Biotech Values

[DewDiligence]

[OT] Brazil's New King of Food

http://online.barrons.com/article/SB124727518474926343.html

›July 11, 2009
By KENNETH RAPOZA

When two of Brazil's biggest food companies agreed to merge earlier this year, they didn't simply create an industry giant. They also gave rise to a tantalizing investment opportunity, a play on both Brazil's newly energized consumer economy and its long-standing role as a major commodities exporter.

Brasil Foods -- the result of a shotgun wedding between brand-rich Perdigão and capital-poor Sadia -- will get about 45% of its $11 billion in annual sales from exporting beef, pork and other commodity foods, mostly to Europe, Asia and the Middle East. The rest of its business will be in the red-hot local market, where it will offer such products as frozen pizzas and chicken nuggets to increasingly empowered lower classes.

Under Brazil's president, Luiz Inácio Lula da Silva, the country's poor and working classes have been given new welfare programs and work opportunities, markedly increasing families' purchases of just the sort of basics that Brasil sells. The country's average monthly salary has climbed 22% since 2003.

"International investors want equity in companies focused on the domestic market and not overexposed to commodities," [I would modify this by saying that foreign investors who do want exposure to commodities can buy such companies as VALE and PBR] says Mohamed Mourabet, manager of the $250 million Victoire Brazil Investments, an asset manager in São Paulo.

That is why hopes are running high for Brasil Foods' stock. The Brazil-listed shares and American depositary receipts (to be traded on the New York Stock Exchange, as Perdigão's and Sadia's are now) are to debut under the current Perdigão ticker (PDA). Sadia will disappear. Brasil Foods will issue 115 million new shares in a primary offering on the Brazilian stock exchange on July 23. The new company hopes to raise about 4.5 billion reais, or $2.24 billion. The only way to be assured of early entry into the new stock is to hold current Perdigão shares, each of which will be converted to Brasil Foods at a 1-to-1 ratio.

The new company should be a powerhouse, rivaling the likes of Smithfield Foods (SFD) and Tyson Foods (TSN). In fact, an official for Brazil's antitrust agency said last week it may not finish its review of the merger by year end. While that may delay melding certain operations, few observers expect the agency to scotch the deal. "Long-term, Brasil Foods will have substantial market share in chicken, pork and frozen foods," says Renato Prado, an equity analyst at Banco Fator in São Paulo. "You can buy and hold Brasil Foods without being too worried about losing your shirt."

Analysts warn the stock, expected to come out at about BRL40, could take some hits in the short run, the result of dilution from the stock issuance and the normal glitches that accompany large-scale merger integrations. But then the shares could climb nicely. Credit Suisse has a target of BRL52; Banco Fator has an even higher BRL54.50, for a 36% gain.

After the coming stock issuance, Brasil Foods' enterprise value -- market capitalization plus net debt -- is likely to stand at a reasonable 8.3 times EBITDA, or earnings before interest, taxes, depreciation and amortization. That is about midway between the multiples of Smithfield and Tyson.

The merger of Perdigão and Sadia, announced in May, came about after Sadia took a beating in last year's stock-market mayhem. It was hurt when the dollar went from a weak BRL1.56 in July 2008 to as high as BRL2.60 in the post-Lehman Brothers chaos late last year. Sadia posted the first loss in its 64-year existence and reported a staggering first-quarter debt, a result of hedging against the U.S. dollar. Perdigão essentially become Sadia's white knight.

Sadia Chairman Luiz Furlan and Perdigão boardmember Nildemar Secches said the BRL4.5 billion to be raised in the share offering should wipe out half of the combined company's nearly BRL10 billion in debt.

Brasil Foods unquestionably has a big opportunity on its home turf as domestic consumption increases. Not only are salaries going up, but consumers also have been helped by a sharp decline in borrowing rates over the past decade.

Of course, Brasil isn't the only food company eying the new market. Tyson, for instance, is already setting up shop in Brazil. But Brasil Foods will have around a 70% market share in some segments in frozen foods. In short, the company is all but certain to have a seat at the banquet.‹