While the quarter disappointed somewhat from a profitability standpoint, the company has demonstrated ample resilience in light of slowing global conditions and volatile FX movements. Further, the company has room for improvement, given its upward revision of potential synergies, and near-term benefits from the consolidation of Sadia and Perdigao brands onto one IT platform. The company also faces a seasonally strong quarter in 4Q11, which should help cash generation.
The near future requires considerable adroitness by management as the company executes CADE-mandated divestments, and builds out its international presence. However, the company’ brand value, still-considerable market-share in Brazil, and emphasis on further growing its processed food offerings all continue to support the company.
Bonds have proved resilient in the market sell-off, and are currently trading in line with their long-term average spread to US BBB and BB peers. While not highly discounted, bonds still offer value as a core holding in a defensive sector, with demonstrated resilience in a sell-off, significant cross-over investor interest, and some upside potential from a possible medium term upgrade. Any negative price action on the back of earnings or the divestiture program could provide better entry points for which we would recommend adding to positions.
Highlights from Brasil Foods 3Q11:
• Revenues increased 10.3% y/y and were flat q/q.
o The domestic market remained the driver, growing 13.7% y/y and 3.4% q/q. Strength in the domestic market came largely from dynamic pricing increases in meats and processed meats.
o The export market presented more challenging conditions, as sales grew 6% y/y but fell 4.9% q/q. Pricing rose considerably y/y for meats and processed meats, but lower volumes affected overall revenues as the Russian trade embargo on Brazilian meat exports affected the whole quarter. Unfavorable FX also affected the company’ competitiveness for most of the quarter.
• The company reported improving gross margins as it reduced production costs and captured synergies from the merger, despite higher grain costs. Operating expenses increased 10.3% from rising fixed commercial expenses and administrative expenses – which were comprised of the implementation of IT systems and charges for consultancies advising on the merger.
• EBITDA was 17.1% higher y/y, but 8.1% lower q/q. Lower quarterly EBITDA was attributed to FX volatility in the quarter, pressure from grain costs, and shipment delays from the main ports due to flooding.
• The company ramped up investment ahead of the seasonally-strong 4th quarter: Capex was elevated as the company spent more on hog breeder stock (which was also a function of higher prices), but the company also ramped up working capital expenses, increasing its grain position.
• The company continues to work on its internationalization strategy by investing in local production abroad to bring more value-added products to new regions and increase its international footprint. It continues to invest in its a processed products plant in the Middle East (requiring approximately US$120mn investment) and the company acquired a two-thirds stake in a distribution network for dry and refrigerated products and a chicken producer in Argentina for approximately US$100mn (including US$22mn in debt).
• In BRL terms, gross debt increased from FX changes q/q, and cash fell as the company used its cash position in increased investment (both capex and working capital) and a dividend payment. However, given the y/y increase in EBITDA, leverage metrics were not much changed on the quarter: Gross leverage increased to 2.5x (from 2.4x last quarter) and net leverage increased to 1.4x (from 1.2x last quarter).
• The company revised up its estimates of net synergies from the merger of BRL560mn in 2011, and BRL1bn per year in 2012 and 2013, and stable at these levels going forward. According to management, realizing these synergies would take approximately BRL700mn of investment during 2011-2013