The new round of concession auctions will kick off starting April 7 and will consist of 22 regional airports, five port terminals, one highway, and one greenfield railroad.

Table 1

Despite the success of previous concession auctions, the new round faces short-term challenges, such as:

• The economic outlook will largely be shaped by the pandemic's trajectory. Currently, the country faces the worst phase of the pandemic since the outbreak in early March 2020. The recession and large government support measures led to a record fiscal deficit and a significant surge in government debt in 2020. Congress recently approved a limited fiscal reform. Nevertheless, persistent fiscal uncertainty and high government financing needs could weigh on investors' confidence in the short term.
• Congress is willing to discuss reforms, but faces a crowded agenda. The regulatory agenda has continued to advance – including the recent approval of new frameworks for sanitation and natural gas, which should foster private investment in the country. Cabotage and railway reforms are expected to pass in the coming months. However, political tensions could grow in the short term as the pandemic and economic situation worsen, undermining the approval of new reforms.

Essential Nature Of Infrastructure Services Should Attract Investors

At the same time, the essential nature of the service provided by infrastructure assets have sustained their resilience during the pandemic, as demonstrated by the relatively small number of distressed exchanges and bankruptcy proceeding for the sector's players in 2020 (see "Default, Transition, and Recovery: The 2020 Global Corporate Default Tally Reached 226", published Jan. 8, 2021). Although the industry was directly impacted by the mobility restrictions implemented worldwide to contain the virus, traffic impact was relatively limited in Brazil's ports, roads, and regional airports.

Airports

The drop in air travel in Brazil was deeper than our initial expectations, while we forecast the recovery to pre-pandemic levels after 2023, particularly for international flights as most countries kept their borders closed. At the same time, domestic air travel recovery was strong, as outlined in the graph below, resulting in overall 2020 domestic traffic drop of 53% in comparison with 2019 baseline, versus a drop of 72% for international passengers, which eased the negative performance of regional airports.

While we continue to expect international flights in 2021 to only reach 40%-60% of the 2019 level (see "As COVID-19 Cases Increase, Global Air Traffic Recovery Slows", published Nov. 12, 2020), the pandemic's second wave is hindering the recovery of domestic air travel. The current outbreak in Brazil has been more severe than the first, given the higher rate of infections and deaths, which caused many states to reimpose lockdowns. We expect a dent in the Brazilian air traffic in the next few months until the country overcomes the second wave peak. Domestic traffic should follow the same trend of recovery as observed last year starting in June 2021, as the vaccination campaign accelerates in the second half of the year (see chart 1).

Chart 1

Roads

The drop in roadway traffic in Brazil was milder than our initial estimate dropping 13% in 2020. This was due to the roadways' unique status as the dominant transportation mode in Brazil, as commercial trucks continued to move critical supplies of food, medicine, and to support the businesses that have carried on through the restriction measures. On the contrary, a the light vehicle traffic plummeted due to lockdown measures, while the new working from home framework might have caused a permanent loss of commute traffic.

Similar to air traffic, the recently reimposed lockdowns caused light-vehicle volume to drop more than 20% in the first two weeks of March 2021 (from the 2019 baseline) according to the traffic data for the concessions managed by CCR S.A., in line with traffic performance in the previous year. While we expected a full recovery to 2019 traffic levels in 2021, the severity of the second wave should result in an up to a 15% drop in 2021.

Chart 2

Ports

Contrary to airports' performance, cargo volumes at ports posted an overall 4.4% year-on-year growth in 2020, despite a 4.4% contraction in Brazil's GDP. This was mainly due to exports of bulk solids (iron ore and metals, soybean, sugar, etc.), which represented about 60% of the cargo handled, while handling of bulk liquids accounted for about 25% of total. We continue to expect volumes to grow at least in tandem with GDP, which we forecast at 3.4% for 2021, still benefiting from exports of agricultural and metals commodities.

Chart 3

Limited Appetite Among International Operators

In our view, the global infrastructure players' participation in Brazil's upcoming auctions will be lower, given the following factors:

• Limited appetite to widen their geographic diversification to Brazil, a speculative-grade rated sovereign (BB-/Stable/B); and
• Sponsor's ability to absorb higher capex commitments amid slow recovery, particularly among European airport operators.

Global airport operators, particularly European ones, played a major role in the previous auction rounds for Brazilian airport concessions (see table 2). Some of these groups have a negative outlook with financial metrics close to downgrade triggers, while they're implementing cost-cutting measures, and postponing investments to preserve liquidity and cash flows (see "Europe's 2021 Air Passenger Traffic Likely To Stall At 30%-50% Of 2019 Level," published Feb. 18, 2021).

Table 2

The potentially lower participation of international bidders in the next round of concessions might open the door for domestic and regional players. In the previous round, a Brazilian joint venture (Sociacam Terminais Rodoviarios and Sinart-Sociedade Nacional de Apio Rodoviario) won the concessions to operate the Center-West block (four airports in the state of Mato Gross). The joint venture committed to pay R$40 million as a grant fee and invest R$791 million into airports.

In the case of Ferrovia de Integração Oeste-Leste – FIOL, we believe that short- to medium-term challenges would likely limit the number of interested players, both domestic and international. This asset is a greenfield railway in the southern area of Bahia state, divided into three tranches. The first section that's been auctioned now is still under construction (about 80% completed) and will connect mainly an iron ore production facility with a new port of Porto Sul, to be constructed near city of Ilheus in the same area of Bahia. There are timing uncertainties for the construction of this port, along with counterparty risk because the main offtaker will be a relatively small iron ore producer (Minas da Bahia Mineração – Bamin). Bamin's controlling group is currently under investigation for corruption, and the project could also face environmental risks, which could lead to reputational issues for the new concessionaire. The other two sections of FIOL are still under construction (section II), or in the study/project phase (section III), with no clear view about when the entire stretch of railway would be fully operational. After the three sections are completed, the railway would connect with the Ferrovia Norte-Sul railway and could be an alternative route for grain exports from the center-west region of the country.

Auctions Could Offer A Silver Lining

Before the pandemic, Brazil's potential growth was about 2%, one of the lowest rates among emerging markets. Even though the 4.4% GDP contraction in 2020 was milder than most of its regional peers, raising the country's long-term GDP growth rate--estimated at 3.4% in 2021 and 2.5% in 2022--depends on reforms to increase productivity and private investment (see "Despite Growth Picking-Up, Pre-Pandemic Weaknesses Remain" published on March 25, 2021). The challenges of Brazilian infrastructure's quality and capacity are caused by limited investment in recent years (around 15% of GDP in the past five years). The government has had very limited fiscal room to fund public investment, given the structural fiscal crisis. Microeconomic and regulatory reforms--which don't require constitutional amendments--are more likely to continue to advance in the short term, supporting private-sector participation in various industries.

Despite the end of the monetary easing policy following the recent hike of the domestic basic interest rate to 2.75% per year, the still low interest rates offer attractive conditions to invest in infrastructure assets. The new round of concessions could benefit from the ample liquidity in the capital markets, which alleviates the cost of capital and the inherently strong market position of these assets, which are typically monopolies in the areas that they serve, with the exception of ports leases.

Finally, these concessions operate under the regulatory framework that we view as favorable and relatively stable. The framework boasts a good track record of contract performance and regulatory oversight, with more than 20 years for roadway and port concessions, and almost 10 years for airports. We observed either economic or financial compensation mechanisms during regulatory intervention in rate readjustments. In addition, the regulator reduced grant amounts for airport concessions tom compensate for severe traffic losses caused by the pandemic.

Appendix