First Report, iniation of coverage in the Real Estate sector in Brazil

1. Real Estate & Construction
Initiating Sector Coverage February 13, 2007
The Boom is Yet to Come
In this report we are initiating coverage on 5 Brazilian real
•
Table of Contents
estate companies: Company, Cyrela, Gafisa, Klabin Segall, and
Page
Rossi Residencial.
1 - Investment Thesis 02
2 - Valuation Summary 03
The main driver for the sector in the short to medium term
•
3 - Sector Drivers 07
should still be the increasing availability of affordable credit.
- Credit Availability 07
Besides the continued reduction in interest rates, we expect to see - The Housing Deficit in Brazil 10
credit maturities being extended and initial downpayment 4 - Risks 12
requirements made more flexible. 5 - Corporate Governance 13
6 - Company 14
7 - Cyrela 18
The expectation that real estate financing will soon reach the
•
8 - Gafisa 22
lower income population supports the positive momentum for
9 - Klabin Segall 26
the sector. Nonetheless, for this to materialize, some kind of
10 - Rossi Residencial 30
government subsidy is likely to be necessary. Although we are Appendix A – Macro Scenario 34
confident this will happpen, it will probably take 2 to 3 years until Appendix B – Important Disclosures 35
demand from lower income segments is actually unleashed. That is
why we say “the boom is yet to come.”
Meanwhile, middle class demand, boosted by credit availability
•
and necessity from its families’ to upgrade housing, should be
more than enough to generate superior growth rates. As credit
became affordable, a long lasting pent up demand for upgrades
started to be gradually satisfied by real estate developers all over
Brazil.
On the companies covered in this report:
Company: BUY rating, end of 2007 target price of R$37.50, upside of
•
44% in R$ terms and 39% in US$ terms. In our view, Company
presents attractive upside; nevertheless, its concentration in São
Paulo’s market coupled with its policy not to accumulate extensive
land banks are matters of concern;
Cyrela: BUY rating, end of 2007 target price of R$28.35, upside of
•
43% in R$ terms and 38% in US$ terms. Shares having strong
fundamentals and yet a very rewarding risk/reward relationship;
Gafisa: NEUTRAL rating, end of 2007 target price of R$36.17, upside
•
of 17% in R$ terms and 12% in US$ terms. Gafisa’s solid positioning
in the market, as well as the expectations of its future performance,
is mostly priced into its shares at this point;
Klabin Segall: BUY rating, end of 2007 target price of R$26.77,
•
upside of 49% in R$ terms and 43% in US$ terms. We view Klabin
Segall as a unique story, currently priced at a significant discount to
its peers.
Rossi Residencial; BUY rating, end of 2007 target price of R$31.22,
•
Rafael C. de Pinho
upside of 38% in R$ terms and 33% in US$ terms. Rossi’s presence 55 11 3089-8748
and long-time experience in lower income segments should be a rpinho@bulltick.com
competitive differential once demand for this market builds up.
See appendix B for Important Disclosures
This report has been prepared by Bulltick Brasil Consultoria e Assessoria Empresarial Ltda, which is not an NASD member, is not registered with the US Securities and Exchange
Commission, and is not regulated by any US securities or commodities exchange. Non-US research analysts who have prepared this report are not registered/ qualified as research
analysts with the NASD or any other US securities exchange or regulatory body.

2. INVESTMENT THESIS
The real estate sector leaped from black sheep to rising star status in the Brazilian
Brazil´s real estate sector:
market. This affirmation may sound too optimistic, but that has been the tone of thinking
from black sheep to rising
star about the sector for the last year and a half.
The rationale behind the market’s expectations comes from the relative stability the
Brazilian economy has been experiencing, coupled with declining interest rates. Assuming
this benign economic scenario remains, real estate companies are poised to profit from
the country’s housing shortage of approximately 8 million homes.
Additionally, during many years of high interest rates, lack of affordable credit created
pent up demand among homeowners wishing to upgrade existing homes..
Conditions have changed in the sector mainly from 2004 on, when banks, together with
Improved regulation
real estate companies, worked to offset previously perceived risks that prevented
unleashed sector’s growth.
creditors from lending at more attractive rates. Mortgage contracts and sector regulations
evolved in such a way that banks, instead of keeping their traditional distance from
mortgages, reinforced joint work with companies in order to lend as much as possible.
These changes, and some others still to be implemented, have unleashed sector growth.
Once the real estate business regained the market’s confidence, several companies saw
The growth financing option
the capital markets as the best way to finance their growth. Companies have opted to
chosed by market leaders
remain quite conservative due to the difficult past. The growth financing option chosen by
has been to offer their
equity. most of the market leaders until this point has been to offer shares in the equity markets.
The number of listed companies has jumped to the current 11, creating some interesting
opportunities for investors to play the Brazilian housing deficit.
Among currently listed companies several different strategies are being put in practice to
leverage gains, most notably, a movement towards lower income segments, where the
bulk of the deficit lies. To get there, companies must deal with strategic issues like
shifting from building luxury apartments to a much more price-sensitive market.
Another two strategic movements are expected to be intensified in the near future.
Important strategic moves:
Geographic diversification… The first is geographic diversification. Companies have been concentrated in the São Paulo
and Rio de Janeiro markets, where competition now seems fierce. More and more we will
see traditional players in these two markets look for opportunities in different regions
where competition is less intense. Recent moves by Cyrela, Gafisa and Rossi corroborates
to this view.
The second strategic move is consolidation. There are approximately 500 real estate
… and consolidation.
developers in Brazil. As companies look for options to add value to shareholders, scale
gains will push then to consolidate smaller, less capitalized players Listed companies will
probably use their own shares as a currency in future M&A activity. Access to attractive
land banks, superior management teams and geographic diversification are three other
catalysts to the soon-to-start consolidation trend.
2

