April 5, 2012 / 5:02 PM / in 6 years

TEXT-Fitch affirms BRF Brasil Foods ratings

(The following statement was released by the rating agency)	
    April 5 - Fitch Ratings has affirmed the following ratings of BRF Brasil
Foods S.A. (BRF): 	
	
--Local currency Issuer Default Rating (IDR) 'BBB-';	
--Foreign currency IDR 'BBB-'; 	
--Long-term national scale rating 'AA(bra)'. 	
The Rating Outlook of the corporate ratings is Stable. 	
	
The ratings are supported by BRF's strong business profile, as one of the 	
largest food producers and distribution companies in Brazil, its moderate 	
leverage and its double-digit margins. The ratings also incorporate Fitch's 	
expectations that the company will continue to improve its profitability and 	
margins, benefiting both from strong demand for the company's products and 	
synergies from its continuing integration with Sadia.	
	
BRF is exposed to commodity and cyclical risks associated with the commodity 	
protein business, which accounts for about 50% of company's revenue. Margins are	
also pressured by rising raw materials costs, particularly for grain, and cost 	
competitiveness can be affected negatively by changes in strength of the Brazil 	
real versus the U.S. dollar. 	
	
Fitch expects that the company will continue to pursue diversification through 	
both organic growth as well as acquisitions. This will mitigate some of the 	
risks associated with the industry, but will also constrain free cash flow 	
generation in the near term and may result in higher leverage. Positively, BRF 	
has a long track record of equity infusions to support the balance sheet while 	
executing its growth strategy. 	
	
The transactions that resulted from the ruling made by CADE, the Brazilian 	
antitrust authority, regarding the merger of Sadia and Perdigao into BRF should 	
result in changes that will not materially affect the company's credit quality. 	
To comply with remedies required by CADE, BRF entered an asset swap agreement 	
with Marfrig Alimentos S.A. (Marfrig). In addition to swapping some assets, 	
Marfrig will also pay BRF BRL100 million in 2012 and BRL250 million in 72 	
monthly installments. As a result of the swap, BRF will replace less than half 	
of the BRL1.7 billion in revenues associated with the swapped assets (equivalent	
to about BRL150 million of lost EBITDA by Fitch estimates). It will also lose 	
some revenues due to the mandated suspension of certain brands. 	
	
In spite of the above, the businesses that will remain in BRF's portfolio are 	
expected to continue to perform strongly during 2012 and the EBITDA margin is 	
expected to improve as the company realizes further synergies. Synergies are 	
expected to be as large as BRL 1 billion per year in 2012 and 2013, after 	
investment of BRL700 million between 2011 and 2013.	
	
Strong Business Profile:	
	
BRF is the largest world exporter of poultry and has dominant market position 	
with a 50% plus market share in most of its product segments domestically. While	
barriers to entry in the processed food segments are relatively low, BRF 	
benefits from its strong brand recognition, which allows it to charge premium 	
prices. BRF's protein businesses are more exposed to the volatility of raw 	
material costs and international poultry and hog prices, and the competitive 	
pressures on the part of other Brazilian or international producers and 	
exporters. 	
	
BRF benefits from its geographic diversification domestically, with 61 plants in	
all but the Amazonas' states (10 to be divested to Marfrig), and from its 	
dedicated distribution network of 41 distribution centers (eight to be divested 	
to Marfrig). The geographic diversification of its businesses mitigates risks 	
related to disease, the imposition of sanitary restrictions by governments, 	
market concentrations, as well as tariffs or quotas applied regionally by some 	
importing blocs or countries. In 2011, the company was affected by the Russian 	
embargo on meat imports from certain Brazilian states, but was able to mitigate 	
the negative effect by shifting production to different states and shifting 	
exports through its export network to different countries. 	
	
Margin Improvement Expected: 	
	
Fitch expects further gradual improvement in BRF's margins that will be helped 	
by the realization of merger synergies. BRF's margins improved to 11.2% in 2011 	
from 10.3% in 2010 despite the higher cost of grains during the year. Unlike its	
pure-play protein counterparts, grains represent much lower percentage of cost 	
of goods sold (COGS) for the company as a whole, since 50% of its product 	
portfolio is from branded, higher value-added processed food products. This is 	
not the case in BRF's export business where about 80% of revenues are derived 	
from fresh and frozen meat sales and the price of grains has a much larger 	
impact on profitability. Still, BRF's scale and dominance at certain export 	
markets allowed it to successfully carry through some price increases to 	
compensate for increasing cost of operations. During the second half of 2011, 	
the company's profitability was helped by a weakening of the Brazilian real 	
versus the U.S. dollar. Margins were also helped by the continued integration of	
the operations of Sadia and Perdigao. 	
	
Moderate Leverage: 	
	
At the end of 2011, BRF's total debt/EBITDA ratio and net debt/EBITDA ratio were	
2.8 times (x) and 1.8x, respectively. The net leverage ratio is not expected to 	
improve as BRF will invest future cash flow and some of its current cash 	
balances in growth capital expenditures, mostly for expansion of its existing 	
facilities. It is likely that the company will engage in further acquisitions of	
considerable size, as it executes on its growth and diversification strategy. 	
Fitch believes that any spikes in leverage will be quickly brought down to 	
company's long-term target of 2.0x net debt/EBITDA either with cash generation 	
or with additional equity. Fitch considers favorably the company's long track 	
record of supporting the balance sheet through equity infusions. 	
	
Expansion Program Constrains Free Cash Flow: 	
	
In 2011, BRF generated BRL1 billion of negative free cash flow (FCF) as a result	
of BRL1.6 billion of capex, a BRL600 million increase in working capital to 	
support growth in its operation, and BRL500 million of dividends. Going forward,	
capex levels are expected to remain elevated, which will lead to significantly 	
depressed near-term FCF generation. Fitch notes that any pressure on cash flow 	
generation is a result of BRF's growth strategy rather than market trends and as	
such has a sizable discretionary component. 	
	
Liquidity and Debt Profile Manageable: 	
	
The company's liquidity is supported by BRL2.7 billion of cash and marketable 	
securities. BRF is also in the process of securing $500 million of liquidity 	
facilities. Short-term maturities are BRL3.5 billion, of which about one-third 	
are trade related and will be renewed. Part of the remaining maturities will be 	
repaid with cash and part will be refinanced. Fitch believes that refinancing 	
would not be a problem for BRF considering the company's open access to the 	
capital market. 	
	
Key Rating Drivers: 	
	
BRF's ratings are unlikely to be upgraded further unless the company's financial	
strategy is adjusted towards more conservative leverage targets. A rating 	
downgrade could be triggered by a deterioration or lack of improvement in the 	
company's operational performance, or by large dilutive debt finance 	
acquisition, a continuation of negative FCF beyond the short term, a failure of 	
the company to replace the business lost in order to comply with CADE's judgment	
that will impair its long-term market position, and/or a significant 	
deterioration of operations due to trade restrictions or sanitary outbreaks. 	
	
 (Caryn Trokie, New York Ratings Unit)

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