The bulk of Brazil's soybean, beef, and pork exports are bound to China, while soymeal exports are mainly bound to the EU (please see graph below). Brazil's poultry, sugar, ethanol, cotton, and corn exports are more evenly distributed throughout the world, although there are some concentrations in ethanol and cotton.

Brazil is already the world's largest soybean, poultry, beef, and sugar exporter, and should reach the top position in corn trade in 2022-2023 according to USDA's forecast (please see graph below). Brazil ranks second in soymeal, soy oil and cotton exports, and third in pork. Although we don't have USDA forecasts for ethanol, Brazil is the second-largest exporter of biofuel.

Higher Soy, Corn, And Cotton Export Volumes, Due To Favorable Weather Conditions, And Stable Continue To Strengthen Margins

Booming Export Revenues Thanks To Surging Commodity Prices And Weak Real

Brazilian soft commodity export revenues have ballooned in the past three years due to a solid increase in demand for food since the beginning of the pandemic and because of supply shortages that were exacerbated by the Russia-Ukraine conflict, since both countries are large grain and oilseed exporters. Average export prices have increased by about 71% for soybean, 66% for corn, and about 34% for cotton since 2020. The 2022 soy production volumes declined by 10% to 125 million tons due to the severe drought in Brazil during the 2021-2022 harvest season. Corn yield reached record levels in 2022, jumping 30% to 113 million tons, given a bumper winter crop--which is currently responsible for about three quarters of Brazil's corn output (as opposed to the summer crop)--after weak 2021 levels due to lower harvest yields. Cotton production volumes grew about 8% to 3,700 tons, still shy of the 2019-2020 harvest output of 4,300 tons, mainly due to a smaller harvest area given competition from more profitable crops as well as decreasing productivity.

So far this year, adequate rain levels across the country, except in the southern region, should boost productivity and result in robust output of soy, cotton, and corn in 2022-2023. The Brazilian Ministry of Agriculture's Supply Management Company (CONAB) expects a record-high production in excess of 150 million tons of soybean in the 2022-2023 harvest that will reach export markets mostly during the first half of 2023, while that of corn should reach 124 million tons and that of cotton about 4,000 tons, mainly due to stable production and a slight increase in the harvest area.

China Is The Main Driver Of Brazil's Grain Export Growth, But The Increasing Share Of Sales To It Poses Risks

The removal of sanitary restrictions has bolstered export volumes of some Brazilian agricultural commodities in the past few years. China has traditionally purchased more than 90% of corn from the U.S., but it opened its corn market to Brazil's exports last year, which jumped from nearly zero in 2021 to $325 million in 2022 and should continue rising as China seeks to diversify its corn imports while continuing to expand its poultry and hog herds. Egypt opened its market to Brazil's cotton in January 2023--the country imported a total of $633 million in 2022--and could help boost Brazilian exports in the future.

China currently receives close to 70% of Brazil's soybean exports, 30% of cotton, and about 3% of corn exports--but its share of the latter, is significantly growing. This concentration poses risks, such as the uncertainties regarding China's economic recovery after the lifting of its zero-COVID policy in December 2022 and the exposure to future trade restrictions. Other risks include a potential global recession that could depress commodity prices worldwide and profitability of grain, oilseeds, and cotton producers.

Higher Volumes And Prices Should Continue To Support Profitability Despite Still High Costs

The spike in commodity prices and volumes was mitigated by the surge in fertilizer and input prices following the start of the conflict in Ukraine in February 2022. These prices have generally been receding in the past few months, but still remain high, which coupled with inflationary pressures on leasing, labor, fuel, and other costs will hinder margin expansion among Brazilian agribusiness players. This is despite agricultural commodity prices remaining at the highest levels of the last 15 years, even with the recent declines in soybeans, corn and cotton prices by almost 25%, 30% and 50%, respectively, from their 2022 peaks. We expect a fairly stable scenario for grain and cotton producers in Brazil, including those that we rate. In the meantime, cash flows could slip from peak levels because of high interest burden in Brazil for an expanding and working-capital-intensive sector. We expect SLC Agricola S/A to raise its volumes thanks to increased harvest area and favorable weather conditions, which coupled with supportive prices and stable to declining input costs--mainly fertilizers--should bolster cash flows that the company uses to reduce leverage after several acquisitions in recent years. Grupo Cereal benefited from high crushing spreads in Brazil, as demand growth for soymeal and oil generally outpaces production, while it's investing to sharply expand its processing capacity. The recent hike of the mandatory biodiesel blend in Brazil--from 10% to 12% in 2023 and to 15% in 2026--should also support the company's results. Strong demand for soybean and cotton seeds in Brazil's Center-West region, larger harvest area, and favorable climate conditions are lifting Girassol Agricola Ltda.'s volumes, while prices remain supportive.

