SLCJF - SLC Agricola: A Solid Investment In Brazil's Agribusiness For The Long Term

2023-12-17 12:56:43 ET

Summary

• SLC Agrícola is a major player in Brazilian agribusiness, focusing primarily on soybeans, corn, and cotton, with strategic use of self-owned and leased lands.
• The company utilizes joint ventures, leases lands, and operates SLC LandCo for real estate, showcasing adaptability and operational scalability.
• Despite challenges in 2023, SLC Agrícola exhibits robust financials, boasting strong revenue growth, efficient cost management, and a solid financial position with low debt.
• The outlook for Brazilian agribusiness in 2024 remains favorable, although concerns persist regarding logistics and climatic conditions.
• With a diversified portfolio, competitive advantages, and a discounted valuation, SLC Agrícola presents an attractive long-term investment, despite short-term challenges and uncertainties.

SLC Agrícola ( OTCPK:SLCJY ) ( OTCPK:SLCJF ) stands out as one of Brazil's major agribusiness firms, primarily focusing on cultivating soybeans, corn, and cotton, with additional involvement in raising cattle on a smaller scale.

The company efficiently utilizes its self-owned and leased land, employing joint ventures with other companies to enhance its operational scalability. Furthermore, SLC Agrícola operates a subsidiary, SLC LandCo, as its real estate arm, dedicated to land acquisition and sales. The company's operational footprint spans seven Brazilian Cerrado region states.

In 2023, the performance of SLC Agricola's shares was predominantly influenced by the impact of the El Niño weather phenomenon. This resulted in the devaluation of commodities, coupled with high production levels of soybeans and corn, exerting pressure on prices and costs without alleviating the company's margins.

However, the outlook for Brazilian agribusiness in 2024 remains favorable, propelled by the nation's prominent standing in the global sector, even with lower average prices for soy and corn. There is potential for a more positive outlook for cotton. Despite generally positive margins, concerns persist regarding logistics and climatic conditions.

Notwithstanding short-term challenges, investing in SLC Agrícola is an attractive option for the long haul. The company boasts a robust financial position characterized by low debt and leverage. Its competitive advantages, including scale and diversification across geography and products, position SLC Agrícola as one of Brazil's largest and most versatile entities in the agribusiness sector.

Company's Business Model

In Brazil, agribusiness constitutes over 24% of the GDP, firmly establishing itself as a critical sector in the Brazilian economy. The nation's abundant productive land and favorable climate further solidify Brazil's prominent global position in producing and selling agricultural commodities, mainly soybeans and corn.

SLC Agrícola is one of Brazil's largest agricultural producers, boasting significant land cultivation for cotton, soybeans, and corn and holding a prominent position as a substantial landowner. Additionally, SLC operates a dedicated segment that produces and sells soybean and corn seeds through SLC Sementes. The company manages a portfolio of 23 farms spread across 7 Brazilian states, utilizing a combination of leased, owned, and partnership lands, totaling 589.6 thousand hectares under its control.

SLC Agrícola has progressively transitioned its business model to more asset-light in the past decade. While initially relying solely on its land, the company now follows a model of approximately 50% owned land and 50% leased. This strategic shift has facilitated easier expansion, enabling the company to achieve a grander scale and efficiency.

One of SLC Agrícola's notable competitive advantages is its distinctive approach to exchange rate hedging, setting it apart from many agribusiness players in Brazil. Unlike its counterparts, the company engages in exchange rate hedging practices, using financial instruments to shield itself from currency fluctuations. This strategic choice aims to maintain flexibility and adaptability in response to market dynamics while leveraging the predictability of commodity prices through financial instruments.

Additionally, SLC Agrícola boasts a substantial storage capacity for its production, encompassing 1 million tons of grain and 190,000 tons of cotton. This significant storage capability enables the company to transport its products to markets utilizing a mix of road, rail, and river transportation. Beyond mere logistical efficiency, this extensive storage capacity empowers the company to time the sale of its harvested goods strategically. By choosing optimal moments within the market cycle, SLC Agrícola maximizes the value of its produce and enhances overall operational efficiency.

With a geographically diversified portfolio that mitigates exposure to climatic risks, SLC holds a significant position in the agricultural sector. The company's involvement in multiple crops diversifies its activities and allows for utilizing its land throughout various harvest and off-season cycles, resulting in increased productivity for SLC.

