Most Of JBS Segments Are Back On Track (OTCMKTS:JBSAY)

JBS (OTCQX:JBSAY) is the largest meat protein company in the world and the largest food company by revenue.

In January I wrote a Buy article on the company. The reason was the company’s moat on its markets, good capital allocation and returns, geographical and protein source diversification, long-standing management and strong controlling shareholders, and the fact that it traded at a discount to historical earnings because of temporary headwinds.

In this article, I review the company’s Q4 and FY23 results. Most of the company’s segments have recovered, while the main segment (US beef) is still in a low portion of its cycle. The company has reduced debt and extended maturities at attractive terms.

I believe that JBS is an opportunity at these prices, with several catalysts ahead to close the valuation gap.

Q4 and FY23 developments

The company reported results this week. My main takeaway is that the company’s segments have recovered a big part of the profitability they lost at the end of 2022 and the beginning of 2023. At the time, many feared that the company was facing problems, but management promised that the low margins were cyclical and would recover, something that has proven true quarter after quarter.

As seen above (from the company’s Q4 earnings release) after most of the company’s segments bottomed in terms of profitability between 4Q22 and 2Q23, they have all recovered.

The reasons are varied; in the case of Seara, it had operational problems in its factories early in the year, which recovered by the end of the year. In the case of JBS Brazil and Australia, the improvement comes from the positive bovine cycle in those countries (excess of cows leads to lower prices that JBS can sell at a premium abroad). In the case of Pilgrim’s (poultry and international pork) and JBS USA Pork, the improvement was possible thanks to lower feed costs (corn above all).

The segment that is yet struggling is JBS Beef North America. It is one of the company’s largest segments and, one could argue, the most important in EBITDA. US Beef is personally managed by Wesley Batista, one of the two brothers who took the company from a Brazilian local player to world dominance.

Management is confident that the current results are caused by a negative cycle in US bovine markets. Contrary to Brazil or Australia, herds are shrinking in the US, leading to lower supply and higher cow prices.

Cycle diversification: JBS has always understood that markets cycle and that is why it has a geographically diversified base (cows from Brazil, the US, or Australia) and a protein-diversified base (cows, but also poultry, pork, and processed meat products). One market normally generates meager profits or losses for some time, but others can compensate. This is especially true in beef, whereas pork and poultry are more stable unless there is volatility in feed inputs.

Eventually, US beef will improve and probably worsen in Brazil or Australia. It represents a bigger problem because US beef is larger than Brazil and Australia combined.

Continued investments: One of the aspects I like about JBS is how they have successfully deployed capital into larger and larger operations at increasing margins. The company’s asset base and ROCE grow in tandem because more assets give it a bigger cost advantage and increase its market power.

This year, the company continued expanding (half its CAPEX is expansion and half maintenance). It opened two automated Seara plants in Brazil focusing on prepared products like breaded chicken and sausages. It also opened an Italian specialty plant in the US. These are, in my opinion, the most promising areas, as JBS expands downstream, coupling its cost/manufacturing advantages upstream with brand power.

It also started building its first production-scale cultivated protein factory in Spain. It will be the world’s largest plant and will be able to produce 1 thousand tons of cultivated protein per year, with potential for up to 4 thousand tons. This is obviously only a drop in the bucket of normal meat, which amounts to 350 million tons per year. McKinsey estimated that this market would produce 40 thousand tones in 2025, meaning JBS will be a small but noticeable player.

Debt refinancing: JBS’ debt is rated as investment grade, and its financing cost is relatively low and fixed. 85% of the company’s debts are denominated in dollars (the rest in Brazilian reais), with an average cost of 6%. The average maturity of the company’s debt is 11 years.

The company repaid parts of that debt this year because the EBITDA decrease of early 2023 caused it to get into high debt-to-EBITDA ratios. Today the company has about $4.7 billion in cash and securities, which would be sufficient to pay all maturities until 2029. The company’s cost of debt is approximately $1.4 billion on $20 billion gross, or approximately 7%.

Progress on US listing: JBS is listed in Brazil and has an OTC ADR in the US, with low liquidity for a company of its size and importance. The company announced that it planned a full ADR listing in the US and is moving in that direction. It published its first 20-F this week. This would open the stock for index funds.

Revisiting valuation

JBS trades today for a market cap of about $10 billion and an EV of $25 billion ($20 billion gross debt minus approximately $5 billion in cash and securities).

The company’s revenues are $72 billion, and its historical average EBIT and EBITDA margins have been 5% and 7%, respectively. The upward trend in both types of margins until the problems of 2022/23 is a mix of the cycles in meat markets, plus the movement of the company downstream (capturing share and margins) and the scale returns of its asset base.

The company’s current EBITDA margin is more than enough to cover interest payments, resulting in an EBITDA of $3.6 billion. It could fall by half and still cover interest.

On the operating side, depreciation reflects well the cycle-average CAPEX that the company has made, although a big portion of that CAPEX is expansion and not a cost of current sales.

Most importantly, as shown below, the margins are improving every quarter, with recent quarterlies already above the worst of Q4. The TTM figure keeps falling because the 3Q22 figure (close to 8%) left the statistic this quarter. However, next quarter, the company’s negative margin in 1Q23 will also be replaced, and therefore, the TTM figure should get closer to 3/4%. This is without improvements in US Beef, one of the main profit engines.

Approaching the valuation from an EV perspective, the current valuation would require $2.5 billion in NOPAT to generate a 10% earnings yield, which I consider reasonable for a company of JBS size, moat, financial position, and managerial capabilities. Applying a 25% effective tax rate (guided by the company) would result in $3.3 billion in operating income, or a 4.5% operating margin, below the historical levels and close to the current recovery.

Again, the current levels include bad operations in US Beef, and the historical margin of 5% does not account for the relatively clear upward trend in JBS’ cycle-average margin.

For a 10% return on $10 billion in market cap, the company needs to generate $1 billion in net income. Add taxes for $1.3 billion in pre-tax profits or $2.8 billion in operating profits to cover interest. The result is an operating margin of 3.8%. The figure is lower for equity than for debt because JBS’ cost of debt (6/7%) is well below its historical returns on assets (at least 8/10%). This means that equity benefits from leverage, as long as it is long-term, fixed rate.

Considering historical margins of 5%, the EV/NOPAT multiple is 9x, and the P/E multiple is 6.3x. The EV/EBITDA figure at historical margins (7%) is 5x.

I consider that JBS’ history of expansion and riding several cycles in Brazil, the US, and global markets indicates that operating margins return to the mean, with maybe a positive trend bias over time. Expecting returns 20% below the historical average seems conservative, in my opinion. The company’s financial position is strong enough to guarantee an investment-grade rating for an emerging market domiciled company. The resulting 10% yield is reasonable for a company of its size, moat, and managerial capabilities. I believe JBS continues to be a Buy at these prices.

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