Brazilian protein - 2Q13 sector update - discipline required
JBS's 2Q13 results were strong but they did not incorporate all of the debt expected to be transferred from Marfrig (BRL5.85bn). More debt should be transferred in 3Q13 following the recent approval of the deal, raising leverage by approx a turn. Rating agencies have diverging outlooks for the deal's implications and it remains to be seen if JBS can deliver FCF performance after assimilating Seara's assets. We maintain our Hold recommendation on the complex until we can further assess the impact of the Seara transaction.
BRF is making a comeback but valuations remain fair
In our view the return to normal profitability levels, the expected ramp up of the product portfolio renovation in 2H13, the potential for M&A transactions, and higher commodity risk in BRF's operations relative to HG peers are being fairly reflected in current premium valuations. We maintain our Hold recommendation although we might be compelled to review it if margins show signs of deterioration in 2H13 or a major M&A transaction is undertaken.
Eoin Treacy's view Due to the slaughter schedule, cyclicality is evident in how feeder cattle contracts perform relative to one another. Backwardations tend to peak in October and November before moving into contangos that trough in March and April. The interesting thing about this relationship is that its volatility compressed between 2003 and early this year.
The March contango trough represented a dislocation in the market and was much deeper than any in the last 20 years. The current backwardation has broken the progression of lower rally highs and potentially suggests supply shortage following the large contango earlier in the year.
Feeder Cattle futures broke out to new nominal all-time highs yesterday, While some consolidation of recent powerful gains is possible, a sustained move below $150 would be required to question potential for additional upside.
Among Brazilian beef producers, JBS is testing the upper side of an almost two-year range but will need to sustain a move above BRL8 to confirm a return to demand dominance beyond the short term. BRF encountered resistance near BRL 60 two weeks ago and a process of mean reversion appears to be underway. Marfrig continues to hold a progression of lower rally highs and is testing historic lows.