JBS: Valuation Gap Closing After Good Q1, Still A Buy, With More Caution

seekingalpha05-23

JBS's 1Q24 results showed a margin recovery and strong performance across most segments, except for US Beef.The company's net debt-to-EBITDA ratio is expected to be below 3x by the end of the year, ...

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Adam Gault/OJO Images via Getty Images JBS S.A. (OTCQX:JBSAY) is one of the world's leading meatpackers, with enormous global operations in beef, pork, poultry, and value-added products. I started covering JBSAY in January 2024 with a Buy rating. The rating was based on comparing the company's valuation to its cycle-average earnings capacity. After a challenging cyclical period, the stock sold off to levels below a reasonable valuation for cycle-average profitability. I maintained the rating after 4Q23 earnings based on the recovery shown in most segments. In this article, I review the company's 1Q24 results and earnings call. The results aligned with expectations, showing no significant changes in profitability across segments from 4Q23. The first quarter was also seasonally low in terms of sales, margins, and cash flow generation. However, the market really liked the result because the stock jumped almost 20% since the release. Because of the recent stock appreciation, I revisited the valuation and rating. Although the gap to fair value has shrunk, the company still offers an attractive multiple to conservative cycle-average profits. In addition, it provides the potential for speculation on catching the upper portion of the cycle, especially in US Beef. For that reason, I maintain my Buy rating on JBSAY. 1Q24 results JBS' 1Q24 results were aligned with the recent margin recovery from the low points reached in 2023. The TTM margin figure should improve meaningfully in 3Q24, as the low point generated in 3Q23 leaves the statistic. Data by YCharts Seara's big comeback: This recovery was shared among most segments, except US Beef (more on this later). However, the note of the quarter was given by Seara's EBITDA margin improvement of 5 percentage points QoQ. Like in BRF's call (BRFS), JBS' management touted its operational improvements. However, the majority of the improvement (across all segments but especially in Seara) came from decreasing input costs, as explained in the company's MD&A. Strong despite low season: One of the developments that was probably read very positively by the market was that JBS was able to post strong margins across most segments despite Q1 generally being a low-volume quarter. Q1's revenues were 7.3% lower than in 4Q23. In a low-margin, capital-intensive business such as JBS', maintaining margins in the low-volume quarter is positive. The market may have read that margins will improve for the rest of the year, despite management not making such comments during the call. Potential for higher dividends: As the company's net debt to EBITDA ratio is expected to be below 3x by the end of the year, JBS will have more flexibility in increasing dividends. Some analysts asked management if they would instead consider doing more M&A, but management answered that would only happen under opportunistic conditions. Waiting for US Beef: The only segment lagging at this point is US Beef. The beef meatpacking market in the US is undergoing a downward cycle, with a lower supply of live cattle driving input prices up (purple line in the chart below) and demand pressure in cuts driving output prices down (orange line in the chart below). Data by YCharts Management was cautious and mentioned some signs of an improvement in the cycle, but it still had a negative outlook. The segment's EBITDA margins have already been below 2% for six quarters. The segment's cycle-average profitability is closer to 5/6%, and previous downward cycles had bottomed in the realm of 2%, so this cycle is particularly unfavorable. An improvement in margins to 4% would add almost $1 billion in EBITDA. Valuation  The valuation needs to be revisited, given that JBS' share price is 20% above my original Buy rating in January and 37% above my second Buy rating from March. As explained in more detail in the March article, I prefer to use a cycle-average profit margin applied to the company's current revenues to determine a conservative estimate of the company's long-term profitability. The company's average operating margin has been 5% since it went public. An upward bias could be considered given that the company has expanded operations in the higher-margin businesses of pork, poultry, and value-added products since. Data by YCharts With revenues of $72 billion, a 5% historical margin leads to operating income of $3.6 billion. Applying a tax rate of 25% leads to cycle-average NOPAT of $2.7 billion. Finally, removing interest expenses of about $1.5 billion and an effective tax rate of 25% from the $3.6 billion in operating income leads to cycle-average net income of $1.57 billion. Compared with a market cap of $12.7 billion and an EV of $29.4 billion, this would result in an EV/NOPAT multiple of 11x and a P/E multiple of 8x. This compares with multiples of 9x and 6.3x, respectively, that the company posted back in March. Data by YCharts I believe a fair multiple for JBS is 10x, based on the company's competitive end-markets, which depress profitability, but also positive characteristics like fixed-rate, long-term debt financing, a history of correct capital allocation, long-term management with a significant stake in the company, and operational excellence across several businesses. Therefore, I maintain my Buy rating for JBS, with a more cautious tone than in March, given that the fair value gap has shrunk. I recently covered BRF, a comparable Brazilian meatpacker giant. Using the same cycle-average valuation, I arrived at EV/average-NOPAT multiples of 20x and P/average-E multiples of 15x, well above JBS'. These are multiples twice as high for a company that has consistently lagged JBS in terms of operations and, consequently, stock price over the long term. In addition, I believe JBS offers opportunities in the more speculative realm. For example, the company continues its listing process in the US, which would open the stock for more significant institutional allocation compared to the current ADR. Further, a recovery in the US Beef segment could temporarily boost profit margins above the historical average. I do not sustain my Buy rating on these speculative developments, but they provide additional upside. In terms of downside risk, we should consider the possibility that some of the individual segments' cycles worsen. For example, an increase in the price of corn and soybean is not accompanied by a rise in beef, pork meat, or poultry prices. In particular, the US Beef segment operates at breakeven, and a further deterioration of the cycle would make it a loss-generator. Another risk is the potential devaluation of the Brazilian real. Because JBS carries its functional currency in Brazilian real, but has most of its debt denominated in dollars, when the BRL depreciates against the USD, it generates an accounting (non-cash) loss from financing in JBS' income statement. Given that JBS is an exporting company and, therefore, has as much access to dollars as to Brazilian reals, the accrual loss is mostly inconsequential. However, it could still spook investors.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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