Marfrig's H1: Resilience Amidst Cattle Cycles And Deleveraging Opportunities

seekingalpha2024-10-14

Marfrig's deleveraging process, including plant sales to Minerva, is crucial for unlocking stock value and improving financial stability.Despite unfavorable cattle prices in the U.S., Marfrig benefits...

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Marfrig has sold some of its plants to Minerva (OTCPK:MRVSY) and is going through a deleveraging process, mainly in Uruguay and Brazil. Marfrig is seeking decisions that favor the deal and still faces some regulatory challenges. However, the transaction with Minerva should be completed soon. This will be a fundamental step for Marfrig towards deleveraging and one that, I believe, could unlock more value for the stock in the near future. Additionally, when it comes to the macroeconomic picture, Marfrig is facing an unfavorable cycle in the price of cattle in the U.S., which has negatively impacted its margins during the first half of the year, but on the other hand, it is benefiting from the fall in grain prices, which is resulting in less compressed consolidated margins. Still, if it hadn't been for BRF's (BRFS) operations, in which Marfrig owns 50% of the company's capital, the consolidated results for H1 would have been much worse. With a clear strategy of reducing dependence on Asia and increasing exports to the United States, Marfrig has the opportunity to consolidate itself in the protein market, benefiting from more favorable trade relations in South America. I believe that, to some extent, the outlook for Marfrig, especially in the U.S., indicates that the worst is probably behind us and that the second half of 2024 will bring better numbers for the company. Since my first article covering Marfrig in the middle of last year, the stock has jumped more than 50%, and over the past twelve months, the stock is up nearly 60%, being one of the top gainers in my portfolio. In this article, I'll update the investment thesis, but I already anticipate that I still see good reasons to keep holding this stock for the long term. Data by YCharts Marfrig's H1: Kicking Off with Some Not-so-Good News Recapping Marfrig's first half, the company reported some not-so-great results, although not a big surprise. The first quarter came in rather weak, disappointing in terms of margins, with the restricted supply of cattle in North America (which represents 41% of the company's revenues) putting significant pressure on the operation's costs and, thus, on its profitability and the margins of the company's consolidated results. Net revenue in Q1 2024 stood at R$17 billion, representing a year-over-year increase of 3.8% and with an EBITDA margin of 3.4% (excluding BRF's operations), equivalent to a compression of 2.0 p.p. year-over-year, due to high costs in North America, due to the restricted supply of cattle in the region. On the brighter side, the consolidated EBITDA margin was 8.7%, an increase of 4.1 p.p. year-over-year when including BRF operations. In addition, Marfrig reported a consolidated net profit of R$63 million vs. a loss of R$531 million, excluding BRF. This shows that BRF continues to contribute positively to Marfrig's profitability, while North America has been strongly damaging the consolidated result. Marfrig's Investor Relations In Q2 2024, Mafrig reported slightly more encouraging results, but far from great. In short, sequential results were better, with net revenue of R$19.9 billion (excluding BRF), where despite a 2.3% year-on-year drop, it increased 16.7% compared to Q1. EBITDA margin stood at 3.8%, with a consolidated margin (including BRF) coming in at 9.7%. However, it's worth noting that this sequential acceleration was due to the seasonal effect (barbecue season). This is because the tighter costs in North America, in the face of the negative cattle cycle, likely reached their worst phase in Q2 2024. More specifically, in the North America division, gross profit fell 31.7% year-over-year, reaching a total of US$157.7 million, reflecting an 8.6% increase in COGS, driven by the higher purchase price of slaughter cattle. Marfrig's IR The bright side of this story is that, although Marfrig's first half was severely impacted by the negative cattle cycle in the U.S., driving up costs, a slow and gradual improvement is possible moving forward. However, a reversion to a positive cycle in the U.S. may not be seen until late 2026 or early 2027. Considering that slaughter steer prices rise, Marfrig has to pay more for the cattle it buys to process into beef. When we look at the graph below, it shows cattle prices in the main five producing regions in the U.S. this year; the price jumped from just over $170 to almost $200 halfway through the year. The outlook for the rest of the year is for prices to remain at similar levels in Q3, only to fall back in Q4. For 2025, the outlook is that, at least in the