Rising Export Volumes Offset Sluggish Recovery In Domestic Consumption

Brazil remains a key global player in the protein export market. Its meat exports totaled $25 billion in 2022, an increase of nearly 30% compared with 2021. This is primarily thanks to a 20% rise in prices but also due to an 8% gain in volumes. Most of Brazil's beef exports are bound for Asia, especially China, while pork and poultry destinations are more diversified. Beef export volumes grew 22.7% in 2022 after weak levels in 2021 when China imposed a ban on Brazilian exports for about six months. But such exports also grew 12.5% compared with 2020 normalized volumes, demonstrating consistently strong demand. Poultry and pork volumes increased more pronouncedly in 2018-2019 when the African swine flu (ASF) took a severe toll on China's poultry and pork production. Volume growth fluctuated 5%-10% annually in 2020-2022, probably more related to global demand and supply balance, rather than due to a structural change in global trade or consumption patterns.

We expect export volumes to continue growing, as global food demand continues to rise, and we don't forecast a significant increase in global production levels. In addition, China should continue to have a more balanced mix between domestic production and imports despite its recovering hog and chicken herds, following the disruption the ASF caused in domestic volumes that considerably boosted global meat prices and caused inflation. Meat consumption in Brazil has suffered from inflation pressures and a weaker consumer purchasing power amid low economic growth and high household debt levels, and we saw consumers shifting to cheaper proteins such as poultry, pork, and eggs.

Brazilian Beef Exports Could Continue To Rise Amid Favorable Prices, Boosting Margins

After fluctuating from 215 million to 218 million in 2016-2020, Brazil's cattle herd should start to increase more noticeably in 2023, according to CONAB, to 228 million heads. This shows an upswing in Brazil's cattle cycle, which usually lasts three to six years, and is likely to reduce cattle prices due to higher animal availability. After two to three years of consecutive record-high cattle prices due to high global beef prices and low cattle availability, prices already declined almost 30% from a peak of 2022, which will support Brazilian meatpackers' margins.

We estimate that China's beef consumption will increase by 2%-3% this year, supply of which will come mostly from South America. This is mainly because the U.S. consumes most of its large beef production, and its declining cattle herd is boosting cattle prices and reducing meatpackers' margins, which tend to lower somewhat the country's production levels. China imposed an automatic ban on Brazilian beef exports because of a single case of atypical Mad Cow Disease in the country, which was lifted after only one month (as opposed to over three months in 2021), but volumes returned to normal levels in April 2023, which probably won't affect materially Brazil's export volumes for the entire year.

High Grain And Input Costs, Weak Domestic Demand, Export Destination Concentration, And The Risks Of Avian Flu Contagion Pose Difficulties For Poultry Producers

Grain prices have eased in 2023 due to an estimated large harvest yield because of favorable weather conditions, while fertilizer costs have declined from their peak in 2022 and returned to 2021 levels. These costs jumped due to import restrictions following the start of Ukraine-Russia conflict, while Brazil currently imports more than 80% of its fertilizer needs. However, prices for corn and soy main agribusiness inputs currently remain at high levels, and previously higher cost inventories still dent profitability of poultry producers as they are used along the year. In addition, China's increasing appetite for Brazilian grains and byproducts, higher ethanol production in Brazil, and the corn harvest failure in Argentina will increase demand for grain and likely keep pressure on its costs. This, coupled with heavy reliance on exports to Asia, which can impose trade barriers or influence the pace of purchases, can generate sizable seasonal volatility. For example, China's lifting of all Covid-19 restrictions in late 2022 and the consequent reduction in purchases dropped poultry prices globally, flooding the domestic market with products that further weakened margins.

China's weaker demand, future trade restrictions, and a further rise in raw material costs could prevent the poultry sector's margins from improving in 2023. Therefore, we have a cautious outlook for margin improvement amid so much uncertainty. Our forecast for rating trajectories may differ somewhat from our view of a stable trend, because companies such as JBS S.A. have a large exposure to the U.S. market, in which margins have been more pressured because of high supply and large inventories.