3. VALUATION SUMMARY
Despite each company’s strategy, our valuation of land developers was undertaken using
the same methodology, as a way to make comparisons between them easier.
We used a discounted cash flow based model to value companies. Free cash flows to firm
were discounted at the WACC according to a set of parameters for each company, shown
on exhibit 1. We also based our valuation on comparison between the multiples for the
companies under analysis. In all models, long term growth used in perpetuity was 4%
per year, which is our base scenario for the long term growth rate for Brazil’s GDP.
Exhibit 1: Valuation Parameters
Company Cyrela Gafisa Klabin Rossi
Cost of Equity
Risk-Free Rate 4.5% 4.5% 4.5% 4.5% 4.5%
Equity Risk Premium 6% 6% 6% 6% 6%
Beta 1.2 1.2 1.2 1.2 1.2
Inflation Differential w/Brazil 2% 2% 2% 2% 2%
Country Risk 2.25% 2.25% 2.25% 2.25% 2.25%
Cost of Equity 15.95% 15.95% 15.95% 15.95% 15.95%
Cost of Debt
Sovereign Debt 7% 7% 7% 7% 7%
Spread to Sovereign 2.50% 2.00% 2.00% 2.50% 2.50%
Inflation Differential 2% 2% 2% 2% 2%
Cost of Debt in R$ 12% 11% 11% 12% 12%
Tax Rate 34% 34% 34% 34% 34%
After Tax Cost of Debt 7.59% 7.26% 7.26% 7.59% 7.59%
Target Capital Structure
% of Debt 30% 30% 40% 30% 40%
% of Equity 70% 70% 60% 70% 60%
WACC 13.4% 13.3% 12.5% 13.4% 12.6%
Source: Bulltick
As the valuation model assumes that, on average, all companies sell 100% of
developments by the end of construction, our main driver for value creation resides in the
capacity of delivering potential sales value (PSV) growth. Our models used company
guidance when available as an input for PSV and a decreasing growth rate curve over the
remaining years. Our assumptions until 2010 are summarized on exhibit 2.
Exhibit 2: PSV of 2006/09 launchings – R$ BN
2006E 2007E 2008E 2009E 2010E CAGR
10%
Cyrela 3.52 4.00 4.60 5.06 5.57
15%
Gafisa 1.01 1.26 1.57 1.81 1.99
21%
Rossi 0.88 1.25 1.65 2.06 2.27
12%
Klabin 0.77 0.89 1.07 1.23 1.35
30%
Company 0.35 0.80 1.00 1.20 1.32
Source: Companies, Bulltick
We present below our ratings and target prices for the end of 2007 and expected upsides
for the stocks being covered. In the company specifics section, we will discuss in detail
our assumptions on each company’s valuation.
Exhibit 3: 2007 Year-end Target Prices and Stock Ratings
Current Target Price Upside Upside
Company Rating
Price 2007 R$ US$
Company R$ 26.00 R$ 37.50 44% 39% BUY
Cyrela R$ 19.80 R$ 28.35 43% 38% BUY
Gafisa R$ 31.00 R$ 36.17 17% 12% NEUTRAL
Klabin R$ 18.00 R$ 26.77 49% 43% BUY
Rossi R$ 22.55 R$ 31.22 38% 33% BUY
Source: Bloomberg and Bulltick
3

4. Exhibit 4: PER 2008E
20.0x
16.0x
12.0x
8.0x
4.0x
Company Klabin Rossi Average Cyrela Gafisa
Source: Bloomberg and Bulltick
Exhibit 5: FV/EBITDA 2008E
16.0x
14.0x
12.0x
10.0x
8.0x
6.0x
4.0x
Klabin Company Rossi Average Cyrela Gafisa
Source: Bloomberg and Bulltick
Exhibit 6: PER08-to-growth Ratios
0.7x
0.6x
0.5x
0.4x
0.3x
0.2x
0.1x
0.0x
Klabin Rossi Company Gafisa Average Cyrela
Source: Bloomberg and Bulltick
4

5. Exhibit 7: FV/EBITDA08E-to-growth Ratios
0.4x
0.3x
0.3x
0.2x
0.2x
0.1x
0.1x
0.0x
Klabin Rossi Company Average Gafisa Cyrela
Source: Bloomberg and Bulltick
Exhibit 8: Price-to-Book Ratios
4.0x
3.0x
2.0x
1.0x
Rossi Klabin Average Company Cyrela Gafisa
Source: Bloomberg and Bulltick
Exhibit 9: Firm Value to Launchings 2008E Ratios
2.3x
2.1x
1.9x
1.7x
1.5x
1.3x
1.1x
0.9x
0.7x
0.5x
Klabin Company Rossi Average Cyrela Gafisa
Source: Bloomberg and Bulltick
5

