BRFS - BRF S.A.: 2023 Improvements

2023-06-02 03:56:30 ET

Summary

• BRF SA shares have declined significantly due to poor performance in the past year.
• Factors driving BRFS's underperformance include Brazil's political risks and higher input costs in 2022.
• Despite concerns, BRF SA has strong growth prospects through global acquisitions and a dominant market position in Brazil.

Overview

Shares of BRF S.A. ( BRFS ), a leading meat company in Brazil, have declined substantially in the past year, mainly because of poor performance in Q4 2022 . However, there may be light at the end of the tunnel, as conditions appear more optimistic following its latest quarterly update.

Shares of BRF SA have outperformed Brazil equities and other agriculture ETFs in the past three months.

However, BRF SA still trades at a 10-year low. Shares have declined over 90% in the past ten years.

What went wrong?

BRF SA has found a new bottom after poor Q4 2022 performance, sending shares down circa 40% since my initial coverage of this stock. Below are some factors that may be driving underperformance.

Brazil Sentiment : A lot of investors are concerned about equities in Brazil and the perceived political risks and have not been impressed by its discount to regional peers. However, this trend may change in the future, as Brazil outperformed emerging market equities in 2022, for the first time since 2019 .

The biggest risk that BRF SA has faced includes higher input costs in 2022, although this is not a new issue for the company. This fact, coupled with its rising leverage, has resulted in lower valuation on a lower price/sales basis.

Brazil ETFs have outperformed BRF SA, although most have declined by over 40% during the past decade.

Company Outlook

This stock provides exposure to domestic growth in Brazil, as well as other international markets like China, MENA, and Turkey to name a few. BRF SA is a diversified exporter, with a roughly equal split of revenue between its domestic and global operations.

Brazil's meat consumption per capita is higher than that of regional peers, including Argentina, Chile and Colombia. Brazil's rising middle class will likely consume more meat this decade, and it can also target favorable export markets like Asia . BRF SA has a very strong market share in Brazil and is a leading exporter in the country.

Concerns over temporary, lower beef demand in markets like China and Brazil have been a concern. However, the main cause of the negative share price performance has been concerns over the company's financials, rather than its growth prospects.

If BRS SA can reduce its leverage and improve its operating cash flow, as it did last quarter, then its valuation may be able to return to the pre-covid highs.

As seen above, one reason for poor performance has not been solely a result of poor industry sentiment. JBS S.A.'s ( OTCQX:JBSAY ) share price has remained relatively flat over the past decade but declined significantly in the past twelve months.

Operations and Sources of Growth

BRF SA already commands a 40-50% market share in many meat categories in Brazil and has been expanding rapidly through global acquisitions. As I mentioned in my last article, BRF SA has been focusing on halal meat production, which could be a significant source of growth moving forward. Introspective Market Research projects that the halal food market will have a CAGR of 9.6% through 2022 . One of the main concerns moving forward is the company's margins, as rising input costs have put pressure on the company in recent quarters.

BRF SA had favorable results in Q1 2023. BRF SA generated positive operating cash flow in Q1 2023. It also grew its revenue from price and volume increases and improved its margins.

The company added over 10,000 new customers in Brazil and increased the number of products sold/customers. It also expanded into other international markets. As of Q1 2023, the company had a 50% market share in GCC and a 23% market share for value-added products in GCC and Turkey. Its success in Turkey was largely driven by its previous acquisition of Banvit , the country's largest poultry producer. According to its recent annual report, the company also gained a 10% market share in the pet food segment. The company is currently the third-largest player in the market now. Mordor Intelligence projects that this market will grow by over 6%/year through 2028. The company recently gained market share for chicken/pork exports in the Americas, Africa, and Asia in the last quarter.

Global Significance of Brazil

Many countries were hit hard by higher commodity prices in 2022. Although there has been a relief in food and natural gas prices, food security may be a stronger global topic moving forward. Countries like Saudi Arabia have been increasingly focusing on agriculture and realized their dependence on companies like BRF SA (which imports 7% of the company's chicken). Saudi Arabia may also invest in shares of BRF SA , as local companies have also invested in companies like Olam Agri Holdings and LT Foods. Saudi's Public Investment Fund also partnered with BRF SA in a $500 million venture to produce chicken for Saudi Arabia.

In 2018, Brazil was the world’s largest beef exporter, accounting for 20% of global exports. The USDA projects that Brazil will account for 23% of the world’s total beef exports by 2028. 62% of the country’s exports go to China, so this will be a major growth source for BRF SA moving forward.

Risks and Final Thoughts

The main risk to consider is the company's relatively higher leverage. BRF SA’s net debt/EBITDA is still over 3x, and the current average debt term is slightly over seven years. This company is a leveraged play, and it may be best to consider other meat exporters if you are looking for safer investments. However, the company has very favorable growth prospects, which will be driven by its strong market share and Brazil and successful global expansion. The company's international expansion will be a key driver of growth moving forward.

It has also maintained a favorable market share in Brazil, with a 30+% market share in key categories.

This stock could be a solid inflation hedge, as most of its growth has been attributable to price increases. While its volume growth in 2022 was only around 2%, its revenue still grew by over 10%. This is one of the most intriguing risk/reward set ups relative to other Brazilian ADRs.

BRF SA has underperformed all of the first 10 ADRs listed here . 2023 looks like a good time to continue accumulating shares.

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