Once Solid, Brazil's Big Food Companies Now Wobbling

There will be mergers and rumors of mergers and there will be corporate failures and name brands disappearing - for many of Brazil's heavy-hitting food companies, these are indeed the end times.

Beef companies Independencia and Arantes have defaulted on debt payments and filed for credit protection recently. Brazil's No. 2 beef exporter, Bertin, could be next, according to Moody's.

In the sugar market, which Brazil dominates globally, big names are acquiring weaker ones. Like their peers in the meat markets, companies were over-leveraged at a time when credit around the world has just run dry. Add a global recession to the mix, and demand for the very products these companies churn out has deflated.

"The market is definitely punishing the entire sector," said Bruno Lima, an equities analyst at Rio de Janeiro-based Mercatto investments.

It's a sharp contrast from the 2006 to the mid-2008 period. Back then, demand for the food and commodities produced by publicly traded Brazilian-owned companies, whether chicken or sugar, was sky high. Margins were tight in some cases, but the biggest problem facing Brazilian food companies was whether the dollar was going to weaken further against the Brazilian real, reducing export revenue for companies that sell at least 50% of their goods abroad.

The dollar was as low as BRL1.56 to the real in July, weakening consistently over the last three years. It has since bounced back to a range of BRL2.25 to BRL2.30, but that hasn't helped much. Beef exports on the year are down 8.9% in volume and 22.8% in revenue in February, according to Trade Ministry data. Chicken exports are off 6%, with revenue down 26.3%. Ethanol, a major component of sugar companies' bottom lines, is down 65% in volume and 63% in revenue in February.

March hasn't started off any better, with beef sales down 1% in the first week of the month compared to the same period in February. Sugar sales are down 18.8% over the same period.

Last year, Brazilian food companies were busy investing in expansion projects locally and globally.

Sadia (SDA) finished building its first overseas meat packing plant in Russia. JBS (JBSS3.BR) acquired Australian and U.S. meat companies, making it the largest company of its kind in the world.

Those were the good old days.

Today, Brazil's second-largest sugar company, Santelisa Vale, is in dire financial straits and looking to be acquired, according to executives who could not comment on the record. Its chief executive officer, Anselmo Rodrigues, recently left the helm of Santelisa's ethanol joint venture with Goldman Sachs (GS) and Carlyle Riverstone.

Last Friday, leading sugar company Cosan Ltd. (CZZ) agreed to buy rival Nova America (NOVA3B.SI), owners of the leading sugar brand in the country.

The same day, Moody's downgraded Sadia's debt to B2 from B1, five levels below investment grade.

"Sadia's credit outlook is definitely negative," said Suommo Mukherjee, an analyst at Moody's in Sao Paulo. "They really rely on capital injection or selling assets because the company is cash flow negative and loaded with unsustainable short term debt."

Sadia's total debt, including off-balance-sheet debt, is estimated to be 5.4 billion Brazilian reals, or $2.38 billion. Its enterprise value is around BRL7.2 billion, according to Renato Prado, an equity analyst at Banco Fator of Sao Paulo.

Short-term loans of BRL1.5 billion are coming due in September, according to Moody's.

"The main problem with Sadia, like all companies across the food segment, is international demand. Local demand is okay. But when 50% of your revenue comes from exports and those exports are in a general decline because of a recession or because credit just isn't there to buy, then it really hurts the revenue streams of all these players," Prado said.

This week, newsmagazine Veja said that Sadia and its rival Perdigao (PDA) were in merger talks. Sadia had no comment about the report. It tried to acquire Perdigao two years ago in a failed bid but today it needs Perdigao more than Perdigao needs Sadia, said Mercatto's Lima.

In New York, Sadia's American Depositary Receipts are up 6.2% to $3.78. Perdigao is up 3.6% to $26.69. The company's enterprise value is around BRL8.2 billion, with just BRL2.6 billion in short and long-term debt obligations, according to Prado.

"The only names we like in this sector right now are Perdigao and Marfrig (MRFG3.BR)," said Lima. "Both companies have great, trustworthy management."

Marfrig is one of Brazil's top three beef exporters. Its shares are down 10% since January, while the general Ibovespa stock index is up 5.6%. Rival JBS is down 5.7%.

In the long term, the industry's prospects are still good. "The outlook is still positive," said Lima. "Despite the credit crisis, people still need to eat."

-By Kenneth Rapoza, Dow Jones Newswires, 5511-2847-4541, [e-mail]