6. Exhibit 10: Real Estate Sector Stock Guide
Klabin Average /
Company Cyrela Gafisa* Rossi
Segall Total
Ticker CPNY3 CYRE3 GFSA3 KSSA3 RSID3
Rating BUY BUY NEUTRAL BUY BUY
Current Price in R$ 26.0 19.8 31.0 18.0 22.6
Target Price in R$ 37.5 28.3 36.2 26.8 31.2
Potential Upisde in R$ terms 44% 43% 17% 49% 38%
Potential Upisde in US$ terms 39% 38% 12% 43% 33%
Market Cap in R$MM 936 7,018 3,203 1,037 1,778 13,973
Firm Value in R$MM 978 6,666 3,253 826 1,611 13,334
Operational Data
3-year CAGR
Launchings 50.4% 12.9% 21.6% 16.8% 32.7% 23.5%
Net Revenue 44.1% 40.9% 26.2% 77.5% 40.8% 42.5%
EBITDA 46.0% 43.0% 65.8% 80.1% 79.2% 57.0%
Net Profit 43.6% 28.5% 74.0% 107.6% 76.3% 51.9%
EBITDA Margin
2006E 20.5% 23.5% 10.3% 26.5% 12.3% 18.5%
2007E 21.7% 24.7% 16.0% 26.0% 19.6% 22.1%
2008E 22.3% 25.1% 20.5% 27.7% 23.2% 24.1%
2009E 21.4% 24.6% 23.3% 27.7% 25.3% 24.7%
Net Margin
2006E 17.5% 23.1% 6.9% 11.8% 10.5% 15.6%
2007E 17.3% 21.6% 11.9% 26.1% 19.8% 20.4%
2008E 17.8% 18.9% 15.7% 19.6% 19.8% 19.3%
2009E 17.3% 17.5% 18.2% 18.9% 20.7% 18.9%
Capital Structure / Working Capital
Net Debt / Equity 0.13x N.R. 0.06x N.R. N.R. N.R.
Net Debt / (Net Debt+Equity) 0.11x N.R. 0.05x N.R. N.R. N.R.
Net Debt / EBITDA07E 0.62x N.R. 0.39x N.R. N.R. N.R.
Change in Net Working Capital
2006E 175 627 397 55 294 1,547
2007E (73) 832 174 125 123 1,180
2008E 60 622 176 283 323 1,465
2009E 198 1,618 99 315 570 2,801
Current Liquidity 4.4x 4.4x 4.0x 2.4x 4.7x 4.2x
Quick Ratio 3.2x 2.9x 2.7x 1.0x 2.8x 2.7x
Valuation
FV/EBITDA
2007E 14.4x 18.2x 25.4x 11.4x 14.6x 17.9x
2008E 8.2x 13.2x 14.2x 6.2x 8.8x 11.4x
2009E 6.5x 10.2x 10.4x 3.9x 5.8x 8.3x
2008 Multiple-to-Growth
0.18x 0.31x 0.22x 0.08x 0.11x 0.20x
(3-year EBITDA CAGR)
PER
2007E 17.4x 21.9x 33.7x 14.3x 15.9x 21.4x
2008E 9.7x 17.9x 18.3x 10.3x 10.8x 15.0x
2009E 7.5x 14.5x 13.2x 6.7x 7.4x 11.2x
2008 Multiple-to-Growth
0.22x 0.63x 0.25x 0.10x 0.14x 0.29x
(3-year EPS CAGR)
EV/FCFF
2007E 7.4x N.R. N.R. N.R. N.R. N.R.
2008E 21.5x N.R. N. R. N.R. N.R. N.R.
2009E N.R. N.R. 22.1x N.R. N.R. N.R.
EV/PSV
2007E 1.2x 1.7x 2.6x 0.9x 1.3x 1.6x
2008E 1.0x 1.5x 2.1x 0.8x 1.0x 1.4x
2009E 0.8x 1.4x 1.8x 0.7x 0.8x 1.2x
PBR 3.3x 3.6x 3.9x 2.6x 1.7x 3.1x
*Note: This report uses Gafisa’s 2006 actual figures, reported on Jan 29th, 2007
**N.R.: Non-representative
Source: Gafisa and Bulltick
6

7. SECTOR DRIVERS
Credit Availability
Funding for real estate financing in Brazil comes mostly from the FGTS fund and savings
SFH: funding comes from
deposits that accrue TR (Referential Rate, currently 2% to 3% per year) plus 6%. Banks
savings deposits and FGTS
need to use 65% of their savings deposits for housing financing purposes: (i) 52% of
savings are lent within the SFH program at TR+12% per year and finance homes of up to
R$350,000 in value; and (ii) 13% of savings are lent at free market rates, currently TR
plus 13% to 14% per year. Additionally, the FGTS is used to fund special credit lines for
those acquiring their first home, limited to R$120,000 at TR plus 8% per year. Exhibit 11
summarizes the Brazilian mortgage system.
Exhibit 11: The Brazilian mortgage system
CAIXA
ECONOMICA Borrowers
FEDERAL
Employers FGTS Lent at TR + 3% - 7%
SFH Borrowers
80% of funds
(52% of deposits)
Lent at TR +12%
Mortgage
65% of savings deposits
Lending
20% of funds
(13% of deposits)
Lent at TR +13%-14%
Savings
Banks
Deposits
Lent by banks
Borrowers
at market rates
Unused funds acrrue
80% of TR by
Central Bank
Reserve
15% of savings deposits
Requirements
At Bank’s
20% of savings deposits
Borrowers
TR +10% - 14% discretion
Source: Bulltick
*Note: TR is the Brazilian “referential rate”, currently around of 2-3% per year.
Among real estate sector catalysts, affordable credit is definitely the main driver. The
Affordable credit is the main
recent growth in mortgage volumes resulted from a conjunction of factors that reduced
sector catalyst.
the risks banks face in this market, thus enabling more accessible credit lines to be
offered to clients.
7

8. Exhibit 12: Mortgages Volume in Brazil
Credit Volume (R$ BN)
CAGR 43%
9.5
4.8
3.00
2.22
10
9.10
6.00
4.45
2003 2004 2005 2006
CEF Banks
Source: BACEN, ABECIP and Bulltick
Among the changes that have been implemented to expand the volume of credit we cite:
Improved regulation
(i) new contracts making it safer and faster for banks to claim sale of the financed home
diminished perceived risk.
as collateral in case of default; (ii) contracts using constant amortization instead of the
traditional Price amortization schedule, thereby reducing borrowers’ lawsuits regarding
interest; (iii) continued amortization of mortgages during any lawsuit regarding interest
payments or contract validity; and (iv) segregation of developers’ and projects’ equity by
means of establishing SPVs.
Far from being comparable to countries like Mexico or Chile, where mortgages to GDP
Brazil’s current mortgage to
ratios are 9% and 16%, respectively, Brazil’s current ratio is about 2%. However, this
GDP ratio is about 2%.
number started to increase since 2004 when most of the above-mentioned improvements
in the mortgage market started to happen.
Once access to credit became a reality, Brazilian families in the middle to middle-high
With access to affordable
income brackets started to finance upgrades from their existing homes. Moving to a
credit, middle and middle-
high income families were home that was bigger, newer, or located in a better area became common through the
the first to finance home sale of the family’s existing home or apartment plus borrowing of the difference.
upgrades…
This movement makes sense when we look at the average price for the 2006 launchings
using the potential sales value (PSV) and the number of units launched by Brazil’s listed
companies. The average price at this point is roughly R$400,000. Additionally, exhibit 13
shows that the maximum allowed real estate value for a top income family earning
R$10,000 monthly should be R$277.500, based on a 20-year long mortgage at 10% per
year of nominal interest.
Exhibit 13: Maximum Mortgage per family income – R$
Family
Monthly Mortgage Initial Down Real Estate
Income
Installment Value Payment Value
(R$/month)
1,000 300 25,000 2,750 27,750
1,500 450 37,000 4,120 41,120
2,500 750 62,000 6,860 68,860
3,500 1,050 86,000 9,610 95,610
10,000 3,000 250,000 27,500 277,500
Source: Bulltick
The average price approach we used simply tells us that the dynamic of the real estate
… telling us that the
boom in Brazil is different from the one observed in other countries such as Mexico or
dynamics of the Brazilian
Chile.
market is different from
Mexico’s.
8

