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Marfrig Mergers Make Investors Biggest Losers: Corporate Brazil

Marfrig Mergers Make Investors Biggest Losers
Cattle has jumped 47 percent in the past three years on the Chicago Mercantile Exchange as grain costs rise. Photographer: Noah Friedman-Rudovsky/Bloomberg

Marfrig Alimentos SA is delivering the worst returns of major meat companies in Latin America after building up debt to make 20 acquisitions in five years.

The region’s second-largest beef producer lost shareholders 12 cents on every dollar invested in 2011, compared with a return on equity of about 15 cents from top performer Grupo Bafar SA and 10 percent from BRF - Brasil Foods SA, according to data compiled by Bloomberg. JBS SA, the biggest beef company, lost shareholders 1 cent per dollar, the second-worst result.

Chief Executive Officer and founder Marcos Molina dos Santos, who opened his first slaughterhouse in 2000, is using acquisitions to transform Marfrig into a diversified food maker as China-led demand for grains used to feed livestock increases costs for meatpackers. The company spent $2 billion in 2010 to buy Seara Alimentos from Cargill Inc. and McDonald’s Corp. supplier Keystone Foods, causing debt to quadruple in two years.

“They didn’t deliver announced synergies,” Pedro Herrera, a New York-based analyst at HSBC Holdings Plc who rates the stock underweight, said in a telephone interview. “So far, the acquisition of Seara didn’t translate into significant market share gains.”

Marfrig, based in Sao Paulo, slumped 36 percent in local trading in the past 12 months before today. That compares with a 13 percent gain for Brasil Foods, the world’s largest poultry exporter, and a 10 percent gain for JBS. Mexican meat processor Grupo Bafar gained 26 percent.

The negative return on equity stemmed from the Brazilian real’s 11 percent decline against the U.S. dollar last year, which boosted the value of foreign debt in local-currency terms, Marfrig said in an e-mailed response to questions.

Cattle Prices

Cattle has jumped 47 percent in the past three years on the Chicago Mercantile Exchange as grain costs rise. Corn, the main ingredient in animal feed, soared 64 percent in two years.

Marfrig acquired Seara and other food companies to compete with Brasil Foods, the country’s largest maker of TV dinners, as rising wages drove consumption of frozen lasagnas and hamburgers. While the purchases led debt to balloon, they resulted in “modest improvement” in market share, Herrera said.

Net debt rose to 8.49 billion reais ($4.1 billion) at the end of 2011 from 2.12 billion two years earlier. Marfrig’s portion of the Brazilian market for processed-meat products rose to 7.7 percent in the first quarter from 7.2 percent two years earlier, according to a May 14 earnings report.

About 40 percent of Marfrig’s sales last year came from processed-meat products such as sliced ham and chicken nuggets, up from less than 10 percent four years ago, according to data on its website. The remaining 60 percent came mainly from raw beef, pork and poultry.

State Development Bank

The company has to pay about 2.2 billion reais of debt annually until at least 2014, Standard & Poor’s, which has Marfrig’s B+ junk rating under a negative outlook, said in an April 24 report.

“They have bitten off more than they can chew,” Caue Pinheiro, an analyst at Sao Paulo-based SLW Corretora who has a hold recommendation on the stock, said in a telephone interview. “Most of their acquisitions made sense from the strategic point of view but occurred at the expense of taking on more debt.”

Net debt rose to 4.5 times earnings before interest, taxes, depreciation and amortization in the first quarter, the highest since Marfrig’s initial public offering in 2007.

The acquisitions were partly financed by Marfrig’s 2.5 billion-real convertible bonds sale in 2010. Brazil’s development bank, known as BNDES, bought all the bonds at the offering.

Asset Sales

Marfrig is seeking to shed some assets this year in a bid to curtail its surging debt. Last month it concluded the sale of U.S. and European distribution units to Illinois-based Martin-Brower Co. for $400 million. The sales, coupled with efforts to cut costs, may help the company reduce debt and boost returns in coming years, Pinheiro said.

“They seem to be doing their homework,” Pinheiro said.

Yields on Marfrig’s dollar bonds due 2018 have jumped 353 basis points, or 3.53 percentage points, in the past two months to 13.67 percent. They reached 13.71 percent on May 18, the highest since Jan. 9. Borrowing costs for global speculative-grade food, beverage and tobacco companies fell two basis points during the same period to 6.74 percent, Bank of America Corp. data show.

Marfrig’s expansion through acquisitions mirrors JBS’s, which became the world’s top beef producer through more than 10 acquisitions in five years, including Pilgrim’s Pride in 2009, Smithfield Foods Inc. units in 2008 and Swift & Co. in 2007.

“Both Marfrig and JBS were too aggressive on acquisitions and now must work hard to regain confidence from investors,” HSBC’s Herrera said.

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