* Spanish firm's bond collapse highlights Brazil risk
* Hedge funds look for short opportunities
* Petrobras exposure in the spotlight
By Robert Smith
LONDON, Sept 17 (IFR) - Brazil's deteriorating economy is not an obvious threat to European corporate debt investors, but the crash in Abengoa's bonds has provided a stark reminder of the risks emerging markets exposure can pose.
When the Spanish company shocked bondholders by slashing free cashflow guidance in half at the end of July, it primarily blamed the "one-off impact from projects in Brazil".
The clean energy firm denied it would need additional capital to plug the hole, but just days later announced plans to raise 650m. It is yet to announce any underwriters for the cash call and most of its bonds are still trading at less than half their face value.
Last week it was the turn of US dollar bond investors to reassess their exposure to Brazil after Standard & Poor's stripped the Latin American country of its investment grade rating, prompting bonds, particularly from the banks such as Banco do Brasil and Itau, to tank.
Several investors said they are now examining other European companies with Brazilian operations for potential short-selling opportunities.
"There's not a huge amount of exposure in Europe overall but there's definitely some companies that made big bets on Brazil," said a credit analyst at a hedge fund. "For those companies, the Brazilian Real's performance has been disastrous."
Brazil's currency has declined more than 30% versus the euro from its peak earlier this year, straining the balance sheets of companies that report in euros but have large Brazilian operations.
The analyst said his fund had recently taken profits on a short position on the debt of French supermarket group Casino and its controlling shareholder Rallye, but had not closed the position entirely.
Brazil accounts for around 40% of Casino's group sales and 60% of operating profit, with the group booking 39m of restructuring provisions and expenses in Brazil in the first half of the year.
Price action on Rallye's CDS has been savage, with the cost of five-year protection nearly tripling from 231bp on July 20 to 658bp on September 15.
European high-yield bond managers are also increasingly wary about exposure to Petrobras, which is at the centre of the country's "carwash" corruption scandal but also got caught up in S&P's sovereign downgrade and was cut two notches from BBB- to BB.
The Brazilian oil giant has 6.9bn of euro bonds outstanding, alongside £1.75bn of sterling, and its downgrade last week will push them into some high-yield bond indices.
Bank of America Merrill Lynch chose to keep emerging market corporates in its euro high-yield index in July, but also created new high-yield indices comprising only developed-market names.
"A lot of managers will consider changing their benchmarks, as their clients do not want exposure to emerging market bonds through their European high-yield portfolios," said Peter Aspbury, a portfolio manager at JP Morgan Asset Management.
But even those who switched to the new benchmarks may not be completely free of Petrobras exposure.
Vallourec produces steel tubes primarily for the oil and gas industry, with Petrobras one of its largest clients, and met bond investors for a credit update this week
The French company has had a punishing year so far. Ebitda in the first half fell 85% year-on-year to just 66m, while its free cashflow slumped from 37m to just 3m.
Vallourec has lost its investment grade rating in the process. Having begun the year at BBB from S&P it is now pegged at BB+. Bondholders have booked heavy paper losses, with a 500m 2.25% 10-year note issued a year ago now bid at 69.70 to yield 6.90%.
The credit analyst noted that Galp Energia is a minority partner in large Brazilian oil fields controlled by Petrobras, which are expected to contribute the majority of the Portuguese energy firm's Ebitda by 2018.
"Galp don't have a lot of leverage and are reasonably conservative, but still that's a lot of exposure to Brazil," he said.
In contrast to companies like Vallourec, the unrated company's bonds have held up well in recent weeks, with both of its euro deals trading above par, according to Tradeweb prices.
But as the example of Abengoa shows, price action can be swift and brutal if companies that bet big on Brazil get it wrong. (Reporting by Robert Smith, editing by Alex Chambers and Julian Baker.)