9. The Brazilian government has not yet positioned itself in the strategy it plans to use to
enable the lower income segments to enter the market. So far, this has been a top-down
movement in terms of target buyers for most of the developments being launched.
In order to reach the lower income segments, developers count on further advances in
To reach lower income
regulation for the mortgage market or direct government subsidies for housing. On the
segments, further advances
regulation front, some changes could enable banks to view this market as less risky, thus
in mortgage regulation are
enabling offering of longer maturities and lower interest rates.
needed…
A very interesting example is that of payroll deductible loans. This kind of operation was
…like payroll deductible
responsible for a consumer credit explosion in Brazil due to the lower risks and lower
loans.
interest rates offered. It seems quite reasonable to expect its extension to housing.
Going forward, improvements in terms of maturity and interest rates should happen
Further decline in interest
without the need of government action, as the Brazilian economy remains stable and
rates and longer credit
approaches investment grade status, thus bringing more potential buyers to the market.
maturities are also
expected.
As a rule of thumb, Brazilian banks will not lend to a family in which the resulting
mortgage commitment is more than 30% the family’s total income. In Exhibit 14 we
present the family income needed in R$ in order to finance the acquisition of a R$50,000
home with a 20% down payment, with interest rates ranging from 10% to 6%, and the
maturity from 20 to 30 years while considering a 30% mortgage commitment. Looking at
the two highlighted results, we have the example of the current situation and the one
expected in 2 to 3 years, where a family with 37% less income will be able to finance the
same kind of property.
Exhibit 14: Family Income vs. conditions of mortgage
Mortgage Maturity (Years)
20 21 25 30
240 252 300 360
10% 1,619 1,592 1,508 1,434
9% 1,517 1,490 1,405 1,331
Interest 8% 1,413 1,387 1,302 1,228
7% 1,309 1,283 1,198 1,124
6% 1,205 1,178 1,093 1,019
Source: Bulltick
As Brazilian families at lower income levels usually lack savings, we must consider that
The major barrier to lower
before a family buys a home it needs to accumulate some savings. If we assume a family
income families is the lack
starts saving for its house with monthly deposits equal to the payments of its mortgage, it
of savings for the mortgage
downpayment. will take approximately 20 months for it to save the R$10,000 needed with the R$485.00
monthly savings. Actually, this is a family’s main entry barrier to home ownership.
Therefore, this is where government should act to create some kind of subsidy in order to
offset such requirements.
Our conclusion on credit lines for housing in Brazil is that, at this point, we are far from
We are 2 to 3 years away
the so-called housing boom. Currently, companies are still working to satisfy pent up
from the Brazilian housing
demand in the middle to higher income segments, and not yet effectively covering the
boom, which is yet to come.
housing deficit. In our scenario, this should happen only in 2 to 3 years. In that sense,
we view the current moment as the right one for investors to analyze companies and their
ability to deliver growth in order to anticipate the winners in the actual housing boom in
Brazil, which is yet to come.
9

10. The Housing Deficit in Brazil
Consensus about the housing deficit in Brazil points to roughly 8 million homes needed to
Brazililian housing deficit: 8
cover it. This number keeps growing, and is highly concentrated in the lower income
million homes.
segments of the Brazilian population and in the big urban centers.
Exhibit 15: Brazil’s GDP and Housing Deficit
Northeast
35% of Deficit
14% of GDP
28% of Population
Brazil
GDP: R$1.766T
Population: ~185M
Housing Deficit:7,9M units
North and Center-West
18% of Deficit
13% of GDP
15% of Population
Southeast and
South
47% of Deficit
73% of GDP
57% of population
Source: IBGE, FGV, CBIC and Bulltick
Another interesting piece of data on housing is the profile of Brazilian families’ home
Home ownership data
ownership. Exhibit 16 shows this profile and brings to our attention something that is
supports our view that
current demand is mostly intuitive: the deficit is concentrated in the lower income segments. Another observation
for home upgrades. from the data accords with our previous comment: the fact that most of the recently sold
homes in Brazil have been bought by people looking for upgrades to their existing homes,
as 80% of the higher income families already own their homes. We do not see this level
of ownership growing much greater than 90%, leading us to conclude that most of the
last years’ absorption of new launchings came from people upgrading to bigger, newer, or
better located homes.
Exhibit 16: Home Ownership
90%
82%
80%
80%
77%
73%
71%
70%
60%
<5 5~10 10~20 >20 Total
Fam ily Incom e (Minim um Wages)
Source: PNAD (IBGE) and Bulltick
10

