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Writing about BRF S.A. (NYSE:BRFS), a year ago, I talked about the opportunities for the management of this leading Brazilian food producer to drive meaningful operational improvements, as well as the risks that costs and export prices may not go in their favor. As it turned out, management executed well on costs and operational improvements and benefited from input cost tailwinds as the year, sending the ADRs up around 140% since that last article.
I was impressed by the pace of the improvements that management were able to realize in 2023, and grain costs are looking fairly benign so far in 2024. A key question, though, is whether management can build on the progress achieved in 2023 and once again make mid-teens EBITDA margins a credible goal. Likewise, it remains to be seen whether BRF will stay independent if this performance improvement trajectory continues.
Mid-teens EBITDA margins in 2028 could support a fair value well into the $4’s today, if not higher (as I’m sure the Street would award a higher multiple), but there’s still work to do before that becomes a credible default assumption. I still see upside in this turnaround story, but solid margins and cash flow in the upcoming Q1 ’24 quarter will be important drivers for the shares.
Price/Cost Behavior Seems Benign For Now
There is still a very credible risk that global oversupply in commodity chicken will pressure prices as 2024 moves on (particularly in markets like China and Japan), but recent trends haven’t been too bad. Recent data from Brazil’s SECEX shows ongoing year-over-year declines in export prices for chicken coming out of Brazil (down 4% in March), but there was some modest sequential improvement and it looks like prices are once again bumping along near the low end of the long-term range (suggesting not a lot of room for prices to fall further before producers cut back on production).
While metrics like SECEX can provide some indication of what BRF is seeing in its International export business, it’s well worth remembering that the company benefits from operating in several markets and can prioritize shipments to more attractive markets – prices and demand in the Mideast have been comparatively healthier and I expect BRF can benefit from its strong presence in these markets. I’d also note that China recently did away with its import tariffs on chicken imports from Brazil, and that could be an incremental positive for BRF’s business in the coming months.
Domestic prices likewise offer a mix of news. Unprocessed (“natura”) chicken prices have been basically stable between Q1 ’24 and Q4 ’23 looking at CEPEA data, while processed food prices have declined modestly ((margarine continues to be a weaker category).
On the other side of the equation, feed costs should continue to be a net positive. Corn prices have ticked up modestly in the last quarter within Brazil (up about 6%), but are still down more than 20% from a year ago, while soybean prices are down about 15% and 25% over those periods. Please note that BRF’s actual input costs will not match this – the company can and does hedge, and recent prices in Brazil are not necessarily representative of what the company is experiencing. Still, as a “directional indicator,” I think it’s fair to say that feed costs are benign, though other cost items like labor and freight remain a risk in 2024 and are definitely something to monitor in the upcoming results and commentary.
Self-Help – More Of That, Please
While I liked the “BRF+” plan that management laid out more than a year ago now, I did have my concerns as to whether they would be able to execute on those plans – BRF has been a perpetual restructuring story for a long, long time now, and some of the cost/efficiency centers management was targeting have proven stubbornly resilient.
As it turns out, management did quite well and executed ahead of what analysts expected a year ago. The efficiency program saw gains of R$2.2B for the year (R$525M in the last quarter), with about 90% of that already working its way into the income statement.
These improvements have run the gamut, with the company seeing improved feed conversion (up 2.5% in the fourth quarter), meat yields (chicken up 0.6% in Q4, with pork up 5%), and improved mortality. The company also showed real progress on plant efficiency and logistical efficiency. Last and by no means least, the company’s retail efforts are paying off as well, with BRF seeing improvements in shelf space allocation and compliance with suggested prices.
Given that BRF was only targeting 2019 KPIs with the initial plan, I think there’s still more that can be done. Whether management lays out new targets and/or an expanded efficiency program for 2024 and beyond is definitely something to listen for in the upcoming Q1’24 conference call.
Competition Remains A Concern, But The Brands Are Sound
One of the ongoing risks to the BRF story is the company’s competitive position in its lucrative processed foods operations. As processed foods offer better margins and tend to be more stable businesses than commodity protein, this has long been a cornerstone of bull theses for the shares.
In Brazil there is no question that JBS S.A. (OTCQX:JBSAY) has gotten more aggressive with its Seara brand, not only significantly increasing capacity/production, but also ramping up its marketing and price competition with BRF and its Sadia and Perdigao brands.
Management has acknowledged the strength of this competitive push, but branded share has held up well (around 40% overall) and I’d note that JBS has posted some below-expectations quarters for its Seara business lately, including a 6% revenue decline and a 6.4% EBITDA margin in the last quarter. You can’t directly compare that to BRF’s 15.6% margin for the comparable period, but I believe BRF’s processed margins are holding up well and I think JBS may be under more pressure to ease up on its price competition.
Outside of Brazil, the company has continued to build share in key markets like Turkey and the Gulf states, where it holds over 20% and 40% share in processed foods, respectively. BRF has continued to build out these business, benefiting from in-country production, including an important JV with Saudi Arabia’s Public Investment Fund, as Saudi Arabia looks to favor and improve domestic production to improve food security.
The Outlook
One of the biggest ongoing questions I have about BRF is whether investors will see the full benefit of this self-improvement program. Management’s execution in 2023 suggests there’s less risk of the company failing to reach its targets, but outperformance carries its own risks – namely whether the company will remain independent.
Marfrig Global Foods S.A. (OTCPK:MRRTY) has increased its ownership of BRF to over 50%, and I do see a risk that the company may move to take full control at a price that could ultimately deprive investors of the longer-term upside to a better-run BRF. Whether Marfrig can do such a deal (considering both the debt it would require and antitrust concerns in Brazil) is very much an open question, and I would hope that the presence of SALIC as a significant owner (10%+ ownership) would ensure a fairer price were there to be a formal takeover.
I’m looking for around 5% revenue growth in FY’24 and I think mid-single-digit revenue growth is a credible target over the long term, as the company still has ample room to benefit from increased consumption of processed foods in Brazil and key export markets, not to mention the potential to add other markets over time.
Input costs will do what they will do; projecting commodity costs is notoriously challenging, but I do think BRF has made sustainable process efficiency improvements that will provide a lasting boost to margins. I’m looking for a 12% EBITDA margin in FY’24, but I can see upside to 12.5%. How much this can improve over the next three to five years is a key unknown. A 15% EBITDA margin is possible, but I’m not modeling that today and instead expect gradual improvement into the 13%’s as some of the feed cost tailwinds abate.
At the bottom line, I’m expecting adjusted free cash flow margins in the 3% range over the next few years, and that should help the company further improve its net debt situation (there was significant improvement here in 2023, helped by a large and dilutive equity offering). Longer term, I do think a mid-single-digit FCF margin is attainable.
As far as valuation goes, I think $3.50 to $3.90 is a reasonable near-term range (FCF modeling gets me to the low end of that; a 6.25x multiple on my ’24 EBITDA estimate gets me to the high end). If 15% EBITDA margin is doable in 2028, I can get well into the $4-$5 range on EBITDA, but that’s still to be determined.
The Bottom Line
It’s tempting to advise investors to not get greedy and to take their gains (if they have them) in these shares. After all, this is still a commodity-driven business operating in a world of volatile grain prices and potential oversupply of chicken into the export market. Likewise, this is a company where sustainable progress has been very difficult to achieve.
I have no issues with investors who want to call it a day, but I will note that successful turnarounds frequently exceed initial expectations and BRF S.A.’s turnaround story may have yet to run. A lot rides on the next few quarterly reports, but this is still a decent opportunity to consider.
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