By Christian Plumb
NEW YORK (Reuters) - When global oil prices peaked in 2008, Brazil's Petrobras (SA:PETR4) had a market value of $290 billion, outranking U.S. tech bellwethers like Microsoft Corp (O:MSFT) and Apple Inc (O:AAPL). Today, the one-time state champion is worth one ninth of that.
The oil company's fall from grace is emblematic of how Brazil has seen its profile eclipsed in the investment world as commodities prices slumped, the country's worst economic recession in a generation took hold and a sweeping corruption scandal gripped the country's elites.
Brazil's weighting in the benchmark MSCI emerging markets index has been drastically slashed to around 6 percent from nearly 18 percent at its peak as investors fled for markets like India and South Africa, both of which have far outperformed Brazil's Bovespa index over the past 5 years.
Now, amid a raging political storm, fund managers are sifting through the rubble and finding beaten-up companies that could benefit from a change in government. They consider new leadership increasingly likely as leftist President Dilma Rousseff faces impeachment efforts in Congress and a vast graft scandal reaching her inner circle.
"Brazil as an emerging market is at a very low level in investable terms but if we have the patience I believe there are significant investment opportunities," said Maria Negrete-Gruson, who manages New York-based Artisan Partners' emerging market fund.
She noted some Brazilian small caps like heavy equipment renter Mills Estruturas e Servicos de Engenharia (SA:MILS3) saw their market values swoon to the $100 million range at the market's bottom in January from $2.1 billion in January 2013. Mills is now worth $151 million, but even so trades at a 68 percent discount to its peers on a forward price-to-book basis.
Negrete-Gruson compared Brazil now to Argentina a couple of years ago, when a handful of smart investors made a longshot bet that Cristina Kirchner's days as president were limited and more market-friendly policies would eventually come into play.
Argentina's Merval stock index (MERV) has more than doubled over the past two years, compared with a 4 percent rise in the Bovespa (BVSP).
POISED FOR REBOUND
By the end of 2015, institutional exposure to Brazilian equities had fallen by more than 50 percent from the second quarter of 2012 to $45.88 billion, according to figures from eVestment, which tracks global investment trends.
But the extent of investors' retreat from Brazilian equities could mean it is poised for a rebound, said Dan Raghoonundon, Latin America equity research analyst at Janus Capital, mentioning Banco do Brasil (SA:BBAS3) and Petrobras as two companies that trade at less than their book value.
Both state-controlled firms have been mismanaged under the Rousseff government and could benefit from political change, he said.
Brazilian shares are trading at an average of 1.22 times forward price/book ratio, far short of the 1.5 ratio hit in September 2014, when investors bet Rousseff would lose her re-election bid that year, he said.
To be sure, investors have already started wading back into the Brazilian market, pushing the Bovespa up 14 percent this year, as Rousseff's mentor and predecessor Luiz Inacio Lula da Silva was detained by corruption investigators for questioning and later charged in a money laundering probe.
Some view the rally, which has seen several research departments, including at Bank of America Merrill Lynch (NYSE:BAC), Morgan Stanley (NYSE:MS) and HSBC, upgrading Brazilian stocks to "overweight" from "neutral", as unjustified.
"The problem with the optimism is that the only way it makes sense for the market to be rallying would be if another government were to come in and make all the tough decisions on structural reforms," said UBS global emerging markets head Geoffrey Dennis. "That just seems so unlikely."
He and other skeptics say Rousseff's removal, while possibly positive for sentiment, would do little to resolve such problems as the country's swollen budget deficit and what may soon be the worst recession in over a century.
Others argue that while the recent rally has left valuations pricier based on forward earnings, those earnings could rebound to a more normalized level if a reform-minded government succeeds in lowering interest rates.
"The new government turning around business confidence and over time consumer confidence would be key" to such a scenario, said Verena Wachnitz, lead portfolio manager for T. Rowe Price's Latin America Fund.
Banks like Itau Unibanco Holding SA (SA:ITUB4) and Banco Bradesco SA (SA:BBDC4), two of the $440 million fund's top holdings, could be quick beneficiaries of lower rates, she said.