There probably has been no better test of the staying power of emerging market companies and their managers than after this summer’s sell-off, when some of these firms could no longer count on huge capital investment and growth.

In Latin America, Brazil was one of the emerging market countries that suffered a huge correction. As the IMF reported last April, large policy stimulus measures undertaken by the Brazilian authorities had failed to spur private investment. The country as a result had suffered deteriorating confidence in both the local and international investor communities. And slower economic growth in China and falling commodities prices had this summer only added to Brazil’s problems, including stubbornly high inflation and massive social protests.

But many emerging market stocks remain undervalued following the summer sell-off, when investors overreacted in part to Federal Reserve Chairman Ben Bernanke’s tapering comments and pulled their money from overseas investments with the expectation that Treasury rates would soon rise.

Despite the correction, in October the IMF reiterated that even as there has been a slowdown in emerging markets, these developing countries are still expected to grow faster than developed economies, which continues to make companies in the region attractive.

In the center of Latin America’s largest economy, where some of the market turmoil has been heaviest, there is the Brazil-based, global bank Itaú Unibanco Holding SA (NYSE: ITUB).

The bankers at Itaú not only kept their heads during the market’s hyper gyrations, but their steady, conservative approach to growth in Brazil and diversification into other fast-growing economies has produced a firm that is increasingly challenging the position of top tier US and European banks in Latin America and throughout the world

“China and a growing number of emerging market economies are coming off cyclical peaks. Their growth rates are projected to remain much above those of the advanced economies but below the elevated levels seen in recent years, for both cyclical and structural reasons,” noted the flagship report of the IMF.

When the institution revised its world growth figures in October, IMF projected that emerging markets would still account for much of that growth, with their economies forecast to expand nearly four times as fast this year as advanced economies. But the IMF also noted that the heady expansions some have enjoyed may be a thing of the past.

Diversification, Caution and Growth

Itaú is a Brazilian publicly quoted bank with headquarters in San Paulo, Brazil. The bank is the result of the merger of Banco Itaú and Unibacno, which occurred on November 4, 2008 to form the largest financial conglomerate in the Southern Hemisphere and the 10th largest bank in the world by market value.

In addition to its listing on the New York Stock Exchange, the bank is also traded on the BM&F Bovespa in São Paulo. Itaú currently is the second biggest Brazilian bank by assets, after Banco do Brasil. Despite recent economic headwinds, Itaú is now planning to expand into high growth countries in Latin America.

As previously noted, Itaú in Brazil has shunned many high-risk loans (at the expense of growth) but its conservatism has paid off in positive earnings growth (see chart A).

Chart A: Itaú Delivers Shareholder Value

 

Source: Y Charts

Itaú this summer had revised its expansion expectations to no more than 11 percent in its credit portfolios in 2013, down from 14 percent expected previously. “Our previous guidance was based on an expected economic expansion of 3.5 percent for this year, but now our forecast for Brazilian economic growth is just 2.3 percent, so we were obliged to reduce our credit expansion view,” said Mr. Rogerio Calderon, the bank’s comptroller.

Moreover, the bank has been pursuing diversification by expanding its credit card services, retail and investment banking businesses throughout the region. In a conference call with reporters last spring, Calderon said Itaú was interested in expanding both its retail and its investment banking operations in the sprawling region.

“When it comes to the retail area, we see expansion opportunities in Latin America, mainly in countries where we already have a presence,” Calderon said, citing Argentina, Chile, Paraguay and Uruguay. “We are looking to expand in these countries, via organic growth or through acquisitions.”

In the case of Peru and Mexico, Calderon said Itaú was interested in expanding through both its retail and its investment divisions. He said expansion into investment banking in Peru and Mexico could follow the existing model created by Itaú’s investment bank, Itaú BBA, in Colombia.

“We formed a strong investment banking unit in Colombia via Itaú BBA,” he said. “Peru and Mexico are on our radar too.” In June 2013, the bank agreed to buy Citibank’s retail banking operations in Uruguay. Itaú also took over Citigroup’s Credicard unit, an R$8 billion asset business that includes the Credicard brand and credit cards as well as 96 consumer finance outlets. The bank, at he time, also bought 51 percent of the credit card operations of Cencosud in Chile and Argentina, for example.

Despite double-digit growth in the number of credit cards in circulation in Brazil in recent years, there is still room for increased penetration both in that country and throughout Latin America (see chart B).

Chart B: Itaú Forecasts Considerable Growth in Credit Cards in Latin America

Source: Itaú

Compared to developed nations like the US, the region is still in the very early chapters of its growth story. According to one report, “As a percentage of personal consumption expenditure (PCE), Brazilian card payments in 2011 were only 26.7 percent, or about the same percent the United States had back in 1998. In 2011, the US came in at 48.1 percent of PCE. In 2010, the number of transactions per card in Brazil were just 11.2 compared to the United States’ 58.6 transactions per card. Needless to say, Brazil still has a long way to go to reach the level of US credit card use.”

A Look at the Numbers

On August 1, Itaú reported second-quarter 2013 recurring earnings of R$3.6 billion ($1.74 billion), up 2.9 percent sequentially. Including non-recurring items, Itaú’s second-quarter 2013 net income came in at R$3.58 billion ($1.73 billion), marginally higher than the prior-quarter earnings of R$3.47 billion ($1.73 billion).

The sequential increase was primarily attributed to stable expenses for allowance of loan and lease losses and increased managerial financial margin with clients, along with higher banking service fees and income from banking charges. However, many analysts have noted decreased financial margin and elevated non-interest expenses as current headwinds.

But those same analysts have pointed to Itaú’s diversified product mix, increasing operating revenues and expanded credit portfolio as reasons to be optimistic about the firm’s prospects. Furthermore, Itaú’s improving asset quality remains an outstanding positive for the firm.

Year to date, Itaú’s total return (capital gain plus dividends reinvested) has been 21.27 percent, versus 25.06 for the S&P 500. Banking peers Banco Bradesco (NYSE: BBD) and Banco Santander Brasil (NYSE: BSBR) have posted YTD returns of only 8.84 percent and 3.39 percent, respectively.

Itaú Unibanco Holding SA is a buy up to 17.