Brazil's Agribusiness Perspective for 2024

Anticipated trends for 2024, as outlined by the World Agricultural Supply and Demand Estimates (WASDE), suggest a landscape characterized by cheaper inputs, increased pressure on soybean and corn prices (potentially favoring the protein segment), and promising returns for sugar, coffee, and orange producers.

In Brazil, while the overall outlook for agriculture appears positive, 2024 may demand continued vigilance and effective financial management, especially considering lingering climate uncertainties linked to the El Niño phenomenon and prevalent logistical challenges. Despite declining agrochemical prices, the lower prices for soybeans and corn may lead to compressed profit margins in producing these grains.

Following price fluctuations driven by the pandemic's impact on agrochemicals and the Russian invasion of Ukraine affecting fertilizers, input prices in the Brazilian market started to decrease in the second half of the previous year. Consequently, the cost of production in agriculture during the 2022/23 harvest decreased, and these lower levels are expected to persist into the following year.

SLC Agrícola, for instance, is forecasting for the 2023/2024 harvest a 10% reduction in the average total cost, primarily pushed by cotton and corn.

For soybeans, the flagship crop of Brazilian agriculture, 2023 witnessed record harvests and falling prices. This situation disrupted marketing and exacerbated logistical bottlenecks, impacting the marketing of the corn crop and leading to conflicts over storage space in warehouses and ports, including those handling sugar.

With a robust harvest in the United States and expectations of another record harvest in Brazil, the global soybean supply is projected to reach 400 million tons in the 2023/24 season. However, there is anticipated pressure on prices due to relatively stable demand.

Regarding corn, attention in Brazil is focused on the off-season crop, with potential delays in sowing if the soybean harvest extends due to adverse weather conditions during planting. Lower prices, less lucrative than those for soybeans, have dampened producers' enthusiasm. According to Rabobank, feed and ethanol production demand is expected to rise, offering potential support to domestic prices. In contrast, international prices may face pressure from ample global supply, particularly with stocks rebuilding in the United States.

Overall, global final stocks of corn are projected to be higher in the 2023/2024 harvest, primarily driven by increased supplies in the United States, partially offset by reduced stocks in Brazil and China.

SLC Agrícola's Financial Overview

In the first place, SLC's revenues have exhibited year-over-year solid growth, reaching R$5.3 billion in the first nine months of 2023.

What stands out in this analysis is that despite the decline in commodity prices, particularly for soybeans, cotton, and corn—critical contributors to the company's overall performance—SLC has consistently demonstrated robust financial results throughout 2023.

In recent years, the company has experienced significant growth in net profit and Adjusted EBITDA, particularly from 2021 onward. This surge can be attributed to China's unprecedented demand for corn during this period, with imports skyrocketing from 8 million tons in 2019/2020 to an impressive 30 million tons.

In the last twelve months, SLC reported an EBITDA margin of 37% and a net margin of 17%. Although slightly down in 2021, the net margin remains robust, showcasing the company's overall financial resilience.

It's important to highlight that the robust margins in 2021 were also influenced by favorable interest rates in Brazil, hovering around 2%, in contrast to the peak of 13.25% observed throughout 2023. Notably, only since the second half of 2023 have interest rates begun to decline, a trend expected to enhance the company's margins progressively. SLC Agrícola maintains a relatively low and well-controlled debt ratio at 1.3x Net Debt/EBITDA.

Additionally, it's worth noting that long-term debt bears a significant cost, primarily tied to the Brazilian interest rate ('CDI') plus a pre-fixed component, resulting in a debt cost of 14.6% per year.

However, with the anticipated decline in the interest rate trend in Brazil, projecting a rate of 9% to 9.25% for 2024, there is an expectation for the cost of debt to decrease concurrently. This, in turn, should contribute to an overall improvement in the net result for the company.

Furthermore, SLC Agrícola has consistently delivered attractive dividends in recent years, boasting an average yield of 4.5% and maintaining a payout ratio of a moderate 50%. The outlook suggests that this ratio will be sustained in the coming years, signaling the company's commitment to continue providing value to its shareholders through dividends and buybacks.

For instance, in 2023 alone, SLC Agrícola repurchased 2.2% of the company's total capital, demonstrating its dedication to returning value to shareholders through strategic buyback initiatives.

3Q23 Financial Results

Despite a slight decrease in performance for most crops in the first nine months of 2023 compared to the same period in 2022, SLC Agrícola demonstrated a solid third quarter.

