Venezuela's devaluation of the bolivar has arrived sooner than we expected. While we admit this is not a complete surprise to us, we didn't expect it to occur prior to Venezuela's national assembly elections in September.
Venezuela's last currency devaluation occurred in 2005. Unlike the previous occurrence, we don't expect this most recent devaluation to have a significant impact on the fair value estimates of relevant companies under Morningstar's coverage. Since 2005, CANTV, the country's incumbent telephone operator (and the only company we covered that was domiciled in Venezuela), has been privatised by the government. In addition, the majority of other companies that held large asset positions in Venezuela--mostly in the electricity, steel and oil and gas sectors--have since seen them expropriated.
However, we think retail providers with exposure to Venezuela are more vulnerable. Some global consumer product companies, including US-based enterprises such as Avon and Colgate-Palmolive, have surprisingly large business footprints there. Venezuela accounts for 5% of Avon's sales and 11% of its operating profit. Mexican beverage companies Coke Femsa and Femsa derive 10% and 9% of their annual revenues from Venezuela, respectively. Venezuela is also the second largest Latin American market for Telefonica, one of Europe's largest phone companies, accounting for more than 6% of its revenue during the first three quarters of 2009.
Venezuelan President Hugo Chavez's populist economic programmes have left him walking a political tightrope. Chavez had earlier contended that Venezuela's economy was impervious to the effects of the global recession. That was before softening demand for oil began to pressure prices, making the ground shift under his feet. During 2009, Venezuela's GDP declined 2.9% on top of an eye-popping domestic inflation rate in excess of 25%. By devaluing the bolivar, oil export revenues will double as the official bolivar rate will go from 2.15 bolivars to the dollar, to 4.3 bolivars to the dollar. While the increased oil revenues will help the government sustain some of its commitments, especially to other governments, it will likely have the unwanted side effect of thrusting the nation's economy into a vertiginous inflation spiral.
In what could be interpreted as a pre-emptive strike against significant price increases, Chavez has threatened to send in the army to confiscate businesses that dare to raise prices. Despite this threat, inflation in Venezuela is expected to rocket to 40% annually. Complicating matters further is the fact that essential items such as food and medicine will only drop to 2.6 bolivars to the dollar, with the government trying to control the black market floating rate, which is around six bolivars to the dollar.
The higher inflation rate and the increased cost of imports will likely dull the shine on Chavez's popular economic programmes, possibly sparking broader dissent leading up to the national assembly elections. A defeat at the polls could break Chavez's control of the Venezuelan economy, rendering his "Bolivar Revolution" decidedly less revolutionary. In our view, the bolivar's devaluation prior to the election amounts to a political gamble for Chavez, but it may also be a more visible symptom of the Venezuelan government's desperation for cash, which could be deeper and decidedly more persistent than at first glance.
We will be reviewing the above-mentioned companies, as well as MercadoLibre to determine the extent to which the bolivar's devaluation impacts our fair value estimates.