11. Expected advances in In order to try to estimate the impacts of an improvement in financing conditions on the
mortgate should add 4.5 existing market, as well as on the housing deficit, one should look at some data on the
million potentital buyers to income of Brazilian families. Exhibit 17 shows Brazilian family income data and outlines
the market.
potential buyers of a R$100,000 unit using a 20-year loan paying 10% per year nominal
interest. Additionally, it also shows the new potential buyers added to the market in our
scenario of 30-year mortgages at a 7% per year interest rate. A total of 4.5 million new
families could access the market, reaching the 5 to 10 minimum wages bracket at which
home ownership is much lower.
Exhibit 17: Potential Real Estate Buyers
Current scenario: Expected scenario:
20 years maturity, 10% per year 30 years maturity, 7% per year
Interest rate Interest rate
Potential real Potential real
estate new estate new buyers:
buyers: 7.1 mm 11.7 mm families
families
Population: 48.5 mn families
Source: IBGE (PNAD) and Bulltick
Another way of analyzing the deficit in order to define where there are better
Crossing per capita GDP
opportunities for developers is to cross per capita GDP data with the housing deficit
with regional housing deficit
provides a better view on relative to each state’s population and in absolute terms per state. This approach is
which are the best markets shown on exhibit 18.
to be in.
Exhibit 18: Per capita GDP versus relative housing deficit
35%
MA
Population within deficit / State population (%)
30%
AM
PA
25%
PI
RR
CE
20%
TO
PB RJ
PE SP
AC BA
15% RO
Brazil
SE DF
AL
MG
MT
MS
RN GO
10% AP PR
ES RS
SC
5%
0 5.000 10.000 15.000 20.000
Per Capita GDP (R$ / inhabitant)
Source: IBGE, FGV, CBIC and Bulltick
11

12. It is interesting to note that some companies which have chosen to diversify operations,
have geographically targeted markets in a somewhat rational way starting from Rio and
São Paulo and then following a seemingly logical path through other markets such as Rio
Grande do Sul, Santa Catarina, and Paraná. Some of the more diversified companies,
such as Cyrela and Gafisa, have reached Bahia state at this point.
CORPORATE GOVERNANCE
The real estate sector companies came to market adopting the highest level of corporate
governance in the Brazilian market, which is the “Novo Mercado.”
As most investors should be aware at this point, the “Novo Mercado” features include: (i)
companies have voting-shares only; (ii) full tag-along rights; (iii) a minimum free-float of
25%; and (iv) disputes resolved through arbitration.
In the table below we summarize the main differences in terms of corporate governance
features for analyzed companies in order to provide investors with a comparison for the
sector:
Corporate Governance in Real Estate Companies
N° of Stake
CEO and Chairman of the N° of Board Specific Minimum
Company Outside Board of Controling
Board, same person? Members Committees Dividend
Members Shareholders
Company Yes 6 4 - 51% 25%
Operational, Engineering,
Cyrela Yes 7 2 Marketing and Development, 35% 25%
Finances, Credit, Sales
Auditing, Compensation,
Gafisa No 7 2 24% 25%
Remuneration
Klabin Segall Yes 6 3 - 32% 25%
Land purchase, New Business,
Rossi No 6 2 43% 25%
Auditing, HR, Finances
Source: Companies
RISKS
Risks to our scenario for real estate companies in Brazil are mostly macroeconomic given
the enormous demand for housing in the country. A sharp downturn in the economy or
an external crisis could adversely impact the population’s savings capacity, thus impacting
home purchases.
Looking at the microeconomic scenario, we do not see, at this point, reasons for concern,
although we should point out that the quality of working capital management will remain
crucial for the companies. The typical construction process, (from groundbreaking to
sale/occupancy of units), in urban centers in Brazil has an average lifespan of 3 years.
Therefore, companies need to focus on keeping themselves liquid in case of any setbacks.
In this sense, it is interesting to note that most companies are underleveraged at this
point and tend to maintain conservative capital structures.
Relative to the real estate market, some risk lies in the fact that leading companies are all
operating in similar markets at this point. This risk, though, is partially offset by the
strong demand we have been identifying for the sector so far.
Shifting to market risks, we see the recent wave of IPOs and other possible offers with
concern. Despite recent increases in the relative weight of the sector in portfolios, it
should not represent a significant piece in the near future; IPOs bring volatility to stocks
as portfolio managers tend to do reallocations in order to take advantage of offer
12

13. discounts.
Another risk linked to markets is the fact that most, if not all, stories in the sector are
growth stories. Markets tend to react negatively even on the minor disappointment of
expectations, whereas upside is limited once quarterly results come in line or above
expectations.
13

14. Company (CPNY3)
Sector: Real Estate & Construction
Target Price: R$37.50 / US$17.00
Current Price (02/12/07): R$26.00 / US$12.30
Upside: 44.2% / 38.6%
Initiating Coverage
Attractive Valuation, Lacking Diversification BUY
We are initiating our coverage of Company’s shares with a BUY rating Table 1
•
and 2007 year-end target price of R$37.50/share, which implies a Market Cap in R$MM 936
potential upside of 44% in nominal terms and a 39% upside in dollar Firm Value in R$MM 978
terms over the current market price. 52-week Hi-Lo in R$ 26.7 - 9.4
30D ADTV – R$000 1,131
Traditionally associated with high-end segments, Company still Share Price:
•
focuses on those segments, profiting from its top-tier clients, who Variation 1M 3M 6M
were the first to benefit from the access to more affordable credit. At Absolute 1.7% 31.4% 108.8%
Relative -0.3% 21.4% 73.8%
the same time, Company is heading towards the middle to middle
Volatility 1M 3M 6M
high income segments. The kind of product Company delivers is
Absolute 20.0% 31.9% 37.6%
usually sought by clients looking for some upgrade in their living
Relative 2.4% 10.0% 14.6%
style. These clients are not highly dependent on credit, although
some may expect to leverage themselves to a minor extent. Table 2 – R$MM 2006E 2007E 2008E
Net Revenue 240 312 544
EBITDA 49 68 121
As its target market was the first to respond to the improvement in
• Net Profit 42 54 97
the scenario for the sector, Company was one of the first companies Dividends 10 13 24
to consider the capital markets to boost growth. It offered shares to FCFF (131) 133 46
the market in February 2006. Since then, Company’s shares jumped ROIC (%) 15.4% 16.1% 23.4%
63% which compares to the Ibovespa 12% return in the same
Table 3 2006E 2007E 2008E
period.
PER 22.3x 17.4x 9.7x
FV/EBITDA 19.0x 14.4x 8.1x
FV/FCFF N.R 7.4x 21.4x
In terms of multiples, Company’s shares currently trade at 9.7x
•
Dividend Yield 1.1% 1.4% 2.6%
PER08E and 8.2x FV/EBITDA08E, both at discount to the average of FCFE Yield N.R. 13.6% N.R.
our coverage universe of 15.0x PE08E and 11.4x FV/EBITDA08E. Net Debt to EBITDA N.R. 62.4x 44.5x
Table 4
PEG Ratio 0.22x
Comparing the 2008 multiples with the 3-year CAGR, we see
•
EBITDA Mult/Growth 0.18x
Company’s PEG ratio at 0.22x and the EBITDA multiple to growth
PBV 3.3x
ratio at 0.18x. These figures compares to the sector average of
Net Debt/Equity 0.1x
0.29x and 0.20x, respectively.
Net Deb/ Total Cap 0.1x
N.R. – Non-representative
Company is still using the proceeds from its IPO to invest in new
•
projects; thus 2007 should still be a high-growth year in which we
assume R$800 million of launchings PSV, a roughly 130% increase y-
Share Price vs Ibovespa Performance
o-y. After reaching R$1 billion of launchings in 2008 and leveling to
a new standing, our valuation model considers 20% and 10%
180
180
launchings PSV expansion for 2009 and 2010, respectively.
140
140
The risks to Company’s investment case are: (i) an over supply of
•
100
100
projects in the high-income segment; (ii) in the case of a shift to
lower income segments, these projects are more capital demanding
60
60
and Company’s size may be an issue; and (iii) concentration of
3/06
5/06
7/06
9/06
11/06
1/07
business in São Paulo, the biggest but most competitive market in
Brazil. CPNY3 Ibovespa