In addition, avian flu remains a risk, particularly given China's temporary ban on poultry exports from regions where cases have been identified–China is a large importer of dark meat, including parts not generally consumed in the U.S. In South America, avian flu has been detected in Peru, Chile, Colombia, Venezuela, Ecuador, Argentina, Bolivia, and Uruguay--some of which border Brazil, the world's second-largest poultry producer and largest exporter. So far, no cases have been reported in Brazil, but the contagion could dent operations of its poultry exporters such as BRF S.A., Goncalves & Tortola S.A., and JBS's Brazilian poultry subsidiary, Seara.

Record-High Ethanol Export Volumes Because Of Higher Premium Over Volatile Domestic Prices

Since the COVID-19 outbreak, ethanol demand in Brazil has been decreasing. Therefore, domestic ethanol makers have been redirecting an increasing share of their production to the export market--export volumes were up 26% to nearly 2.5 billion liters in 2022, comprising almost 10% of Brazil's total ethanol output. This trend was supported by the world energy crisis triggered by the conflict in Ukraine, prompting Europe to seek other sources of fuel. In this sense, Brazilian ethanol export volumes to the continent through the Low Countries have ballooned sixfold, while revenues increased nearly eightfold. Other European countries, such as the U.K., France, and Sweden, also increased ethanol imports from Brazil. Export prices premium over domestic prices in Brazil were significant--gross export prices rose by more than 30% to about $1,110 (nearly R$5,750) per cubic meter. At the same time, domestic hydrated ethanol prices were flat at about R$2,960 per cubic meter and anhydrous ethanol prices were down slightly to about R$3,420 per cubic meter in 2021 and 2022. Therefore, companies such as Raízen and Sao Martinho S.A. have been channeling increasing volumes to export markets to offset weaker domestic consumption. The latter resulted from taxation changes that came into effect in June 2022 during the previous administration: the state-level ICMS (sales and services) tax on gasoline was capped at 18%, while the federal-level fuel tax (CIDE) and social security tax on gasoline (PIS/Cofins) were suspended. These factors impacted ethanol parity prices, which are usually at 70% of gasoline prices, because the majority of light vehicles in Brazil are flex-fuel.

Recent Fuel-Tax Hikes Should Support Domestic Ethanol Prices, But Exports Remain An Alternative

Earlier this year, Brazil's new administration has implemented changes in fuel taxation that should benefit domestic ethanol prices. First, the resumption of PIS/Cofins tax of R$0.47 and R$0.02 per liter for gasoline and ethanol, respectively, on March 1, 2023, which restored the price differential from gasoline in favor of the biofuel. Second, the new ad rem (charged on a fixed value in dollars)--as opposed to the old ad valorem (charged on a variable value in percentages)--ICMS tax on gasoline will rise to R$1.22 per liter starting on June 1, 2023, from the current average rate of R$0.99 per liter. We also expect that PIS/Cofins and CIDE taxes on gasoline and hydrated ethanol will rise by another R$0.34 and R$0.22 per liter, respectively, on July 1, 2023. These measures should offset (because high taxes on gasoline increase the price of ethanol, while lower Brent prices decrease them) the forecasted drop in average Brent oil prices to $85-$90 per barrel in 2023 from about $98 per barrel the previous year. In addition, there are uncertainties if the government will change the state oil company Petróleo Brasileiro S.A. – Petrobras current policy of following international prices, which could reduce the biofuel's profitability. Exports, however, tend to remain a viable alternative to lower domestic volumes and prices, and favors the companies that have the necessary export certifications and appropriate logistics networks to direct additional volumes to the external market. In a longer-term scenario, the Brazilian Minister for Mines and Energy recently affirmed that a working group would discuss the gradual increase of the mandatory ethanol blend in gasoline from 27.5% to 30%, which would bolster demand for anhydrous ethanol. Production of green hydrogen and sustainable aviation fuel (SAF) from ethanol could also support ethanol demand in the future.

