The Long and Short

BRF has potential to outperform

| August 18, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

In the face of persistently challenging chicken pricing, BRF, a leading global food company headquartered in Brazil, should benefit from lower grain costs in the second half of the year. Corn prices have plummeted by over 35% year-to-date with soybean prices down 20%. These reductions in key input costs, accounting for approximately 50% of BRF’s operational expenses, should pave the way for enhanced profit margins.

Despite lower input prices, BRF continues to grapple with weakened pricing strength in its end products. Notably, there has been a nearly 20% dip in chicken prices in the domestic market, accompanied by a greater than 10% decline in the Brazilian real (BRL). Moreover, the decline in export prices by around 10% further exacerbates the margin squeeze faced by the company.

This combination of factors could impact BRF’s full-year EBITDA, potentially settling around the R$4 billion mark, a slight dip from previous consensus estimates. Despite this, the company’s resilience is evident in its recently announced second quarter results, which displayed sequential improvement.

During the second quarter, BRF’s initiatives to protect profit margins aligned with more favorable global operating conditions. The outcome was a substantial surge in EBITDA margin, reaching 8.2%. This figure stands in stark contrast to the 4.6% recorded in the first quarter of 2023 and the 6.9% from the corresponding period the previous year.

In terms of financial performance, the company reported adjusted EBITDA of R$1 billion for the quarter, contributing to an overall improvement in cash generation. However, the gains were partially offset by capital expenditures and interest expenses, which totaled R$1.6 billion. Consequently, the working capital cash generation fell short of offsetting a consolidated cash burn, amounting to roughly R$1.7 billion for the first half of 2023.

As for leverage, BRF reported an increase of approximately 0.4x its EBITDA during the quarter, bringing the net leverage to 3.75x EBITDA by the end of June. This figure represents a rise from 3.35x at the end of the first quarter this year and 2.98x a year ago. However, after incorporating a significant equity injection of R$5.4 billion, the pro-forma net leverage drops substantially to 2.42x EBITDA.

The company’s potential for future liquidity growth is further buoyed by tax credit-driven liquidity and anticipated mergers and acquisitions (M&A) activity. This could position BRF to outperform its peers in terms of credit ratios, offering a positive outlook for its financial health in the upcoming quarters.

Additionally, BRF’s potential mergers and acquisitions in the pet food sector could come to fruition in the second half of 2023. The implementation of a tax credit program also looms on the horizon, possibly being realized by the end of the current year or early 2024. If successful, these efforts could lead to a significant reduction in leverage for the first time in over five years, setting the company apart from peers whose credit metrics are moving in the opposite direction.

In terms of liquidity, BRF boasts a robust balance sheet, with a committed revolver of R$3 billion contributing to a cash reserve of R$8.3 billion. While the credit line faces maturation in the coming year, expectations are that it will be rolled over to ensure sustained flexibility.

Reflecting these developments, BRF’s bond prices have seen a reversal of the underperformance witnessed in recent years. The company’s drive to enhance its metrics has contributed to a narrowing of the spread against benchmark bonds. Additionally, exposure to the US beef market through its strategic counterpart, Marfrig, has lent further support to BRF’s bond prices.

Now, at about 45 bp through the MRFGBZ bonds in the belly, BRF’s expected outperformance in the coming year is being reflected, in part.  Additionally, in the long bond (BRF 2050s), the US beef cycle has driven convergence to the JBS 2052 bond issue and with relatively more difficult comps upcoming for JBS, this spread differential should converge further, made additionally attractive by the 23-point pick in the bonds even given the differing investor bases.

Declan Hanlon
declan.hanlon@santander.us
1 (212) 973-7658

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