15. Brief Company Description
Company is a fully integrated developer, focused on the high and middle income
segments. Its activities include every aspect of projects and it has a solid track record in
construction.
Company was founded in 1984 and develops mostly residential apartments in the city of
São Paulo. It may develop commercial buildings opportunistically. Working as a
contractor, though, Company is able to, and has, implemented several projects in markets
outside São Paulo.
Different from most of its peers, Company does not maintain long-term land banks.
Nevertheless, as per 3Q06 release, it already holds almost all land needed to deliver its
launchings guidance for 2007, reducing the execution risks.
So far, Company has not disclosed any plans to diversify its operations geographically.
Capital Structure and Working Capital Management
Company’s clients usually pay for their properties at a faster pace compared to its peers.
This aspect enables the company to be in a favorable position in terms of working capital
management. Thus, working capital needs per project are lower than its peers’, as its
client’s payment schedule closely follows the construction of the building.
The capital structure we used for Company in our valuation model was 30% debt, 70%
equity, keeping a conservative profile as with most of the sector.
Main Model Assumptions
Our valuation model assumes a quite strong y-o-y growth for Company in 2007, roughly
130%, decreasing the rate then to 25% in 2008, 20% and 10% in 2009 and 2010,
respectively.
It is worth noting that most of the results for a given Company’s project is recognized in
the last year of development. In exhibit 19 we detail our assumptions in terms of revenue
recognition for Company.
Exhibit 19: Revenue Recognition
1st Year 2nd Year 3rd Year
% of Sales 60% 20% 20%
% of Cost Inc urred 30% 28% 42%
Recognized Revenues 18% 28% 54%
Source: Bulltick
15

16. Exhibit 20: Multiples and Return
Multiples 2006E 2007E 2008E 2009E 2010E 2011E 2012E
PER 22,3x 17,4x 9,7x 7,5x 6,3x 5,2x 4,6x
FV/EBITDA 19,0x 14,4x 8,2x 6,5x 5,5x 4,5x 4,1x
FV/Launchings 2,6x 1,2x 1,0x 0,8x 0,7x 0,7x 0,6x
FV/FCFF N.R. 7,4x 21,5x N.R. 18,6x 15,6x 8,8x
Return
ROE 24,9% 17,5% 26,5% 27,7% 27,1% 26,8% 24,9%
ROIC 15,4% 16,1% 23,4% 24,5% 24,2% 24,0% 22,6%
ROA 11,6% 8,6% 12,4% 13,4% 13,7% 14,4% 14,1%
Source: Bulltick
Exhibit 21: Sensitivity Analysis (Multiples as Target)
PER 08E 1.00 1.10 1.20 1.30 1.40 Beta FV/EBITDA 08E 1.00 1.10 1.20 1.30 1.40 Beta
14.0 12.6% 13.0% 13.4% 13.9% 14.3% WACC ### 12.6% 13.0% 13.4% 13.9% 14.3% WACC
3.0% 14.4x 13.7x 12.9x 12.3x 11.7x 3.0% 12.0x 11.3x 10.8x 10.3x 9.8x
3.5% 15.0x 14.2x 13.4x 12.7x 12.1x 3.5% 12.5x 11.8x 11.2x 10.6x 10.1x
g 4.0% 13.0x 12.3x 11.6x 11.0x 10.4x
g 4.0% 15.7x 14.8x 14.0x 13.2x 12.5x
4.5% 13.6x 12.8x 12.1x 11.4x 10.8x
4.5% 16.5x 15.5x 14.6x 13.7x 13.0x
5.0% 14.3x 13.4x 12.6x 11.9x 11.2x
5.0% 17.4x 16.2x 15.2x 14.3x 13.5x
Target Price 1.00 1.10 1.20 1.30 1.40 Beta
37 12.6% 13.0% 13.4% 13.9% 14.3% WACC
3.0% 38.76 36.66 34.74 32.98 31.36
3.5% 40.40 38.12 36.05 34.16 32.42
g 4.0% 42.23 39.75 37.50 35.45 33.59
4.5% 44.29 41.56 39.11 36.89 34.87
5.0% 46.61 43.60 40.91 38.49 36.30
Source: Bulltick
Exhibit 22: Geographic Presence Exhibit 23: Shareholder Structure
Controlling Free
Group Float
49%
51%
Company
Company’s Presence
Source: Company and Bulltick
16