High Sugar Prices And Better Agricultural Yields Should Continue To Underpin Sugarcane Mills' Profitability In 2023 And 2024

Brazil's sugar export volumes have been flat in 2022, at about 27 million tons, given the recovery in cane crushed after the severe drought and frosts in 2021 reduced output in the 2021-2022 harvest (April 2022 to March 2023) by 15%.. Gross prices, however, have picked up by almost 20%, reaching slightly more than $500 (about R$2,600) per ton. Since most of the more capitalized sugar producers in Brazil hedge their exports one to two years beforehand, effective prices were much lower--below R$2,000 per ton for most mills. Although the gap between hedged and spot prices for 2023 remains wide--most mills have hedged sugar exports at between R$2,300 and R$2,400 per ton, while spot prices are reaching R$2,800 per ton due to record-high international sugar prices at over 25 cents per pound--the profitability of the sweetener should improve. Therefore, mills will increase the share of sugar production over that of ethanol. In this context, companies that lean more towards sugar production will have competitive advantage in 2023 over their peers with the lower ability to switch to sugar production (such as Adecoagro S.A. and Santa Adélia) or that only produce ethanol (such as FS Bio and Cerradinho Bioenergia S.A.). In addition, the likely increase of almost 10% in sugarcane availability to close to 600 million tons in the Center-South region--due to adequate rain levels--should boost productivity and help dilute fixed costs, improving overall profitability. Nonetheless, the ability to produce at lower cash costs due to efficient agricultural productivity, low average distance from plantations to mills, cheap leasing costs, economies of scale of each mill, and a logistics network, among other factors, remains key credit factors for the subsector.

Other Risks For Brazilian Agribusiness Companies, Such As New Regulations And Credit Restrictions Appear Contained

The EU Deforestation Regulation Should Have A Limited Impact On Most Brazilian Agribusiness Exporters

The EUDR, which the European Parliament passed on April 19, 2023, bans exports into the EU of cattle, cocoa, coffee, palm oil, rubber, soybean, and timber--as well as derived products from these commodities--linked with deforestation and forest degradation. The proposed law will rank exporting countries based on their deforestation risk. Low-risk countries will have simpler procedures to follow in exporting such products, while high-risk countries will have to go through more rigorous checks and verifications. The European Council needs to endorse the law. After the EUDR comes into force, exporters of these products will have 18 months to comply with the new rules.

Out of subsectors we analyze in this article, only beef and soybean (as well as its byproducts) are subject to the EUDR. Only about 4% of total Brazilian beef exports in 2022 were bound for the EU, which could be redirected to other destinations--although less profitable ones. The share of Brazil's total soybean exports to the EU was about 9% in 2022, but they could also mostly be shifted to other destinations. Brazil's soy oil export volumes to the EU are negligible (less than 1% of the country's total exports), but the share of its soymeal exported to the EU reached about 45% in 2022, with the bloc as the largest buyer of this commodity. This means that Brazilian soy crushers that don't comply with the EUDR could find it harder to redirect their production to other markets, especially as Argentina's soymeal export volumes recover after the current drought.

Export Profits Should Continue To Boost Revenues And EBITDA, But Liquidity Risks Could Differentiate Best Performers From Peers

High policy rates in Brazil are taking a toll on the corporate sector's cash generation and pressure liquidity as tighter credit conditions make refinancing upcoming maturities harder. Agribusiness companies are also suffering from higher cost of debt, but restrictions for the sector have been less pronounced as their profitability prospects are generally stronger due to supportive commodity prices and large shares of revenue coming from exports. Moreover, many companies in the sector have accessed local market debt (agribusiness receivables certificates and infrastructure debentures) in order to extend overall maturities in recent years. Therefore, the current credit crunch in the country has been less severe for the agribusiness companies we rate, but there are a few exceptions. For example, S.A. Usina Coruripe Acucar e Alcool had been struggling with short-term debt concentration and exposure to foreign-exchange rate variation for several years--the latter was addressed by its 2022 bond issuance, but hedging (and overall debt) costs are hurting its cash generation, while short-term debt concentration remains significant, which is reflected in the negative outlook on our rating on the company. Bioenergetica Vale do Paracatu S.A.'s liquidity has also been weak since the COVID-19 outbreak, but the company has been gradually taking steps to address this issue by contracting longer-term debt, which is reflected in the positive outlook on our rating. Overall, we don't forecast high short-term liquidity risks for the sector but if Brazil's monetary tightening remains in place for a longer period, even the most efficient and less leveraged companies could face difficulties to generate free operating cash flows.