JBS is the world’s largest meat company by revenues, capacity, and production including beef, poultry, lamb and pork. It is the largest beef exporter from Brazil. JBS sells its meat products under a range of brands including Swift, Friboi, Seara, Pilgrim’s Pride, Gold Kist Farms, Pierce, 1855, Primo, and Beehive. JBS has executed an aggressive acquisition strategy outside Brazil. As a result, it has high net debt and low equity valuation multiples and now the company lacks room for continued consolidation. Consequently, JBS planned an IPO in May or June 2017 of its activities outside Brazil. This planned IPO of JBS Foods International (JBSFI) represents 85 percent of JBS sales. Barclays PLC is lead underwriter.

In March 2017, allegations of meat contamination, corruption, and deforestation led to a delay of its IPO, which should have generated proceeds of at least USD 1 billion. On May 12, 2017, the Brazilian Federal Audit Court (TCU) released an audit of alleged fraud into Brazilian Development Bank (BNDES) loans used by JBS to finance its Swift & Company acquisition. Because of these allegations, JBS shares dropped. On May 26, 2017, JBS Chairman of the Board resigned. On May 31, 2017, family-controlled J&F Investimentos SA agreed to pay BRL 10.3 billion (USD 3.16 billion) over 25 years as part of a leniency settlement over bribery allegations. On June 6, 2017, JBS announced the sale of its beef operations in Argentina, Paraguay, and Uruguay to Minerva for USD 300 million. Further divestments were announced in June 2017.

Key Findings

• JBS corruption and a USD 3.16 billion leniency agreement by J&F are connected to financial and governance risks that may prevent the company from reaching its goals of reducing net debt and unlocking shareholder value.
• JBS conduct raises concerns over implementation of its Corporate Social Responsibility policies. Cattle ranching is a major driver of deforestation in Brazil. It has large a greenhouse gas emissions footprint requiring ambitious and transparent action to eradicate deforestation from JBS supply chains.
• JBS revenue and EBITDA may continue to be weak as 50 percent of customers might be sensitive to ESG concerns like corruption, contamination, deforestation and slave labor allegations. Waitrose, McDonald’s and Domino’s Pizza Brazil already have reacted. Assuming 33 percent revenue-at-risk in Brazil (USD 2.4 billion), this could affect more than 10 percent of JBS’ market cap.
• International investors may be hesitant to invest in JBSFI IPO amid growing allegations. Investors increasingly have ESG and zero-deforestation policies in place. The current allegations and investigations create a climate in which an IPO can only occur with a large valuation discount versus peers. JBS USA bondholders and investors holding Pilgrim’s Pride shares might also divest.
• A risk of a larger-than-anticipated share-offering and/or low-priced divestments; both might dilute existing JBS equity. To decrease its 4.4X Q4 2016 net debt/EBITDA ratio to 2X, JBS needs its JBSFI IPO to exceed USD 6 billion, probably with a valuation discount in that IPO. JBS equity dilution would be 30 percent if JBS would reduce its stake in JBSFI to 50 percent. This dilution considers lower interest charges due to the JBSFI IPO proceeds. In an alternative scenario if JBS continues with its divestments, its dilution might then be 63 percent.

Financial Risks: High Alert

JBS has significant issues to solve before it can continue with its planned IPO of JBSFI. JBS risks are:

• Due to investigations and allegations of corruption, contaminated meat, illegal deforestation in the Amazon and slave labor, revenue and EBITDA may continue to be weak for JBS’ activities particularly in Brazil.
• Including investigations on financial ties with BNDES, it means the JBSFI IPO can probably only occur with a large valuation discount versus peers.
• JBS will have difficulties to find investors for this JBSFI IPO. JBS risks that investors owning Pilgrim’s Pride shares (78 percent is controlled by JBS) might divest from the stock. Also, JBS USA bondholders might divest.
• To reduce its high net debt/EBITDA ratio of 4.4X (Q4 2016), which is above industry average (1X), JBS JBSFI IPO needs to be greater than USD 6 billion. Under current circumstances, this is not possible. JBS may instead increase divestments.
• In the JBSFI IPO scenario: in combination with a discount in valuation multiples at the IPO offering in order to lure new investors, the EPS dilution/reduction to JBS shareholders would be 30 percent. The plan to unlock shareholders value for JBS shareholders by establishing JBSFI might dilute existing JBS shareholders.
• In the divestment scenario: the intended sale to Minerva for USD 300 million and a plan to divest a further USD 1.6 billion leads to EPS dilution for existing shareholders. If all JBSFI activities are divested, the dilution would be 63 percent.
• In both scenarios, the ratio net debt/EBITDA of JBS could be reduced to a lower level although the company might face continuing problems in refinancing debt. In both scenarios, existing shareholders would still face high EPS dilution and downside risk in their share price.
• If JBS wants to reach all its goals of reducing its net debt, unlocking shareholder value, and a better position given future consolidation of the global food industry, the company must increase its transparency, improve governance, achieve zero tolerance for corruption, and achieve zero-deforestation in its supply chains.

Download the full report as PDF: JBS: Financial Restructuring Could Be Delayed Due to Serious Allegations

Note: JBS Investor Relations commented on this report June 20, 2017. All JBS comments are included in this report.