The company reported a volume of 670kt of corn, reflecting an 18.1% year-over-year increase, 59kt of soybeans with a year-over-year decrease of 26.8%, and 56kt of cotton, showing a year-over-year increase of 54.7%. Corn was the exception, experiencing a positive trend in the nine-month comparison.

While prices displayed varying dynamics, being positive for corn and cotton and negative for soybeans, SLC Agrícola opted for a limited hedging strategy for its cotton production, with only 13.5% hedged for the 23/24 harvest. This decision aligns with the company's anticipation of a rise in cotton prices, driven by more robust demand for clothing in the US as the economy remains resilient in services and discretionary goods, encouraging the consumption of cotton clothing.

To enhance returns, SLC Agrícola is directing a portion of its corn production towards cotton, leading to a 16% annual increase in the planted area for cotton and a corresponding 25% decrease for corn in the expected 23/24 harvest.

Despite lower cotton lint invoiced, SLC reported a robust 21.8% year-over-year increase in net revenue to R$1.3 billion, benefiting from both price and volume. On the cost side, the unit cost showed a consolidated growth of 23.8% year-over-year, driven by higher costs in cotton and soybeans, offset by a retreat in corn costs. The rise is attributed to factors such as lower productivity in cotton, increased spending on inputs indexed to the dollar (seeds, fertilizers, and pesticides), and the USD/BRL exchange rate nearing R$5 per dollar.

Positive aspects include SLC's reported Adjusted EBITDA of R$492 million, a 25.5% year-over-year increase, influenced by improved results for corn and cotton crops. The company also reported a net profit of R$167 million, a significant improvement from the R$78 million loss in the same period last year, aided by hedging results of R$198 million.

Regarding cash flow, the third quarter of 2023 saw positive generation at R$580 million, a 70.4% year-over-year increase, primarily driven by higher operating cash generation, including a release of working capital amounting to R$208 million. However, when assessing the first nine months of 2023, the cash flow is negative at R$248 million, influenced by lower operating results, increased investments, and a cash burn of R$386 million in the second quarter of 2023.

Risks To Consider

The primary risk to SLC Agrícola's performance is climate related.

Fluctuations in weather conditions within plantation areas can adversely impact the company's results. However, SLC Agrícola has strategically positioned its operations nationwide and diversified its product portfolio to include soybeans, corn, cotton, and other products. The company maintains a presence in 7 Brazilian states, which serves as a risk mitigation strategy.

Notably, the year 2023 has been characterized by the El Niño phenomenon, leading to anomalies in rainfall. Consequently, the company adjusted its total planted area projection for the 2023/24 harvest, reducing it by 3.3%, as disclosed in a material fact. This proactive measure reflects SLC Agrícola's commitment to managing and mitigating climate-related risks.

Additional noteworthy risk factors for the thesis include potential crop failures, which could adversely affect the company's business. Furthermore, the lack of investment in logistics in Brazil poses a challenge, impacting SLC's distribution capacity and potentially diminishing the competitiveness of its products.

Valuation and Concluding Remarks

SLC Agrícola stands out as a company that creates value by aligning its growth with the expansion of Brazilian agribusiness and consistently returning value to shareholders through dividends and buybacks.

As per SLC Agrícola's recent results, both crops remain challenging, particularly with a negative basis at the soybean port. This is due to the delivery price being lower than the commodity price quoted on the stock exchange, a trend attributed to logistical bottlenecks. Despite this, there are signs of resilience in demand as many producers, having held back supply, are now dispatching shipments.

Looking ahead to 2024, the forecast for corn and soybeans is not overly encouraging due to predicted oversupply, leading to more pessimistic assumptions. However, amid these challenges, possibly already factored into the company's valuation, SLC's shares have experienced a substantial decline. The company is trading at a 24E EV/EBITDA of 5.8x compared to a historical average of 8.5x, suggesting a reasonable discount.

While recognizing ongoing pressure on prices into 2024, the recent significant recovery in soybean prices over the last month provides some optimism. Nevertheless, uncertainties persist regarding pricing and the resolution of logistical bottlenecks.

In conclusion, despite the likelihood of continued price pressure into 2024, albeit mitigated by the effects of El Niño causing fewer issues, I view SLC Agrícola as an excellent long-term investment, potentially trading at a discounted valuation.

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