17. Exhibit 24: Company’s Financials
Income Statement (R$ MM) 2006E 2007E 2008E 2009E 2010E 2011E 2012E
Launchings 353 800 1,000 1,200 1,320 1,452 1,597
- Real Estate Sales 229 598 756 991 1,180 1,329 1,472
Gross Revenues 250 324 564 743 939 1,185 1,387
Net Revenues 240 312 544 716 905 1,142 1,337
- COGS (157) (210) (363) (481) (615) (788) (933)
Gross Profit 82 102 181 235 290 354 404
- SG&A expenditures (23) (34) (60) (82) (109) (137) (160)
- Other Operational (10) - - - - - -
EBIT 49 68 121 153 181 217 243
Financial Results (2) (6) (11) (12) (12) (12) (12)
- Financial Expenses (22) (19) (19) (19) (19) (19) (19)
- Financial Revenues 20 12 8 7 7 7 7
Non-Operational Results 0 - - - - - -
EBT 47 61 110 141 169 205 231
Income Tax (5) (7) (13) (17) (20) (25) (28)
Employee Interest - - - - - - -
Minority Interest - - - - - - -
Net income 42 54 97 124 149 181 204
Depreciation 0.1 0.2 0.3 0.3 0.4 0.4 0.5
EBITDA 49 68 121 153 181 218 244
Adjustments - - - - - - -
Adjusted EBITDA 49 68 121 153 181 218 244
Gross Margin 34% 33% 33% 33% 32% 31% 30%
EBITDA Margin 21% 22% 22% 21% 20% 19% 18%
Net Margin 17% 17% 18% 17% 16% 16% 15%
FCFF 2006E 2007E 2008E 2009E 2010E 2011E 2012E
EBITDA 49 68 121 153 181 218 244
Taxes (4) (8) (15) (18) (22) (26) (29)
Change in Assets (175) 73 (60) (198) (106) (127) (102)
CAPEX (0) (0) (0) (1) (1) (1) (1)
FCFF (131) 133 46 (64) 53 63 112
Balance Sheet 2006E 2007E 2008E 2009E 2010E 2011E 2012E
Assets
Cash and Equivalents 127 81 69 69 69 69 69
Accounts Receivable 227 191 208 275 238 256 282
Inventories 159 229 323 505 680 826 940
Other 35 212 252 158 173 192 252
Total Assets 547 712 852 1,007 1,161 1,343 1,543
Liabilities
Short Term Debt 32 32 32 32 32 32 32
Suppliers 14 32 40 48 53 58 64
Real Estate Acquisition Payables 9 21 27 32 35 39 42
Clients Advance Payments 1 1 0 - - - -
Long Term Debt 91 91 91 91 91 91 91
Other 112 207 262 310 344 382 420
Equity 288 329 401 494 606 741 894
Total Liabilities 547 712 852 1,007 1,161 1,343 1,543
Working Capital
Net Working Assets 290 217 277 475 581 709 810
Change in Assets (175) 73 (60) (198) (106) (127) (102)
Source: Bulltick
17

18. Cyrela Brazil Realty (CYRE3)
Sector: Real Estate & Construction
Target Price: R$28.35 / US$12.90
Current Price (02/12/2007): R$19.80 / US$9.40
Upside: 43.2% / 37.6%
Initiating Coverage
Solid Fundamentals, Strong Upside BUY
We are initiating our coverage of Cyrela shares with a BUY rating and Table 1
•
2007 year-end target price of R$28.35/share, which implies a Market Cap in R$MM 7,018
potential upside of 43% in nominal terms and a 38% upside in dollar Firm Value in R$MM 6,666
terms over the current market price. 52-week Hi-Lo in R$ 22.53 - 12.40
30D ADTV – R$000 38,296
Cyrela has been the leader in the recent developments in the sector Share Price:
•
from the start: it was the first company to come to market on Variation 1M 3M 6M
September 2005 with a successful equity offering that opened the Absolute -3.6% -5% 23%
Relative -5.5% -12.5% 2.3%
capital markets doors to the rest of the sector. The initial offering
Volatility 1M 3M 6M
was followed on in July ’06 by a R$837 million offering, capitalizing
Absolute 44% 42% 44%
the company further.
Relative 23% 18% 20%
Table 2 – R$MM 2006E 2007E 2008E
Leadership is the best word to describe the company that has used
• Net Revenue 988 1,483 2,074
the firepower from the two capital increases to boost launchings and EBITDA 233 367 521
position itself ahead of competition. 2006 launchings speak for Net Profit 229 321 392
themselves, evidencing the benefits of being the pioneer in capital Dividends 57 80 98
markets. FCFF (532) (620) (320)
ROIC (%) 15.1% 16.1% 17.9%
Table 3 2006E 2007E 2008E
In terms of multiples, Cyrela shares trade currently at 17.9x PER08E
•
PER 30.7x 21.9x 17.9x
and 13.2x FV/EBITDA08E, a well deserved 19% and 16% premium
FV/EBITDA 27.3x 18.2x 13.2x
over our aggregated 15.0x PER08E and 11.1x FV/EBITDA08E for the
FV/FCFF N.R. N.R. N.R.
sector.
Dividend Yield 0.8% 1.1% 1.4%
FCFE Yield N.R. N.R. N.R.
Although we agree that multiples may look expensive at first glance, Table 4
•
we must remind investors that Cyrela is a growth case where PEG Ratio 0.63x
multiples tend to get much more civilized when viewed at the long EBITDA Mult/Growth 0.30x
PBV 3.6x
term.
Net Debt/EBITDA07E N.R.
Net Debt/Equity N.R.
Net Deb/ Total Cap N.R.
Comparing the 2008 multiples with the 3-year CAGR, we see Cyrela’s
•
PEG ratio at 0.63x and the EBITDA multiple to growth ratio at 0.31x. N.R. – Non-representative
These figures compare to the sector average of 0.29x and 0.20x,
respectively.
Share Price vs Ibovespa Performance
Cyrela delivered an impressive 235% YoY growth in launchings in 06.
•
To be on the conservative side, our model assumes a 15% growth 180 180
rate in terms of launchings in 2007 and 2008, and 10% per year
during the 2009-2010 period. It would not surprise us, though, if the 140 140
company beats those rates as the scenario for the sector improves
furder. 100 100
60 60
2/06
4/06
6/06
8/06
10/06
12/06
Among our concerns for Cyrela’s case we cite: (i) the still
•
unanswered question on the CEO’s succession; (ii) the company’s CYRE3 Ibovespa
ability to successfully adapt its business model to offer to the lower
income segments; and (iii) the strong growth in demand may require
staff increases to support: a) new launchings, and b) guarantee
quality will be maintained and brand recognition is preserved.