first half of the year, prices will remain between $190. USDA, Economic Research Service Marfrig's H1: Now for the Good News Despite all the margin pressure from livestock prices in North America (with EBITDA margins falling from 5.2% to 2.9% year-over-year), the operation has nevertheless been robust in terms of sales volume, growing 2.5% year-over-year and a 5.5% increase in revenues. In South America, Marfrig saw a 30% increase in sales volume and a 17% growth in net revenue in the most recent quarter, but margins also fell, although less sharply than in North America, from 10.5% to 9.1%. Marfrig's Investor Relations The South American region, especially Brazil, continues to be a strategic area for Marfrig, which focuses on production for export. Brazil, due to its neutral diplomatic position, has been able to navigate well on the international stage without facing significant sanctions from the United States or China. An interesting change in Marfrig's strategy is the reduction in dependence on Asia (especially China and Hong Kong), which went from representing 70% of exports last year to 46% this year. The focus is now on the United States, whose share of Marfrig's exports has increased from 6% to 17%. The Middle East also stood out, almost doubling its share of the company's exports. Marfrig's Investor Relations Marfrig obtained 29 export licenses in the first half of 2024, which reinforces Brazil's role as a major food supplier in the global market. Despite the climatic challenges, the grain harvest in Brazil was positive, with a sharp drop in corn and soybean prices, which helped ease Marfrig's production costs. In financial terms, the company managed to record financial results of R$138 million in the first half of 2024 versus a loss of R$1.41 billion in the same period last year. Although it is a leveraged company, Marfrig seems to be successfully controlling its debt and maintaining its profitability, even in a challenging scenario, especially in the United States. Therefore, although I believe that Marfrig's leverage continues to be a point of caution in this case, in Q2, Marfrig managed to report a drop in leverage to 3.05x Net Debt/EBITDA (vs. 3.39x in Q1 2024), given the better FX rate for debts still in BRL, which represent 38% of the total pool. On the other hand, if we measure leverage in BRL, the indicator comes to 3.38x Net Debt/EBITDA (vs. 3.43 in Q2 2024). Marfrig's Investor Relations However, the best is yet to come. The Brazilian CADE (equivalent to the “FTC” in the U.S. Federal Trade Commission) issued a favorable opinion on the R$7.5 billion deal between Minerva and Marfrig, which involves the sale of 11 plants in Brazil (out of a package of 16 assets) and a distribution center. As for the use of the funds from the transaction, the company said that it will maintain its commitment to financial discipline and reduce leverage. As such, it is possible to see a good improvement in net debt/EBITDA very shortly, reaching close to, or even, 2.5x. Marfrig currently has a Fitch rating of BB+ but points out that net leverage below 2.5x, respectively, and gross leverage below 3.5x, on a sustained basis, could lead to a positive rating action or upgrade. And that, in my view, would be a great catalyst for Marfrig's shares to continue rising. Final Remarks Overall, Marfrig continues to navigate a scenario full of complexities mainly dictated by the cattle cycle in North America, hitting the company's operations hard in H1. However, I believe that Marfrig has managed to hold off these headwinds reasonably well, given the resilience of its well-diversified operations, and this is an excellent bullish point. With this, I see the company still well positioned to deleverage and benefit from more favorable cycles going forward, especially with a focus on shifting towards more stable markets like the U.S. The continuation of the asset sale to Minerva should also prove to be a strong short-term catalyst, which I anticipate will unlock value for the stock as leverage falls more rapidly. With the recent rally, Marfrig now trades at an EV/EBITDA of 7.4x, which, while still almost 40% below the average of its international peers, is almost 3% above its historical average over the last five years. However, I still see attractive multiples for entry, especially with leverage set to be reduced very shortly, likely resulting in even more attractive multiples. For instance, Marfrig's forward EV/EBITDA is forecasted at 5.4x. I believe investors who fail to capitalize on the current opportunity at still discounted valuation multiples — especially with the unfavorable cattle cycle in the U.S. likely having peaked and deleveraging moving toward a favorable outcome—may regret their decision later when Marfrig is trading at much higher prices during a bullish cycle.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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