projects outside of public ports have        still a few unclear terms such as for: renewals, auction criteria and
                                          been constrained by the lack of regulatory support.
                                                                                                                         different conditions for public and private ports.

Source: Credit Suisse Research / (*) PPP: Public-Private Partnerships                                                                                                                                23
You can also read