This week we look at four year, investment grade bonds denominated in Brazilian real, from one of the largest food conglomerates in the world, Brasil Foods. Discounted to 87% of par, we think this 7.75% couponed debt of Brasil Foods presents an outstanding, and possibly quite timely, opportunity to diversify away from the U.S. dollar and return a high 12¼% yield-to-maturity in the currency of one of the world’s strongest economies. The following review further explains our reasoning and why we have targeted these high quality, Baa3 rated, notes for addition to both of our managed, high yielding, global income portfolios, Fixed-Income2.com and Fixed-Income3.com.
Already the largest and most populous country in South America, in recent years Brazil has taken steps to enhance both its industrial and agricultural growth. Its economy outweighs that of all other South American countries.
GDP growth in Brazil has been similar in recent quarters to that of the United States. Standard & Poor’s rates Brazil’s debt at BBB- (stable). Brazil’s debt-to-GDP ratio was 56.8% at the end of 2013. By comparison, the USA’s debt-to-GDP ratio was 100.1%. Not only is the USA’s debt load as a percentage of GDP significantly higher than Brazil’s, but the USA recently received a downgrade to AA+ from Standard & Poor’s.
Brazil has vast natural resources, a large labor pool, and well-developed agricultural, mining, manufacturing, and service sectors. It is currently the world’s 11th largest oil producer, and the second-largest exporter of iron-ore. In the agricultural sector, Brazil is the world’s largest producer of coffee, sugar, and orange juice, and the second-largest exporter of soybeans.
About Brasil Foods
Brasil Foods (BRF S.A.) was formed in 2009 as a merger of two well-known Brazilian food companies, Perdigão and Sadia. The company produces and sells meats (poultry, hogs and beef cattle), processed meats, dairy products, margarines, pastas and frozen vegetables. It sells these products domestically under household brand names such as Sadia, Perdigão, Batavo, Elegê, and Qualy, among others.
BRF S.A. is one of largest food conglomerates in the world, with consolidated net revenues of R$30.7 billion in the twelve months ending March 2014. Processed food, which typically generates higher and less volatile margins than the protein export business, represented just over 40% of net sales in 2013. The company operates 60 plants and 30 distribution centers, exports to over 120 countries, and is one of the world’s largest protein producers, with a leading position in poultry exports. By itself, the company’s sales account for more than 9% of the total world trade in animal protein.
Exports accounted for 30% of net sales in 2013. In the overseas market, the company operates nine industrial units in Argentina and two in Europe (United Kingdom and the Netherlands), and has nineteen commercial offices doing business in over 120 countries.
Within Brazil, BRF’s well positioned brands improve the company’s margin stability. BRF also has a well-developed logistics and distribution structure to supply and deliver its products across virtually all of Brazil.
Net operating revenue of R$30.5 billion in 2013 increased by 7.0%, over 2012. This increase was achieved thanks to good sales performance in the first half of the year in the domestic market and by revenue recovery in the external market. Exports benefitted from a devaluation of the Real against the US Dollar by 10.4%. Average prices increased by 15.6% in the period compared to 2012, with a 7.4% lower volume. Cost of sales, by comparison, increased by only 4.0%.
Gross profit totaled R$7.6 billion, an increase of 17.3% over 2012, with gross margin of 24.8% against 22.6% in the previous year. Cash flow from operating activities was R$3.3 billion, an increase of 36% over 2012.
On May 15th, Moody’s Investors Service assigned a Baa3 (global scale) foreign currency rating to these notes, adding that “the ratings outlook is stable.” The Baa3 rating reflects the company’s good business profile, solid financial position and leadership in its processed food categories and in global poultry exports. It is also worth noting that the debt ratings for most foreign and emerging market bond issuers are constrained by debt ratings of the country in which it is based and/or has the majority of its operations. It is our belief that if BRF were an American company, this issue would likely achieve an even higher credit rating than is currently assigned to it.
We like companies with a solid domestic base in essential industries
Food is arguably the most essential industry of all. Within Brazil, BRF is one of the most recognized food companies. It owns several strong brands that enjoy widespread public recognition within South America.
We like companies with a growing international presence
BRF sells its products in over 120 countries. This diversification in markets provides the company with increased brand-name recognition, and cushions it from local supply and demand volatility. People have to eat – and as standards of living increase, people consume more animal protein (cattle, pork, and poultry). BRF is already one of the leading suppliers of animal protein around the globe, and figures to grow along with the economies of emerging nations.
We like companies where management moves toward higher-margin businesses
BRF management has stated that it wants to transition the company more toward processed foods than commodity animal protein products. Processed foods provide higher profit margins. As evidenced in last quarter’s improving EBITDA profits, that transition is well on its way.
We like companies with increasing cash flows from operations
From 2012 to 2013, cash flow from operating activities increased by almost 36%, from R$2.4 billion to R$3.3 billion.
The company’s balance sheet showed the value of its cash and marketable securities as R$3.8 billion at the end of the first quarter of 2014. This is approximately R$1 billion more in cash than it needs to pay its debts over the remainder of 2014.
The default risk is Brasil Foods’ ability to perform. Given the company’s established business presence and extensive branding within Brazil, its solid profits, and its position as one of the largest food conglomerates in the world, we view this risk as negligible relative to its highly favorable return potential.
Any change in the value of the Brazilian Real relative to the US dollar could affect the returns of these bonds. On the other hand, in the event of a weakening of the dollar against Real, the returns of this bond are likely to increase substantially. Note in considering this risk that the USA has a much higher debt load relative to GDP than does Brazil, as noted earlier. (100.1% for the USA, 56.8% for Brazil at the end of 2013).
As with most foreign debt issuers, there is a hard to define degree the geopolitical risk. Since we find it hard to understand many of the political changes even in our own country, perhaps the uncertainties of changes on a foreign soil become less formidable. With that said, it is our opinion that diversification into other forms often serves to reduce risk. Our strategy here, as with other Yankee bonds, is to focus on unique or required services that can be seen as a adding key economic value to the society it’s associated with. BRF’s food production is a basic need for any society, and it is regarded as one of the best operators in its homeland.
We believe that these Brazilian real linked bonds have similar risks and maturities to other Brazilian bonds we have previously reviewed, such as the 10.6% AmBev 2017 bonds, the 8.5% Morgan Stanley 2017 bonds, or the 9.94% Coelba 2016 bonds. These reviews can be read on our Bond-Yields.com blog.
Considering Brazil’s prominent position as a leading emerging market economy, and BRF’s position as a leading food supplier both domestically and internationally, we view this bond as an opportunity to gain a substantially greater yield than comparable US dollar-denominated bonds.
Brasil Foods is a big company, one of the world’s largest food conglomerates. It has improving revenues, EBITDA, and cash flow. It has cash on hand equal to over R$1 billion more than their debt for the remainder of the year. Management targets EBITDA growth at 12% (good for a food company), with a goal to increase margins as they move to a higher percentage of processed, branded food offerings.
This bond is rated investment grade, and is one of the higher rated debt issues for a company based in Brazil. Furthermore, sound diversification away from an overweighting in US dollar denominated assets can actually lower overall risk. Add to this the cash flow from a 12¼% yield to maturity on a bond that matures just 48 months from now, and you have a compelling argument for their attractiveness. Consequently, we have chosen this bond for inclusion in our FX2 and FX3 global portfolios.
Issuer: Brazil Foods
Rating: Baa3 (Moody’s)
Rank: Senior Unsecured
Yield to Maturity: ~12.25%
Disclosure: Durig Capital and certain clients may have positions in Brasil Foods 2018 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisers that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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