19. Brief Company Description
Cyrela is Brazil’s top developer, working on a fully integrated basis. Its main market is
São Paulo, but more recently Rio de Janeiro gained importance, especially after RJZ’s
acquisition in May 06. The company also diversified its business by creating joint ventures
with companies from other markets. Currently, Cyrela has reached five other markets in
attractive states. Besides market diversification, the JV model enabled Cyrela to identify
synergies to RJZ’s operations, resulting with its acquisition.
Operationally speaking, the company has roughly 90% of its revenues generated in the
land development business; another 7% comes from the rental of corporate space, and
the remaining 3% comes from sales of construction services to third parties.
In terms of land bank, the company has a clear strategy of keeping land bank in-house or
through joint ventures for 4 to 5 years of future launchings. The company also tries to
maximize the level of swaps of land per developed product with land owners instead of
paying cash for land. The focus of the strategy is to keep the company liquid to take
advantage of market opportunities.
Historically, Cyrela has primarily developed high income focused projects. During the last
two years it started to target clients with income below its traditional market segment and
hit the middle-high income segment. More recently, the company announced the creation
of a separate brand called Living to target a lower income segment than that of Cyrela’s
brand. Living is focused on the middle and middle-low income segments for apartments
in the R$100,000-120,000 per unit range.
Capital Structure and Working Capital Management
We view Cyrela as one of the most conservative companies in the sector. The company
focuses on being liquid as well as avoiding use of much leverage. Cyrela strives not to
surpass the 1.5x net debt/EBITDA ratio. In our valuation model we translated that into a
30% debt, 70% equity target capital structure.
We consider working capital management one of the most important aspects of the real
estate business. A development is a 3-year-long process and managing sales, client
payments, and especially construction speed may create or destroy value in this business.
In this sense, Cyrela adopts some simple, and yet very efficient, policies in terms of
avoiding high cash exposure to its projects: (i) on average 70% of units are sold and 15%
of the sales value is received from clients before construction commences; and (ii) 56% of
the units’ value is received before delivery. Both policies let the company work currently
on an almost “customer-financed” basis.
Main Model Assumptions
We expect Cyrela launchings PSV to grow by 15% y-o-y in ’07 and ’08, lowering the pace
to 10% y-o-y for 2009 and 2010. Another particular aspect of the model is that Cyrela
currently finances 65% of its remaining receivables after product delivery. We expect the
company to keep that practice as long as rates are attractive. Currently, this strategy
yields 16% p.a. On exhibit 2 we detail our assumptions in terms of revenue recognition
for a typical 3-year Cyrela project.
Exhibit 25: Revenue Recognition
1st Year 2nd Year 3rd Year
% of Sales 70% 10% 20%
% of Cost Inc urred 4% 40% 56%
Recognized Revenues 3% 32% 65%
Source: Bulltick
19

20. Exhibit 26: Multiples and Return
Multiples 2006E 2007E 2008E 2009E 2010E 2011E 2012E
PER 30.7x 21.9x 17.9x 14.5x 9.6x 7.7x 6.7x
FV/EBITDA 27.3x 18.2x 13.2x 10.2x 7.3x 6.0x 5.3x
FV/Launchings 1.8x 1.7x 1.5x 1.4x 1.2x 1.1x 1.0x
FV/FC FF N.R. N.R. N.R. N.R. N.R. 44.3x 9.6x
Return
ROE 15.4% 15.6% 16.8% 18.2% 23.4% 24.5% 23.4%
ROIC 15.1% 16.1% 17.9% 19.7% 23.2% 23.1% 22.1%
ROA 9.7% 9.9% 10.5% 11.4% 14.3% 14.9% 14.5%
Source: Bulltick
Exhibit 27: Sensitivity Analysis (Multiples at Target)
FV/EBITDA 08E 1.00 1.10 1.20 1.30 1.40 Beta
PER 08E 1.00 1.10 1.20 1.30 1.40 Beta
26 12.5% 12.9% 13.3% 13.8% 14.2% WACC ### 12.5% 12.9% 13.3% 13.8% 14.2% WACC
3.0% 26.7x 24.7x 22.8x 21.2x 19.6x 3.0% 19.8x 18.3x 16.9x 15.7x 14.5x
3.5% 28.3x 26.1x 24.2x 22.3x 20.7x 3.5% 21.1x 19.4x 17.9x 16.6x 15.3x
g 4.0% 22.5x 20.7x 19.0x 17.6x 16.2x
g 4.0% 30.2x 27.8x 25.6x 23.7x 21.9x
4.5% 24.0x 22.1x 20.3x 18.7x 17.2x
4.5% 32.3x 29.6x 27.3x 25.1x 23.2x
5.0% 25.8x 23.6x 21.6x 19.9x 18.3x
5.0% 34.7x 31.7x 29.1x 26.7x 24.6x
Target Price 1.00 1.10 1.20 1.30 1.40 Beta
28 12.5% 12.9% 13.3% 13.8% 14.2% WACC
3.0% 29.50 27.28 25.25 23.41 21.72
3.5% 31.34 28.92 26.72 24.73 22.91
g 4.0% 33.40 30.74 28.35 26.18 24.22
4.5% 35.72 32.78 30.16 27.79 25.65
5.0% 38.34 35.08 32.18 29.59 27.25
Source: Bulltick
Exhibit 28: Geographic Presence Exhibit 29: Shareholder Structure
Free
Rogério
Elie Horn Eirenor
Float
Zylberstajn
36% 6% 2% 56%
Cyrela
Brazil Realty
Cyrela’s Presence
Source: Cyrela and Bulltick
20