BRF Is Already Priced For Peak Margins, With Poultry Cycles Peaking

seekingalpha09-04

BRF S.A. posted strong 2Q24 results with full margin recovery due to improved poultry and pork markets, falling grain prices, and BRL depreciation.Despite impressive results, BRFS stock is a Hold due ...

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(NYSE:BRFS) posted impressive 2Q24 results, with a full margin recovery thanks to improving poultry and pork markets, falling grain prices, and the BRL depreciation. These results have not changed my original thesis on the company: that it was cheap considering the current positive cycle, but not so much when considering the cycle-average profitability of the company, especially when adding a history of terrible capital allocation decisions. The boost from poultry and swine markets seems to have tapped, and the future most likely includes either a plateau or a decrease in margins, which are both difficult to predict. BRF's stock price not only does not protect from such a scenario but continues to embed growth that is only possible under positive cycle conditions. For that reason, I continue to believe the stock is a Hold. Record 2Q24 Margin recovery: BRF's EBITDA margins continue to post an impressive recovery of almost ten percentage points YoY. This has helped the company post even more fiercely growing operating income numbers, as revenues leverage through the income statement. Data by YCharts Grain prices falling: The main determinant of BRF's profitability is grain prices, which affect the cost of raising animals for slaughter. BRF is a producer of these animals, and also buys from the market. In this respect, prices are already as low as the average during the 2015-2020 bear market. Prices are expected to remain low, given good expectations of higher harvest (BRF commented on this during the 2Q24 call), but have little space to go down even more. Data by YCharts Price recovery: At the same time, poultry and swine prices globally have continued to increase as the market found itself under supplied after a terrible 2022/23 cycle. When margins are low, producers simply slaughter the hens (similar to destroying the factories), and reduce production capacity. Although the cycles of poultry and swine are faster than those of cows, they still take some time to adjust. Strong Brazilian demand: BRF also benefited from strong demand in Brazil, a market where it generates about 40% of its EBITDA. Brazil's unemployment has been low, salaries have been rising, and the decrease in animal production costs allows processing companies to pass some of the savings to consumers, increasing product demand. BRL depreciation improving BRL statements: Different from peers like JBS (OTCQX:JBSAY), BRF continues to post Brazilian real financial statements. This generates some accounting differences. In this quarter, in particular, the real depreciation meant that at the same dollar-denominated price for international sales, the company would record higher BRL revenues and higher BRL profit margins. Because inventory cycles are not fast enough to reflect the higher BRL grain costs in margins, 2Q24 saw impressive margins in BRL, at 21% EBITDA, improving a whopping 17 percentage points versus last year. The company did not disclose the effect of the BRL depreciation on the margins, but with the currency depreciating 10%, the effect was probably substantial. Data by YCharts Operational improvements: The company also commented that it gained 57 new exporting licenses YTD and that it expects another 40 by the end of FY24. BRF does not disclose what a 'license' means, as it could mean either a whole country, a specific factory to a specific country (therefore, if two factories are allowed to export to Japan, that would count as two licenses), or even one product from one factory to one country. Still, opening more markets gives BRF flexibility to avoid the more over-supplied markets. On the operating side, the company mentioned that YTD, it has generated close to BRL 800 million in operating savings from its BRF 2.0 program. It is not clear where those savings are coming from. BRF is now priced to perfection If we take the company's current revenues ($11 billion YTD) and EBITDA margins (17.5%) we arrive at annualized EBITDA of close to $2 billion. From this, we have to remove CAPEX of BRL 3 billion and interest expenses of BRL 2 billion (or $890 million aggregate at the current exchange rate). To arrive at a pre-tax cash income of $1.1 billion, and after taxes of 15%, net income of $940 million. With a current market cap of $7.7 billion, that implies a P/E ratio of 8x. This is not too high, but barely enough to cover a sufficient 12/15% return with some growth on top. The problem is that the above assumes record profitability margins going forward. The company's margins are all but sure to eventually decrease, as that is the nature of the commodity markets in which the company operates. There are two sources of margin contraction: first, increasing grain prices. Second, if grain prices remain low, chicken, and pork production will grow and outpace demand. This second scenario is the most likely. Animal supply has not yet affected BRF's markets because these animals still have cycles that last at least a year and a half (or three years in the case of pork). As mentioned, farmers need to start keeping more hens and sows alive so that they can then expand chicken and pig production. This is already happening, as disclosed by BRF during the 2Q24 call. Therefore, in my opinion, BRF, as any other commodity company, has to be valued on cycle-average earnings, assuming that eventually margins will decrease. The company's long-term average EBITDA margins are 10.2%, not 17%. Data by YCharts If we use that average, coupled with current revenues (a bullish bias given that margins usually contract because of revenues falling), we arrive at EBITDA of $1.1 billion, barely enough to cover interest and CAPEX of $950 million. Data by YCharts Therefore, on a cycle-average basis, the company could generate about $200 million in cash pre-tax profits. Valued at $7.7 billion, it seems pretty overvalued.  For that reason, I believe BRF continues to be a Hold, despite recent operational improvements. The stock was a great cyclical call, assuming margins would improve from their FY23 lows, but now that speculative thesis is no longer valid.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2464345782"}