Fitch Affirms BRF Brasil Foods' IDR at 'BBB-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed the following ratings of BRF Brasil Foods S.A. (BRF):

--Local currency Issuer Default Rating (IDR) 'BBB-';
--Foreign currency IDR 'BBB-';
--Long-term national scale rating 'AA(bra)'.

The Rating Outlook of the corporate ratings is Stable.

The ratings are supported by BRF's strong business profile, as one of the largest food producers and distribution companies in Brazil, its moderate leverage and its double-digit margins. The ratings also incorporate Fitch's expectations that the company will continue to improve its profitability and margins, benefiting both from strong demand for the company's products and synergies from its continuing integration with Sadia.

BRF is exposed to commodity and cyclical risks associated with the commodity protein business, which accounts for about 50% of company's revenue. Margins are also pressured by rising raw materials costs, particularly for grain, and cost competitiveness can be affected negatively by changes in strength of the Brazil real versus the U.S. dollar.

Fitch expects that the company will continue to pursue diversification through both organic growth as well as acquisitions. This will mitigate some of the risks associated with the industry, but will also constrain free cash flow generation in the near term and may result in higher leverage. Positively, BRF has a long track record of equity infusions to support the balance sheet while executing its growth strategy.

The transactions that resulted from the ruling made by CADE, the Brazilian antitrust authority, regarding the merger of Sadia and Perdigao into BRF should result in changes that will not materially affect the company's credit quality. To comply with remedies required by CADE, BRF entered an asset swap agreement with Marfrig Alimentos S.A. (Marfrig). In addition to swapping some assets, Marfrig will also pay BRF BRL100 million in 2012 and BRL250 million in 72 monthly installments. As a result of the swap, BRF will replace less than half of the BRL1.7 billion in revenues associated with the swapped assets (equivalent to about BRL150 million of lost EBITDA by Fitch estimates). It will also lose some revenues due to the mandated suspension of certain brands.

In spite of the above, the businesses that will remain in BRF's portfolio are expected to continue to perform strongly during 2012 and the EBITDA margin is expected to improve as the company realizes further synergies. Synergies are expected to be as large as BRL 1 billion per year in 2012 and 2013, after investment of BRL700 million between 2011 and 2013.

Strong Business Profile:

BRF is the largest world exporter of poultry and has dominant market position with a 50% plus market share in most of its product segments domestically. While barriers to entry in the processed food segments are relatively low, BRF benefits from its strong brand recognition, which allows it to charge premium prices. BRF's protein businesses are more exposed to the volatility of raw material costs and international poultry and hog prices, and the competitive pressures on the part of other Brazilian or international producers and exporters.

BRF benefits from its geographic diversification domestically, with 61 plants in all but the Amazonas' states (10 to be divested to Marfrig), and from its dedicated distribution network of 41 distribution centers (eight to be divested to Marfrig). The geographic diversification of its businesses mitigates risks related to disease, the imposition of sanitary restrictions by governments, market concentrations, as well as tariffs or quotas applied regionally by some importing blocs or countries. In 2011, the company was affected by the Russian embargo on meat imports from certain Brazilian states, but was able to mitigate the negative effect by shifting production to different states and shifting exports through its export network to different countries.

Margin Improvement Expected:
Fitch expects further gradual improvement in BRF's margins that will be helped by the realization of merger synergies. BRF's margins improved to 11.2% in 2011 from 10.3% in 2010 despite the higher cost of grains during the year. Unlike its pure-play protein counterparts, grains represent much lower percentage of cost of goods sold (COGS) for the company as a whole, since 50% of its product portfolio is from branded, higher value-added processed food products. This is not the case in BRF's export business where about 80% of revenues are derived from fresh and frozen meat sales and the price of grains has a much larger impact on profitability. Still, BRF's scale and dominance at certain export markets allowed it to successfully carry through some price increases to compensate for increasing cost of operations. During the second half of 2011, the company's profitability was helped by a weakening of the Brazilian real versus the U.S. dollar. Margins were also helped by the continued integration of the operations of Sadia and Perdigao.

Moderate Leverage:
At the end of 2011, BRF's total debt/EBITDA ratio and net debt/EBITDA ratio were 2.8 times (x) and 1.8x, respectively. The net leverage ratio is not expected to improve as BRF will invest future cash flow and some of its current cash balances in growth capital expenditures, mostly for expansion of its existing facilities. It is likely that the company will engage in further acquisitions of considerable size, as it executes on its growth and diversification strategy. Fitch believes that any spikes in leverage will be quickly brought down to company's long-term target of 2.0x net debt/EBITDA either with cash generation or with additional equity. Fitch considers favorably the company's long track record of supporting the balance sheet through equity infusions.

Expansion Program Constrains Free Cash Flow:
In 2011, BRF generated BRL1 billion of negative free cash flow (FCF) as a result of BRL1.6 billion of capex, a BRL600 million increase in working capital to support growth in its operation, and BRL500 million of dividends. Going forward, capex levels are expected to remain elevated, which will lead to significantly depressed near-term FCF generation. Fitch notes that any pressure on cash flow generation is a result of BRF's growth strategy rather than market trends and as such has a sizable discretionary component.

Liquidity and Debt Profile Manageable:
The company's liquidity is supported by BRL2.7 billion of cash and marketable securities. BRF is also in the process of securing $500 million of liquidity facilities. Short-term maturities are BRL3.5 billion, of which about one-third are trade related and will be renewed. Part of the remaining maturities will be repaid with cash and part will be refinanced. Fitch believes that refinancing would not be a problem for BRF considering the company's open access to the capital market.

Key Rating Drivers:
BRF's ratings are unlikely to be upgraded further unless the company's financial strategy is adjusted towards more conservative leverage targets. A rating downgrade could be triggered by a deterioration or lack of improvement in the company's operational performance, or by large dilutive debt finance acquisition, a continuation of negative FCF beyond the short term, a failure of the company to replace the business lost in order to comply with CADE's judgment that will impair its long-term market position, and/or a significant deterioration of operations due to trade restrictions or sanitary outbreaks.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 13, 2010);
--'National Ratings Criteria' (Jan. 19, 2011).

Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
National Ratings Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=595885

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.